A Low-Silicon Diet

On March 25, 2014, in Investing, by Dave

After 17 years in the semiconductor (silicon) industry, I am switching to software.  Why?  Many reasons, but one is worth blogging about.  I believe the long-term trend is economic contraction in hardware (silicon), and significant growth in software.

The trends I see are secular trends — a fancy way of saying very long-term. In fact the trends are just a continuation of the trends of the last few decades.  What ever you call it — hardware, silicon, or electronics — continues to be commoditized:

  • DRAM becomes a commodity — 1980s.
  • Storage (hard drives) become commodities — late 80s, early 90s.
  • Chip-sets  – late 90s.
  • Low-end graphics: early 2000
  • Other sub-systems: Ethernet, audio, USB, PCIe, cable-modems, etc.  Early 2000s
  • 64-bit computing — 2004
  • Routers, Cable Modems — late 2000′s
  • Mid-range graphics — late 2000′s, early ’10s
  • SSDs — 2014

The transition from premium product to commodity is a continuum.  A premium product does not become a commodity overnight.  The premium just gradually decreases for a given class of products.  Another was of saying this is that profit margins gradually erode as competing products accelerate the “race to the bottom.”

Today some of the last hold-outs — high-performance, high-reliability computing, and high-end graphics — are showing early signs of diminishing premiums.   Some analog and mix-signal silicon commands premium prices too.  However, the overarching trend is towards lower profit margins.

This tectonic shift in silicon margins will create winners and losers.  Consumers, technology users, and software vendors will tend to be favored.  Hardware suppliers will tend to face headwinds.  Similarly, those who work in software-related fields will tend to benefit, while those working in hardware-related fields will tend to become stuck in a low-growth environment.

Commoditization is not the end of the road.   After all, oil is a commodity that makes billions of dollars per year for companies like XOM.   It simply means that gross profit margins for silicon are likely to fall from 60% to perhaps 30% in the next 5-10 years.

Overall, I expect silicon volume (units) to keep increasing, silicon revenue to modestly increase, while silicon profit and profit margins decrease.  The mantra of “silicon everywhere” is misleading, while the model of cheap silicon everywhere” is quite apt.

Conversely, I see a brighter future in software, app, and web development.  Online retail revenue was about 6.5% in 2013, but the upward trend is strong. Hosting E-business in the cloud will become cheaper as hardware performance increases while hardware cost decreases (and hardware performance/Watt improves).  In this environment of healthy growth, software will differentiate; content will differentiate; and hardware will simply serve.

 

 

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When I think about the phrase “high-tech portfolio”, I don’t think tech stocks.  Instead I think about using technology to build a smarter portfolio.   Most actively-managed portfolios are constructed, in full or part, using 50-year-old “modern portfolio theory” methods.  I’m working to change this by bringing superior portfolio technology to market.

So, while writing for this financial blog remains a passion of mine, I will likely be spending much more time refining software and building a financial software business.  Much of that effort will be off-line at first.  Occasionally, however, I will provide business and software updates on the Sigma1 Financial Software Blog.

Developing portfolio-optimization software combines two of my long-term passions:  software development and finance.

Rest assured, that I will keep this blog up and going.  I think it contains some hidden gems that are worth discovering.  I will also continue to blog here when inspiration strikes.

Poker Chips (financial asset allocation)My current employer is radically revamping its 401K plan.  I have noticed that companies tweak their 401K plans about annually, and dramatically change them every 5-7 years.  This time it’s big. One of the choices allows for both ETF and mutual funds purchases.  The EFT option has me excited.

So far in my career I have worked for three Fortune 500 technology companies.  Long story short, I have two 401Ks and a couple IRAs.  Between them I have about 8% invested in ETFs and the rest in mutual funds.  After the 401K redux, I’ll likely have about 30/70 ETF to mutual fund mix.  I’ll keep my asset allocation largely the same, but I’ll work out a bit of math here and there to do so.  Some mutual funds stay, some funds go, some switch to higher expense-ratio versions, and some are frozen from new money after a certain date.  Over time my retirement assets may approach a 50/50 ETF-to-mutual-fund ratio.

