What to Do with Your 'other Money'? 401k or 'Other Non-trading Account'

[Frank 10]

This thread is to discuss strategies that relate to your ‘other money’ --- the money you either have in a 401(k) or another more conservative account not marked for intraday trading.

 

My professional background was in asset management. I realized 5 or 6 years ago that I really needed to learn trading better as when volatility becomes high, the trading aspect to money management increases in importance (this move paid off big-time in 2008). So I read book after book on trading. My favorites are Linda Raschkes Street Smarts & Jim Daltons Markets In Profile. I actually eventually went on to write a more formal book review of Daltons book on Traders Lab over two years ago here: http://www.traderslaboratory.com/forums/f6/markets-profile-detailed-book-review-3605.html

 

So after a career in professional money management (~10 years+ and a CFA charterholder) – as well as a ‘career’ in trading – I feel I have a nice diversified background to offer some perspective on how one complements the other.

 

I believe money managers can learn a lot from traders but traders have a lot to learn from money managers as well.

 

Successful money managers are good at finding good secular themes and sticking with them. Successful traders are good at understanding volatility and how to use volatility to make lots of money when the market is offering it -- while preserving it when conditions are not good for short-term trading.

 

I believe that this is where my background has led me --- to merge these two worlds into something coherent. This thread will discuss some of these ideas.

 

I believe that the fusion of these two worlds is in the Exchange Traded Fund (ETF). This product is actually a very sophisticated product masquerading as something that looks so simple. High-end Wall Street strategy is very often about a money manager calling up Morgan Stanley or Goldman Sachs to execute program trades that execute 'basket trades' --- these long lists of individual trades have the designed effect of altering a portfolios exposure away from one type of exposure and towards another type of exposure (exposure representing a theme, such as an economic sector, large cap vs small cap, growth vs value, stock vs bond, international vs domestic etc...). Well, guess what --- buying 100 shares of XLF (U.S. Financials) and selling 100 shares of EWZ (Brazil Fund) does the exact same thing -- except it does it cheaper. Call it the ‘mainstreamization of program trading baskets’. This is a very powerful (and disruptive) innovation which has destroyed the mutual fund model --- has destroyed many of the premiums options market makers used to get from selling options on 'index baskets' and has opened up access to new segments of the world previously inaccessible. While the mainstream world is trying to find stocks --- the real future is in finding 'markets' -- the regions and segments of the world that are the growth engines of the futrue. This is what ETF's represent.

 

This thread will discuss methods and strategies for your ‘other money’ --- focusing on ‘global ETF rotation.’ These will be a blend of longer and shorter timeframe strategies -- just not intraday.

 

Frank

[Frank 10]

A good ‘ETF rotation’ strategy can be based on the simple yet powerful concept of ‘Find Global Relative Strength’ and overweight it. This does not mean just equities – it can be anything from U.S. Corporate Bonds to Emerging Markets Infrastructure stocks to Country Funds like Canada, Brazil or Australia. The ETF marketplace has 1000 choices that represent many, many segmented trading baskets – all pre-packaged for you by professional index providers like MSCI and Russell and S&P. This is very advantageous -- MSCI is for example part of the same company that does very high-end institutional portfolio management software (the Barra unit of MSCI-Barra).

With some help from an automated software environment – you can find which region of the world and which asset class is showing good relative strength – and then create a portfolio that manages whatever the risk chartacteristics of the chosen markets is. High relative strength --- and risk-controlled through position sizing --- and some portfolio concepts that blend portfolios with low risk bonds or cash to dilute overall volatility to your personal risk tolerance.

Try out this relative strength application for an introductory example:

 

ETF Relative Strength Backtest

 

 

Disclosure: a friend and I developed this website to track global money flows -- it is all free.

[brownsfan019 17]

Great thread Frank. I do not pay nearly enough attention to this as I get wrapped up in my trading, so I hope you keep this thread going and give us some ideas to work with.

