We had two outrageous stimulus policies: 1) the Fed (with no help from the fiscal side) to deal with the financial crisis of 2007-08, and 2) the fiscal policy to counter the pandemic of 2019-20 (which ultimately forced the Fed to Act).
Both events were completely unexpected, although the first was endogenous while the second was exogenous. The somewhat unprecedented economic policy – monetary and fiscal – affected not only the economy and the financial market, but also shook society in many ways.
In retrospect, the questions are 1) were they the correct policies, 2) what is the correct normalization policy, 3) what is the correct execution procedure. The Federal Reserve and the Administration are now in very challenging positions.
Stubborn inflation, the upcoming recession, and the controversial bear market have been major news headlines in recent months. The Fed rate hike is scheduled for this week (September 20-21).
The article is mainly to write a practical guide on how to start “investing and trading” for various investors: 1) active and recently discharged military force, 2) students, 3) new graduates, 4) new employees, 5) new 401 (K) holders, 6) new immigrants, 7) new heirs, 8) new divorcees, etc.
I have published 20 articles (2012 – 18) that are independent, that is, not only updated periodicals, but individually independent. The target investors were mostly elderly (over 50 years old).
Since my 21st article last week (September 12, 2022), my lens is on the younger crowd (50 and under) and investment beginners in particular.
Top to bottom is my foundation, first looking at: 1) macroeconomic conditions, second checking 2) microeconomic fundamentals, and finally analyzing 3) market data on stocks, bonds, and cash (where there are some variances).
The current investment condition
A recession is not in the near future in my opinion. The main tools for analyzing business cycles are composite indicators (leading, coincident, lagging, and inverted lagging leading to the leading with a long lag) and various diffusion indices.
The Terminal Rate (a classic late 19th century Swedish economist by Knut Wicksell or neutral, or natural) (which we can’t directly observe, so simulate with a little neo-Keynesian model, reinforced by artificial intelligence – AI) is 4.5%. Therefore, the worst inflation (such as in 1973 or 1980) was probably already behind us.
“Knut Wicksell… emphasized the concept of an equilibrium level of the rate of interest… In his 1898 book, Interest and Prices, he wrote that ‘there is a certain level of the average rate of interest which is such that the general prices have no tendency to move up or down’… In modern parlance, this level of the rate of interest is generally known as the natural rate of interest.”
(Speech by Fed Vice Chairman Stanley Fischer at the 40th Annual Central Banking Seminar, sponsored by the New York Fed in late 2016).
A bull market (started March 9, 2009) is still with us, per my previous article from September 12, 2022. Currently, the S&P 500 has moved along the surface of the bear market established on June 17 ($3636.87, that’s not intraday but closing price): 1) two weeks minus Momentums, 2) one week +M and 3) one -M again last week. When will we have a solid uptrend? Nobody knows.
As a long-term investor (5 years or more), you can start investing at any time (be it up or down, no trend, choppy or whatever): It really doesn’t matter.
The only issue is to select the best quality and lowest cost investment products and services of brokerage houses and mutual companies. You have to shop around extensively, looking at the right sources.
It is better to navigate the smooth and steady bull market, which is normal, rather than the sharp decline and volatile bear market that usually lasts about six months. Also, avoid margin lending, don’t try options (although TD Ameritrade advertises “Think or Swim”), and don’t initiate short sales whose loss is theoretically unlimited. Currently, I defensively trade only three short ETFs (DOG, SH, and PSQ, which are short DOW, S&P 500, and QQQ, respectively).
However, as a short-term trader, you shouldn’t jump into the water without patiently testing the waves and temperature or the sharks. After going through a long and complicated learning curve, I would start with pen and paper first, and then gradually increase the trade: My current betting limit (1% of my account balance), the frequency (as many as possible), and the the threshold of a profit (+1% above cost) would be used.
I currently allocate 30-40% (depending on market conditions) but probably shouldn’t exceed 5% of your total money like I did until 2020.
A portfolio is not just a group of stocks and bonds, but a selection of stocks and bonds supported by portfolio theory, which historically show negative correlations with each other. Some ETF portfolios are recommended. I never offer any individual shares.
My top dozen ETFs are:
Vanguard Total Stock Market ETF (VTI)
Schwab US Broad Market ETF (SCHB)
Vanguard Total Bond Market ETF (BND)
Schwab US Aggregate Bond ETF (SCHZ)
Vanguard Short-Term Inflation Protected (VTIP) Index ETF
Schwab US TIPS ETF (SCHP)
Vanguard Total International Stock ETF (VXUS)
Schwab International Equity ETF (SCHF)
Vanguard FTSE Emerging Markets ETF (VWO)
Schwab International Small-Cap Equity ETF (SCHC)
Vanguard Total International Bond ETF (BNDX)
SPDR Bloomberg Barclays International Treasury Bond ETF (BWX)
(Note: Trading in all ETFs and individual securities online is free at Charles Schwab and TD Ameritrade.)
For long-term investors (at least 5 years), a dozen ETF templates are illustrated for your convenience:
T.60:40 – VTI (60%) BND (40%)
T.60:40 – VTI (50%) VXUS (10) BND (30%) VTIP (10%)
T.60:40 – VTI (50%) VXUS (5) VWO (5%) BND (30%) VTIP (5%) BNDX (5%)
T.50:50 – VTI (50%) BND (50%)
T.50:50 – VTI (40%) VXUS (10) BND (40%) VTIP (10%)
T.50:50 – VTI (40%) VXUS (5) VWO (5%) BND (40%) VTIP (5%) BNDX (5%)
S.60:40 – SCHB (60%) SCHZ (40%)
S60.40 – SCHB (50%) SCHF (10%) SCHZ (30%) SCHP (10%)
S60.40 – SCHB (50%) SCHF (5%) SCHE (5%) SCHZ (30%) SCHP (5%) BWX (5%)
S.50:50 – SCHB (50%) SCHZ (50%)
S50.50 – SCHB (40%) SCHF (10%) SCHZ (40%) SCHP (10%)
S50.50 – SCHB (40%) SCHF (5%) SCHE (5%) SCHZ (40%) SCHP (5%) BWX (5%)
Note: T: TD Ameritrade and S: Charles Schwab.
The Permanent Asset Allocation (‘PAA’) vs. Rebalance (‘RB’)
I have advocated for PAA for many years:
What are the relative merits of PAA (which is my preference), compared to Rebalancing (RB) (that’s the advice of Vanguard and others)? Think very carefully as a long-term investor.
First, RB requires good timing, which should be a challenge. We simply don’t know WHETHER an asset category (ie stocks) peaks and holds (meaning the top one would go up continuously) over time OR NOT.
Second, and more importantly, comparing the current prices of two asset categories is likely to be misleading. Because bond yields are much higher than stock dividends, and some portfolios don’t even reinvest dividends.
Third, PAA provides unwanted dollar cost averaging (DCA), which is an excellent systematic investment timing strategy. Younger investors can accumulate (or save) money with small amounts regularly over a long period. PAA provides them with DCA as a by-product, but not RB.
Fourth, PAA is more tax-advantaged than most non-tax-deferred (‘TDA’) accounts. Since tax-deferred TDAs like IRAs must be paid off eventually, a careful tax plan is required for all accounts—taxable or tax-deferred. The elderly (over 60 years) in particular should consider PAA instead of RB.