April 13, 2020: A Closer Look At 401(k) Investment Portfolios

Apr 14, 2020 | Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

 

Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Friday May 1, 2020.

Please note: As of March 1, 2020, we officially phased out our old rebalance calendar for both SAA and TAA. They are now always rebalanced on the first trading day of a month. 

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.

A Closer Look At 401(k) Investment Portfolios

One of MyPlanIQ’s main services is to provide investment model portfolios for various retirement plans such as a 401(k), 403(b) or an IRA account. Since we started more than 10 years ago, we have provided and monitored model portfolios for plan participants to follow (or customize and then follow) for thousands of 401(k) plans. In this newsletter, we look at an example plan portfolios more closely. 

How does it work? 

In this section, we briefly review the way our service works to help a (401k) plan participant. If you are a long time user and believe you are familiar enough with our services, feel free to skip to the next section. 

Though we have tried our best to simplify our website, over the years, we still find plenty of people who are confused with how our service works. Here are some basic summaries: 

  • We are not a plan provider, a plan administrator, a plan manager or a plan custodian. 
  • We do not have your plan account information. Nor we are by any means affiliated with your plan. So if you are looking for your long lost plan account information, you’ll have to directly contact your plan administrator. 
  • We provide ‘model portfolios’ for your plan’s investment options (funds). By ‘model portfolios’ we mean they are ‘virtual’, i.e. they are NOT your real plan (investment) account. They are just constructed out of available investment options (funds) in your plan so that you can study and/or follow in your real investment accounts. 

For example, CONOCOPHILLIPS SAVINGS PLAN is what we created based on inputs from some ConocoPhillips plan participants. They are essentially a list of available investment options and associated investment model portfolios using our asset allocation strategies. We also regularly updated the investment options based on some public information. In this case, ConocoPhillips has a public plan page here. 

The plan has the following available investment options (funds):

Our system then generates moderate risk model portfolios using a few of asset allocation strategies (Asset Allocation Composite (AAC) , Strategic Asset Allocation (SAA)  and Tactical Asset Allocation(TAA)). A moderate risk portfolio has at most 60% allocated to stocks. Users can then follow these portfolios or customize a new portfolio using their personal risk profile. 

Let’s review these portfolios in some details. 

ConocoPhillips Savings Plan Model Portfolios Performance

By default, users can see two model portfolios on CONOCOPHILLIPS SAVINGS PLAN  page. The following table lists these two portfolios: 

Portfolio Performance Comparison (as of 4/6/2020): 
 
Ticker/Portfolio Name Max. Drawdown 1Yr AR 3Yr AR 5Yr AR 10Yr AR 15Yr AR Since 2001 AR
Asset Allocation Composite Moderate 12.8% 11.2% 9.1% 6.1% 7.4% 8.6% 9.4%
Strategic Asset Allocation – Equal Weight Moderate 30.1% 1.6% 3.4% 3.4% 5.3% 5.2% 5.7%
VFINX (Vanguard 500 Index Investor) 55.3% -1.7% 7.6% 7.9% 10.9% 7.9% 6.1%
VBINX (Vanguard Balanced Index Inv) 36% 1.6% 6.1% 5.7% 8.0% 6.8% 6%

AR: Annualized Return

Drawdown: Peak to a subsequent trough loss

Returns from 2009 to 2020: 

Comments:

  • VFINX: Vanguard S&P 500 index fund (similar to SPY). VBINX: Vanguard 60% stocks 40% bonds balanced index fund. These are the two default benchmarks used for all MyPlanIQ portfolios. 
  • Asset Allocation Composite Moderate (AAC Moderate) portfolio uses MyPlanIQ Asset Allocation Composite strategy that is essentially based on asset class momentum and fund momentum  to choose asset classes and funds to invest monthly. It can also reduce stock allocation when markets are under stress. The decision on whether to reduce stock allocation is based on factors like broad base stock index momentum, credit and interest rate risk, market internals and valuation. 
  • Strategic Asset Allocation – Equal Weight Moderate  portfolio allocates equally into both US and international stock classes. It then uses fund momentum score to choose top funds in each class to invest monthly. 
  • Since 2001, AAC Moderate returned more than double (456% vs. VBINX’s 198%) since 2001. It has also incurred much lower (one third) drawdown (peak to trough loss) than VBINX. 
  • However, AAC Moderate has underperformed VBINX for the past 10 years. Even though it has timely avoided the recent stock market large loss and compares well for the past 1, 3 and 5 years, it wasn’t always the case. In fact, from the second chart in the above, one can see that the portfolio lagged behind both VBINX and VFINX before February this year. So performance comparison can change dramatically when timeframe changes. 
  • More detailed portfolio detailed statistics can be found here. 

