I have already executed some important aspects of my 401k/403b/IRA investment plan for 2005:
Sell first and ask questions later.
When in doubt, sell.
Sell, sell, and be merry.
And selling gives you cash, which is just as good as money.
Give me cash, or give me bankruptcy!
Where's the cash?
To sell, or not to sell, that is the question.
Sell stocks for the long term.
You can't handle the market!
I did not buy stocks with that woman!
Not now, dear, I have some stocks to sell.
Seriously, what did I sell? Stock index funds, growth funds, technology funds, generic international funds, and any other funds that are highly correlated to the SP500 index. I will discuss the reasons to sell, then summarize my 2004 portfolio performance, and last give my 2005 investment shopping list.
We are in a long-term "secular bear" market in the U.S. (and most international) stock market indexes that began in 2000. I will not repeat the financial literature that gushes with historical identification of 10-20 year bull/bear trends. Timing the market successfully doesn't mean day trading. It means big-picture situational awareness of the global markets. How about decade trading? Like staying away from SP500 index funds until maybe 2015? Instead, the macro trend moves me toward stock and bond sectors; to not be afraid to hold "cash" (i.e. money market funds); and to pay down debt, keep precious metals in a safe deposit box, and maintain a liquid emergency reserve fund to prevent crisis raids on retirement accounts. My entire investment strategy derives from the top-down secular theme.
What's that? I hear a lot of rebuttals out there already. Stocks, and my retirement accounts, have been doing quite well since 2003, thank you very much Mr. DiFalco. Ah yes, I say, let me make some points about this shorter term "cyclical" bull market within the secular bear. No markets go straight up or down. There are countertrend rallies even in a secular bear market. Also, the corporate earnings recovery from 2002 looks to be in the 7th or 8th inning. The "as reported" earnings of the SP500 companies will finally come in around $58 for 2004, and the current Standard and Poor's estimate for 2005 is about $65. I think the 2005 estimate might come down because of higher business energy prices and interest costs, which have not yet trickled through the economy, and possibly a countertrend rally in the dollar. Thus, at a current price level of 1200, the price/earnings ratio of the SP500 is about 20. For comparison's sake, secular bear market lows occur at a PE of 10 or below. Also, the SP500 sports a paltry dividend yield of less than 2%. These statistics do not tell me if the market will drop or will continue to rise. Indeed, the 1979-80 gold and the 1998-2000 NASDAQ manias prove that overpriced markets can become ridiculously overpriced markets. What the numbers do tell me is that there is much RISK in the overall stock market. The 2000-2002 cyclical bear market in US and international stocks should have taught all middle class investors about risk. A 50% loss means that a 100% gain is required to get back to even ("The DiFalco Rule"). Also, with currently high investor sentiment a contrarian indicator, I don't put much stock (literally) in the supposedly bullish "year 5" rule. 2005 might still be an up year for US stocks, but if so, they will go up without me.
My Scorecard for 2004
My family's tax-advantaged retirement accounts gained only about 5.5% in 2004, compared to the Vanguard SP500 index fund's gain of 10.7%. I had moved most of our stock mutual fund money into fixed income investments before the November-December SP500 index runup. Also, an odd event happened to my portfolio in April. I wanted to move some of my wife's 403b money into a precious metals fund, but the mutual fund company refused to transact unless they received a signed letter from her employer officially declaring that she was vested. Whether she was vested or not was beside the point. I discovered a new form of investment risk - bureaucratic risk! April is the time of year that my household is most busy: tax forms, yard work, softball, soccer, preparing for exams, preparing for the family vacation. Besides these activities, each adult holds a full time job plus various part time jobs. Sound like your experience? Any added complication, if not a crisis, would have to wait. By the time life settled down in September, the sale on precious metals funds was gone.
