Finding Bottom

While the markets continue to walk the plank, I've been trying hard to think of ways not to completely lose my mind. I like to repeat the mantra, It's all about the number of shares, not the dollar amount, the number of shares... Does it work? Uh, not really.

After the Dow cracked 8000 yesterday, I decided to buy in. Because after all, you buy low, right? Honestly, the best thing to do with your money right now is to buy stock. But that is much easier said than done.

The problem with buying low these days is that you never know how low it can go. To make matters worse, to find the bottom of the market is much easier after the fact. Frankly, anyone who tells you they know when this market is hitting bottom has his/her pants on fire they're such a liar, liar. Nobody predicted this. While Buffet warned of the dangers ahead, I don't think that even he thought it would unravel quite like this.

About a month ago I bought some stock that was near its 52 week low. The market at the time, as you may recall, was going apoplectic and I thought I was buying a good company at a bargain. Boy was I wrong. Because oil fell on its ass, the S&P fell on its ass, and today when I logged in to my Scottrade account I found out I too had fallen on my ass-- I lost 60% of my money on that stock in less than four weeks. So what did I do? I bought more. But not of that company. I was so spooked by that loss, even though I know it'll be okay in the end, that I bought an ETF of the S&P 500. If that's alphabet soup, I did a post a while back on index funds and ETFs here.

To be honest, I was torn. I've been casting sidelong glances at blue chip companies like GE. This afternoon it was at $18 and change, smashing its 52 week low. It's now up to $21 and change as I type this. I could lose my lunch trying to pick the moment to strike. And then you have sparkly American companies like Apple and Google offering steep discounts. The risk is that you could find out later that this nice big blue chip is on the brink of bankruptcy, or that the floor of the Dow Jones Industrial Average just collapsed and took everybody with it.

I work for a man who made his money as a successful investor. Today he shook his head and said, "The problem is, all the rumors so far have turned out to be true." So I steered clear of GE, even though I was tempted, and conservatively bought SPY. If you have some spare change lying around and you don't mind looking at it for at least five years, I'd suggest you buy an ETF with a wide net of diversity tracking an index you understand (in other words, the S&P 500 versus Brazilian small caps). Because it's not about finding the absolute bottom, it's about buying into the market at a much lower price than it will be five to ten years from now. Stocks haven't been this cheap since 1985! And because companies are dropping oops-we-lost-billions-of-dollars kind of surprises on us left and right, I'd really really encourage the average investor to stick with index funds/ETFs through a ROTH IRA. Also, don't go all in. For example, if you have $4,000 to invest, you could invest $1,000 a week for a month to spread your price risk.

In the meantime, prepare for a rough ride. And remember, as long as a company doesn't go belly up, they can't take away how many shares you have. While that's been of little emotional comfort to me, it does keep my panic in check.

Profit Like Yale: Breaking It Down

I'm sick as a dog today and spending a little more time than usual catching up on the online news. One of my stumbles was the Times article, Keep It Simple, Says Yale's Top Investor. The "Investor" happens to be the guy who runs Yale's endowment, David F. Swensen. Last year when everyone else's portfolios were toeing the precipice (yours truly included), he killed the market with a 28 percent gain, bringing the portfolio up to $22.5 billion. E-effing-gads.

So his advice to the little guys and gals is exactly what the title suggests.

For most people, he recommends a very basic approach: use index funds, exchange-traded funds and other low-cost instruments, and stick to your long-term asset allocation — even when the markets are in tumult.

Don’t be distracted by market forecasts, he said. “You have to diversify against the collective ignorance,” he said. “I think nobody is in a position to react to these big macro-issues. Where is the dollar going to be or what is G.D.P. growth going to be in China? For every smart person on one side of the question, there is another smart person on the other side.”

To translate the first paragraph, index funds are mutual funds that track an index. And to translate the translation-- a stock index is like a book index. So let's take a cookbook. Everything under the Soup section of the index is the contents of the book that are soup. An index lists contents, that's all.

