Archive for the ‘Investment Strategy’ Category

10-Year Future Returns For Model Portfolios From 5 Thought Leaders

Monday, October 16th, 2017

Let’s look at what 5 important thought leaders had to say about constructing a portfolio for the long-term (10+ years); and how their portfolio models are expected to perform over the next 10 years, based on asset returns, volatility and correlations according to JP Morgan Asset Management and Research Affiliates.

Here’s the spoiler:

  • Ray Dalio’s “All Weather” portfolio has the best risk adjusted expected return
  • David Swensen’s “Reference” portfolio has the highest expected return
  • John Bogle’s traditional “60/40 Balanced” model using global stocks is a contender
  • Harry Browne’s “Permanent” portfolio isn’t a contender
  • Warren Buffet’s “Estate Plan” portfolio has the highest potential, but the worst risk adjusted return
  • For all portfolios, the expected returns are significantly below returns of the last several years.

Here are mug shots of the 5 thought leaders.

(click images to enlarge)

Their portfolio models in our approach, would be for the Broad Core sleeve.  More income intensive securities would go into the Income Core sleeve of the portfolio.   And, when, as and if it makes sense to make some tactical bets, we can add narrowly focused assets we believe will do particularly well in the Tactical Opportunity sleeve of the portfolio.  This discussion is only about portfolio models for the Broad Core sleeve.

  • David Swensen is the long-time CIO of the Yale endowment.  He is acknowledged as one of the best at that job, if not the best.  In 2005, he translated his 2000 book for institutional portfolio managers (“Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment”) to one suitable for individual investors.  In that book (“Unconventional Success: A Fundamental Approach to Personal Investment”), he described a “reference portfolio” for the long-term.  He made it clear that adjustments are needed to fit the specific needs, goals, limitations and psychology of each investor; but that the reference portfolio is a good place to begin the thinking process about a suitable portfolio. In his reference portfolio he stresses the functions which must be provided (capital growth, inflation protection, deflation protection, and protection in times of crisis).  He specified assets for the portfolio and how much of each function each asset provides.
  • Ray Dalio is the founder and CEO of Bridgewater Associates, one of the oldest and largest private funds (about 40 years old and about $160 billion in assets).  He wrote about his All Weather strategy in a white paper in January 2012.  His fund has been very successful with the core All Weather portfolio model, and around which they make certain other tactical investments.  Their core portfolio is equally weighted to deal with 4 scenarios (rising corporate profits, falling corporate profits, rising interest rates, and  falling interest rates).  Then within each of those 4 segments of the All Weather portfolio, he specified suitable asset categories, which are then equal weighted for volatility (“risk parity”).
  • Harry Browne (deceased) was an investment advisor and author, who in his 1999 book “Fail Safe Investing” was focused on limiting losses in a portfolio that would be profitable in any market, which he posited was best accomplished with equal amounts invested in stocks, long-term Treasuries, T-Bills and Gold.  That was dubbed a “permanent” portfolio.
  • John Bogle is the founder and former CEO of Vanguard.  He virtually created the index mutual fund industry, launching the first ever index fund (dubbed “Bogle’s Folly”) on December 31, 1975, to track the S&P 500 index.  He is a firm believer that no amount of effort can predict the future of markets, and that active management is not competitive with index funds over long periods.  He recommends simply owning a broad index stock fund, such as one based on the S&P 500, and a broad bond index fund, such as one based on the aggregate US bond market.  He is an advocate of a 60% stocks, 40% bonds allocation.
  • Warren Buffet is the CEO of Berkshire Hathaway, which has made him one of the richest people in the world.  He is a fierce critic of the expense drag created by actively managed funds and their trading costs due to high turnover.  He believes that low cost index funds are the only way to go, and that a domestic focus is at least good enough, if not best.  In his 2013 letter to Berkshire Hathaway shareholders he gave investment advise which he felt was good enough for most investors by revealing his instructions to his estate trustee:  “… instructions I’ve laid out in my will … cash will be delivered to a trustee for my wife’s benefit … My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”

Using the 10-year forecasts for asset returns, volatilities and correlations published by JP Morgan Asset Management (optimistic) and by Research Affiliates (less optimistic), let’s see how the recommended portfolios from those 5 thought leaders would be expected to perform in the future.

It is important to know that any single value projection of portfolio return is not a good idea.  Because assets go up and down in price over time, it is more reasonable to think of future returns in terms of a probability range of return; with the most likely return near the middle of the distribution, and the increasingly less likely, but still possible returns spread out above and below the middle.  That is how our first image is presented.  The probability distribution is developed through Monte Carlo simulation.

For each portfolio, the return probability distribution is represented by a box with whiskers.  The line in the middle of the box is the 50th percentile return, which is equal to or near the mean expected return.  Half of the probable returns expected to be higher than the 50th percentile, and half lower than that value.  The entire box encompasses the middle 80% of probable returns (from the 10th to the 90th percentile).  The whiskers extend out above and below the box so that the entire box and whiskers encompass 98% of probable returns (only 1% are expected to be higher, and only 1% are expected to be lower).  Because of shocks and crises, the lower 1% could be a lot lower.  For that, we present what could be thought of as a worst case (at least a very bad case) year, when the return is 3.5 standard deviations below the expected mean return.

This chart is the main one we used to decide our spoiler alert at the beginning of this letter.

The green colored boxes and whiskers are based on the more optimistic JP Morgan assumptions.  The yellow colored boxes and whiskers are based on the less optimistic Research Affiliates assumptions.

Note, that only the deeper green and deeper yellow colored boxes and whiskers have their 1st percentile above zero. If the bottom whisker is above zero, it means that the forecasts expects a 99% chance that at the end of 10-years, your portfolio will be worth more than at the beginning.

The portfolio models with the bottom whisker above zero when using JP Morgan assumptions are the Swensen Reference, Dalio All Weather, and Bogle 60/40 with global stocks. The models with 99% chance of a positive 10-year outcome when using the Research Affiliates assumptions are only the Dalio All Weather portfolio, and the Simple 2 Asset Risk Parity model (which uses the S&P 500 and intermediate-term Treasuries in a ratio that expects the same risk from each asset).

