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Booknotes: Perfect Portfolio

November 15th, 2008 at 06:05 pm

When I read a good book on investing, I sometimes like to take notes and record them here on my blog -- both for my future reference and for others here who might be interested.

Today's book is The Standard & Poor's Guide to the Perfect Portfolio: 5 Steps to Allocate Your Assets and Ensure a Lifetime of Wealth by Michael Kaye. It focuses mainly on how to decide upon the right asset allocation for you. You need to understand the basics about stocks, mutual funds, and bonds before reading this book.

The three main asset classes are equities (ie stocks and mutual funds), bonds, and cash (ie bank account, money market, CD, etc.). Real estate and commodities can also be considered asset classes.
Suggested Asset allocations -- adjust these to suit your own risk tolerance and other factors discussed in the book(age, marital status, investing experience, dependents, and affluence).

Goal: Capital Preservation
stock: 0%
bond: 25%
cash: 75%
real estate: 0%
commodity: 0%

Goal: Income
stock: 25%
bond: 45%
cash: 20%
real estate: 10%
commodity: 0%

Goal: Growth & Income:
stock: 45%
bond: 30%
cash: 20%
real estate: 5%
commodity: 0%

Goal: Growth
stock: 60%
bond: 20%
cash: 10%
real estate: 5%
commodity: 5%

Goal: Aggressive Growth
stock: 85%
bond: 0%
cash: 0%
real estate: 5%
commodity: 10%
Universal Rules for your portfolio
* No more than 75% of your portfolio in any one asset class.
* At least 5% in cash instruments
* At least 5% in international equities
* Have exposure to at least three asset classes.
* No more than 10% in any one stock
* At least 25% in stocks
* At least 10% in bonds
* Consider rebalancing if an asset class moves at least 5% from your target, but do not rebalance more than once a year.
For the best tax treatment here are the best places to hold different kinds of investments:
Taxable Account:
* Index mutual funds
* Index ETF
* Municipal bonds
* Individual stocks (held > 1 yr)
* Tax-managed mutual funds
* International funds
* Cash instruments

Tax deferred and tax free accounts:
* Actively managed mutual funds
* High-yield junk bonds
* Stocks held < 1 yr
* Corporate bonds
Impact of the Economy
Historically, different strategies have worked best in the following economic conditions:

Low Interest Rates
* stocks & bonds perform better than real estate and commodities
* mory risky stocks and bonds are the best performers

High Interest Rates (nominal > 8%)
* conservative investments perform best
* equity: staples, pharmaceuticals
* bonds: short-term
* cash: money markets

Rising Interest Rates
* increase short-term bond & money market
* equity: staples, pharmaceuticals

Falling Interest Rates
* stocks & bonds
* equity: banking, home building
* long-term bonds
* CD's

High Inflation
* stocks, bonds, and cash all do poorly -- but of these stocks fare best
* real estate and commodies do well
* international equities
* money market best for cash

Low Inflation
* stocks, bonds, cash do better than real estate and commodity
* more aggresive stocks do well -- technology, consumer discretionary
* longer term bonds

Growing Economy
* more aggressive investments

* staples, pharmaceuticals, utilities
* lower maturity, high quality bonds
* real estate does poorly

Compare your investments against benchmarks:
* equity -- S&P 500
* small cap equity -- S&P 600 Small Cap Index
* bonds -- Lehman Aggregate
* cash -- Citigroup 3 month T-bill index
* commodities -- S&P-Goldman Sachs Commodities Index

Other notes:
In taxable accounts, don't rebalance by selling -- instead redirect new money to a different asset class.

small-cap mutual funds tend to generate larger tax bills than large-caps due to companies growing out of the small-cap classification and the stocks being sold.

REITs are one way to hold real estate. Two main kinds:
* equity REIT owns rental properties
* mortgage REIT owns mortgages

I fall in the "Middle Career" phase of life. Recommendations:
* life insurance important
* fund retirement
* fund 529
* have will & guardian in place
* 6 months expenses for emergency fund
* tax-advantaged -- slightly more conservative than early career
* taxable accounts -- slightly more aggressive than early caeer
* focus on investments with low expenses, low taxes

2 Responses to “Booknotes: Perfect Portfolio”

  1. scfr Says:

    I like that they use goals rather than age as a basis for determining asset allocation! I've always had issues with the standard "if you are xx years old you should invest xx% in stocks" formulas.

    Their suggested portfolios break their own "Universal Rules" in several instances tho'!

  2. Broken Arrow Says:

    That's a good entry from what appears to be a really good book.

    As for the universal rules... I could be wrong, but it seems to be trying to give a sort of basic, low-maintenance approach to asset allocation and rebalancing. Perhaps that's why it also breaks the rules a bit, so that it can maintain some level of ease-of-use?

    Anyway, thanks for sharing!

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