It’s not a pretty sight, is it? Investors still aren’t at the real return break-even point. It’s even worse when you consider that these plotted returns include dividends but exclude the effects of taxes and fees.

Granted, the chart is based on peak valuations but isn’t that what many folks tend to do – jump on the bandwagon when the market is hot?

Now you know why I’m not counting on the equity markets to fund my basic retirement needs. I have a different plan to provide that retirement income.

Here is a link to the source of the chart: What is “Break-Even” in the S&P 500?.

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I am growing more cautious. A few weeks ago I placed stop orders on our major retirement holdings. I think I’m going to increase the stop price.

I encourage you to read the article and make decisions for yourself. In these troubling economic times, inaction due to inertia is not a decision.

Here is the link: ROI: Is a Crash Coming? Ten Reasons to Be Cautious

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You don’t want pure anti-correlation either, where your different asset classes always move inversely to each other. Preferably, your investments would change in value in a somewhat independent fashion. This gives your portfolio an opportunity to thrive in good times and to survive in bad times, without a need for constant buying and selling.

There is a problem developing with practical implementation of a portfolio based on an asset non-correlation theory. The problem is that stock correlations are now ridiculously high, at 0.82. This is higher than since 1982, except for the “crash of 1987″ period. To bring even more attention to this situation, here is a recent quote from the Seeking Alpha site:

Over the nearly 40 years of data, there have only been a total of three readings over 0.80 (including the current reading) and only five reading over 0.67! Thus, the current correlation of stocks to the market is indeed quite rare.

What does this mean for the average investor? In one sense, it warns you that all of your perceived stock-picking skills may be to no avail. When a highly-correlated market falls, your picks are likely to tag along, no matter how clever you think you have been.

What can you do to respond to this situation? I’ll tell you what Mr. ToughMoneyLove has done.

First, I checked the relative correlation of our long term holdings. That is easy to do by plotting their respective market movements during the past year (or other period) on a chart. You can quickly do that displaying a Google Finance chart for one of your holdings, then use the “Compare” box to add additional investments from your portfolio to the chart.

When I did this for our ten speed “couch potato” portfolio, I observed that too many of the ten different asset classes were moving in tight correlation. This was not how it was when I first set up the portfolio in 2007.

What I did next was to reduce the number of different investments in the portfolio. I chose asset classes that were consistent with a long term “couch potato” investment plan and that were generally non-correlated. A related motivation was to make it easier to manage risk and to lower transaction costs by using stop loss orders.

If you are a long term investor, I suggest that you investigate the correlation (in today’s market) of your different asset classes. If they are tightly bound together, make a change. If you don’t, you are losing the benefit of owning different classes of investments and increasing your risk.

Or do you have a better idea to share?

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Several months ago we opened a new primary checking account at a community bank paying 3.85% interest on funds up to $25k. Last week we went to that same community bank for a mortgage refinance on our Tennessee home. Bank of America was not competitive so we will be paying off our existing BOA mortgage.

Yesterday I sent instructions to Bank of America to close our home equity line of credit (which we had never used). Our new bank will open one for us with no fees or costs involved. Today I stopped by the Bank of America branch and closed one of our two remaining accounts. This is the account for which BOA started charging account fees after years of providing the account for free.

We will keep the one remaining BOA account for now because it is linked to our brokerage account, where for the time being we get to trade without paying commissions. That will change soon and then we will move our IRAs and other assets in the BOA brokerage account to our Vanguard account. Vanguard is now allowing its brokerage customers to trade Vanguard ETFs commission-free which is an excellent feature.

I am still in the process of simplifying and re-balancing the investment classes in our retirement accounts.  This has involved a series of transactions in our 401(k) self-managed brokerage account. My job in managing risk will be much easier after everything is complete, such as by effectively using stop-loss orders.

What changes are you making in your financial life?

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Let’s start with this article which summarizes the thoughts of those who believe that the U.S. is on its last legs.

Next, there is the Elliot Wave Theory.  The technical analysts who follow it say that the markets are headed for real trouble and that we all should take cover.

There is also the recent pattern of extreme market correlation in which every class of equity investments rises and falls together. This is a big problem for the so-called stock picking geniuses, of which there are actually none.

So what should the more rational investor do in times like this? The market is now swinging upward, yet again. What if this is a last gasp rally before the negative predictions prove correct?  I’m going to ride it up but limit our downside with trailing stop loss orders on our major equity holdings.  Our new money will continue to flow into non-equity classes, reducing our exposure.

What about you?

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Mrs. ToughMoneyLove has been closely following gold prices and periodically mentioning them to me. I read about gold regularly (it’s hard not too in this economy). I have written here and at Go To Retirement about my lack of faith in gold as a true investment. We had some exposure to gold in our ownership of some commodity and natural resources funds. That apparently not enough to satisfy my beloved.

Anyway, one of our more conventional holdings – a dividend ETF – had been performing very poorly and way below the expectations we had when we bought it. It also replicated assets we own in our tax deferred accounts. I was tired of watching it move down or sideways.

What if the gold bugs who predict gold to hit 5,000 were right?

So I decided to make a defensive move and make Mrs. ToughMoneLove happy at the same time. I sold the dividend ETF and used that cash to buy shares in the SPDR Gold Trust EFT (GLD) on a small dip. Owning shares in GLD is the closest thing to owning gold bullion without having to keep it in your personal storage vault. I have no interest in maintaining a stash of gold coins in the house.

So now instead of wondering if I should buy more gold, I will be asking myself when I should sell it. That has always been a problem for me in analyzing gold as a long term investment.

The odds are we will not sell it until we are ready to spend the cash on a non-investment. Maybe that will be after gold prices make another major run up. If so, will that mean that our economy is in the tank? I hope not.

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This year’s most prominent ex-genius fund manager is Ken Heebner. He is the manager of the CGM Focus Fund and has been proclaimed by some to be the “top-performing U.S. stock-picker of the new century.”

So what has genius Ken done for his fund investors lately?

The $3 billion CGM Focus Fund, which Heebner runs from Boston, is the only domestic stock fund to trail at least 96 percent of peers in 2008, 2009 and again this year, according to research firm Morningstar Inc. The fund has lost 54 percent since June 30, 2008, compared with the 8.7 percent decline by the Standard & Poor’s 500 Index, a proxy for the U.S. stock market and the fund’s benchmark.

Was Ken ill or evil? No. According to one commenter, Heebner was just in all of the wrong sectors at the wrong times. How could that happen? We thought he was smarter than the rest of us. Now index investors are doing better.

Heebner’s fund has done remarkably well over the past decade, for which he is to be commended. The problem is that ordinary investors tend to look at a hot performer like Heebner’s fund,  buy-in, then expect the upward run to continue. Then things turn south and they become big losers. They sell and move on to the next hot fund. Folks, perceived investing genius doesn’t last. Heck, the stock market doesn’t last, does it?

Here is the link to the full article: Once Americas hottest investor, CMGs Heebner on a cold streak

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