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, August 26, 2013. 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.

Total Return vs. High Yield Investing

Investors are long in favor of dividend and interest paying securities. In a balanced portfolio, that means (high) dividend paying stocks and (high) interest paying bonds. In old days, stocks that paid healthy 5-10% dividends were often called widow stocks as many old widows would just rely on dividends or coupons to fund their daily spending.  Examples are Williams Companies (WMB) (current dividend 3.4%) or AT&T (T) (current dividend 5%).  Unfortunately, in today’s extremely low interest rate and generally expensive stock valuation environment,  it is hard to build a solid stock portfolio that yields 5% or so, it is even harder to build a balanced stock and bond portfolio that yields this high. Currently, for example, on stock side, S&P 500 SPDR SPY yields 2.08% while  on bond side, Total Bond Market Index BND yields 2.23%. It is thus fair to say on average, a reasonable portfolio yields approximately around 2%, a far cry from 5% or higher. 

High yield oriented investing are popular among retirees or income oriented investors. The following are the main reasons often cited: 

  • A high yield portfolio generates a steady stream of cash without needing to sell a security, giving investors a sense of ‘income’.
  • If dividends received are ‘qualified’ dividends, they are still taxed at a low 15% rate for annual income up to $400,000 ($450,000 for joint filers). This is compared with capital gain tax that can be as high as ordinary income tax. 
  • In general, stocks paying dividends are more reliable and they produce better returns with less risk in the long term. This argument has a qualification which we will discuss shortly. 

As we detailed in May 6, 2013: High Dividend ETF Portfolio Construction, there are the several classes of high yielding stocks or bonds: 

  • Domestic REITs. 
  • Mortgage REITs. 
  • International REITs. 
  • Master Limited Partnership (MLPs). 
  •  Business Development Comapnies (BDCs). 
  • Preferred stocks. 
  • Closed end funds (CEFs). 
  • International and emerging market dividend paying stock ETFs. 
  • High yield (junk) bonds. 
  • Long term bonds. 

High yield investing was very much in favor earlier this year before the bond debacle that started in May and ran through the end of June. Most ETFs or mutual funds in the above categories took a hit. This offers a reminder that high yield investing is not without risk. 

Compared with high yield investing, total return based investing focuses on the total return which includes both the price appreciation and dividends/interests (reinvested). The following are its pros and cons: 

  • On equity (stock) side, we urge investors to understand high dividend paying specialty stocks such as REITs, BDCs and MLPs. These stocks generally pay high dividends. However, they can be affected by some specific economic conditions. For example, REITs and BDCs are sensitive to borrowing cost and in general they can have difficulties in a rising interest rate environment. This was evident in the current situation. Both REITs (such as VNQ) and BDCs incurred large loss from May to June. It is thus not always the case that the higher dividend the better in every economic cycle. 
  • Investors should also understand the difference between dividend hogs and dividend appreciation stock investing or ETFs. In general, we favor companies that increase their dividend payout over time instead of merely going for high dividends. We have discussed this in previous articles Dividend ETFs Aren’t Created Equal: Dividend Appreciation vs. Dividend Hogs and Dividend Stock ETF Investing: Growth vs. Value. Again, this indicates that the high dividend criterion should not be the only one in choosing stocks. 
  • Both stock and bond markets usually go through cycles: on stock side, in some periods, high growth stocks that pay little dividends can be in favor (as in technology stocks, some of which have morphed into bellwethers that are paying healthy dividends — though still not high dividends by any means). Similarly, high yield junk bonds are good in some periods while in other periods they can suffer from big loss. This was evident in 2008-2009 crisis when high yield bonds had over 30% loss. Furthermore, in the current rising rate environment, long term bonds are definitely not a place to be. Short duration bonds or even cash are the best at the moment. Investors who are merely chasing high interests should be aware that long term bonds can have significant loss if the interest rate rising scenario (or withdrawal of quantitative easing) indeed materializes further.
In general, we favor total return based investing approach. However, we also recognize the fact that high quality dividend paying stocks (aka dividend appreciation high quality stocks) can offer better risk adjusted returns (better or comparable returns with less risk) in the long term. 

The following are some examples: 

High Dividend Stock Portfolios vs. Total Return 

Upon the request from a group of users, we constructed a high dividend stock ETFs portfolio using many special segments of stocks mentioned above. The portfolio High Dividend ETFs Liquid TAA Risk Profile 0 was first mentioned in our newsletter May 6, 2013: High Dividend ETF Portfolio Construction. At the time, we stated that “We caution that this is still work in progress and we will not support this portfolio until we finalize our work. Furthermore, the candidate funds will be changed from time to time to reflect new opportunities and more mature ETF offerings.

