Banking on Dollar Decline

The bulk of my assets is invested in low cost index funds, as all the experts recommend. That should be good enough for most people out there, but if you want to gain an extra edge over the market, there are a few options. I discourage trying to time the market or to bet on individual securities. Rather, if you must deviate from indexing, the safest is to practice strategic reallocation.

What this means is to skew the composition of your index funds towards a mix that fits with your investment thesis. For instance, an aggressive investor may stick with Warren Buffett’s recommended mix of 90% S&P 500 index tracker, and 10% short term US treasury bonds, implemented like this using iShares ETF tickers:

  • 90% IVV
  • 10% SHY

Whereas a more conservative posture with a higher allocation towards bonds may look like this:

  • 40% IVV
  • 20% SHY
  • 40% AGG

There are of course a myriad of other strategies in allocation that can be done. Some popular ones include splitting between growth vs value stocks, international vs domestic, and mixes of various types of bonds (domestic, international, short-term, long-term, TIPS, municipal, business, high-yield). Generally speaking, you get the most diversification when choosing between major categories such as stocks vs bonds rather than within a category.

My own inclination is not to mess around too much with these sub-categories, as they generally have higher fees without adding to extra return. I stick with the tried and true basics to minimize the temptation of tinkering with the portfolio.

However, if you were to force me to make a bet on the future and to structure my portfolio against a macro trend, I would bet against the US dollar. If there’s one thing we can all do to prepare it’s for a slow drop in the value of the US dollar relative to the rest of the world. With soaring deficits and entitlement obligations, declining prestige, tariffs/trade wars, I don’t see how the dollar can rise in the next few decades. At best it will tread water. The implications for quality of life in the US are profound. We can anticipate more costly imports, especially electronics. For food we should be self-sufficient, but overall prices will rise as food is now sold on the world market, and farmers would have incentive to export their hogs and corn instead of keeping them for domestic consumption. While there may be more low-end jobs such as manufacturing and textiles, the country will also be beset by wealthy foreigners 

How can we best position our portfolios to benefit from this trend? I would diversify outside of the dollar with a splash of international equities and bonds (especially in Asia). However, note that with the S&P 500 companies already having significant international operations, even if you invest purely in “domestic” companies you’ll automatically have some international exposure. This is also why when the dollar falls, the earnings (measured in dollar terms) of S&P 500 companies generally rise. No wonder foreign personal finance bloggers look on with envy at the cheap, mature, and diversified American stock market.

This would look something like:

  • 50% IVV
  • 40% IXUS
  • 10% SHY

Which actually is close to my own allocation.


Don’t Do Something, Just Stand There

Another week, another all time in the stock market. North Korea’s saber rattling and the devastation wrought by the hurricanes don’t seem to have put a dent in the market’s relentless ascent. Furthermore, with this being the “most hated” bull market in history (or so they all say), things don’t seem primed for a major collapse. A mild pullback on the order of 5-10%? Sure, perhaps it will happen within the next year, but a major recession doesn’t seem to be in the cards.

What’s the best mentality for an average investor to have? The same as always – don’t change your long-term strategy due to short-term circumstances. Ignore the noise going on around you and robotically invest what you won’t touch in the next 5-10 years. The mantra that my mentor in medicine told me, which brings “do no harm” into the modern world, is encapsulated by the title of the post. Sometimes it’s simply better to do nothing than to react like a jumpy cat to every slight movement.

Take this advice of this article for instance:

“If you don’t want to invest in equities because you fear a market crash, then you should never be in equities, because equities always crash,” Ritholtz said, speaking at Morningstar’s annual ETF conference.

He noted that there was a bear market in equities—defined as a 20% drop from a peak—every five years, on average, although the recent market environment has been bereft of even much smaller declines. Current valuations have led to concerns that such a crash could be imminent, but “If you’re under [the age of] 50, you should be rooting for a market crash, because it would be nice to have a 20% discount and then 20 years to compound that discount.”

He added, “there’s no escaping this: markets go up and down, that’s what they do. But if you’re still worried, you should significantly lower your expectations for future returns” by buying safer—but lower growth—alternatives. He noted that over the past century, U.S. stocks have returned about 10 times what Treasurys have, although they also experienced numerous massive selloffs over that time, something the government bonds hadn’t.

