May 28, 2015


Dear Friends,

At the end of my presentation to the Portland Chapter of the American Association of Individual Investors (AAII) onMay 16, I didn’t have time to answer all the questions posed. I promised to answer them on podcasts and in this newsletter. The past two podcasts have addressed the majority of the questions while the following Q&A’s complete the job. An archive of all Q&As can be found at “Ask Paul“.

Please note that I appreciate receiving your investment questions at Please keep them short and to one issue at a time. I’ll do my best to answer them via podcasts or newsletter.

To your success,

What asset classes do you recommend for market timing?


Q: I would like to use market timing on a small part of my portfolio. I have the list of asset classes you recommend for your buy-and-hold portfolio, but what do you recommend for market timing?


A: In the market-timing portion of my portfolio, I have almost the same asset classes as I do in the buy-and-hold portion. When all of the asset classes in my market-timing account are on a buy signal, I will hold a couple dozen funds, including a handful of bond funds. The biggest difference with timing is the bond funds are intermediate to long-term rather than the short-to-intermediate that I use in my buy-and-hold portfolio. Also, most of my holdings in my market-timing account are in ETFs.


What should we do with $500,000 we inherited?


Q: My husband is retiring this year at age 70. We have our retirement investments in TIAA-CREF with enough to last 30 years. We need some advice on what to do with $500,000 we inherited. It is presently sitting in a money market account. With the market at all time highs we don’t think it’s a good time to put it in the market.  Should we wait for a pull back?


A: I have no problem with waiting to put the equity part to work, but at what level of loss will you put the money into the market? If you conclude you should wait for the average bear market loss of 30%, you could wait for many years. In November 2012 Bill Gross warned of an impending devastating bear market. His bearish position cost his followers dearly as the market has gone up about 60% over the last 2 ½ years. (I wonder how many of his followers sold short). Now he is calling for a mild bear market – when it comes. He doesn’t know. I don’t know. Nobody knows. On the other hand, almost everyone expects a pull back. The S&P 500 suffers an average 30% decline about every 5 years. It’s hard to forget the 50%-plus losses of the 2000-2002 and 2007-2009 bear markets. How about putting 25% in now, dollar cost averaging another 50% over 2 years, and hold the final 25% to invest when the market is down X%? X could be 20% to 30%. I can promise this will not produce the best result but it might give you a path to being invested that will serve you for the rest of your life. Of course I am only addressing the equity part of the portfolio.


What rate of return do you think is most likely over the next 10 to 15 years?
Q: What rate of return do you think is most likely over the next 10 to 15 years? My portfolio is 50/50 stocks and bonds.


A: The average 15-year return for the S&P 500 from 1928-2014 was 10.9%. The worst 15-year compound rate of return was less than one percent and the best was 18.9%. Experts warn that slow expected growth for the U.S. economy and the present relatively high price-to-earnings ratio suggest lower returns over the next 5 to 10 years. My sense is the return could easily be in the 6 to 8 percent range. That takes care of the equity part of your portfolio. Along with low inflation we have had low interest rates over the last decade. If we assume a 3% return on the fixed income portion of your portfolio, that would suggest a 4.5 to 5.5% portfolio return for your 50/50 portfolio. If you add the small cap, value and international asset classes to your equity portfolio, you might add another 1%.


What about investing in high yield bonds?

Q: What about investing in high yield ETFs or mutual funds for income?


A: In my Vanguard Monthly Income Portfolio I recommended a 25% high-yield bond position. It is important to understand the difference between an income portfolio based on bond dividends and the use of short-to-intermediate bonds to defend against losses in the equity part of a portfolio. For example, in 2008, high-yield bond funds fell from 20 to 80%, while the short-to-intermediate U.S. Government bond funds were up about 7%. During major market declines there tends to be a rush to U.S. Government bond funds. Some high-yield bond funds improve their performance with the use of leverage. Of course that can increase losses if the timing is wrong. I suggest you stay away from high-yield bond funds that use leverage.


Has your investing philosophy changed much in the past 10 years?


