Wednesday, March 26, 2014

The Order of Allocation

I’m not all that good at “allocating investments.” However, I have come up with some ideas that are at least good enough to write a blog about.

Allocating your investments is very much like shopping for Pesach. It’s very stressful and there are no guarantees. However, the better you plan your menus, the more likely it is that you will be successful at avoiding Rami Levi the night before the seder.

The stress is actually quite fitting because you stand to gain or lose more by how you decide to allocate your money than you will by deciding which specific stocks or bonds to buy. I’ve only made it worse by convincing you that you also need to consider whether your money is invested in dollars or shekel. (No need to thank me – that’s what I’m here for.)

This blog is on the “internet,” where there is already enough written about “how to allocate your portfolio” to make your head spin. I see no reason to be redundant on this topic. If you want to make your head spin, you could easily just pour yourself four large glasses of wine. That is why I recommend that you sip – not gulp – that wine as you think about how to allocate your investments.

The 60/40 Portfolio

The 60/40 portfolio allocation is the starting point for most allocation strategies that you read about on the “internet.” You can find plenty of articles on it from the basic to the advanced, but only at Investing by Accident can we say that anyone who wants to understand asset allocation must read these 3 principles:
  • Stocks historically have performed much better than bonds. This makes us want to put all of our money into stocks. However, the trouble is that they fluctuate considerably in value. This means that for any given time, we could see a huge drop in the value of our investments. We do not like losing money, even though we’re pretty sure over time that it will recover.
  • Bonds historically have not performed as well as stocks. This does not want to make us put all of our money into bonds. However, they fluctuate relatively less than stocks. This means that in any given year, we can usually count on having our money if we keep it in bonds. We like having money. 
  • Stocks and bonds tend to fluctuate in value differently, at different times. This means that on average they will not have good years and bad years at the same time.
At this point, the people who understand math came along and discovered that if you allocate 60% of investments to stocks and 40% to bonds, you can gain much of the benefit of the traditional gains from stocks while minimizing how bad you will feel during the times when the values of stocks decline. This was certainly enough for us to say “thank you,” but the experts still came along with more.

Making it Complicated

The experts began to ponder each part of the 60/40 and wonder which investments within “stocks” and “bonds” were really the best. They were motivated by the fact that any expert who expounds on the virtues of asset allocation is considered praiseworthy.

They analyzed whether it would be best to invest in large, medium or small companies. Then, they considered whether it was better to invest in “value” or “growth” stocks. Before long, the experts starting looking at where “real estate” and stocks with “high dividend yields” belong within the allocation. Soon thereafter, other experts began suggesting that thinking about stocks as “domestic” or “international” would be particularly interesting. More recently, experts have been looking at “alternative investments,” but we simply do not have enough wine for that.

In bonds, the choices are much simpler, but there is still enough room for experts. Should you invest in long, intermediate or short bonds? Should they be regular bonds or inflation protected?

So Now What!?
I have been struggling with how to allocate investments for as long as I can remember having money. I guess that wouldn’t be very long. But still.

There are many highly intelligent systems that you could follow that should make it very easy. I recently came across Paul Merriman’s investment approach which contains a lot of wisdom that I’ve read about in other places as well. He even translates his allocation recommendations to a practical guide by listing the ETF’s that you could buy to use it.

I want to allocate my portfolio just the way Paul did at the time that he allocated his, but I find myself struggling to come up with a plan. The first challenge is that I’m never quite sure whether I want to be “aggressive” or “conservative.” I like to think about myself as a “moderately aggressive Orthodox with a cynical conservatism” which just isn’t one of the options.

The other issue is that even when I think I know precisely what I want to invest in, I find it almost impossible to apply the allocation. I have 10 different accounts (5 retirement and 5 non-retirement) in two different countries.

I suppose that 10 should be manageable, but I have to balance it against investment options that are limited in different ways in each account. Worse still, there are 25 words in the last sentence and 10 times 25 is 250 which is a lot of plagues.

If so, you should refill your cup now, which could only mean that are you wondering…

How is Investing by Accident’s advice on allocation different than all other advice?

The obvious answer I could give you is that we were slaves to our money before you read this blog, but that would be too easy.

The less obvious answer is that my advice is to think about the different kinds of money that you have and allocate each one according to its own special nature.

In other words, this blog speaks to the 4 types of money: Wise, Wicked, Simple and I-Have-No-Idea. I’ll explain them in increasing complexity:

Simple Money. You have a certain amount of money (hopefully, less than or equal to your monthly income) that you are using for your expenses (food, shelter, clothing, bank fees, etc.). This money is very easy to invest because you shouldn’t be investing it at all. You should just keep it cash and use it to pay your bills. It’s also fairly straightforward to think about which currency to keep this in. Just keep it in whichever currency your expenses are in. For me, it is about 95% in shekel and 5% in dollars. 

Wicked Money. I was recently reading an article about successful investors and was inspired by one of the ideas that they shared. The idea came from a wealthy investor who always keeps $2 million sitting in a reserve account. This way, he never has to touch the money that he has invested. I suppose he is thinking that he may want to suddenly buy a house and does not want to have to worry about selling stocks.

In any case, I think this is a very good idea. You want the money that you invest to be off limits until you reach your financial goals. That is the only way you will be able to take a long term perspective on the investments.

