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DEAR FAMILY, YOU KNOW I don’t typically give unsolicited investment advice. But today, I’m breaking that rule, because I don’t want you to get hurt financially.
I can’t promise that, by following my advice, you’ll be better off in the short run. But I firmly believe that you’ll be better off in the long run, by which I mean in the next five to 10 years. Please take this letter for what it is, simply a warning and food for thought. Ultimately, you must make your own decision.
1. If you’re fortunate enough to have large gains in growth stocks such as Amazon, Apple, Facebook, Microsoft, Netflix, Tesla and Zoom, I urge you to take some profits. At a minimum, I recommend selling an amount equal to your cost basis—what you paid for these stocks. If you have great conviction in these companies, hold whatever remains after selling your cost basis. That way, you cannot lose. If these stocks drop dramatically—I’m not necessarily predicting that—you’ll still have a profit because you’ve sold your cost basis. These stocks are selling at extremely lofty valuations. History is clear: Trees do not grow to the sky, and nor do growth stocks.
2. If you’re overweight U.S. stocks and underweight international stocks, rebalance into international. The U.S. market has trounced international stocks since 2009, with the S&P 500 up 261%, versus 37% for developed international markets and 86% for emerging markets (excluding dividends).
How much should you have in international stocks? I advocate allocating at least 30% of a stock portfolio to international. But if you’re like most people, you’ve given up on international stocks and are overweight U.S. shares. This is exactly the wrong time to take such a position. Valuations matter. There’s simply no question that the U.S. is among the world’s most highly priced markets.
What’s the cheapest? Emerging market stocks. While I don’t recommend that you follow my footsteps, I have almost no U.S. stocks. Almost my entire stock allocation is international. This is extreme and I don’t recommend you do this, but I mention it so you know how much conviction I have.
3. Again, if you’re like most people, there’s a good chance you’ve given up on value stocks. For what seems like an eternity, growth stocks have triumphed and value stocks have underperformed. The valuation disparity between the two has never been so great, perhaps with the exception of the market peak in 2000. If you’re overweight growth, do yourself a favor and rebalance into value. You might take some of the proceeds from your sales of growth stocks and put them into value stocks and, better yet, international value. One of my favorites is Dodge & Cox International Stock Fund (ticker: DODFX).
4. My final piece of advice: Have a small amount of gold exposure. This could be accomplished by buying an exchange-traded fund (ETF) such as SPDR Gold Shares (GLD) or iShares Gold Trust (IAU). When I say “small,” I’m talking about 5% or less of your total portfolio. I personally have about 5% in SPDR Gold and 2% in VanEck Vectors Gold Miners (GDX). The latter is an ETF invested in a diversified basket of goldmining companies.
This is perhaps my most controversial suggestion, so let me explain. Over the past decade, and especially this year, there’s been extreme money printing by the Federal Reserve in the form of QE, or quantitative easing. Take a look at this chart, which represents how much money the Fed has printed. Next, check out this graph of U.S. money supply, particularly the far right end of the curve. On top of this, the Fed recently made a substantial change in policy. It’s now targeting average inflation of at least 2%, which means we may see higher inflation in the future to compensate for the recent far lower inflation rate.
The bottom line: Inflation is a greater risk today than ever before in my investing career. While there’s no guarantee that inflation will spiral out of control, think of gold as insurance for your portfolio. Normally, Treasury Inflation Protected Securities, often known simply as TIPS, would also serve as an inflation hedge. But their yields are currently negative, which is not terribly attractive, though they would certainly provide some protection if inflation spiked higher.
My first three points are based on two fundamental tenets of investing. First, valuations matter. Second, regression to the mean is real. Both principles argue for moving from growth to value and from U.S. stocks to international markets. I don’t have a crystal ball, but everything that I know about investing tells me the above advice is sound. Think about it.
Sincerely yours,
John
John Lim is a physician and author of How to Raise Your Child’s Financial IQ, which is available as both a free PDF and a Kindle edition. His previous articles include My Bad, Six Lessons and Risk Returns. Follow John on Twitter @JohnTLim.
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Sorry, but this is foolish advice. If you buy some winners hang onto them !
My guess is the very strong value orientation at Dodge and Cox, which is consistent with the thrust of the article. VXUS and VWO are couple of ETF’s that also check the boxes, or their identical twins in mutual fund flavor. The next decade is going to be interesting.
Dear Family,
Take my advice and ignore John Lim. Any so-called expert who advises you to “buy gold” or to invest a substantial portion of your life savings into such specific sectors as 100% emerging markets, or “international value,” should be avoided. I’m surprised to be reading an article with such misguided advice on Humble Dollar.
Reread this article after waking up some more, Ben. He didn’t advise readers to invest 100% in emerging markets, and he never mentioned international value. What article are you reading?
I think that you’re correct that most investors would do far better with a diversified buy and hold portfolio, rather than trying to time the market per any advisor or guru.
At the same time, I think you are mis-characterizing John’s post. His advice would not be unreasonable for an experienced investor who understood the risks involved and found that it jived with their own considered opinion, and was then applied with judicious perspective. However, as advice to the general populace, my opinion is that it’s unfortunately problematic, despite the caveats.