The lighter colored boxes and whiskers have varying probabilities less than 99% that the portfolio will grow in value over 10 years.  In fact, the simplified Dalio All Weather portfolio (published  by Tony Robbins, based on his discussions with Dalio), has about a 10% chance after 10 years of being worth less than the starting value.  The Warren Buffet “estate plan” portfolio has by far and away the higher upside potential (because it is 90% stocks), but also something near a 10% chance of a cumulative negative return.

The best “worst case” year is with the Dalio All Weather portfolio with both the JP Morgan and Research Affiliates assumptions, but it has an unsatisfying most likely return below 5%.  The highest most likely return is the Swensen Reference portfolio, which has a 99% chance of a positive 10-year return under JP Morgan assumptions, but has a small chance of a negative 10-year cumulative return with assumptions from Research Affiliates.

The Bogle 60/40 with global stocks fares well under JP Morgan assumptions, but has a small chance of a negative 10-year return under Research Affiliates assumptions.

The Swensen portfolio and the Bogle portfolio have the highest current yield, which is somewhat of a hedge against the downside, at 2.35% and 2.36% respectively — essentially the same yield.

Overall, for the more risk averse folks who can tolerate returns below 5%, the Dalio All Weather portfolio is attractive.  For those who require return of 5% or more, with limited risk of a 10-year negative return; the Swensen mode is attractive.  The Bogle 60/40 with global stocks is a close runner-up to the Swensen model, but not quite as attractive based on the two sets of assumptions we used.

The 90% stocks approach from Buffet is just fine if you very young and have more than 10-years for “time in the market” to work for you; or, you are wealthy enough to start, and would continue to be wealthy enough with no retirement lifestyle change even if you had a cumulative 5% annualized 10-year negative return.  Otherwise, 90% in stocks may be a bit to aggressive for most investors over 50 to 55 years old, particularly at this time in the market cycle.

Here is a different way to look at the same data.  These next two tables are color coded to show 10-year annualized returns:

  • greater than 7% in dark green
  • from 5% to 7% in light green
  • below 5%, but positive in light pink
  • negative returns in dark pink.

With JP Morgan Assumptions:

With Research Affiliates Assumptions: 

And here is yet one more way to use color coding to gain perspective on the relative merits and demerits of the portfolio models.  All of the returns taken together are coded red, yellow or green on a sliding scale from lowest in red to highest in green.

With JP Morgan Assumptions:

With Research Affiliates Assumptions:

Now for the grand reveal.  What is inside each of these portfolios?  Focus on the category, not just the proxy ETF. We did the projection without any specific security in mind.  The securities we show here as proxies are not the only ones that fit into those models, but they are representative of those that do.

The ETFs used to label the allocation in this next table are simply short-hand to identify the asset classes from the table above.  The numbers are all percentages.

I’d to ask each of you to think about these projections for these model portfolios as general approaches, and tell me which appeal most and least to you as they relate to your Broad Core sleeve (as distinct from the Income Core sleeve and Tactical Opportunity sleeve of your portfolio) to see if we are still on the right track for your personal situation and needs.

Looking forward to our discussion.


[symbols identified in this article: SPY, VXUS, VWO, VGIT, TIP, VNQ, GLD, DBC, VGLT, BND]

How to prepare a portfolio for war with North Korea

Thursday, August 10th, 2017

QVM Clients:

I have received some calls asking whether and how to prepare portfolios for possible war with North Korea. Whether a war is likely is beyond my capacity to respond, but whether portfolios should be prepared for extreme market conditions resulting from any number of catastrophic situations is something on which I will comment.

Let me state right out of the gate, preparing a portfolio for a generalized Black Swan or catastrophic event is prudent. We should all have a protective component of our portfolios, all of the time – more for the older of us and less for the younger of us, based in great part on the time horizon before calling on the portfolio for withdrawals. However, tailoring a portfolio against a specific catastrophic event is generally not prudent, unless you are dead certain it will happen. And in that case, everybody else is probably dead certain too, and the event would already be substantially priced into the market.

So, while I can suggest a portfolio specifically tailored for a war between the USA and North Korea, I do not recommend implementing it. Such a portfolio would not represent your long-term strategy (which should include a protective component), and if that specific event did not materialize you could find yourself way off course.

With that caveat, let’s think about what a portfolio specifically tailored for an anticipated war between the USA and North Korea.

Don’t think me cold-hearted in discussing portfolio war preparation, because the tragic death of 100’s of thousands of people, including thousands of US troops stationed in South Korea would be horrific almost beyond imagination. According to former US Defense Secretary Cohen today, North Korea could lay waste to Seoul South Korea in about 1 minute from the 10,000 artillery pieces trained on that city at all times. But some of you asked about portfolios, not human tragedy. I am not inclined to plunge into portfolio war preparation, unless an individual should prevail upon me to do so, but I am prepared to say what portfolio might fare better in the event of such a war.

So whether it is war with North Korea, or worldwide plague, or hackers shutting down our electrical grid and somehow disabling our Internet for a prolonged period; the assets that provide clear defensive protection are:

• Cash (insured bank accounts or Treasury money market funds)
• Gold (proxy: GLD)
• Treasury bonds (proxy: VGIT).

