Stepping Back: The Ultimate Wealth-Building Counsel

From The Autobiography of Benjamin Franklin (Chapter 8):

1. Temperance.

Eat not to dullness; drink not to elevation.

2. Silence.

Speak not but what may benefit others or yourself; avoid trifling conversation.

3. Order.

Let all your things have their places; let each part of your business have its time.

4. Resolution.

Resolve to perform what you ought; perform without fail what you resolve.

5. Frugality.

Make no expense but to do good to others or yourself; i.e., waste nothing.

6. Industry.

Lose no time; be always employ'd in something useful; cut off all unnecessary actions.

7. Sincerity.

Use no hurtful deceit; think innocently and justly; and, if you speak, speak accordingly.

8. Justice.

Wrong none by doing injuries, or omitting the benefits that are your duty.

9. Moderation.

Avoid extremes; forbear resenting injuries so much as you think they deserve.

10. Cleanliness.

Tolerate no uncleanliness in body, cloaths, or habitation.

11. Tranquility.

Be not disturbed at trifles, or at accidents common or unavoidable.

12. Chastity.

Rarely use venery but for health or offspring, never to dullness, weakness, or the injury of your own or another's peace or reputation.

13. Humility

Imitate Jesus and Socrates.

From Common Sense to Wealth

Money saving strategies can be highly potent wealth drivers.

For example, our blog posts have highlighted this in terms of buying index funds rather than managed funds because the annual fee differentials can halve an investor's lifetime wealth accumulation.

On the topic of saving, we also recall that Warren Buffett once said he thinks about spending money: Before buying something -- any frivolous item or depreciating good -- he thinks about his foregone interest accumulation as a result of spending the money. Instead of buying a $10,000 watch, he's recall that investing the money in stocks would normally allow him to clip annual coupons of $1,000 a year into perpetuity. Put another way, a saver would remind himself that the same $10,000 invested in equities has typically accumulated to $11,000 in year 2, $12,100 in year 3, roughly $20,000 in year 7, $40,000 in year 14, and $160,000 at the retirement age of a 37 year old (in 28 years).

It also makes sense to consider the long-run carrying cost of any asset before purchasing it. The $10,000 carrying cost of a second home equates to $200,000 sunk cost after 20 years, assuming zero inflation.

Along the same lines of thinking, we loved the short article by Scott Burns on AssetBuilder.com about the compelling economics of saving on carry-cost, titled Pruis at Five. It highlights another way to consider the real asset value of a dollar saved (in bold):

• According to the trip meter on our 2003 Prius, my wife and I have covered the last 2,200 miles at an average of 46.1 miles per gallon. That’s pretty typical of the mileage we’ve enjoyed since buying the car five years and 62,800 miles ago....

  When we bought it, our expectation was that it would cut our gasoline consumption by about 500 gallons a year, saving us $750 a year based on the $1.50-a-gallon price of gasoline at the time. (Those were the good old days…) If gasoline prices rose to $2 a gallon, as many expected, we might save $1,000 a year.

  Figuring $3.20 a gallon---well below the current national average price of $3.39--- the Prius is saving us about $1,600 a year of after-tax income.

  It’s interesting to look at the $1,600-a-year savings in terms of what you’d have to invest to enjoy the same income. An investor in the 25 percent tax bracket buying a 10-year Treasury obligation, recently yielding 3.76 percent, would have to invest $56,738 to get the same net cash benefit. At the end of the ten years, if inflation averaged 4 percent, his original investment would have lost about a third of its purchasing power, providing more depreciation than income. More important, he wouldn’t have had transportation.

  We figure, by the way, that we saved the $3,500 cost of a replacement battery in the first 30 months or so of driving. The battery, like the rest of the car, is doing fine. So a big “yes, but” question is behind us.

  The Prius, over the same 10-year period, will depreciate more than a Treasury obligation--- probably about 70 percent--- but it will also have provided actual transportation. According to autotrader.com the recent average offering price of the 49 used 2003 Priuses for sale in the entire country was $14,309. The NADA value for a clean retail car is $13,600. That’s dirt cheap for five-year depreciation.

