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, May 2, 2016. You can also find the re-balance calendar for 2015 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.
Low Cost Index Fund Investing
This weekend, in Berkshire Hathaway’s annual meeting, Warren Buffett renewed his attack to hedge fund industry and suggested that individual investors (and many institutional investors too) stick to low cost index fund such as S&P 500 index fund (Vanguard’s 500 ETF VOO, for example). While we believe that in addition to cost, there are other important factors to consider, we agree that investing in low cost index funds is the way to go.
Fees matter
Though readers can find plenty of articles to discuss this, it is still worthwhile to point out the following:
First of all, even after many years’ campaign by people like John Bogle and Warren Buffett, investors still carry their inertia to continue to invest in expensive funds. For example, when it comes to S&P 500 ETFs, one can find several ETFs and no load mutual funds such as the following:
S&P 500 ETFs & mutual funds (as of 5/2/2016)
Fund | Expense Ratio | YTD Return** |
1Yr AR | 3Yr AR | 5Yr AR | 10Yr AR |
---|---|---|---|---|---|---|
IVV (iShares Core S&P 500) | 0.07% | 2.1% | 0.3% | 11.6% | 11.1% | 6.9% |
SPY (SPDR S&P 500 ETF) | 0.09% | 1.7% | 0.1% | 11.2% | 10.9% | 6.8% |
VOO (Vanguard S&P 500 ETF) | 0.05% | 1.8% | 0.1% | 11.1% | 10.8% | |
PREIX (T. Rowe Price Equity Index 500) | 0.27% | 1.7% | -0.1% | 11.1% | 10.7% | 6.6% |
SWPPX (Schwab S&P 500 Index) | 0.09% | 1.7% | 0.1% | 11.2% | 10.9% | 6.9% |
VFINX (Vanguard 500 Index Investor) | 0.16% | 2.5% | 0.8% | 11.7% | 11.1% | 6.9% |
When we tried to construct mutual fund portfolios for our Brokerage Investors, we were frequently frustrated with the lack of no transaction fee index funds in various brokerages. For example, PREIX (T. Rowe Price Equity Index 500) is the only low fee S&P 500 index fund available transaction fee free in Etrade and Merrill Edge. This fund is 0.09% to 0.15% more expensive than the others. The above table only shows the funds for the most popular index S&P 500 stock index. For other index funds such as various stock style indexes (for example, mid cap value index fund), you’ll be surprised to find out that there are still many alternatives whose fees can vary to 0.5% or so!
We can only attribute this to investors’ inertia or reluctance to deal with the trouble to move to a better brokerage. Maybe the following discussion can further help you to look at this issue more seriously.
0.5% is a big deal. To put things under perspective, 0.5% of $100,000 is $500, or the cost of an iPhone. When it comes to purchase an iPhone, people would go extra miles to find a cheaper price, but for investing, these become some intangible numbers and people respond differently. Remember this is the recurring annual extra cost. Furthermore, when your asset grows, this number can become much bigger.
Because of the recurring cost, this extra cost can affect your long term growth dramatically. For example, at an annual 8% growth rate, a $10,000 initial investment would become $46,610 after 20 years. But with the extra 0.5% fee bite, the value after 20 years would be $42,479, a $4,131 difference.
In a realistic 6% to 8% per annum portfolio return world, 0.5%, let alone 1%, is a big deal. Most active funds have a hard time to outperform an index fund even before fee. Investors tend to be confused by the short term performance phenomenon: yes, it is very common to see funds that outperform (or underperform) a benchmark index by a large margin in a particular year. But over time, in the long term, it has been shown that it’s incredibly hard for a fund to outperform. At best, you might end up getting the index fund return while your fund managers or advisors getting their fees, i.e. the managers derive their fees by ‘beating’ the index with just the fee amount. Odds are, however, that investors might get an even lower return.
Paying a manager to manage a simple strategic portfolio or a fund of funds with anything above 0.1% is questionable, in our opinion. Vanguard’s 60/40 index fund VBINX charges 0.22% expense while VFINX (the stock portion) and VBMFX (Vanguard total bond market index) charge 0.16% annually. With lower cost ETF alternatives, one can get VOO that only charges 0.05% and BND that charges 0.06%, thus, saving about 0.15% to construct a 60/40 balance portfolio, compared with VBINX. Another glaring example is PRPFX (Permanent Portfolio) that charges 0.8% while one could construct a Harry Brown type permanent portfolio with as little as 0.2% or lower expense, a saving of 0.6%! We will discuss permanent portfolio performance shortly.
Similarly, we believe that low cost indexing is also applicable to portfolio management. This is especially true for strategic asset allocation portfolios that only require simple rebalances a few times per year. Recently, there have been a new crop of on line investment advisors (the so called robo advisors) that offer low cost strategic portfolio management services. It’s debatable whether such ‘low’ cost (as low as 0.25%) is justifiable or not. Regardless, investors just need to do the math and be extremely cost conscious to understand the value added by these services.