Holding any of these three assets creates a current drag on portfolio income, and with the possible exception of gold, a drag on total return. Any form of protection (like insurance) has a cost, and that cost is a lower long-term total return than a flat-out equity market exposure. Except for investors with a very long time horizon before entering the withdrawal stage, some level of cash and bonds is appropriate in any event

Now for the specific war preparation portfolio, keep these index weights in mind, which will help interpret the allocation suggestions below:

  • South Korea is almost 15% of the Emerging Markets index followed by iShares; but 0% of the index followed by Vanguard
  • South Korea is almost 5% of the non-US Developed Markets index followed by Vanguard; but 0% of the index followed by iShares
  • China is about 29% of Emerging Markets indexes
  • Taiwan is about 16% of Emerging Markets indexes
  • Hong Kong is about 3% of non-US Developed Markets indexes
  • Japan is about 21% to 23% of non-US Developed Markets indexes
  • Apple is about 4% of the S&P 500 and about 5% of the Dow Jones Industrials

Changes one might consider (excluding shorting and options) to specifically prepare for possible war with North Korea are:

  • Above target cash
  • Target or above target level gold (proxy: GLD)
  • Above target intermediate-Treasuries (proxy: VGIT)
  • Add defense industry exposure (proxy: ITA)
  • Below target Emerging Markets allocation – to reduce China, Taiwan, Hong Kong and South Korea Exposure
  • Within reduced diversified Emerging Markets allocation; Hold VWO not EEM – to eliminate South Korea Exposure
  • Within non-US Developed Markets exposure, hold EFA not VEA – to reduce South Korea Exposure
  • Possibly replace diversified non-US Developed Markets funds with Europe funds (VGK) – to reduce Japan exposure (proxy: EWJ)
  • Reduce broadly diversified US stock holdings (proxy: SPY) beyond lowered target levels, and rebuild to lowered target levels with sector funds, not including technology sector (proxy: XLK)
  • Sell single stock Apple holdings (AAPL).

Note, there may be significant non-recoverable tax costs to such a portfolio reconfiguration in regular taxable accounts. That would need to be evaluated in terms of each investor’s embedded gains, and how much of which assets are held in tax deferred or tax-exempt accounts, as well as other aspects of the investor’s general tax situation.

Why sell Apple or reduce technology sector exposure? Because, South Korea (think Samsung) is a key part of the technology supply chain (including parts for iPhones). It could take a couple of years to build replacement chip foundries to supply the needed chips for Apple, unless they could find non-Asia suppliers.

Think of the war a step farther out. China decides not to fight the USA on behalf of North Korea, but does decide the war is the perfect time to invade Taiwan to reclaim it. The USA might well be unprepared to defend Taiwan while fighting North Korea, and might accept the invasion of Taiwan in exchange for China not involving itself in the North Korea conflict. Such an invasion could further damage the technology supply chain. Then, of course, Vladimir might decide to take the rest of the Ukraine or some other land grab, which would be very hard on the Europe stock markets.

What happens after the early war stages is unknowable, but as past wars have shown, the world rebuilds, and capital continues to work. So be prepared to restore equity allocation once hostilities are clearly over and stock markets begin to recover.

There would, of course, be no option to do those things to the portfolio once a shooting war opened up, as the pricing adjustments would be near instantaneous. For myself, I am not making such drastic single scenario preparations, but rather holding some level of generally protective assets along with a diversified global equity exposure. That is what I suggest to you.

This is a quite unpleasant topic to contemplate, but to make sure we’re always thinking, this is what we can fathom at the moment, as preparation for first order effects. Where second and third order effects go, is beyond pure speculation.


[securities mentioned in this letter: GLD, VGIT, ITA, VWO, EEM, VEA, EFA, VGK, SPY, EWJ, XLK, AAPL]

21 Lowest and 21 Highest Cost US Large-Cap ETFs In The Current Expenses Price War

Monday, May 1st, 2017

There is a price war going on among fund sponsors with some ETFs now having expense ratios from 3 basis points to 5 basis points.

Keeping costs low is key to long-term returns generally, and specifically to index funds.

Here is a list of the 21 lowest expense ratio and 21 highest expense ratio US large-cap ETFs that have at least $100 million of assets under management.

(click image to enlarge)

The largest ETF (the S&P 500 tracker, SPY) is among the least expensive at 9 basis points, but more expensive than two other S&P 500 ETFs (IVV at 7 basis points, and VOO at 4 basis points).

For a $1 million position, 1 basis point amounts to $100 per year; or $200 extra return per year with IVV and $500 per year extra return with VOO.

If all you want to do is buy and hold the S&P 500, VOO probably is the most sensible approach.  On the other hand, if you want to be able to sell covered options on your S&P 500 position for income, you need to stick with SPY.

Schwab has a US large-cap and a US broad market (also large-cap) ETF at 3 basis points.

Before you know it, some very large ETFs may have zero expense ratios — it could happen.

How so?  Two things possibly:

  • Some sponsors may chose to offer “lead funds” such as a US large-cap fund at zero expense (operating at a loss) to gather assets on the assumption that if they can capture a core assets, they have a good shot at capturing other assets that are operated profitably — certainly that has been the case with money market funds for the past 8 years.
  • The combination of mega-size and revenue from securities lending should make is possible to operate at least marginally profitably on some funds to either gather assets, or compete to retain assets against others who lower fees to gather assets.  When funds lend securities, they earn a fee, which is shared partially with the manager in most cases (not shared at Vanguard).

iShares, for example keeps from 15% to 28.5% of the securities lending revenue on it funds.  If sponsors could live off of the lending revenue share alone, and also make certain competitive asset gathering or retention decisions, expense ratios on some funds could go to zero.

Here is some of what iShares published about securities lending by ETFs:

2017-05-01_ishare sec lending dist



Whether sponsors do or do not keep a share of securities lending fees, as expense ratios approach zero (and 3 basis point to 5 basis point expense ratios are approaching zero in effect), the impact of securities lending begins to have a significant effect on the tracking error of an index fund — such that on occasion the fund could outperform its benchmark even with the drag of a management fee.

Other important factors that impact tracking error include the amount of cash held for liquidity; the effectiveness of sampling if index replication is not used; and the timeliness and accuracy of rebalancing and reconstitution.

Anyway, we are approaching the time where Warren Buffet’s concern about Wall Street drag on returns, and the damage to investors, may be approaching an end for large index funds.  It is typically said that you cannot buy an index, only a fund tracking an index.  Well, they two are approaching the point of being one and the same.

Overall, the highest costs US large-cap funds, with expense ratios from 48 to 64 basis points did not do worse than the lowest costs funds.

