Down Year for Institutions

You got me running
Going out of my mind
You got me thinking
That I'm wasting my time
--Electric Light Orchestra

The fiscal year for many institutional funds, e.g., pension funds and higher ed endowments, ends June 30. 2022 was not kind.

Public pension funds were down about 8%.

College endowments did even worse, losing more than 10%.

The worst performance for both since the credit collapse. To be fair, however, this down year follows one of the best years for both groups.

Down years hit pensions particularly hard due to their chronically underfunded nature. Drawdowns reduce fund capacity for meeting short and long term obligations. Making up for lost ground will likely require some combination of raising pension fund contributions, cutting benefits, and/or taking on more risk in hopes of boosting future returns. 

As for the latter option, not sure how much more room fund managers have after years of pushing the risk envelope.

Stocks Still

A gambler's share
The only risk that you would take
The only loss you could forsake
The only bluff you couldn't fake
--Bob Seger

Time series of AAII asset allocation indicates that, despite the nasty market pullback, individual investors have maintained their historical allocation to equities.

Usually, big market declines cause investors to dump stocks in favor of cash.

So far, however, stock allocations remain at about 70% of financial assets. There has been a slight uptick in cash to about 18% at the expense of bonds at about 12%.

Another point supporting the narrative that while individual investors feel bad about the market decline, they haven't acted on it in a substantial way--at least not via their investment accounts. 

Positioning for Retirement

Doing the garden
Digging the weeds
Who could ask for more?
--The Beatles

With retirement coming up fast I've been doing a few things w.r.t. personal finance. I've been saving more and spending less in order to build cash. Have also been selling some stuff on ebay and elsewhere to collect extra 'juice.' Also helps thin things out at the house--much needed.

Preparations are being made to rollover my 401(k) from work. I'm looking forward to allocating this capital among far more choices than those available thru the current fund administrator.

In both my brokerage and IRA accounts, I've been buying dividend paying stocks. Dividends are real cash that can provide a significant, and perhaps under-appreciated, income replacement in retirement.

Inflation is particularly bad for retirees as it erodes purchasing power of savings. To hedge against the prospects of Big Inflation, I've been building stock positions in the oil complex (e.g., ENB, XOM) and miners (e.g., AEM, AGI, PAAS). 

The miners appear particularly attractive. The financial strength of many in this group has perhaps never been better. Solid balance sheets and cash flows. Many are paying significant, and increasing, dividends (which helps me kill two birds with one stone). The sector has been pounded down to attractive valuation levels--particularly given the growing inflationary environment.

I've been swapping funds out of precious metal ETFs such as PHYS and into the miners to more fully express my perception of this situation--albeit at a slightly higher risk profile. 

positions in AEM, AGI, ENB, PAAS, XOM

Dividend Geese

Billy Chapel: Are you saying I should retire?
Gary Wheeler: Why not? It wouldn't hurt the negotiations. And it would serve those sons of bitches right.
Billy Chapel: I, uh. I don't know. I don't know what to say.
Gary Wheeler: Well, you can't tell me that you haven't thought about it. And you've been smart with money, right?
--For Love of the Game

Until recently, dividends didn't matter much to me. Like most investors, I focused on price appreciation potential. 

A few years back my brother reacquainted me with the value of cash dividend payouts. Managing my mom's portfolio, he invested primarily in stalwart dividend paying stocks. Over time, he built an income-producing machine capable of covering a large share of monthly living expenses. Yes, the portfolio gradually increased in value as well. But so did the dividend payouts.

The capacity of a well-designed stock portfolio to generate income--particularly 'replacement' income for retirees--impressed me, perhaps in part because I'm approaching retirement myself.

In the olden days, common wisdom was that aging people in need of income replacements should invest in bonds and other fixed income instruments. Being traditionally less volatile, fixed income was seen as less prone to big capital loss. Moreover, many fixed income instruments tended to offer yields superior to stocks.

In the late 1970s/early 1980s, for example, 10 yr Treasury yields traded north of 10%. Those cash payouts were far higher than dividend yields on stocks. Of course, inflation was also flying which negated much of those cash gains.

Since then, of course, T-note yields have been in secular decline--due largely to interventionary policies of the Federal Reserve. Dividend yields on stocks have also declined as shown by the yield in the S&P 500 since 1900.