Finally, the last point is worth repeating: before March this year, for the past several years, users would have been very discouraged to see that AAC Moderate portfolio were behind a simple 60% stocks 40% bonds buy and hold index fund (portfolio) VBINX for most of 1, 3, 5, and 10 years. However, patience pays off for those who follow this portfolio for a long period of time. 

Other strategic and tactical portfolios

We also want to take a look at the two long running portfolios (Strategic Optimal and Tactical Asset Allocation) that expert subscribers can still use: 

Portfolio Performance Comparison (as of 4/6/2020):
Ticker/Portfolio Name Max Drawdown 1Yr AR 3Yr AR 5Yr AR 10Yr AR 15Yr AR Since 2001 AR
Tactical Asset Allocation Moderate 8.9% 5.5% 6.7% 4.7% 5.7% 6.2% 7.0%
Strategic Asset Allocation – Optimal Moderate 38.6% 1.2% 4.1% 3.8% 6.5% 6.1% 5.8%
VFINX (Vanguard 500 Index Investor) 55.3% -3.0% 7.3% 7.6% 10.8% 7.9% 6.1%
VBINX (Vanguard Balanced Index Inv) 36% 0.6% 5.8% 5.5% 7.9% 6.8% 6%

Comments: 

  • Tactical Asset Allocation Moderate (TAA Moderate) finally did better for the past one year than VBINX. However, this portfolio has struggled for the past 3, 5, 10 and 15 years. Its global balanced approach and overly relying on relative strength between bonds and stocks to reduce stock allocation have not helped much in a period where US stocks and bonds have done very well. 
  • However, since 2001, TAA Moderate again excels, better both VBINX and VFINX. 
  • Strategic Asset Allocation – Optimal Moderate has higher target allocations to international and emerging market stocks. This has hurt its returns for most of periods since 2001. However, for the first 15 years since 2001 (i.e. from 2001 to 2015), it compared well against VBINX.  

Even though the above data are for ConocoPhillips 401(k) plan, similar conclusions can be drawn from other retirement plans. Interested readers can browse this page or search for a plan for more data. 

To summarize, sensible tactical asset allocation strategies can achieve better long term returns and lower risk, compared with a buy and hold or a strategic asset allocation portfolio. This is evident because of the recent market weakness. Considering at the moment, US stock valuation is still extremely high and thus it has uninspiring long term (10 or 12 years) returns, we firmly believe tactical strategies like our AAC or TAA will help to mitigate loss and enhance returns. 

Market overview

Covid-19 pandemic is now finally approaching to peak/flattened period: In Europe, both Italy and Spain have shown daily death numbers declining. US also sees lower death and infection numbers. IHME now expects lower total death number in the US: reduced from 81k to about 68k. The social distancing does play an important role here! As expected, the US and most of Europe will probably come out of the current draconian shutdown/shelter in place phase by the end of this month. 

In the meantime, the Federal Reserve even indicated that they might/will buy high yield corporate bonds (ETFs) to stabilize debt markets. With ‘whatever it takes’ measures thrown at the current crisis, financial markets are now stabilized and recovered a lot from its recent deep loss. 

In the coming weeks, companies will begin to report their first quarter earnings. Though it’s widely expected the earnings figures in the first and the current quarters will be dire, investors and financial markets will soon brace more surprises. 

Furthermore, even though financial markets can be somewhat managed to stabilize and companies can get some short term stimulus financial support such as emergency loans, there are still a lot of uncertainties on this pandemic and some measures/containment will still be implemented even after the economy is somewhat reopened. One of the main concerns, for example, is whether companies will be able to have good cash flow to sustain its debt service (i.e., pay interests and refinance, as so many companies have incurred much more debts in the recent years and many have used the new debts to buy back their shares or expand their business) and operations when there is no enough demand. Monetary and fiscal policies can only help to some extent, ultimately for the economy to back on track, underlying businesses need to function in a healthy way.  

Stocks are now recovered to a level that is again overvalued by many long term metrics. We emphasize the following: 

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or longer. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Finally, this is also a good time for experienced investors to look at the hybrid approach: investing in both strategic and tactical portfolios. As stocks are getting cheaper, it’s sensible to invest a portion to a strategic buy and hold portfolio. Of course, investors should understand fully the implications before taking a plunge in any new approach in a time like this. 

For more detailed current market trends, please refer to 360° Market Overview.

In terms of investments, stocks are finally getting cheaper. Investors should not be swayed by the current market volatility and economic distress, instead, they should stand ready to take advantage of the opportunities. For most Americans, we offer the following Winston Churchill’s remark made in the darkest days of World War II: “The Americans will always do the right thing, but only after they have tried everything else.” As a country, the US (and the rest of the world) will get over this, as always, even after stumbles.

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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