[DugDug 10]

On this note, a book that seems to be getting some press and covers this area. (I have not read it, and dont have the time to at present, but it might be of interest to this thread)

 

Amazon.com: A Practical Guide to ETF Trading Systems (9781906659271): Anthony Garner: Books

by AJ Garner (??)

 

Plus - I have only had a brief look - but great site for the ETFs Frank.

[Kiwi 16]

Anthony posts over at tradingblox and seems a pretty smart guy so I'd guess the book will be systematic and pretty good.

[Frank 10]

I am going to elaborate on my last post:

 

In a recent institutional research piece by Goldman Sachs targeted at European portfolio managers, they offer various ways to trade ‘the divergence theme in the Eurozone.’

 

 

In the note, they discuss the problems with domestic demand in Europe within the construct of strong global growth, led by the BRIC (Brazil, Russia, India, China) theme. This note was on April 28th and followed a similar note discussing a similar theme targeted at US portfolio mangers.

 

The basic idea of the note is to “Go long international growth & short Eurozone domestic demand.” In both research pieces, they do lengthy analysis of long lists of ‘basket trades’ that portfolio managers could do to implement this longer-term trend. The bottom line of these studies was to create a long basket of stocks (to be long) that has companies with high sales exposure to the strong parts of the world and create another basket with high sales exposure to mainstream Europe and go short that basket.

I should point out that these types of basket trades by portfolio managers may not be with a high level strategy in mind – perhaps you have a new account and you just want to get it invested in line with other accounts – or had some outflows from your funds and need to increase cash to meet the outflow.

 

To execute this, you would submit a list of trades, with quantities of shares, to a firm like Goldman or Morgan Stanley or Merrill Lynch and say ‘buy(sell) this basket of 70 stocks on the market close today.’ Then, Goldmans quantitative ‘experts’ figure out how they are going to both ‘guarantee you closing price’ – and make money for themselves. They ultimately do some kind of elaborate combination of trades that hedges themselves --- and can use the liquidity in the futures market with a hedge ratio or whatever else they do to create a profit for themselves – and then they charge an extra fee to the buyside firm to do the program trade.

 

Now – enter ETFs. Think about what you can do now – you can buy any of 1000 pre-set trading baskets that were created by index construction experts at MSCI, S&P, Russell etc. In some cases, such as at Schwab or Fidelity, you can do this for zero transaction fee. Its like the world has aligned in favor of the small investor/advisor here. This is very powerful.

 

I should go on to note that in this most recent research piece by Goldman on ‘trading the divergence’ --- they spend nearly 1/3 of the report going into backtests of their newly created trading baskets. Well, with ETF’s – the trading history total return chart of the ‘basket’ is known. You don’t have to simulate it with high-end, expensive portfolio management software --- you can just run the total return chart.

 

 

So this is the power in ETFs: 1) the index has been constructed for you by index experts already (the people at firms like MSCI are every bit as smart (I would say smarter) as the people at your typical large financial institution) – they know what they are doing. 2) the trading history of the ETF ‘basket’ is known and 3) you haven’t done any actual work yet and you are already analyzing the characteristics of the ‘ ETF basket’ (its volatility, out/underperformance, historical relationships etc).

 

The bottom line is that banks makes good money recommending these kinds of things for portfolio managers. The longer the list, the more the profits. Big portfolio managers with huge assets under management cannot buy most ETF’s – the ETF’s just aren’t big enough. But you – as the small advisor, small hedge fund or individual investor can -- and that is what our site is all about -- leveraging the inherent and underrated power that ETF’s bring to neutralize the investment landscape.

 

(by the way, our relative strength model pointed towards this weakness in Europe months before Goldman wrote research on this – just go into the ETF screener and move the date back to January and see for yourself)

 

Frank

Edited May 1, 2010 by Frank

[TheDude 10]

It is quite interesting what strategies ETF's can allow.

 

Not a trade, but just something I'm following (since Feb this year) to get other ideas flowing is

SPXU & BPO (buying both)

 

SPXU is an ETF that is short the S&P components. In other words, if you buy this, you are short the S&P. Thats interesting to me because it seems to be targeted at those who have a bearish view of the S&P, but do not like the idea of going short; perhaps long only fund managers (I don't know if I'm joking there???!!), or retail traders who dont like the perceived risk or too traditional to take the margin account.