Overlaying the two trends reveals a couple of things. One is that stock dividend yields have not always been lower than bond yields. In early decades of the 1900s, stocks generally yielded more than bonds by a couple of percent. The other note is that, more recently, the offset between stock and bond yields has narrowed to the point where cash returns on stocks once again looks attractive.

Index-to-index comparisons tend to understate the superior cash-yielding capacity of stocks. For example, the yield on the S&P 500 Index currently stands at about 1.3%. However, many stocks in the SPX pay tiny or no dividends. Investors can readily assemble a portfolio of reliable dividend payers from the SPX with an overall yield north of 3%. This handily beats the current 10 yr Treasury yield of about 1.5% (and nearly all other fixed income alternatives for that matter).

If Treasury yields should rise relative to stocks then the calculus changes, of course. That said, because central banks worldwide are determined to suppress sovereign yields, large increases in bond yields seem unlikely unless policy makers lose control of the interest rate markets. While this could certainly happen, it is likely to occur in the context of Big Inflation. Big inflation jeopardizes the attractiveness of bonds. Moreover, companies may be able to navigate inflationary environments in a manner that preserves value. Dividend payouts might even increase.

Preparing for retirement, then, I view the cash-generating capacity of dividend paying stocks as central to creating 'replacement income' when the paychecks no longer roll in. Essentially, the dividend payers write the checks instead of an employer. The more I can draw on steady-to-rising dividend payments, the less I will have to cut in on the principal that generates the cash.

Stated differently, I don't want to kill the dividend-paying geese that lay the golden eggs.

Inflation and Stocks

Hundred dollar car note
Two hundred rent
I get a check on Friday
But it's already spent
--Huey Lewis & the News

Some believe that if Big Inflation cometh, stocks will get creamed. Surging prices will drive folks to spend less. Simple ECON 101.

Lower demand for goods and services should be bad for stocks.

A counterargument is that Big Inflation occurs when people get nervous about the value of their dollars sitting idle, so they put them to work today assuming that they can buy more today (i.e., goods, services, AND stocks) than tomorrow. The psychology feeds on itself, creating, in its ugliest form a reinforcing cycle of higher prices and money printing that feeds it.

Although producers are hurt on the input side with higher costs, they can offset them at least partially by raising prices, thereby preserving profit margins to some degree. To the extent that producers own tangible assets, these are also likely to appreciate in value as inflationary pressures rise--giving a boost to book value at least in nominal terms.

In this scenario, stocks are likely to rise. Perhaps not to a degree that completely compensates for purchasing power decline, but at least to serve as a partial hedge that preserves wealth (note Kyle Bass estimates perhaps 85% coverage).

Historical analysis supports this thesis. Weimar Germany, Venezuela, Zimbabwe. Equities tended to rocket in the local currency--even if they didn't keep pace with exchange against more stable currencies (and gold).

One thing seems increasingly clear. In Big Inflation environments, stocks are likely to be a better place to be than cash.

It also seems that, in the current market environment where the CPI is starting to print some big numbers, stocks seem unfazed--like they want to go higher.

position in gold

Extreme Correlation

This is the biggest band you'll find
It's as deep as it is wide
--The Who

In leveraged systems, selling builds on itself as margin calls drive investors to sell anything that isn't nailed down. That's what we're seeing. Everything's being sold--including  asset classes considered 'safe' (e.g., Treasuries, gold).

Correlations have spiked during recent rout, threatening to take out the GFC highs @SoberLook @BofAML @FactSet pic.twitter.com/WB4CyWBuRn

— Liz Ann Sonders (@LizAnnSonders) March 18, 2020

That means  correlations are going up as everyone scrambles to accumulate the single uncorrelated asset: cash. We're at correlations not experienced since the credit crisis.

When correlations reach extremes like this, we're probably late in the selling game. Many stocks I'm watching are beginning to resist further lows during selloffs.

I continue to be constructive and nibble around.

New Bonds

"Negative! Negative!"
--Lt Chris Burnett (Behind Enemy Lines)

Real 10 yr yields are at -1.5%. Lowest since 1980. This means that T-note owners are losing money on their bond coupons.

