July 22, 2015


Dear Friends,

In my June 11 newsletter, I told you about a friend who was improperly sold a financial product that would have cost him over $1,000,000 in future returns to his family. It was my great pleasure to be able to help him recover all his money. But I know that everyday people are duped, taken advantage of, and swindled out of their money by liars.

I found this TED Talk very interesting because it addresses the research on our inability (most of the time) to spot a lie. Knowing how to spot a lie is a very important piece of information, as one lie could be the difference between having enough in retirement or outliving your money. I plan to write several future articles on how to protect your self from trusting the wrong person or sales pitch. I hope you watch this video now and learn more about protecting your self and loved ones from lies and liars.

I appreciate receiving your short “Ask Paul” questions. However, amid summer travels for pleasure and work, I’ve fallen a bit behind on answering directly. I seek to address some of your questions in these Q&A’s (archived on my website) and in my podcasts. Please be patient and stay tuned.

To your success,


Won’t the direction of interest rates have a devastating impact on the market?  

A: This is one of the most common questions I get. Sometimes it’s a question and sometimes it’s a comment. Recently a reader wrote, “Both stocks and the bond markets are going to fall at the same time.” My response made no attempt to predict something I can’t know, but I did remind him, “We like to talk like we know what’s going to happen, yet one of the interesting aspects of investing is how often very smart people are proven wrong.”


The last time that the Federal Reserve began a rate tightening cycle was almost 11 years ago (6/30/04). In the first month following the increase in short-term rates, the S&P 500 fell 3.3%. In the 6 months following the increase on June 30, 2004, the S&P 500 gained 7.2%. And 5 years later the S&P 500 has compounded at about 10% a year. Of course most had expected the increase in rates would be a market killer.


Are Stable Value Funds a good idea?


Q: Do you consider a Stable Value Fund inside of a 401k plan to be a good substitute for a bond fund, given the low interest rates offered on bond funds now and the potential loss principle, once interest rates rise? The fund is currently earning just shy of 3% and makes up approximately 20% of my portfolio.
A: I do like most Stable Value Funds, especially those that are diversified among several different insurance companies. As you know, the Stable Value Fund is only guaranteed by the insurance company that writes the guaranteed interest contract; it is not guaranteed by the government. I use a combination of government bond funds in my buy-and-hold portfolio. If I had a GIC available, I would hold 30% to 50% of my fixed income in it.


Should we really invest value stocks, and what about gold?


Q: Do you really think someone should be investing in value stocks? Value funds are only good or useful towards the end of a stock market boom. They don’t really run as much as other funds and tend to catch up later.  Get out of bonds. Both bonds and stocks will fall at the same time. Your best bet is cash and probably 15% in gold. With WWIII coming, gold is going to the moon.


A: I don’t want to sound argumentative but I disagree with your comment on value stocks and gold. First value: You contend value stocks are good at the end of a bull market.  I suggest you read an article I wrote: “The one asset class every investor needs.” This article is about small cap value but the numbers are similar for large cap value as well.


Here is one line from the article: “In the 20 calendar years immediately after the S&P 500 lost money, small-cap value stocks on average gained 32.4%.” You may be right that value is good at the end of bull markets, but it looks like value may also do well early in the cycle.


About gold: In my 50+ years of investing I never found a time when gold wasn’t about to go to the moon. At the end of the 50 years it turned out that Government Bonds did better than gold.


Here is my favorite Buffet quote on gold: “You could take all the gold that’s ever been mined, and it would fill a cube 67 feet in each direction. For what it’s worth at current gold prices, you could buy – not some – all of the farmland in the United States. Plus, you could buy 10 Exxon Mobil’s (XOM), plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?”
That quote was made when gold was about $150 higher than it is today and the S&P 500 was about 950 points lower. Since, the S&P 500 made another 10% in dividends.


Should I be nervous that my return was relatively low?


Q: I allocated my 401K as per your Vanguard recommendation. After a year, I noticed my personal rate of return is 4.7% (while S&P 500 is 14.7%). Is this what you expect some times to happen?


A: Yes, that’s is a common result. Over the last 45 years, the annual difference in return between the WW equity portfolio I recommend and the S&P 500 is 9.9%. Your question is a good one as one of the challenges of a “properly diversified” portfolio is dealing with what could have been without all the diversification. How has it worked this year so far? I think you will find it is a very different result from last year. Expect it!


How can I keep my investing most simple?


Q: I have not been a very successful investor. I want to keep it simple. Is it possible to achieve a similar return to your recommended portfolios by using a similar risk fund like Fidelity’s Balanced (FBALX) or Puritan Fund (FPURX)?


A: I find most investors don’t want to go to the work of maintaining the 10+ fund portfolios. I don’t think the Fidelity funds you mentioned will do as well as my portfolio, but if what you want is a basic balanced fund, I suggest the Vanguard Wellington Fund (VWELX). The Vanguard fund has lower fees and less turn over. Over the last 15 years the Vanguard fund has compounded at 8.1% vs. 7.5% for the Balanced and 6.9% for Puritan.


