April 16, 2015


Dear Friends,

Amid the beauty and wonder of spring, and with the 2014 tax season (hopefully) behind you, I encourage you to review your investment strategies and understand more about the”Performance“of your investments through my series of articles and podcasts on this most important subject.

In each bi-monthly newsletter and in various podcasts, I seek to answer many of the questions posed in the hundreds of emails I receive each week. While I welcome your questions, I ask that you keep them brief and limited to one question. You may send multiple emails with a different question in each, and please refrain from lengthy descriptions of your specific circumstances. In this way, I hope to answer those questions that may apply to a number of readers and listeners. Even better would be if you read and ask questions or make comments directly at myMarketWatch articles, as they can be shared with the broadest audience. Below you’ll find 10 new Q&A’s, all of which are archived at my website.
Personal Finance for Non-Business Majors

In 2012, the Merriman Financial Education Foundation funded the development of a curriculum at my alma mater, Western Washington University. “Personal Finance 216” has become a popular and requirement-fulfilling course, and each year I have the pleasure of meeting and addressing the students, educating them in the wisdom and power of saving and investing. On April 20, I’ll be at WWU teaching a 2-hour class and addressing graduating seniors for 90 minutes.  The title is “Zero to Hero: 10 things every first time investor should know.” This is a topic Rich Buck and I will address after we finish the Performance series.
Upcoming Presentations
Please share with friends and family in these areas:

May 5, I’ll be addressing the Bellevue, WA Rotary.
May 7, those of you in the Santa Barbara/Ventura area are invited to attend my 3-hour presentation at the AAII Chapter. Pre-registration is required. Pleaseclick here for more information.

May 16, I’ll make a similar presentation to the Portland, OR chapter of AAII, also open to the public. For more information, click here.


Should I own REITS in addition to rental property?

Q: I currently own rental houses that account for approximately 10% of my investments. Do you still recommend including REITs in my portfolio?

A: Some very smart advisors would suggest you already have enough real estate in your portfolio, while others would say you should also include REITs. I side with those that believe REITs should be in your portfolio. I assume you own rental houses in your community. REIT funds and ETFs hold a diversified portfolio of commercial properties in most of the major cities in the U.S. Plus, REITs are an asset class that has outperformed the S&P 500 by almost 1% a year since 1978. Another advantage is that REITs often go up and down at a very different rate than the other asset classes I recommend. For more on REITs, read my MarketWatch article and listen to the podcast.

Can you recommend a no-load Vanguard International REIT?

Q:  I’m reading your book Financial Fitness Foreverand saw that you recommend international REITs, among them VGXRX Vanguard Global Ex-US Real Estate Index. They charge a .25% fee to purchase and remove money from it. They don’t consider it a “load,” as it is deposited in the actual fund for the benefit of all shareholders, but I see it as a load. Is there another international REIT at Vanguard or somewhere else that you recommend without a fee?

A: A good substitution for Vanguard’s Global Ex-US Real Estate (VGRXRX) is their commission-free ETF of the same name. The ticker symbol is VNQI. The expenses of VNQI are lower (.27% vs. .37%) and the 3-year records are less than .1% difference with the small advantage going to VNQI. Of course, while the mutual fund trades without a spread, the spread between the bid and ask on VNQI is over .2%, almost as much as the .25% cost you are trying to eliminate.

Is silver a good store of wealth?
Q: Is silver a good store of wealth currently?

A: Not in my book or any piece of academic research I have read. The only people I know who push silver as a store of value are those who make a living pushing it. Here is a chart that shows the prices of silver and gold over the last 100 years.http://www.macrotrends.net/1333/gold-and-silver-prices-100-year-historical-chart. Please note the difference in the silver price in 1915 and today  is not very much.  During the same period, the Dow Jones grew to become worth more than 1700 times it’s original value, including dividends.  Inflation adjusted, $100 worth of silver became worth less than $10, over the past 100 years, while the Dow Jones is worth almost $1,300.  Please note silver didn’t pay any dividends.


How should I allocate assets that will be inherited by our kids?

