where to stick 50k for 10 years

[ayamaguc]

I don't have a lot of time freedom to post at the moment, but I'll try to fill in my perspective in bits and pieces here. I'm writing as a sidebar on my desktop so it'll take a little while. I'll try to us layman's language and examples where I can for the non-industry folk among us.

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Ongoing research leads me to believe that
- this (index nirvana) is not the most likely outcome for future
- that indexes (the big ones) will yield limited returns over the next decade
- in general we are in a low return period
- that index multiples are high enough to make me quite uncomfortable
- i don't believe 'this time it's different'


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Let me start by discussing this, since it affects most of my thinking below.

Ok. The picture: There are significant macro/structural issues in the US and world economy that concern me. Thought process for the U.S..
-Tech/Internet companies was a bubble.
-Housing was a bubble which is in the process of deflating.
-I feel the data are unambiguous that rising housing values allowed people to grow their spending in excess of the growth in their incomes.
-Homeowners as a class used rising valuations to refi-cashout and spend.
-Consumer spending is a big part of the economy and growth.
-0.5%+ contributed to GDP growth each year for a few.
-With the housing market rolling over, refi-cashout is coming way down.
-Spending is slowing but appearing not enough given less $ from housing pullouts.
-There is some early but troubling data that people are cashing investments and cracking savings to keep spending / maintain lifstyles. This is very bad.
-I think inflation is high. More imporantly, inflation numbers are above the Fed's stated 1.5-2% comfort zone.
-New Fed chairmen tend to err on too far with rate hikes in their first go-around to establish and maintain inflation hawk credibility.
-Yield curve inversion (another discussion for another time).
-'This time it's different' or the 'goldilocks' scenario is not one I put much faith in. The idea that the Fed will raise rates juuust enough to slow growth to get inflation down < 2% but not enough to dip the economy AND that the economy can unwind and self-correct its problems AND everything else will be nice and stable with no shocks to the equilibrium is not where I will put my money. I will always watch and be ready to adjust, but unless I rigged the deck I'm never going to betting to hit my one-outer.

This ties in with the trade picture where
-Americans buy hoardes of cheap goods from China (and other places).
-The Chinese get jobs to stabilize and grow their society.
-Many of the profits from these sales come back to the US as corporate profits (returns to capital, but not labor).
-The Chinese lend the profits they keep back to us to finance our ability to keep buying their cheap shwag.

Obviously these cycles have to change. They can't last forever. At some point there's no more money for Americans to keep spending this way. There's no more ways to be in hock. Debts must be serviced and the piper must be paid. Consumption must return to come inline with income. Developing economies must cultivate a middle class and begin consuming. American must start saving. Etc.

At the macro level..
-I see what I consider to be excess and capital misallocation, especially in housing. And we're not alone. China is filled with projects that create jobs but not economic value. Inefficiency like this is not good for anyone beyond the immediate short term.
-Energy is expensive. Or at least, more expensive (significantly) than it has been. We are all unavoidably levered to energy, and it costs way more today. That is a drag on growth, especially in the transition period before substitution and tech. advances take hold. It is a real paid cost, so it is real inflation.
-Sept. 11 and the government's Hurricane Katrina 'response' should make clear to everyone that we are in a much more dangerous, turbulent, RISKY world than the late 90s 'peace dividend' era. So there's more risk. Or more likelihood at least, which needs to be priced in.
-Billions in capital and human potential are being ground to dust in Iraq with no end (to the stream of costs) in sight. Any payoff is way way into the future. Ugh.

Obviously if you disagree with one or more of my notions above, you may disagree with my conclusion. The higher up the chain you disagree, the more divergent our outcomes may be...


I think the original thrust of this thread was to the effect of 'where do i stick a lump of 50k for 10 years'. Funds (big indexes in particular) seem to come up as a popular answer. I have a few quibbles with that:

