Occasionally I’m asked what investments to consider for a short time frame. My answer is always the same: NONE! If you’re saving for something short term (3-18 months) like a down payment on house, a tax bill, or a trip, trying to invest in something “safe” can surprise you. Even the safest sounding investments like “ultra short duration bond funds” can experience undesirable losses. The chart below shows the 12 month return of the SPDR SSgA Ultra Short Bond ETF (ULST). Bounces around a bit, doesn’t it?

My CNBC Fame

Ok… It’s just a little article, but I thought it was cool. Click the CNBC logo to read my quotes. In the article I discuss the merits of bond funds like the one above. While the author didn’t capture everything I said verbatim, she got my main point; an investor should be rewarded for the risk they’re willing to take, and based on current interest rates this type of bond fund might have to wait a while to see a positive real return.

Ultra Short Duration Defined

This type of fund invests in corporate, government, or a combination of both types of bonds with maturities of 1 year or less. At maturity, a bond holder gets their original investment back, and usually receives interest (technically dividends within an ETF) along the way as a reward for the risk taken. Duration reflects the amount of time expressed in years, a bondholder would have to wait to break even given an interest rate rise. There’s a lot that goes into the calculation, but simply put, the bigger the duration the more the bond price would be impacted if rates shot up. Historically, ultra short bond funds have been pretty boring, and right now there is a lot of hype around using them as hedges against rising interest rates.

The Potential Pitfalls With These Funds

First off, rates are pathetically low. The current yield on ULST is 0.36%. After taxes, inflation, and the potential for price declines, an investor is almost certain to lose money in the short term. Second, let’s say rates do rise this year. Will investors owning these funds be able to commit to holding onto them to recoup their investment via ETF dividend reinvestment? Maybe… Experience suggests that when investments decline further or faster than anticipated, it quickly becomes very difficult to stay invested.

The Alternative

When’s the last time a financial advisor told someone not to invest, but to use the bank instead? Like, never, said the financial advisor… Ok here’s a valid exception. As of today, Bankrate.com lists 23 banks offering 1-year CDs with APRs at 1% or more. ETFs are nice because you can sell them for cash at any time, unlike CDs that require a holding period to actually make money. However, CDs are FDIC insured. This means they’re safer investments (if one can actually call it that) than ultra short duration bond funds. At least at this point in time, why take on investment risk for a lower yield when you could buy a safer investment with a higher yield?

The Takeaway

If you want to earn something more than nothing on short term cash, don’t try to get fancy. It’s not worth the risk! Accept that you won’t make much on your short term investment, and just play it safe!

Thanks for reading. Due to the amount of advertising spam I get in the comments section, it’s very difficult to identify real inquiries and comments. As a temporary solution, please shoot me an email at greg@aspenleafllc.com with your questions or comments. Have a fantastic day!

Greg Lessard, CRPC^®

Probably not. Recently I ran two hypothetical tests on a basic, globally diversified portfolio (the one you’re looking at to the right). The general allocation I used follows a traditional 60/40 blend of stocks and bonds. Since I wanted to test if commodities were worthy of a spot in my client’s portfolios, I used low cost, index style investments with slight “tilts” towards small company stocks as well as value stocks. If you want to know more about how an investor can benefit from this portfolio structure, you can read more HERE. To test the commodities position I used a broad based commodities ETF. Primarily I used Monte Carlo statistical analysis to project expected risk versus expected return over a 10 year time horizon. I also looked at back tested data to see which was the highest returning portfolio. First I tested an allocation of 3% to commodities, then decided to test a higher allocation (8%) to see if it created more of an impact one way or the other. 

A Portfolio Without Commodities Seems To Do Better

When I tested a 3% allocation to commodities, average annualized returns fell from 5.31% to 5.22%, and risk basically stayed the same. Big deal, right? However, when I tried an 8% allocation to commodities, annualized returns sank down to 5.06%. However, I did notice a measurable reduction in risk with the 8% allocation to commodities. Overall though, results suggest that adding commodities to a globally diversified portfolio hinders growth.