The Real 10-Year Treasury Yield (yield minus core CPI) moved down to -1.5% today, its lowest level since July 1980. Back then the 10-year yield was 10.8% and core inflation was 12.4%. pic.twitter.com/09J8854OzP

— Charlie Bilello (@charliebilello) March 6, 2020

For those seeking income, dividend stocks look increasingly attractive. Falling stock prices up the ante even more.

As long as bond markets remain the object of monetary policy manipulation, it is hard to ignore the income generating capacity of dividend-paying equities here--particularly for investors less sensitive to fluctuations in underlying account value due to volatile markets.

Lower stock prices provide opportunity to buy more income. Perhaps stocks are becoming the new bonds.

Income Providers

Katherine Garrison Geary: Oh, Ed, what do Alice or I know about newspapers?
Ed Hucheson: It gives you an income.
--Deadline U.S.A.

To the extent that earnings yield translates into dividend yield, chart shows why bids are unlikely to be completely lost under dividend-paying stocks in today's market environment. In fact, would think chart of SPX dividend yield vs bond yield would show a similar pattern.

Spread between S&P 500 earnings yield & BBB corporate bond yield widest since 2014 @SoberLook @bloomberg pic.twitter.com/vZcYaDgQY1

— Liz Ann Sonders (@LizAnnSonders) February 26, 2020

If you're looking for investment income, and you're not particularly sensitive to changes in principal/account value, then dividend-paying stocks seem a good deal relative to fixed income. Stocks are generally far more capable of providing income in today's world.

Key is finding dividend payers where yield is likely to be stable/growing even in difficult environments.

New Year's AA

Sometimes you picture me
I'm walking too far ahead
You're calling to me
I can't hear what you've said
Then you say, "go slow"
And I fall behind
The second hand unwinds
--Cyndi Lauper

Every now and then I like to estimate my asset allocation (AA) across all financial accounts. Helps keep me aware of where I stand.  Here's my current AA as we usher in the new year:

Equities   40.3%
Fixed income   1.0%
Cash   48.0%
Alternative assets   10.7%

Note that this breakdown is for securitized (i.e., paper) assets only. It does not factor in physical assets such as my house.

Fixed income portion would be higher if my work 401(k) would make certificates of deposit (CDs) available. Instead, I have to settle for money market funds that currently yield close to CD rates (although they do not provide FDIC protection). If CD's were available in the 401(k) account then I would be targeting an asset allocation of ~ 40 equities/30 fixed income/20 cash /10 alt assets.

Top stock holdings include D, INTC, JNJ, MRK, PAAS, WFC, XOM. Alternative assets consist largely of closed end gold and silver funds CEF and PHYS.

Asset allocation should evolve this year as funds from pension fund buyout are allocated primarily toward dividend paying stocks and precious metal proxies.

Household Stock Allocation

Anthony Judson Lawrence: Mrs Allen, now I don't mean to pry, but I assume that you have some stock--General Motors, General Electric--something like that.
Mrs. J Arthur Allen: Well, doesn't everyone?
--The Young Philadelphians

Interesting graph showing percentage of household assets allocated to equity vs subsequent 10 year stock market returns. We're near the high end currently, with slightly more than 50% of household assets in stocks.

The bad news is that subsequent returns following these peaks have historically not been impressive. When household allocations toward stocks have been in the upper quintile (as they are now), market returns 10 yrs later have averaged about 4%.

On the other hand, equity allocations in the bottom quintile have preceded rosier futures--with market returns averaging ~16% a decade later.

An implication is that households tend to buy high and sell low. They add exposure as markets rise, and they cut exposure as returns fall.

Consequently, household asset allocation toward stocks serves as a contrarian indicator of sorts.

Inflation and Purchasing Power

Hundred dollar car note
Two hundred rent
I get a check on Friday
But it's already spent
--Huey Lewis & the News

While inflation carries many meanings, a popular contemporary definition is loss of monetary purchasing power. Stated differently, as inflation goes up, the value of the dollars in your wallet goes down.

The same is true with streams of dollars coming your way in the form of income. Picking up on our previous pension example, suppose that you are 65 and begin drawing a pension income of $1,000 per month (amounting to $12,000/yr). Let's also assume that inflation amounts to 2% annually. That's the Federal Reserve's current inflation 'target,' btw. (Think about that for a second. The Fed is saying that it wants to destroy your purchasing power by 2% each year.)

