by Alexander Green, Chairman, Investment U
When I speak about my Gone Fishin’ portfolio at financial conferences around the nation, I often tell investors not to watch MSNBC, CNBC or any of the other investment networks.
Members of the audience sometimes find this comical – or even hypocritical – since I’m on these networks occasionally myself. But if you watch these channels regularly, I promise it will make you dumber and poorer.
Why? The underlying premise of these networks is that there is constant breaking news that you need to react to immediately.
Oil prices are up. What should you be buying? The Fed has cut rates a quarter point. How should you respond? Warren Buffett says the recession will last longer than expected. What should you be selling?
The financial media parades one so-called “expert” after another in front of you. Each offers different opinions on the economy and the markets. Is that because you’ll profit by reacting to every government statistic, earnings release or economic forecast?
Of course not. The circus of activity is there to attract viewers. That keeps advertisers happy and the networks’ bottom line growing. But as a viewer and investor, it costs you money.
Wall Street and the financial press spew out so much analysis and so many opinions each week, most investors lose sight of the big picture. And that’s unfortunate…
6 Factors That Determine Your Investment Portfolio Value
In essence, there are only six factors that determine the long-term value of your investment portfolio.
- How much you save.
- How long your investments compound.
- Your asset allocation. (How you divide your portfolio between stocks, bonds and other investments.)
- Those assets’ annual return.
- How much you pay in annual expenses.
- How much you pay in taxes.
That’s it. Whether you’re investing $10,000 or $10 million, these six factors will determine your eventual net worth.
Of all these factors, the only one you cannot control is the fourth. You cannot know with any certainty what stocks or bonds will return from one year to the next.
More sophisticated investors often say, “Well, of course no one knows for certain, but you have to guess.”
No, you don’t. And you shouldn’t.
Rather than guessing or pretending you have answers to unanswerable questions – like what the stock market will do this year or where interest rates are going – you can use a “lazy” portfolio philosophy that allows you to capitalize on the uncertainty inherent in the markets.
A “Lazy” Index Fund Portfolio
I can’t predict the future, and neither can you. That’s why I created the Gone Fishin’ Portfolio.
The portfolio is breathtakingly simple. All we do is divide our money among different asset classes – like stocks, bonds, precious metals and real estate investment trusts – and then rebalance once a year to bring each class back to our original percentage.
It works like a charm. The portfolio has beaten the S&P 500 every year, while taking much less risk than being fully invested in stocks.
We also back-tested the system through the bear market of 2000-2002. Again, it beat the market every single year.
That’s what you want, an investment portfolio that holds up well when the markets are down – and sprints ahead when the market is moving higher.
Since its inception, The Gone Fishin’ Portfolio has compounded at 17.3% a year. And this is an extremely risk-averse approach, making it the perfect home for what I call your “serious money.”
Where It All Started
In 1990, Dr. Harold Markowitz won the Nobel Prize in Economics for his groundbreaking discovery of the math behind the Gone Fishin’ Portfolio. Although many of the concepts used by Dr. Markowitz are hard to understand, he won the award because he showed how investors can master uncertainty and, at the same time, generate excellent investment results.
You don’t even need a computer to implement this strategy. All the adjustments you’ll need to make to your portfolio can be done once a year – with a single 15-minute phone call. The rest of the time you’re supposed to go fishing or you can just spend your time however you choose. Because this strategy works.
Instead of struggling with trying to figure out when to get in and out of the market, do something simple: Spend 15 minutes a year on your Asset Allocation – a nominal amount of time when you consider the impact it can have on your portfolio and your life.
What Asset Allocation Is
Asset Allocation is the process of developing the most effective – optimal – mix of investments. In this case, optimal means that there is not another combination of asset classes that is expected to generate a higher ratio of return to risk.
And what does it consist of? Quite simply, it’s breaking down your portfolio into different baskets, or classes of investments, to maximize returns and minimize risk. As the cliche goes, “Don’t put all your eggs into one basket.”
So let’s take the first steps in breaking down your portfolio into baskets, or asset classes. By the way, an asset class is a group of securities that have similar financial characteristics. For the purpose of today’s letter, let’s focus on the five principal types of long-term investments – stocks, bonds, cash, real estate and precious metals.
How To Spread Your Eggs Around
Diversification is a strategy designed to reduce exposure to risk by combining a variety of investments, which are unlikely to move in the same direction. In other words, you don’t want to put all your money in investments that will perform similarly.
One of the best ways to diversify your portfolio is by placing your money into index funds. Because index funds are generally invested in a diverse portfolio of investments (an entire index), they provide the greatest degree of diversification. By owning several investments you lessen the chance that you’ll suffer if one or two of them drop in value.
