Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.
For regular SAA and TAA portfolios, the next re-balance will be on Monday, January 13, 2014. You can also find the re-balance calendar for 2013 on ‘Dashboard‘ page once you log in.
As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.
Please note that we now list the next re-balance date on every portfolio page.
How to benchmark portfolio returns
As 2013 is drawing to a close, we naturally would like to understand how well our investments have done. We often receive suggestions and complaints from our users on our portfolio comparison as our portfolios are always compared with the two de facto funds:VFINX (Vanguard 500 Index Investor) and VBINX (Vanguard Balanced Index Inv). However, simply comparing with these two funds is misleading, as many have pointed out.
First, the risk profile or level of these funds might be different from the actual risk profile your portfolio has. That makes it less comparable. A simple way is to scale up or down VBINX to get the right scale. But that is not obvious and too kludge.
Secondly, these two funds are predominantly U.S. stocks and bonds based. So they are not really comparable with a portfolio that is supposed to invest in global stocks and bonds.
Strategic Asset Allocation Equal Weight as benchmarks
One way to do so is to compare with some well known global balanced indices. For example, one can compare this with Dow Jones Global Asset Allocation Indices. These indices were originally designed as static balance indices and since have been used for target date funds. However, they are not open and the allocations are not publicly disclosed (to the level of US, international stocks etc.) Furthermore, it is still not precise or unfair to compare a portfolio that has commodities with an index that has no exposure in commodities.
A simplest way is to compare your portfolio with a Strategic Asset Allocation (SAA) – Equal Weight based major asset portfolio of the same risk profile. For example, let’s say you have a portfolio that has exposures to the six major asset classes: U.S. equities, international equities, emerging market equities, REITs, commodities and US bonds, you can compare this portfolio with a customized portfolio that is based on SAA-Equal Weight with the same risk profile. For example, all of MyPlanIQ’s moderate portfolios can be compared with Six Core Asset ETFs Strategic Asset Allocation – Equal Weight Moderate.
The reason one can choose the equal weight allocation is due to its simplicity: it just allocates equally among risk assets (i.e. excluding bonds). We have written many articles on the effectiveness of equal weight allocation: see, for example, July 18th 2011: Equal Weight or Not Equal Weight in Strategic Asset Allocation?.
As an interesting follow up, even up to today, if one looks at the annualized returns since 12/31/2000, the start date of Six Core Asset ETFs Strategic Asset Allocation – Equal Weight Moderate, one can see the following performance comparison:
Table 1: Portfolio Performance Comparison (as of 12/30/2013)
| Ticker/Portfolio Name | YTD Return** |
1Yr AR | 3Yr AR | 5Yr AR | 10Yr AR | Since 12/31/2000 |
|---|---|---|---|---|---|---|
| Six Core Asset ETFs Strategic Asset Allocation – Equal Weight Moderate | 4.9% | 5.7% | 4.9% | 10.2% | 6.4% | 6% |
| VBINX (Vanguard Balanced Index Inv) | 17.2% | 17.6% | 10.6% | 13.5% | 6.9% | 5.7% |
**YTD: Year to Date
So even after strong US stocks’ out performance in the last 1, 3 and 5 years over other risk assets (international and emerging market stocks and commodities), VBINX, the 60% US stocks and 40% bond index fund still lags behind the equal weight since 12/31/2000.
This comparison is certainly a bit arbitrary but the key message is that the SAA equal weight is a very good benchmark to measure against, if not to beat.
The following shows how our featured ETF portfolios listed on Major Brokerage Investors are compared with their benchmarks:
Table 2: Portfolio Performance Comparison (as of 12/30/2013)
| Ticker/Portfolio Name | YTD Return** |
1Yr AR | 3Yr AR | 5Yr AR | 10Yr AR | Since 2000 | 10Yr Sharpe |
|---|---|---|---|---|---|---|---|
| Six Core Asset ETFs Tactical Asset Allocation Moderate | 12.5% | 13.5% | 6.7% | 9.3% | 10.0% | 9.1% | 0.84 |
| Six Core Asset ETFs Strategic Asset Allocation – Optimal Moderate | 8.1% | 9.0% | 6.4% | 10.9% | 6.0% | 5.6% | 0.38 |
| MyPlanIQ Diversified Core Allocation ETF Plan Tactical Asset Allocation Moderate | 11.6% | 12.7% | 7.9% | 10.3% | 10.3% | 9.2% | 0.9 |
| MyPlanIQ Diversified Core Allocation ETF Plan Strategic Asset Allocation – Optimal Moderate | 8.2% | 9.0% | 6.9% | 11.8% | 7.9% | 4.9% | 0.55 |
| Six Core Asset ETFs Strategic Asset Allocation – Equal Weight Moderate | 4.9% | 5.7% | 4.9% | 10.2% | 6.4% | 6.0% | 0.4 |
| Retirement Income ETFs Tactical Asset Allocation Moderate | 9.2% | 10.3% | 8.9% | 9.1% | 10.0% | 10.2% | 0.86 |
| Retirement Income ETFs Strategic Asset Allocation – Optimal Moderate | 7.6% | 8.5% | 8.1% | 11.9% | 7.5% | 7.1% | 0.52 |
| Five Core Asset Index ETF Funds Strategic Asset Allocation – Equal Weight Moderate | 6.6% | 7.6% | 5.9% | 11.7% | 6.7% | 6.3% | 0.38 |
Notice that Retirement Income ETFs portfolios have exposure to only the five core assets (no commodities) and thus they should be compared with the Five Core Asset portfolios.
