Asset Allocation for June 2007

This weekend I spent some time tweaking our portfolio a little bit, to factor in money rolled-over from my wife's old 401(k) to her IRA (see this previous post for several reasons to roll-over an old 401(k) fund).

Here is our currect asset allocation:



After the re-balancing, we are pretty close to our target allocation for the near term. Note that we are currently below our target exposure to the real estate market. We establish our exposure to this asset class through Vanguard's Total REIT Index fund (VGSIX). Our REIT investments have seen several years of double digit price appreciation and I think they are probably due for a substantial correction. In addition, I am still not comfortable that the real estate market has returned to sanity, so while I did not sell any of our current VGSIX holdings, I did not put any more money into that fund. In the longer term, probably within the next 24 months, it is my intention to raise our exposure to the real estate market segment to approximately 10% of our portfolio.

I am also considering creating a direct exposure of approximately 5% of the portfolio to a basket of diversified commodities (including precious metals, oil & gas, and agricultural commodities). I will only do so if I come to the conclusion that this will create some diversification benefit, i.e. I need to understand if and how commodity prices are correlated with the value of some of our other asset classes. If I decide to pursue this investment option it will be as a long term risk reduction strategy, not as a speculative move.

Any insights on the subject will be appreciated.

Attention: Frequent Flyer Miles Expiring...

Recently I received a letter from United Airlines - that's on top of the seven credit card offers I get from them every week. This specific message notified me that United was changing its frequent flier program such that unused miles expire after 18 months of inactivity in the account. That is, if you have not earned or redeemed miles during any 18 month period, kiss you miles good-bye.

For me this is not a big deal since I fly United for most of my business trips, and I travel frequently. My wife's account is not at risk, since she receives miles for our supermarket purchases at Safeway. However my son's miles are in danger of expiring, since we only fly with him rarely.

This morning I read this article from Money Changes Things, according to which American Airlines is following suit and having miles expire after 18 months of inactivity, instead of 36 months previously. Hey, if you can screw your customers why the hell not, right? I checked American's website, and sure enough the few miles that I have will expire at the end of this year. I very rarely fly on American, so I only have a few thousand miles there. I figured that if they are going away, I might as well spend them, so I signed up for a two year subscription to Business Week at a cost of 2,300 miles.

Just to be on the safe side, I also checked my miles over at Continental. Lo and behold, there is one righteous company among the wicked. Continental miles do not expire (!) although the company reserves the right to add an expiration date to its miles at any time. Strange. I bet this won't last and Continental too will follow its evil brethren.

Anyone knows what other airlines are doing with their frequent flier programs?

Why Your Next Car Shouldn't be an "American" Car

A slightly off-topic post today.

It's no secret that American car manufacturers have been struggling for years, and have been losing ground to imported brands. Personally, I think that many foreign vehicles are a better value than American cars, particularly Japanese brands. Every car we have ever had, with one exception, has been either a Toyota or a Honda, and we have never had cause for complaint.

However, what I am writing about today is a (not so) new reason to avoid buying a car made by the so called "Big Three" U.S. car manufacturers. Big Three management and labor alike have been fighting an ongoing battle to prevent Congress from enacting new Corporate Average Fuel Economy ("CAFE") standards. The proposed rules will require automakers to improve gas mileage for the vehicles they sell, but apparently the Big Three couldn't care less about global warming or about the true cost of America's reliance on fossil fuels from questionable regimes. All they care about is selling more of their gas guzzling behemoths, and damn the rest of us.

Rick Wagoner, Chairman and CEO of GM testified recently before the House Energy and Commerce Committee. Here is a link to his full testimony, in which, while paying lip service to the environment, he makes it abundantly clear that GM is very much against the whole idea of CAFE standards. Instead he offers up such grand visions as bio fuel, hydrogen cars and electric vehicles. All visions that will take decades to become truly viable commercial products. Anything to prevent us from thinking about what can be done to reduce emissions today.

Another brilliant gentlemen, representing the United Auto Workers, the union representing... errr, auto workers... testified before the Senate Committee on Commerce, Science and Transportation. He went as far as to say:

"... because of the foregoing structural problems in the pending CAFE bills, the UAW urges the committee to reject these bills..."