-Most folks seem comfortable that gross returns or returns net inflation will be > 0 over ten years. I don't think I disagree. I'm just not comfortable with hearing that as advice either as dogma or an 'everyone's doing it, there's nothing you can do about it' kindof way. If you got your money in at the end of the 1920s, you were underwater for a long time. I can't seem to find a good s&p500 chart from the 70s, but I think that if you got your money in at the wrong time in 73-74, you were negative for many years. So nobody really asked about withdrawal timelines or talked about averaging or such, which seems like a basic first step to control risk. Definitely won't recommend to the OP to try to time the market.
-So I'm not so hot on the economy or the U.S. marketplace. Since the economy tends to show up in index returns, this makes me uncomfortable.
-VALUATION. DC- you should be all about this since you're a value guy. Index prices are a function of two things, or two principal things: earnings (or some other measure of value like book, revenues, ebitda) and multiples. Earnings are just that-- earnings per share for the index companies weighted according to the index, etc. Corporate profits. The multiple is the premium to earnings investors are willing to pay per share of an index company, again weighted etc. etc. for the index. Sortof the catchall for investor expectations, reflecting growth prospects, overall risk, risk premium relative to other instruments, and so on. Index multiples fluctuate, but they have ranges. Right now we are towarsd a high end, which is an uncomfortable place to be comtenplating putting money to work (which I am-- moving money around, simplifying, and consolidating has left me with a lot of wealth in cash looking for an entry point). An S&P multiple in the 20s like now means that profits could grow, and the S&P could internally do well (using measures of value growth like EPS) but could experience multiple compression back to a mean and provide unhappy returns to investors. I need to poke around more or do some math to see if returns could be negative. I think it's possible net of inflation. John Hussman writes thought-provoking commentary along these lines (search Hussman s&p500 multiple).


So I'm not saying the 50k should go into TIPS and be forgotten. But there are scenarios involving returns < 0% (absolute or net inflation) on the map and they need to be considered and accounted for. For growth, where is the killer app today? We've just gone through a 15 year period of rapid transition and innovation in the information business. The Internet, email, cell phones, txt messaging, satellite radio, HDTV, and my silky smooth dual-core processor. I feel like now we're in a digestion period where more and more these innovations are advancing progressively but not explosively, consolidating and becoming every-day conveniences and necessities. I don't see explosive new market kindof growth anywhere right now, and I don't see changes that could come that feel likely to make a continued high multiple, or yet higher future multiple something to bet on.

What could open up multiples? Cure for cancer? Surrender by all Al-Qaeda leaders and capitulation and renunciation of Wahhabism by all practitioners? Fusion reactors? Severe about faces by the governments of North Korea and Iran?


Bill Gross writes much more capably than I about low returns (search for Alpha/Beta Anemia). Short- total asset growth is linked to GDP. I'm not so hot on GDP now. Low returns will mean more people chasing return and pushing down risk spreads.

More intuitively and anecdotally, there's giant amounts of capital swishing around chasing return. Astonishing. I watch some of it go by every day. Finding opportunities to generate returns seems to be getting harder all the time. As more and more people pile into things, returns for everyone are dissipated away (scuttlebutt going around now about some hedge funds returning 6% and such). Private equity and managements take firms private. Etc. So now having capital is not enough to generate a return. Your capital needs to be connected to get in. Things that are good, like hot IPOs, seem to go to good customers and those in the know.

This is why I flippantly tossed out there the 'stock-picker's market' thing. In a low return environment, high valuation environment, I think it's easier for individuals to outperform by picking stocks or allocating well.

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My opinion as a value investor is that these academic definitions of "value" and fundamentals are pretty silly, you can't find true value with a computer. But it does seem like a fundamentally weighted fund would be closer to optimal than a regular index fund.

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I think this is where my edge has come the last few years. My thinking here started in college more intuitively. The DJIA, being share price weighted (at least in this age of splits), was the stupidest. But I didn't like cap-weighted indexes either. I didn't feel like paradigm shift/new market type explosive growth and innovation was coming from large, established companies with existing business to maximize. It was coming from small and medium sized companies with new ideas. That and the law or large numbers kept speaking to me-- I felt in my gut like there was implicitly a ceiling to growth for huge giants like GE and MSFT. They couldn't keep growing at 15% or 20% forever, right? Else they would eventually become the whole market.

Over time my thinking has evolved more like this-- an index is a basket of companies. At the end of the year, it will have a return. It's about as certain as anything can be that the end of year return for all of the stocks will not be the same as the index's return. Rather, some companies will underperform a little, some companies will underperform a lot, some companies will outperferform a little, and some companies outperform a lot. If you knew which one stock would perform the best, you'd just put all your money there and revisit in a year. You don't know, which is why you buy the index. No controversy so far, right? Well, every dollar you put in gets split among the index companies according to the weights. The fact that some components of the index will provide you a better return than others means that some components (stocks) are more 'deserving' of your investment funds than others. Implicitly then, without asking the customer, cap-weighted indexes are saying that the bigger companies in the index are more deserving of your investment dollars than the smaller ones. Mechanically. Without any regard to what's happening in the business or real world. None whatsover. That's stupid.