It is clear that our TAA has done so much better in the 1, 3, 5, 10 and since 2000 time frames than their benchmarks. Same can be said for the SAA optimal.
For other risk profile, you can customize a portfolio with that risk profile and do the comparison.
Readers are reminded that our SAA equal weight is free for registered users.
Static portfolios as benchmarks
A more natural way to create your own blended benchmarks is to create a static portfolio with your own fund and allocation choices. Again, static portfolios are free for registered users.
For example, if your risk profile is 52 (i.e. 48% in equities and 52% in bonds or cash), you can create a static portfolio such as 30% in US equities, 10% international equities, 8% in emerging market stocks and 52% in US bonds and then use this as your global blended return benchmark. You then compare it with the portfolio you are following, for example, let’s use Six Core Asset ETFs Tactical Asset Allocation Risk Profile 52:
Portfolio Performance Comparison
| Ticker/Portfolio Name | YTD Return** |
1Yr AR | 3Yr AR | 5Yr AR | 5Yr Sharpe | 10Yr AR | 10Yr Sharpe |
|---|---|---|---|---|---|---|---|
| Six Core Asset ETFs Tactical Asset Allocation Risk Profile 52 | 9.3% | 10.0% | 6.0% | 8.4% | 1.03 | 9.1% | 0.98 |
| My Custom Benchmark Demo | 10.0% | 10.9% | 7.0% | 9.6% | 1.05 | ||
| VFINX (Vanguard 500 Index Investor) | 31.0% | 31.7% | 15.7% | 18.4% | 0.94 | 7.4% | 0.31 |
| VBINX (Vanguard Balanced Index Inv) | 17.2% | 17.6% | 10.6% | 13.5% | 1.15 | 6.9% | 0.48 |
**YTD: Year to Date
Absolute return based benchmarks
As many readers might have known, MyPlanIQ’s investment philosophy has always been to seek solutions that deliver acceptable returns with managed risk. We are not here to compete against a particular market index or a fund. What we care most is whether our investments can help for our long term retirement needs.
For example, let’s say you are in retirement. You would like to withdraw or spend 4% (a popular rule of thumb figure in retirement planning), adjusted with inflation, every year from your investment portfolio. To make sure your portfolio can last in your retirement lifetime and still leave some to your heirs, you would need to not only earn enough returns but also need to make sure your portfolio’s volatility to be minimum.
The topic of withdrawal rate and the timing of withdrawing has been studied extensively. For example, we showed in July 8, 2013: When To Retire And Bear Market Impact On Retirement Income And Spending that withdrawing from an all stock buy and hold portfolio since 2000 vs. withdrawing from a tactical portfolio can result in a dramatic difference over times.
Again, we resort to rule of thumbs here: a reasonable safe assumption is that if you can earn an excessive 4% return over inflation, you probably can sustain your retirement spending need. In fact, assuming your portfolio has zero volatility (meaning no fluctuation) and inflation rate is 3% and the portfolio’s annual return is a constant 3%+4% = 7%, your portfolio’s balance would have the following chart after factoring 4% (with annual inflation adjustment) annual spending rate:
In reality, your portfolio fluctuates a lot more and thus the above is really an ideal case. That is because the portfolio volatility or loss is paramount (again, see the July 8, 2013: When To Retire And Bear Market Impact On Retirement Income And Spending as an example).
To summarize, you can benchmark your portfolios using real returns — returns after inflation. You can setup your expectation such as for a moderate portfolio, the nominal return (nominal return is before inflation) is 4% over inflation. You can then compare your portfolio returns with your objective.
