I'm New to The Index Investor

First, thank you again for subscribing to The Index Investor.

Broadly speaking, we focus on seven key issues:

Establishing long-term financial goals, and the long-term portfolio return required to achieve them.
Deciding on the asset classes and uncorrelated alpha strategies to include as possible portfolio investments.
Developing a methodology for identifying robust asset allocation solutions.
Applying this methodology to determine long-term asset allocation and rebalancing policies that will maximize the likelihood of achieving this long-term portfolio return under a wide variety of possible future scenarios, subject to constraints on maximum asset class allocations, downside risk and the like.
Identifying the specific products to use to implement this allocation, and how to divide them between taxable and tax-advantaged accounts so as to maximize after-tax returns.
Monitoring current asset class valuations and levels of systemic risk, and using political and economic analysis to forecast how they could change in the future, in order to avoid the large losses that occur when asset classes become substantially overvalued and crash.
New methodologies and approaches for making good decisions in the face of uncertainty.

Before getting into these issues, it may be helpful to start with a quick review of the many different meanings of two simple words: "investment return."

The objective of asset allocation is to maximize the probability of your portfolio achieving at least the minimum level of return needed to achieve your goals, while taking on as little risk as possible. What that minimum rate of return is, however, depends on a number of other factors, including the current value of your portfolio, your expected future savings, the amount of money you want to accumulate, and the number of years remaining until the date by which you want to have achieved your goal. Given this, it may be helpful to read more about how to determine the size of the goal you should pursue.

If you would like to start by learning more about asset allocation, a good place to begin is with our introduction to asset allocation. After that, you might want to read more about the methodology we use to generate our model portfolios. We think it is critically important that investors understand the strengths and weaknesses of the methodology behind any asset allocation idea, whatever its source. After reading this section, we encourage you to explore different model portfolio solutions, in our section on generating a model portfolio.

Our model portfolio solutions are based on potential allocations to ten basic asset classes and a separate mix of uncorrelated alpha strategies. You can start to learn more about them by reading our introduction to asset classes. Alternatively, each of them has an individual section you can explore in more depth, including real return (inflation linked) bonds, domestic investment grade bonds, foreign currency bonds, domestic commercial property, foreign commercial property, commodities, timber, domestic equity, foreign developed market equity and emerging markets equity, and uncorrelated alpha strategies.

We have also written about others that we have not included as options in our model portfolios (you'll see why when you read the articles on them). These include high yield and emerging markets bonds, and private equity (both leveraged buyout funds and venture capital). We also do not include residential property in our basic model portfolios. However we have written about its potential impact on asset allocation decisions. The same is true for the impact of labor income on asset allocation.

Four other interesting asset allocation issues include volatility as an asset class, socially responsible investing, whole life insurance as an asset class, and taking "tilts" within different asset classes, including debt markets and, in equity markets, towards value, momentum, mid-cap or small and micro-cap stocks.

Having decided upon an asset allocation for your portfolio, you next have to decide whether to implement it using index (tracker) or actively managed funds and other investments. A good place to begin exploring this issue is with our article on "The Case for Active Management". More in-depth information on this subject can be found by clicking on the blue button labeled "Mutual Funds True Costs." Our preferred approach is a mix of low cost, broadly defined asset class index funds and actively managed uncorrelated alpha strategies.

If you have decided to use index (tracker) investments to implement your asset allocation, another issue you will have to decide is whether to use index mutual funds or index exchange traded funds (ETFs). A summary of the advantages and disadvantages of both alternatives can be found in our article on Mutual Funds versus ETFs.

Careful attention to whether different funds are held in taxable or tax-advantaged accounts can help increase after-tax portfolio returns over time. We provide an overview of this issue in our article on "Asset Location and Tax Efficiency".

It is also important to periodically rebalance your portfolio back to its target asset allocation weights. Interestingly, there is more to this issue than most people realize.

We also place a very high importance on monitoring current asset class valuation levels, and forecasting how they could evolve in the future under different political/economic scenarios. We take a different approach to our research in this critical area than many sell side firms, and consequently help improve our subscribers' forecasts by providing them with a different perspective. Our analysis is grounded in complex adaptive system theory (what MIT's Andrew Lo has termed "the Adaptive Markets Hypothesis"), which assumes that economic disequilibrium and inefficient markets is the normal state of affairs, and that asset classes can become substantially over and undervalued, due to the interaction of multiple investment strategies, as well as investor decisions that reflect not only rational thought, but also emotional and social influences. In each month's issue, we update our asset class valuations, as well as our economic outlook and its implications for how these valuations could change in the future.

Last but not least, we receive many letters from readers about the articles we have written. Our basic belief is that if one person asks about it, fifty thinking the same thing. The Letters to the Editor section of our home page contains a recent collection of these letters, and our replies.

We hope this guide will help you get the most from your subscription to The Index Investor. There is a lot more on our site than we have covered here, including all our back issues. If you ever need help navigating our site, or if you have questions about anything we have written, please don't hesitate to contact us, either by email (usually the fastest) or by telephone, on 401-295-0092.