Revenue Content

Wednesday, May 6, 2015

7 Habits of Highly Effective Investors

Many Americans are in a holding pattern when it comes to their finances, yet there's also a small group of investors who are getting it right.  What can we learn from them?

These Highly Effective Investors are twice as likely to be confident they are making the right savings and investing decisions, twice as likely to say they enjoy managing their investments, and have more than 2.5 times the retirement savings of other Americans.  Here's what they are doing differently:

7 Habits of Highly Effective Investors (Infographic)

Panhandle Pete

Sunday, May 3, 2015

So You Think You Are Diversified?

So You Think You Are Diversified?

By Tyler Feldman

In today's financial markets, risk is not the exception, but the rule. While China is struggling to find solutions for slowing economic growth, Europe is looking to spend $1.16 trillion in hopes of stimulating its economy and bolstering deflationary pressures. While positive earnings reports from U.S companies bode well for investors, the uncertainty of a Federal Reserve interest rate hike has forced many to proceed cautiously. This inherent risk has increased due to the current uncertainty in financial markets as well as the likelihood of choppy waters ahead. Investors would be foolish not to have their portfolios protected against risk. While most investors engage in some form of traditional capital allocation, such as an 80/20 portfolio (80% equities, 20% bonds), few realize that these strategies do not properly account for risk and volatility. A Simple Risk Parity Portfolio is the "new" smart alternative strategy worth pursuing.

Panhandle Pete

When employing a Simple Risk Parity investment strategy, risk and volatility are properly accounted for in the fund. Using this strategy, capital is evenly invested among three asset classes: equities, commodities, and bonds. To fully understand the value of this investing strategy, an important metric to observe is the Sharpe Ratio. Essentially, the Sharpe Ratio measures risk-adjusted returns, or the returns earned after accounting for the level of risk exposure. While many would believe that equities have a higher Sharpe Ratio than commodities and bonds, the past 40 years have proven otherwise. From 1971 to 2009, equities, commodities, and bonds have demonstrated nearly identical Sharpe Ratios (Understanding Risk Parity, by Brian Hurst, Bryan W. Johnson, and Yao Hua Ooi). Contrary to intuition, the risk-adjusted returns of these three asset classes, after accounting for the varying levels of risk endured, converge. 

Therefore, in order to construct a truly diversified portfolio, one that does not present a concentrated level of risk in one particular asset class, a Simple Risk Parity strategy is a great choice.

Some critics criticize the Simple Risk Parity investment strategy's inability to achieve similar nominal returns of more traditional strategies. To a certain extent, these criticisms are justified. By creating a portfolio with far more bonds and commodities, the investor will naturally limit the ability to earn high nominal returns. After all, these assets are less risky for a reason. 

However, by applying leverage to an already risk-balanced portfolio, thus increasing positions held, the investor is able to achieve the same nominal gains as those investing in a traditional strategy.

If an investor has a long-term horizon, then a Simple Risk Parity investment strategy ought to be strongly considered. During previous financial crises, many investors lost fortunes in seemingly balanced portfolios because they did not diversify properly according to risk. 

While Simple Risk Parity is viewed as an alternative investing strategy, it is quickly gaining momentum and popularity among large investment funds. If an investor simply adheres to the strategy for only a portion of his fund, the portfolio's overall Sharpe Ratio will drastically increase. As U.S stocks hover near record highs, and international financial markets show no clear positive economic signs, do not get burned in the next turndown. Diversify properly through a Simple Risk Parity approach.

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  • Hardog
    Apr 20 08:36 AM
    Any suggestions as to picks? 
  • 12284371
    Apr 20 08:47 AM
    To post an article like this and provide nothing but a name for a strategy is not very professional or insightful. 
  • gary747
    Apr 20 09:29 AM
    WOW!! Talk about being "left in the lurch," this is a good one! A question with no answers. Really good show!! Not very professional for sure. 
  • bill233
    Apr 20 12:19 PM
    Could not be more true 
  • Tyler Feldman
    Apr 20 12:52 PM
    Understanding Risk Parity, by Brian Hurst, Bryan W. Johnson, and Yao Hua Ooi should be credited for statistic on Sharpe Ratio of certain assets over the past 40 years. 
  • cross
    Apr 20 12:53 PM
    The issue of diversification is an interesting one. For the investor into individual stocks it's more than holding a certain quantity of companies. 
    Some considerations:
    It's balance within your holdings. If you own 300 JPM and 10 IBM are you really diversified into 'tech' and 'finance' with a 10 to 1 ratio of dollars invested?
    If your holdings are many in number but restricted to a couple of industries out of dozens of possibilities, are you properly diversified?
    What about geographic diversification? Does one have to be worldwide in their investments in order to be diversified? Does that suggest more multi-national companies if one wants to stick to U.S. listed companies? Should that investor be in companies in other-than-dollar denominated currencies?
    What about time diversification? If an investor throws all his capital into stocks at one time, no matter how many stocks, industries, currencies, is he properly diversified?
    If you own positions in fifty companies are you only ten percent as diversified as owning the SPY, a proxy for five hundred companies? 
  • bobzic
    Apr 20 04:07 PM
  • 29807905
    Apr 20 05:45 PM
    We should not criticize anyone for taking the time for sharing their thoughts. As someone who knows this strategy thank you for sharing. Everyone should at least be aware of this strategy and how it works. 
  • MJJad
    Apr 20 06:25 PM
    "In today's financial markets, risk is not the exception, but the rule." What? 
  • TimNeuman
    Apr 20 09:17 PM
    I would appreciate a bit more discussion on the issue of commodities and equities. Does the strategy require one to invest directly in commodities, or are commodity-sensitive equities sufficient? For example, need one hold and Ag fund such as DBA; or could one fulfill the commodity risk element by buying, for example, ADM or other agricultural-related stocks? (Same is true, for example, for owning physical Gold vs. Gold mining stocks). The problem with commodities as part of a long term portfolio is the lack of income; owning correlated equities paying a dividend can address this. Also -- is there an appropriate mix of commodities? There are precious metals, agriculture, basic materials, etc. -- is some standard mix appropriate? A final question I have relates to real estate. I would have thought a risk parity strategy would include this fourth area... not to mention a fifth area, cash (the latter being necessary to take advantage of situations when one or more asset class is clearly mispriced). For the record, I have structured accounts that I manage to hold all these basic asset classes, but not in the one-third proportions suggested. Currently my portfolios are structured for 62% equities, 12% bonds/debt, 9% commodities and real estate, 13% cash, and 4% leveraged equity and interest rate hedges, which are intended to and have been successful in reducing the overall volatility of the portfolio. 
  • Emerging Investor
    Apr 20 10:09 PM
    Risk parity has some merit but a lot of it is psychological. If equity volatility does not lead to poor decision, a heavy equity allocation will return better return in the long run. Before considering a risk parity portfolio I suggest reading the following article.
  • 8566031
    Apr 21 01:21 AM
    Volatility is but one form of risk in a portfolio. 
  • David Van Knapp
    Apr 21 08:01 AM
    I wouldn't be too harsh. We all know that personal finance is woefully under taught and understood. These guys are trying, and if posting some stuff on SA helps them get good feedback, I am all for it. They are not professionals, they are kids. Let's help them along. 
  • nicholas davout
    Apr 22 06:59 PM
    Duh, I'm supposed to load up substantially with commodities for which there is weak demand and also bonds which are on the cusp of losing principal value due to US FED raising rates in 3-9 months? Thanks for nothing. My accounts hold over 100 positions in many sectors hedged by covered calls & trailing % stop loss orders. The only bonds I hold are through cefs of all investment grade munies.