“The risk you assume when you buy equities is that there will be a significant drawdown in the 20 to 30 years you own them. But you get rewarded for that risk. Treasurys don’t have the same kind of drawdowns, but don’t deliver the same kind of returns.”


Secrets to Successful Investing

It feels like we’re always hammering the same points on investing over and over again. Don’t watch your portfolio. Stop tracking the market’s daily gyrations. Focus on the long term. Stay diversified. Don’t try to stock pick or market time. Stick with the asset allocation determined earlier and rebalance. Stick to these tried and true principles based on solid research and you’ll be fine.

Sometimes, we feel that we can be exceptional or lucky and we try for the moon. Humans are poor learners from others’ failures, and rather learn best from a strongly emotional personal experience (like a major loss in the market due to a self-inflicted error). I believe everyone should learn that by starting out playing single stocks with small amounts of play money, ideally earlier in life rather than later, so we can quickly return to the right path having learned our lesson in a way that sicks.

In other words, use the “the martyr system” to your advantage, letting the hippocampus impart the long-term financial scars from personal failures that will leave lasting memories of what not to do.


No Regrets

My last post touched briefly on the nature of regret in missing out (selling too soon, buying in too late). However, this is not a healthy mindset to have. As Marketwatch pointed out today, very few people have the intestinal fortitude to ride out the market’s gyrations and hold for the 10+ years needed for wealth to compound exponentially. How many of us would have sold out during one of the times when bitcoin or Netflix crashed >50%?

This Morningstar article serves as a reminder that we are our own worst enemies:

Well, it’s really about the target-date funds because they are sort of the confluence of good behavior. In other words, they are boring funds. You’ve got tremendous diversification. They don’t cause fear or greed. They are just boring. But then the other part of it is, in 401(k)s where you see nearly all the target-date money, people are investing every paycheck very steadily. So, they are also kind of shielded from the ups and downs of the market. So, if you go back to ’08, ’09, 2010, people just kept steadily investing, people generally did not panic in their 401(k)s, and so that meant you are really buying low and then staying with it to see those benefits. So, if you think about it, target-date is kind of the intersection of good funds and good investor behavior and it kind of suggests where we might want to go as an investing group as a whole because this is where things really work well.

The best returns actually came from disciplined boring investing. As Monevator likes to say, keep investing as boring as watching paint dry, so you won’t be tempted to buy and sell all the time. As another former mentor once told me, “Don’t just do something, stand there!” That is really the approach to take when investing.


Are ETFs Too Risky?

There’s a lot of news out there about ETFs lately, focusing on their negatives. They’re an untested instrument. The bid-ask spreads are too wide. They tempt people into trading when they should be holding on to their investments.

My book on wealth recommends using ETFs as the instrument with which to build a diversified mix of stocks and bonds, a time tested approach to accumulating wealth over the long haul. Just in time to discredit the rash of negative reports is a great Schwab article on the facts of ETFs.

Like anything, ETFs are an instrument, and can be used for good or evil. Like any instrument, the ETF in question can be sharp or blunt. Here’s the lowdown on why they’re still useful and things to look out for:

  • You don’t have to worry about the wide bid-ask spread at times. If you’re using ETFs as a mutual fund substitute, you shouldn’t be looking at daily prices and being tempted to trade in and out. Broad market stock or bond ETFs are meant as vehicles for investing. Even though they offer you the ability to trade in or out at any time as easily as individual stocks doesn’t mean we should. Moving too much incurs frictional trading expenses and incurs taxes.
  • For the same reason, you shouldn’t worry about temporary fluctuations in value versus the underlying asset. 99.9% of the time the two will be correlated. When things are derailed, it will be temporary (usually minutes at most), so hold on to your investment through the panic. Chances are you won’t even notice that anything happened unless you obsessively follow the market every day, which you shouldn’t be doing.
  • Stick to the tried and true (broad market funds). Don’t get suckered in by fancy ETFs such as triple inverse or super sector specific funds. Those exotic instruments usually have much higher expenses (you can see how much on Morningstar) and offer no benefit for long-term investors.

As you can see, ETFs are not to be feared, but rather something that the wise ones can control. Use ETFs like this and stay on the slow but steady well-trod path to wealth. Tune out the noise and you will prosper.