Q: Due to the declining value of the U.S. dollar, I would like to look for a non-dollar investment to balance my portfolio. Would international stock and bond funds meet this purpose?
-- L.L., by e-mail
A: Hedges against inflation and a falling dollar include the following:
International stocks, as represented by the Morgan Stanley EAFE index ETFs such as iShares EAFE (ticker: EFA).
International bonds, as represented by the SPDR Lehman International Treasury Bond ETF (ticker: BWX).
Emerging Markets, as represented by the Morgan Stanley Emerging Markets index, through the Vanguard Emerging Markets Index ETF (ticker: VWO). Unlike the developed economies, many of these countries have pegged their currency to the dollar and will slowly allow their currency to appreciate. This is likely to be a better bet than focusing on the euro, which is rapidly becoming overvalued simply because there are few alternatives to the dollar. Recently, this index ETF was up a whopping 40 percent year-to-date. So a small commitment would have overcome bad news from many other asset classes.
REITs, as represented by major REIT index ETFs such as the Vanguard REIT index ETF (ticker: VNQ). You can also invest more directly in large REITs such as Equity Residential (ticker: EQR).
Energy, as represented by indexes that capture the major oil companies. One example is the Vanguard Energy ETF (ticker: VDE). Another is the Energy SPDR (ticker: XLE).
Domestic inflation-protected fixed-income securities, as represented by the ETF iShares Treasury Inflation-Protected Securities (ticker: TIP). Recently, for instance, the year-to-date return of TIP was a hefty 10.44 percent. That's double or better than the average returns of every other domestic bond category according to Morningstar.
A quick way to learn your way around these asset classes is to visit the Morningstar Web site at http://www.morningstar.com/. Once there, click on "funds," then click on "category averages." This will show you category average returns for trailing periods from one month out to five years. To learn about the individual ETFs, type the ticker for the ETF into Morningstar's "quotes" box and read the standardized report.
Rather than select one of these asset groups as a cure, I suggest buying them all. Use them to dilute your ownership of domestic equities and to eliminate your exposure to unprotected domestic fixed-income investments. I have been suggesting this kind of diversification for several years. "The Coming Generational Storm" (MIT Press, 2004), which I co-authored with economist Laurence J. Kotlikoff, explains why.
You can diversify your portfolio at very low cost provided only that your portfolio is large enough. A $100,000 portfolio can be spread over 10 ETFs for a commission cost of $120, assuming a $12 commission. That's only 12 basis points, 0.12 percent. You'll likely have fewer commissions to pay when you rebalance. Mix ETFs with core index mutual funds, such as the major index funds available at Fidelity with expense ratios of 10 basis points, and you can self-manage a very diverse portfolio at a fraction of the total cost for managed funds.
The Couch Potato Building Block portfolios, which you can learn about on my Web site, http://www.scottburns.com/, incorporate all these asset classes into simple, low-cost portfolios.
Some readers, I'm sure, will be shaking their heads. REITs, for instance, have had a long positive run but had a flat tire this year, down about 10 percent. But if you look at the recent history, you'll see that REITs were up early this year when emerging markets were down. Today, REITs are down, but emerging markets are still up for the year. The reason we should all be building portfolios with broad diversification is to "encourage" these helpful offsets. The end result should be a higher return over time, with less violent ups and downs.
Another common worry is that making such changes now would be a clear case of "too much, too late." Not so. While the average 401(k) plan participant has been transferring money out of company stock (at last!) and into mid-cap, small-cap, international and emerging markets equities, only 9 percent of total assets were invested in international stocks as of June. Just more than 1 percent of total assets were invested in emerging markets. You can check this for yourself by visiting the Web site for Hewitt Associates, a major benefits consulting firm, at http://www.hewittassociates.com/ and examining the Hewitt 401(k) Index, updated monthly. It provides a good map of what we are collectively doing with our investments.