What happens to your fixed income pension over time in this environment? A 2% decline in purchasing power after one year may not seem like much, but the losses compound annually. After 10 years, that $12,000 in annual income spends like it was only $9,800 in today's dollars (an 18% decrease). At the ripe old age of 85, the purchasing power of your pension would have deteriorated to about $8,000--a 33% decline.

If inflation goes higher, then your pension's purchasing power declines more rapidly. A 4% annual inflation rate turns $12,000 into $5,300 after 20 yrs. At 6% inflation, your annual pension would be worth about $3,500 twenty years later--that's a 70% decrease.

Don't think higher inflation rates can happen? In the 1970's the US saw prolonged inflation rates well above 5%. Other countries (recent example Venezuela) have experienced 'hyperinflation' where inflation rates increase by over 100% annually.

This pension example may seem arcane, but lessons here readily transfer to a mainstream asset class: fixed income. Like pensions, most bonds and CDs pay a preset level of income to their owners on a routine schedule. Inflation erodes the value of these income streams just as it does to pension payouts.

The message should be clear. Inflation, even at 'low' rates, can whittle away at the purchasing power of an income stream. How can individuals protect against the wealth-destroying forces of inflation? If you're still working, you can endeavor to be more productive so that you earn more and outpace the eroding effects of inflation on your paycheck. Retirees, of course, can't employ this approach because by definition they are no longer working.

Another way to hedge against inflation is to invest in asset classes that generate returns deemed to keep up with inflation. Asset allocations that favor stocks and some alternative assets such as gold have historically been decent inflation hedges. Retirees or prospective retirees who have built sizable investment portfolios can offset risk that inflation poses to fixed income pension benefits.

A third way to manage inflation risk presented to some prospective retirees is the lump sum pension buyout. If a decent lump sum offer is made by the pension plan, then it might make sense to take the offer and then invest the proceeds in a manner that hedges against inflation.

Personally, I suspect that inflation rates are likely to increase in the years ahead--perhaps substantially. As I consider the pros and cons of accepting the lump sum buyout recently offered by my former employer's pension plan, my inflation outlook constitutes a 'pro.'

position in gold

Situational Awareness of Markets

I follow you around but you can't see
You're too wrapped up in yourself to notice
--Madonna

An important factor in making sound investment decisions is situational awareness about markets. Generally speaking, situational awareness is a state of knowledge and sensitivity about the environment that you're operating in. People with high situational awareness perceive critical forces at work around them, understand their meaning, and project what can happen to a system in the future.

Stated differently, the more you know about the surroundings that you're operating in, then the better you'll be able to operate.

Situational awareness starts with understanding important concepts and their relationships in a decision-making domain. In the investment domain, we've considered many core market concepts over the past few months.

Once you've grasped concepts, you have to put them to work. By this I mean observing what goes on routinely in the socio-economic reality of markets--the happenings that bring concepts to life. The more you immerse yourself in the flow of events, the more situational awareness you'll gain.

Here are some ideas for developing greater situational awareness of markets:

Start with a watchlist. Apps abound that enable you to create lists of stocks, bonds, commodities, indexes, et al. whose prices you want to track. Because prices are a central expression of market behavior, understanding price levels and trends is an effective way to elevate situational awareness of markets. Watchlist apps often include charting capabilities as well as relevant headlines. My favorite watchlist app came with my iPhone. I usually roll through my watchlist at least once/day.

Review the news flow. In the dark ages prior to the internet, staying apprised of business and market headlines took some doing. I would spend hours scouring daily newspapers like the Wall Street Journal and Investor's Business Daily plus weekly magazines like Business Week and Fortune to stay apprised of events. Cable TV stations that catered to investors, such as CNBC, Fox Business, and Bloomberg, subsequently added to the process of assimilating information. Today, these media outlets, alongside many others, operate websites that stream news flow 24/7 to the convenience of investors. My recommendation is to locate a source or two that you like, and then visit regularly. Over time, you'll be stunned at how much situational awareness you'll acquire by 'osmosis.'

Keep tabs of your personal financial situation. What is your current asset allocation? What stock positions are you holding? How much dividend income are you collecting on an annual basis? How much cash have you set aside to fund life's expenses? Good situational awareness of markets requires that you are aware of your own financial situation! Establish a routine where you review your financial situation regularly. You might start with account web pages or statements generated by your broker or bank. To make the process active rather than passive, consider setting up spreadsheets that require you to plug in up-to-date data regarding your accounts. You might also consider a spreadsheet that aggregates information across accounts so that you can estimate overall asset allocation.

