Thank you so much to everyone who took an interest in my previous post, "How about applying this method to stock investing? #2".
In particular, the in-depth questions we exchanged in the comments became an occasion for me too to look back on my own investing principles.
@lifetree asked me to organize the content into a separate post since it was good, so, a little embarrassed, I am going to gather the answers exchanged in the second post and organize them once more. ^^;
(I have freely polished the wording of those who asked, but the content is unchanged.)
Along with the first and second posts, this one is also quite long.
But it holds the concerns of those who asked about 'with what mindset do I build a system' rather than simply 'which stock do I buy', so I would be grateful if you read it slowly.
Let me say again that I am not a finance professional.
It is only my own 'personal conclusion' reached after more than 20 years of various attempts and on the basis of many books and material from places like bogleheads, so please take it not as the right answer but as one reference case. 😂
0. To begin: the danger of 'lucky success'
Before the answers proper, there is something I really want to say through one person's case. Someone liquidated 90% of their assets when the index was in the 8,400~9,000 range and, as it turned out, made an excellent return.
That is genuinely something to congratulate.
But I think this kind of success is the hardest experience to handle in investing. Masters like Peter Lynch and some successful investors use the method of 'buying good companies cheap and selling them dear', but the probability that ordinary individual investors like us can keep doing this successfully over a long period is very low.
The problem is that when you get it right once, a strong confidence arises that your judgment will be right next time too. But there is no way to confirm whether it was skill or luck. I too got it right by luck many times during the financial crisis and during COVID, but I also suffered equally painful failures in stock selection.
The conclusion I eventually reached was that "individual investors find it hard to beat the market consistently over the long term". So I came to focus on 'response' and 'principles' rather than 'prediction'.
(For reference, Warren Buffett, one of the people I respect, winning his bet against a hedge fund investor is the same story.)
1. Bonds: how should you hold them? (especially if you are living in retirement)
Many people agonize over bonds. Those covering living costs after retirement in particular consider the role of bonds as 'financial crisis insurance' important.
How about starting by defining why you hold bonds.
Bonds are not an asset for generating returns.
- To lower the maximum drawdown (MDD) of the whole portfolio to a level you can endure.
- To be the 'ammunition' for buying stocks cheaply in a crash.
These two are enough. Theoretically, long-term bonds with a long duration (maturity) are said to defend well because their price rises when share prices crash.
That said, holding them on the basis of over 50 years of analysis found in books by masters such as Benjamin Graham, as well as my own experience of the financial crisis, and then going through a market like 2022 where stocks and bonds fell together because of inflation, I remember being a little flustered.
(Personally I think a situation where stocks and bonds fall together is unlikely to come again. That is because what happened this time was the first in history. But please note that there is no guarantee this situation will repeat, nor any guarantee that it will not happen again. )
And I would like to talk about currency exposure.
With stocks you will hold them for 10~20 years so bearing the currency risk is the natural orthodoxy, but if "money you need to take out when required" swings 20% on the exchange rate, that is not a safe asset, so keeping it in won, in deposits, a CMA or domestic ultra-short-term bonds, may be right.
In particular, for most members here who live on won, overseas long-term bonds carry one more risk called 'exchange rate volatility'. If the exchange rate also swings just when you need the money, it stops being a safe asset.
Therefore, rather than studying complicated maturity structures, it may be better to hold assets with extremely low volatility such as ultra-short-term bonds like SGOV, MMFs, or domestic deposits/CMAs.
In my own case, however, I live in Italy on the euro, so (though not to the extent of won/dollar exposure) I am exposed to euro/dollar and euro/other currency risk.
Even though Italian ultra-short-term bonds, MMFs and domestic deposits/CMAs offer high rates, I do none of them, and in line with the IPS I wrote I maintain roughly 85% equities centered on global index ETFs plus 15% global bond ETFs such as VAGF.
(Following the Bogleheads recommendation) I invest in equities without currency hedging, and hedge bonds 100%.
Among equity products, for example VOO is 100% US, VT is 60% US, and in a global bond ETF like VAGF the US share is about 45%.
