Portfolio Strategy Vs. Portfolio Tactics

When managing your assets you have to consider your overall strategy as well as tactics. Hopefully by now you've overcome all the gloom and have re-equitized your accounts. If not you may want to read some of my previous posts. So what is the difference between strategy and tactics?

Portfolio Strategy
The primary determination of your longer term returns are tied to the asset allocation decision between stocks, bonds and cash. Many are overweight to bonds and cash right now. For those who want growth and a higher potential return, stocks are the way to go. Adding bonds lowers the volatility of your portfolio, but also lowers the potential return. John Bogle, founder and former CEO of the Vanguard Group,  suggests "a bond percentage equal to your age". That's reasonable if you have enough money to retire. However, for people under 60 years old you may want to consider a portfolio of all equities. Why? You will probably live at least another 40 years and have a risk of running out of money. Yes, we will probably see more bear markets in the future. However, the inflation adjusted return on bonds is hard to live on and they also experience bear markets. Based on different studies this simple decision can account for upwards of 85-90% of your long term returns. Where do the rest of the 10-15% of the returns come from?  It comes from portfolio tactics.

Portfolio Tactics
This is where your financial advisor, money manager, mutual fund, or hedge fund tries to add value above the market return. How successful are they? About 85% can't beat their respective benchmark (a non-managed index like the S&P 500) after their management fees of 1-2%. They will try to outperform by selecting growth vs. value, large cap vs. small cap, domestic vs. foreign, etc.

Lately, I've been wondering if there is a lasting trend of small cap outperforming large cap. Small cap tends to outperform at the beginning of bull markets and is outperforming so far this year. However, when venturing down this path one has to remember these trends can be short lived. One of the best illustrations of this is the Callan Periodic Table of Returns. These trends may last for one year or few years, but are short lived. So you have to make two good decisions in order to make it effective. The first is buying it at the right time and the second is switching out of it at the right time. Unfortunately, there are few professionals who can do this effectively. However, if you have this skill you are probably very wealthy. Congratulations! For the rest of us, a global index fund or low cost global mutual fund (<1% per year) would be the better investment.

Vanguard is one of the best low cost mutual fund providers you can find. They have many index funds and some low cost actively managed funds. Their global index fund is called the Vanguard Total World Stock Index Fund (VTWSX). It has an expense ratio of .50% as of 10/31/09. If you would like an actively managed global mutual fund, the Vanguard Global Equity Fund (VHGEX) has an expense ratio of .47% as of 9/30/09 and a solid track record versus it's benchmark.