For example, since 2000, the average annual inflation (CPI, Consumer Price Index) is about 2.3% (see http://www.usinflationcalculator.com/ for a calculator). That would mean you should achieve 2.3+4=6.4% for your goal. If you compare this figure in table 1 and table 2, you can see that VBINX barely missed this while other SAA – optimal and TAA portfolios have done better.
Market Overview
US stocks made a new historical high last week again. Others are not as lucky. The following shows how the major 6 benchmarks have fared for the last year:
Asset Performance Comparison (as of 12/30/2013)
| Ticker/Portfolio Name | YTD Return** |
1Yr AR | 3Yr AR | 5Yr AR | 10Yr AR |
|---|---|---|---|---|---|
| SPY (SPDR S&P 500) | 31.7% | 32.5% | 15.9% | 18.6% | 7.4% |
| EFA (iShares MSCI EAFE Index) | 21.0% | 21.5% | 8.4% | 12.7% | 6.7% |
| EEM (iShares MSCI Emerging Markets Index) | -4.8% | -3.1% | -1.9% | 13.5% | 10.2% |
| IYR (iShares Dow Jones US Real Estate) | 1.4% | 1.7% | 8.4% | 16.6% | 6.2% |
| DBC (PowerShares DB Commodity Index Tracking) | -6.9% | -6.7% | -1.5% | 5.3% | |
| BND (Vanguard Total Bond Market ETF) | -2.2% | -2.3% | 2.6% | 3.6% |
The parabolic rising of US stocks (international stocks somewhat) is a concern and we recommend John Hussman’s latest commentary Estimating the Risk of a Market Crash to interested readers on a discussion of stock market crash.
For more detailed asset trend scores, please refer to 360° Market Overview.
We would like to remind our readers that markets are more precarious now than other times in the last 5 years. It is a good time and imperative to adjust to a risk level you are comfortable with right now. However, recognizing our deficiency to predict the markets, we will stay on course.
We again copy our position statements (from previous newsletters):
Our position has not changed: We still maintain our cautious attitude to the recent stock market strength. Again, we have not seen any meaningful or substantial structural change in the U.S., European and emerging market economies. However, we will let markets sort this out and will try to take advantage over its irrational behavior if it is possible.
We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.
We wish you a Happy New Year!
Latest Articles
- Momentum as a Growth Replacement
- December 23, 2013: Vanguard ETF, Mutual Fund & Retirement Income ETF Plans Update
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Diversified Asset Allocation Portfolios For Your Plans
Effective Benchmarking is an apparition that even Ghost Busters would be hard to corral, IMO. Generally, when looking beyond the typical S&P 500 comparisons (which is so often used incorrectly with little consideration as to time frame or risk), there are two types of benchmarks to consider: 1) A benchmark against investment objective (I/O), and 2) A benchmark against real world “buyable” alternative investments that represent the style of the investment strategy (or industry of the stock, sector of the ETF, etc.).
Benchmarking against an I/O requires all types of assumptions to be made if done in the manner that most firms employ today. Typically, I/Os are lined up along an efficient frontier* that is built using historical data and forward looking assumptions based upon that data. This is the least effective way to judge how any investment strategy is doing over the short run and can lead to bowing out of excellent long term methodologies at exactly the wrong time. But like many industry norms, it is a traditional form of evaluating investment account performance and, therefore, covers everyone’s rear end at the brokerage or RIA firm.
Hmmmm….You might be thinking, how does that protect investors or inform him or her (or the institutional client) as to how their investment accounts are doing? Frankly, it provides very little investor protection especially when we consider how most investors react to short term underperformance.
A more effective benchmark approach is to build an index out of securities that have similar strategies. Tactical portfolios can compare themselves against a group of tactical funds in the same manner as individual stock performance is compared against their industry group. Building an index is simple and the data is free from Morningstar and/or Yahoo Finance.
Investors of all levels would be wise to ask themselves or their portfolio manager, how they judge the performance of their portfolios, what are the historical returns of the benchmark they are using, how has the benchmark performed (over and under periods) relative to traditional benchmarks, and under what conditions would they be dissatisfied with the performance of their investment account.
For some, buying the tactical index (Bogel-izing) may be a better approach, especially in those instances when either the investor or the hired portfolio manager do not have the discipline to stay the course when it is only short-term numbers that are not up to snuff.
*For information regarding the randomness of the efficient frontier, take a look at this chart.
http://www.afcgllc.com/sites/afcgllc.com/files/files/Rydex%20SGI%20The%20Inefficient%20Frontier.pdf