Big companies don't keep getting bigger. Otherwise there would only be a few huge behemoths in the world crowding out all others. So there are better ways to gauge which parts of an index deserve more dollars and which deserve less than size of company no day 0 of the index weights. And that's I think part of what Rob Arnott was after.

I think I just found the fund version of this beast - PIMCO Fundamental IndexPLUS TR Fund A (PIXAX). It's a Bill Gross fund and combines fundy indexing with Pimco's active management of fixed income collateral approach. Expense ratio is 1.14%.

PRF is an etf and has no holding period. It has an expense ratio of 0.6%. A broker like Firstrade can get you in for $7/side. If the zero commission things takes (which I think it will) then that adds to the flexibility.

This does not relive from my valuation concerns..


Anyway my edge-- I've operated by trying to beat my chosen index taking a core+ approach. Tweak the core in a way that made more sense to me as far as asset balance (usually but not always a rough equal balance between large, mid, small, growth and value) and build around with a limited set of investments that I felt would outperform (sector bets, technicals/momentum screening). There are definitely markets and instruments out there like RE that are trendy and inelastic to moderating forces (rates). They make good bets. Energy and metals probably played that role in a lot of folks portfolios the last few years.

DC- I know you're skeptical of finding a good fund or manager, or that such a person would be incented or willing to manage public money, or that a person of open mind can find real opportunities, but since I do and see it, I know they exist. I could likewise spout efficient market theory to you and tell you how you can't possibly find and unlock value in your occupation, but the fact that you're eating what you kill every day says otherwise. In both cases it's hard, but possible.

Can I beat the PRF? Or some fundy total market? Don't know. Need to think more.

Finally-- pls pls no one take this as investment advice. Everyone do your own homework. There's a lot of good data and commentary out there on pretty much everything I touched on. As you do your own research you may find yourself in a different place. More importantly you will start to build the thought process in your mind, which is the most valuable part since this post won't update itself unlike the model in my head.


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I'm a big believer a small investor can beat the market through smart stock picks, but as I said, it's a ton of work.

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Especially as commissions and intermediary friction keep coming down..


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I have little belief you can beat it through "astute allocation and asset selection". There is literally a trillion dollars on wall street being run by 150 IQ types trying to figure out which asset classes are going to outperform in the future, you certainly are at a disadvantage to these guys.

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How do you know I'm not a wall street type? Or 150 IQ? You're fine and welcome to doubt. It's all part of learning together. But I felt that while I had to watch closely, it was my best bet (lock) that my RE fund would beat the S&P this year. I'm nimbler and don't move the market like the big guys. And my port certainly enjoyed the 35%+ I got from the fund.

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Predicting future fund manager outperformance is very hard. You need to find a manager who's done it for at least 10 years. This ensure they weren't lucky, or that their style (momentum, value, technology, growth, GARP, etc) hasn't just been hot for a couple years. And if it's someone who beats the market by 1/2% a year for ten years, that's not much evidence of skill. You really want someone who's shown a big edge for a prolonged period.

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It may be more accurate to look at my approach as 'manager within a sector'. I looked for the right manager, at the right fund, in the right sector (sector, capsize, style, etc.) for now. By 'stock-picker's market' I'm not saying go with active management here either. My #1 concern is macro/structural/valuation scariness. Since the index is righly valued, I think my strategy for this year is to pick more stocks-- trying to find the handful of best ideas I can generate about those parts of the index which are most deserving of my dollar. Also, play defense, and wait patiently for entry points.


Good questions and discussions. I hope that helps clarify. I know this process has helped clean it up a bit in my mind.

Now get to work and cut me to bits!

[James282]

This thread is great. Continue the discourse, please!

James

[stinkypete]

cliff notes?

[gull]

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If you got your money in at the end of the 1920s, you were underwater for a long time. I can't seem to find a good s&p500 chart from the 70s, but I think that if you got your money in at the wrong time in 73-74, you were negative for many years. So nobody really asked about withdrawal timelines or talked about averaging or such, which seems like a basic first step to control risk. Definitely won't recommend to the OP to try to time the market.