Index Fund Portfolio Allocation
The Gone Fishin’ Portfolio allows you to put this strategy to work through the lowest-cost group of index mutual funds in the country, the Vanguard Group. Here’s how you would asset allocate your “Nobel Prize” portfolio:
- Vanguard Total Stock Market Index (VTSMX) – 15%
- Vanguard Small-Cap Index (NAESX) – 15%
- Vanguard European Stock Index (VEURX) – 10%
- Vanguard Pacific Stock Index (VPACX) – 10%
- Vanguard Emerging Markets Index (VEIEX) – 10%
- Vanguard Short-term Bond Index (VFSTX) – 10%
- Vanguard High-Yield Corporates Fund (VWEHX) – 10%
- Vanguard Inflation-Protected Securities Fund (VIPSX) – 10%
- Vanguard REIT Index (VGSIX) – 5%
- Vanguard Precious Metals Fund (VGPMX) – 5%
Notice that we have a 30% allocation to U.S. stocks. It is divided between small-cap and large-cap stocks. Likewise, the 30% allocation to international markets is evenly divided between Europe, the Pacific and Emerging Markets.
You might wonder how including some of these riskier assets – like emerging markets, gold and small-cap stocks – actually makes your portfolio less volatile. By combining these riskier – but non-correlated – assets, you actually increase your portfolio’s return while reducing its volatility.
It is also important to note that the Gone Fishin’ Portfolio is not exclusive to the Vanguard Group. We selected Vanguard as our family of funds simply because they have the lowest expense ratios (in fact, for the moment, Vanguard has stopped admitting new investors to two of these funds). In an effort to maximize returns through Asset Allocation, reducing expenses with the Vanguard Group provides the best fund platform. But it can be used with any fund family.
If you’d like to imitate the above portfolio and don’t know where to start, Schwab is a good company to contact: www.schwab.com. Simply use the same percentage breakout as noted above for your Asset Allocation. Then select, from the list of funds available to you, the ones that most closely mirror the Vanguard funds.
The 8 Advantages of The Gone Fishin’ Portfolio
There are eight primary advantages to using The Gone Fishin’ Portfolio…
- It prevents you from being too conservative or too aggressive, so your investments neither tread water nor blow up due to crazy risk-taking.
- It eliminates shortfall risk, the risk that inflation will destroy your purchasing power over the long haul. (It keeps your index fund portfolio from kicking the bucket before you do.)
- It requires no economic forecasting or market timing.
- It eliminates individual security risk. (There is no chance of holding a WorldCom, Enron or any individual stock or bond that causes your investment portfolio to crater.)
- It is exceptionally cost effective. You will do a complete end run around Wall Street, paying nothing in brokerage commissions, planning fees, sales loads, or 12b-1 fees.
- It is highly tax efficient, allowing you to defer capital gains taxes each year. (That keeps your net returns higher.)
- It is based on the only investment strategy ever to win the Nobel Prize in Economics.
- And, finally, it is so simple to implement, you can do it yourself in less than 20 minutes a year. (The rest of the time you are encouraged to travel, play golf, or “go fishin’.”)
How does one investment system do all these things? I don’t have the space to tell you in this column. But I wrote a book – out this week – that explains exactly how it’s done.
It’s called “The Gone Fishin’ Portfolio” – and the subtitle says it all: “Get Wise, Get Wealthy… and Get On With Your Life.”
This book is the distillation of the best things I’ve learned in 23 years as a research analyst, portfolio manager and investment advisor. (As I sometimes tell my readers, I’ve made the dumb mistakes so you don’t have to.) I can save you a lot of time – and a boatload of money – by showing you to profit from my hard-earned experience.
The Best Reason For Using the Gone Fishin’ Portfolio
However, I still haven’t told you the best reason to use The Gone Fishin’ Portfolio. The high returns and low risk are only the beginning.
You see, money is not your most precious resource. It’s time. Your time is limited, perishable, irreplaceable and unlike money, cannot be saved.
The real beauty of the Gone Fishin’ Portfolio is it allows you to redirect your time to high-value activities, whether it’s work you enjoy, time spent pursuing your favorite activities, or just relaxing with your friends and family.
The Gone Fishin’ Portfolio gives you an excellent opportunity to grow your wealth. Nothing offers better odds of long-term success.
But, more importantly, it guarantees you peace of mind and the time to devote to the people and pastimes you love.
Perhaps that is what recommends it most.
Today’s Investment U Crib Sheet
Alex’s new book perfectly illustrates the principles behind our 4 Pillars of Wealth…
- Pillar 1: Stick to an Asset Allocation Model
The only way to consistently beat uncertainty is to asset allocate. No other investment strategy can boast the same. That’s why it earned a Nobel Prize. Following this model and rebalancing annually ensures our portfolios will be well diversified and positioned to profit in any market condition.