At any rate, lowering your fees is the only true ‘free’ lunch that can immediately boost your returns without risk.
Indexing and mechanical investing
We would also like to draw readers’ attention to indexing. Although indexing almost becomes a misnomer for ‘dumb down’ investing, if one looks at what’s under the hood in an index, you’ll find that things are far more sophisticated. For example, the popular S&P 500 index is constructed based on a non-trivial, rigorous addition/deletion and rebalance policy. To us, indexing is a just loose term for a mechanical/rule based investing.
Mechanical/rule based investing has several advantages over human driven investing. First, mechanical investing eliminates the costly human labor. More importantly, it eliminates human errors which can occur frequently due to emotions and other human factors (such as manager change). Precisely because of the pre-selected rules or strategies in mechanical investing, investors are forced to vet the strategy or ‘index’ thoroughly beforehand, unlike those funds or portfolios managed by human managers that can ‘improve’ or change as time goes, making it hard to predict, hard to understand and prone to mistakes in the long investing process.
It’s also because of the requirement to fully understand the method or strategy behind an index, indexing or mechanical investing entails a simple and intuitive explanation for its method or rules. All of the traditional capitalization based indexes have very basic intuitive rules and they have been vetted for many years. Again, it all comes down to our belief that simpler is better. Just like Buffett said, no investment consultant would like such business because there just isn’t one on their end. No wonder you see so many sophisticated and super secretive hedge (or mutual) funds popping up. Without such ‘sophistication’, how can they charge such a high fee?
Finally, with the above said, we would like to point out that we do believe there are some outstanding investment managers or strategies out there that can beat the market consistently. However, it’s just not for an average investor. In fact, for any individual investor, overly relying on finding these managers is a fool’s game: this is because individual investors can not withstand the consequence of committing to a bad investment (which has a very high probability) in their limited lifetime. After all, there aren’t many 10 years in one’s life. So go for a safer route instead of chasing a home run.
Permanent portfolios
Though Buffett’s portfolio consists of only S&P 500 and a short term bond index fund, the low cost indexing investing can be extended to other alternative portfolios. The following table shows examples permanent portfolios:
Portfolio Performance Comparison (as of 5/2/2016):
Ticker/Portfolio Name | YTD Return** |
1Yr AR | 3Yr AR | 5Yr AR | 10Yr AR | 10Yr Sharpe |
---|---|---|---|---|---|---|
Harry Browne Permanent Portfolio | 7.6% | 4.1% | 3.5% | 4.6% | 6.3% | 0.78 |
Permanent Income Portfolio | 4.5% | 3.8% | 3.7% | 6.2% | 6.4% | 0.96 |
PRPFX (Permanent Portfolio) | 10.9% | 1.4% | 0.8% | 0.3% | 5.2% | 0.42 |
VFINX (Vanguard 500 Index Investor) | 2.5% | 0.8% | 11.7% | 11.1% | 6.9% | 0.29 |
VBINX (Vanguard Balanced Index Inv) | 2.9% | 0.9% | 7.4% | 7.9% | 6.4% | 0.47 |
One can see that the Harry Browne Portfolio and Permanent Income Portfolio have done well recently. These are attributed to the recent strength in gold and long term bonds. PRPFX (Permanent Portfolio), a mutual fund, recovered a bit recently. However, its long term performance has been damaged. Furthermore, as we discussed above, one can construct a very low cost Harry Browne permanent portfolio using the following
Ticker/Portfolio Name | Percent | Expense |
---|---|---|
IAU (iShares Gold Trust) | 25% | 0.25% |
VGLT (Vanguard Long-Term Government Bond ETF) | 25% | 0.1% |
VOO (Vanguard S&P 500 ETF) | 25% | 0.05% |
CASH (CASH) | 25% | 0% |
Total | 100% | 0.1% |
So, instead of 0.8% charged by PRPFX, you can have a permanent portfolio with 0.1% expense. If you tweak this portfolio further, it might cost a bit more, but for sure no more than 0.25% (permanent income portfolio has 0.22% overall expense), still a big saving here.
For the above portfolio, you just rebalance once a year. You are paying yourself 0.7% of the portfolio by doing the buying and selling two or three funds at most once a year!
Market Overview
Stocks underwent some correction last week. This was caused by several major earning misses (Apple, Microsoft and Google). However, overall, S&P 500 earnings actually improved over the expectation on March 31, 2016: from Factset, so far for Q1, the reported and estimated S&P earnings combined till the end of last week declined -7.6%, better than the previously expected -8.7%. Markets are making guesses by fluctuating up and down. What we need to do is to ignore the noise and stay with the strategies we have chosen.
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 6 years. Since the financial crisis in 2008-2009, we have not seen substantial structural change in the U.S., European and emerging market economies. Even though U.S. stocks have had a recent correction, their valuation is still at a historical high level. It is thus not a good time to take excessive risk.
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.