  ExxonMobil shares were recently selling at $94 with a dividend of $1.40 to yield 1.49 percent. Since the dividend is taxed at 15 percent, you’d have to own 1,344 shares to get the same spendable income benefit that the Prius is now providing. That means you’d have to invest a whopping $126,386 to “produce” the income benefit of a 2003 Prius. As energy guru Amory Lovins has pointed out relentlessly since 1973, the cheapest way to produce more energy is to use it more efficiently. Sounds like a plan to me.

  Which brings me to the future.

  There have been rumors that the 2009 Prius will be a plug-in car with enough battery power for short commutes. Instead of refilling the gas tank, drivers will recharge the car at night, reserving the gasoline motor for highway trips. Problems with the development of more powerful batteries, however, appear to have delayed the plug-in and its potential to achieve 100 mpg.

  A car like that… well, it could get us to think trade-in.

Investing and Earth's Fate, x2

Last month we wrote how Socolow and Pacala's concept of C02 "stabilization wedges" also presents a powerful investment framework. Since civilization as we know it depends on stabilizing C02 production, and since humanity is girding for the challenge already, we would like to be fully invested in companies working toward each solution.

Socolow and Pacala propose seven C02 "stabilization wedges" (a reduction of a billion metrics tons of C02/year) are necessary to prevent dramatic changes to humanity's life on earth. Joseph Romm summarizes here on Grist.org why that actual number is 14 wedges. To us they represent a powerful investment framework:

Efficiency & Conservation:
Increased transport efficiency
Reducing miles traveled
Increased heating efficiency
Increased efficiency of electricity production

Fossil-Fuel-Based Strategies:
Fuel switching (coal to gas)
Fossil-based electricity with carbon capture & storage (CSS)
Coal synfuels with CCS
Fossil-based hydrogen fuel with CCS

Nuclear Energy:
Nuclear Electricity

Renewables and Biostorage:
Wind-generated electricity
Solar electricity
Wind-generated hydrogen fuel
Biofuels
Forest storage
Soil storage

And there are more possibilities, but this represents an outstanding list for investors wanting to participate in major secular trends and allocate capital to businesses working to sustain human life on earth.

Finally, "Real" Asset Allocation For Individuals

The famously successful asset allocation strategies of top investors and university endowments such as Yale have been the envy and goal of many sophisticated individual investors for years. Yale's endowment, for example, is up an astonishing 16.1% per year for the past 22 years, with remarkably low volatility, since current head David Swensen took over. Look at the Yale annual report and our blog summary "Yale and You" here to see how Yale does it.

But individual investors haven't been able to participate directly in such diverse and exclusive funds, and instead have had to (1) try to construct their own sophisticated asset allocation from the bottom-up, (2) hire professionals for enormous fees and scant accountability, or (3) settle for the badly inferior "life-cycle" funds that offer a simplistic mix of stocks vs bonds as individuals age.

Happily, today Vanguard announced its Managed Payout Funds, which will help individuals gain access to more of the true diversification benefits that professional asset allocators achieve. Vanguard will offer three funds containing not only U.S. stocks & bonds (which are often highly correlated and therefore far from optimal), but also international stocks, REITs, Treasury Inflation Protection Securities (TIPS), commodity-linked investments, and market-neutral equity funds. These additional asset classes have different return and correlation characteristics in comparison to U.S. stocks & bonds; institutional investors have been exploiting them for years to obtain higher returns and lower variability of returns year-to-year.

Vanguard will construct its Managed Payout portfolios to achieve closer-to-optimal portfolios (in a Markowitz sense) than most investors can achieve for themselves. The new funds will pay out a percentage each year to investors needing retirement income and (probably) better risk-adjusted returns than are widely available to them otherwise. Vanguard will re-balance each asset class regularly to accord with long-run allocation targets, something individual investors also fail to do. Astonishingly (though perhaps not for Vanguard), annual fees will be only 0.57-0.58%.

Of course, the new funds' reward/risk tradeoffs won't come close to the characteristics of the best institutional asset allocators, who beat market-averages within traditional asset classes, and push into private investments and emerging asset classes that Vanguard's public funds will not be able to incorporate. But Vanguard's Managed Payout product will open a new efficiency frontier to many individual investors.