 

BPO is simply the stock with the highest Beta that I could find, currently at 1.99

 

An interesting pairs trade which to my thinking in a bull market should pick up volatility returns of BPO, while taking out the returns of the stock market. I'm collecting beta.

 

Like I said, this is just something I'm tinkering around with. I know it could be done better with options, or better product choice - the main purpose is to see how it behaves which in turn generate other ideas....

[Frank 10]

In my experience, Betas are not stable -- something might have a really high beta looking back but then suddenly just trade with the market for a 0.99 beta.

 

The other thing is that volatility itself is not static -- so a high beta in a high vol market might be tricky when vol goes dead:

 

http://www.etfreplay.com/etfimages/vol99.png

[Frank 10]

here is what you don't do with your retirement money.

 

crazy video of Thursdays intraday action:

 

[TheDude 10]

lol. Sounds like the horse race of all horse races! (Which I guess it was)

[MightyMouse 12]

Frank,

 

Why take a risk with your retirement money?

 

American have bought into the bull shit that mutual funds have been pitching to the public so that they can make money while you take the risk.

 

If you're going to take a risk with retirement money, then risk maybe 5% or so, but nothing more than that. Anyone who's 401(k) advisor had them in assets that went down in value during 2008 2009 should sue for damage and the advisor should go back to selling cars.

 

Why would you want to take a chance on having less money than you are supposed to have in retirement? Really think about that. If your risk of having less money is "only" 1 in 10, is that way to high? Keep in mind that each of the 10 instances for this chance bet is a lifetime of retirement savings and not a quickly repeatable monte carlo simulation, It just so happens that the win/loss determination of your "lifetime retirement savings bet" occurs when you are tired or working or infirm, and less valuable to the workforce.

 

From some of your other posts I see that you enjoy mulling though historical data. I challenge you to find a period of time within the last 40 years that you would not have been better off invested in treasuries than in the S&P. And if you need to, compare that to how often you would have been worse off and then decide if taking a risk is worth it.

 

I take retirement investing very seriously.

 

My 2 cents

[Frank 10]

mighty mouse,

 

did you read the posts above? the point of the thread is to enhance return and reduce risk -- you made some big assumption about having to sit long in some regional equities (S&P 500)?

 

there are so many options so easily available. you can be in treasuries, corporate bonds, real estate, preferred stocks, convertible sotcks, emerging markets equities, emerging market bonds, sector funds, currencies, industry funds, gold, copper, silver etc --- and the choices grow every month as more and more of these things come out, get trading histories and become liquid.

 

check out my blog on the site. sheesh, I even posted the Goldman 'short europe' research on this site on May 1st. You saw what happened this week. europe collapsed --- even long US/short Europe pair was very solid winner. While you can't sell short in a 401k --- there are inverse funds getting liquid for such types of LOWER risk long/short ideas (volatility is lower/less risky in a long/short environment). you certainly can follow global trends and keep your portfolio generally in line with what is going on --- simply by adding or reducing risk in line with some of our backtested models on the site. that is the beauty of portfolio management -- you choose the level of risk and volatility that is right for you -- and you can structure themes into your own personal risk-tolerance. buy and hold the S&P 500 is for the birds.

 

examples of recent leadership on long side:

Long bonds

Long gold

Long 2x inverse Euro

Long Dollar Index

Long inverse U.S. Basic Materials

(all of these are liquid enough)

 

Your logic missed the entire point of this thread.

[MightyMouse 12]

  Frank said:

mighty mouse,

 

did you read the posts above? the point of the thread is to enhance return and reduce risk -- you made some big assumption about having to sit long in some regional equities (S&P 500)?

 

there are so many options so easily available. you can be in treasuries, corporate bonds, real estate, preferred stocks, convertible sotcks, emerging markets equities, emerging market bonds, sector funds, currencies, industry funds, gold, copper, silver etc --- and the choices grow every month as more and more of these things come out, get trading histories and become liquid.

