finances

In my previous article I explained why investing is important. The reasonable follow-up question is, how do you pick the right investment?

Don’t try to predict the future

The economy goes up and down in cycles creating different seasons. According to the self-made multi-billionaire investor, Ray Dalio, you should have assets for every season. Instead of trying to predict the future, be ready for all possibilities. Recession, expansion, inflation and deflation. The four seasons and asset types that do well in each are:

Higher than expected inflation (rising prices):

• Commodities (Food, metals, energy sources)
• Gold
• Inflation-protected bonds (TIPS) (Provides inflation-adjusted return in your favor)

Lower than expected inflation (deflation):

• Treasury bonds (A promise of a payment guaranteed by the US government)
• Stocks

Higher than expected economic growth:

• Stocks
• Corporate bonds (Like treasury bonds but riskier and with higher return)
• Commodities
• Gold

Lower than expected economic growth:

• Treasury bonds
• Inflation-protected bonds (TIPS)

If you have assets (investments) that do well in each season you’re always covered. In case you didn’t read my last article, it’s very hard picking winners when you’re investing and trading, so this strategy is more about protecting yourself. Picking stocks isn’t going to do much good when the whole stock market is going down, for example. It’s better to be able to do well in any season. Most people not only focus on one kind of asset but they only go long. For example, always stocks, and always that they will rise. This limits your possibilities a lot, especially when the beauty of the investing trade is that there’s never the excuse of “bad times” in the industry.

Risk management

The key to the strategy is not only having assets for each season, not even having the same amount of money in each, but dividing your risk evenly across the four. If you put half your money in stocks and half in bonds, 80% of your risk would still be in stocks. Based on the risk of different asset types, Dalio recommends the following money allocation as a good place to start out without getting too complicated:

• 30% in stocks. Pick your own or buy into a fund that tracks an index.
• 15% in intermediate-term bonds (7-10 years).
• 40% long-terms bonds (20-25 years).
• 7.5% in gold (highly volatile).
• 7.5% in commodities (highly volatile).

ETFs

It’s estimated that this strategy will yield up to 10% growth per year (I should probably mention not to take this article as professional advice). It would have lost money only 3 years the past 30 and actually made money in the crash of 2008. At least once a year you’ll need to rebalance the portfolio, so you spread out the earnings of the investments that do well. Getting ahold of bonds may be tricky but there are ETFs that are a good alternative. They also provide a convenient way to buy commodities without filling your garage with stacks of gold and oil barrels. ETFs (Exchange Traded Funds) are funds that you can easily buy and sell like stocks in the stock market (most take a small fee). If you’re really into getting the best portfolio possible you may want to look into placing your money in mutual funds, not exchange traded ones. Below are some alternatives with fees known as expense rations in the parenthesis. I’ve included alternatives to not seem bias and also because not all ETFs are available to everyone.

Stock indexes

DIA SPDR Dow Jones Industrial Average, 30 (0.18%)
QQQ PowerShares QQQ, Nasdaq 100 (0.20%)
SPY SPDR S&P 500 (0.06%)
VOO Vanguard S&P 500 (0.05%)
IWM iShares Russell 2000 (0.20%)
VTWO Vanguard Russell 2000, offers large exposure (0.15%)
IWS iShares Russell Mid-Cap Value, resembles the index but is a bit more selective for growth (0.25%)
VTI Vanguard Total Stock Market, all sectors but tilt toward large (0.05%)
VWO Vanguard FTSE Emerging Markets, emerging markets such as China, Brazil, Taiwan, and South Africa (0.15%)
SCZ iShares MSCI EAFE Small-Cap, offers more industries than included in just large-cap (0.40%)
EWJ iShares MSCI Japan, hundreds of stocks mostly large cap in one of the world’s largest markets (0.48)
VGK Vanguard FTSE Europe, hundreds of equities (0.12%)
EWU iShares MSCI United Kingdom, one of the worlds largest markets but does not reflect Europe as a whole. (0.48%) VSS Vanguard FTSE All-World ex-US Small-Cap, Small companies in emerging and developed countries outside US. (0.13)

Intermediate-term bonds

IEF iShares 7-10 Year Treasury Bond (0.15%)
BND Total Bond Market, popular but contains all terms (0.17%)
VGIT Vanguard Intermediate-Term Government Bond, note it’s 3-10 years (0.12%)
SCHR Schwab Intermediate-Term US Treasury (0.06%)
TIP iShares TIPS Bond, popular (0.20%)
VTIP Vanguard Short-Term Inflation-Protected Securities (0.10%)

Long-term bonds

VGLT Vanguard Long-Term Government Bond Index Fund (0.12%)
BLV Vanguard Long-Term Bond, popular and not just government bonds (0.10)
TLT iShares 20+ Year Treasury Bond (0.15%)
TLO SPDR Barclays Long Term Treasury (0.10%)
EDV Vanguard Extended Duration Treasury, very cheap but 20-30 years (0.07%)
LTPZ PIMCO 15+ Year U.S. TIPS Index, long-dated riskier TIPS (0.20%)
VWOB Vanguard Emerging Markets Government Bond, for bonds outside US (0.32%)

Gold

GLD SPDR Gold Shares, bigger and more liquid than IAU (0.40%)
IAU iShares Gold Trust ETF, cheaper than GLD but less liquid (0.25%)

Commodities

VAW Vanguard Materials (0.10%)
IRV SPDR S&P International Materials Sector, over 100 foreign stocks (0.40%)
DBC PowerShares DB Commodity Index Tracking Fund, popular but note it also contains futures contracts (0.85%)
GSG iShares S&P GSCI Commodity-Indexed Trust, like DBC but heavy on energy. (0.75%)
DJCI iPath Bloomberg Commodity Index Total Return, offers even exposure and is cheaper version of DJP (0.50%)
USCI United States Commodity Index Fund, like DBC but monthly based on observable price signals and lessens contango. (1.03%)
BCI ETFS Bloomberg All Commodity Strategy K-1 Free, very cheap but low liquidity (0.29%)
PDBC PowerShares DB Optimum Yield Diversified Commodity Strategy Portfolio (0.60%)

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Why You Should Invest Your Money