Taxable Accounts:

• Index funds – very low turnover stock funds
• Tax-managed mutual funds – usually avoids dividend paying stocks, holds securities for a long time, and sells losing stocks to reduce taxable gain
• Municipal bonds – tax free bonds
• ETF – as long as not dividend paying ones
• Variable annuities
• Individual stocks – as long as not dividend paying ones

 Tax Deferred/Tax Free Accounts:

• Taxable bonds – zero coupon or deep discount bonds
• Dividend producing stocks
• High turnover mutual funds
• Any investment that generates frequent cashflow or distributions through interest, dividends, and capital gains

 Based on the information, I believe my situation can be considered tax efficient. I hold cash for emergencies, which is taxed very little since I don’t hold that much cash. I hold gold through the ETF GLD in a taxable account that I don’t receive dividends and will not churn often. My short-term and long-term bonds and stocks are held in tax deferred and tax free accounts. My foreign currencies are held in non-taxable safety deposit boxes and offshore bank accounts. And my real estate can be taxed, but only if the gain is beyond the 250k tax exemption. Furthermore, the income from real estate is offset by depreciation, mortgage interest, etc… expenses. So overall, based on current circumstances and tax laws, I don’t need to worry about my investments paying a lot of taxes. Of course this can change as new tax laws are enacted.

But you might be wondering why do we need these four asset classes that perform differently under different economic circumstances. The explanation is simple: We don’t know what is going to happen in the future. The talking-heads on television don’t know what is going to happen in the future. Everyday we hear conflicting stories about impending deflation, runaway inflation, or struggling green shoots. The truth of it is, we just don’t know. We don’t know what is going to happen 1, 5 or 10 years from now. No one can accurately predict tomorrow and hindsight is 20/20. So the best strategy is to plan for all economic circumstances as if they might come to roost. So we dab 25% into stocks in case of prosperity. We throw another 25% into gold to hedge against runaway inflation. We allocate 25% into long-term treasury bonds in the situation of impending deflation. And if we have the transitionary state of recession, we will have 25% in cash/short-term bills to keep us worry-free at night.

At first glance, this might seem crazy. I sure thought so. The Permanent Portfolio advocates putting 25% of your investments into each of the four asset classes: stocks, gold, long-term treasury bonds, and short-term bills/cash. Wha??? 25% of your investment into the commodity Gold??!! Yea, that’s how I reacted too. But it is important to reflect that the strength in this portfolio allocation method is the unity of the four asset classes. When one falls, another will inevitably rise, offsetting the difference while also exceeding it into the positive return territory. You cannot think of each asset class individually, rather you need to think of it as one entire package that works together. Take out one, and we are leaving ourselves vulnerable to that corresponding economic condition.

In addition, a luring aspect of the Permanent Portfolio is the fact that it was created a long time ago, it is not some theory that was backtested and invented a year ago. For the last thirty or so years that it has been in existence, the results are astounding. The annualized returns have been around the 9.5% range with very minimal volatility (the greatest drop was 6% back in 1981). So with this asset allocation you can get pretty good returns while not have gut-wrenching rollercoaster rides.

After doing numerous research about this on the boglehead forums, listening to Harry Browne’s radio recordings, and reading about it in various informative websites, I believe this allocation method is sound. I just makes sense. I’ve tried counter-arguments but cannot come up with a scenario in which this doesn’t work. If you really think about it, if anything really bad happens to the market, is the typical stock/bond allocation method going to cut it? No I don’t think so — October 2008 sure taught us that lesson very well. So if we cover all our bases and rebalance every once in a while, this portfolio will help keep us sane. Currently I have been reorganizing my investments to correspond to the Permanent Portfolio. Unfortunately I cannot buy real gold and only the ETF GLD. Also, I am buying the Vanguard Long-Term Treasury fund for the long-term bond portion. I will give updates on how this is going on a yearly basis. And if you want more information, check out the website CrawlingRoad.

