Low Bond Yields Make Building a Portfolio Harder

AppId is over the quota
AppId is over the quota
United States Treasury bonds and other high-grade bonds used to be the safe way for older investors to generate income in their portfolios. But yields on these bonds are now so low, they are not generating much income.

The Federal Reserve’s announcement on Wednesday that short-term interest rates would remain close to zero through 2014 confirmed that there was little hope in the near term for much change in bond income.

But it is not easy to find something to replace that income. Other options are not nearly as safe. The wild gyrations in the stock market at the end of last year further unsettled investors who did not need much to remind them of their losses from 2008.

“We think the search for yield will continue for a few structural reasons,” Barbara M. Reinhard, chief investment strategist at Credit Suisse’s private bank, said.

The first, she said, is low interest rates. But the second reason is what keeps many retirees awake at night. “You have this aging population in the U.S. saying: ‘I need to supplement my retirement through income generation. My life expectancy is long. I retired at 65, but I could live another 18, 20 years,’ ” Ms. Reinhard said.

So what can investors, particularly those nearing or in retirement, do to guarantee a big enough and regular stream of income? Here is a look at three variations.

LESS RISK It may seem obvious, but low risk means lower return. Tom McNulty in Scottsdale, Ariz., who worked in the automobile and mortgage businesses before retiring six years ago, found an adviser who practiced a variation on this theme.

Mr. McNulty said he depended on income from his portfolio for about 70 percent of the living expenses for him and his wife, Peggy. His adviser keeps four years of expenses in safe but low-yielding bonds, leaving the rest of the portfolio to grow.

“It wasn’t just providing us the income but protecting the asset base we did have,” Mr. McNulty said. “We hope to live another 20 or 30 years. We learned that 70-30 in stocks and bonds in the accumulation phase and reversing it in the distribution phase is just not going to work.”

Jeremy A. Kisner, president of Sure-Vest Capital Management, which works with Mr. McNulty, said his firm wanted clients to feel as if they had a pension even if they did not. “What we’ve found is that retirees who have a pension sleep really well at night and they’re happy,” he said. “The clients who don’t have that worry about running out of money, no matter how much money they have. We try to create a pension for them.”

Mr. Kisner said his firm settled on putting aside four years of income for two reasons: If the growth part of the portfolio has a down year, money will not have to be moved into the safe assets, and the firm found that five years of safe money was too much, given the need to increase the rest of the portfolio through retirement.

“The strategy of ‘I’m just going to live off this interest’ was never the right strategy,” Mr. Kisner said. “This low-interest environment has laid that bare.”

MORE INCOME Henry Fleischer, a retired engineer who lives outside Detroit, has opted for a strategy that will provide more income now, require him to dip less into the principal of his retirement account and still have little exposure to equities.

His sizable nest egg is divided among investments in three income-producing assets: real estate investment trusts, master limited partnerships — most commonly companies involved in the transportation of natural resources — and annuities.

“We don’t need to be superaggressive,” said David B. White, his adviser, who runs David B. White Financial. “We don’t want the volatility of the stock market.”

Last year, REITs had yields of 4.5 percent, according to the FTSE Nareit index, and master limited partnerships had 5.6 percent yields, according to the Alerian MLP index. But neither is risk-free. Another downturn and collapse in the rental market could hurt REITs, and master limited partnerships can be volatile; they fell as much as the equity markets in 2008.

What is telling about these nervous times is that Mr. Fleischer should not have to worry. He is 89, and while he wants to make sure his wife has enough money if he dies first, he is less concerned about his two sons, who are successful and self-sufficient. Still, his portfolio lets him sleep well.

View the original article here

It’s Time to Rebalance the Investment Portfolio - Your Money

AppId is over the quota
AppId is over the quota
As the markets ebb and flow, the mix of investments that you originally put into place will probably change shape over time. And if you let your portfolio roam free for too long, your long-term plan can be thrown off kilter. Your retirement savings could become too heavily invested in stocks, potentially magnifying your losses when the market takes its next dive. Or your savings could become too conservative, and that’s a problem, too.

You can solve all of this, though, by regularly rebalancing, the industry’s term for putting your investments back in the proportions you originally set. But unless you hand off the reins of your portfolio to a financial planner, you need to make the time to do this yourself (ditto for investors who periodically hire a professional and want to carry out the advice themselves).