Latest Articles
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- April 11, 2016: Construction of Sound And Conservative Portfolios
- March 28, 2016: Total Return Bond ETFs Review
- March 21, 2016: Small And Large Company Stock Performance In Different Economic Expansion Cycles
- March 14, 2016: Are Tactical And Timing Strategies Losing Steam?
- March 7, 2016: Defined Maturity Bond Fund Analysis
- February 29, 2016: Smart Strategic Asset Allocation Rebalance When Market Trend Changes
- February 22, 2016: Be Cash Smart
- February 15, 2016: Bond ETF Portfolios
- February 8, 2016: Newsletter Collection Update
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- January 25, 2016: Alternative Portfolios Review
- January 18, 2016: Strategic Asset Allocation: A Cautious Outlook
- January 11, 2016: Review Of Trend Following Tactical Asset Allocation
- January 4, 2016: What Worked And Didn’t In 2015
- December 21, 2015: Distressed Assets
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- November 30, 2015: Investors and Speculators Combined
- November 23, 2015: Active Stock Fund Performance Consistency
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- November 9, 2015: Broad Base Core Mutual Fund Review
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- October 26, 2015: Total Return Bond Fund Review
- October 19, 2015: Advanced Portfolio Review
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- September 14, 2015: Core Satellite Portfolios In Market Turmoil
- September 7, 2015: Market Rout Creates An Opportunity to Reposition Your Portfolios
- August 31, 2015: Review of Asset Allocation Funds and Portfolios
- August 24, 2015: Market Rout And Your Portfolios
- August 17, 2015: ETF or Mutual Fund Based Portfolios
- August 10, 2015: Updated Newsletter Collection
- August 3, 2015: Slippery Asset Trends
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- July 13, 2015: Pain in Tactical Portfolios
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- June 29, 2015: Core ETF Commission Free Portfolios
- June 22, 2015: Secular Asset Trends
- June 15, 2015: Giving Up Bonds?
- June 1, 2015: Summer Blues?
- May 26, 2015: Cash, Bonds and Stocks In A Rising Rate Environment
- May 18, 2015: Portfolio Update
- May 11, 2015: Pain in Fixed Income?
- May 4, 2015: The Balanced Stock and Long Term Treasury Bond Portfolios
- April 27, 2015: Long Term Treasury Bond Behavior
- April 20, 2015: 529 College Savings Plan Rebalance Policy Change
- April 13, 2015: Total Return Bond Funds As Smart Cash
- April 6, 2015: The Low Return Environment
- March 30, 2015: Brokerage Specific Core Mutual Fund Portfolios 2
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- March 9, 2015: Newsletter Collection Update
- March 2, 2015: Total Return Bond ETFs
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- January 26, 2015: Composite Portfolios Review
- January 19, 2015: Fixed Income Investing Review
- January 12, 2015: How Does Trend Following Tactical Asset Allocation Strategy Deliver Returns
- January 5, 2015: When Forecast Fails
- December 22, 2014: Long Term Asset Returns: How Long Is Long?
- December 15, 2014: Beaten Down Assets
- December 8, 2014: Implementing Core Asset Portfolios In a Brokerage
- December 1, 2014: Two Key Issues of Investment Strategies
- November 24, 2014: Holiday Readings
- November 17, 2014: Retirement Spending Portfolios Update
- November 10, 2014: Fixed Income Or Cash
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- October 20, 2014: Strategic Portfolios With Managed Volatility
- October 13, 2014: Embrace Volatility
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- September 22, 2014: Why Total Return Bond Funds?
- September 15, 2014: Equity And Total Return Bond Fund Composite Portfolios
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- September 1, 2014: Risk & Diversification: Mint.com Interview
- August 25, 2014: Remember Risk
- August 18, 2014: Consistency, The Most Important Edge In Investing: Tactical Case
- August 11, 2014: What To Do In Overvalued Stock Markets
- August 4, 2014: Is This The Peak Or Correction?
- July 28, 2014: Stock Musings
- July 21, 2014: Permanent Portfolios & Four Pillar Foundation Based Framework
- July 14, 2014: Composite Portfolios Review
- July 7, 2014: Portfolio Behavior During Market Corrections
- June 30, 2014: Half Year Brokerage ETF and Mutual Fund Portfolios Review
- June 23, 2014: Newsletter Collection Update
- June 16, 2014: There Are Always Lottery Winners
- June 9, 2014: The Arithmetic of Investment Mistakes
- June 2, 2014: Tips On Portfolio Rebalance
- May 26, 2014: In Praise Of Low Cost Core Asset Class Based Portfolios
- May 19, 2014: Consistency, The Most Important Edge In Investing: Strategic Case
- May 12, 2014: How To Handle An Elevated Overvalued Market
- May 5, 2014: Asset Allocation Funds Review
- April 28, 2014: Now The Economy Backs To The ‘Old Normal’, Should Our Investments Too?
- April 21, 2014: Total Return Bond Investing In The Current Market Environment
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