Using P/E Ratio of an ETF to decide on asset mix
"P/E alone would not work very well. See for example http://www.hussmanfunds.com/html/peak2pk.htm and http://www.hussmanfunds.com/rsi/profitmargins.htm (in short, P/E is affected too much by cyclical changes in profit margins, or you might say: booms inflate the E beyond sustainable levels, thus making the P/E look more favorable than it is). Here's a random blog post that points to Schiller's normalized earnings measure: http://seekingalpha.com/article/247257-s-p-500-is-expensive-using-normalized-earnings I think even Price to Sales is supposed to work better than P/E for predicting 10-year returns on a broad index, because it effectively normalizes the margins. (Normalized valuation explains the variance in 10-year returns better than the variance in 1-year returns, I think I've read; you can't rely on things ""reverting to mean"" in only 1 year.) Another issue with P/E is that E is more subject to weird accounting effects than for example revenues. For example whether stock compensation is expensed or one-time write-offs are included or whatever can mean you end up with an economically strange earnings number. btw, a simple way to do what you describe here would be to put a chunk of money into funds that vary equity exposure. For example John Hussman's fund has an elaborate model that he uses to decide when to hedge. Say you invest 40% bonds, 40% stocks, and 20% in Hussman Strategic Growth. When Hussman fully hedges his fund, you would effectively have 40% in stocks; and when he fully unhedges it, you would have 60% in stocks. This isn't quite the whole story; he also tries to pick up some gains through stock picking, so when fully hedged the fund isn't quite equivalent to cash, more like a market-neutral fund. (For Hussman Funds in particular, he's considered stocks to be overvalued for most of the last 15 years, and the fund is almost always fully hedged, so you'd want to be comfortable with that.) There are other funds out there doing similar stuff. There are certainly funds that vary equity exposure though most not as dramatically as the Hussman fund. Some possibilities might be PIMCO All-Asset All-Authority, PIMCO Multi-Asset, perhaps. Or just some value-oriented funds with willingness to deviate from benchmarks. Definitely read the prospectus on all these and research other options, I just thought it would be helpful to mention a couple of specific examples. If you wanted to stick to managing ETFs yourself, Morningstar's premium service has an interesting feature where they take the by-hand bottom-up analysis of all the stocks in an ETF, and use that to calculate an over- or under-valuation ratio for the ETF. I don't know if the Morningstar bottom-up stuff necessarily works; I'm sure they make the ""pro"" case on their site. On the ""con"" side, in the financial crisis bubble bursting, they cut their valuation on many companies and they had a high valuation on a lot of the financials that blew up. While I haven't run any stats and don't have the data, in several specific cases it looked like their bottom-up analysis ended up assuming too-high profit margins would continue. Broad-brush normalized valuation measures avoided that mistake by ignoring the details of all the individual companies and assuming the whole index had to revert to mean. If you're rich, I think you can hire GMO to do a varied-equity-exposure strategy for you (http://www.gmo.com/America/).  You could also look at the ""fundamental indexing"" ETFs that weight by dividends or P/E or other measures of value, rather than by market cap. The bottom line is, there are lots of ways to do tactical asset allocation. It seems complex enough that I'm not sure it's something you'd want to manage yourself. There are also a lot of managers doing this that I personally am not comfortable with because they don't seem to have a discipline or method that they explain well enough, or they don't seem to do enough backtesting and math, or they rely on macroeconomic forecasts that probably aren't reliable, or whatever. All of these tactical allocation strategies are flavors of active management. I'm most comfortable with active management when it has a fairly objective, testable, and logical discipline to it, such as Graham&Buffett style value investing, Hussman's statistical methods, or whatever it is.  Many people will argue that all active management is bad and there's no way to distinguish among any of it. I am not in that camp, but I do think a lot of active managers are bad, and that it's pretty hard to distinguish among them, and I think active management is more likely to help with risk control than it is to help with beating the market. Still you should know (and probably already do know, but I'll note for other readers) that there's a strong argument smart people make that you're best off avoiding this whole line of tactical-allocation thinking and just sticking to the pure cap-based index funds." "P/E is a useful tool for evaluating the price of a company, but only in comparison to companies in similar industries, especially for industries with well-defined cash flows.  For example, if you compared Consolidated Edison (NYSE:ED) to Hawaiian Electric (NYSE:HE), you'll notice that HE has a significantly higher PE. All things being equal, that means that HE may be overpriced in comparison to ED. As an investor, you need to investigate further to determine whether that is true. HE is unique in that it is a utility that also operates a bank, so you need to take that into account. You need to think about what your goal is when you say that you are a ""conservative"" investor and look at the big picture, not a magic number. If conservative to you means capital preservation, you need to ensure that you are in investments that are diversified and appropriate. Given the interest rate situation in 2011, that means your bonds holding need to be in short-duration, high-quality securities. Equities should be weighted towards large cap, with smaller holdings of international or commodity-associated funds. Consider a target-date or blended fund like one of the Vanguard ""Life Strategy"" funds."