In fact if you simply average the returns (not asset weighted), the highest cost group did a little bit better than the lowest cost group.  That was not due to better management, but to somewhat specialized large-cap strategies that did better, such as technology oriented NASDAQ exposures.

That shows that it is possible for higher fees to be justified in some cases by deviating from the broadest indexes, but that is a case-by-case situation.

If you are buying broad indexes, pay really close attention to expenses as one of the primary drivers.  For specialized funds, category relative expenses can be important, but absolute expenses may not be as important as for broad index funds.

Securities Mentioned In This Article:







Rational Risk Retirement: Gerontological and Estate Perspective on Target Date Funds

Saturday, March 25th, 2017
  • some investors want full auto-pilot on their investments during retirement.
  • many investors will have cognitive impairment sometime during retirement.
  • many investors will develop outright dementia sometime during retirement.
  • all investors planning to leave assets for the benefit of others will die.
  • portfolio construction for these conditions differs from pre-retirement years.

[This is Part 3a of a 3 part series on Rational Risk Retirement – Traditional Withdrawal Strategy, Alternative Withdrawal Strategies and Retirement Portfolio Construction.  Part 1: Withdrawal Strategies is available here. Part 2 is pending.  The is the first two pieces for Part 3 on Retirement Portfolio Construction.]

It is widely acknowledged that longevity risk (risk of outliving your investments) in retirement must be addressed in portfolio construction.

Probabilistic projections such as Monte Carlo simulations are an important part of that process; as well as designing so that withdrawals can be taken from somewhat stable value assets during equity bear markets, to reduce the risk of ruin associated with selling assets into a decline.

In contrast, is not widely acknowledged  that cognitive risk with aging in retirement should also be addressed.

There are numerous dimensions to dealing with cognitive risk, ranging from how assets are titled and held, lines of succession of decision-making if the investor no longer has the capacity to manage assets, and how to structure the portfolio (and the advisor relationship) so that as cognitive decline slowly creeps up from minimal to meaningful, investments are not endangered by lack of attention, poor decisions or conflicts of interest.

For some investors, particularly during or preparing for near-term retirement, target date funds from a major institution may be a suitable choice for part of the cognitive risk mitigation element of retirement.  They may not be a suitable choice for  everybody, but clearly are for  some.  Let’s look a little bit at cognitive decline and then a deep dive into what is actually inside target date funds.

(click images to enlarge)


This is not an argument against using an advisor.  I am one myself, but not everybody wants to, has affordable access to, or should use an advisor.  Similarly (and this can be an argument for either an advisor or a target date fund), not everybody can, wants to or should manage their own money.

Behavioral Finance

There is a lot of study and discussion of behavioral finance, with an emphasis on the problem with doing the wrong thing with investments due to emotions overriding logic, and  filtering information for confirmation of biases.

That is all well and good to understand, but less well discussed are the behavioral issues of reduced cognitive capacity and less effective problem solving related to aging.  That is a real issue to think about before retirement, and to put the proper vehicles, instructions, trustees and portfolio together at least by the time of retirement, if not before.  Remember, you could have an event at any age that reduces your cognitive capacity (such as a traumatic brain injury from an automobile accident).

About Cognitive Impairment and Investing

In 2011, the American Association of Individual Investors interviewed Harvard economic profession David Laibson about cognitive impairment and dementia impact on investing decisions. He said;

“As we gain experience, we become better investors. But our ability to solve novel problems [is] peaking around 50–55, and then we’re gently declining thereafter. The decline tends to become steeper as we age, and by the time we’re in our 80s, for many of us, the ability to make good decisions is significantly compromised, particularly decisions that involve complicated new problems. ….

The likelihood of dementia .. doubles every five years … starting out as tiny levels in the early 60’s .. by the time we get to our 80’s, the likelihood of having dementia is about 20%. … and about 30% of the population in their 80’s has cognitive impairment but not dementia … in total, half the population in the 80’s is not in a position to make important financial decisions.

[a] mistake that I think people make is that they falsely believe that somehow they’re going to magically notice significant cognitive decline setting in, and then at exactly the right moment do [all the things they need to do], before the cognitive decline is too significant. They’ll somehow time it perfectly. At age 82, they’ll wake up one morning and say, “You know what? I’m losing a lot of cognitive function”; they’ll walk out that day [and do what they need to do]. That’s a grave mistake. We don’t have that ability to suddenly recognize it and do the right thing just before we lose the capacity to make these decisions well.”

He provided this data on the prevalence of cognitive impairment and dementia in North America.


State Street Global Investors published a paper in 2016 titled “The Impact of Aging on Financial Decisions”.

They also talk about the difficulties advisors have raising and exploring the investment implications of aging; and the reluctance and fear clients have discussing the topic or planning for what needs to be done.

They discussed many aspects of aging and investments, including a mini-max graph of increasing wisdom and understanding with experience versus declining problem solving ability, with the suggestion that people are generally at peak decision-making capacity in their mid-50;s (as shown in the image below).



I am sure than many of you have witnessed the cognitive decline problem in real life with your parents or other people in your family or among friends, as I have as well.  You may also have observed or been involved in modifying the investments and investment management control of portfolios for parents no longer able to monitor and control the situation, as I have as well.  It is good to do all you can to minimize those problems ahead of time.

Nicole Anderson, associate professor of psychiatry at the University of Toronto identified these intellectual problems experienced with cognitive impairment:

  • reduced memory
  • reduced ability to multi-task
  • reduced ability to switch back and forth between two tasks
  • reduced ability to inhibit irrelevant information to stay focused on what it is important

Anderson also points out that the best ways to reduce cognitive impairment risk are brain exercise along with body exercise and healthy diet:

  • obtain higher levels of education
  • continuing education and intellectual activities
  • job with complex mental requirements
  • social networking
  • avoiding depression.

Heredity is luck of the draw, but there is some hope to pushing that cross-over point farther into the future. It is about brain exercise in youth and throughout life.  Just as your body is a use it or lose it proposition; so to is your brain, and its capacity to make decisions and solve problems.

What are some of the arguments supporting target date funds?