Agreed. Wow, disappointing to read this. I would definitely not agree. Jonathan – time to start vetting your contributors.
Nailed it again !!
Loved the article John, thank you. You do a great service in challenging prevailing opinions and making us think about the most important part of our investments: asset allocation. For me, the big question for the coming decade is not about whether to increase my non-US allocation, but by how much. I feel the same way about inflation, but prefer the real return of equities over the long-term to deal with it.
Regression toward the mean clearly applies when there is random variation of a normally distributed variable, which is why short term market variance is greater than long term variance. Likewise, the short term variance of both value stocks and growth stocks will be greater than their long term variances. However, given that the two types of stocks are conceptually different I have doubts that conditions underlying the statistical definition of regression toward the mean can be used to support your argument that value stocks are likely to outperform growth stocks in the near future.
There is nothing unreasonable about this advice, within context. I suspect Value, EM, Int’l will all do well over the next decade (also, small and mid caps.) However, it’s also dangerous advice that most investors would struggle to implement effectively. To borrow a phrase, I prefer time in the market to timing the market.
1) I have a small allocation to NASDAQ stocks. I offset that with an LCV fund. I see no need to change that, the net is reasonably neutral.
2) International/EM has both led and trailed the US the past several decades, but has trailed the US the past 10 years. However, not for this past month. If you’re diversified, you didn’t have to time the market – you just stay the course.
3) If you are in diversified index funds, you don’t need to guess whether value or growth is going to do better.
4) For two decades we have experienced inflation in things we need (education, healthcare, food), deflation in things we want (cars, gadgets, TVs). There’s modest indications of that changing, but if it does, gold doesn’t do a great job of protecting against inflation. A 5% allocation to gold has helped most portfolios slightly over the past 5 decades, so it’s a reasonable idea – but as long as one’s time horizon is long enough, stocks have outpaced inflation.
5) I’m convinced statistical concepts as applied to stocks are of modest value. Stock returns are not random and returns do not form a bell curve. Most people don’t realize that the median stock (ranked on returns) has negative returns each year. Yes, statistical methods can be useful, but their application to stocks can also flip on you in a New York minute.
Regression to the mean requires static conditions. Economic & regulatory conditions have seen substantial shifts these past 20 years. I’m less than confident that all asset classes will return to past normative averages relative to one another.
“For two decades we have experienced inflation in things we need (education, healthcare, food), deflation in things we want (cars, gadgets, TVs).” Thanks for the thought-provoking comment! I’m definitely going to steal that insight.
I appreciate HumbleDollar for the spectrum of opinions, and (hopefully) the spirited but not mean-spirited discussion. Read this with intrigue, as it may be a bit controversial, and welcome the comments and thoughts regarding John’s basis for his recommendations,”based on two fundamental tenets of investing”. Personally, I never get past one, “past performance is no guarantee of future results”. Waiting for valuations to “regress to the mean” and for the “return of value” have always struck me as an expectation to return to past performance, and in my own investing career would have been stunningly underproductive. I lean more towards playing a “weighted field”, i.e. diversification with exceptions that won’t ruin me if they’re wrong. Over the past 25 years with a buy and hold (ok, i’ll be honest, a “buy and forget”) strategy, health care and tech have been flyers that have, for lack of a better term, flown into space. But the base bat on the S&P 500 and large cap growth hasn’t been shabby either. Following John’s advice now seems to be excess risk on some assumptions I don’t agree with, that there will be some “reconing” in the coming years. Welcome thoughts as to what gravitational effect would have us either devaluting stocks or shifting to value (may by synonymous).
What structural economic factors are goiing to drive this surge in inflation? The last time there was significant inflation it was driven, in part, by oil prices. Is globalization about to reverse in the near future? If the US and China divide the world into spheres of influence that could be perilous for inflation. Is the tremendous growth in sovereign debt exhibited by the major powers going to raise inflation? Do you see a resurgence in oil? On the other hand, if there are serious efforts to address climate change, what does that do to oil?
Is there really anything wrong with those individual stocks you talk about as long as the investor keeps no more than 5% or so of these particular stocks or any other individual stocks in a portfolio? Investment performance is all about managing the volatility of the various components of a portfolio. For the rest of us, investing is about making a series of bets without betting the farm on any one thing which you appear to be moving slowly toward doing.
Wow, I thought I was one of the only ones to almost totally sell off the US market based on all the points you have mentioned! The Shiller Cape 10 is the 2nd highest its ever been in 140 years! US vs international market performance ALWAYS rotates. I actually am probably more extreme as I have 50% emerging markets including emerging markets VALUE which has perhaps been the biggest underperformer. For US, I have an ‘absolute value’, very conservative small cap value fund run by awesome, proven absolute value managers – PVCMX. And large and small cap developed nations international funds as well. Like yourself, I feel strongly that if you’re able to hold on 7-10 years if need be, one will be quite rewarded over time. And as this outperformance happens to varying levels, periodically take $ off this allocation table and rebalance, obviously that’s the toughest part, not to get greedy as mean reversion eventually happens. Yes, it’s timing, but longer term timing with history consistently on your side (i.e., mean reversion). I don’t believe in ‘this time it’s different’.