As your situational awareness of markets improves, so will the quality of your investment decisions.

Beginner's Portfolio Template

"First learn stand. Then learn fly. Nature's rule, Daniel-san. Not mine."
--Miyagi (The Karate Kid)

How to tie what we've discussed about investing so far into actionable outcomes? Here's a template of sorts for what a beginner's investment portfolio might look like:

Equities* 
stock 1
stock 2
stock 3
stock 4

Fixed Income 
CD

Cash and Money Market
money market fund
residual cash

*Shoot for four equity positions of the dividend paying, anchor stock variety

How much to allocate to each asset class? Because young investors have time on their side, they can afford asset allocations tilted toward more equity exposure. Aggressive designs might even ignore fixed income in favor of more stocks (particularly if those stocks generate income).

On the other hand, if your risk tolerance is lower or if you are less confident in the outlook for equities, then a more balanced or cash rich allocation with fewer equity positions makes more sense.

Keep this template in mind while assembling your own portfolio.

Investing Reference Page

"The most valuable commodity I know of is information. Wouldn't you agree?"
--Gordon Gekko (Wall Street)

Reference page to catalog posts on investing. Will be updated as new missives appear.

Personal Finance
Income, Saving, and Investing
Debt Reduces Freedom
Net Worth
Determining Portfolio Yield
Taxable or Tax-Deferred?
Emergency Fund
Situational Awareness of Markets
Pensions
Inflation and Purchasing Power
Taking the Buyout
New Year's AA 

Investment Strategy
Primary Asset Classes
Asset Allocation
Capital Gains vs Dividends
Dividend Stocks I
Dividend Stocks II
Starting With Diversification
Anchor Positions
Beginner's Portfolio Template
Buying Small, Scaling In
Raising Cash
Working Orders

Valuing Securities
Valuation
Market Cap
Moats
Income Statements
Fortune 500
Cash Flow Statements
Balance Sheets
Price-to-Earnings Ratios
Discount Rates

Market Structure
Prices
Interest Rates
Ten Year Yields
Money
Central Banks
Underfunded Pensions and Systemic Risk

Technical Analysis
Uptrends and Downtrends
Support and Resistance

Behavioral Finance
Sentiment and Investing
Bulls and Bears
Loss Aversion

Sentiment and Investing

I'd hold onto you
Till the mountains crumble flat
I'd hold onto you
'Till you figure out just where you're at
--Ric Ocasek

Previously we discussed the primary asset classes available to investors and shared some sample asset allocations. We also examined the relationship between income, saving, and investing as well as the negative effects of debt on the process. Finally we offered a brief primer on technical analysis using uptrend and downtrend patterns.

Today, let's briefly consider sentiment and its influence on investing. In our context, sentiment is synonymous with emotion. Many assume that humans make economic and financial decisions rationally with little emotion. Research suggests that this can be a bad assumption. At best, people are 'boundedly rational,' meaning that limits in cognitive capabilities limit capacity to be completely rational. At worst, people rarely choose to engage the slower thinking, rational portions of their brain, opting instead to let fast thinking, emotionally charged thought processes govern most of their decisions.

This general tendency to weave sentiment into our thought processes can impair ability to make consistently good investment-related decisions. Impulse purchases at the mall reduce capacity for saving--the necessary precedent for investing. Get-rich-quick desires motivate speculation on popular high flying growth stocks with unknown underlying fundamentals. Overconfidence drives belief that we are smarter than other investors in the market. Fear of missing out on big market moves encourages asset allocations tilted toward risky extremes. On the other hand, fear of losing money can prompt overly conservative asset allocations, or keep us from cutting losses by selling poorly performing investments that we should no longer own.

How can people keep their emotions in check when making investment decisions? A few ideas come to mind. Slow the process down. Think, read, study the possibilities before making a choice. The more rushed the investment decision, the lower the likelihood that it will be a good one. Also, consider tracking your investments on a routine basis. Make some spreadsheets that lay out your investment positions and show their performance over time. Calculate your asset allocation so that you know where you stand. It is more difficult to let your emotions drive you too far into the weeds when you routinely review the numbers. Finally, talk to others about markets and investing. Bouncing ideas and experiences off of others helps you learn how well you are thinking things through.