*In this case VOO is 100% currency exposed, VT is 60% exposed, and VAGF is exposed to various currencies for the 75% (US + UK/Japan and so on) excluding the 25% European share; but since the global bond ETF I buy is a currency-hedged product, you can regard the actual currency exposure as applying only to the equity side.
The reason I hold currency-exposed global bonds (hedged 75%) instead of Italian bonds is that I receive my salary in euros, my home is in Italy, and I will later receive my pension in Italy, so as I said in earlier posts I think concentrating on a single country is not good, and I intend to carry this asset allocation strategy on even after retirement; it would be hard to say this suits everyone.
For retirees in particular, I think 'stability that lets you sleep at night' is far more important than 'the theoretically optimal return'.
Because rather than a higher return through duration, a certain cash-like asset you can take out immediately when needed may be the sturdier insurance.
2. VT (the whole world) vs VOO (US S&P 500): which is the right answer?
I received a really good question: "the power of the US market is absolute, so is there any need to diversify across the whole world?"
Banker on Wheels is one of my favorite sites, and I strongly recommend taking a look at the link below.
It visualizes how the weight of world stock markets has changed since 1900.
https://www.bankeronwheels.com/global-equity-etfs/
To give the conclusion first, this is not a question of the ranking of returns but of 'the number of bets'.
Buying an ETF of a single country like the S&P 500 through VOO means buying two things at once. One is the asset class called equities, and the other is the forecast that "the US will continue to be the best in the world". The second is a forecast with no way to verify it.
An all-world ETF like VT buys only the first. If the US keeps doing well, the US share inside VT grows on its own, and if it does poorly it shrinks on its own. I do not need to get it right at all. (It includes not only Korea's Samsung and Hynix but also famous large companies outside the US such as TSMC, ASML, Nestlé, Novo Nordisk, Tencent, LVMH and Novartis.)
"The power of the US market over world equities" is a fact. But that is already fully reflected in prices. That is exactly why the US share of VT is over 60%. Buying VT does not mean buying less US. It means buying exactly as much US as the world has valued.
The claim that an all-world ETF like VT underperforms an S&P 500 fund like VOO is correct if you look only at the last ten-odd years.
But the ten years from 2000, when I first started investing, to 2009 were the exact opposite. The S&P 500 was effectively flat over that decade and emerging markets and Europe did far better. Back then nobody talked about going all in on the US.
An even more extreme example is Japan in 1989. This is a case commonly cited in the several books I recommended in my first post and on Bogleheads: at the time Japan was more than 40% of world stock market capitalization, and the line "Japan is the center of the world economy so just buy Japan" was seriously accepted. I only heard of it second hand so it does not feel entirely real to me, but the sentence structure is identical to what we now say about the US. After that it took more than 30 years for the Japanese index to recover its 1989 high.
I am not saying this because I think the US will do badly.
(In fact I hold both VT and VOO, and rather than liquidating one and paying tax now, I judged it better to enjoy the compounding effect, so I am holding both long term by force of taxes even though the holdings overlap. ^^;)
It is only that if you lay the prediction "the US will keep winning" as the premise of your portfolio, you have no way to respond when it turns out wrong.
If you are confident that in 15~20 or even 30 years the US market will hold its current position or do even better, then a US-centered ETF like VOO is right; if the risk of what comes after looks concerning or you are not confident, then an ETF like VT may be the alternative. Just know that much, and judge according to personal preference.
To add one thing: as I said in an earlier post, the real utility of global diversification is not returns but "making you not sell". Right now the US market is doing well so 100% US may feel comfortable. Decide on the basis of whether you would feel the same when the US market stagnates for three years in a row. The same goes for the Korean market.
3. Gold: must you hold it?
This is a topic on which even experts are divided. But I will cautiously offer a different opinion.
Gold pays neither dividends nor interest. It is an asset that depends purely on the belief that "the next person will buy it for more". It is said to have an inflation hedging effect, but over multi-decade horizons it has not been consistent.
"Is cash (dollars/won) not better than gold?"
Yes, that is what I think. Cash has no volatility and can become ammunition at any time, whereas gold is as volatile as equities. In particular, when a liquidity crisis comes, people often sell even gold. That means your ammunition may have shrunk at the very moment you need it.
