I stuck a thermometer in the snow before every race. It might sound quirky. But every cross-country ski racer did it. We checked the snow’s temperature before putting wax on our skis. The right temperature-dependent wax gave us the perfect combination of kick and glide. But if we chose the wrong wax (which I often did) halfway through the race we wished we had stayed home.
Experienced ski racers got it right almost every time. Unfortunately, picking the stock market isn’t like that at all. We can’t pick investments based on the economic climate. The stock market finds a way to humiliate almost everyone.
But what if you had a special wax that worked almost every time? There might be such a thing. It’s called mean variance optimization. AssetBuilder builds portfolios that use it. It’s inspired by the work of economic Nobel Prize laureates William F. Sharpe and Harry Markowitz.
These guys might be geniuses. But their strategy is simpler than it sounds. You just put investment eggs into more baskets than the average duck. Such a strategy provides decent long-term returns while reducing portfolio risk.
AssetBuilder’s portfolios serve as an example. They include almost everything, rebalanced once a year:
- Small-cap, mid-cap and large-cap stocks
- U.S. value stocks and U.S. growth stocks
- International value stocks and international growth stocks
- Small, emerging market stocks
- Emerging market value stocks
- Short-term U.S. bonds and longer term U.S. bonds
- Global bonds
- Real estate
Such diversification might sound like common sense. But when an asset class runs, we’re tempted to chase it to the cliff. Over the past ten years, plenty of investors have done just that, chasing (most specifically) U.S. growth stocks.
They have overlooked U.S. value stocks, developed international and emerging market stocks to chase the winning sector. But they’re now scrambling high on some pretty shaky ground. That doesn’t mean you should dump U.S. growth stocks. It does mean, however, that other asset classes could create some wind-aided growth with a higher degree of safety.
It might be happening now. Some overlooked sectors are starting to make their move. From January 1st to July 31, 2017, they’ve pushed ahead of the broad U.S. market and U.S. growth stocks.
For example, DFA’s International Small Cap Value Portfolio (DISVX) is up 18.88 percent for the year, to July 31. DFA’s Emerging Markets Value Portfolio (DFEVX) is up 23.70 percent. DFA’s Emerging Markets Small Cap Portfolio (DEMSX) is up 22.36 percent. DFA’s International Small Cap Growth Portfolio (DISMX) is up 23.94 percent.
International currencies are also gaining ground on the U.S. dollar. For example, Americans paid $1.05 to buy a euro at the beginning of the year. By August 4, Americans had to pay $1.17 for the same euro. That’s a difference of 11.4 percent. When the U.S. dollar falls, it gives a boost to global bond market funds.
January 1, 2017 – August 4, 2017
U.S. Dollar Losing Ground To Foreign Currencies
|January 1, 2017||August 4, 2017||Percentage Gain On The USD|
|Source: Currency X-Rates|
I’m not saying the U.S. market or the U.S. dollar will tumble over a cliff. But broad diversification might provide a profitable safety harness. AssetBuilder’s DFA portfolios offer a solution.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and The Global Expatriate's Guide to Investing: From Millionaire Teacher to Millionaire Expat.