I am currently contemplating the risks and returns associated with investing in a money market fund and a short-term bond index fund. The vanguard funds are chosen here for comparison purposes.
The Vanguard Prime Money Market Fund is yielding 2.26% at this writing. The short-term yields are rising with the Fed rate hikes and some projections put Fed rates at 3.50% by the end of 2005. This will cause the yield of the Vanguard Prime Money Market Fund to rise to about 3.25% by the year end. On average, an investor in this fund will earn about 2.75% return for 2005.
The Vanguard Short Term Bond Index Fund is yielding 3.49% today. The projections put the yield of this fund at about 4.50% at the end of 2005. The expected “income” part of the return an investor will receive in this fund this year will be about 4%. The duration of the fund is 2.4 years. Since the yield will rise about 1% this year the price of the bonds will fall by 2.4%. That is, the “total” return an investor will receive will be 4% - 2.4% = 1.6%. This return is approximately 125 basis points lower than the expected Money Market fund return.
Relatively speaking, the Money Market Fund is the better parking place for the money as of today.
All disclaimers apply.
Saturday, February 26, 2005
Monday, February 14, 2005
Mutual Fund Wish List
Many academic studies have concluded that the investment return of a portfolio is controlled by asset allocation more than anything else. Allocating assets in various classes in right proportions is the best thing an investor can do to maximize the returns. Rebalancing the portfolio at regular time intervals supposedly adds value.
I believe rebalancing is the hardest thing for an investor to do. Let's suppose someone has target asset allocation of 65% stocks/35% bonds. After a few good months of above average stock returns, this investor finds the portfolio at 70% stocks/30% bonds. This investor should sell some stocks and buy some bonds to drag the allocation back to the target 65%/35%. But, after few good months for stocks, the investor finds that the media is bullish all the way. The sunny forecast for stocks is coming from all the analysts on TV, radio and newspaper. Selling assets in better performing classes to buy assetsin lagging classes is hard for a human to do.
That's why I am a big believer in balanced funds. These funds have a steady target allocation described in the fund objective/investment policies. These funds stick to these investment allocations regardless of the market condition. If the stocks outperform, they sell stocks and buy bonds. If stocks underperform, they sell bonds and buy stocks. This automatic rebalancing takes away emotions away from the investing process for the average individual investor. Also, the indexed balanced funds are better because they have lower expense ratios and they are not controlled by any manager's emotions or views of the market.
The Vanguard Balanced Index fund is such an index fund, whose assets are allocated following way: 60% total stock market index and 40% total bond market index. The rebalancing is done automatically. I would love to invest in this fund, but the 40% of assets in total bond market index fund with duration of 6 years prevents me from doing so. Vanguard should start another fund with 60% assets in total stock market index fund and remaining 40% assets in short term bond index fund. My guess is that there are many investors who would love to invest in such a fund.
There should me one more offering from vanguard in the following fashion: 60% in value index fund and 40% in short term bond index fund. The beta of this fund will be very low compared to the balanced index fund offered today. I don't know why vanguard does not have such an offering. These funds of funds do not have any expense ratios. The shareholders just pay the expenses of the underlying funds. They should just set this fund up and allocate the invested money in the underlying funds.
How about a world index fund? A fund where the assets are allocated in market cap weighted baskets of various countries. The spectrum should cover from United States to Europe to Pacific rim and emerging market countries. Investors should not have to allocate the assets themselves among various regiouns/countries of the world. There should be a fund which should take all these emotions away from the investors.
When we are at it, why not a global balanced fund? 60% in total world market index and 40% in total world bond market index.
I am sure sooner or later one fund/ETF complex will start such a fund. Maybe fidelity should get into the game, and offer abover described funds. The keys are lower expense ratios and indexed portfolios. Even the rebalancing should be done at some secret pre-defined schedule to prevent market timing by the manager.
Finally, a thought: If you build it, they will come.
I believe rebalancing is the hardest thing for an investor to do. Let's suppose someone has target asset allocation of 65% stocks/35% bonds. After a few good months of above average stock returns, this investor finds the portfolio at 70% stocks/30% bonds. This investor should sell some stocks and buy some bonds to drag the allocation back to the target 65%/35%. But, after few good months for stocks, the investor finds that the media is bullish all the way. The sunny forecast for stocks is coming from all the analysts on TV, radio and newspaper. Selling assets in better performing classes to buy assetsin lagging classes is hard for a human to do.
That's why I am a big believer in balanced funds. These funds have a steady target allocation described in the fund objective/investment policies. These funds stick to these investment allocations regardless of the market condition. If the stocks outperform, they sell stocks and buy bonds. If stocks underperform, they sell bonds and buy stocks. This automatic rebalancing takes away emotions away from the investing process for the average individual investor. Also, the indexed balanced funds are better because they have lower expense ratios and they are not controlled by any manager's emotions or views of the market.
The Vanguard Balanced Index fund is such an index fund, whose assets are allocated following way: 60% total stock market index and 40% total bond market index. The rebalancing is done automatically. I would love to invest in this fund, but the 40% of assets in total bond market index fund with duration of 6 years prevents me from doing so. Vanguard should start another fund with 60% assets in total stock market index fund and remaining 40% assets in short term bond index fund. My guess is that there are many investors who would love to invest in such a fund.
There should me one more offering from vanguard in the following fashion: 60% in value index fund and 40% in short term bond index fund. The beta of this fund will be very low compared to the balanced index fund offered today. I don't know why vanguard does not have such an offering. These funds of funds do not have any expense ratios. The shareholders just pay the expenses of the underlying funds. They should just set this fund up and allocate the invested money in the underlying funds.
How about a world index fund? A fund where the assets are allocated in market cap weighted baskets of various countries. The spectrum should cover from United States to Europe to Pacific rim and emerging market countries. Investors should not have to allocate the assets themselves among various regiouns/countries of the world. There should be a fund which should take all these emotions away from the investors.
When we are at it, why not a global balanced fund? 60% in total world market index and 40% in total world bond market index.
I am sure sooner or later one fund/ETF complex will start such a fund. Maybe fidelity should get into the game, and offer abover described funds. The keys are lower expense ratios and indexed portfolios. Even the rebalancing should be done at some secret pre-defined schedule to prevent market timing by the manager.
Finally, a thought: If you build it, they will come.
Tuesday, February 01, 2005
Chinese and Indian Stocks in Emerging Market Stock Index
The vanguard emerging market index fund (Symbol: VEIEX) invests in the 18 "emerging market" countries as of today. This fund allocates the money among the countries in "proportion to their weighing in the index".
There has been a lot of noise about the two emerging markets lately: India and China. The current weighing of these two countries in the index is 8.3% for China and 6.2% for India. I was little surprised to see such a low numbers. In comparison, the Korean basket right now accounts for 19.4% of the emerging market fund. Korea is followed by Taiwan at 15.4%, South Africa at 12.6%, and Brazil at 10.5% in the emerging market fund.
It is true that, eventually, China and India will have top two spots in the index. But, looking at the current makeup of the index, it is safe to say that that "eventual" time may be a long time away.
There has been a lot of noise about the two emerging markets lately: India and China. The current weighing of these two countries in the index is 8.3% for China and 6.2% for India. I was little surprised to see such a low numbers. In comparison, the Korean basket right now accounts for 19.4% of the emerging market fund. Korea is followed by Taiwan at 15.4%, South Africa at 12.6%, and Brazil at 10.5% in the emerging market fund.
It is true that, eventually, China and India will have top two spots in the index. But, looking at the current makeup of the index, it is safe to say that that "eventual" time may be a long time away.
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