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VWO: Good Diversification At A Low Cost

I have made no secret of the fact that we are in the process of transitioning our portfolio allocation such that our portfolio’s core will be comprised of mostly passive index investments . We feel there are several advantages to this approach, but the biggest reasons for the transition are: Greater diversification while achieving tremendous time savings I don’t believe there are enough Great/Amazing companies to build a portfolio around Our intention is adjust the core of our portfolio to consist of relatively non-correlated assets. With those parameters, we can hold this passive index core year in and year out and only have to rebalance periodically. In the past I have talked about the various ETFs we intend to own. Vanguard’s FTSE Emerging Market’s ETF (NYSEARCA: VWO ) is one of them, and I profile it below. Emerging market equity investments have struggled over the past few years. Below you can see how VWO has performed over the past 5 years, compared with the S&P 500 (using SPY as a proxy). While the bull market in US equity investments has surged higher, an investment in Vanguard’s FTSE Emerging Market ETF would have lost about 28% of its principal (excluding dividends). Click to enlarge The tremendous disparity in these returns has scared some investors out of investing in emerging markets, but this is the wrong call for our portfolio. Truth be told, I am not saying that every investor should have an allocation to emerging market equities. I won’t pretend to know YOUR personal hopes, goals, etc. If, however, you have chosen to include emerging markets as part of the plan for your portfolio, you must be happy with the poor performance of emerging market equities over the past few years. I know I am. Our most recent purchase of VWO shares was at $28.37 per share, but we made earlier purchases at higher levels. We, my wife and I, believe that exposure to emerging markets is an important part of our portfolio, and we have a great deal more money we would like to allocate to this asset class. Lower prices means that we get more for our investment dollar, but more importantly it also means that we are buying more of profits of the underlying businesses with the same investment. So what do you get when you invest in Vanguard’s FTSE Emerging Market’s ETF? Well for starters, you gain exposure to more than 3600 stocks scattered throughout emerging market economies. Below is a table from Vanguard’s website of the countries with the largest exposure to VWO. The exposure is weighted more heavily toward Chinese companies than I would prefer, but on the whole this fund provides excellent exposure to quite a few different economies. Additionally, being a Vanguard ETF, the fund’s expense ratio is very low at 0.15% annually. On their website, Vanguard claims this is lower than 90% of the fund’s competitors. The less money an investor shells out in fees, the more of the investment return that investor makes. Over time, those savings compound every year. Below is a table listing the 10 largest holdings in the ETF. Many of the company names are probably recognizable to you. Many of these companies are considered the “blue chips” of their respective countries. These businesses are some of the largest and best known companies in these markets. It is important for me to know my circle of competence, and I am aware that I do not understand emerging market businesses as well as I do American companies. The transparency of company filings and foreign accounting practices generally keep me from investing in individual companies that are based in emerging market economies. Using a vehicle like Vanguard’s FTSE Emerging Markets ETF allows me to gain my desired exposure, while also diversifying away the risk that a few individual companies are fraudulent and corrupt. Clearly these companies are found across the spectrum of industries. A breakdown of VWO’s sector representation can be found below. I am pleased with this diversification because it spreads the risk of industry specific downturns across all industries. It’s very convenient to have exposure to such a range of economies, industries, and companies from a single emerging market index ETF. As discussed earlier, the stocks of many emerging market companies have taken a drubbing over the past few years. According to Vanguard, the average price to earnings ratio of the companies found within Vanguard’s FTSE Emerging Markets ETF is 14.8 and the ETF pays out a dividend yield of 2.9%. Those both compare favorably to the S&P 500’s (with SPY as a proxy) price to earnings ratio of 16.77 and dividend yield of 2.17%. Most importantly, we are gaining exposure to economies that are growing, and demographic trends ensure these economies will make up a larger portion of global GDP in the future. Disclosure: Long Vanguard’s VWO ETF. This article is for informational purposes only and should not be considered a recommendation for anyone to buy, sell, or hold any equities. I am not a financial professional. The information above is provided by Vanguard.com and Yahoo Finance. Disclosure: I am/we are long VWO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The Rational Vs. Irrational Investor

By Kevin Hansen, Director Business Development – Retirement Solutions, Principal Financial Group, Principal Funds Distributor, Inc. On occasion, we all make questionable decisions and reach incorrect assumptions. Often, this is due to cognitive biases – built-in tendencies that we all share. Many social psychologists believe cognitive biases help us process information more efficiently. But in some situations, these biases can lead us to make serious mistakes. When it comes to investing, it’s important to recognize (and hopefully avoid) the negative impact of cognitive biases on your financial decisions. I highlight four of these biases below and point out some rational responses to counteract them. Irrational Bias 1: Overconfidence Investors who see their portfolios rising for extended periods can easily forget previous down markets. This overconfidence can lead them to make risky decisions. Research shows that men are particularly vulnerable to this bias. According to Brad M. Barber, Professor of Finance at the UC Davis Graduate School of Management: “Men tend to be more overconfident than women, and overconfident investors tend to think they know more than they actually do.” Rational Response In these situations, revisiting your comfort level with risk could help you get your confidence in check. A quick call or email to your financial professional could also give you added insights. Irrational Bias 2: Anchoring The concept of anchoring revolves around people’s tendency to cling to a single piece of information during the decision-making process. This is often the first information they encounter. Once the “anchor” is set, other judgments are made based on that anchor. Consider an investor who first encounters a mutual fund that is priced at $22 a share. If the price of that fund later drops to $18.50, that person may think he or she has found a “bargain.” In reality, however, the original $22 price may have been overvalued. Rational Response Evaluate an investment based on a variety of fundamental metrics over time. Focus on the overall asset allocation plan and less on the day-by-day prices of individual investment options. Irrational Bias 3: Loss Aversion As Nobel-Prize winner Daniel Kahneman discovered, a loss generates 2.25 times more pain than the pleasure generated by an equivalent gain. A loss of $1,000, for instance, could only be offset emotionally by a gain of at least $2,250. This level of emotional “pain” could easily lead an investor to sell during periods of volatility – just to make the pain stop. Rational Response Focus on your goals for the long term to help avoid this pitfall. Irrational Bias 4: Mental Accounting Our brains have a natural tendency to organize information. When it comes to money, we tend to view some assets as being different from others based on their source or intended use. This can be helpful for investors who set aside a specific amount of money each month for retirement or another goal. That money is off the table, in a sense, because it’s in their mental “savings” box. In other situations, however, this can work against investors. A modest but unexpected inheritance is a good example. Because those inherited assets aren’t part of the investor’s current financial plan, he or she may feel like it’s “fun money,” even though investing those assets could go a long way toward helping the investor achieve an important financial goal. Rational Response Working with a financial professional on a “save some/spend some” plan to help overcome this bias. The Payoff Of Rational Thinking Emotional investing can be costly. Taking a rational approach, on the other hand, can help you focus on the essential elements of successful investing – a diversified approach and a focus on the long term. Asset allocation and diversification do not ensure a profit or protect against a loss. Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc.

