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Market Oracle FREE Newsletter

5 "Tells" that the Stock Markets Are About to Reverse

How to Build a "Stockless" Investment Portfolio

Portfolio / Investing 2011 May 19, 2011 - 06:20 AM GMT

By: Money_Morning

Portfolio

Best Financial Markets Analysis ArticleKeith Fitz-Gerald writes: I've lectured on investment strategies the world over, but I recently got one of the most intriguing questions I've been asked in a long time at the Global Currency Expo in San Diego, California.

An attendee asked me: "Is it possible to achieve decent performance if I don't want to include stocks?"


In short, the answer is "yes" -- though I wouldn't recommend a "stockless" portfolio because of the tradeoffs involved.

Still, it is possible to achieve a "decent" performance without stocks.

Here's how you'd do it.

A successful allocation model for a stockless portfolio would look something like this:

•Bonds: 45%
•Master Limited Partnerships (MLPs): 25%
•Commodities: 10%
•Gold: 10%
•Preferred Stocks: 10%*

*You could argue that these are actually stock investments and I would take your point. But for purposes of our discussion and our objectives of achieving stock-like returns, I think we need to include preferred stocks because of the high, fixed dividend they kick off that makes them more bond-like.

We'll take an in-depth look at the allocation model in a moment. But let's examine the negative points of a stockless portfolio first.

Stockless Portfolio Tradeoffs
There are negative aspects to owning a stockless portfolio.

To begin with, the U.S. Federal Reserve's loose monetary policy right now is bullish for stocks, so by forgoing equities, you'd be missing out on some big potential gains. At the same time, you'd be exposing yourself to more volatility and greater risks. You'd also miss out on some hefty dividend payouts.

Here's what I mean.

•The Fed's Zero Interest Rate Policy -There are obviously going to be wiggles along the way, but generally speaking, the Fed's bailout policies should continue to factor into higher earnings, higher cash stockpiles, and continued reinvestment. That, in turn, suggests stocks are still the place to be - at least until something changes inside the Beltway.
•Volatility - Investors who eliminate stocks and refocus their efforts on other asset classes are introducing additional risks to their portfolio. The reason for that is very simple: By taking stocks out of the picture and putting a greater emphasis on the remaining asset classes, investors are reducing the amount of diversity and balance necessary to maintain stability. That makes their portfolios a lot more volatile.
•Lack of Dividends - While avoiding stocks may make you feel better, there's a good chance you'll be left behind - especially if you cut out dividend producers. Let me give you an example. Dividends are likely to grow at an annualized rate of 10% to 12% over the next five years. That means the effective yield on a portfolio that presently yields 1.9% will see its yield grow to 3.4% in five years, according to Don Kilbride, who manages the $5.72 billion Vanguard Dividend Growth Fund (MUTF: VDIGX). If you're not along for the ride, you'll have to make up this money somewhere else. It's also one more roadblock you don't need in a low interest rate environment.
•Out of the Frying Pan, Into the Fire - In their rush to avoid risk by removing stocks from the equation, investors simply may be trading one set of risks for another. That is, bonds aren't necessarily a safer investment than stocks. Bond values will fall dramatically when interest rates begin to rise in earnest, and that actually may be a rougher ride than the corresponding rodeo we'll see in equities.
•You'll have to save a LOT more - By cutting stocks from your portfolio you'd be eliminating a powerful upside. This in turn means you'd have to dramatically increase your savings to make up the difference. In fact, a 32-year old earning $50,000 a year who wants a targeted income of $3,125 a month in retirement would have to increase their savings from 12% to 16% of their annual salary, according to Money Magazine's Walter Updegrave. That translates into an extra savings of $167 a month to make up for the lost value -and that's on top of the $500 a month already going to retirement accounts in his projections. Jumping from 12% to 25% would require an extra $542 a month.

Building a Stockless Portfolio
Now that you're aware of the risks, we can take a closer look at our stockless portfolio asset allocation model.