So, in theory, the task should be as simple and as automated as possible. Otherwise, you probably won’t find the time to do it. And really, most of the time, you just need to do a little maintenance.

Going through the exercise should be as easy as it is at TIAA-CREF, the financial services organization. When I recently set up a new 403(b) there for a family member — 403(b)s are essentially another flavor of 401(k) plans — I was pleasantly surprised by one of the options presented: Would you like to rebalance your portfolio back to your original allocations on your birthday?

That’s genius, I thought, and so incredibly simple. Why doesn’t my 401(k) plan offer this? Why doesn’t everyone’s plan offer this? And what online brokerages offer similar types of automated services?

As it turns out, automatic rebalancing is a standard option in many, but not all, 401(k) plans. But it should be. There’s little downside as long as you’ve already set up the proper investment mix. It shouldn’t cost you anything, there are no tax implications and you’re simply keeping your risk level intact. Aon Hewitt, a giant retirement plan administrator, said that more than half the companies in its database that offer 401(k) plans — covering more than 12 million workers — offered employees the ability to rebalance last year. That’s a large increase from a decade earlier, when less than 15 percent offered the feature.

Surprisingly, only a few of the larger online brokerage firms, including TD Ameritrade and Fidelity, offer anything remotely similar. Part of the reason, some providers said, is that the situation becomes more complicated when investors hold a mix of taxable and nontaxable accounts, since there can be tax implications and trading costs.

Of course, there are plenty of investments, namely target-date funds, that will automatically rebalance for you. These funds include a mix of investments that gradually becomes more conservative over time. As long as you fully understand what you’re buying and you’re not overpaying, they are good options for many investors, particularly those with smaller balances. Unfortunately, the entire category came under fire after the big market dive because many funds were too aggressively invested and managed to lose more than the broader stock market.

But if you’re trying to do this on your own, the question becomes this: How often should I rebalance and which providers make this as easy as possible?

There are a couple of schools of thought. Some experts recommend rebalancing based on an indicator, like when a piece of your portfolio moves a certain percentage outside your desired range, while others say it’s perfectly fine to pick a date and do it once a year. Vanguard has found that, historically, rebalancing once or twice a year — and only when a portfolio has drifted from its goal by at least 5 percent — produces results that are just as good as more complicated, frequent rejiggering strategies.

Consider what might happen if you did nothing at all. Beginning in 1987, a portfolio of 60 percent stocks and 40 percent bonds would have ballooned to 71 percent stocks by the end of last year, according to Vanguard. Rewind the same portfolio back to 1946 and it would have almost completely changed into an all-equity portfolio, at 97 percent stocks.

It is a counterintuitive strategy, since you’re basically adding money to your losing investments and selling off those that are doing well. But by sticking with it, the exercise helps take the emotion out of investing.

Of course, there are several low-cost services that can do it for you, while many online brokerages will manage your account for a fee. But here’s an informal survey of the offerings for those who want to handle it on their own, both inside and outside of retirement plans (if we missed any, you can add your own suggestions to the list on our Bucks blog):

FIDELITY The firm offers a rebalancing feature through its Portfolio Review tool, available to its 401(k) participants and to retail brokerage customers. After you set up a portfolio, it automatically sends you alerts through its “myPlan monitor” service when your portfolio drifts more than 10 percent from your goals. When you revisit the tool, it will ask you a few questions to make sure your goals remain the same and then recommend how to get back into balance. “So while it’s not automatic, there is an educational element of taking a few minutes to go through it,” said Jeffrey K. Cimini, executive vice president in Fidelity Investments’ personal investing division. Then you can “click to trade” to put everything back into balance.

T. ROWE PRICE The company offers automatic rebalancing as a standard option within the retirement plans it provides to employers. But only 25 percent of workers with access to the tool sign up for it, according to James Griffin, a senior product manager in its retirement plan services group, and that number has been declining over the last few years given the widespread adoption of target-date funds. It offers a similar option for its I.R.A. customers. After filling out a form indicating your selected mix of investments — you need to keep at least $1,000 in each fund in the portfolio — the firm will automatically rebalance your portfolio each quarter if your investments stray more than 5 percent from those goals.