- Pillar 2: Adhere to a Sell Discipline
Everyone knows you should cut your losses early, and let your profits run. The only way to consistently do both is to use a trailing stop. It defines an exit strategy for all our positions right from the start… and makes sure we have the gumption to stick to it.
- Pillar 3: Understand Position-Sizing
Knowing how much to invest in each and every situation is crucial to building long-term wealth. Position-sizing ensures that even if a number of our investments turn sour, we won’t lose our shirts. As a guideline, we recommend investing no more than 4% of your equity portfolio in any particular stock.
- Pillar 4: Always Look to Minimize Investment Expenses and Taxes
There’s nothing we can do to affect a stock’s performance once we own it. But there is a way for us to guarantee our portfolio will be worth more 5, 10, 20 years from now. All we have to do is cut our expenses… and stiff-arm the taxman (legally, of course). On the expense side, that means avoiding investments that carry front-end loads, back-end loads, 12b-1 fees, or surrender fees. On the tax side, it means reducing what the IRS is entitled to take. We can do that by avoiding actively managed funds in non-retirement accounts, owning high-yielding investments in tax- deferred accounts and buying high quality investments (high-quality = less turnover = less capital gains taxes).
In short, Alex’s “Gone Fishin’ Portfolio” lets you put all of these strategies into action… with just a few simple moves that take less than 20 minutes a year.
Why It Works
- It has beaten the market and over 90% of investment professionals each year for the past decade, with only a fraction of the risk of being fully invested in stocks. (Even Warren Buffett has lagged its performance.)
- It allows you to do a complete end-run around Wall Street and its mountain of fees and expenses.
- It is based on the only investment strategy that won the Nobel Prize in economics.
- Yet it is so simple to use, it allows you to manage your money yourself in just 20 minutes a year. The rest of the time you are encouraged to travel, play golf… or just “go fishin’.”
- It eliminates the risk of being in or out of the stock market at the wrong time. (The strategy requires no economic forecasting or market timing.)
- It keeps you from handling your money too conservatively, so you don’t have to worry that your long-term purchasing power won’t keep up with inflation.
- It keeps you from handling your money too aggressively, so you don’t have to worry about blowing up your portfolio.
- It doesn’t require you to own any individual stocks or bonds. So there is no possibility of them causing your portfolio to crater. (Think Enron, WorldCom, Lehman Brothers or Wachovia.)
- It does not require you to use a broker, money manager, financial planner, or anyone else who would like to attach himself to your portfolio like a barnacle, siphoning off fees every year.
- It eliminates the risk of unwise delegation. No one cares more about your money than you do. The Gone Fishin’ Portfolio allows you to manage it yourself, simply, safely and effectively.
A Long Term Strategy
How do we achieve this? By asset allocation – and rebalancing once a year – among large and small stocks, foreign shares, real estate investment trusts, gold stocks and three different types of bonds: high-grade corporates, junk bonds and inflation-adjusted Treasuries.
The system is straightforward. There is no economic forecasting, market timing or individual stock selection. Its genius is an unusual asset mix, broad diversification, rock-bottom costs and high tax efficiency.
How has it worked? Like a charm. The Gone Fishin’ Portfolio has beaten the S&P 500 every year – including last year – since its inception in 2003. Importantly, it did this while taking much less risk than being fully invested in stocks.
How does our portfolio stack up against active money managers? For starters, history shows that three-quarters of all equity managers cannot outperform an unmanaged benchmark. Over longer periods, more than 95% of them can’t.
The Gone Fishin’ Portfolio: Beating the Market For 6 Straight Years
Over the past six years, The Gone Fishin’ Portfolio hasn’t just beaten the market every year. It has outperformed 99% of the nation’s equity funds, as well as Berkshire Hathaway.
Although our methodology is fairly simple, a lot of smart investors still don’t understand it.
For example, a prominent economist who reviewed my book “The Gone Fishin’ Portfolio” forThe Wall Street Journal – and recommended it – asked in his review: “But one has to wonder: If he were to set up the GFP today, might Mr. Green be more likely to choose oil stocks instead of real estate investment trusts?”
His question is meaningless in three different ways:
- First, asset allocation works precisely because it has absolutely nothing to do with predicting which industries will perform best.
- Second, oil stocks are a market sector, not an asset class.
- Third, The Gone Fishin’ Portfolio already owns every major publicly traded oil company from Houston to Shanghai.
Despite its many advantages, the portfolio will not go up every year. In my book, I back-tested the portfolio and showed readers that it would have declined slightly each year in the 2000-2002 bear market. But it would have declined far less than the broad market each year.
