Volume IV: Frank Armstrong answers questions from readers of Investment Strategies for the 21st Century every Tuesday, at MFI. To submit a question to Frank, write to us.

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Questions and Responses:

• Will Japan's woes influence the U.S. economy in the 21st Century?
• Suggestions for riskier funds?
• How much of one's mutual portfolio should be in index funds?
• How do I allocate funds on a regular basis?

• Next volume of Frank's Q&A
• Previous volume of Frank's Q&A

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Will Japan's woes influence the U.S. economy in the 21st Century?

 

from Ray

 

Q: Since we always hear the term "World Economy", I am wondering if the sorry state of Japan's economy can influence the U.S. economy in the 21st Century. From what I've read, Japan is slow to act on resolving its many portfolios ridden with debt. If it should decide to cash in on the government treasuries to meet these debts, could it possilby adversely affect our economy?

 

A: Whenever one of the world's biggest economies, one of our largest trading partners, and the a huge holder of our debt has economic problems, we are going to feel some of their pain.

The United States, and the rest of the G-7 nations consult with each other to attempt to smooth out the problems that each experiences from time to time. In the event of a dire emergency you can be sure that they will step in to help. Not that any of them are charitably inclined, it just meets their own self interest to keep their partners healthy.

I am optimistic that the Japanese will muddle through their problems, as we muddled through ours 10 to 20 years ago. As a country they are too smart and industrious to let problems fester for long. But, it takes a while for any people to face facts, pull themselves together and muster the political will too change.

There are always things to worry about. Most of them don't come true. Every once in a while a situation such as you mentioned with the Japanese jumps up to bite us. Meanwhile, the benefits of a global economy outweigh the risks

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Suggestions for riskier funds?

from Kurt

Q: I have just graduated from college and I am looking to invest in some mutual funds. Since I am only 23 I want to invest in some of the riskier funds. Do you have any suggestions?

A:  Most of us prefer to follow a policy of maximizing our rate of return per unit of risk. However, if you are serious about high risk, high reward strategies you can accomplish your objective using mutual funds. But, you will need a very high level of discipline. If you lose heart during the downturns and abandon your strategy, you will most certainly shoot yourself in the foot. 

Certain asset classes have higher expected rates of return than others. Invariably these asset classes have high levels of risk. But, you can build a diversified portfolio of reasonably risky assets that doesn't have insane levels of risk when measured at the portfolio level.

Asset classes which are highest in expected return include emerging market funds, small company funds, value funds, foreign small company funds,foreign value funds, and foreign small company value funds. If you have lots of time, and the stomach for the risk, load up on these funds.

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How much of one's mutual portfolio should be in index funds?

Q:  In percent, how much of one's mutual fund portfolio should be in index funds?

A:   I really don't believe that over the long haul "managers" can ad value to a portfolio through either market timing, or individual stock selection. So, I don't use any actively managed funds where I can get an index fund.

A few markets don't have index funds available such as Africa, India, Latin America, and Eastern Europe. So, I'm stuck with actively managed funds in those markets until an index fund is available if I want an exposure there. In that case, I just hope that the managers don't screw it up too badly, and cost me too much.

Over 90 percent of my portfolios are index funds.

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How do I allocate funds on a regular basis?

from Sankar

Q: I have read your book and was inspired enough to start investing using your strategy, so far my experience with it is pretty good. However I have two questions:

1) I would like to use dollar-cost-averaging by contributing to my account every month by a fixed amount. I have 8 mutual funds in my portfolio (using 30 % bond and 70 % stock fund, and splitting the 70 % in 7 different classes of stock fund). Also I have an account with Charles Schwab. Now if I want to contribute to my account every month, the minimum amount for each of the stock funds is $500, which means I need to come up with $3500 for the stock funds and to keep the 70-30 balance I need to come up with $1500 more for the bond fund. This means that the smallest contribution I can make without distorting the portfolio allocation percentage is $5000.00. This is too big an amount for monthly investment. Even this is only when I continue with my existing funds. For switching  over to new funds the minimum is $2000.00 (for non-Schwab funds) per stock fund. How do I get around this problem ?

2) In your strategy of Asset Allocation with various classes of investment, is the past performance of the individual funds that I choose important? According to your book, as long as these funds invest in the style they propose (i.e value funds do value investing, small company funds do invest mostly in small companies etc), the choice of specific funds should be almost unimportant. Is it then OK to select these funds randomly, since there are so many different Mutual funds in each class/style of investment ?

A: 1) You can move your account to a brokerage with smaller purchase minimums (i.e., Jack White or Waterhouse.) Or, you can rotate investment purchases. I don't think it's critical to be exactly weighted every second. Just move toward your allocation plan goal over time.

2) There is a very neat solution to the fund selection problem. Use the lowest cost no-load index fund that tracks your asset class. The odds are that this strategy will put you in the top 25% over time for each asset class you have. Along the way, you will pay less in taxes, and subject yourself to the least risk possible within the class.

copyright (c) 1997, Frank Armstrong.

Disclaimer

Investing in equities involves a serious principal risk, and no assurance can be given that the techniques described here will be successful. Returns vary and you may have a gain or loss when you sell your shares. Past performance is no guarantee of future results. Index returns shown are historical and include the change in share price, reinvestment of dividends, and capital gains. Indexes are unmanaged and do not reflect the impact of transaction costs. Transaction costs would have reduced the total returns.

International investments, especially those in emerging markets, entail greater risks (as well as greater potential rewards) than U.S. investing. These risks include political and economic uncertainties of foreign countries, as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less-established markets and economies.