AI
Friday, April 10, 2009 5:50:45 AM
Hi AIMster
A reasonable model to work with is that stock capital values pace inflation over time. Cash also paces inflation.
Stocks however pay a dividend yield which might be considered as the risk premium element.
We can see how inflation and stock prices are correlated if we look at longer term history
Holding some funds in cash means therefore that we pass on the dividend yield or risk-premium benefit. Since 1870's the average dividend yield has been around 4.8% (at least in the UK).
That's quite a premium to pass-over. However in a year when stocks decline then it only takes a 4.8% decline to eliminate that difference.
What AIM is in effect doing is after stocks have risen quickly and there's a greater risk of a reversal, then AIM moves some funds into cash in pre-empt that cash might relatively outperform stocks by losing less. Similarly when stock prices have declined significantly then AIM assumes that stocks will outperform cash in the forward direction so it reduces cash and adds to stocks.
To put some figures on this, from the previous chart, from present levels stocks would have to decline 70% to encounter the inflation line. Which would drop the UK's FT100 down from present 4000 levels down to 1200 levels (8000 Dow down to 2400).
We also see however from history that more typically inflation rises to in part close the gap. So more likely it will be a combination of both declining stocks and rising inflation. Of course yet another scenario would be for stocks to remain flat and for inflation to roar.
For my own part, I've opted for a midway meeting and in my volatility capture component (Ladder) I've allowed sufficient cash reserves to cover a 35% price decline (FT100 low of 2600, Dow low of 5200). That coincides with a 8% dividend yield level, so my current stock Ladder is set to a 3% yield top (all-out) and 8% yield bottom (all-in).
Much like CoachG I'm spread 60/40 between stocks and bonds (I don't hold REIT's however as I consider I've got enough exposure in that class via my home property). I've set a 9% Ladder top yield on the bond side (4% bottom), which means that at present levels I'm mainly in cash on the bond side, and around 54% stock exposure on the stock side. I additionally apply my stop-loss style to those combined cash reserves which helps uplift the actual stock exposure but in a very capital value protective manner.
I had been tempted to go all-in on a long term buy-and-hold basis in view of recent stock price levels (FT100 yield of near 6%), but on further thought have decided that giving up on volatility capture benefits and the wider source of potential investment benefits is not for me.
No one knows in advance which class or style will be the better investment choice. AIM provides further diversification in that rewards can arise out of price appreciation, volatility capture, income and/or losing less in downturns. Buy-and-holders are more concentrated purely on income and price appreciation alone.
That wider diversification of multiple sources of potential benefits helps smoothes out the overall ride, which in turn adds benefit in the form of better compound averaging (e.g. 10% year on year is better than alternations of 20% one year, 0% the next).
Whilst B&H has performed well over the 1980's/1990's I suspect that alternative styles (volatility capture/losing less in downturns) will come more into vogue in the forward direction.
The present government ploys of throwing money into the fire to rekinder 1980/90 like heat levels is just selfishly growing higher debt levels for our children to have to repay. Given the choice of taking a sharp cold shock now, or leaving future generations out in the cold and we've opted for the latter.
It's a shame that governments don't also use AIM as that way they might have built up cash reserves during the good times to better carry us through the bad times.
Best. Clive.
A reasonable model to work with is that stock capital values pace inflation over time. Cash also paces inflation.
Stocks however pay a dividend yield which might be considered as the risk premium element.
We can see how inflation and stock prices are correlated if we look at longer term history
Holding some funds in cash means therefore that we pass on the dividend yield or risk-premium benefit. Since 1870's the average dividend yield has been around 4.8% (at least in the UK).
That's quite a premium to pass-over. However in a year when stocks decline then it only takes a 4.8% decline to eliminate that difference.
What AIM is in effect doing is after stocks have risen quickly and there's a greater risk of a reversal, then AIM moves some funds into cash in pre-empt that cash might relatively outperform stocks by losing less. Similarly when stock prices have declined significantly then AIM assumes that stocks will outperform cash in the forward direction so it reduces cash and adds to stocks.
To put some figures on this, from the previous chart, from present levels stocks would have to decline 70% to encounter the inflation line. Which would drop the UK's FT100 down from present 4000 levels down to 1200 levels (8000 Dow down to 2400).
We also see however from history that more typically inflation rises to in part close the gap. So more likely it will be a combination of both declining stocks and rising inflation. Of course yet another scenario would be for stocks to remain flat and for inflation to roar.
For my own part, I've opted for a midway meeting and in my volatility capture component (Ladder) I've allowed sufficient cash reserves to cover a 35% price decline (FT100 low of 2600, Dow low of 5200). That coincides with a 8% dividend yield level, so my current stock Ladder is set to a 3% yield top (all-out) and 8% yield bottom (all-in).
Much like CoachG I'm spread 60/40 between stocks and bonds (I don't hold REIT's however as I consider I've got enough exposure in that class via my home property). I've set a 9% Ladder top yield on the bond side (4% bottom), which means that at present levels I'm mainly in cash on the bond side, and around 54% stock exposure on the stock side. I additionally apply my stop-loss style to those combined cash reserves which helps uplift the actual stock exposure but in a very capital value protective manner.
I had been tempted to go all-in on a long term buy-and-hold basis in view of recent stock price levels (FT100 yield of near 6%), but on further thought have decided that giving up on volatility capture benefits and the wider source of potential investment benefits is not for me.
No one knows in advance which class or style will be the better investment choice. AIM provides further diversification in that rewards can arise out of price appreciation, volatility capture, income and/or losing less in downturns. Buy-and-holders are more concentrated purely on income and price appreciation alone.
That wider diversification of multiple sources of potential benefits helps smoothes out the overall ride, which in turn adds benefit in the form of better compound averaging (e.g. 10% year on year is better than alternations of 20% one year, 0% the next).
Whilst B&H has performed well over the 1980's/1990's I suspect that alternative styles (volatility capture/losing less in downturns) will come more into vogue in the forward direction.
The present government ploys of throwing money into the fire to rekinder 1980/90 like heat levels is just selfishly growing higher debt levels for our children to have to repay. Given the choice of taking a sharp cold shock now, or leaving future generations out in the cold and we've opted for the latter.
It's a shame that governments don't also use AIM as that way they might have built up cash reserves during the good times to better carry us through the bad times.
Best. Clive.
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