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AA and 4 Pillars book
Old 09-02-2013, 09:43 PM   #1
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AA and 4 Pillars book

I just finished reading the 4 Pillars book by William Bernstein, and I have a question. I know a lot of you have read it, so maybe you can help me with what I missed ...

Most of the book seemed to be convincing the reader to just buy the "whole" market, when it comes to your US Stock investments. Messing around with anything else just leads to lower-than-market performance over the long term. He even gave an example story about "Charlie Cringe" should invest 35% of his money into the Total Market, "not just the S&P 500."

But when you get to the last section of the book, there are several more examples of asset allocations based on different circumstances. In these examples, he doesn't include the "total market" fund in any of them. Instead, he recommends a mix of the following 4 funds:

S&P500, Vang Value Idx, Vang Small Cap, Vang Small Cap Value

The examples he gave from the above list (same order):

Wendy Wonk: 10%, 10%, 5%, 7.5% (total 32.5%)
Sheltered Sam: 20%, 5%, 15%, 10% (total 50%)
Young Yvonne: 12%, 15%, 3%, 9% (total 39%)

I do understand why these 3 examples have a different total amount of US stock (more bonds for safety, etc.), but I don't feel like there was enough explanation why the above 3 examples would not just go with 32.5%, 50%, and 39% Total Market, respectively. And, why these particular mixes?

... I have a feeling the answer to this might require reading another book.
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Old 09-02-2013, 09:53 PM   #2
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Maybe check out A Random Walk Down Wall Street by Burton Malkiel.
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Old 09-02-2013, 10:38 PM   #3
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Originally Posted by slowsaver View Post
But when you get to the last section of the book, there are several more examples of asset allocations based on different circumstances. In these examples, he doesn't include the "total market" fund in any of them. Instead, he recommends a mix of the following 4 funds:

S&P500, Vang Value Idx, Vang Small Cap, Vang Small Cap Value
It's been a while since I read "4 pillars", but it sounds like Bernstein is recommending a tilt to small stocks and value stocks in his sample portfolios. Small stocks and value stocks do outperform other types of stocks even on a risk-adjusted basis, which is why it is common to tilt to them a bit. I know Bernstein explained this in his earlier books. For more on this, see his "The Intelligent Asset Allocator" book. For Googleable info, see "Fama-French Three Factor." And here's a short article from Bernstein from 2002 on the small/value premium.

Tilting a bit to small stocks and value stocks ("slicing and dicing") rather than going with just a total market index is a fairly common technique. Books written by Rick Ferri and others also discuss the idea.
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Old 09-02-2013, 11:15 PM   #4
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Thanks Samclem.
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Old 09-03-2013, 05:38 AM   #5
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Historically, value and small cap have had a better return than the total market. It's anyone's guess if that will continue in the future but the logic for it seems reasonable. This does come with added volatility so the "base" is still heavy with the total market.

I've always referred to his book as the 7 Pillars because I can't accept that 4 Pillars could be so boring. Congratulations on slugging through it. For pretty much the same recommendations but with less mathmatical justification, ready Bernstein's Investor Manifesto.
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Old 09-03-2013, 07:42 AM   #6
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I do understand why these 3 examples have a different total amount of US stock (more bonds for safety, etc.), but I don't feel like there was enough explanation why the above 3 examples would not just go with 32.5%, 50%, and 39% Total Market, respectively.
Yes, you're quite right. I didn't check again this precise section of this (excellent!) book, but this does seem a tad inconsistent with what Mr Bernstein seems to advocate everywhere else in his literature.

(I personally did follow his advice of using TSM as a foundation, then adding some small/value tilt... We'll see 20 years from now if I did the right thing!)
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Old 09-03-2013, 08:23 AM   #7
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Originally Posted by slowsaver View Post
Most of the book seemed to be convincing the reader to just buy the "whole" market, when it comes to your US Stock investments. The book/author does recommend the whole market as a core holding.

Messing around with anything else just leads to lower-than-market performance over the long term. The book author goes to some lengths to explain why most "anything else" may reduce performance. However, he very clearly advocates tilt exceptions for value and small equity - Step Three: Size and Value in The Perfect Portfolio chapter (pg 120 of 297) and REITs and Precious Metals - Step Four: Sectors (pg 122)

He even gave an example story about "Charlie Cringe" should invest 35% of his money into the Total Market, "not just the S&P 500." As his name infers, Charlie Cringe "hates investing and wants to keep it as simple as possible...he'll be retiring in a few years." Steps one and two - the stock/bond allocation and domestic/foreign decisions - constitute asset allocafion's heavy lifting. Once you've answered them, you're 80% of the way home. If you're lazy or just plain not interested, you can actually get by with only three asset classes, and this, three mutual funds: the total US stock market, foreign stocks, and short term bonds. That's it - done." (pg 124) Sounds like Charlie...