 

check out my blog on the site. sheesh, I even posted the Goldman 'short europe' research on this site on May 1st. You saw what happened this week. europe collapsed --- even long US/short Europe pair was very solid winner. While you can't sell short in a 401k --- there are inverse funds getting liquid for such types of LOWER risk long/short ideas (volatility is lower/less risky in a long/short environment). you certainly can follow global trends and keep your portfolio generally in line with what is going on --- simply by adding or reducing risk in line with some of our backtested models on the site. that is the beauty of portfolio management -- you choose the level of risk and volatility that is right for you -- and you can structure themes into your own personal risk-tolerance. buy and hold the S&P 500 is for the birds.

 

examples of recent leadership on long side:

Long bonds

Long gold

Long 2x inverse Euro

Long Dollar Index

Long inverse U.S. Basic Materials

(all of these are liquid enough)

 

Your logic missed the entire point of this thread.

 

Frank, I honed in on "retirement money."

 

Retirement money is money that is going to provide you income during your retirement. Your "other" money is likely going to provide income in retirement too if you have any left. You do not want to introduce market risk into money that you are going to need in retirement.

 

I did read your thread and my post addressed 95% of the money you are talking about. 95% of your money should be invested in the safest, highest yeilding investments you can find. Only 5% of it should be invested in the high risk investments. So, in essense your thread deals with what you should do with 5% of your other money.

 

A good long term guess of what to do with that 5% is to invest it in a leveragerd portfolio that will benefit in a long term rise in commodities prices, Structure it so that it will never have an affect on the other 95% of your money. With global cash printing presses running, at some point hyper inflation has got to come back. If I am wrong, then your money is 100% safe plus interest. All the backtesting in the world isn't going to tell you what is going to happen in the future.

 

Goldman made a great guess on Europe. I suggest you check Goldman's track record; specifically, how many of Goldman's recommendations didn't perform. But for the time being, kudos to Goldman.

 

I am also assuming that when you say "other money" that you are referring to money other than your trading capital, as in money that you intend to invest for the long run. Some of the suggestions you have listed above are short term in nature which has the effect of moving the "other money" into your trading account.

 

I know my post goes completely against the grain.

 

 

MM

[Frank 10]

<<95% of your money should be invested in the safest, highest yeilding investments you can find. Only 5% of it should be invested in the high risk investments. So, in essense your thread deals with what you should do with 5% of your other money. >>

 

you can pursue some 'tactical ideas' and still implement them in very conservative ways. you could be 5% gold / 95% short-term bonds. or I could be 30% long US equities and short 30% Europe and long 40% gold. this website allows you to simulate these types of things and gauge for yourself how risky it is. For example, the 30/30/40 portfolio just described is materially less volatile than the standard 60/40% stock/bond portfolio described by John Bogle.

 

 

 

then you can look at the trailing volatility for a standard 60/40 portfolio during the 'stress test' of 2008 to gauge how risky that is... trailing 36 month volatility is 6.4% for this portfolio vs 30.1% for the S&P 500. I am trying not to be rude here -- just trying to help you educate yourself on these things that are admittedly complex. holding 95% short-term, risk-free assets for retirement that is far off is just ridiculous.

 

if you can't handle 1/5th the volatililiy of the S&P 500 despite a long-term time horizon to retirement all because the world is just too scary, then you are right, this isn't for you.

 

Edited May 8, 2010 by Frank

[MightyMouse 12]

  Frank said:

<<95% of your money should be invested in the safest, highest yeilding investments you can find. Only 5% of it should be invested in the high risk investments. So, in essense your thread deals with what you should do with 5% of your other money. >>

 

you can pursue some 'tactical ideas' and still implement them in very conservative ways. you could be 5% gold / 95% short-term bonds. or I could be 30% long US equities and short 30% Europe and long 40% gold. this website allows you to simulate these types of things and gauge for yourself how risky it is. For example, the 30/30/40 portfolio just described is materially less volatile than the standard 60/40% stock/bond portfolio described by John Bogle.