Should a 20-year-old invest in bonds?


Q: I am 20 years old and hesitating on whether to invest in bonds. From my research and analysis, I would go for a 20% portfolio on German bonds. What is your advice, as well as what bonds to invest in?


A: I teach a university class once a quarter and I am very aggressive in recommending an all-equity portfolio for the long-term portion of a portfolio. If your investment is to fund a short-term need, I would stick with short-term bond funds. I do not track country specific funds other than U.S. funds. In the U.S. I am a fan of the Vanguard Investment Grade Short-Term Bond Fund.  I hope that helps.


Why not invest more in larger economies?


Q: You recommend about an even split between the USA and foreign equities. However, the Chinese and EU economies are each individually larger than that of the USA. Why not recommend investing in these economies in closer proportion to their sizes?


A: My portfolios are not capitalization weighted but, rather, asset class weighted. If the portfolio were based being weighted by capitalization, it would be more than 50% international and mostly large-cap growth. It is the asset classes that will make you successful, not the size or numbers of companies. It is possible large growth companies will make more than small and value oriented companies, but not likely.


What do you expect the market to do when interest rates go up?


A: That’s a bigger unknown than people think. I imagine most expect the market to go down with higher interest. But making the right call as to how the market will respond is tricky. The last time that the Federal Reserve began a rate-tightening cycle was on 6/30/04. In the 1st month following the 6/30/04 Fed hike to short-term rates, the S&P 500 fell 3.3%. In the 6 months following the 6/30/04 Fed hike to short-term rates, the S&P 500 gained +7.2%.


The market has gone almost 1400 days without a 10% decline. How much longer can this move go on?


A: I suspect you know my answer: I have no idea! But I’ll give you a historical fact you can use to make up your own mind. The longest streak in the last 50 years without a 10% decline was the 2553 calendar days from 10/11/90 to 10/07/97.  The number I like even better was the 25 calendar years from 1975 (following another huge bear market) to 1999 that the worldwide equity strategy I recommend only had one losing year of 12.2%. Following that amazing 25 years the market entered one of the worst 15 years in stock market history.


How does one decide who to listen to and how best to invest?


Q:There is an article on AARP’s website by Allan Rothabout what he does with his portfolio. It seems like every advisor has his own approach. How does one decide?


A: I have known Allan for many years and have great respect for his advice. But, we strongly disagree when it comes to asset class selection. Our disagreement is not about asset allocation (how much in stocks and bonds) but in the asset classes that should be in the portfolio. I believe in equal helpings of small, large, value, growth, REITs, and similar asset classes in the international markets. Allan believes in owning a couple of Total Market funds at Vanguard, so his equity portfolio is mostly large cap growth.


We sat together for a long lunch in Seattle many years ago and debated this very topic. I don’t think either of us convinced the other to reconsider their misguided beliefs. But here is something I believe without question: The best known academics support my beliefs rather than Allan’s. I don’t know who came up with his approach (probably John Bogle) but I know the results of the decades of serious research that Dr. Eugene Fama and Dr, Kenneth French produced. In fact, since the lunch Allan and I had years ago, Dr. Fama has been award a Nobel Prize for his work.


Let’s assume you come up with 3 people who make sense. How about breaking your portfolio into 3 separate parts, each being guided by one of the 3 strategies you found fit your beliefs?  Don’t combine the strategies. Keep each one separate so it won’t be tainted by the others.


Let me make a case for Allan’s portfolio recommendations. Allan does not personally handle accounts, rather he tells people what to do and it’s their job to do the hands-on work. His simple approach with a couple of funds may cost investors one percent a year, but hopefully they will be able to manage the account as Allan suggests. In my case, I was speaking as an advisor who did everything for the investor so it could be more complex. Allan may have been right about his client, and I was right for the client who wanted someone else to do it.


Now that I am retired I continue to have my portfolio managed by someone else as I, like many of you, don’t want to do anything that takes a lot of effort.

So maybe Allan’s do-it-yourself approach is better than mine. Or put another way, mine may be right for 2 out of 10 and his would work for 8 out of 10. But I do believe my 2 out of 10 will do a lot better than Allan’s 8 out of 10.


Will you be updating your mutual fund recommendations?


Q: I am in the process of following some of your investment advice, as discussed in your recentMarketWatch article, The Ultimate Equity Portfolio Mix, and I have a question regarding your mutual fund recommendations. In two asset classes (international small cap index and international real estate index), all of your recommended offerings from Vanguard, Fidelity, and T. Rowe Price appear to be closed to new investors. Do you discuss alternatives anywhere on your site?  Or perhaps will you be making replacement recommendations at some point?

A: At this point I do not recommend alternatives on my site. But by year-end I will. My challenge is that when there are too many moving parts, people stop reading. Also, for larger accounts at some fund families, they are allowed to trade without cost while others have to pay a commission.

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