Climate Change -- Investment Waves Will Keep Coming

Lest there be any doubt that there will continue to be exponential growth in investment allocation toward securities that address and/or exploit climate change, we attach the following from a March 27 article in FT (DeAm plans green private equity fund, by Deborah Brewster):

• Deutsche Asset Management, the $800bn fund unit of Deutsche Bank, plans to launch the world’s first private equity fund specialising in climate change, or green investments.

  “We’re developing the product,” Kevin Parker, DeAm chief executive, told the Financial Times. “We are already the biggest climate change investors in the world. That has happened really in just the past 18 months.”

  The move dovetails with DeAm’s commitment to climate change as a potentially huge investing trend and with its desire to develop more products in the higher-margin end of the asset management business.

  DeAm last year took a minority stake in a private equity firm. It also launched a private equity funds of funds. The green fund will be its first direct private equity fund. “The $12bn we have in climate change is almost exclusively retail,” said Mr Parker. “We want to broaden this to institutional. We intend to be leaders in the space in both retail and institutional.”

  “For us to go into private equity today, with no track record and so many established players already there, is probably not a smart move,” he said. However, climate change was a new area and uncharted territory. “Nobody has a track record, so we could be at the starting line with Carlyle and Blackstone and the other big guys.”

  He said climate change investing incorporated a broad spectrum including green technology, agriculture and infrastructure related to alternative energy. “It lends itself to multiple products to create. We can roll them up into a diversified strategy around climate change.”

  Financiers and insurance companies, he added, were starting to recognise the problem of carbon emissions and fossil fuels and this would result in rapid change in the area. “If you can’t finance it and you can’t insure it, it probably isn't going to get built.”

  Mr Parker said asset management divided increasingly between low-margin indexed products and high-margin absolute return products, with hedge fund-like strategies offering performance incentives.

  “On one side you have exchange traded funds and on the other you have [private equity firm] Blackstone and the hedge funds,” he said. “It leaves firms like ours, traditional long-only buyside firms, needing to make some very tough decisions. The growth in the traditional segment is far outdistanced by the growth in passive strategies and by the growth in alternative strategies.

  “You’re going to have absolute return products and you’re going to have passive products – and what’s left in the middle is an endangered species.”

NOTE: At some point, hot sectors that attract too much new capital and create too much supply of new securities are bound to come back to earth. We think that's a long way off in a world where our traditional fossil-fuel energy infrastructure needs to be gradually replaced.

Asset Allocation and Sustainability

The emerging investment class outperformers will exist where giant bottlenecks are taking hold.

Right now, the most obvious example is in fossil fuels, where prices continue to rise faster than general inflation, because of the increasingly credible view that earth's "peak" annual oil production is upon us, or behind us.

A whole array of emerging investment class outperformers are forming around earth's pending environmental disasters. There are many approaches to identifying them. For example:

• (1) Issue-by-issue: We've highlighted agriculture supply/demand pressure emerging from not only demographic shifts but also weather volatility and dessication driven partly by global warming. Another "issue" example is water scarcity, and we've also highlighted some investment implications of this.
• (2) Sizing earth's needs: Our recent post "The New S&P, and Earth's Fate" highlighted another conceptualization of investment landscapes and earth's sustainability. The "S&P" is Socolow and Pacala's article on ways to reduce CO2 emissions by 7 billion tons by 2054 -- in 1 billion ton increments or "wedges."
• (3) Price of C02. Today we're highlighting a crucial debate, blogged in "Climate Progress" beginning on April 8, of what price C02 will need to be and what kind of technological breakthroughs will be needed to prevent C02 from rising above 450 parts per million in earth's atmosphere. 450 ppm is the level at which earth's future becomes much less predictable, and potentially disastrous. The global and regional carbon policy and credit debate outcomes will go a long way to informing investors where to place their bets. A high price of carbon will only accelerate investors' demands for solutions, and this will accelerate investment returns for those who invest accordingly.

Our view is that asset allocators -- and investors of all stripes -- will pay increasing attention to the environment and sustainability initiatives.

Swensen on Volatility

NPR.org, a superb general news & culture website, has posted a very good summary of David Swensen's asset allocation philosophy. He's one of the world's leading asset managers, and has grown Yale's endowment by an incredible 16.8% in the past twenty years.

We've quoted his book "Unconventional Success: A Fundamental Approach to Personal Investment" several times in this blog. We also blogged Yale's latest investment statement, here.

