Week 3 - Goldilocks Allocations

Goal: To introduce asset allocation choices (the main drivers of investment returns) that minimize the risk of temporary loss while maintaining strong returns over two market cycles.


The internet makes it possible for investors to simply point and click their way to a balanced portfolio and cut out paying the middle man. This is important in the maintenance of a balanced portfolio for several reasons. First, it is less expensive—management fees are eliminated and commissions are reduced to less than a dollar a share. Second, use of an intermediary agent, such as a mutual fund portfolio manager, introduces what are called agency issues. Agents carry additional costs besides fund management fees: your investment can be allocated in ways that subject your funds to excessive risk of loss, and you will know nothing about it until it is too late. You own the cash you entrust to financial intermediaries but they are not required to act in your best interest. For example, the manager of a mutual fund may select risky stocks in an attempt to out-perform the relevant benchmark. This fund could achieve that during an “up market” but would surely underperform during a “down market” because stock market “risk” is what statisticians call “variance”: it cuts both ways. Risk, with respect to stocks, translates into the risk of bankruptcy for that company. For example, a stock that is unable to pay a dividend and is issued by a company that is deeply in debt is risky—its expenses exceed its earnings. The price of that stock will vary depending on whether the economy is strong enough for its products to be sold at a profit. Its price swings will be exaggerated because the chance it will have to declare bankruptcy is about the same as the chance it will earn enough to pay its debts. Another example is that of companies that are publicly owned but mainly operated by employees who are not shareholders (Berkshire Hathaway and Microsoft being notable exceptions). Those employees are being paid to act as the owner’s agents but they will probably act first to secure their own jobs and enhance their own remuneration.


An individual investor can best minimize the conflict between her needs and agency issues by eliminating this middleman, diversifying her holdings, and investing in companies that value shareholders by paying a reasonable dividend (25-50% of earnings) that increases every year. Direct ownership of stocks is done through Dividend Re-Investment Plans (DRIPs). Almost every S&P 500 company has a DRIP; some companies even waive all expenses. Computershare (computershare) services the largest number of DRIPs. The US Treasury issues the largest number of investment-grade bonds (treasurydirect) and also waives all commissions.


Changes in the macro economy (such as recession and inflation) are externalities that we try to anticipate through asset allocation decisions. For example, commodity-related stocks keep step with inflation and consumer-staples stocks retain value during a recession. Our ITR asset allocation plan is designed to weather these storms without sacrificing upside potential.


In future blogs, we will explore the ITR Investment Strategy:

• Use do-it-yourself point-and-click investment in assets that generate dividends or interest (computershare);
• Use a 50:50 balance of stocks and bonds;
• Select stocks that yield as much or more than the S&P 500 Index (SPY);
• Select stock in companies that have increased annual dividends for at least 10 years;
• Avoid derivatives (assets linked to other assets) except for a global allocation stock fund and two bond mutual funds;
• Stock allocations: 50% industrial & commodity-related, 33% defensive (consumer staples and health care related), and 17% in a global allocation mutual fund;
• Bond allocations: 17% in 10-year US Treasury notes (treasurydirect); 33% in an international bond mutual fund, and 50% in a diversified investment-grade bond mutual fund. A future blog will provide detailed information about purchasing no-load bond funds online.

Bottom Line: Conserve assets, minimize expenses, and maintain what you’ve obtained. Forget about the big kill but instead seek a portfolio similar to one which investors call a “Goldilocks Economy”— not too hot and not too cold.


Click here to move to Week 4