March 19, 2015


Dear Friends,

As I continue with my series on “Performance,” I encourage you to visit the new page on my website where you can access, in one place, all the articles, podcasts and tables on the topic. This should make it easy for you to reference the material as well as forwarding the page of articles to friends and family who you believe will find it useful. My latest MarketWatch article explains what I call “The 4-Fund Solution, and I encourage you to listen to the podcast about it as well.

To put together statistical data for articles like “The Ultimate Buy and Hold Strategy”, “Fine Tuning Your Asset Allocation,” “Retirement Distributions: How Much Can You Afford,” and the “Performance Series“. We needed someone with the analytical experience to provide the information and the motivation to help investors.

I am thrilled that Daryl Bahls has agree to take on the responsibility of researching and producing the studies that are so important for investors to understand and trust the strategies I recommend. Daryl has the formal background and experienceto provide the information we need, and he has been following my work for almost 25 years. Retired from Boeing after 37 years as an Aerospace System Engineer specializing in complex systems analysis, Daryl attended more than 10 of my workshops, starting in Spokane, WA in the early 90s. He has generously donated his time to our foundationto help others benefit from information he has found valuable to his investment decisions. Many thanks to Daryl Bahls!

Now, for this week’s 10 Q&As. All Q&As are archived here.

Robo investing

Q:  I have seen a fair amount of press on so called Robo Investing firms such as Wealthfront, Betterment and others. From what I can tell these firms follow a good deal of the best advice out there. They use ETF’s and low fee index funds in diversified portfolios to manage your investment. Are these Robo Adviser firms a good investment strategy?  Are they a better value than using traditional advisors such as Edward Jones or Ameriprise?

A:  I intend to do an article for MarketWatchregarding Robo Investing firms in the coming months.  They are generally doing a good job of asset allocation and fund/ETF selection. The one process they do, that is difficult for a lot of investors is rebalancing the portfolio.  Are they a better value than using commission-based advisors? Yes, if the investor can make sure they understand their own return needs and risk tolerance.  A lot of investors panic during major market losses. I suspect the robo advisor will not be effective in helping those people stay the course. But, if you combine the robo advisor with an outside hourly advisor, that might help during times of great stress.

How should I rebalance a taxable account?


Q:  How do you suggest rebalancing in a TAXABLE account? I have always automatically reinvested my dividends and capital gains, but then my allocation balances get off and I would have to sell funds, incurring extra income taxes, to rebalance. What about NOT automatically reinvesting and then periodically (once a quarter?) reinvesting to keep my asset allocation balanced?  Or do you have a better method?

A: Rebalancing is one of the most difficult challenges for investors. For people who have both taxable and tax deferred investments, it is often possible to do some of the rebalancing within the tax-deferred part of the portfolio. It is not required that a certain asset allocation be achieved within each account. Assuming similar amounts in taxable and tax deferred accounts, you could end up 60/40 in one account and 40/60 in the other to for an overall 50/50 balance. I like the idea of accumulating the dividends and capital gains to give you more money to invest so you can minimize taxes and other costs.  Of course the most efficient way to rebalance is with new money. For most people rebalancing every 1 to 2 years is often enough. The longer you wait to rebalance the more money you are likely to make. Rebalancing is another topic I will address in my performance series of articles.

Why is compound growth more important than average growth?


Q: In your recent MarketWatch article you impliedthat if you are offered two investments, one with a 10% average annual return and one with a 10% compound annual growth rate, that you would likely be better off choosing the latter? Why is that the case?

A: Compound is the only return that matters for the long term. The average rate of return, with a volatile security, will overstate the expected rate of return. In an upcoming article on Marketwatch about combining 4 major asset classes, I include a table that lists the average and compound rate of return for each of the four asset classes. The difference is as much as 4% a year. The compound return represents the real return you would get but the average return understates the impact of the years the investment lost money. The compound rate of return for small cap value is 13.6% compared to an average return of 18.2%. At a 13.6% growth rate you double your money every 5.3 years. At 18.2% the money doubles every 4 years. Anyone who uses the average return is either purposely misleading investors or ignorant of how compounding works.

What’s the worst-case scenario for 100% global equity portfolio?


Q: If one is invested 100% into global equities, what would you consider as a realistic worst-case one-year return? I’m leaning towards a loss of up to 70% but not sure what history would show.