(1) Some investors want to totally retire – no job, no involvement in their investments, and no concerns about who is managing their money or how

(2) In retirement, for many (and you could be one), there will come a time when cognitive skills will fade; at which point it may not be reasonable to manage one’s own money.  At that time use of an advisor may not be a good choice, because the investor would no longer have sufficient intellectual capacity to adequately monitor the activity of the advisor, and would not necessarily know when or if to make a change — and in a change may not have sufficient intellectual capacity to make a good substitution choice.

(3) If dementia sets in (and that could include you), an investor is incompetent to manage or oversee management of assets.  In preparation for that possibility, assets in trust with specific arrangements for asset management for potentially many years could be useful

(4) After death, presuming there are significant residual assets in a trust, or to be put into trust, for a surviving spouse or other family members; there is no opportunity for the deceased investor to assure that the money is being managed responsibly, cost effectively and prudently, if left to the judgement and decisions of trustees to manage it themselves; or to retain an advisor or broker or annuity agent to do the job, particularly non-professional trustees.

(5) After death, if a professional trustee is used, that is another significant layer of expense, that portfolios can ill-afford, — as cost control is one of the keys to long-term total return.

(6) Cognitive decline and death aside, target date funds for some may be a reasonable way to hold a core position (a boring, quiet bucket) in a portfolio at any age without the complexity of owning multiple broad core funds — using the other assets to tactically tilt overall exposures, or to pursue specific opportunities (an interesting, active bucket).

For those and similar reasons, some people may be good candidates for a large or full allocation of their portfolio to a low-cost, index-based target date fund from a well established investment organization that is likely to be around longer than the investor is likely to be alive; or longer than the portfolio is expected to exist post-death.

Even if target date funds are not the best investments, they are far from the worst.  They are diversified, world asset, all season funds, suitable for  a long-term horizon.

On-Balance Best Choice

Why emphasize large, well established organization?

An advanced age investor who has cognitive impairment would not be in a position to make a change decision if the target date fund was liquidated or the investment organization changed so radically that the target date fund moved in a different direction, or the expenses ramped up.

We think Vanguard is a particularly good choice.

Their target date funds are massive, and invest in a collection of massive low-cost index funds, none of which is likely to be liquidated.  They are a mutual company, which means they are not a takeover target as a stockholder owned assets manager may be.  Because they use index funds, their target date funds are not subject to risk of a manager going “sour” or leaving and being replaced by someone of lesser talent.  They have great depth of skills at index management.  Remember, you might be holding the target date fund for a very long time.

Advisors Not Excluded

All that said, a well selected advisor, can do something a target date fund cannot do, and that a robo-advisor can’t do well — tailor a portfolio to the specific goals, preferences, risk limits, asset complexity, tax exposures and other  circumstances of each unique individual investor (which can be complex with wealthier investors) — as well as to help keep the investor on an even emotional keel, to avoid emotional versus rational investment decisions during periods of excess risk enthusiasm or pessimism.

Target Date Funds to Dominate Defined Contribution Plans

Even if you don’t like the idea of target date funds, they are a large and growing part of the employee benefits landscape.  They currently account for 12.5% of assets in employer defined contribution plans, such as 401-k and 403-b plans.  They are projected to be 48% of plan assets by 2020, according to Kiplingers.

It is a lot less stressful on employees to choose a retirement date than an asset allocation plan among plan choices.  And, it is less stressful (and lower liability) for employers to offer target date funds along with the traditional menu of stock and bond funds.  Target date funds are here to stay, so people should be aware of them.

Three Primary Asset Types Determine 80% to 90% of Return

Investors can get fancy and complex in their portfolio construction, but in the end 3 primary asset categories have been shown to determine the vast bulk of portfolio returns (80% to 90% in some studies).  That leaves only 10% to 20% of return coming from asset category subsets of the primary classes and from security selection.

LOR simple small

There are only 3 things you can do with investment money (outside of speculating with derivatives such as options and futures), and those are Owning something, Loaning money to others, and holding cash or equivalents in Reserve.

Accordingly, we refer to those categories as OWN, LOAN and RESERVE.

For the most part, OWN is stocks, but it also includes tangible assets such as real estate, physical commodities such as gold, and private equity funds and venture capital investments.  For the most part, LOAN is bonds, but it also includes private debt funds, private individual mortgages and other non-traded debt.  RESERVE includes sweep cash in brokerage accounts, demand accounts and ultra-short CDs at banks, fixed price money market funds, and variable price ultra-short bond funds, and cash under the mattress or buried in the back yard.

OWN, LOAN and RESERVE is a functional description of asset categories, instead of a mere label such as equities and bonds.  We believe using functional terms helps investors better understand what is in their portfolios.

We have examined target date funds timeline glide paths in terms of those functional categories.  To keep it very simple, and because target date funds conceptually do not raise tactical reserves, we have combined LOAN and RESERVE in the glide path chart as simply LOAN.

The Glide Path

A key attribute of target date funds is the “glide path”.  Each fund sponsor has a planned schedule of allocation change for each fund as the current date approaches the fund’s stated retirement target date.

The glide paths of the leading fund sponsors differ, but they behave similarly, as shown in this glide path chart for 6 target date fund families that carry current Gold or Silver ratings by Morningstar for expected forward relative performance within their class.

Those families are: Vanguard, Fidelity, T. Rowe Price, BlackRock, JP Morgan, and American Funds.  All are no-load funds at the retail level, except American Funds, which are load funds.  We specifically recommend against investing in any load fund.  There are just too many good no-load funds to give up assets to a load fund.  At the 401-k or 403-b level American Funds are not load funds.

In this chart the black lines are for the Vanguard funds (solid line for OWN) and dashed line for (LOAN).  The red lines are for the highest allocation for OWN and LOAN by any of the six fund families along the path. The blue lines are for the lowest allocation for OWN or LOAN by any of the funds.


Side Bar: Capitalizing Pension Income

It may not be unreasonable to “capitalize” highly secure pension income as if it were from bond holdings, and to use that capitalized value in measuring the OWN / LOAN allocation of your “portfolio”.

