Grok’s Tips #11 and #12

grokGrok’s Tip #11: Take Grok’s pledge!

Grok decided an investing pledge would be a good idea after looking at investor’s bad behavior during the growth years of the late 1990s. (I admit that I exhibited very bad investing behavior during that time, and paid the price in 2000-2001.)

1. I will index at least half of my equities. [I would expand this to 90-100% of my equities. --Bryce]
2. I will own some international equities
3. I will own at least 20% bonds in my portfolio:

Benjamin Graham’s rule of thumb was to always have at least 25% of your portfolio in bonds. And yet young and/or aggressive investors sometimes propose putting 100% (or more!) of their portfolio into equities. Vanguard itself puts 90% of the Target Date 2050 fund into stocks. The rationale for this seems to be the belief that, over long enough periods of time, stocks will beat bonds.

And yet:
a) Looking decade by decade, stocks have only beat bonds in 3 of the past 5 decades:
(http://www.raymondjames.com/weisswealth … Decade.pdf)
b) Over the past 30 year period, Bonds have beat stocks.
(http://www.bloomberg.com/news/2011-10-3 … ntury.html)

The reality is, as William Goldman used to say “Nobody knows nothing”. Faced with uncertainty, wise investors spread their bets. Do yourself a favor- buy some bonds!

4. I will avoid funky bonds like junk bonds, convertibles, structured CDs, etc. Take your risk on the equity side!
5. I will own some ibonds or TIPs.
6. I will not try to time the market. (See William Goldman quote above!)
7. Instead I will evaluate my portfolio for rebalancing at least once a year. Even if I am too chicken to rebalance (think March 2009) I promise not to sell out of my stocks when the market is down.
8. I will not put more than 10% of my portfolio in the stock of my employer (because maybe I work for the next Enron and don’t know it. Again see William Goldman quote above).
9. I will not put more than 10% of my portfolio in individual stocks.
10. I will not sell covered calls.

I have taken Grok’s pledge to heart, and hope you do too.

Grok’s Tip #12: “Press on, regardless” [of the past 5 years]

This was written in October 2012.

 “Press on, regardless,” John Bogle
“Keep moving forward,” Walt Disney.

A week ago I went to a corn maze. As some may know, one way to get through a maze is to consistently take only right turns. Or consistently take only left turns. I had tried this approach last year and it worked just fine then. I’m sure it wasn’t the fastest way through the maze but I didn’t get lost. Moreover because I was confident of not getting lost I was able to move at a steady pace-no hemming and hawing over which way to turn, etc. I found moving steadily forward through the twists and turns of the maze to the final goal to be very satisfying emotionally.

Well I had so much fun a year ago that I decided to go again this year. So a week ago I went to a different maze and tried the same approach. It didn’t work out so well this year! At the start of the maze there was a fork. I took the right fork and then took all right turns and yet after about 15 minutes I found myself coming back down that same fork to the place where I started. Frustrated, I took a coffee break and thought things over. I then started again, this time taking the left fork and taking all left turns and, yes, you guessed it, the same thing happened- I ended up back where I started after about 15 minutes. Frustrated, I quit!

I’m sure many of you have this all figured out by now. When I got back to the beginning the first time through, I should have then made a right turn into the other fork (i.e. the left hand fork if you are facing into the opening of the maze) and then continued taking all RIGHT turns. When I had got back to the “beginning” I was actually in the MIDDLE of my “take all right turns to get through the maze” path. But I couldn’t see that at the time. Returning to the beginning felt like “failure” although really I was on the path to success if only I had “pressed on, regardless” and “kept moving forward.”

