How to Build an All-Weather Portfolio

greetings my name is Davy s key I'd like to spend just a few minutes sharing a few thoughts with you on the topic of how to build an all-weather portfolio a portfolio that can weather all of the ups and downs all of the economic storms that inevitably show up on the horizon we believe there are fundamentally five building blocks to assembling an all-weather portfolio they include the imperative to think globally consider the investment opportunities the world over and not stay focused simply in the u.s. think low price consider the advantages of buying stocks that are trading at low prices relative to their earnings or their assets think small consider the advantages that have been offered by small company stocks over the long run focus on diversification there is nothing you can do that will more powerfully reduce risk in your portfolio and there are at least four dimensions along which you need to focus your diversification efforts and finally build resilience into the portfolio design it so that it can weather those inevitable downturns without doing harm to your long-run financial prospects so think globally well the US market is still the largest market in the world it represents less than half the value of the world stock market we believe that to get the best of all of the investment opportunities in the world you need to consider the entire world stock market and we also believe the best way to do that is to allocate your capital in a way that's proportional to each country and each reason regions share of the global stock market and that's exactly what we do when assembling the stock portion of our portfolios one of the things this does is it gives you diversification because not every country is experiencing the same state of economic affairs at the same time some countries are surging while others are in recession exchange rate fluctuations will also add a degree of diversification this is one of the things that is critically important when thinking about risk factors like low price stocks and small company stocks you want to be able to select those across the largest possible universe of stock and that means starting with the world stock market think low price so low price stocks have certain advantages but I have to first say what I mean by low price low price can refer to a stock's price relative to its earnings compared to other stocks or relative to its assets let's take a look at a concept called Book value which is a way of measuring the value of a company's assets it's a book value encompasses the value of buildings and plants that are owned by a company it encompasses the value of equipment and inventory as well as retained earnings so Book value can become a very very valuable benchmark when thinking about which stocks are high priced in which are low price here's an example consider it consider ABC Inc which if you took its book value the value of all of its assets and you divided it by the number of shares outstanding the number of shares throughout trading in the market you'd find that it had $3.00 per share of book value if you then observe the market price how much are people buying and selling it for at this point you'd see that it was trading for six dollars a share well if you divide the $3.00 book value per share into the six dollar market price per share you come up with a price to book ratio of two by contrast to consider another company XYZ Inc which owns the same $3 per share in assets but it's trading at fifteen dollars a share when you divide that $3.00 into them into this market price of $15 a share you come up with a price to book ratio of five so for every dollar of assets owned by X Y is the ink you have to pay five dollars whereas for every dollar of assets owned by ABC Inc you only have to pay two dollars we would call ABC Inc a value stock and we call XYZ a growth stock now your next question is undoubtedly why should you care let me let me show you if you had invested $1 into a basket of growth stocks back in 1920 and then watched it grow suing who'd live so long you'd find that that $1 invested 1927 would have grown to nearly two thousand dollars today which at first blush doesn't sound too bad however had you invested $1 in a basket of value stocks as defined as we define them in the prior slide today that $1 investment would be worth $7,000 so you can see that there is a there's clear evidence for the superiority of buying low price stocks and there's a degree to which that makes sense I mean when you buy something on sale you expect you expect to get a more value for what you invest when you buy if you if you can buy a your house cheaply you might expect more appreciation well the same thing applies to stocks when you can buy them at low prices you generally will earn a bigger return over the long run think small small company stocks also have behaved uniquely over the long run if you had invested $1 also back in 1927 into the S&P 500 which is a very common popular index of large blue chip stocks you would have seen that $1 today had grown to $3,000 again at first blush that sounds pretty good had you invested that same dollar however in a basket of small company stocks in this case stocks that are that represent the smallest fifth of the market the bottom 20% by size that $1 investment would have grown to nearly $21,000 again history shows us that the unique risks associated with owning small company stocks have tended to be rewarded with a unique increment of return now let's bring it all together this illustrates the way in which yes key buoys portfolios are allocated with respect to the stocks as you can see we've broken it down along two dimensions size and value you can see that the small company stock allocations are illustrated in the front row the mid cap stocks from middle sized stocks in the middle row and the large company stocks across the back row likewise growth stocks are represented by those bars in the right-hand row and value stocks on the left well the first thing to notice is that when we build a stock portfolio we're covering all the categories in terms of size and value yes we own some growth stocks but you'll