It depends on what you are looking for in the investment. Sharpe is generally used when you are choosing among portfolios(mutual funds, hedge funds, ETFs, etc.) to be the optimal risky portfolio. Treynor is typically used when deciding which security will be added to your portfolio. And the information ratio (alpha/residual standard deviation) is used when deciding which one you will add to a passive portfolio. Also don't forget, when analyzing a stock you need to look at the fundamentals. I hope this helps. And correct me if I'm wrong any you more experienced guys. The P/E ratio is a measure of historic (the previous financial year) earnings against the current share price. If the P/E is high, this means that the market perceives a big increase in future earnings per share.  In other words, the perception is that this is a fast growing company.  Higher earnings may also equate to big increases in dividends and rapid expansion.  On the other hand, if the P/E is low, then there is a perception that either earnings per share are decreasing or that future growth in earnings is negligible.  In other words, low P/E equates to a perception of low future growth and therefore low prospects for future payout increases - possibly even decreases. The market is (rightly) usually willing to pay a premium for fast growing companies. "If you need less than $125k for the downpayment, I recommend you convert your mutual fund shares to their ETF counterparts tax-free: Can I convert conventional Vanguard mutual fund shares to Vanguard   ETFs? Shareholders of Vanguard stock index funds that offer Vanguard ETFs   may convert their conventional shares to Vanguard ETFs of the same   fund. This conversion is generally tax-free, although some brokerage   firms may be unable to convert fractional shares, which could result   in a modest taxable gain. (Four of our bond ETFs—Total Bond Market,   Short-Term Bond, Intermediate-Term Bond, and Long-Term Bond—do not   allow the conversion of bond index fund shares to bond ETF shares of   the same fund; the other eight Vanguard bond ETFs allow conversions.) There is no fee for Vanguard Brokerage clients to convert conventional   shares to Vanguard ETFs of the same fund. Other brokerage providers   may charge a fee for this service. For more information, contact your   brokerage firm, or call 866-499-8473. Once you convert from conventional shares to Vanguard ETFs, you cannot   convert back to conventional shares. Also, conventional shares held   through a 401(k) account cannot be converted to Vanguard ETFs. https://personal.vanguard.com/us/content/Funds/FundsVIPERWhatAreVIPERSharesJSP.jsp Withdraw the money you need as a margin loan, buy the house, get a second mortgage of $125k, take the proceeds from the second mortgage and pay back the margin loan. Even if you have short term credit funds, it'd still be wiser to lever up the house completely as long as you're not overpaying or in a bubble area, considering your ample personal investments and the combined rate of return of the house and the funds exceeding the mortgage interest rate.  Also, mortgage interest is tax deductible while margin interest isn't, pushing the net return even higher. $125k Generally, I recommend this figure to you because the biggest S&P collapse since the recession took off about 50% from the top.  If you borrow $125k on margin, and the total value of the funds drop 50%, you shouldn't suffer margin calls. I assumed that you were more or less invested in the S&P on average (as most modern ""asset allocations"" basically recommend a back-door S&P as a mix of credit assets, managed futures, and small caps average the S&P). Second mortgage Yes, you will have two loans that you're paying interest on. You've traded having less invested in securities & a capital gains tax bill for more liabilities, interest payments, interest deductions, more invested in securities, a higher combined rate of return. If you have $500k set aside in securities and want $500k in real estate, this is more than safe for you as you will most likely have a combined rate of return of ~5% on $500k with interest on $500k at ~3.5%.  If you're in small cap value, you'll probably be grossing ~15% on $500k. You definitely need to secure your labor income with supplementary insurance.  Start a new question if you need a model for that. Secure real estate with securities A local bank would be more likely to do this than a major one, but if you secure the house with the investment account with special provisions like giving them copies of your monthly statements, etc, you might even get a lower rate on your mortgage considering how over-secured the loan would be. You might even be able to wrap it up without a down payment in one loan if it's still legal.  Mortgage regulations have changed a lot since the housing crash." Are you implying that Amazon is a better investment than GE because Amazon's P/E is 175 while GE's is only 27?  Or that GE is a better investment than Apple because Apple's P/E is just 13.  There are a lot of other ratios to consider than P/E.  I personally view high P/E numbers as a red flag.  One way to think of a P/E ratio is the number of years it's expected for the company to earn its market cap.  (Share price divided by annual earnings per share)  It will take Amazon 175 years to earn $353 billion. If I was going to buy a dry cleaners, I would not pay the owner 175 years of earnings to take control of it, I'd never see my investment back. To your point.  There is so much future growth seemingly built in to today's stock market that even when a company posts higher than expected earnings, the company's stock may take a hit because maybe future prospects are a little less bright than everyone thought yesterday. The point of fundamental analysis is that you want to look at a company's management style and financial strategies.  How is it paying its debt?  How is it accumulating the debt?  How is it's return on assets?  