Below is the NPR.org article, titled "Yale Money Whiz Shares Tips on Growing a Nest Egg." See the full link for the graphics.

• The turmoil in the stock market has a lot of people nervous about their retirement savings. If only they had David Swensen investing their money.

  Swensen manages Yale University's endowment. Last year, he made a 28 percent return, adding a whopping $5 billion to Yale's endowment, which is now valued at $22 billion. And that wasn't a fluke: Over the past two decades, under Swensen's watch, Yale's endowment has grown an average of 16.8 percent a year, more than any university, foundation or pension fund.

  In scary economic times like this, he cautions that individual investors shouldn't trust their instincts.

  "The human tendency in this kind of environment is to do something — to make a change," he says.

  Stocks seem risky, especially since they've been falling. Swensen says most people he talks to get nervous and want to sell stocks.

  "And that's exactly the wrong reaction," he says. "Buying high and selling low is not a way to make money. It's not hard, right? It's very simple: You want to do the opposite."

  Finding the Right Investment Mix

  To share the wealth with everyone, Swensen wrote a book about retirement investing that details his allocation strategies. He advises having the right long-term mix of stock index funds, bonds and real estate investment trusts (see chart below).

  But when stocks tank, that mix gets out of balance: For example, U.S. stocks that once constituted 30 percent of a portfolio may now constitute just 29 percent or 28 percent.

  When that happens, Swensen rebalances, shifting more holdings into stock index funds. Then, if the market comes back up and ends the day flat — where it started — Swensen sells those stock index funds.

  Swensen's ability to buy low and sell high on the market roller coaster has in some instances earned upwards of $1 million in a single day for Yale's endowment — just by rebalancing amidst volatility.

  "So you end up at the same place you started, except a million dollars ahead, that's not bad," he says. "But from rebalancing, not speculating — just sticking with your long-term targets."

  That's the upside: The stock market can end up flat, but investors still make money because they rebalanced when it was down. Sometimes the market keeps going down. But over time – five, 10 or 20 years — as the market keeps rising, Swensen says, investors can goose out extra returns by rebalancing along the way.

  Paying for Investment Advice?

  One of the reasons that Swensen can rebalance so frequently is that Yale, like other educational institutions, is tax-exempt. Before attempting to rebalance their portfolios, individual investors need to understand the tax implications of any trades they might make.

  Figuring out the right mix of what to own can be tricky. Many people seek out professional advice.

  And that's a good idea, says Jim Barnash, the national director of financial planning for Ameriprise Financial. He says in volatile markets like this one, people need quality one-on-one advice to make sure they're properly diversified.

  But Ameriprise's advice comes with a price: up to 1.25 percent of the total investment. That means an investor with a half-million dollars invested in a retirement 401K would end up paying about $6,250 a year in fees.

  Over 20 years, that person is losing hundreds of thousands of dollars because of fees. Of course, that's better than not investing at all, and a lot of people want an adviser to help them.

  But Swensen says most of these investment services provide pretty mediocre advice, and it's just not worth giving them a percentage of your life savings.

  "That's the wrong path," Swensen says. "And the reason it's the wrong path is it's a very, very expensive path."

  Index Funds or Mutual Funds?

  Swensen says fees are also the big reason you should buy index funds instead of classic mutual funds. Index funds, which track market segments like the S&P 500, are a lot cheaper.

  Swensen says the vast majority of professional mutual fund managers fail to beat those indexes.

  "When you look at the results on an after-fee, after-tax basis over reasonably long periods of time, there's almost no chance that you end up beating an index fund," he says. The odds, he says, are 100 to 1.

  Swensen, who cautions against trying to pick individual stocks, favors nonprofit funds like Vanguard and TIAA-CREF. There too, the lower fees will mean more money in your pocket over time.

The article finishes with a more detailed listing of the index funds that Swensen recommends investors use to establish their asset allocation.

Asset Allocation: New Paradigms

Finding our efficient portfolio frontier ("Asset Allocation Insights") -- and pushing it outward (with help from "Major Investment Trends") -- is our primary interest in this blog.

A book on the same subject is "Inside the House of Money," by analyst Steven Drobny whose clients are many of the best Global Macro fund managers. It's a fascinating study because it consists of detailed interviews with 13 money managers talking about their approaches and investments.