VANGUARD It also offers a similar free rebalancing feature in its 401(k) plans, but employers have to choose to turn on the feature. While offering the service within a 401(k) is relatively straightforward, since there are no tax implications and rarely any related trading costs, the company said it did not currently offer the service to individual investors, though that was something it continued to consider.

SCHWAB It does not offer automatic rebalancing options to retail customers, though it has a couple of tools that illustrate whether your portfolio is off track. But its 401(k) plan participants can elect to have their portfolios rebalanced quarterly, semiannually or annually, and they receive a notice each time it has been reallocated.

TD AMERITRADE Its customers can automatically rebalance through its free Portfolio Planner tool, where you can analyze an existing portfolio or get help building a new one. While the service does not send any automatic reminders letting you know when your portfolio needs to be rebalanced, after you go through the tool, you can choose to “align your current portfolio to your target portfolio,” and it will do the math and set up and execute your trades with a few clicks. You can try to keep commission costs to a minimum by using its 100 commission-free exchange-traded funds and more than 700 mutual funds that don’t charge any transaction fees or commissions.

View the original article here

Taking a Chance on the Larry Portfolio

AppId is over the quota
AppId is over the quota

This turns out to be a pretty good instinct. After all, people consistently brag about their winning bets without disclosing their losers. They also tend to obsess over whatever’s happened in the markets most recently, assuming things will be that way forever.

But the one thing that we all ought to be able to agree on is this: The point of any long-term portfolio for the vast majority of investors is to earn whatever return you need to meet your goals while taking the least amount of risk.

I recalled this first principle of investing when I heard about something called the Larry Portfolio earlier this year.

Named for Larry Swedroe, the director of research and a principal at BAM, a wealth management firm in Clayton, Mo., the portfolio tracks indexes that achieved nearly the same 10 percent annual return between 1970 and 2010 as a portfolio invested entirely in the Standard & Poor’s 500-stock index. And here’s the Larry Portfolio’s trick: It did so with less than a third of its money in stocks, with the rest in one-year Treasury bills.

So how does it work? It starts with a bit of investing history. Between 1927 and 2010, small-cap value stocks outearned the S.& P. 500 by roughly four percentage points annually. This is according to an index of such stocks that two academics, Eugene Fama and Kenneth French, developed in conjunction with their research on the small-and-value phenomenon.

The reasons for this outperformance aren’t entirely clear, though plenty of theories exist.

Smaller companies may be more vulnerable if they lose a single big customer, or if a single big lender cuts them off. Value stocks, which generally have low price-to-earnings ratios, often have more debt. Then there are the many investors who choose growth stocks over value, buying them up because they tend to be more familiar names.

What these factors share is that they all have something to do with risk. For whatever reason, market participants see small and value companies as being more risky. So on average, it makes sense that investors should expect to get a little more back over the very long haul if they have the guts to take the risk and invest in them.

Mr. Swedroe, who is 60, was not the first person to build investment portfolios around these ideas. But he was particularly well suited to get the word out.

As a young adult, Mr. Swedroe, who was Bronx-born and still talks like it, worked diligently toward a night-school Ph.D. and considered becoming a professor. Instead, he found his way into the risk management field, working for CBS, the old Citicorp and Prudential Home Mortgage.

A friend had started a money management firm called Buckingham Asset Management in Missouri and was struggling to explain his investing philosophy to new clients. Seeing an opportunity to satisfy his teaching urge, Mr. Swedroe agreed to join the firm and help spread the word.

In the 15 or so years since then, Buckingham has come to be known as BAM and oversees investment strategy for other firms’ clients, too. Mr. Swedroe, the co-author of “Investment Mistakes Even Smart Investors Make and How to Avoid Them” and many other books, became enough of a cult figure that BAM’s Web site now sheepishly explains that, alas, he’s too busy to be the personal adviser for every BAM client who wants him to serve in that role.

As for the Larry Portfolio, which he prefers to refer to by more technical names, the only stocks it contains are mutual funds that hold small or value stocks (preferably both) from around the world. Everything else tends to go into very safe bonds.