Seems like quite a bit right? Unfortunately that amount of money is in Yuan (or if you prefer, the Chinese RMB). The current exchange rate is about 6.83 Yuan = 1 USD. So at that spot rate I have about 6,589 USD stashed away. A much more paltry sum compared to the weighty 45,000 Yuan. But the upside is I paid (5,715+725) 6,440 for that amount of Yuan, so there was already a little profit to be made.

If you recall, part of my 2009 Goals was to diversify my holdings into a RMB account. Since I have been unable to open one in China while being held hostage in the States, the next best thing was to exchange cold hard cash for more cold hard cash. So I got off my butt and asked around if I could exchange my depreciating dollars for the rising Yuan. Since we are located in the States, they took me up on my offer and I got an awesome exchange rate to boost. In a way, this ameliorates that goal for 2009.

I plan on visiting China sometime next year and bringing this little bundle of joy to China to deposit into a fresh new account. Once I open an account there I can start to online deposit my USD and convert it to Yuan whenever I want. The faster I get cash into a stabler foreign currency the better… the way the government is Zimbabwing our hard-earned dollars is going to instigate stagflation and that doesn’t bode well for my future lifestyle.

Overall this book was kind of a mishmash of personal finance advice, not relating specifically to one topic such as index investing, value investing, growth investing, asset allocation, etc… Rather, it had trace elements of all these topics along with much needed common sense. Throughout the book you could tell that the author advocates passive index investing in an asset allocation suitable for the reader that is rebalanced occasionally. He gives down-to-earth advice that is chock full of common sense about saving regularly, starting early, assessing home wealth, and paying off debts.

For me, it was too basic because I already have marinated myself in these ideas over these last few years. I didn’t really learn anything new, but I highly advocate most U.S. consumers to give this book a go seeing how many of us have a savings rate at 5% or less. Common sense isn’t always so common.

However, one paragraph in the book did resonate with me:

We associate wealth with the trappings of wealth, including the designer clothes and the luxery cars. But these trappings aren’t a sign of wealth. Rather, they are a sign of money spent – and the people involved are poorer for it. In fact, the richest family in the neighborhood may live in the smallest house with the oldest cars. Their frugality allows them to save like crazy. I am not suggesting this is desirable. Neither spendthrifts nor misers deserve our admiration. Instead, we should strive to strike the right balance, spending our money on the things that are important to us, but also saving enough for our goals.

I wrote a post related to this topic previously, of when people brag about how much money they spent I don’t feel envious  but rather sympathy because all it means is they are accruing more debt and it would be even harder for them to escape the proverbial rat race. I guess this is why this paragraph from the book just pinged to me. In addition, I definitely believe in enjoying the Now while also making sure we can attain our future goals.

Here’s a listing of the chapters to give a better idea of what this book is about:

1. Introduction – Let the Rebuilding Begin
2. Our Finances Are Bigger than a Brokerage Account – Pondering the Paycheck in the Mirror
3. We Can’t Have It All – And That Means We Need to Make Tough Financial Choices
4. Money Can Buy Happiness – If We Spend It Carefully-Getting in Touch with Our Inner Caveman
5. Even the Best Investors Need to Be Great Savers – Thrift Doesn’t Come Naturally, So Try Trickery
6. Time Is as Valuable as Money – Investment Compounding? Yes, It Is Truly Magical
7. No Investment Is Risk-Free – It’s a Dangerous World-Even for Those Hiding out in Savings Accounts
8. Portfolio Performance: It’s All in the Mix – Our Stock-Bond Split Powers Our Investment Results
9. Stocks are Worth Something – Getting a Piece of the Economic Action
10. To Add Wealth, We Need to Overcome the Subtractions – If We Aren’t Careful, We’ll Double Our Money-in 47 Years
11. Aiming for Average Is the Only Sure Way to Win – Why the Meek Will Inherit the Earth
12. Wild Investments Can Tame Our Portfolios – Looking to Zig When Everything Zags
13. Short-Term Results Matter to Long-Term Investors – Keep One Eye on the Horizon-And the Other on the Ground Ahead
14. A Long Life is a Big Risk – The Danger: We Run out of Money Before We Run out of Breath
15. Markets May Be Rational, but We Aren’t – Investing Is Simple-And Yet It Sure Isn’t Easy
16. Our Homes Are a Fine Investment that Won’t Appreciate Much – They’re Money Pits-with Impressive Dividends
17. Paying off Debts Could Be Our Best Bond Investment – How Does a Guaranteed 15 Percent Sound?
18. Saving Taxes Can Cost Us Dearly – But Retirement Accounts are the Big Exception
19. A Tax Deferred Is Extra Money Made – Why We Should Keep Uncle Sam Waiting
20. Insurance Won’t Make Us Any Money-If We’re Lucky – The Best Protection is a Plump Portfolio
21. Even If We Have a Will, We May Not Get Our Way – Don’t Fret Over Estate Taxes-but Worry About Those Legal Bills
22. Financial Success: It’s About More than Money – Family Can Be Our Greatest Asset-and Our Greatest Liability
23. Conclusion – Wall Street? That Isn’t So Far from Main Street