What does all this have to do with investing you may ask? Well the S&P 500 is at around 1450 today. And 5 years ago it is was at, you guessed it, around 1450 as well. So we’ve spent 5 years going nowhere but have experienced tremendous volatility- the S&P 500 bottomed out at 666 in March of 2009. And like my experience with the corn maze this year, many investors seem to be throwing in the towel on stocks. The 10/4/12 Wall Street Journal article “Despite Gains Many Flee the Stock Market”
http://finance.yahoo.com/news/despite-g … 00651.html
cites fund flow data from the investment company institute (ICI) that since the market’s bottom in March 2009 investors have pulled $138 Billion out of stock funds but added $1 Trillion to bond funds. And in total over the past 5 years, investors have pulled roughly $500 Billion out of stocks.
http://www.ici.org/info/flows_data_2012.xls

However even though the S&P 500 is back where it started 5 years ago, some things have changed:

  1. Over the past 5 years the Shiller PE10 (http://www.econ.yale.edu/~shiller/data/ie_data.xls) has dropped from 26 to 22. While a PE10 of 22 is still high compared to the long term average of 16, arguably stocks are cheaper now-i.e. expected future returns should be higher.
  2. Inflation is lower now.
  3. 10 year treasury yields have dropped from 4.5% in late 2007 to 1.7% today. So real bond yields have dropped from +1.3% to -0.6%- i.e. bonds are less attractive now.
  4. Putting the above together the equity risk premium (the enticement to invest in stocks rather than bonds) should be higher now. The equity risk premium = expected future nominal stock return – 10 year treasury return. From 1) and 2) expected nominal stock returns should now be about 1 percentage point higher. And 10 year treasury yields are about 3 percentage points lower. So the Equity risk premium should now be about 4 percentage points higher.
  5. Which means of course that, rationally, investors should have shifted money from bonds to stocks over the past 5 years. Instead the opposite has happened.

So even though it FEELS like we are in the same place and haven’t gotten anywhere, the numbers above suggest that, just like me in the corn maze, that feeling may be wrong. If we “press on, regardless” and “keep moving forward” the next 5 years may very well turn out quite different (better!) than the last 5 years for equity investors.

This was a very prescient post from Grok. He looked at the indicators he had and decided the market would likely head up. We all know how the stock market did in 2013. We shall see what the market has in store for us in 2014 and beyond. I plan to “press on, regardless” and “keep moving forward.”


8 thoughts on “Grok’s Tips #11 and #12

  1. I do many of these things just by default (not because I pledged to do them), except I don’t think I own 20% bonds in my portfolio. Bonds lately have not been doing that well and I have never been compelled to buy them. I think I have less than 20%.

    1. Hi Daisy, The pledge just highlights good investment practices. Glad to hear you are already following most of them. And yes, I know bonds are tough to hold now with their low interest rates and the likelihood that they will drop in value when interest rates increase. A good alternative are CDs in taxable accounts, as well as i-bonds. The main reason is to have some ballast in your portfolio when equities get volatile. Equities had two periods in the 2000-2009 decade where they dropped 50%. As long as you can handle that sort of decrease in the value of your portfolio without selling, you should be OK. When you get closer to retirement, though, you will want to own more bonds, CDs, or so-called fixed assets. Hopefully interest rates will be higher by then.

    1. Hi Done by Forty, Since Grok is a CFA, he may be for hire. You would have to send him a private message on the bogleheads.org site.

      I agree with you on his knowledge and wisdom. That’s part of why I joined the Bogleheads. There are many others with similar wisdom that they often share.

      Thanks for reading and commenting.

  2. I agree with owning at least 20% in my portfolio. It may not have high interest rate, but it has a low risk and if anything bad happens, you’ll be the first one to be reimbursed. Also, it’s good for long-term investment I guess, given its rather stable nature.

    1. Hi Suburban Finance, John Bogle gives a rule of thumb to own your age in bonds. Some people adjust that to age-10 in bonds. If you are between 20 and 30, then 20% bonds is good. I am 57, so I have 50% in bonds and other fixed income investments.

  3. Who knows, only the future can tell whether if its a good or bad investment now. You just cannot see the future. However you can minimize risk by making calculated risks. Getting a lot of money from investments will open many doors for your retirement options. What month is good to buy stocks or bonds?

    1. Hi Jeff, You are so right about no one knowing what the future holds. We can only control what we put our money into.

      Thanks for your comment.

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