It also helps you realize that wrestling with sentiment when making investment decisions is not just a 'you' problem. It is part of the general human condition.

Asset Allocation

Another night in any town
You can hear the thunder of their cry
Ahead of their time
They wonder why
--Journey

Previously we discussed the primary asset classes available to investors: cash, fixed income, equities, and alternative assets. How investors blend them together in their portfolios is known as asset allocation (AA). Studies suggest that AA matters more to investment returns over time than does the choice of particular securities inside each asset class.

Asset allocation is a personal thing, meaning that there is no one particular allocation pattern right for everyone. An individual's AA can depend on many factors including age, personal tolerance for risk, one's general view of the world, and estimation of value offered by risky asset classes.

Let's see how these factors associate with three model AA patterns that employ various combinations of the four primary asset classes. (Note, however, that this is for demonstration purposes only. Portfolios do not have to be invested in all four asset classes.)

1) "High cash" portfolio: 60% cash, 20% fixed income, 10% equities, 10% alternative assets.

High cash portfolios are attractive for older people who need more certainty from their investments during retirement. People with lower risk tolerance will also prefer more cash. This particular AA is also 'defensive' in nature. If you have a pessimistic 'macro' outlook, or if you believe that risky asset classes such as stocks are overvalued, then cash-rich portfolios are also a good fit. Note that alternative assets such as gold help offset the risk of holding lots of cash--if the purchasing power of cash declines because of inflation, then gold and other hard assets usually increase in price to compensate. Also note that equities in high cash portfolios often consist of large stalwart company stocks that pay steady dividends.

2) "Balanced" portfolio: 25% cash, 35% fixed income, 35% equities, 5% alternative assets.

Balanced portfolios are spread more evenly among the three 'traditional' asset classes of cash, fixed income, and equities with perhaps a sliver of alternative assets for insurance. Middle aged individuals and those with a medium risk tolerance match well with balanced AAs. People who have no strong views either way when it comes to state of the world or valuation of risky assets also tend to be good fits with the balanced approach. Balanced portfolios can be a good in-between step for people who want to move toward more extreme 'risk on' or 'risk off' positions in the AA spectrum. By seeking balance first, those individuals can sense whether they are moving in the right direction.

3) "Growth" portfolio. 10% cash, 10% fixed income, 75% equities, 5% alternative assets.

Growth portfolios are characterized by high allocations toward equities. As a general rule, equities carry the most potential for reward--but they also carry the most potential for loss (read: risk). The high risk:reward profile of growth portfolios is a good match for young people since their age allows them to time to a) participate significantly in bull market runs and b) recoup losses that happen periodically in bear market declines. Growth AAs also attract individuals with high risk tolerance. If you have an optimistic macro view of the world, and/or you think that stocks and other risky assets are undervalued, then growth-oriented asset allocations match well with your outlook. Growth portfolios sometimes ditch the insurance of alternative assets to gain a bit more 'juice' from their capital (for better or worse).

Again, the above AAs merely demonstrate some possibilities. How you tailor your particular portfolio, and how you adjust it over time, is unique to you.

Primary Asset Classes

"The most valuable commodity I know of is information. Wouldn't you agree?"
--Gordon Gekko (Wall Street)

Investors generally choose from four primary asset classes:

1) Cash. Cash is the fundamental asset class upon which other asset classes are based. It is denominated in units of currency (e.g., dollars). Cash is liquid, meaning that it is easily exchanged at its nominal value (e.g, 'one dollar'). It carries low short-term risk, meaning that its value is unlikely to decrease over the next few days or weeks. Over longer periods of time, however, the value of cash can decline in inflationary environments when the creation of additional money (typically by government) causes the purchasing power of cash to go down.

That said, the primary objective of cash is capital preservation. In uncertain times, or as a parking place for investment capital until better opportunities arise, cash can be an attractive asset class.

2) Fixed income. Fixed income includes a variety of investment vehicles ranging from bonds (both government and corporates) to certificates of deposit (CDs). Fixed income securities usually pay predetermined streams of income to their owners over the life of the investment. The timing of these payments is nearly always pre-set as well (e.g., monthly, semi-annually, annually, at maturity). This predictability is an attractive feature of fixed income instruments. A primary risk for owners of fixed income is 'credit risk,' meaning that it is possible that the borrower who sold the debt may default on some or all payments. To compensate, investors demand higher interest rates from debtors deemed to be riskier.

