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.

Construction of Sound And Conservative Portfolios

In the past, we have pointed out that a portfolio that has conservative allocation usually commands best risk adjusted return or Sharpe ratio. A conservative allocation usually allocates around 20-30% to stocks. For example, VWINX (Vanguard Wellesley Income Inv) had about 30% allocated to US stocks and 7% allocated to Non US stocks on 12/31/2015. 

If you are a conservative investor or just a retiree, you might not have much choice but going for a conservative allocation. However, even if you are an investor who can tolerate more risk, you might want to consider a conservative portfolio because of the following reasons:

  • You might not want to take more risk since stock markets are at a high valuation level. For example, at this moment, using a long term stock market valuation metric such as Shiller’s CAPE 10 or Buffett’s total market capitalization over gross domestic or national product (see Market Indicators for more details), stocks are at a historical high level and overvalued by over 40%. John Hussman has frequently discussed this subject. Based on his modified Buffet valuation metric, he estimated that S&P 500 will return around 2% annually for the coming 12 years (see his latest weekly commentary). A risk averse investor might want to reduce stock exposure in such market conditions. However, as stock markets can be at a high overvalued level for a long time and it is hard to predict their behavior, one might not want to totally abandon stocks even at such a high level. A conservative allocation is thus a good portfolio to be with in this type of situations. 
  • A conservative portfolio not only provides the best risk adjusted return, it actually can deliver better returns when markets are at a late stage bull market or have been mostly at high valuation levels for a long period of time. For example, in the following table, a conservative portfolio or fund has had a better 10 year return than a stock index such as S&P 500 total return index. Simply put, it doesn’t pay to take excessive risk when markets are frothy. So a conservative portfolio can be a good anchor to wait it out without losing much return opportunity. 

Conservative allocation mutual funds

There are several ways to invest in a conservative portfolio. One way is to invest in a mutual fund. There are several excellent conservative allocation funds one can consider. The following table shows some of them: 

Portfolio and Fund Performance Comparison (as of 4/11/2016):
Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR 10Yr Sharpe
Conservative Total Return Bonds REITs Dividend Stocks 2.8% 0.6% 4.9% 7.6% 8.6% 1.14
Conservative Total Return Bonds REITs Stocks 2.5% 0.0% 5.0% 7.4% 8.3% 1.02
VWINX (Vanguard Wellesley Income Inv) 4.0% 3.3% 5.8% 7.8% 7.1% 0.97
BERIX (Berwyn Income) 3.0% -1.3% 5.1% 5.4% 6.8% 1.04
GLRBX (James Balanced: Golden Rainbow R) 0.1% -3.8% 3.8% 5.6% 5.9% 0.62
AONIX (American Century One Choice Vry CnsrvInv) 2.7% 0.3% 3.0% 4.2% 4.4% 0.72
SWCGX (Schwab MarketTrack Conservative Investor) 1.8% -1.6% 4.0% 4.9% 4.1% 0.4
VFINX (Vanguard 500 Index Investor) 0.8% 0.4% 11.6% 11.2% 6.8% 0.29

See detailed comparison>>

VWINX (Vanguard Wellesley Income Inv) is one of the most consistent conservative allocation mutual funds. It even outperformed VFINX (a proxy of S&P 500 total return) in the last 10 years. Another good conservative fund BERIX (Berwyn Income) has the same 10 year annual return as VFINX. Other conservative funds have not done as well as these two funds. 

There are several reasons that hinder an investor to invest in a good conservative fund. The very first one (and the most practical one) is that many brokerages do not carry all of the good conservative funds as no transaction funds. For example, Schwab, Fidelity and many others charge transaction fees for VWINX. 

The other reason is that one can never trust an actively managed mutual fund, no matter how excellent it has been. This has always been one of our investment tenets. There are just too many incidents that a good fund went awry and hurt its investors. The very recent example is SEQUX (Sequoia) fund that had a big loss due to its excessive bet on Valeant stock. Let’s not forget Legg Mason Value fund, Dodge & Cox Stocks and/or,  GLRBX (James Balanced: Golden Rainbow R), FPACX etc. It is a long list one can produce. 

We are more comfortable with using a fund rotation portfolio to weed out losers such as our conservative upgrade portfolios listed on Brokerage Investors page (or see this link) or a fail safe method in stock component: using stock index funds instead. 

Other reasons to construct your own portfolio instead of investing in a mutual fund include tax consideration and flexibility. For example, when stocks are very undervalued, one can simply sell some bond funds in the portfolio and buy stocks if you are willing to take extra risk to boost returns. 

Constructing a conservative portfolio using stock index funds and total return bond funds

The conservative portfolios shown in the above table allocate 30% to stocks and REITs. They are strategic or static portfolios. They have the following components: 

Conservative Total Return Bonds REITs Dividend Stocks

USStocks VDIGX 20%
TotalReturnBond P_46880 70%

VDIGX (Vanguard Dividend Growth Inv) is Vanguard’s (index) dividend appreciation fund. 

P_46880 is Schwab Total Return Bond that is again listed on  Brokerage Investors page. It invests in no load and no transaction fee total return bond fund in Schwab. Investors should choose other portfolios if their brokerage is not Schwab. 

Conservative Total Return Bonds REITs Stocks

USStocks VFINX 20%
TotalReturnBond P_46880 70%

The difference between the above two portfolios is in the stock portion: either invests in S&P 500 (VFINX) or a dividend growth fund (VDIGX). 

From the first table, one can see that not only both portfolios had a better total return than VFINX in the last 10 years, they both have done better than VWINX, a coveted and hard to beat conservative fund by more than 1% annually in the last 10 years. We attribute the outperformance to the excellent total return bond portfolio’s performance and the consistent index type performance in both stock and REIT portions of the portfolios. Investing in an index fund may not get you home runs, but it will not incur man-made errors that sometimes can be hard to repair. 

The two portfolios have about 3-5% annual dividends/interests, which are good for income investors too. 

Investors can tweak the allocations to suit their own risk tolerance. For example, if 30% of stocks and REITs is too much for your liking, you can reduce the allocation further. The two portfolios lost about 10-12% in 2008 and have about 20% maximum drawdown during that period. See  detailed comparison for more portfolio data. 

Since the portfolios always buy and hold the stocks and REITs, it is possible to pay up one time transaction fee to initiate holding of VDIGX in those brokerages that charge transaction fees for this fund. For other funds such as VFINX and VGSIX, one can find plenty of substitutes in major brokerages. You can even use ETF VNQ, for example, to substitute VGSIX in almost all brokerages. 

If stocks are at a very under valued level (such as it can deliver more than 10% annual return for the next 10 years), one can take extra risk to sell some portion of bond funds and overweight the stock funds. You can then liquidate the extra stock portion or rebalance back to conservative level when stocks are fairly valued or over valued. 

The investing approach in the proposed conservative portfolios enables investors to be less psychologically impacted by volatile markets while in the meantime, it is still possible to deliver reasonable or even market beating returns with far less risk. 

Market Overview

Stocks are now stuck at a level that is just above its 200 day moving average. In the meantime, long term bonds and gold are all exhibiting positive strength. It’s possible we are yet into another goldilocks or at least that is what investors are perceiving. However, we are more concerned about the general economy and the upcoming earnings season. Again, as stated in the above, it does not pay to take excessive risk at this moment.  

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. 

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