A: I think your 70% number is probably realistic. As you will see in this table, the worst calendar year (1931) for U.S. large cap value was a loss of 62%. I’m sure there are 12-month periods that were worse. Of course, when we are living off our money in retirement, we should also be concerned about multiple year losses. For example, the S&P 500 had a 22.7% compounded annualized loss from 1929-1932. At that rate of loss, $100,000 would be worth $35,704 at the end of 4 years. For the same period the small cap value asset class had a 37.7% compounded annualized loss with a final value of $15,064 for the initial $100,000 value. I think most people believe we now have tools to protect against the devastating impact of a great depression, but we do have proof it can happen.  In some bear markets a broadly diversified, globally diversified portfolio protects investors against huge losses, like 2000-2002, but most big bear markets are more like 2007-2009 when almost all equity asset classes fell.

Is it better to invest a lump sum at once or spreadit out over time?


Q: I have been gifted a largish sum of money and I am trying to determine whether to put it all in the market per my target asset allocation or spread it out by investing over 6-12 months. Your thoughts?

A: The industry has always taken the position that money should be invested ASAP. A must-read study from Vanguard may help you make your decision. In fact, I suggest you read it before you read my thoughts.

The Vanguard study supports the case for immediate investment. When I was an advisor, I often counseled people in your position and found they were more comfortable making lump sum investments when markets were rising and reticent to commit 100% when markets were in decline. Of course the amount of money they had to invest, in relationship to what they already had invested, was an important consideration. Also, money that had been gifted from a loved one was often treated more conservatively than money that came from a bonus or some other less-emotional source.

You may decide to use the 12-month DCA and at the end of the 12 months the market collapses. You may decide to put it all in now, as the Vanguard study supports, and immediately lose 30% of your money. (Of course you would have lost part of that even if you used the 12-month DCA.) I can’t give specific advice, as I am no longer an advisor, but a compromise may be to put half in now and DCA the balance over 12 to 24 months. If, during the 12 to 24 months the market goes down 20% or 30%, go ahead and invest the rest.

Now I am always looking for mechanical answers to overcome the emotional challenges of investing. I should have invested much more aggressively over my life. I would have much more today if I hadn’t invested so aggressively in my 20s and so conservatively for the last 40. But after the early lessons from being too aggressive, I was more comfortable taking a more conservative approach. Your previous experience will probably dictate the answer to your present question. Your answer will not be perfect regardless what you do.  I promise there will be something you could have done better.   We always know what we should have done to do better.  My goal for investors is to find comfortable, trustworthy ways to meet their long term goals.  Let’s say you use the 12 month DCA and you discover you would have better off using lump sum, are you still likely to reach your financial goals?

What can I learn from asset class performance history?


Q: Jim Collins, at always promotes Vanguard Total Stock Market Index (VTSAX) as the exclusive stock fund for index investors. Please shed light on the superiority of your diverse recommendations vs. VTSAX.

A: Check out the 4 Fund Solution Table in my series on the performance of many major asset classes. The S&P 500 (virtually the same long-term track record as VTSAX) has an 87-year track record of producing a 9.8% compound rate of return (CRR), including dividends. The total market index produced a 9.9% CRR over the same period of time. The balance of 4 asset classes (large cap blend, large cap value, small cap blend and small cap value) compounded at 11.9% for the same period. The table also compares the returns of 15 and 40-year periods.

When you review the Performance articles, I know you will understand why I take a very different approach than Jim. I visited Jim’s site and I think he is working hard to give readers a wide range of prudent financial advice. I suspect he is trying to make investing very simple for investors but, like so much of life, with a little extra work and time, much higher returns are highly probable. I think picking the stocks that will be successful in the future is very difficult. I suspect there is a lot of luck in the outcome. On the other hand, picking successful asset classes is very easy. The academics have already done all the research. Once you figure out the best asset classes your job is to select the best mutual funds to represent those asset classes. I find junior high school kids can understand this information, so I’m not concerned about adults understanding it. The hurdle is usually the belief, “Investing is just too complicated for me to understand.” Besides reading the Performance articles, I suggest you read, “Why Vanguard Total Stock Market isn’t the best ship in the fleet.”

What’s the matter with leveraged funds?


Q: I have enjoyed your series on the performance of the asset classes and funds you recommend. What do you think of adding leverage to these asset classes through the leveraged mutual funds or ETFs?