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If you bought the S&P 500 at the beginning of 1929, right before the Great Depression, it would have taken six years to get positive (although then the market dipped again and it would have taken a 14-year period to get in the positive permanently - by the way, this is the longest decline in the S&P 500 in history).

If you bought at the beginning of 1973, it would have taken less than four years to get positive (and less than six years total to get permanently positive). If you bought at the beginning of 1974, it would have taken less than two years to get positive permanently.

[gull]

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cliff notes?

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The future is grim.

Because the future is grim, most stocks are overvalued.

Because most stocks are overvalued, investing in indexes will yield poor results.

Because investing in indexing will yield poor results, stock picking is better.

I pick stocks, but it may not be for everyone.

[gull]

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But I didn't like cap-weighted indexes either...

Over time my thinking has evolved more like this-- an index is a basket of companies. At the end of the year, it will have a return. It's about as certain as anything can be that the end of year return for all of the stocks will not be the same as the index's return. Rather, some companies will underperform a little, some companies will underperform a lot, some companies will outperferform a little, and some companies outperform a lot. If you knew which one stock would perform the best, you'd just put all your money there and revisit in a year. You don't know, which is why you buy the index. No controversy so far, right? Well, every dollar you put in gets split among the index companies according to the weights. The fact that some components of the index will provide you a better return than others means that some components (stocks) are more 'deserving' of your investment funds than others. Implicitly then, without asking the customer, cap-weighted indexes are saying that the bigger companies in the index are more deserving of your investment dollars than the smaller ones. Mechanically. Without any regard to what's happening in the business or real world. None whatsover. That's stupid.

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This is a very good point. The main benefit of cap-weighted index funds is that there's no unnecessary buying and selling to rebalance. Even so, non-cap-weighted funds offer bigger benefits. If you figure that overvalued stocks will be overrepresented in cap-weighted funds and undervalued stocks will be underrepresented, then it makes sense that non-cap-weighted funds outperform. Some funds are equal-weighted, but even better are the funds that use other weightings. For example, there are funds and ETFs that weight stocks by how small or valuey the stock is. This really boosts performance.

[ayamaguc]

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Housing was a bubble which is in the process of deflating.

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I'm actually kindof surprised everyone let me get away with this one. Bubble notions being the subject of wild, angry debate the last few years. Really emotional stuff...

[DesertCat]

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If you bought the S&P 500 at the beginning of 1929, right before the Great Depression, it would have taken six years to get positive (although then the market dipped again and it would have taken a 14-year period to get in the positive permanently - by the way, this is the longest decline in the S&P 500 in history).

If you bought at the beginning of 1973, it would have taken less than four years to get positive (and less than six years total to get permanently positive). If you bought at the beginning of 1974, it would have taken less than two years to get positive permanently.

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I'd guess Gull is using dividend adjusted returns. The mistake many people make (myself on occasion as well) is just look at the index level on two dates and assume that you can directly calculate returns. This is forgetting the stream of dividends you receive as an index owner, a stream which was much larger in past decades. From 1871-1960 the lowest dividend yield on Dow Jone stocks was 4% per year, and it reached over an average 6% for long periods.

Nowadays dividends are less, but still add up significantly over time.

[adios]

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i dont want to put this money into my IRA or anything, but i also don't want it sitting around doing nothing....whats my best plan? i want maximum growth potential, however as it gets closer to the 10th year i want it to chill out...i was thinking one of the vanguard (or any other investment firms) life cycle retirement funds would be good, except i would choose a 2017 'retirement' date.....thoughts/advice/idiotic one lines?

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I haven't been on this forum for awhile. Similar posts have appeared in the past. Without some idea of the risk you're willing to take it's really, really hard to answer your question. Also you seem to be implying that you want to have your money is some sort of managed account. There's a cost for that so I guess I'd look around for a money manger that you had a lot of confidence in.

I don't think you'll be able to put $50k in some account and forget about it either FWIW. Everytime I think about doing something like that I know that there are economic events such as changes in the business cycle that will have me re-thinking what I should have in my portfolio.

[adios]

$500 a sq. ft. for a fixer upper is a bubble to most people.