We'll offer a few quotes from "The Family Office Manager" chapter featuring Jim Leitner of Falcon Management. Leitner employs an endless diversity of investment vehicles that wouldn't be found in any "traditional" asset allocations, but his goal is to construct a higher-performing efficient asset allocation nonetheless. That's why we're interested. And he happens to be a self-made billionaire who is reported to have produced 30% compound annual returns since he founded Falcon in 1997 with proceeds from his successful Wall Street career.

Here are a few snippets from the Leitner chapter that speaks to the point of our post today -- New Paradigms in Asset Allocation and Investment Trends:

• [Drobny asks] If you allocate 6.5% to one strategy, does that mean you generally run about 15 independent strategies in your portfolio at all times?
  
• [Leitner responds] That's where we'd like to get to eventually.... We're trying to get there by learning from what the real money [i.e. long only] funds do so well. Again, just look at the endowments at Harvard and Yale as the prime examples of having done something really intelligent. They have averaged 16% or so annual returns for the past 10 years, which are just phenomenal returns, especially considering they're without leverage! We always want to be a step ahead of them and the market, so we've done a lot of research on how we can take what they're good at and improve on it....
• Yale has seven asset categories where they look to extract risk premia and Harvard has eleven. The question is, why doesn't Harvard throw in a twelfth category? They should be looking at other uncorrelated markets such as foreign exchange for more sources of risk premia. Once they identify new sources, they can allocate X percent and, in a Markowitz sense, run an efficient frontier to come up with what the correct allocation should be. But they don't do it. Asset categories like foreign exchange or options are not thought of as an asset category where risk premia can be earned. As a hedge fund, we'll look anywhere for opportunities. The currency markets are a place where global macro hedge funds especially earn risk premia. [He then names three risk premia in currencies that he doesn't think any real money manager has ever attempted to earn on a a systematic basis.
• [For example, in Leitner's words:] As a family office, we can take the requisite long-term view. I'm doing this with a 30- or 40-year time frame in mind, so I am free to go out and do things like buy Ghanaian value stocks because I think Ghana is an interesting country. I bought them three years ago and guess what --since then the Ghanaian stock market has outperformed almost every other market I know of and is up several hundred percent.
  

That's an example of where Asset Allocation meets Global Macro hedge funds. To us, the combination opens whole cans of new paradigms for money management.

[And for more on Yale, see our post titled "Yale and You"]

The New S&P, and Earth's Fate

If potential ecological disaster could be neatly framed as a set of giant investment opportunities, then we save our species and make the investors a lot wealthier.

That's why I like Socolow and Pacala's (S&P) increasingly-famous conceptualization of how to save the world -- their concept that we need to prevent seven billion tons of CO2 from being emitted by 2054 or else we'll be sending offspring to the dungeons of the Dark Ages. (Google search "Socolow and Pacala & wedges" for the whole article.)

A new book on the topic -- Hell and High Water -- aroused the same manic concern and opportunism that Field Notes from a Catastrophe ignited within me last year.

Below are a few ways of the ways we can save one billions tons of CO2 from being emitted by 2054 -- though remember we need seven (more like eight or nine at this point), and we have to start immediately. Anyone can see that each "wedge" of a billion tons of CO2 creates enormous investment opportunities.

• Increase fuel economy for 2 billion cars from 30 to 60 mpg.
• Cut carbon emissions by one-fourth in buildings and appliances for 2054
• Produce twice today's coal power output at 60% instead of 40% efficiency (compared wtih 32% today)
• Replace 1400 Gigawatt 50%-efficient coal plants with gas plants (four times the current production of gas-based power
• Add 700 gigawatts of nuclear power (twice the current capacity)
  
• Add 2 million one-megawatt-peak windmills (50x the current capacity)
• Add 2000 gigawatt-peak photovoltaic (700x the current capacity)
• Decrease tropical deforestation to zero instead of today's rapid deforestation, and double the number of new tree plantings globally.
  

Following is a schematic diagram of the seven wedges -- or seven billions tons of CO2 we need to prevent from being emitted in order to hopefully stave-off irreversible ecological catastrophe. (Again, the figure now is probably north of eight billion tons, because of delay and "creeping normalcy" whereby we think everything is okay because the environment doesn't seem that much worse than we can remember in past times.)