For illustration purposes, he points people to the S.& P. 500 index, which returned about 10 percent annually between 1970 and 2010. If you wanted to gin up a portfolio to match closely (at 9.8 percent) that performance with much less risk, all you would have needed to do was put 32 percent of your money in a fund mimicking the United States stock index of small and value companies that Mr. Fama and Mr. French developed. Then you’d put the other 68 percent of your money in one-year Treasury bills.

The execution is where this gets a little complicated. Mr. Swedroe, who invests this way with his own money, and BAM use small-cap value funds from, among others, Dimensional Fund Advisors, where both Mr. Fama and Mr. French are consultants and board members. Retail investors generally can’t put money into the funds unless they work with advisers who have been vetted by D.F.A. and have attended its California boot camp, which I wrote about in January. (Some 529 college savings and workplace retirement plans include D.F.A. funds too.)

Then there are the caveats. While having just 32 percent of your portfolio in stocks means you can lose only so much, that low equity allocation also keeps you from winning big when stocks are on a multiyear tear.

In fact, whenever something like the Larry Portfolio looks different from whatever the Dow or the Nasdaq are doing, there is sizable risk of regret. In 1998, for instance, the S.& P. 500 earned 28.6 percent, while that Fama/French index lost 10 percent.

Anyone watching that unfold in slow motion would be at risk of giving in and selling, thus locking in their losses. “You have to tell yourself that you are not going to have portfolio envy or listen to what Jim Cramer is saying on CNBC,” Mr. Swedroe says. “Are you willing to pay that price?” (If you are, you might also see years like 2001, where the Fama/French index gained 40.6 percent while the S.&P. 500 lost 11.9 percent.)

Education is the armor that protects you from emotions, according to Mr. Swedroe. Given who he works for, he’s a big believer in the idea of hiring an educator — an investment adviser — who protects you from the hair-trigger impulses that position your fingers over the sell button.

Lest you think this is all a ruse to get people to pay BAM’s fee — up to 1.25 percent of their invested assets annually, with additional family members benefiting from discounts — it’s worth noting that Mr. Swedroe spends about an hour on most days answering questions from people who write to him, BAM clients or not.

His challenge is that there aren’t a lot of options for people who want to have all of their stock money in the kind of inexpensive, very small and deep-value mutual funds that can most efficiently mimic the Larry Portfolio.

And much depends on how you construct that portfolio. Vanguard, using a set of indexes that serve as a foundation for its mutual funds, including an index that goes back only to 1979, couldn’t recreate the Larry Portfolio’s 4o-year performance. Mr. Swedroe countered with a different approach that would at least allow a Vanguard investor to reduce risk significantly without sacrificing returns. (Meanwhile, the future, as always, is unknowable, though all of the science would suggest that the small-and-value outperformance ought to persist.)

People should be so lucky as to have any choice among indexes in the first place. Too many investors are subject to whatever mediocre mutual fund choices their employer puts in front of them in their workplace retirement plans. If you’re not stuck in your employer’s plan, you can take a deep dive on some of the smallest and most value-oriented mutual funds that exist and take your pick. In the online version of this column, I’ve linked to a spreadsheet that Morningstar cooked up for me this week that lists more than 50 of them. Beware, as actively managed mutual funds can and do perform poorly over multiyear stretches with no warning or apology.

The Rydex S&P SmallCap 600 Pure Value exchange-traded fund is also worth a look. Its expenses are low, and it contains stocks whose market capitalization, price-to-earnings ratios and price-to-book ratios are all low — attributes to seek from the mutual funds, too.

Hand-holding may still be attractive to you, though, and there are some professionals who can put you in D.F.A. funds for well under the standard annual fee — 1 percent of assets — that many professionals charge. I particularly like AssetBuilder, where annual fees start at 0.45 percent and go down from there. You need $50,000 to get started there.

Other firms worth a look include Index Fund Advisors, Evanson Asset Management and Cardiff Park Advisors. I’ve linked to their fee information from the online version of the column.

Just keep in mind that you may not always get comprehensive tax, insurance and estate advice from more value-priced money management operations. When and if your portfolio number gets bigger and your life becomes more complicated, paying for all of that wisdom is sometimes the best investment of all.

