December 24, 2014

paulDear Friends,
My team and I send you wishes for a happy, stress-free holiday season! While one of the greatest stressors in life can be financial worries, the mission of my foundation and my passion in retirement is to help you make sound investment decisions to give you, your family and heirs peace of mind in this regard.
Throughout 2015 we have provided you information to maximize 401(k) plans, a series on Performance, updates on my “most important advice” and the free download of a chapter of my book, “Financial Fitness Forever” which give “12 numbers to change your life,” along with weekly podcasts, articles published in the Wall Street Journal’s and hundreds of answers to many reader and listener questions.
As we approach 2016, we are pleased to expand our reach with articles on Scutify, a site devoted to young investors who believe in active management.  The editor, who was responsible for inviting us to write for the site, is hoping our information will help readers understand the advantages of buy and hold. We will also updates our mutual fund and ETF recommendations, with more focus on young investors, so they too can get on the road toward a stress-free financial future. We also expect to offer several major video presentations in 2016. We appreciate you reading and tuning into our work, as well as sharing it with family and friends.
Happy Holidays!
Here are new Q&A’s, all of which are  archived at my website.

Q: Do you recommend the Vanguard international bond fund?

An advisor at Vanguard is recommending I invest part of my bond portfolio in an international bond fund (VTIBX). You previously noted you don’t recommend international bonds because currency changes cause more volatility. However, Vanguard claims to hedge their international bonds so currency changes won’t impact the returns. Since they are hedging the currency risk would you recommend this fund?

A: There are several reasons to own bond funds. One reason is for the payment of interest and a second is for the stabilizing impact of fixed income compared to stocks. Yes, the Vanguard International Bond Fund (VTIBX) is hedged for currency risk (at an additional coast) but the portfolio has a longer term maturity, as well as 20% of the portfolio in high yield bonds. The bond funds I recommend in the tax-deferred portfoliosare all AAA quality and have a shorter maturity than VTIBX.
Q : How do I execute a long-term buy and hold strategy when the ETFs have such a short history and how much history of returns do you need for the results to be meaningful?
A: All I care about is the history of the asset class. Of course we would like 80 years of performance, like U.S. large and small cap value, but an asset class that has 30 or 40 years of returns is meaningful. For example, if we find 40 years of U.S. small cap value indexes and 40 years of international small cap value have similar returns and premiums, we would likely conclude the asset class is worthy of adding to the portfolio. If a U.S. small cap value ETF only has a couple of years of performance, that’s okay, as long as we know that the small cap value fund or ETF holds the right size companies and right value orientation.
Q: Can you explain your decades return table?
I’ve looked at many different small cap value ETFs and mutual funds. All of the ones with more than 15 years of performance seem to hover around an 11% annual average compound return. This is much less than the decades of the small cap performance. These include the Vanguard and DFA funds that you’ve recommended. Am I missing something in your decades return table?
A: In the period 1969 through 1978, the S&P 500 compounded at 3.2%. For the same period the small cap value index compounded at 7.1%. When we extend the return from 10 to 20 years, the S&P ends the period with a 9.2% compound rate of return. For the same 20 years, the small cap value index compounded at 14.4%. If you remember, the academics expect a 2% premium for small cap over large cap and another 3% for the value premium. Over the last 15 years the 9.4% return for small cap value has almost a 5% premium over the 4.5% return for large cap blend. By the way, we would expect small cap growth to make about 3% less than small cap value. For the last 15 years the average small cap growth fund has compounded at 6% compared to over 9% for the average small cap value fund.  The challenge is to remember that great long term returns are always hiding periods of high underperformance.
Q: When are you going to update your Microsoft recommendations? It looks like some of your recommendations are no longer available.
A: As it turns out they have not changed their offerings. But you are right about the differences in some of the names. I suggest using the ticker symbols to identifying the funds on the Microsoft list. By the way, I appreciate the heads up when you think your 401(k) offerings have changed. As I said in an earlier Q&A, I hope to have some help next year in keeping up with the 401(k) plans we are following.
Q: What is the best small cap value ETF fund at Schwab to begin with a small investment?
I enjoy listening to and sharing your podcasts with friends and children. I have three children ranging from 10-16 years old. The older children have started custodial Roth accounts, one with Vanguard and the other with Schwab. The youngest has earned income and will be starting his Roth this year. Which company would be easier to work with? The $3000 minimum at Vanguard is a hurdle and the only account that we were able to use previously was the STAR fund with a $1000 minimum. My daughter is at Schwab and I’m diversifying her using your sample ETF’s at Schwab and leaning aggressively towards small cap and international. I had her started in SCHB before I had the pleasure of leaning about your podcasts. I’m leaning towards Schwab for my youngest but what would be the best small cap value fund there (assuming an ETF) with only a $1000 to start?
A: For a small account Schwab is a better choice.  Take a look at RZV and SLYV. RZV is more risky so consider putting 25% in RZV and the balance in SLYV. I will do an article on the Vanguard, Fidelity, Schwab and TD Ameritrade commission-free ETFs in the coming weeks.

Q: Should an investor be concerned with putting all his eggs in the DFA basket?

My concern is the company could be sold, and fees could be raised by the new owner.
A: I suspect we will see DFA lower their fees in the future, as they have in the past. It is possible the DFA management company will be acquired by another firm eventually, but I think it would be suicide for the new owner to raise the fees as almost all their clients originate their purchase with the help of an investment advisor. The bigger concern I have is DFA will make their funds available to a wider market of less-qualified investors. One of the advantages of DFA is their low turnover due to all of their clients working with professional advisors. If they open up their funds to the public, like Vanguard, I suspect the turnover will double to that of Vanguard. That would likely lead to a portfolio that would require greater liquidity and therefore lower returns.
Q: Should I be more aggressive with my equity investments?
I have 30+ years until retirement. My gut is telling me to lean toward the more aggressive side with my equity investments. Using your recommended portfolio as a model, I was considering a 100% equity position but eliminating the U.S. large blend and international large blend asset classes and adding a mid cap value fund in their place. I realize this will increase volatility but over the long-term, I believe the small and mid cap value tilts will produce healthier returns, albeit with a bumpier ride.
A: I have no problem with what you are suggesting. You are ready for more volatility and you’ll get it. Of course you should be paid a premium for the additional risk. I know a lot of investors who have all value positions in the equity part of their portfolio. The challenge is there are times that value underperforms growth, so you have to be ready for years of lower returns.
Q: What are the pros and cons of adding more real estate (REITS) to our portfolio?

My wife and I have several rental units. We think we have enough real estate and are questioning adding REITs to our portfolio. What are the pros and cons of adding more real estate?
A: REITs are very different from owning local rental properties. REITS are normally regionally diversified as well as owning shopping malls, office buildings, large apartment complexes, etc. It is possible to build a portfolio without REITS but I don’t think they are the same as owning the rental properties you hold.

Compound interest’s effect on $100 is explosive
The following questions were generated in response to my recent article describing how to turn $3,000 (or alternatively $365 a year) into $50 million.  More



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