For example, if an investor receives $30,000 from Social Security, at a 3% capitalization rate, that is the equivalent of having $1,000,000 in AAA bonds (at 4% capitalization rate the bond equivalent is more like $750,000).  And since there is a COLA on Social Security, it’s better than a bond which has fixed interest payments.  The same sort of capitalization could be done with a pension benefit from employment.

You might want to put that capitalization into your asset allocation assessment, and potentially take on less actual LOAN assets and more OWN assets to achieve your overall intended risk level, in light of your secure Social Security and pension income.

55%/45% OWN/LOAN to 40%/60% OWN/LOAN

Vanguard ends up with a 45% OWN and 55% LOAN portfolio in retirement.  Within the group of six families the highest  OWN allocation in retirement is 55% and the lowest is 38%.  The highest LOAN allocation is 62%, and the lowest is 45%.

So for someone following the same general approach using multiple funds, those sponsors are suggesting for retirement somewhere generally in the 55% OWN/ 45% LOAN to the 40% OWN to 60% LOAN range.  Vanguard in the middle area at 45% OWN/55% LOAN.

Note that target date fund are basically funds-of-funds.  They just hold them for the investor in the target date fund wrapper and do the rebalancing and allocation shifting automatically over time.

When it comes to the allocation to sub-classes within OWN and LOAN, the funds separate more in how they structure the portfolios.  In addition to the difference between active management and index funds within OWN and LOAN; the allocation to US and international assets differs; as does the allocation to large-cap and small-cap equities; as does the allocation to duration and credit quality among bonds.  They also hold different levels of cash, perhaps more as a function of tactical decisions among those using active management instead of indexes within their funds.

Deep Dive Into 2020 Target Date Funds

For those nearing retirement, a year 2020 target date fund may be of interest.  Let’s look deeply at the six 2020 funds to see what is inside.  The title in the charts should be sufficient to let you know what they are about.

In each case, data for Vanguard’s 60/40 balanced fund (domestic only, using S&P 500 and US Aggregate bonds) fund is provided for comparison — that being a traditional all-in-one fund.

2017-03-24_Size and rating

In terms of return and risk ratings by Morningstar, the Vanguard target date fund is superior.

Keep in mind as you view the allocation between US and international assets, that this level of portfolio allocation is programmatic, even if the security selection is active in some of the funds.

2017-03-24_Asset Alloc

Notice the allocation between developed and emerging markets diverges significantly.

2017-03-24_DM EM

The allocation between economically cyclical, defensive and in between (sensitive) stocks differs markedly.


So too does the equity sector allocation vary significantly.


The rolling returns and volatility are more similar than the detailed portfolio composition.  That is because the primary OWN/LOAN ratios more similar than the detailed portfolio composition.

This is anecdotal support to the research conclusions that asset allocation between OWN, LOAN and RESERVE (mostly stocks, bonds and cash) determines perhaps 80%-90% of portfolio returns.  And, that only about 10% to 20%, or so, of returns come from more granular asset allocation and individual security selection.

You can see that T.Rowe Price had the superior returns, but at the cost of the highest volatility.  The next table will solidify the appearance on this table that Vanguard had the best balance between return and volatility.



Vanguard and American Funds came out ahead in terms of risk/reward, both by Sharpe Ratio (which considers both up and down volatility), and the Sortino Ratio (which considers only downside volatility).

2017-03-24_risk reward

On a calendar year basis, Vanguard had the lowest drawdown in the 2008 crash.


For assets in tax deferred accounts everything comes out as ordinary income, but in regular taxable accounts, taxation of distributions and proceeds is really important.

Taxation of proceeds depend on the investors holding time, but taxation of distributions is a function of what goes on inside the funds — long-term and short-term cap gains; qualified and non-qualified dividends; and interest earned — as reported on 1099’s to the IRS.  Vanguard and T.  Rowe Price look best in terms of after-tax distributions.


These equity valuation data do not include earnings quality or earnings growth rates which would help interpret the valuations, but it looks like Vanguard has lower equity valuation multiples than the other funds — slightly more of a value proposition.

2017-03-24_equity valuation

Bond metrics are a little harder to compare visually, but here is a simple thing that may be grossly useful in comparing the overall valuation of the bond portfolios:  multiply the yield by the duration and divide that by a numeric value of the credit quality (AAA = 1, AA =2, A = 3 …..).  If you do that, Vanguard seems to give more yield for the combination of duration and credit quality than the other funds.

2017-03-24_bond metrics

Vanguard and BlackRock have only investment grade credit quality, while the other four families use some below investment grade credits.

2017-03-24_quality spread

Fidelity and BlackRock are holding a lot more cash than the other funds.

2017-03-24_bond sec type

Target date funds may or may not be appropriate for you or someone in your family, but they should not be dismissed out of hand, as some have done.

The word NEVER is never supposed to be used in investment, but this I can say with confidence,”As diversified portfolios (like any diversified portfolio), target date funds will never be the very top performing funds, and will never be the very worst performing funds (that is an attribute of diversification), but they are designed to be solid performers over the long-term.”

Target date funds might be used as a component of the broad-based core of an investment portfolio (the quiet, boring part); or for some people in retirement as the entirety of a portfolio.

Please call —  happy to discuss.


Stocks With Strong Potential Earnings Boost From Trump Tax Plan

Friday, December 9th, 2016
  • Companies that have low effective tax rates due to current “tax loop holes” may find their effective tax rate rise (and profits decline), even if nominal corporate tax rates decline, because “tax loop holes” may be closed to pay for the tax rate change
  • Companies that have effective tax rates near the nominal rates, would likely see their effective tax rate fall (and profits rise), if nominal corporate tax rates decline
  • Searching for companies that may benefit from a tax rate decline, and are otherwise potentially attractive is a useful exercise
  • We found 22 stocks among all listed with favorable yield and valuation attributes that may provide interesting Trump tax plan return potential
  • We found 100 stocks in the S&P 500 with effective tax rates from 30% to 35% that would like benefit significantly from a corporate tax reduction
  • 34 of those 100 S&P 500 stocks are in current up trends.