View the original article here

It’s Time to Rebalance the Investment Portfolio - Your Money

The remote server returned an unexpected response: (417) Expectation failed.
The remote server returned an unexpected response: (417) Expectation failed.
As the markets ebb and flow, the mix of investments that you originally put into place will probably change shape over time. And if you let your portfolio roam free for too long, your long-term plan can be thrown off kilter. Your retirement savings could become too heavily invested in stocks, potentially magnifying your losses when the market takes its next dive. Or your savings could become too conservative, and that’s a problem, too.

You can solve all of this, though, by regularly rebalancing, the industry’s term for putting your investments back in the proportions you originally set. But unless you hand off the reins of your portfolio to a financial planner, you need to make the time to do this yourself (ditto for investors who periodically hire a professional and want to carry out the advice themselves).

So, in theory, the task should be as simple and as automated as possible. Otherwise, you probably won’t find the time to do it. And really, most of the time, you just need to do a little maintenance.

Going through the exercise should be as easy as it is at TIAA-CREF, the financial services organization. When I recently set up a new 403(b) there for a family member — 403(b)s are essentially another flavor of 401(k) plans — I was pleasantly surprised by one of the options presented: Would you like to rebalance your portfolio back to your original allocations on your birthday?

That’s genius, I thought, and so incredibly simple. Why doesn’t my 401(k) plan offer this? Why doesn’t everyone’s plan offer this? And what online brokerages offer similar types of automated services?

As it turns out, automatic rebalancing is a standard option in many, but not all, 401(k) plans. But it should be. There’s little downside as long as you’ve already set up the proper investment mix. It shouldn’t cost you anything, there are no tax implications and you’re simply keeping your risk level intact. Aon Hewitt, a giant retirement plan administrator, said that more than half the companies in its database that offer 401(k) plans — covering more than 12 million workers — offered employees the ability to rebalance last year. That’s a large increase from a decade earlier, when less than 15 percent offered the feature.

Surprisingly, only a few of the larger online brokerage firms, including TD Ameritrade and Fidelity, offer anything remotely similar. Part of the reason, some providers said, is that the situation becomes more complicated when investors hold a mix of taxable and nontaxable accounts, since there can be tax implications and trading costs.

Of course, there are plenty of investments, namely target-date funds, that will automatically rebalance for you. These funds include a mix of investments that gradually becomes more conservative over time. As long as you fully understand what you’re buying and you’re not overpaying, they are good options for many investors, particularly those with smaller balances. Unfortunately, the entire category came under fire after the big market dive because many funds were too aggressively invested and managed to lose more than the broader stock market.

But if you’re trying to do this on your own, the question becomes this: How often should I rebalance and which providers make this as easy as possible?

There are a couple of schools of thought. Some experts recommend rebalancing based on an indicator, like when a piece of your portfolio moves a certain percentage outside your desired range, while others say it’s perfectly fine to pick a date and do it once a year. Vanguard has found that, historically, rebalancing once or twice a year — and only when a portfolio has drifted from its goal by at least 5 percent — produces results that are just as good as more complicated, frequent rejiggering strategies.

Consider what might happen if you did nothing at all. Beginning in 1987, a portfolio of 60 percent stocks and 40 percent bonds would have ballooned to 71 percent stocks by the end of last year, according to Vanguard. Rewind the same portfolio back to 1946 and it would have almost completely changed into an all-equity portfolio, at 97 percent stocks.

It is a counterintuitive strategy, since you’re basically adding money to your losing investments and selling off those that are doing well. But by sticking with it, the exercise helps take the emotion out of investing.

Of course, there are several low-cost services that can do it for you, while many online brokerages will manage your account for a fee. But here’s an informal survey of the offerings for those who want to handle it on their own, both inside and outside of retirement plans (if we missed any, you can add your own suggestions to the list on our Bucks blog):

FIDELITY The firm offers a rebalancing feature through its Portfolio Review tool, available to its 401(k) participants and to retail brokerage customers. After you set up a portfolio, it automatically sends you alerts through its “myPlan monitor” service when your portfolio drifts more than 10 percent from your goals. When you revisit the tool, it will ask you a few questions to make sure your goals remain the same and then recommend how to get back into balance. “So while it’s not automatic, there is an educational element of taking a few minutes to go through it,” said Jeffrey K. Cimini, executive vice president in Fidelity Investments’ personal investing division. Then you can “click to trade” to put everything back into balance.