Our tax advantaged investment accounts ARE our retirement accounts. I did use a taxable account to buy precious metals funds (a two minute transaction) in May. I don't count that money, however, into investment returns. That investment will be sold this year to help pay for a vehicle to replace our rapidly aging 1995 car. In the Houston area, if you don't have a highly reliable vehicle for each household adult, you're dead meat - that is, road kill. Saving for education, higher insurance premiums, bigger gasoline, grocery and utility bills, and growing local taxes suck up whatever is left over, besides subtracting from our ability to put more money in retirement accounts. Somehow, I can't manage to exclude food and energy from my family's inflation rate. The upside on our income is much more limited. Ah, how real life intrudes into our personal economics as well as our investment plans.
My investment goals for this market environment are (1) don't lose money in a calendar year, and (2) beat the SP500 index. How can I implement (1) capital preservation and (2) more risk simultaneously? Obviously these two rules conflict with each other, but they are not necessarily mutually contradictory. In some years like 2004, I will succeed at priority 1, and fail at priority 2. However, the secular bear market, combined with prudent risk management, will often help me accomplish both. Over the last 3 years, for example, my portfolio has risen 4.7% on a compounded annual basis, compared to the 3.5% gain of the Vanguard SP500 fund. How? I had a much smaller loss than the SP500 in 2002. The DiFalco rule helped me out!
My Shopping List for 2005
To make a long story short, right now my retirement portfolio is about half money market, less than 10% stocks, and the rest in bond funds. What will I do with my overweight cash position? Here is my 2005 shopping list for mutual funds:
60% stocks (precious metals, energy, care/biotechnology, emerging markets)
40% bonds (treasury inflation protected, long-term treasury, international, emerging markets)
Notice (1) the priority order, (2) the 60%/40% stock/bond allocation, and (3) no index, growth/value, generic international, or technology stock funds. While some veteran certified financial planners might agree with my "old fashioned" stock/bond ratio, many others might howl protestations at the array of non-traditional investments. "Wouldn't be prudent," they would say, to have greater than 10% allocated to stock sector funds. GET REAL, Mr. and Ms. CFP! Index-correlated stock investments will stink for years in this secular bear market!
I plan to buy into the above listed sectors if and when they go on sale. I might dollar cost average into precious metals and TIPS via payroll deduction. That slow method, though, might not be nimble enough, even if I can overcome the bureaucracy (see above). If there were a huge drop, for example a 50% drop in emerging markets stocks, I would consider going from zero, perhaps in 5% chunks, to 20% allocation. In a perfect world, I would buy on all the dips this year, reach my allocation, and stay put for a few years. However, if something on the list does not go down to a price to my liking, I will not force money just to meet an allocation goal. Taken to the extreme, nothing might go down in price much in 2005. At the start of the year, I don't see anything clearly cheap to buy. I can sit on my cash indefinitely waiting for a better entry point. Doing nothing is the one big advantage that the small investor has over the big professional investor. If a mutual fund manager does nothing, he/she will get fired. If I do little or nothing, like in 2002, I just might beat the SP500 index by 15 percentage points! Speaking of the SP500, I may not buy the index this year even if it crashes to 900 (a 25% drop), since trading a market index in a secular bear market is a dangerous game.
My mutual fund shopping list appears at first glance as though I am heavily anticipating an inflationary environment. Actually, there is hedging for deflation, as the shopping item "long-term treasury bonds" implies. The most interesting debate about this current secular bear market is whether it will be characterized (in the US) by inflation, deflation, or a horrific combination of both. Some very smart people, including James Grant and Marc Faber, have concluded that a secular bear market in US treasury bonds began in 2003. Although possible, I'm not convinced. The bond yield downtrend from the early 1980's is not clearly broken right now. Also, Asian central banks have been, and might continue to be, willing to buy surprising amounts of US bonds to keep the titanic US economy afloat. Financial writer John Mauldin similarly shares my "Two Face" opinion on bonds for 2005. In fact, since I don't have the space to go into details on the merits of all the asset categories I've mentioned, you could read Mr. Mauldin's article "Forecast 2005: The See-Saw Economy". His investment themes are coincidentally close to mine.
In the long term, I'm 6 feet under. Meanwhile, I'll implement asset allocation into investment categories that enjoy secular up trends.