 

 

 

then you can look at the trailing volatility for a standard 60/40 portfolio during the 'stress test' of 2008 to gauge how risky that is... trailing 36 month volatility is 6.4% for this portfolio vs 30.1% for the S&P 500. I am trying not to be rude here -- just trying to help you educate yourself on these things that are admittedly complex. holding 95% short-term, risk-free assets for retirement that is far off is just ridiculous.

 

if you can't handle 1/5th the volatililiy of the S&P 500 despite a long-term time horizon to retirement all because the world is just too scary, then you are right, this isn't for you.

 

 

Frank,

 

I have been advising clients since 1988 and currently manage 7 figures in assets. Very high 7 figures. I regularly acquire new assets because other advisors have rendered poor advice. I own my own firm because I did not fit in with the conventional planning firms. Because of my success, I could easily expand, but at my age and current mind set, I am just not into the added aggravation that comes with expansion, and in fact hope to be winding down as soon as I can.

 

I made no mention of short term securities. High yielding guaranteed investments are not short term. Low yielding guaranteed investments are short term. I can invest a client’s asset and get him a +- 20 year investment that yields him 8% a year guaranteed with 100% guaranteed principal. A little bit of thinking outside the box.

 

Each of the portfolios you are describing, other than the gold bond mix, is far too risky for money that you are going to need for retirement. The only time that the latter two portfolios have performed properly is in the past. What happens if stocks remain flat? What happens if your short allocation in Europe recovers faster than US stocks creating a net loss where as the client would have been better off simply in US stocks?

 

What do you tell a client whose portfolio of stocks is still down 25% since the beginning on 2008? Let’s hold on? Stay the course? Are you going to be able to guarantee them that by retirement they will have all their money back? What if what happened in the past doesn’t happen in the future?

 

I can guarantee you that when you explain the risks and rewards to your clients; they are focused on the rewards and not the risks.

 

I am sure you have faith in the models and tools your firm lets you use.

 

I learned to manage money from my wealthiest client who is a venture capitalist. I manage a very tiny piece of his wealth. He only risks 5% of his assets. The rest is guaranteed. I ran with it and never looked back.

 

I am not trying to say what you are doing is wrong. I assume you are completely within the guidelines of what your broker dealer allows.

 

If you would like to continue this conversation, it is probably best if you pm me.

 

Best of luck

 

 

MM

[Frank 10]

fair enough. this thread is trying to be very specific and it doesn't sound like you actually want to be specific about any of your strategies or holdings -- so I wish you the best.

 

fwiw, what you say is not against the grain, I run into advisors with similar mentalities all the time. its kind of a variation on the banker 3-6-3 model: borrow at 3 percent, loan it at 6 percent and be at the golf course by 3pm. I say this with great respect for the virtues of the successful relationship manager (RM) business model -- its a nice life to earn a fee for simply clipping coupons for your clients.

Edited May 8, 2010 by Frank

[SIUYA 11]

I would have thought - Risk and retirement depends a lot on two things - how old the person involved is, and how much money they have and then also require.

(I will always asset allocate, as buy and hold in only one instrument is actually risky.... dont forget about inflation. When I retire in 25 years $1m aint what is is now - (unless we get Japan worldwide which could be a (slim) possibility ))

[Frank 10]

the time horizon and return objective are key aspects to the step 1 planning aspect of portfolio management.

 

after you get beyond that phase, you eventually get to strategy --- which is what I am talking about. 'capital market expectations' are formed and may change. the situation of the investor might change as well. so this aspect is considered dynamic.

 

whether you are 30 with some small retirement or 40 with a nice amount or 50 with a lot of money, in each case you would like good solid situations with relatively low risk. a trade like buying gold recently easily fits into any of these situations if your capital markets expectations see opportunity in gold.

 

so bottom line, we are all looking for good reward/risk ideas -- how you ACTUALLY factor those ideas into actual positions cannot really be generalized.