This testimony too is filled with platitudes and suggestions for building a better system to control emissions, but the real intention is clear. The American auto industry is doing its best to reject environmental standards in any way they can.

They will (and are) telling you that better fuel economy will compromise safety. They will tell you that "the playing field" is tilted against U.S. car manufacturers and in favor of foreign manufacturers. They will tell you that the American auto industry will collapse. They will say anything that comes to mind, but all I hear is "we are dinosaurs and we will continue to object to any emissions standards".

If Toyota and Honda can produce more fuel efficient vehicles, its time those relics in Detroit wake up and smell the diesel. Until they do, I have no intention of buying a single car that they make. If you care about the environment, you should consider the same strategy.

Good and Bad Insurance

Yesterday I recommended this article from Plus 6. The article lists 5 types of insurance that you probably should not buy. I would like to propose a much simpler test to determine whether an insurance policy is worth buying. Ask yourself the following question: "could I afford to replace the insured item myself if I do not have insurance?" if your answer is positive, you don't need to buy insurance.

My philosophy is that insurance is designed to protect you from catastrophic damage that you cannot afford to bear on your own. It is a method of spreading an unacceptable but rare risk over the entire insured population. For example, most people should probably buy flood insurance or home owners insurance, simply because in the event of catastrophic damage to their home, they would not be able to buy a new home or repair their severely damaged house without the proceeds from their insurance. However, an extremely rich individual, say Warren Buffet for example, should not buy home owner's insurance. If disaster strikes, he can simply buy a new house without financial hardship.

The thing you need to understand about insurance companies is that they are sophisticated. They have an army of statisticians and actuaries working for them and they have a much better understanding of the risk that you are facing than you do. Another funny thing about insurance companies is that they are not in business to lose money, and for the most part they are for-profit organizations.

Combine these two insights and you will understand the following: if you buy insurance your insurance premium will, on average, be higher than your insurance pay-outs. The insurance company, using its superior access to information, knows what the real risk is and is able to compute the likelihood that they will have to pay a claim against the insurance. They also know the average magnitude of that claim. When they understand the expected pay-out for claims, they add a certain profit margin and quote you a price for the policy you are asking for.

Follow this logic: the very fact that a for profit corporation gives you an insurance quote means that they have a profit margin built into the deal. It also means that your expected damage or potential claim is lower than the price you are quoted. On average, you will pay more for insurance than you will get in claims. The difference is the insurance company's profit.

In conclusion, insurance is an important financial instrument. However, you should only insure risks that you cannot afford to self insure against . In my opinion, insurance is best used to hedge against really catastrophic events that you cannot deal with yourself. Examples of good insurance: life, health, disability, homeowner's, professional liability etc. Examples of bad insurance: extended warranty, vacation insurance, and other types of insurance covered in Plus 6's article.

I am guessing this article will create a little debate. I have certainly had many arguments with people over the years regarding this approach. Let's see what the blogosphere thinks.

Recommended Articles & Recent Carnivals

Festival of Frugality #77 and Carnival of Personal Finance #103 are both up and running. A couple of good entries this week:

Plus 6 has an excellent article about all types of insurance you don't need. This is a great topic, which I will cover myself in the next few days. My philosophy: if you can afford to replace the insured item yourself, you are wasting money on insurance.

Accumulating Money wrote a superb piece about stock splits. It is a simple, straight forward explanation that is as good as anything I learned in business school. In essence, a stock split creates two (or more shares) where there was only one before. However, the price of the share is also split in the same way. Essentially, the value of your investment does not change with a stock split, however, stocks often increase in value after a stock split, for reasons covered in the article. Check it out for yourself.

Ask Mr. Credit Card brings up a question I have asked myself a number of times: how much money do you need before you consider yourself rich? I think the number for us is $5 million. This may be within reach for us, but will take us another 30 years to achieve...

Finally, Grad Money Matters is trying to figure out whether spending money on maid service is a waste of money. I am trying to figure out the same thing, but I think I am going to come down on the side of spending the money. We are both working hard enough with full time jobs and three kids to raise, we might as well outsource this little fun activity.