T. ROWE PRICE The company offers automatic rebalancing as a standard option within the retirement plans it provides to employers. But only 25 percent of workers with access to the tool sign up for it, according to James Griffin, a senior product manager in its retirement plan services group, and that number has been declining over the last few years given the widespread adoption of target-date funds. It offers a similar option for its I.R.A. customers. After filling out a form indicating your selected mix of investments — you need to keep at least $1,000 in each fund in the portfolio — the firm will automatically rebalance your portfolio each quarter if your investments stray more than 5 percent from those goals.

VANGUARD It also offers a similar free rebalancing feature in its 401(k) plans, but employers have to choose to turn on the feature. While offering the service within a 401(k) is relatively straightforward, since there are no tax implications and rarely any related trading costs, the company said it did not currently offer the service to individual investors, though that was something it continued to consider.

SCHWAB It does not offer automatic rebalancing options to retail customers, though it has a couple of tools that illustrate whether your portfolio is off track. But its 401(k) plan participants can elect to have their portfolios rebalanced quarterly, semiannually or annually, and they receive a notice each time it has been reallocated.

TD AMERITRADE Its customers can automatically rebalance through its free Portfolio Planner tool, where you can analyze an existing portfolio or get help building a new one. While the service does not send any automatic reminders letting you know when your portfolio needs to be rebalanced, after you go through the tool, you can choose to “align your current portfolio to your target portfolio,” and it will do the math and set up and execute your trades with a few clicks. You can try to keep commission costs to a minimum by using its 100 commission-free exchange-traded funds and more than 700 mutual funds that don’t charge any transaction fees or commissions.

View the original article here

Low Bond Yields Make Building a Portfolio Harder

The remote server returned an unexpected response: (417) Expectation failed.
The remote server returned an unexpected response: (417) Expectation failed.
United States Treasury bonds and other high-grade bonds used to be the safe way for older investors to generate income in their portfolios. But yields on these bonds are now so low, they are not generating much income.

The Federal Reserve’s announcement on Wednesday that short-term interest rates would remain close to zero through 2014 confirmed that there was little hope in the near term for much change in bond income.

But it is not easy to find something to replace that income. Other options are not nearly as safe. The wild gyrations in the stock market at the end of last year further unsettled investors who did not need much to remind them of their losses from 2008.

“We think the search for yield will continue for a few structural reasons,” Barbara M. Reinhard, chief investment strategist at Credit Suisse’s private bank, said.

The first, she said, is low interest rates. But the second reason is what keeps many retirees awake at night. “You have this aging population in the U.S. saying: ‘I need to supplement my retirement through income generation. My life expectancy is long. I retired at 65, but I could live another 18, 20 years,’ ” Ms. Reinhard said.

So what can investors, particularly those nearing or in retirement, do to guarantee a big enough and regular stream of income? Here is a look at three variations.

LESS RISK It may seem obvious, but low risk means lower return. Tom McNulty in Scottsdale, Ariz., who worked in the automobile and mortgage businesses before retiring six years ago, found an adviser who practiced a variation on this theme.

Mr. McNulty said he depended on income from his portfolio for about 70 percent of the living expenses for him and his wife, Peggy. His adviser keeps four years of expenses in safe but low-yielding bonds, leaving the rest of the portfolio to grow.

“It wasn’t just providing us the income but protecting the asset base we did have,” Mr. McNulty said. “We hope to live another 20 or 30 years. We learned that 70-30 in stocks and bonds in the accumulation phase and reversing it in the distribution phase is just not going to work.”

Jeremy A. Kisner, president of Sure-Vest Capital Management, which works with Mr. McNulty, said his firm wanted clients to feel as if they had a pension even if they did not. “What we’ve found is that retirees who have a pension sleep really well at night and they’re happy,” he said. “The clients who don’t have that worry about running out of money, no matter how much money they have. We try to create a pension for them.”

Mr. Kisner said his firm settled on putting aside four years of income for two reasons: If the growth part of the portfolio has a down year, money will not have to be moved into the safe assets, and the firm found that five years of safe money was too much, given the need to increase the rest of the portfolio through retirement.