• Dual Horizon – Have two time horizons. In the short run I will have assets that generate steady cash-flow and in the long run I will have assets that produce growth of capital and income. That way I don’t need to sell assets at depressed prices to meet needs. To do this, i will set aside the equivalent of at least five to seven years’ worth of income needs in the very short-term bonds and money-market funds. The balance can be set aside to grow. Thus, in a bad year, I can liquidate the short-term bonds to provide for income needs. In a good year, the stock-market funds can be reallocated back to bonds to get to the right allocation percentages. In a bad market, the bonds allow me to “live off the fat of the land” while the stock market recovers. This would allow me to truly implement a long-term investing strategy.
• Rebalance Portfolio – Following the prior footsteps, I will rebalance my portfolio once a year or after there are major market swings that create 15% change in portfolio, whichever is sooner.
• Asset Allocation – Some things to know about investment return/risk: Small caps generally have more risk & return than large caps. Value generally has more return with same risk as growth. Foreign stocks have more risk & return than domestic stocks. Short-term bonds have about same return with lower risk than long-term bonds. Thus, for me I would like to get a variety of mixes to take advantage of diversification.
• Dollar Cost Averaging & Index Investing – Definitely implement this through incremental purchases of various indices to avoid market timing, lower risk, and lower taxes/fees.

Overall, I will be putting money into these various allocations:

• 30% – International
• 30% – Short-Term Bonds
• 20% – Small Cap
• 20% – Large Cap

Now if I can break this down even further for my mutal funds (I can’t do that for my current 401(k) so that will use the above allocations):

• 30% – International
• 30% – Short-Term Bonds
• 9.25% – Small Cap Value
• 6.25% – Small Cap Growth
• 9.25% – Large Cap Value
• 6.25% – Large Cap Growth (S&P 500)
• 8% – REIT

The first four are based on the Four Pillars of Investing:

• Asset Class Selection & Weight is the single most important driver of portfolio returns and risk. Various studies have shown that for portfolios the drivers are: 91.5% asset allocation, 4.6% individual investment selection, 1.8% market timing, and 2.1% other. Crazy right? When a portfolio contains more than 1 asset class (eg. Equities and Bonds), the performance of the Asset Classes determines the majority of the return of the portfolio.
• Based on Modern Portfolio Theory, if you have multi-asset investing that combines investments with less than perfect corrleation (<1) then it produces portfolios with higher risk adjusted returns. The key factor is to have different investments that can be uncorrelated to each other over various periods of time. The lower the correlation, the greater the benefits derived – there are no consistent winners or losers. (eg. A balanced portfolio of 25% in each asset category of large cap, small cap, international, and short-term bonds) This is true diversification, asset classes with low correlation to one another. It has been said that “Diversification is the only free lunch in the investment world.” Have things that zig when others zag.
• Index investing minimizes hidden costs. Active management costs are significantly higher than index investing costs. Some costs are visible “Above Water” (higher management fees – 1% versus 0.2%) and others are hidden “Below Water” (trading commissions – churning, bid/ask spread, market impact costs – large buy/sell orders affect price). In addition, there is no consistency for any mutual fund. Star mutual fund managers generally do not continue to outperform, historical performance is no guide to the future.
• Alternative Investments can add significant value when combined with traditional portfolios by reducing risk. Such would be hedge funds, commodities, and managed futures. But generally those are not available to the individual investor.