A similar 401K change may be coming your way soon.  The booming ETF trend is continuing unabated with over $1 trillion dollars in assets under management in 2010; some predict that doubling by 2015.  Why?  1) Institutional investors like ETFs, 2) retail investors like ETFs, 3) exchanges like ETFs, 4) brokerages like ETFs.  Generally for the same reason: lower costs.

The upside of more options is access to better options and greater potential for diversification.  The downside is trading fees for ETFs… $7.95 under the new 401K paradigm.  Wise, infrequent purchases can mitigate trading costs.  This requires a bit of financial planning, but is not really a big deal for serious investors.  And there are ~25 ETFs that trade for free.  One can invest in them every paycheck (like buying EEM for free) then periodically, every 6 months or one year, bite the bullet to sell EEM (for free) and buy the better ETF VEU.  Brilliant — low fees and true dollar-cost averaging.  [Not my idea, but a good one.]

In summary, fear not the change to more ETF-centric investing.  Your particular company may pull a fast one on you… but in many cases not.   Read ALL the fine print before determining the case.  I’m glad I did, and I sense greater investing opportunity.

In my blog post Financial Toolkit: Indexing the World I discussed 5 ETF building blocks for diversified investment portfolio construction.  In this financial blog post I’m going discuss a hypothetical investing situation:

Deborah is a 40-year-old woman with a $100,000 401K who just changed jobs.  She transferred her 401K to an IRA, and has $100,000 now sitting in cash.  Deborah’s new job pays $60K/year and she plans to contribute $10K/year to her new 401K.  How might she invest her IRA funds?

As a proponent of diversified index investing, I suggest the following category questions… What percent  1) Domestic vs. foreign?  2) Stock versus bond?

I put forward the suggestion that Deborah’s choices in regard to these two questions will predict 80-90% of the performance of her chosen portfolio.  (Don’t believe it, then read this asset allocation paper sometime when you are afflicted with insomnia.)

Let’s say Deborah decides that a 80/20 domestic versus foreign allocation, and 60/40 stock versus bond allocation are right for her.  Working out the math that’s $80,000 for US investments and $20,000 for foreign investments.  Applying the second stock vs bond ratio to each yields the following: $64,000 for US equities, $16,000 for US bonds, $12,000 for foreign equities, and $8,000 for foreign bonds.

The US part is pretty easy to achieve.  Plunk $64,000 in a low-cost, broad-market ETF (or mutual fund) like SCHB, and $16,000 into a total (aka aggregate) bond ETF like BND.  The foreign stock component is easy too; but $12,000 into VXUS.  Only the foreign bonds require two ETFs because there are no foreign total bond ETFs (to my knowledge); thus I suggest $4000 in a foreign government-bond ETF like IGOV and $4000 in a foreign corporate-bond ETF like IBND.

There you have it.  A simple example of asset allocation.

My personal opinion is that an initial asset allocation process can be very simple and effective.  Notice that I was able to avoid several secondary asset allocation measures such:

  • Value vs Growth (stocks)
  • Large-cap vs Small-cap (stocks)
  • Sector allocation (stocks)
  • Developed vs Emerging markets (stocks and bonds)
  • Short-term vs Long-term (bonds)
  • Average Maturity or Duration (bonds)
  • Government vs Corporate (bonds)
  • Investment-grade vs non-investment grade (bonds)
  • Average credit rating (bonds)

All of these “secondary asset allocation factors” can be side-stepped by purchasing “total” stock and bond funds as outlined above.  Such total (or aggregate) ETFs seek to own a slice of the total, investable, market-cap-weighted investing universe.  Essentially, a total US stock fund seeks to own a piece of the whole US stock market.  Similarly with a total US bond fund, etc.

In summary, if you have a diversified, low-cost investment portfolio, the two biggest ratios to know are domestic/foreign and stock/bond.    [If you don't have a diversified, low-cost investment portfolio you might want to think about changing your strategy and your financial adviser!]