The primary objective of fixed income is predictable income or cash flow.

3). Equities. Equities, also known as stocks, are investments in for-profit companies. Partial ownership of a company is obtained by purchasing its shares either directly or via funds (mutual funds or exchange traded funds (ETFs)) that hold its shares. Equity shares can commonly be purchased on a stock exchange such as the New York Stock Exchange (NYSE) or the National Association of Securities Dealers Automated Quotations (commonly called the 'NASDAQ').

Stocks entitle the owner to participate in future wealth-building activities of the company that can result in share price appreciation (a.k.a. 'capital gains') or dividend payouts. Of course, owners also face risk that the company may not perform well in the future, thereby causing share prices to drop or dividend payouts to decline/terminate. The risks associated with stock ownership generally exceed those associated with either cash or fixed income. However, the rewards are generally greater as well. (Remember that risk and reward are related: the higher the risk, the higher the prospective reward, and vice versa. If that was not the general rule, then markets would have trouble functioning)

The primary objectives of equity ownership are capital appreciation and dividend income.

4) Alternative assets. The three asset classes discussed above--cash, fixed income, and equities-- are considered 'conventional' asset classes and comprise the bulk of investment portfolios. However, over the past few decades, financial market innovations have enabled investors to gain exposure to another group of assets called alternative assets. Alternative assets, sometimes termed 'hard assets' because they typically involve tangible goods, include commodities (such as oil, farm products, and gold), real estate, and even collectibles such as art. In the old days investors wishing to own alternative assets had to buy the tangible property and hold it in physical form. Today, many alternative assets have been 'securitized,' meaning that investors can readily buy exposure to them through ETFs and related vehicles. Many of these securities carry idiosyncratic risks, however, and investors must understand these risks before getting involved with this group.

Alternative assets can be attractive from two standpoints. Owning hard assets such as real estate or gold can be an effective way to hedge against inflation and other forms of financial or social disorder. If the value of the dollar goes down, for example, then the price of land or gold typically goes up. Another feature of alternative assets is that their value often moves up and down in a manner that is weakly or even negatively correlated to stocks and bonds--making this asset class an attractive way to diversify an investment portfolio.

The primary objectives of alternative assets, then, are inflation/disorder protection and diversification.


One of the major decisions facing investors involves 'asset allocation,' or how to divide their capital among the four above asset classes. We'll discuss in a future post.

position in gold

Current AA

I never wanted another
Come over to me and discover
--Orchestral Manoeuvres in the Dark

Current asset allocation in securitized (paper) form:

Stocks  13%
Fixed income. 1%
Alternative assets  28%
Cash  58%

Alternative assets mostly include precious metal ETFs and stocks are primarily in PM miners.

Primary goal this year is to broaden equity exposure to include a stable of dividend payers. Not too much too fast, though, given elevated valuation levels and field position. Hoping to use lower prices to my advantage.

Bonds vs CDs

You're emotion
Running cold running warm
The young just getting older
--Dio

Article considers whether fixed income investors are better off with CDs rather than bonds. As shown below, CD yields are surprisingly close to bonds of similar duration.

Bonds have generally been favored for their liquidity and their capital appreciation potential if interest rates fall. On the other hand, bond investors are exposed if interest rates rise (as many have learned recently). Bonds also carry risk of principal fluctuation and defaults.

CDs are FDIC insured. And interest rate exposure can be hedged by 'laddering' CDs of various duration as discussed in the article.

For my money (literally), CDs are my preferred vehicle for fixed income purposes.

position in CDs

Slow But Sure

"You can't expect an enormous volcano with three tiny bags of explosives. You have to let nature take her course. Give it time. It'll work."
--Miller (Force 10 From Navarone)

Short rates closed the week at their highest levels in nine years.

Higher short term rates serve to curb near term credit markets. They also boost attractiveness of CDs and other low risk, cash-like instruments vis-a-vis riskier yield-bearing securities such as dividend-paying stocks.

Slowly but surely, higher short rates are altering the competition for capital.

position in SPX