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The Silver Lining to This Cloud

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On the week of October 8, 2007, the NYSE closed at 10,301.49. One year later, the week of October 6, 2008, the NYSE closed at 5704.13. That was 44.63 percent decline. The resultant thud was felt in the chests of many a long-term investor.

Much blame has been tossed around about the risks that Wall Street bankers took. However, many long-term investors were handed evidence that they, too, had accepted too much risk in the long-term portions of their portfolios. Some feel as duped as do some home purchasers who were assured that they could refinance at favorable rates later, and some should have known better.

Much financial and emotional pain has resulted, so it's difficult to think that there could be any silver lining to this debacle. If there is in fact a silver lining to this mess, it's that markets have delivered an opportunity for investors to assess the performance of their own portfolios or those suggested by their brokers or financial advisors.

Did your portfolio balance drop by more than or less than 44.63 percent from that weekly close of October 8, 2007 to the weekly close of October 6, 2008? I told subscribers beginning in October, 2007, that I had gone to cash in all but my trading accounts and one small mixed stock-and-bond fund my husband held, but that money will have to be put back to work at some time. Now I'm on the outside looking in, assessing the performance of various suggested portfolios to see which held up the best. Which outperformed the markets?

Sadly, I'm not finding many that did. My search led me to study several sample portfolios. A self-professed "personal finance novice struggling to understand some pretty complex and confusing topics" ("About Jim," Blueprint for Financial Prosperity) recently listed several sample asset allocations (October 23, 2008). He culled these from sources such as Smart Money as well as articles by Paul Farrell of MarketWatch, Scott Burns of the Dallas Morning News, neurologist Dr. William Bernstein who studies modern portfolio theory, and money manager Bill Schulteis.

I'm not suggesting investments in any of these portfolios. I'm not a financial advisor, and, for all I know, the originators of these sample portfolios might long since have altered their suggestions. Instead, I'm using these sample portfolios as a basis upon which to begin an investigation into how various allocations behaved during the downturn. The intention is to motivate subscribers to compare the performance of their own portfolios both against the broad market's performance and these sample portfolios as a starting point for thinking about their own risk profiles. This could be a prelude to discussions with their brokers or financial advisors.

The Blueprint for Financial Prosperity blog first mentioned a Smart Money take on replicating the previous stellar performance of Harvard and Yale's asset allocations. Right away, I noticed that this allocation does not appear appropriate for all investors, particularly those of us couples with one spouse already retired, but the allocation is nevertheless detailed below.

Smart Money's Replication of the Harvard and Yale Portfolios:
20 percent domestic equity: DJ Wilshire Total Market ETF (TMW)
15 percent emerging equity: T. Rowe Price Emerging Markets (PRMSX)
10 percent developed equity: iShares MSCI EAFE (EFA)
5 percent fixed income: Loomis Sayles Bond Fund (LSBRX)
10 percent energy: Guinness Atkinson Global Energy (GAGEX)
3 percent metals: SPDR S&P Metals and Mining (XME)
2 percent timberland: Plum Creek Timber (PCL)
10 percent real estate: Alpine U.S. Real Estate Equity (EUEYX)
10 percent private equity: PowerShares Private Equity (PSP)
15 percent absolute return: Hussman Strategic Growth (HSGFX)
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Loss: 40.57 percent

The loss calculation is mine, not culled from Blueprint for Financial Prosperity. For the sake of comparison, I assumed a round-number $100,000 fully invested in this mix of assets on the close of the week of October 8, 2007. Then I computed the loss in the portfolio if all assets were held into the close of the week of October 6, 2008.

The other portfolios listed in Blueprint for Financial Prosperity were known as "Lazy Portfolios." One was Dr. William Bernstein's "No-Brainer Portfolio."

No-Brainer Portfolio:
25 percent Vanguard 500 Index (VFINX)
25 percent Vanguard Small Cap (NAESX or VTMSX)
25 percent Vanguard Total International (VGTSX or VTMGX)
25 percent Vanguard Total Bond (VBMFX or VBISX)
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Loss (using VFINX, VTMSX, VTMGX and VBISX combo): 31.22 percent

Scott Burns' "Couch Potato Portfolio" was the simplest. It was composed of only two funds.

Couch-Potato Portfolio:
50 percent Vanguard 500 Index Fund (VFINX)
50 percent Vanguard Total Bond Fund Index Fund (VBMFX)
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Loss: 22.27 percent

Scott Burns' "Margaritaville" Portfolio included only one more fund.

Margaritaville Portfolio:
33.33 percent Vanguard Inflation-Protected Securities (VIPSX)
33.33 percent Vanguard Total International Stock Index (VGTSX)
33.33 percent Vanguard Total Stock Market Index (VTI)
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Loss: 31.70 percent

Each of these portfolios lost a bit less than the NYSE's 44.63 percent loss, but choosing an investment strategy that's right for you isn't as simple as choosing the one that lost the least in the downturn. For example, if I altered Burns' Couch Potato Portfolio to reflect standard suggestions for a couple with one spouse already retired, instead of splitting the two funds 50/50 I might have chosen to allocate 40 percent to the stock fund and 60 percent to the bond fund. That combination would have lost only 18.24 percent during the period I was using for the calculations.

However, perhaps that combination would also gain the least in any bull market, so perhaps it wouldn't be right for young parents looking toward funding both college and retirement needs far in the future. Perhaps it would under-perform to the upside. Therefore, even a cursory knowledge of asset allocation suggests that some of these portfolios might need to be tweaked before being appropriate for a retired couple in their early 90's or for a single guy in his late 20's, just starting out building a long-term portfolio.

It should be obvious then that these aren't presented as investment ideas but rather as a starting point for comparing the performance of your portfolio or your broker or financial advisor during the downturn. Did you, unwittingly or not, take on too much risk? If so, perhaps any bear-market rallies that might occur will deliver a chance to reallocate your portfolio, bringing your risk in alignment with your risk profile. First, do the prep work. Start with these sample portfolios or ones you discover after your own research and begin planning or talking with your advisor.

Absolutely ask lots of questions and do your own research. My husband and I recently requested a sample portfolio from a big brokerage that's now holding his still-all-in-cash-since-October, 2007 401K monies. (This is not the brokerage or broker used for my trading accounts, which are both excellent.) That suggested portfolio from the other brokerage included a 22 percent investment of the total 401K monies in a single company's--a financial--corporate bond. This was in addition to other corporate bond exposures. That 22 percent concentration in one financial's corporate bond is just not going to happen on my watch. That's too much risk for us, as a 77-year-old relative's $10,000 investment in a Lehman bond turned out to be for that relative. Maybe the fat cats on Wall Street took on too much risk, but maybe some of us did, too, unwittingly believing what we were told. We each need to take responsibility for determining our own risk parameters and sticking to them.

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