Bonds: 45%

When it comes to bonds, the key is choosing funds with durations of seven years or less. That will avoid most of the volatility expected to arise when rates start to go up and bond prices start to fall. (Bond prices and interest rates go in opposite directions, so when one is falling the other is rising.)

I suggest splitting your money between high-yield corporate bonds and intermediate- to short-term investment grade municipal holdings.

The former are less likely to bounce around than Treasury or mortgage bond alternatives even if rates rise. They also allow you to keep at least some exposure to the underlying companies that issue them, if only by proxy. The iShares iBoxx $ High Yield Corporate Bond (MUTF: HYG) is a great way to get started here, and it's hard to beat the 7.84% yield.

As for the latter, fears of a meltdown in municipal bonds remain overblown. The historic default rate for investment grade munis from 1970-2009 is 0.06% within 10 years of issuance, according to Moody's Corp. (NYSE: MCO). That's not to say things won't heat up as rates rise and cash flow tightens further. But general obligation bonds backed by near-complete taxing power are probably going to do just fine, as opposed to specific project bonds like the monorail system Las Vegas tried to finance with high yield munis.

I think the PIMCO Municipal Income Fund (NYSE: PMF) is appealing because of the consistent returns it's demonstrated since 2003. Right now the fund yields 7.4%.

Gold: 10%

At the risk of sounding like a broken record, you want to own gold as a means of hedging the principal value of your bonds and your income stream. In a portfolio where bonds are even more important, like the stockless one we're considering today, this is especially crucial as we enter what could be a protracted rising rate environment. While there are all kinds of ways to own gold, most investors will find it easy to get started with the SPDR Gold Trust (NYSE: GLD).

Master Limited Partnerships (MLPs): 25%

Master limited partnerships may trade like stocks, but technically speaking they're a different vehicle and therefore qualify for our hypothetical stockless portfolio. Most investors are at least somewhat familiar with these investment vehicles because of the large number of resource-related MLPs. But you may not be aware of some other choices here, such as The Blackstone Group L.P. (NYSE: BX) and Fortress Investment Group LLC (NYSE: FIG).

The key is that MLPs typically pay regular quarterly distributions that can help boost your income, making up for the gains you have given up by moving away from stocks. However, make certain to talk with your tax professional before you purchase an MLP because they can also kick off unrelated business income (and losses). That may make this type of investment better suited for taxable accounts, rather than tax-advantaged alternatives like IRAs or 401ks.

Investors might also consider Niska Gas Storage Partners LLC (NYSE: NKA). It was recently beaten down after an analyst downgrade, but I like the 6.7% yield and its turnaround prospects.

Commodities: 10%

Right now there's a lot of talk about demand for commodities slowing down. Don't believe a word of it.

Demand is accelerating, and when it comes to such basics as food and water, there are no replacements. For food-related commodities, try the MarketVectors Agribusiness ETF (NYSE: MOO). And those wishing to get their hands on resources may want to consider the Pimco Commodity Real Return Fund (NYSE: PCRDX). Both make a nice inflation resistant hedge, too. Yield on the former is 0.58%, while yield on the latter is 8.45%.

Preferred Stocks: 10%

As I said earlier, you could argue these are actually stock investments, and I would take your point. But for purposes of our discussion and our objectives of achieving stock-like returns, I think we need to include preferred stocks because of the high, fixed dividend they kick off that makes them more bond-like. I don't think you can get any more plain vanilla than the iShares U.S. Preferred Stock Index Fund (NYSE: PFF), which yields about 7.3% at the moment.

So, if you're determined to pursue a stockless portfolio, this should help get you started. But remember, abandoning equities will increase your risk and lower your portfolio's overall returns. So as far as investment strategies go, I'd advise you to stick with stocks - if only for the dividends.

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Source :http://moneymorning.com/2011/05/19/...

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