Promptly, after the introduction, this portfolio got a big hit. The following is the updated performance table we used in the newsletter: 

Portfolio Performance Comparison (as of 8/5/2013)

Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe 10Yr AR 10Yr Sharpe
VFINX 21.1% 26.8% 17.4% 1.01 8.6% 0.33 7.7% 0.32
High Dividend ETFs Liquid TAA Risk Profile 0 0.5% 6.0% 7.9% 0.65 11.8% 0.8    
P Portfolioist Considine 7 Percent Income Portfolio -9.0% -10.0% 2.8% 0.52 6.4% 0.54    
VBINX 11.7% 15.8% 11.9% 1.18 7.9% 0.52 7.2% 0.52
P Relative Strength Trend Following Five Assets Dividend Stocks 11.7% 19.0% 10.1% 0.71 10.1% 0.7 12.7% 0.89
Retirement Income ETFs Tactical Asset Allocation Risk Profile 0 8.3% 13.9% 8.5% 0.62 11.9% 0.71 15.6% 0.85

*: NOT annualized

**YTD: Year to Date

See detailed latest comparison >>

This is a good example that just focusing on high dividend yield funds is not good enough. Even though the portfolio is still doing well in the last 5 year time frame, we feel it is not the best portfolio for our broad base users. As a result, we will no longer actively maintain this portfolio. However, expert users who are willing to do their home work can use this as a starting point to build better dividend paying portfolios. It is also possible in the future, after high paying dividend ETFs become more mature, we might modify the list of funds to have a better higher dividend paying portfolio. For now, we’ll have to skip this. 

High Yield Bonds vs. Total Return Bond Portfolios

Even in bond investing, we believe total return based approach offers much better risk adjusted returns. For example, the following table shows how our Fixed Income Bond Fund Portfolios have done compared with Vanguard high yield bond fund VWEHX: 

Portfolio Performance Comparison (as of 8/5/2013)

Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 5Yr Sharpe 10Yr AR 10Yr Sharpe
VBMFX (Vanguard Total Bond Index Fund) -2.5% -2.2% 3.0% 5.0% 1.17 4.8% 0.87
Schwab Total Return Bond 0.5% 4.7% 6.3% 8.0% 1.97 6.8% 1.51
TDAmeritrade Total Return Bond 0.4% 4.7% 6.7% 8.6% 2.27 7.4% 1.71
VWEHX (Vanguard High Yield Bond Fund) 0.7% 5.9% 9.0% 9.4% 1.55 7.2% 1.26
Fidelity Total Return Bond 0.5% 4.7% 6.2% 9.0% 2.23 7.3% 1.63
PTTRX (PIMCO Total Return Bond) -2.7% -0.1% 4.3% 7.3% 1.65 6.4% 1.24
Etrade Total Return Bond 0.5% 4.7% 6.2% 7.6% 1.86 6.7% 1.46
FolioInvesting Total Return Bond 0.5% 4.7% 6.3% 7.8% 1.94 6.8% 1.5

Notice that even though VWEHX is doing as well as the total return bond fund portfolios in the last 10 trailing years, it incurred such a large maximum drawdown 30.2%, compared with around 7% for the portfolios. 

Tactical vs. Strategic

Even though investors can construct a strategic portfolio that consists of high quality dividend paying ETFs (or mutual funds) and bond funds, we believe tactical strategy is an integral part of the total return based approach. The following compares SAA and TAA portfolios for both Retirement Income ETFs and Schwab Income Mutual Fund Select List:

Portfolio Performance Comparison

Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe 10Yr AR 10Yr Sharpe
Retirement Income ETFs Strategic Asset Allocation – Optimal Moderate 3.9% 8.7% 9.0% 0.96 7.4% 0.48 8.2% 0.58
Retirement Income ETFs Tactical Asset Allocation Moderate 4.0% 6.8% 9.2% 1.08 9.3% 0.88 11.2% 0.95
Schwab Income Mutual Fund Select List Strategic Asset Allocation – Optimal Moderate 6.0% 11.7% 9.8% 1.03 7.7% 0.52 8.2% 0.62
Schwab Income Mutual Fund Select List Tactical Asset Allocation Moderate 6.7% 10.6% 8.9% 1.16 11.0% 1.21 10.2% 1.14
VBINX 11.7% 15.8% 11.9% 1.18 7.9% 0.52 7.2% 0.52
VFINX 21.1% 26.8% 17.4% 1.01 8.6% 0.33 7.7% 0.32

See latest detailed comparison >>

From the above, one can see that the TAA portfolios are doing as well as the SAA Optimal portfolios, even in the past 3 and 5 years. However, TAA portfolios still do much better in the 10 year time frame. 

To summarize, total return based approach is our preferred way in constructing a portfolio, both in stocks and bonds. However, we do believe that dividend paying stock ETFs can still add value as long as these are broad base dividend ETFs. This is exemplified by Retirement Income ETFs Tactical Asset Allocation Moderate.

Market Overview

Though S&P 500 and Dow Jones Industrial Index continued to make new highs, markets have not been uniform at all. Both REITs and Emerging market stocks are now ranked below cash, along with commodities. On the fixed income side, bonds retreated again. It is a tough environment going forward: rising rate, over valued and over bought. We call for caution for any new money to initiate new investments. 

For more detailed asset class trends, see  360° Market Overview.

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. 

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