“The strategy of ‘I’m just going to live off this interest’ was never the right strategy,” Mr. Kisner said. “This low-interest environment has laid that bare.”

MORE INCOME Henry Fleischer, a retired engineer who lives outside Detroit, has opted for a strategy that will provide more income now, require him to dip less into the principal of his retirement account and still have little exposure to equities.

His sizable nest egg is divided among investments in three income-producing assets: real estate investment trusts, master limited partnerships — most commonly companies involved in the transportation of natural resources — and annuities.

“We don’t need to be superaggressive,” said David B. White, his adviser, who runs David B. White Financial. “We don’t want the volatility of the stock market.”

Last year, REITs had yields of 4.5 percent, according to the FTSE Nareit index, and master limited partnerships had 5.6 percent yields, according to the Alerian MLP index. But neither is risk-free. Another downturn and collapse in the rental market could hurt REITs, and master limited partnerships can be volatile; they fell as much as the equity markets in 2008.

What is telling about these nervous times is that Mr. Fleischer should not have to worry. He is 89, and while he wants to make sure his wife has enough money if he dies first, he is less concerned about his two sons, who are successful and self-sufficient. Still, his portfolio lets him sleep well.

View the original article here

Taking a Chance on the Larry Portfolio

The remote server returned an unexpected response: (417) Expectation failed.
The remote server returned an unexpected response: (417) Expectation failed.

This turns out to be a pretty good instinct. After all, people consistently brag about their winning bets without disclosing their losers. They also tend to obsess over whatever’s happened in the markets most recently, assuming things will be that way forever.

But the one thing that we all ought to be able to agree on is this: The point of any long-term portfolio for the vast majority of investors is to earn whatever return you need to meet your goals while taking the least amount of risk.

I recalled this first principle of investing when I heard about something called the Larry Portfolio earlier this year.

Named for Larry Swedroe, the director of research and a principal at BAM, a wealth management firm in Clayton, Mo., the portfolio tracks indexes that achieved nearly the same 10 percent annual return between 1970 and 2010 as a portfolio invested entirely in the Standard & Poor’s 500-stock index. And here’s the Larry Portfolio’s trick: It did so with less than a third of its money in stocks, with the rest in one-year Treasury bills.

So how does it work? It starts with a bit of investing history. Between 1927 and 2010, small-cap value stocks outearned the S.& P. 500 by roughly four percentage points annually. This is according to an index of such stocks that two academics, Eugene Fama and Kenneth French, developed in conjunction with their research on the small-and-value phenomenon.

The reasons for this outperformance aren’t entirely clear, though plenty of theories exist.

Smaller companies may be more vulnerable if they lose a single big customer, or if a single big lender cuts them off. Value stocks, which generally have low price-to-earnings ratios, often have more debt. Then there are the many investors who choose growth stocks over value, buying them up because they tend to be more familiar names.

What these factors share is that they all have something to do with risk. For whatever reason, market participants see small and value companies as being more risky. So on average, it makes sense that investors should expect to get a little more back over the very long haul if they have the guts to take the risk and invest in them.

Mr. Swedroe, who is 60, was not the first person to build investment portfolios around these ideas. But he was particularly well suited to get the word out.

As a young adult, Mr. Swedroe, who was Bronx-born and still talks like it, worked diligently toward a night-school Ph.D. and considered becoming a professor. Instead, he found his way into the risk management field, working for CBS, the old Citicorp and Prudential Home Mortgage.

A friend had started a money management firm called Buckingham Asset Management in Missouri and was struggling to explain his investing philosophy to new clients. Seeing an opportunity to satisfy his teaching urge, Mr. Swedroe agreed to join the firm and help spread the word.

In the 15 or so years since then, Buckingham has come to be known as BAM and oversees investment strategy for other firms’ clients, too. Mr. Swedroe, the co-author of “Investment Mistakes Even Smart Investors Make and How to Avoid Them” and many other books, became enough of a cult figure that BAM’s Web site now sheepishly explains that, alas, he’s too busy to be the personal adviser for every BAM client who wants him to serve in that role.

As for the Larry Portfolio, which he prefers to refer to by more technical names, the only stocks it contains are mutual funds that hold small or value stocks (preferably both) from around the world. Everything else tends to go into very safe bonds.

