Friday, October 24, 2008

Correspondence

Flg,

You were an international economics major, right? Do you see any international opportunities during this crisis? China maybe?

Paul


Dear Paul:

Yes, I was an international economics major. No, I don't particularly see any international opportunities. Other countries are going to be worse off than the US. The old adage about the US sneezing and the rest of the world getting a cold still applies. And China scares me too much to put a lot of money there.

Actually, let me take this opportunity to articulate my investing strategy. Again, I am not a professional and caveat emptor. This is what I do, and might not be correct for your circumstances.

Around the time of my birthday on years that are divisible by 5, I figure out two things. I subtract my age from 100 and add 20. That's how much I will put in equities. I put the remaining percentage in a highly rated bond fund.

Then the issue is how to invest in equities. My goal is to minimize risks. There are two types of financial risk -- systematic and unsystematic. Unsystematic risks can be eliminated through diversification in a broad portfolio of assets. I do this by purchasing index funds that try to replicate the entire stock market. I am not trying to pick individual stocks, but a piece of all of them. That way I don't have to pay attention to any individual company's quarterly reports, their legal troubles, etc.

Systematic risk cannot be eliminated through diversification. However, it can be minimized by diversifying internationally. So, if the Europe has trouble, your Asian stocks might still do well. I determine each continent's percentage of world GDP, well, except Antarctica. Ideally, I would do this for every country, but that is just too time consuming and is more work than probably would be worth the time. I invest my money according to the percentage represented by each continent. If Asia is 25% of the world economy, then 25% of my equities will be invested in Asia.

I then buy and sell ETFs to reconcile the current percentages to what I need them to be. Every five years my bond percentage will increase and I will readjust my equities to account for economic growth in different continents. Since I only trade every five years, my commission charges are exceedingly low and I don't worry about what the market does every single day.

Oh, I find the market interesting as an intellectual matter, but it does not concern me monetarily. Perhaps I will be more concerned when I am closer to retirement, but I believe the system will work well to manage my downside risks.

One last thing. Yes, I've taken a bath in this crisis like everybody else. A global credit crisis is a systematic risk that cannot be diversified through international exposure, but I am too young to keep a huge amount of money in cash and bonds.

-FLG

2 comments:

Withywindle said...

I can't find an image on the web, but there's an old Bloom County Sunday strip in which Oliver, dressed as a pirate, hacked into the NYSE and sent the message "Avast ye scurvy dogs, the Bank of America is about go belly up!" Causing worldwide financial panic, burning cities, etc. Clearly you must find this image, scan it, and post it.

FLG said...

I will visit the nearest bookshop presently to acquire this image.

 
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