Q: I am retired and have been taking 4% from my IRA. I am 67 and wife is 66. Beside our regular IRA, we have $800,000 in a Roth IRA. The current asset allocation is 50%/50% equity/bond allocation in diversified Vanguard index funds. I do not plan to take much if any assets out of Roth, so I am thinking I should increase the Roth equity allocation to 80/20? I am investing for my kids, so why not?

A: I totally agree with your suggestion, depending on what the appropriate asset allocation should be for your children. I have investments intended for my children and invested the money with their risk tolerance in mind. I have that portfolio 100% in equities. The ages of my children are from 19 to 49, so I have exposed them all to the same amount of risk. If I believed this money would be necessary for them to meet their cost of living, I would set up all-equity portfolios for my 19 and 22 year old daughters and something more conservative for my children in their 40s. I think it’s completely legitimate to create a custom asset allocation for each of your children, even though it means they will get different amounts at your passing. Of course it’s up to you to explain that to them now rather than later. There is another possible move you could make: Since you have money you don’t need to live on, you could cash out part of your Roth to have your children use the proceeds to put into their own Roth. This will eliminate the need for them to take a required minimum distribution at the time of your death.

How do I avoid big losses – and reap the premiums – in value stocks?

Q:  Why should I invest in an index of out of favor companies that are likely to be big losers?  After all, Enron became a value stock that never came back. I’d just as soon take a pass on the value stocks that don’t have a future.

A:  We would all like to take a pass on Enron and any other value stock that doesn’t pan out. One of the fascinating aspects of value stocks is that if we identify those stocks that are out of favor today, in 5 years half of them will still be dogs. The huge long-term premium of value comes from the half that solve the problems which made them out of favor in the first place. The reality is that no one has found a way to determine which out-of-favor companies are likely to become the big winners. That’s why the academics suggest it’s foolish to try to pick the winners. The premium is so juicy that there is no reason to try to pick the big winners, as the outcome may be you end up with too many of the losers, and miss the premium.

Why do you recommend the asset classes and percentages you do?

Q: Until about a year ago I was quite blind to the details of investing. I’ve always been a good saver and good at math, so the importance of compounding has come naturally to me as well as trying to minimize taxes using vehicles such as 401k’s.I thought I was doing well. I save quite a bit and invest it. Last year I happen to start reading about index funds and Vanguard. I hadn’t realized that a large portion of my investments were in non-index mutual funds and had significant expense ratios. I’ve now switched most of my funds over to index funds at Vanguard and put them into the Total Stock Market Index Fund and International Total Market Index fund.

Then I came across your article about The Ultimate Buy and Hold Strategy and realized I might be able to improve my situation with more diversification. I’ve been doing a lot of reading about it and am looking at making adjustments to follow something similar to your Vanguard index fund recommendations.

Which brings me to my questions in regards to the ultimate portfolio. When you constructed the “ultimate portfolio” you split things into several parts to diversify and reduce risk. That makes perfect sense to me, along with rebalancing, the advantage of having small and value funds. But how did you decided upon the relative percentage amounts of each class? For example, why 6% US LV and 6% US SV? Why not 5% or 7% US LV or similarly for US SV or any other portion? Did you ever play with these amounts to see if the return could be increased without increasing risk?

A: In this Q&A, I included a lot more than just the question as I thought the information leading up to the question included some important points that many investors should consider as they try to figure out what to do that’s in their best interest. This investor discovered the most obvious reason to move to index funds: lower expenses. Then he learned that the index funds he chose (total U.S. and international stock indexes) had huge long-term weaknesses like lower expected returns and minimal exposure to asset classes that have long histories of higher returns without much additional risk.

The investor is asking very important questions: Why did you select the allocation between all the important asset classes you think will provide a superior return over the long term? Is there some way to use these asset classes to make higher rates of return? All of those questions are important to understanding what to expect from your portfolio.

My recommended portfolio is over-weighted to value but still has a significant portion devoted to growth. While most portfolios have 20 to 30 percent in small cap, I recommend 50% in small cap. Also, most equity portfolios have about 20 to 30 percent in international, while I recommend 50% in international. My recommendations are not built to make the most money as they are balances of a lot of asset classes which all have very good rates of return. If I wanted to build a portfolio for the highest past returns, I would throw out the growth and large cap since a portfolio of value and small cap has done better. It is possible that large will do better than small in the long run. If so, I want investors to have a good exposure to large cap. It is possible that growth will do better than value in the long term, so I have a decent exposure to growth. The broad diversification guarantees less than the best return, but should have a decent long-termreturn regardless who comes out number one.