For illustration purposes, he points people to the S.& P. 500 index, which returned about 10 percent annually between 1970 and 2010. If you wanted to gin up a portfolio to match closely (at 9.8 percent) that performance with much less risk, all you would have needed to do was put 32 percent of your money in a fund mimicking the United States stock index of small and value companies that Mr. Fama and Mr. French developed. Then you’d put the other 68 percent of your money in one-year Treasury bills.

The execution is where this gets a little complicated. Mr. Swedroe, who invests this way with his own money, and BAM use small-cap value funds from, among others, Dimensional Fund Advisors, where both Mr. Fama and Mr. French are consultants and board members. Retail investors generally can’t put money into the funds unless they work with advisers who have been vetted by D.F.A. and have attended its California boot camp, which I wrote about in January. (Some 529 college savings and workplace retirement plans include D.F.A. funds too.)

Then there are the caveats. While having just 32 percent of your portfolio in stocks means you can lose only so much, that low equity allocation also keeps you from winning big when stocks are on a multiyear tear.

In fact, whenever something like the Larry Portfolio looks different from whatever the Dow or the Nasdaq are doing, there is sizable risk of regret. In 1998, for instance, the S.& P. 500 earned 28.6 percent, while that Fama/French index lost 10 percent.

Anyone watching that unfold in slow motion would be at risk of giving in and selling, thus locking in their losses. “You have to tell yourself that you are not going to have portfolio envy or listen to what Jim Cramer is saying on CNBC,” Mr. Swedroe says. “Are you willing to pay that price?” (If you are, you might also see years like 2001, where the Fama/French index gained 40.6 percent while the S.&P. 500 lost 11.9 percent.)

Education is the armor that protects you from emotions, according to Mr. Swedroe. Given who he works for, he’s a big believer in the idea of hiring an educator — an investment adviser — who protects you from the hair-trigger impulses that position your fingers over the sell button.

Lest you think this is all a ruse to get people to pay BAM’s fee — up to 1.25 percent of their invested assets annually, with additional family members benefiting from discounts — it’s worth noting that Mr. Swedroe spends about an hour on most days answering questions from people who write to him, BAM clients or not.

His challenge is that there aren’t a lot of options for people who want to have all of their stock money in the kind of inexpensive, very small and deep-value mutual funds that can most efficiently mimic the Larry Portfolio.

And much depends on how you construct that portfolio. Vanguard, using a set of indexes that serve as a foundation for its mutual funds, including an index that goes back only to 1979, couldn’t recreate the Larry Portfolio’s 4o-year performance. Mr. Swedroe countered with a different approach that would at least allow a Vanguard investor to reduce risk significantly without sacrificing returns. (Meanwhile, the future, as always, is unknowable, though all of the science would suggest that the small-and-value outperformance ought to persist.)

People should be so lucky as to have any choice among indexes in the first place. Too many investors are subject to whatever mediocre mutual fund choices their employer puts in front of them in their workplace retirement plans. If you’re not stuck in your employer’s plan, you can take a deep dive on some of the smallest and most value-oriented mutual funds that exist and take your pick. In the online version of this column, I’ve linked to a spreadsheet that Morningstar cooked up for me this week that lists more than 50 of them. Beware, as actively managed mutual funds can and do perform poorly over multiyear stretches with no warning or apology.

The Rydex S&P SmallCap 600 Pure Value exchange-traded fund is also worth a look. Its expenses are low, and it contains stocks whose market capitalization, price-to-earnings ratios and price-to-book ratios are all low — attributes to seek from the mutual funds, too.

Hand-holding may still be attractive to you, though, and there are some professionals who can put you in D.F.A. funds for well under the standard annual fee — 1 percent of assets — that many professionals charge. I particularly like AssetBuilder, where annual fees start at 0.45 percent and go down from there. You need $50,000 to get started there.

Other firms worth a look include Index Fund Advisors, Evanson Asset Management and Cardiff Park Advisors. I’ve linked to their fee information from the online version of the column.

Just keep in mind that you may not always get comprehensive tax, insurance and estate advice from more value-priced money management operations. When and if your portfolio number gets bigger and your life becomes more complicated, paying for all of that wisdom is sometimes the best investment of all.

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