Challenges With The Hypothetical Test

First off, I tested adding commodities to a globally diversified 60/40 portfolio. Most people don’t actually a portfolio as diverse the underlying proxies I used in my test model. That said, adding commodities to a less diversified portfolio may provide a higher degree of benefit. Additionally, the test couldn’t account for portfolio rebalancing of any kind. Sorry, my research technology simply isn’t capable of that. However, most individuals aren’t familiar with the mechanics of when and how to rebalance anyway, so it’s probably pretty accurate real life behavior modeling.

The Big Picture and What You Can Do To Increase Return and Lower Risk

First off, get globally diversified. Here’s an excerpt from a recent newsletter I prepared for my clients:

Only 49% of the world’s investable stock, and 28% of the world’s investable bonds are US based. If an investor had only been invested in large, US companies over the decade January 2000 – December 2009, they would’ve seen a return of -9.1%. If they would have maintained a diversified global portfolio, they would have seen the following returns: 175.6% return in real estate, 48.7% return internationally, 121.3% return on US small company stocks, 154.3% return on emerging market stocks, and 82.0% return on government bonds.

Second, evaluate what you want to achieve from your investments. If you want to lower risk in an already diversified portfolio, then you might want to aim to include an 8% allocation to commodities. If your goal doesn’t just revolve around reducing risk, and you want to balance cost, tax efficiency, liquidity, and return, then you probably want to stay away from commodities.

Last, if you made it this far into the blog post and you have a headache, but still want to know if adding commodities to your portfolio makes sense, just ask me! It’s easy for me to plug commodities in with your current investment lineup to see what impact it creates. No cost, no commitments required.

Thanks for reading!

Greg Lessard, CRPC^®

The financial credit crisis proliferating during 2008 was considered a “black swan” market. If you’re not familiar with the term, a black swan is any event that deviates from a normal expected outcome, making it difficult if not impossible to predict. Investors were rightfully shocked by losses the market suffered in 2008, and many panicked, only recently getting back in. Two financial advisors based on St Louis recently released a book describing how an investor can learn from the 2008 black swan market, as well as practical advice on how to design a portfolio that can help insulate your portfolio when markets decline. I’ve ordered the book for myself and if interested, you can find it HERE.

If you don’t have time or patience for the book (I don’t blame you), a friend and colleague of mine recently released a short video discussing the book’s highlights. Click the image below to watch the video.

Now that you’re an expert on how an overweight in value and small cap equities can reduce a diversified portfolio’s statistical bell curve tails (hahahhahah that was fun to say), let’s explore how this can be implemented and what its effect is on your long term financial plan.

HOW TO IMPLEMENT THIS STRATEGY

If you work with my financial advisory practice, we’re already doing this to an extent. I’ve been researching the benefits of overweighting value stocks and small cap stocks for over a year. Today I’m flying to Austin, TX to attend a two day workshop covering this portfolio design to cap off my studies. If you don’t work with my advisory practice, you can implement this with your own accounts at a discount brokerage like eTrade, TD Ameritrade, or Scottrade. Some 401K plans even have a robust enough fund lineup to employ the strategy. Your first step is to determine your target allocation (based on risk capacity, investment time horizon, general level of anxiety, etc), then go a bit more conservative by using a higher allocation to less volatile assets like bonds. Since bonds tend to drag on long term returns, you’ll want to mitigate the loss of return by overweighting to value stocks and small cap stocks. This can be accomplished using very specific mutual funds, or even better, index funds and ETFs. Many times a fund’s name will identify what type of strategy it sticks to. If you get stuck on finding these types of investments within your 401k or brokerage firm, ask me. I won’t charge you a fee, and I won’t hound you to death to become a client. Just making deposits in my karma bank.

WHY BOTHER DOING ANY OF THIS

Because if you’re nearing retirement or recently retired (5-10 years plus or minus), the sequencing of your portfolio returns matters! Research studies show how your portfolio behaves around the time you retire influences your ability to generate income. Here’s an example; if you retire and your portfolio takes a beating, it can take a long time to recover. Over the short term (3-7 years), a severe enough beating may rob you of a higher level of investment income you might have otherwise enjoyed. Over the long term (more than 10 years), your overall level of investment income will likely end up lower (with the portfolio beating) than had you taken steps to reduce investment risk. This is just another example of how managing risk in your investment portfolio makes a difference when looking at the big picture.

Thanks for reading my blog, and remember to share it with anyone you think would benefit from the content. Contact me if you want any additional information on this topic. Have a great day!