How do I rebalance to minimize taxes?


Q: My question is about rebalancing when a large portion of funds are in taxable accounts. Since selling the “winners” to buy more of the “losers” would result in capitals gains, do you have recommendations for how to best deal with that?

A: Here are the best steps I know to minimize taxes:

1. Use tax-efficient funds that are managed to minimize taxes. I use DFA funds that are managed to minimize taxes. In some cases those funds have multiple asset classes so they are able to manage both taxes and asset class exposure.If you don’t have access to tax-managed funds, index funds are the next best choice.

2. Rebalancing can be done inside tax-deferred funds rather than using taxable accounts. If you have an imbalance in your taxable accounts, see if there is a way you can rearrange your tax deferred investments to reach the right balance.

3. Rollover previous 401(k) into an IRA to use the proceeds to rebalance. The IRA will likely give you more asset class flexibility.

4. Don’t automatically reinvest fixed income, dividend or capital gains distributions. The proceeds can be used to rebalance the asset classes in your portfolio.

5. The most tax-efficient way I know to build portfolios is with new investments. Use new investments to invest in asset classes that are under represented.

6.  Don’t rebalance every year. It’s okay to rebalance every 2 years. That way you can focus on the year you choose to take the tax hit.

Is there a substitute for the Vanguard Developed Markets Index?


Q:  I recently came upon your site while looking for information regarding Vanguard index funds and have really enjoyed reading your articles. There was one in particular called “Vanguard fund strategy to double your nest egg that interested me, but I noticed that one of the funds – the “Developed Markets Index” – is no longer available. Do you have a substitute?


A: I’m glad you have found my work helpful. The Vanguard Developed Markets commission-free ETF (VEA ) has a .09% index fee. The Developed Markets Vanguard Fund is also available as VRMGX, an Admiral index fund with a $10,000 minimum investment and .09 minimum expense ratio.  For those who don’t quality for VRMGX, VDVIX has a $3000 minimum.


What is the advantage of buying Vanguard Admiral over ETFs, where expense ratios seem the same?


Q: I started buying funds yesterday in a Vanguard account and was looking at your suggested Vanguard portfolios, specifically the ETFs. I noticed that a lot of them had alternative index funds, and with Admiral shares you could get the same funds (with enough invested, of course, to reach the $10K minimum). I ended up purchasing the Admiral shares of these funds because I was investing $10K+ in each. Did I make a mistake in not picking the ETFs instead? Between Admiral shares and ETFs, where expense ratios seem to be the same, what is the advantage of buying one over the other? Just for reference, one such example is VOO (ETF) vs. VFIAX (Admiral).

A: For those that have the ability to use the Vanguard Admiral shares, there are a couple of advantages: When you decide to rebalance there will not be any cost to buying and selling the Admiral shares. The Vanguard managed ETFs do not have a commission to trade, but there is a spread between the bid and ask prices. The difference between the bid and ask is not a cost to the mutual fund owners as the price, whether a buyer or sell, is the same. As far as returns, they should be very close. According to Morningstar, for the 3 years ending 2/27/2015, the ETF shares (VOO) compounded at 17.96% compared to 17.92% for VFIAX, the Admiral shares. Another advantage for the mutual funds is the ability to move a specific dollar amount as opposed to a number of shares. Also, I think it’s emotionally easier to simply take the value at the end of the day versus guessing when to buy or sell during the trading hours.


Why small-cap value over small-cap growth?


Q: Why did you ignore comparing small-cap growth stocks to small-cap value in your article, “Buy the best performing stock sector for 87 years“?


A: I use the Dimensional Fund Advisors database as my source of historical returns. According to their data, from 1928 through 2014 the small cap growth index compounded at less than 9%, about 5% less than small cap value. According to Morningstar, for the 15 years ending 3/31/15 the average small cap growth fund compounded at 5.44%, compared to 10.63% for the average small cap value fund. That difference isalmost identical to the difference for the 1928-2014 period.

To your success,


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