Our search for stocks with favorable yield and valuation was of all listed US stocks, for those with these characteristics:

  • 7-year cumulative effective tax rate greater than 30% and less than 36%
  • 12-mo trailing dividend yield greater than 2%
  • PEG ratio less than 2
  • 12-mo trailing shareholder yield (dividend yield + buyback yield) is no less than dividend yield (no share issuance).

There are companies with tax rates  much higher than the nominal rates.  Those cases are too complicated for this simple search, and that is why we limited the effective tax range to less than 36%.   The 30% minimum is to find those with a substantial potential benefit from a corporate tax rate reduction.

These are the 22 companies that came through the filter criteria:

DE Deere & Company
HMC Honda Motor Co Ltd (ADR)
ETH Ethan Allen Interiors Inc.
PII Polaris Industries Inc.
HOG Harley-Davidson Inc
AFL AFLAC Incorporated
LM Legg Mason Inc
PDCO Patterson Companies, Inc.
IPG Interpublic Group of Companies
TEO Telecom Argentina SA (ADR)
AMX America Movil SAB de CV (ADR)
HRB H & R Block Inc
GATX GATX Corporation
IX ORIX Corporation (ADR)
AEO American Eagle Outfitters
M Macy’s Inc
PAG Penske Automotive Group, Inc.
BBY Best Buy Co Inc
MINI Mobile Mini Inc
NSC Norfolk Southern Corp.
CPPL Columbia Pipeline Partners LP

These are the metrics for each company, along with the Standard and Poor’s Capital IQ ratings for 12-months forward (“stars”) and fair value:

(click image to enlarge)





This table presents the trend condition of those 22 stocks, using the QVM 4 Factor monthly trend indicator.

A rating of 100 is for the leading end of the major trend line moving up.  A rating of zero is for the leading end of the major trend moving down. A rating of 50 is for the leading end of the major trend line in transition between trend directions.  At the bottom of this article, there is an explanation of how the QVM 4 Factor indicator works.



The median tax rate among S&P 500 stocks that have positive 7-year cumulative tax rates is 30%, and the average is 24%.

Our search among S&P 500 stocks simply eliminated those with 7-year cumulative effective tax rates below 30% and greater than 35%.  We found 100 such stocks shown in this table:


Thirty-four of those 100 stocks are currently in up trends as measured by the QVM 4 Factor monthly trend indicator, as follows



Companies currently with effective tax rates below the 20% rate that is often mentioned in Washington for the next Congress, may find their effective tax rate rising and profits declining, if the “tax loopholes” they have relied upon are repealed to pay for a new lower corporate tax rate.  Companies with rather full effective tax rates (such as those in between 30% and 35%) in our filter, would likely find their effective tax rate dropping and profits increasing under a new lower corporate tax rate.

Currently low effective tax rate companies with high valuation multiples would possibly see the double effect of declining profits and declining valuation multiples.

Currently high effective tax rate companies with high valuation multiples may see support for their multiples as their profits increase as their taxes decline.

If a company with a current 35% tax rate (with a 65% after-tax income rate) goes to a 20% tax rate (with an 80% after-tax income rate), that would be a 23% increase in profits.  That profits increase could offset a similar decline in valuation multiple, that might be triggered by a general multiple contraction in the broad market.

All-in-all that suggests to us that overweighting stocks of companies that would most strongly benefit by a corporate tax rate reduction, and a underweighting stocks whos effective tax rates might increase as a result changes in the tax law is a reasonable idea.

Within these two lists, there should be good hunting ground for strong Trump tax plan beneficiaries, that may be suitable for you.

Post Script: How the QVM 4 Factor Trend Indicator:

A quick summary is in the graphics below.  A more expanded discussion is at this link.


Target Date Funds As Aid In Retirement Portfolio Design

Sunday, October 4th, 2015
  • Investors in or near retirement should be aware of portfolio design leading fund sponsors suggest as appropriate
  • Leading target date funds appear to generally have less severe worst drawdowns than a US 60/40 balanced fund
  • The funds have slightly higher yields than a US 60/40 balanced fund
  • Target date funds have underperformed a US 60/40 balanced fund in part due to a cash reserve component and non-US stocks
  • Non-US stocks drag on historical performance could become future boost to performance.


This article is suitable for investors who are in retirement or nearly so, and who are or will rely heavily on their portfolio to support lifestyle.

It is not suitable for those with many years to retirement, or those with a lot more money in their portfolio than they will need to support their lifestyle.


We have been writing about the short-term recently (here and here and here), because we are in a Correction, that may become a severe Correction, and possibly a Bear.

For our clients who fit the profile of being in or near retirement and heavily dependent of their portfolio to support lifestyle in retirement, we have tactically increased cash in the build-up to and within this Correction, as breadth and other technical have deteriorated.

However, we don’t want to lose sight of long-term strategic investment.  This article is about asset allocation for investors that fit that retirement, pre-retirement, portfolio dependence profile.


We think it is a good idea to begin thinking about allocation by:

  1. reviewing the history of simple risk levels (see our homepage) from very conservative to very aggressive to get a sense of where you would have been comfortable
  2. reviewing what respected teams of professionals at leading fund families believe is appropriate based on years to retirement (they assume generic investor without differentiated circumstances).

This article is about the second of those two important review — basically looking at what are called “target date” funds.

Generally, portfolios should have a long-term strategic core, and may have an additional tactical component.  We think some combination of risk level portfolio selection and/or target date portfolio selection can make a suitable portfolio for many investors.

You may or may not want to follow target date allocations, but you would be well advised to be aware of the portfolio models as you develop your own.

In effect, we would suggest using risk level models and target date models as a starting point from which you may decide to build and deviate according to your needs and preferences, but with the assumption that the target date  models are based on informed attempts at long-term balance of return and risk appropriate for each stage of financial life.

For example, an investor might deviate one way or the other from more aggressive to less aggressive based on the size of their portfolio relative to what they need to support their lifestyle, and the size of non-portfolio related income sources; or merely their emotional comfort level with portfolio volatility.