Climate Change Adaptation -- Unheralded Super-Trend?

Investment dollars have flooded into technologies and areas that attempt to mitigate environmental damage and the impact of climate change -- cleaner sources of power, pollution control, resource-conserving technologies, resource-rich areas such as Brazil.

But a growing number of long-term strategists are starting to accept significant climate change as inevitable, and they may be at the leading edge of a crucial new investment trend that specifically invests in -- or directly hedges against -- the worst (call it "adaptation" for short) instead of working for a more sustainable future ("mitigation" of environmental damage).

For example, today I'm reading that the Center for a New American Security is leading a consortium to plan simulated war games in the event of climate change-driven disaster. (See a short blog post, linked here). The group also includes the Center for American Progress, the Heinrich Boell Foundation, the Power Center on Global Climate Change, the Rockefeller Brothers Fund, the Woods Hole Oceanographic Institution, and Brookings Global Economy and Development.

The group could be taking very seriously some scientists' predictions that large areas of land will be rendered uninhabitable by temperature change and flood, that large fertile areas could become infertile, that population migration and changing disease vectors could pose enormous new challenges, and that some nations may act militarily in their own interests rather than work within the international community. It's one thing to invest in Brazil because it has a lot of water and fertile land (I'd call this part of a "mitigation" investment strategy), but it's another thing to try to model a range of devastating potential outcomes from climate change in order to drive a portion of one's investment.

This latter type of speculation hopefully never occurs or is well beyond the time horizon of most investors, but some fairly dramatic changes are potentially within the time horizon of young home buyers choosing a location, insurance companies (particularly those that write or have stopped writing flood insurance in some areas), and pension funds. Looking shorter term, there is a small group of specialized consulting firms whose services might be in increasing demand. One that has turned up on many radar screens is Exponent, Inc. (EXPO).

What Ignites a Boom?

Why should individual investors interested in long-term wealth accumulation wait for new asset classes to become large and obvious before apportioning their assets to them? By the time the idea was popularized in 2005-2006 that REITs, Energy and Emerging Markets were huge asset classes that required more than marginal exposure, it was nearly time to sell REITs, stop adding to Emerging Markets positions if you had a 1+ year time horizon, and hope you were smart enough to concentrate in Energy.

Now I'm seeing asset allocation recommendations out there for amping up to 15-20% weights in commodities, right when the global economy is slowing down. Many of the portfolio optimization tools I see available to individual investors rely on the past 3-5 years of data as primary inputs to produce an expected return....HARDLY a time horizon that affords anything more than cyclical speculation.

So, what are the seeds of a Major Investment Trend? What should an investor look for in attempting be early to allocate to that asset class, rather than pile on more than half-way through? We have a few basic ideas that will be obvious to many observers -- but most of us would have invested more aggressively if we'd fully considered the import of the changes at hand:

• New economic liberalization. For example, the economic liberalization in China under Deng Xiaoping in the mid-'90s, which continued after the emerging markets crisis in the late-'90s. These events in China stimulated the Emerging Markets boom. Investors looking for investment opportunities in a nation's changing competitiveness can start with this report by the World Economic Forum. They should also beware of "reform fatigue" which sets in after long bull-runs.
  
• New trade & integration agreements. China's very significant entry into the WTO. NAFTA. Many others, all early indicators of the Emerging Markets boom. (The pace of new trade treaties has clearly slowed, a concerning indicator).
  
• Tax code changes. For example, Bush's tax cuts generally, and dividend tax cut specifically, were very important seeds to the boom in all dividend-yielding investments, particularly REITs and Utilities. It took a while for the market to catch on because we were in the middle of a recession, so investors who thought of the idea didn't see "confirmation" right away. Another big example: The Taxpayer Relief Act of 1997 eased taxes on the sale of homes for millions of taxpayers. Thus, the homes became more valuable with the stroke of a pen, and this was a major contributor of the U.S. Housing Boom.
• Shocks. There's a long list of "shocks" of many kinds that have led to booms. For example: Military: the 9/11/01 attacks led to the re-militarization of the U.S. (a boon for military companies and the oil industry). Corporate: Royal Dutch/Shell's massive reserve writedowns disclosed on 1/9/04 showed the world had much less oil than thought (especially of one of the highest-regarded exploration teams had to take such a big writedown). Natural: Hurricane Katrina's impact on New Orleans did more than any other event to usher-in widespread acceptance of global warming and the need for new "green" technologies and infrastructure.
• Technological breakthroughs. The ability to map human genes, utilize stem cells, make solar power economical, carry data wirelessly....
  