The Opposite of Bernie Madoff: The Right Way to Invest
Some investors complain that’s not good enough. They want a system that gives great returns in good years and bad.
Ironically, that’s exactly what Bernie Madoff was promising.
These investors remind me of an old college buddy who used to insist he wouldn’t get married until he met a brainy Victoria’s Secret model who owned a Ferrari dealership. (To which I would always reply, “But why would she want you?”)
Perhaps market commentator Richard Russell put it best: The winner in a bull market is he who makes the most. The winner in a bear market is he who loses the least.
By that realistic standard, our returns have been more than satisfactory.
The only other criticism I’ve heard of The Gone Fishin’ Portfolio – almost exclusively from brokers who have nothing to gain from clients who use this system – is “there’s nothing new here.”
Hmm. If there is another growth strategy out there that has beaten the S&P 500 by more than 600 basis points a year (with far less risk than being fully invested in stocks), that allows you to do a complete end run around Wall Street and its mountain of fees, and takes less than 20 minutes a year to implement on your own, I’d sure like to hear about it.
More importantly, the notion that you don’t want to use timeless principles to manage your nest egg, that you’d somehow be better off entrusting it to someone offering something exciting and new… well, all I can say to these folks is:
“Good luck. You’re going to need it.”
In July 2001, I retired from the securities industry at the age of 43. After 16 years as an investment advisor, research analyst, and portfolio manager, I had gone from a net worth of approximately zero to financial independence.
I was now free to do whatever I wanted, wherever I wanted, with whomever I wanted. It’s called total financial freedom and my Gone Fishin’ Portfolio helped me get there. And I can tell you from experience, it’s a great feeling.
Unfortunately, not all my clients had become financially independent. This was not because I advised them poorly. As an investment advisor, I dealt with my clients honestly and gave them the best advice and service I could.
Yet, in many ways, they operated at a disadvantage. Some clients had a poor understanding of investment fundamentals. Others found it impossible to commit to a long-term investment plan. Many were simply too emotional about the markets, running to cash at the first hint of danger.
Then there was the other small matter of my firm’s fee schedule. Investment professionals don’t get into the industry because the work is meaningful but low paying. You become a broker, a financial planner, or a money manager to get rich. And most of us do, eventually. In truth, many investors aren’t doing that well because their advisor is doing too well.
The Value of Contrarian Instincts
Contrarian instincts are rare, too, I learned. Few people are emotionally stirred by low stock prices. However, I am one of them. Every time there was a correction, a crash, or financial panic, my Scottish blood would surge, my pulse would rise, I’d rub my hands together, and start buying.
My clients often did just the opposite. They were more inclined to curse loudly, sleep little, and hurl epithets, some unrepeatable. Strong emotions like these are often a prelude to bad investment decisions.
Most investors don’t realize that their biggest obstacle to success is not inflation, or bad markets, the taxman, or Wall Street. As Benjamin Graham wrote back in 1934, “The investor’s chief problem-and even his worst enemy-is likely to be himself.”
(Or, as the comic strip Pogo once put it, “We have met the enemy and he is us.”)
Many clients, for example, would take a mental snapshot – if not an actual one – of the best statement they ever received. During market corrections, they would frequently remind me how much they had “lost in the market,” failing to understand that nothing was truly lost unless they panicked and abandoned their equity allocation. They also tended to forget that their account would never have reached that high-water mark if they hadn’t been invested in stocks to begin with.
I tried valiantly to get clients to increase their exposure to stocks during market downturns. The ones who did prospered. But, for many, hanging on was all I could get them to do. Adding to assets that were out of favor was simply out of the question.
Of course, when times in the market were good, many assured me they would welcome the chance to buy in a downturn. But that’s when we were talking in the abstract. When the bear market actually showed up, they sang a different tune. “I never imagined that ‘this’ would happen!” they’d say in frustration. And, of course, “this” is something different each time.
Yet history demonstrates that common stocks are nothing if not resilient. That’s why I refer to them as “the great wealth-creating machine of all time.”
There’s Always a Recession Ahead
Yes, the economy will suffer the occasional recession. And the market will stumble. Expect it. Welcome it. After all, it’s during down markets that you get an opportunity to buy what’s cheap and prosper during the recovery that follows.
I’m talking rationally, however. Bear markets are emotional. They bring fear, loathing, and anguish. (After all, this is real money we’re talking about.) But when these times come, recall that stocks give the highest long-term return because of the inevitable down periods you’re bound to experience. In essence, you get paid to feel scared occasionally.
Embrace this and you’re on your way to being a more successful investor. Remember, there’s nothing wrong with feeling scared when the market swoons. As long as you don’t act on those fears.
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