If you want to hold it because of FOMO, I recommend limiting it to within 5% of total assets. At that level you are happy if it rises a lot, and losing all of it does not disturb your retirement plan.
4. The art of cash weighting and rebalancing
There were concerns about "what percentage of cash should I hold" and "how do I deploy it in stages during a crash".
Experts such as Bogleheads recommend first dividing cash into three kinds.
1) Living defense funds: 6~12 months of living expenses (this is excluded from the asset allocation portfolio calculation.)
2) Short-term purpose funds: money to be used within 3 years (100% cash-like assets)
3) Strategic safe assets: the weight of safe assets such as bonds in the asset allocation (equities : safe assets)
The most important thing is 'what maximum drawdown (MDD) will I design my portfolio for'. If you feel anxious even in a profitable stretch, raising the safe asset weight to 30% rather than 20% is right. Because the moment you cannot endure and sell, every expected return becomes meaningless.
And many people, thinking they will invest when it is down -10% or -20%, exclude funds for purposes 1)~2) and hold a lot of cash instead of 3).
However, this plan has a vague reference point and a large opportunity cost.
Minus 10% against what? Against the all-time high, against this year's high, or against my average purchase price?
If that is not fixed, at the actual moment you will interpret it in whichever way is convenient. And if it is against the all-time high, in a phase where the index crawls sideways for years the trigger never fires.
There is also the opportunity cost of the ammunition. From the March 2009 low until just before COVID, for more than ten years the S&P 500 never once recorded -20% on a closing basis. You have to think about the cost of waiting in cash throughout that period. Minus 10% comes often. But -30% or -40% you may see once in a decade, if that.
I think a better and more mechanical method with a higher success rate is: "if I set my equity weight at 75%, then when prices fall and it becomes 68%, I sell safe assets to bring it back to 75%."
Doing this makes 'buying low and selling high' happen by force, and the cash does not idle but keeps working and earning interest.
The advantages in this case are,
- There is no room for interpretation. You do not need to look at where the index is; you only need to look at your account balance.
- Cash does not idle. Safe assets are working as part of the asset allocation, earning interest even in normal times.
- It works on the upside too. What actually protects the account is rather the side that trims when things have risen a lot.
If you still want to keep the staged deployment method, I recommend writing at least the above principles into your IPS (Investment Policy Statement), if you are thinking of writing one. The definition of the reference point, the total amount of ammunition and the final stage, and the sentence "even if I feel it will fall further at -10%, I put it in anyway". The third is the most important. Because at that moment you will definitely feel that way.
For reference my IPS is only half a page, and preparing and writing it took several months, but I feel it was written well and I would like to recommend it to many people.
5. Finally, about the Korean market
Many people agonize over when to add to the Korean market. But I recommend putting the question itself down. In a volatile market that rises and falls vertically, catching the bottom is close to impossible, near enough to gambling.
(Except for the lucky) nobody can do it. Just as they say even a broken clock is right twice a day, I think it is better to filter out what people who claim to predict the market say. Even the great investors, Benjamin Graham, Bogle and Buffett, say market prediction is impossible.
Also, there is something we must not forget. If you receive a salary in Korea and own real estate, then including human capital, most members' lives are already 100% bet on the Korean economy.
If you pour your financial assets into Korea on top of that, then when the Korean economy struggles your salary, house price and stocks shake at the same time. That is why I think deliberately keeping financial assets outside Korea is true risk diversification.
That said, what I want to say is not that you should not invest in the Korean market, but that it may be good to invest only as much as Korea's share of world stock market capitalization.
For this part you can refer to what I explained in my earlier posts.
What I have said today is by no means the right answer. It is only the conclusion I reached through more than 20 years of trial and error: "doing it this way leaves my mind most at ease and the results satisfying".
I believe the hardest thing in investing is not finding good stocks but "setting good principles that suit me and keeping them for a long time".
Having experienced leverage/short selling, meme stocks and so on several times, there were quite a few nights when I could not sleep, and I think an investing style that gives you enough stress to keep you awake at night is gambling.
I sincerely hope your investing journey is filled with calm rather than anxiety, and with ease rather than impatience.
If you have questions, leave a comment any time. I will think it through with you as far as I know. I wish you all successful investing! 😊