notice that there's a significant skew to the left we skew heavily towards value stocks likewise although we own large company stocks there's a significant skew in favor of small company stocks and in this way we diversified broadly across all categories but we favor the small company stocks and we favor the value stocks now let's talk about diversification so I mentioned that there were at least four important dimensions of diversification the first is to diversify globally to spread your bets if as you were to spread your investments across all countries and regions the second is to invest in is to diversify across different types of investments large company stocks and small company stocks stocks and real estate securities developed markets emerging markets next you need to be sure that you're broadly diversified within each of those categories these are risky categories when you invest in them you get paid a return because you're taking risk that's your compensation for taking the risk so it's important to diversify within that category if you're investing in small value stocks in the US you can't just buy five stocks you have to buy 500 or a thousand in order to have sufficient diversification within that category and finally we believe currency diversification is important when we're investing outside the u.s. we do not believe in hedging away the exchange rate risk we believe in letting the foreign investments be denominated in whatever the local currencies are as a consequence less than half of our equity part of our stock portfolios are denominated in dollar terms now this is not a bet against the dollar it merely means we don't to be a prisoner to the Thar we want to diversify our currency exposure as well as our country exposure as well as our stock exposure finally we want to make it resilient and the way we do this is by adding a stable reserve that's made up of cash and very short-term very high quality bonds and the purpose of this stable reserved especially for those who are spending from their portfolios is to provide a bridge to provide a bridge to support spending needs through through the inevitable cyclical downturn in the stock market the fact that stocks go down in value from time to time it is not something that necessarily should be a cause for alarm it's inevitable economic cycles wax and wane in the stock market moves in sympathy with that however if during a downturn in the market you're forced to sell stock shares or mutual fund shares at depressed prices you can eventually get into what I call a cascading failure where you have to keep selling more and more shares at lower and lower prices in order to meet a fixed spending need as a consequence of these cascading failures you end up with too few shares left over when the market finally hits bottom to fully participate in the subsequent recovery the way around this is to have a stable reserve that can bridge you through five to seven years worth of spending needs giving in the stock part of your portfolio time to recover so let's see how that has added up in historical terms on this graph we've illustrated in in the tan color a benchmark that has made up a benchmark it's made up of two indexes in this case 70% of what we know what we call a blended index it's a blend of both stocks and bonds 70% of his blended index is made up of the MSCI all country world index this is a stock index that as its name applies covers the entire globe and just as with our portfolios it does so in a geographically neutral way so it a liqu AIT's itself to each country and region in a way that's proportional to that country and regions share of the world stock market the remaining 30% of this portfolio is allocated citigroup global government bond index which again as its name implies is an index that encompasses global bonds of very high quality what this is showing you what this graph is showing you is the cumulative return from 1994 until November 30 of 2013 now the cumulative return to this benchmark index was nearly 300 percent or about 5% a year the green area meanwhile represents the performance of the aggregate of all of the yes key buoy client portfolios so essentially we lump them all together and measured them as one big portfolio and this represents the performance net of all fees and expenses along the way as you can see the portfolio did a little bit better than the benchmark which were gratified to point out and the cumulative return over that same period from 1994 until the end of November of this year was over 400 percent or nearly 8% a year on average so how to explain the difference we believe the difference can be explained in terms of our strategic decisions to dial up our exposure to small company stocks relative to the neutral index and to dial up our exposure to value stocks relative to that neutral index and that that has explained the differential and performance so just to review the key five key building blocks of assembling an all-weather portfolio they consist of the following imperatives think globally use all the investment opportunities the world has to offer think low price focus on stocks that are trading at low prices relative to their earnings or their aspects think small focus on the advantages that small company stocks have offered investors over the long run diversify and diversify across at least four dimensions geographically across asset classes within asset classes and in terms of currency and finally build resilience into the portfolio the amount of resilience is going to be a function of your life and circumstances but consider what it would take to bridge you through a five to seven year period during which there was a downturn in the market and during which you'd be giving your stocks an opportunity to recover we hope you enjoyed our discussion of all whether investing and if you're interested in hearing more we have more recordings and many articles that we've offered on our website WWE boo com

Channel: YeskeBuie

Views: 25,419

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Keywords: investing, portfolio managing, financial planning

Id: G8rsg9nmo7E

Length: 13min 31sec (811 seconds)

Published: Thu Dec 19 2013