Buffett Explains Bubbles

Back when the financial crisis was in full blown collapse mode, the government stepped in to shore up the problem areas and infused a huge amount of reassurance in the financial system. It was like a giant hug for the markets, for the people, and anyone else that needed one, that said, “things will be okay.” Then the government did what all governments do best. Congress formed a committee to investigate why it happened. They needed a villain. So the FCIC, Financial Crisis Inquiry Committee, was created to find who or what was to blame. In the end, we all know what happened. The banks took the heat while a lot of the co-conspirators walked away clean. In reality, it was a fairly solid team effort between lenders, borrowers, Congress, rating agencies, regulators, Fannie Mae ( OTCQB:FNMA ), Freddie Mac ( OTCQB:FMCC ), mortgage brokers, real estate speculators, derivatives, media, etc. that led to the largest bubble and crisis in history. This past weekend, the FCIC made available some transcripts and notes from that investigation. One of those transcripts was a two-hour interview with Warren Buffett. I won’t cover the entire interview though it was an interesting read (at least I thought so). Buffett offered an enlightening take on bubbles, which I thought I’d share. It didn’t cause it, but there were a vast number of things that contributed to it. The basic cause, you know, embedded in psychology – partly in psychology and party in reality in a growing and finally pervasive belief that house prices couldn’t go down and everyone succumbed – virtually everybody succumbed to that. But that’s – the only way you get a bubble is when basically a very high percentage of the population buys into the same originally sound premise and – it’s quite interesting how that develops – originally sound that becomes distorted as time passes and people forget the original sound premise and start focusing solely on the price action. So every – the media, investor, the mortgage bankers, the American public, me, my neighbor, rating agencies, Congress, you name it, people overwhelmingly came to believe that house prices could not fall significantly. And since it was the biggest asset class in the country and it was the easiest class to borrow against, it created probably the biggest bubble in our history. … I think every aspect of society contributed to it virtually, but they fell prey to the same delusion that existed throughout the country eventually and it meant that the models that they had were no good. They didn’t contemplate – but neither did the models in the minds of 300 million Americans contemplate – what was going to happen. … Well, there’s a very interesting aspect of this, which will take a minute or two to explain, but what my former boss, Ben Graham, made an observation, 50 or so years ago to me that it really stuck in my mind and now I’ve seen evidence of it. He said, “You can get in a whole lot more trouble in investing with a sound premise than with a false premise.” … It’s a totally sound premise that houses will become worth more over time because the dollar becomes worth less. It isn’t because – you know, construction costs go up. So it isn’t because houses are so wonderful, it’s because the dollar becomes worth less, and that a house that was bought 40 years ago is worth more today than it was then. And since 66 or 67 percent of the people want to own their own home and because you can borrow money on it and you’re dreaming of buying a home, if you really believe that houses are going to go up in value, you buy one as soon as you can. And that’s a very sound premise. It’s related, of course, though, to houses selling at something like replacement price and not far outstripping inflation. So this sound premise that it’s a good idea to buy a house this year because it’s probably going to cost more next year and you’re going to want a home, and the fact that you can finance it gets distorted over time if housing prices are going up 10 percent a year and inflation is a couple percent a year. Soon the price action – or at some point the price action takes over, and you want to buy three houses and five houses and you want to buy it with nothing down and you want to agree to payments that you can’t make and all of that sort of thing, because it doesn’t make any difference: It’s going to be worth more next year. … And the price action becomes so important to people that it takes over the – it takes over their minds, and because housing was the largest single asset, around $22 trillion or something like that…Such a huge asset. So understandable to the public – they might not understand stocks, they might not understand tulip bulbs, but they understood houses and they wanted to buy one anyway and the financing, and you could leverage up to the sky, it created a bubble like we’ve never seen. … It wasn’t like somebody was thinking, “This is going to end in a paralysis of the American economy.” You know, they just – they started believing what other people believed. It’s very tough to fight that. Of course, a similar sound premise was behind the ’29 bubble and internet boom. Buffett explained both cases started with a sound premise – stocks outperform bonds over time and the internet will change our lives – which was a solid argument for owning stocks. But at some point, the sound premise became “you should own stocks because prices are going up,” then momentum and FOMO (Fear Of Missing Out) kicked in. Eventually, people gradually wake up to the reality that it’s not true and the bubble pops. Source: Buffett FCIC Interview Transcript