So 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 Wednesday March 1, 2023. 

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.

In Praise Of A Conservative Strategic Asset Allocation

Many MyPlanIQ subscribers are either retirees or close to retirement. Their investments are mostly conservative. In this newsletter, we want to discuss in some detail on how to properly structure a conservative investment portfolio. We will point out that using a conservative strategic asset allocation (SAA) has many advantages.

A conservative strategic asset allocation has the best risk adjusted return

A conservative portfolio usually has up to 20% to 30% stock allocation and the rest is in ‘safe’ fixed income (bonds). The so called risk adjusted return can be roughly understood as the return per a unit of risk. Normally, a portfolio’s volatility (fluctuation) is used to measure its risk. So a risk adjusted return is the return a portfolio would get per a unit of volatility (standard deviation).

We wrote newsletters many years ago on why a conservative strategic asset allocation had one of the best risk adjusted returns. The following picture best illustrates the concept:

Explanations: In the above picture, the X-axis represents risk and Y-axis represents return. In the upper curve, the higher allocation to a riskier asset (stocks), the higher returns you will get. However, when you decrease stock allocation to a particular level (indicated by Minimum variance portfolio), the allocation of stocks and bonds will make the portfolio’s risk the lowest, meaning if you further reduce stock allocation (say to 0), it wouldn’t give you better (lower) risk. This particular level turns out to be roughly 20% to 30% for stocks in a portfolio of US stocks and bonds.

Intuitively, the reason why a portfolio with some stocks does the best is that some amount of stocks can hedge out bonds’ risk just right. Of course, once you increase the stock allocation, the extra risk it incurs will outweigh the bonds side and thus increases overall risk. On the other hand, when you increase bond allocation (the lower curve), it will only reduce the returns and increase risk. Furthermore, since stocks have a higher long term average return than bonds, that amount of stock allocation actually helps to increase the portfolio’s long returns.

Put it in another way, it doesn’t pay to have higher stock allocation if your main concern is the overall risk (and some reasonable returns). Or it’s always better to have some stocks in your portfolios.

Of course, the above discussion is based on the assumption that your stock allocation is on a broad base stock index fund such as S&P 500 index fund (VFINX, VOO, SPY) or Vanguard total stock market index fund like VTI. Similarly we are not talking about individual bonds in the bond allocation either. They should be in some diversified bond funds such as VBMFX or BND (AGG) or some portfolios with good bond funds.

How does this fit into MyPlanIQ’s investment strategies?

So how can a conservative investor structure investments? The simplest way is to just invest in a well rounded conservative allocation fund such as VWINX (Vanguard Wellesley Income Inv). This fund earns a Morningstar analyst gold rating and has an excellent long term track record. That would be the easiest way to gain some reasonable returns with acceptable risk.

On the other hand, investors can also utilize some conservative portfolios we mentioned over the years that utilize ultra low cost stock index funds and MyPlanIQ’s total return bond portfolios (see Income Investors page). In our 2016 newsletter April 11, 2016: Construction of Sound And Conservative Portfolios, we introduced the following two portfolios that essentially invest in some Vanguard stock index funds in their stock portions. The following is the updated table mentioned in the newsletter that compares returns with several excellent conservative allocation funds.

Conservative Portfolios and Mutual funds Performance Comparison (as of 2/10/2023)
Ticker/Portfolio Name Since 1/2/2001 AR YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR 10Yr Sharpe 15Yr AR
Conservative Total Return Bonds REITs Dividend Stocks 8.2% 2.8% 2.9% 5.1% 7.0% 6.4% 1.07 7.6%
Conservative Total Return Bonds REITs Stocks 8.3% 4.1% 1.7% 5.2% 6.9% 6.6% 1.05 7.6%
VWINX (Vanguard Wellesley Income Inv) 6.4% 2.0% -4.8% 2.1% 5.0% 5.6% 0.78 6.3%
BERIX (Berwyn Income) 6.4% 4.2% -1.4% 2.7% 3.5% 3.9% 0.56 5.3%
GLRBX (James Balanced: Golden Rainbow R) 5.5% 2.1% -2.1% 1.9% 2.0% 3.2% 0.32 4.4%
AONIX (American Century One Choice Vry CnsrvInv) N/A (started in 2005) 2.4% 1.1% 4.0% 5.2% 4.4% 0.72 4.5%
SWCGX (Schwab MarketTrack Conservative Investor) 4.5% 3.6% -3.1% 2.6% 4.3% 4.7% 0.56 4.4%

*: NOT annualized. AR: Annualized Return

Conservative Total Return Bonds REITs Dividend Stocks uses REITs (Vanguard REIT index fund VGSIX) and Dividend stocks (Vanguard dividend growth fund VDIGX) for stock exposure to increase dividend yields. You can use ETFs instead index mutual funds in the above portfolios. The following are their corresponding ETFs:

  • VFINX: VOO or SPY or VTI

From the above, we can see that both portfolios have outperformed Vanguard Wellesley VWINX and other funds by some good margins. VWINX also did a much better job than other also excellent funds such as BERIX. We attribute our portfolios’ outperformance to the outstanding returns of our fixed income portfolio: in this case, we use the representative Schwab Total Return Bond for accounts in Schwab. Users should choose a brokerage specific portfolio for their brokerages (see the table on Income Investors page). If your brokerage is not supported, you can also utilize our ETF bond portfolio MPIQ ETF Fixed Income instead.

Based on the above discussion, for a conservative allocation, we do NOT recommend directly using a tactical portfolio outright that can at times liquidate all stock investments to reduce interim loss (or so called drawdown). For a conservative allocation, it’s a good idea to always retain that small stock allocation up to 30% (more risk averse investors can reduce this down to 20% or so).

What about moderate and/or other risk level allocation?

In general, it’s a good idea to keep at least two accounts such that one or some accounts can always have up to 20% or so stocks while in other accounts, you can adopt a more dynamic strategy such as MyPlanIQ’s tactical allocation strategy. For example, let’s say you decide that your overall risk can be up to 70% stock allocation. You can divide the investments into two accounts:

1. ACcount 1: 20% buy and hold stocks in ultra low cost stock index funds such as VTI, SPY, VOO. You can either choose a MyPlanIQ SAA optimal portfolio that has risk profile 0 (i.e. 100% in stocks) or just simply utilize the stock funds in the above two conservative portfolios (if you are US based and conscious on dividends).

2. Account 2: since we have already had 20% into stocks, the remaining stock allocation should be 50% while the fixed income allocation remains 30%. These percentages are with respect to the overall allocation. For this account, we should allocate 50/(50+30)=62.5% in stocks and 30/(50+30)=37.5% in bonds. This account can be of AAC or TAA with risk profile 37.5.

The above turns out to be a so called core satellite portfolio combo that you break down your overall investments into two sub portfolios, one is Strategic Asset Allocation and and the other is Tactical Asset Allocation.

Conservative allocation portfolios for experienced or expert investors

For experienced or advanced investors (like MyPlanIQ expert subscribers), we believe they can more effectively utilize these conservative portfolios in the current environment.

For those who are concerned about upcoming recession or a big market downturn, using a conservative portfolio that has some nominal stock allocation (like 20%) as an anchor while in the meantime utilizing MyPlanIQ’s total return bond portfolios for fixed income portion should put your investments in a relatively safe and solid footing. This portfolio will carry through periods when stock valuation is still high (like right now) and overall returns will not be as good as bonds, as what we have alluded in previous newsletters (see January 30, 2023: The Bond Era). On the other hand, the (20%) stock allocation would still enable you to participate in stocks’ further advances as no one can’t precisely predict a stock market top.

With a conservative portfolio, you can afford to wait out high (expensive) stock valuation periods. When a big correction finally comes and runs its course (a simple signal would be when MyPlanIQ’s tactical strategies like AAC or TAA increase stock exposure), you then can increase stock exposure to your desired level.

Or if you don’t like the momentum driven tactical strategies such as MyPlanIQ’s TAA or AAC, you can still gradually increase your stock exposure when stocks are going down (Dollar Cost Average), assuming you are comfortable with a further drawdown (as no one can be sure about a stock market bottom). Please note it’s critical to utilize a well diversified stock index fund, not some individual stocks (unless, of course, you are highly experienced and comfortable with these stocks’ fundamentals).

Market overview

Well markets are whipsawed, waiting for the latest CPI report on Tuesday. On the other hand, earnings in last quarter (Q4 in 2022) turned out to be less severe than many had feared: based on Factset, up to last Friday, with 69% of S&P 500 companies reporting actual results, the blended earnings year over year earnings growth was -4.9%, lower than -3.2% expected on December 31, 2022, but didn’t do much worse. Analysts overall are still very optimistic, projecting earnings growth of 2.5% and revenue growth of 2.4% for 2023. Stocks and bonds are more or less positioned to be in a goldilocks — a positive yet not too hot growth environment.

As always, we admit that we have no ability to predict near term market movements. What we can do is to adopt a risk managed approach and let prevailing market conditions and actions guide us further. We call for staying the course:

  • 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 preferably much longer given the current high valuation. 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 and preferably many more 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.

Stock valuation has dropped and now valuation is becoming less hostile. However, it is still not cheap by historical standard. For the moment, we believe it’s prudent to be extra cautious. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to emphasize that 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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