There no precise allocation that is certain to be best, which is revealed by the variation in models among leading target date fund sponsors.  Their allocations are different, but similar in most respects.


For this article, we identified the 7 fund families with high Morningstar analyst ratings for future performance (those ranked Gold and Silver, excluding those ranked Bronze, Neutral or Not Rated).

Those 7 families are:

  • Fidelity
  • Vanguard
  • T. Rowe Price
  • American Funds
  • Black Rock
  • JP Morgan
  • MFS

Fidelity, Vanguard and T. Rowe Price have about 75% of the assets in all target date funds from all sponsoring families combined.


We then used Morningstar’s consolidated summary of their detailed holdings to present and compare the target date funds from each family.  The holdings were summarized into:

  • Net Cash
  • Net US Stocks
  • Net Non-US Stocks
  • Net Bonds
  • Other

While we have gathered that data for retirement target dates out 30 years.  This article is just about target date funds for those now in retirement or within 5 years of retirement.


We simulated the hypothetical past performance of those target date funds using these Vanguard funds:

  • VMMXX (money market)
  • VTSAX (total US stocks)
  • VGSTX (total non-US stocks)
  • VBLTX (aggregate US bonds)

Admittedly, this is a gross proxy summary of the holdings of the subject target date funds  The funds may hold individual stocks or bonds, may hold international bonds, may use some derivatives, and may have some short cash or short equities. Nonetheless, we think these Vanguard funds are good enough to serve as a proxy for the average target date funds, and as a baseline model for you to examine target date funds and to plan your own allocation.


As a benchmark for each allocation, we chose the Vanguard Balanced fund which is 60% US stocks/40% US bonds index fund. Figure 1 shows the best and worst periods over the last 10 years for that fund, as well as its current trailing yield.



So, let’s keep the 2.10% yield in mind as we look at the models, and also the 19.7% 3-month worst drawdown, the 27.6% worst annual drawdown, and 7.3% worst 3-year drawdown.


Figure 2 shows the allocation from each of the fund families for those currently in retirement.  It also averages their allocations for all 7 and for the top three (Fidelity, Vanguard, T. Rowe Price).

(click image to enlarge)


You will note substantial ranges for allocations from fund family to fund family.  For example, MFS using about 19% US stocks while Fidelity uses about 38%; and MFS uses about 64% bonds and Fidelity uses about 36%.

The average bond allocation for the 7 families is about 54%, but the top three by assets average about 42%; and their average cash allocation is about 9% versus the top 3 average of 5%.

Figure 3 shows how a portfolio using Vanguard index funds would have performed over the past 10 years with monthly rebalancing if it was based on the average of the top 3 families.

We recalculated the allocations to exclude “Other” which is undefined, but which is relatively minor in size in each fund.

We also note that the Vanguard index funds have a small cash component, so that the effective cash allocation is higher than the model.

FIGURE 3 – Backtest Performance:
(retired now: average of top 3 families)



  • Yield is somewhat higher (2.28% versus 2.10%).
  • Worst 3 months were somewhat better (-18.4% versus – 19.7%)
  • Worst 1 year was somewhat better (-26.2% versus -27.6%)
  • Worst 3 year drawdown was better (-5.7% versus -7.3%)
  • Underperformed benchmark over 10, 5, 3 and 1 year and 3 months (10 years underperformed by annualized 1.05%).

Reasons For Underperformance:

Inclusion of non-US equities may be the biggest contributor to underperformance versus the balanced fund with 100% US securities.

Another part of the underperformance is maintenance of a cash reserve position that is over and above any cash position within the benchmark balanced fund.  Part is also  due to a higher bond allocation.

Those factors probably account most of the performance difference.  We did not try to determine the exact contributions of each attribute to performance differences.

The historical underperformance due to non-US stocks could possibly turn out to be a long-term reason for future outperformance.

FIGURE 4 – Backtest Performance:
(retired now: average of top 7 families)


  • Yield is somewhat higher (2.19% versus 2.10%).
  • Worst 3 months were significantly better (-12.6% versus – 19.7%)
  • Worst 1 year was somewhat better (-17.7% versus -27.6%)
  • Worst 3 year drawdown was a lot better (-2.3% versus -7.3%)
  • Underperformed benchmark over 10, 5, 3 and 1 year & outperformed over the last 3 months (10 years underperformed by annualized 1.32%).
  • Incurred less drawdown in exchange for lower cumulative return.


FIGURE 5 – Allocation:
(expected retirement within 5 years)

(click image to enlarge)


Again, we see substantial variation between fund families, and also between the averages for the top 3 by assets and for all 7 of the Gold or Silver rated target date families.

The average bond allocation for the 7 families is about 44%, but for the top 3 it is only about 34%.  For the 7 families the average non-US stocks are about 15%, but for the top 3 families it is about 21%.

FIGURE 6 – Backtest Performance:
(up to 5 years to retirement: average of top 3 families)


  • Yield is higher (2.30% versus 2.10%).
  • Worst 3 months were somewhat worse (-21.1% versus – 19.7%)
  • Worst 1 year was somewhat worse (-30.1% versus -27.6%)
  • Worst 3 year drawdown was the same (-7.3% versus -7.3%)
  • Underperformed benchmark over 10, 5, 3 and 1 year and 3 months (10 years underperformed by annualized 0.95%).

FIGURE 7 – BacktestPerformance:
(up to 5 years to retirement: average of top 7 families)


  • Yield is somewhat higher (2.19% versus 2.10%).
  • Worst 3 months were better (-16.2% versus – 19.7%)
  • Worst 1 year was better (-22.9% versus -27.6%)
  • Worst 3 year drawdown was better (-4.4% versus -7.3%)
  • Underperformed benchmark over 10, 5, 3 and 1 year & slightly outperformed over the last 3 months (10 years underperformed by annualized 1.19%).


Figure 8 presents the current yield and rolling returns of the five individual proxy funds used in this review.


(click image to enlarge)



(click image to enlarge)