So a stock index of the S&P 500 is a listing of the contents of the S&P 500; the 500 largest market cap (what they're worth) companies publicly traded on the NYSE and NASDAQ. So how would a mutual fund track the index? The same way a book would, two pages for vegetable soups, one page for green eggs and ham stock. Microsoft 2% of the S&P and Apple 1 %-- I totally made those numbers up. So with an index fund you will never beat the market, but you are the market, so you'll never do worse (within hundreths of one percent, perhaps, because the math is never perfect). And if you'd rather be worried about beating that other bidder on eBay, rather than beating an index return on the New York Stock Exchange, then index funds are for you. They also cost less, sometimes a lot less, than actively managed mutual funds. Paying fees on your investments eats away at your earnings; you pay 2 percent and gain 1 percent, you just lost 1 percent. You pay .018 of 1 percent and gain 2 percent, you just gained- well, you do the math. Over the course of a few decades, the hundreds of dollars turn to tens of thousands.

His next suggestion was ETFs, Exchange Traded Funds. The short answer to what is an ETF is that an ETF is an index fund traded on an exchange (the stock market). While mutual fund companies create their own index funds and you buy from them, ETFs are index funds that you can buy or sell like stock, for example through an online broker like Sharebuilder or Scottrade. A more detailed description of their differences can be found here and here.

So that was a long explanation for a simple investment strategy, but that's partly why Swensen advocates for them. Their low costs boost your returns, their built-in diversification spreads your risk, and the index tracking removes the headache of stock picking.

He proposes a portfolio of 30 percent domestic stocks, 15 percent foreign stocks, and 5 percent emerging-market stocks, as well as 20 percent in real estate and 15 percent each in Treasury bonds and Treasury inflation-protected securities, or TIPS.

So here's an easy example for illustrative purposes only, I do NOT suggest you go out and do this. Let's use Vanguard's ETF page, Vipers, as an example. Let's say you have $5,000 in a savings account. So you would transfer money to an online broker like Scottrade and fund a ROTH IRA account to the annual max, buy $1500 of VTI (30% domestic), $750 of VEU (15% foreign), $250 VWO (5% emerging markets), $1000 of VNQ (20% real estate), and $750 EDV (15% Treasury Bonds), and 15% TIP (not Vanguard, but Lehman's TIP ETF, 15%Treasury inflation protected securities). In this example, ETFs make it easy to plug in asset allocation.

So I decided to compare my largest ROTH IRA holding, T. Rowe Price Retirement 2040 Fund. This is not an index fund or an ETF, it's an actively managed mutual fund, but one of those target funds I like to rave about. Again, target funds should be for your own retirement date. This fund is for a targeted retirement date of 2040 and its asset allocation is as follows:

Domestic Stock 65.5%
Foreign Stock 22.3%
Domestic Bond 8.4%
Cash 3.2%
Convertibles 0.4%
Foreign Bond 0.2%

Swensen's domestic allocation is a little low, and I'm kind of okay with mine (yes, I realise I've never gained 28% annually on my quote unquote portfolio), but I did discover I have no real estate, particularly REITs (Real Estate Investment Trust), which is kind of a big deal. So I think I'll sell off one of my overweights (too much of a percentage in my asset allocation pie) and buy Vanguard REIT Index ETF (stock ticker VNQ), which is, shocker of all shockers, way off its 52 week high so I'll definitely be buying low. Which brings us to his other piece of advice. Rebalance. The market value of your stocks and bonds changes all the time, so at least once a year just buy and sell shares to bring your asset allocation back to target.

If all of this sounds like a lot of work, it's really not. Even if you don't follow his exact percentages, and I don't think you should follow any one person's exact percentages (especially mine!!), the idea is right on the mark, there's a lot of white noise out there for some very simple ideas. And speaking of white noise, I do love when he takes Jim Cramer down a notch.

When possible, he said, rebalancing should be done in a tax-sheltered account, like an I.R.A. or a 401(k), to avoid tax liabilities. “When you are putting fresh money to work,” he said, “you put it in an asset class where you are underweight and take money out of a class that is overweight.”

He says it is fruitless for individual investors to pick stocks. “There is no way that an individual can go out there and compete with all these highly qualified and compensated professionals,” Mr. Swensen said.

HE criticized the approach of Jim Cramer, the CNBC host, who encourages investors to trade stocks in strategies that Mr. Swensen says cost heavily in commissions and taxes.

“There is nothing that Cramer says that can help people make intelligent decisions,” Mr. Swensen said. “He takes something that is very serious and turns it into a game. If you want to have fun, go to Disney World.”