Asset Allocation Clock:

• Economic Recovery & Low/Moderate Inflation – Domestic Equities, Nondomestic Equities, High Yield Bonds, Emerging Market Debt, Private Equity & Venture Captial
• High Inflation – Real Assets, Real Estate, Inflation-Protected Securities, Art, Antiques, and Collectibles
• Disinflation & Deflation – Cash Instruments, High-Quality Domestic Bonds, and High-Quality Nondomestic Bonds.

Other Insights:

• Efficient Frontier – The goal is to achieve a portfolio of assets that generate the highest level of return for a given level of risk. These points of high return, low risk lie on the efficient frontier and is attained through reasonable asset allocations that are truly diversified.
• Portfolio Rebalancing – Establish targeted percentages of your total portfolio that are to be placed in stocks, bonds, cash, real estate, and other investments based on your goals. Along the way, the prices and return of each investment in the portfolio will fluctuate in varying degrees. Then to get back to the originally targeted mix of equities and bonds, you reallocate and rebalance the portfolio. Hence, asset allocation has us selling those assets that rise & swell to too large a percentage of the portfiol and redeploying the money into more out-of-favor sectors and asset classes. This results in Buying Low and Selling High.
• Mean Reversion – What goes up must come down. Through time, things go back to average. In investing this says that over a period of several investment cycles, most assets’ returns will tend to generate their long-term average returns. Almost everytime an asset class goes too far in one direction, it eventually swings the other way – the only questions are how far and for how long. But keep in mind that when the reversing move does occur, prices will often push far past their long-term average in the opposite direction. Note however, a given asset class is probably a better investment after everyone has sold. Buying low, selling high.

Remember:

• The popular concept of every Bull Market is that the public has bought into the value of long-term investing and will never sell their stocks simply because of market fluctuations. And time after time, the investing public loses heart after the inevitable punishing declines that stock markets periodically dish out, and the cycle beings anew.
• Understand that market cycles will occur from time to time and don’t freak out.
• Properly managed and implemented, investing has all the excitement of watching grass grow and paint dry.
• Long term data provides a necessary “reality check.” This combats the virulent behavior of “overemphasis on recent history.”
• Instead of joining the herd mentality, get out when “everybody” knows that something is a good thing. It only means that everyone who wanted to buy already has; there are no buyers left. Prices can only fall.
• To avoid market timing, staggered contribution (dollar-cost averaging) lowers the risk.

Appreciation always eventually reverts back to the mean. Unfortunately, when prices have gone way over average, they have to go below average for a time in order for the mean to reestablish itself again.

Prices may be fairly valued, but whenever you have a bubble of huge proportions, valuations do not simply revert to the mean, they overshoot it and become grossly undervalued.

Whenever prices climb people start believing that prices will continue to climb. So everybody and their neighbors jump in the bandwagon and try to grab a piece of the action (and make a quick buck). This grossly pushes up demand and throws supply out of whack, causing prices to rise even more.

Eventually people realize that the asset is way overpriced and tries to get rid of it as quickly as possible, causing a sharp dropoff in demand and making it underpriced. But sooner or later, prices will revert back to the mean to its true valuation, balancing both supply and demand.

So the best time to make money is to buy when it is undervalued and sell when it is overvalued. Buy low, sell high. Seems like an easy concept but why do so many people fail at it? Because of the herd mentality. We flock toward assets that other people buy, but by that time most of the gains have already been had. And we get rid of assets that other people don’t want, locking in our losses.

I think it is important to research the true valuation of assets instead of looking towards other people to decide which assets to buy and sell.

If from research we find that assets are undervalued then we should still invest in it even if other people are running away from it, most likely the asset price has become grossly undervalued. On the other hand, if through research we believe the asset’s value does not justify its high price then it is time to sell, it probably has overshot the mean and is in a bubble.