More generally, how can investors improve their way of thinking in order to identify major trends EARLY? A superb and eloquent source of ideas is Kiril Sokoloff's (13D Research) "How We Think" statement, subtitled "How To Think Outside The Box." A few tidbits:

• "The Power of Contrary Thinking." "We tried to think of all the things that everyone knew was going to happen or knew for sure could never happen" (then consider the merits of the opposite thing happening). "Despite the passage of only a little more than six months, many of these certainties have been shown to be on very shaky ground" and the corresponding investments were beginning huge moves.
• "My Theory of Contagion." "Whenever I see a bull or bear market occurring in a country, or some unusual development, I watch closely for a contagion. Two or three confirmations is usually all I need. My theory is this: contagion will spread until proven otherwise."
• "My Theory on Anomalies." "I've found anomalies to be highly useful in getting at the truth."
• "My Theory of Investor Psychology." "A long time ago, I came to the conclusion that investors base their attitudes on their last traumatic experience. That says a lot about the past, but virtually nothing about the future. The more traumatic the losses, inevitably, the bigger the bull market in the aftermath." [I worked on a trading desk throughout the early-'00s bull market,when virtually every person I worked with was significantly underweight equities in his personal portfolio because they had been traumatized by the Internet bubble burst. This trauma-overhang extended the bull market longer than most people thought.]
• "How I Process Information." "The common theme among all of [the stock market gurus who have risen and fallen" is that their biases ended up destroying them....One of the reasons for George Soros' immense success is his recognition of his own fallibility, aand his willingness to change his opinions in a nanosecond."
• "My Theory on Change." "I am agnostic about change. Neither good nor bad -- it's simply inevitable, and if you fight it, you will be crushed. How do I recognize change? (A) An unsustainable rate of change always brings a major change in direction ..... (B) Unanimity of opinion signals a change in direction.... (C) Longevity of a trend signals a growing potential for a change in direction,....(D) Excesses and extremism almost always usher in change.... (E) Imagination helps you understand change....The answer is unknown, but it's only through imagination that you can escape the manacles of conventional thinking."
  

Where Are You Versus Your Center?

When market's roil as they have in recent days, it's key to remember what your long-term strategic asset allocation targets are. That's how you avoid unnecessary trading mistakes and emotional turmoil. (What's more, reacting to a big market move by going with the momentum can often be the WORST decision, as discussed in a paper we highlighted yesterday. The paper shows that rapid market reversals often make investors' reactions very costly.)

Your targets will reflect your personal situation. There are many resources to help you determine what your optimal targets are -- your Fiduciary Advisor's resources, IndexInvestor.com, and a host of others. According to David Swensen in "Unconventional Success: A Fundamental Approach to Personal Investment":

• A generic portfolio based on fundamental investment principles provides a starting point for a discussion of portfolio construction. Table I.1 [Domestic equity 30%, Foreign developed equity 15%, Emerging market equity 5%, Real Estate 20%, U.S. Treasury bonds 15%, U.S. TIPS 15%] contains an outline of a well-diversified, equity-oriented portfolio....Ultimately, successful portfolios reflect the specific preferences and risk tolerances of individual investors. Understanding the quantitative and qualitative characteristics of asset-class exposure creases a basis for determining which asset classes to include and in which proportions to invest.

If an investor is following this generic asset allocation and rebalancing at mid-year and year-end, we'd expect him to now be somewhat underweight equities and overweight Treasuries. We don't see a particularly compelling reason to move-forward one's rebalancing.

That said, several weeks ago we substituted long-term Municipal bonds for some of our Treasury weighting. We took the risk that the financial crisis wouldn't cause further dramatic liquidation of Munis. We're about "even" on that bet, but it has caused more hand-wringing than necessary. All told, we're sticking with that position for the reasons highlighted a few days ago: Munis (tax-free) had sold off sharply and were yielding more than Treasuries (taxable), and taxes probably must rise in the next White House administration.