How is the return on assets trending?  This way when you look at a few companies in the same market segment you may have a better shot at picking the winner over time.  The company that piles on new debt for every new project is likely to continue that path in to oblivion, regardless of the P/E ratio. (or some other equally less forward thinking management practice that you uncover in your fundamental analysis efforts). And I'll add... No amount of historical good decision making from a company's management can prepare for a total market downturn, or lack of investor confidence in general.  The market is the market; sometimes it's up irrationally, sometimes it's down irrationally. "First, to mention one thing - better analysis calls for analyzing a range of outcomes, not just one; assigning a probability on each, and comparing the expected values. Then moderating the choice based on risk tolerance. But now, just look at the outcome or scenario of 3% and time frame of 2 days. Let's assume your investable capital is exactly $1000 (multiply everything by 5 for $5,000, etc.). A. Buy stock: the value goes to 103; your investment goes to $1030; net return is $30, minus let's say $20 commission (you should compare these between brokers; I use one that charges 9.99 plus a trivial government fee). B. Buy an call option at 100 for $0.40 per share, with an expiration 30 days away (December 23). This is a more complicated. To evaluate this, you need to estimate the movement of the value of a 100 call, $0 in and out of the money, 30 days remaining, to the value of a 100 call, $3 in the money, 28 days remaining. That movement will vary based on the volatility of the underlying stock, an advanced topic; but there are techniques to estimate that, which become simple to use after you get the hang of it. At any rate, let's say that the expected movement of the option price in this scenario is from $0.40 to $3.20. Since you bought 2500 share options for $1000, the gain would be 2500 times 2.8 = 7000. C. Buy an call option at 102 for $0.125 per share, with an expiration 30 days away (December 23). To evaluate this, you need to estimate the movement of the value of a 102 call, $2 out of the money, 30 days remaining, to the value of a 102 call, $1 in the money, 28 days remaining. That movement will vary based on the volatility of the underlying stock, an advanced topic; but there are techniques to estimate that, which become simple to use after you get the hang of it. At any rate, let's say that the expected movement of the option price in this scenario is from $0.125 to $ 1.50. Since you bought 8000 share options for $1000, the gain would be 8000 times 1.375 = 11000. D. Same thing but starting with a 98 call. E. Same thing but starting with a 101 call expiring 60 days out. F., ... Etc. - other option choices. Again, getting the numbers right for the above is an advanced topic, one reason why brokerages warn you that options are risky (if you do your math wrong, you can lose. Even doing that math right, with a bad outcome, loses). Anyway you need to ""score"" as many options as needed to find the optimal point. But back to the first paragraph, you should then run the whole analysis on a 2% gain. Or 5%. Or 5% in 4 days instead of 2 days. Do as many as are fruitful. Assess likelihoods. Then pull the trigger and buy it. Try these techniques in simulation before diving in! Please! One last point, you don't HAVE to understand how to evaluate projected option price movements if you have software that  does that for you. I'll punt on that process, except to mention it. Get the general idea? Edit P.S. I forgot to mention that brokers need love for handling Options too. Check those commission rates in your analysis as well." "Regarding SPY: ""One SPDR unit is valued at approximately 1/10 of the value of the S&P 500. Dividends are distributed quarterly, and are based on the accumulated stock dividends held in trust, less any expenses of the trust.""  (source)  These are depository receipts, not the actual stocks. Regarding IVV: ""The component stocks are weighted according to the total float-adjusted market value of their outstanding shares. The Fund invests in sectors, such as energy, information technology, industrials, financials, consumer staples, healthcare, telecom services, consumer discretionary and materials.""  (more here) VOO is the Vanguard S&P 500 ETF. The tracking error seems pretty small to me.  I went to Google Finance and plotted the percent change for all four on one chart.  They lie pretty much on top of one another.  The actual dollar value of each one doesn't matter nearly as much as the fact that they move up and down almost in lock-step.  There may be a larger difference going farther out, but for three separate financial products, the agreement is still remarkably good." you can check google scholar for some research reports on it.  depends how complex you want to get...  it is obviously a function of the size of the portfolio of each type of asset. do you have a full breakdown of securities held? you can get historical average volumes during different economic periods, categorized by interest rates for example, and then calculate the days required to liquidate the position, applying a discount on each subsequent day. "To calculate a sector (or index) P/E ratio you need to sum the market caps of the constituent stocks and divide it by the sum of the total earnings of the constituent stocks (including stocks that have negative earnings).  There are no ""per share"" figures used in the calculation. Beware when you include an individual stock that there may be multiple issues associated with the company that are not in the index.... eg. Berkshire Hathaway BRK.B is in the S&P 500 but BRK.A is not.  In contrast, Google has both GOOGL and GOOG included in the S&P 500 index but not its unlisted Class B shares.  All such shares need to be included in the market cap and figuring out the different share class ratios can be tricky."