Q: In the years since you wrote “Live It Up Without Outliving Your Money” and “Financial Fitness Forever,” have you changed any major tenets?


A: The recommended asset classes are basically the same, but there are new products that make it possible to build a productive portfolio with less money. Prior to the commission-free ETFs at Vanguard, Fidelity and Schwab, it took as much as $30,000 to create the balance of asset classes I want investors to own. Today that can be done with $1,000! Each year I update the Ultimate Buy-and-Hold Strategy, Fine Tuning Your Asset Allocation andRetirement Distribution Tables so readers can follow the progress of the portfolios in the books. In “Financial Fitness Forever,” I discuss the pros and cons of target-date funds. While I am a fan of TDFs for some investors, I am critical of the lack of exposure to value and small cap. Since publication of the book, I have encouraged investors to consider TDFs plus a position in small cap value. With that one change, most of the TDF’s limitations are overcome.


Should “high-net-worth investors consider “alternative investments?


Q: Is there a role for “alternative investments” (venture capital, private equity, hedge funds, etc.) in a high-net-worth investor’s portfolio?


A: Just as I don’t think investors need actively managed funds, I don’t think wealthy people need alternative investments. The history of the investment community is coming up with another product when the last one didn’t meet expectations. When the stockmarket fell apart in 2007-2009, the industry started pushing alternative investments that didn’t lose or even made money during the bear market. It turned out most of the previously productive alternative investments did poorly during the market recovery. Some wealthy people like to feel special and be treated special.  Alternative investments are often restricted to people with higher net worth, suggesting they are better-than-average investments. In many cases the only way they are better than other investments is the size of the commission to the salesman.  For example, non-traded REITs often include a 10 to 15% commission. Having said all that, I have 10% of my portfolio in a hedge fund that I helped start. Do I need it?  No. Am I likely to sell it? Only as part of my annual rebalancing.


What about dividend-paying stocks?


Q: How do you feel about having a part of the portfolio focused on dividend-paying stocks?


A: I love dividend-paying stocks and have plenty in my buy-and-hold portfolio. The index funds I own have lots of companies that pay high dividends. Some of the highest dividends are in the U.S. and international value portfolios (including emerging market value stocks). Of course REITs are a source of big dividends. I don’t think it’s necessary to own individual stocks that pay dividends.


When’s the best time of year to rebalance a portfolio?


Q: In your yearly rebalancing examples, what date did you rebalance? Are there studies that indicate the best time to rebalance?


A: My studies assume rebalancing the last day of each year. For tax purposes it makes sense to rebalance after the first of the year so as to move profits into the new year. Also, all the studies I have seen recommend rebalancing during the first quarter to get the most impact from selling high and buying low. There is a lot of randomness to the process, so don’t expect it to work every year.


Are dollar-cost averaging and rebalancing forms of market timing?


Q: Aren’t dollar cost averaging and rebalancing really forms of market timing?


A: I see both rebalancing and dollar-cost averaging as part of a process of managing risk. They are both driven by the direction of the market and work on the margins of your portfolio. Traditional trend following market timing is also a process to manage risk, especially the risk of a catastrophic decline. With rebalancing, the risk management is an attempt to keep the risk exposure within a specific range. Dollar-cost averaging forces an investor to buy more when the market is down and less when it is up.  Market timing is the attempt to be in an asset class when it is rising, and out when it is in decline. The biggest impact of market timing is protecting the portfolio during protracted declines, preserving capital for a future market rise. Yes, they are all timing, but both rebalancing and dollar-cost averaging are very easy to do. Timing is very difficult.


When will your DVD be available?


Q: I am eager to see the DVD of the Portland AAII presentation. I’m hoping to get my kids to watch it. Do you know how soon it will be mailed?


A: I spoke with Kathy Kiwala, President of the AAII Portland Chapter, who said it should go out in the next few days. My intent is to make it available through my website. We are looking into the possibility of breaking it up into a series of internet video pieces to put on our website. I’ll keep everyone posted through the newsletter. Let me know how much you have to pay your kids to spend 3 hours watching me explain asset class selection, asset allocation, fund selection and distributions. Good luck!

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