A: I am not a fan of buy and hold investors or market timers using leveraged funds. Investors should be very careful using leveraged funds or ETFs to access the asset classes I am discussing in my Performance series. Rydex and ProFunds have offered souped-up funds for many years. For the 10 years ending 1/31/14, the Rydex 2X S&P 500 Fund (RYTNX), using 100% leverage, made less than the index (7.7% vs. 8.1%), without leverage, but at twice the risk. I know market timers think they can harness the risk and make better returns but the evidence isn’t very strong. According to Morningstar the average “investor” return with the leveraged fund is about 2.5% a year less than the fund. Bottom line: The average investor in RYTNX made almost 3% a year less than the S&P 500 for 10 years, at twice the risk. If you are interested in why the leveraged funds perform so poorly read this article.

How do large cap funds perform in times of rising interest rates?

Q: Compared with the S&Ps500, how do large-cap value stocks perform in times of rising interest rates?

A:  During the period from 1973 through 1981, inflation was 9.2%. During the same period the S&P 500 compounded at 5.2% and the large cap value 12.8%. So, for that period the S&P 500 lost money, after inflation, and the large cap value made money. My favorite asset class – small cap value – compounded at 17.4% before inflation.

Are you concerned about the poor performance of international funds?


Q: Last year I moved my balance to Vanguard funds to mimic your long-term asset allocation strategy. I just noticed that Vanguard Developed Markets (VTMGX) and Vanguard FTSE International Small Cap (VFSVX) lost value over the last year. I think your long-term strategy based on analyzing past decades of data is sound, but I am wondering if you think the poor international performance is just a blip in the long-term strategy or has something fundamentally changed with those funds?

A: One year has little to do with the long-term return of an asset class. In my “Understanding Performance” series on MarketWatch, I discuss the best of times and the worst of times for all of the major asset classes. The last 15-year period was one of the worst for U.S. large cap blend (S&P 500) and international large cap blend. Both produced less than 5% compound rates of return. Does that mean it’s time to get rid of these two previously productive equity asset classes? Both of these asset classes also struggled for the 15 years ending 1974, with almost the same returns as the last 15 years. For the 15  years following 1974 the S&P 500 compounded at 16.6% and the international large cap blend at 20.6%. For the U.S. and international small cap indexes, 1975 through 1989 returns were 23.1% and 31.5% respectively.

One of the biggest challenges for investors is trusting their investments after a period of poor performance. I have done all I can to protect you against long-term underperformance by recommending massive diversification across many highly profitable asset classes. As I’m sure you are aware, other U.S. and international equity asset classes made 50 to 100 percent more than large cap blend over the last 15 years.

Short-term vs. intermediate-term TIPS?

Q: I have read a lot of articles about the pros and cons of TIPS. You recommend the Vanguard intermediate-term TIPS. It seems a lot more volatile than the short term TIPS. Is the expected return worth the extra risk?

A: I have spoken with a number of experts about short-term vs. intermediate-term TIPS. The expectation is that the difference in return between short and intermediate TIPS will be similar to the difference between short and intermediate term bonds. Over the last 15 years, the Vanguard Short-Term Treasury Fund compounded at 3.7% vs. the Vanguard Intermediate Term Treasury at 5.8%. Of course both the intermediate Treasuries and intermediate TIPS are more volatile than short-term treasuries and short-term TIPS. If investors are uncomfortable with the additional volatility of the intermediate-term TIPS, it is okay to move to the less risky short-term TIPS, but expect a lower long term return.

What international small cap value ETF do you recommend?

Q:  Do you know of any good international SCV ETFs? The only one I can find is DLS but it has an expense ratio of 0.58%.

A: DLS has good track record thus far. For the last 5 years It has compounded at 8.6% vs. 7.2% for the average ETF in its asset class.  It is not uncommon to find that less liquid asset classes, like international small cap value, small cap emerging markets and micro cap have higher average expense ratios.

To your success,



This 4-fund combo wallops the S&P 500 index
U.S. equity investors typically concentrate their money in large-cap blend funds and so-called total market funds, all of which more or less move in step with the Standard & Poor’s 500 Index. More

Looking for action? Try large-cap value stocks
Investors looking for a bit more “action” than they’ll find in the Standard & Poor’s 500 Index and other large-cap-blend funds don’t have to look very far. More



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