To figure how much you should keep in backup, I recommend that you think about all the terrible things that could go wrong and consider how much cash you would like to have on hand to see your way through them. Personally, that makes me too sad to think about so I just use 6 months after-tax salary as my guide.

It makes sense that this money would just be sitting in your checking account; or, you could invest it in a short term deposit like a money market. If you are living in Israel, the emergency that we hope will never happen will most likely occur in shekel, although it may be so far away that having dollars is not really an issue. I wouldn’t know, I don’t think about bad things. I keep it allocated 75/25, with the larger part in shekel.

Wise Money. I skip now to retirement money because it is the next easiest to think about. This money is like the very opposite of the money that you are using to live right now. It is money that you are planning to use to live when you retire. If you are very far away from retirement (25+ years), you can allocate a great deal of this money to stocks. If you outlook is shorter, you will want to decrease the stock allocation accordingly. I personally try to allocate 80% to stocks in my retirement accounts.

In terms of shekel or dollars (or other), it also depends on how far away retirement is. The further away, the less fluctuations in currency should matter. I like to keep all of the money that is not in stocks in its local currency and for the money that is in stocks, anywhere from 20%-80% of it invested in a foreign currency. The actual amount varies each year depending on exactly which markets look like the best value at the moment. I apply the same approach to foreign currency both for retirement accounts in Israel and in the U.S.

I-Have-No-Idea Money. The final category of money is all money which is not in the other categories. This means money in non-retirement accounts which you not using for daily living expenses and is beyond the amount of money you feel you need as back-up money. This money is certainly the hardest because I have no idea what it’s for. Some possibilities: 
  • Paying for celebrations such as bar or bat mitzvahs; or maybe, weddings
  • To help finance advanced education for your children
  • To leave over as an inheritance
  • Buying an insurance policy on your only goat
  • Early retirement
  • For paying down your mortgage in a case where interest rates rise and you can no longer afford it
  • Buying a new car
  • Buying a second home
I have given these possibilities an acronym to make it easier for you to remember them: PT”T BE F”BB. Much easier now, isn’t it?

In these cases, it seems to me that the time horizon for this money is like a moving target. For some of it, I think I may want it earlier, perhaps in about 5 years. For other money, I think I may not need it for 10 years or longer.

I’m sufficiently confused with this money to not be entirely sure what to do with it. However, because I already have money in backup which I could use for some or part of these expenses, I feel comfortable taking a longer term outlook. That’s why I have opted for a classic 60/40 allocation between stocks and bonds for this money. I also balance it 50/50 between shekels and dollars. On the one hand, I will most likely want to buy things in shekel with this money; however, outlook is long enough that I’m not overly concerned with currency fluctuations. Obviously, if your family is traditional, your wife should address this money.

One last thought on the different types of money. How should you think about money that you are planning to use to buy a house in the next few years?

Honestly speaking, this is Simple money. No one wants to be left out as the stock market skyrockets, but you should take into consideration that stocks have wide swings in value. Any money that you invest in stocks may not be there when it’s time for your next house payment. The same is true for longer term bonds; and also, for those with intermediate term. Changes in interest rates could significantly raise or lower the value of these investments in the shorter term.

Summary & Conclusion

In a single table, here is what my allocation plan looks like:

Checking Account
95/5, between shekel/dollar
Short Term Deposits
75/25, between shekel/dollar
Bonds in “local” currency, stocks between 20-80% in “foreign” currency
50/50 between shekel/dollar

So now, loyal readers, I have now given you all that I can to help you come up with your own plan. At this point, if you have any wine left, I recommend that you drink it, especially if it is almost midnight.

Oh, and one last thing…

Who Knows 13?

I do. It is the number of ha-ggadot in this blog. If can’t find them all, try holding this blog upside down. The answers are always there when you hold things upside down. 


  1. What is the category for investing in the Box or Candy Crush IPOs this week? Are those opportunities that should not be missed? Are you joining those high tech opportunities since you are a high tech guy? (even if we cannot play candy crush on Shabbat)

  2. I think Mr. Kramer answered it.*

  3. Danny - are you going to write an article about "selling short" next week? Should we sell KING short?

  4. The question about IPOs and KING is really a question about when to buy anything. I'm going to speaking to my daughter's class about this very issue at the end of April and I'll publish the results of what her class thinks in May. I'm pretty sure they are not experts so we can trust what they say.

  5. I am excited to hear about the young Likud investment club from her school! ;-)

  6. Are you going to create a Yammer chat group? I heard that they have a new iOS app for Yammer and you can also get Office for the iPad. Is the group you are working at Microsoft? Can we become beta testers since we know you? Is there any recommendations for how you can use Visio to map out an investing strategy?

    1. As a rule, I will not talk about the company I work for on the blog. The only exception would be in the context of being a shareholder or as any ordinary customer of their products.

      In terms of mapping out your investment strategy, clearly the best tool would be a seder plate. :)

      I use a spreadsheet to keep track of my investments since they really are in 10 different accounts. I never thought about using a tool like Visio. How would it work?

  7. We do something similar. We split up our investments to high and low risk funds. Then, for each thing we're saving up for(Retirement/new car/college fund/emergency fund) we allocate from those two funds according to how soon we want to be able to access the money. i.e. retirement 100% high risk, emergency 100% low risk, new car 20% high, 80% low, etc.