But when you get to the last section of the book, there are several more examples of asset allocations based on different circumstances. In these examples, he doesn't include the "total market" fund in any of them. Instead, he recommends a mix of the following 4 funds:

S&P500, Vang Value Idx, Vang Small Cap, Vang Small Cap Value

The examples he gave from the above list (same order):

Wendy Wonk: 10%, 10%, 5%, 7.5% (total 32.5%) "she's 28 years old...numbers don't scare her one bit...she inherited her fathers love of investing and is something of a risk taker. (pg 125)
Sheltered Sam: 20%, 25%, 15%, 10% (total 50%) (correction pg 268)
Young Yvonne: 12%, 15%, 3%, 9% (total 39%)
With the correction above, do you see the pattern? If not look, at the tables in the Defining Your Mix chapter after reading previous chapters.

I do understand why these 3 examples have a different total amount of US stock (more bonds for safety, etc.), but I don't feel like there was enough explanation why the above 3 examples would not just go with 32.5%, 50%, and 39% Total Market, respectively. And, why these particular mixes?

... I have a feeling the answer to this might require reading another book.
I'd recommend you just read The Four Pillars again a little more carefully, notably The Perfect Portfolio chapter, all your questions were answered in the book. With all due respect, you and some others missed a lot the first time through. If Dr Bernstein has been inconsistent with his recommendations, I haven't seen a real example of it, and definitely not in The Four Pillars.

If all investors were the same, there would arguably be one ideal portfolio. Of course we're not, so adaptations from the ideal are necessary. If you reread the personal details for each example investor, age, risk tolerance, interest in investing, tax circumstances, etc. - the tweaks are indeed consistent.

See above...
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Old 09-03-2013, 08:57 AM   #8
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I'd recommend you just read The Four Pillars again a little more carefully, notably The Perfect Portfolio chapter, all your questions were answered in the book. With all due respect, you and some others missed a lot the first time through. If Dr Bernstein has been inconsistent with his recommendations, I haven't seen a real example of it, and definitely not in The Four Pillars.
Thanks so much for the detailed reply -- especially the correction. No doubt I missed some things in my first reading.

I do remember him talking about small and value stocks doing slightly better; but didn't realize he was dumping total-market at that point. I'll definitely need to re-read that section.

Another factor that seems to affect my choices is that I cannot really 'get' all these funds in my 401k -- especially since it's with Fidelity, not Vanguard. Then there are those existing investments in taxable accounts ...
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first draft AA
Old 09-04-2013, 12:09 AM   #9
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first draft AA

Quote:
Originally Posted by Midpack View Post
I'd recommend you just read The Four Pillars again a little more carefully, notably The Perfect Portfolio chapter, all your questions were answered in the book.
Thanks again for recommending rereading the 'perfect portfolio' chapter. That helped.

Given I already have a bunch of investments in random funds, I feel like I should clean it up soon. I'm somewhat limited by what my 401k allows and also some taxable investments I don't want to move. Does the following target overall AA seem like a good enough plan? I'm 39 and not really trying to retire early, but would like to be FI in my 50's.

30% Bonds -- TD iBonds, VTMFX (1/2), VBTSX, FSITX.
05% REIT -- VGSNX.
10% Foreign -- VTSNX, FSIVX.
10% US - Small Value -- VSIAX, FSSVX.
10% US - Large Value -- VDIGX, VVIAX.
35% US Market / S&P -- VTSAX, VFIAX, VTMFX (1/2), FSSVX, FXSIX, FSEVX.

I realize there is a lot of annoying duplication of funds here, but I have two 401ks at Fidelity (different options), and the Roth (and Taxable investments) at Vanguard.

Thanks for any opinions....
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Old 09-04-2013, 09:54 AM   #10
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Without knowing how much "room" you have in sheltered/deferred vs taxable, it's hard to meaningfully critique your allocations. That's another aspect of The Four Pillars that has not been discussed so far on this thread, choosing cost & tax efficient funds and tax efficient placement (deferred vs taxable). But I am NOT qualified to critique anyone's choices. IMHO I think this forum is best used as a 'place to learn to fish, not a place to be given a fish' - though it's used in the latter mode often enough. OTOH, the Bogleheads forum will critique your asset allocation if you present it in their somewhat extensive format, if you're interested.

But the book is not meant to provide a handy-dandy recipe for portfolios a reader just plugs into. The whole point of the book is to make a case for choosing your own asset allocation, foreign vs domestic, small & value tilt vs no tilts from TSM and REIT & precious metals vs no sector funds. That's why Bernstein walks the reader through Charlie Cringe, Wendy Wonk, Sheltered Sam, Taxable Ted, In-between Ida and Young Yvonne. My portfolio looks very much like one of them, but not identical.

The book should allow you to define your asset allocation by asset class. From there you follow their fund suggestions or find substitutes available to you (ie, 401k restrictions).

It's a worthwhile exercise to do on your own, so the asset allocation is yours and you fully understand why you've chosen each fund. If you don't, odds are you'll panic during market gyrations, and defeat the underlying purpose of The Four Pillars.

Best of luck...you can do this.
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Old 09-04-2013, 10:03 AM   #11
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Originally Posted by slowsaver View Post
. Does the following target overall AA seem like a good enough plan? I'm 39 and not really trying to retire early, but would like to be FI in my 50's.

30% Bonds -- TD iBonds, VTMFX (1/2), VBTSX, FSITX.
05% REIT -- VGSNX.
10% Foreign -- VTSNX, FSIVX.
10% US - Small Value -- VSIAX, FSSVX.
10% US - Large Value -- VDIGX, VVIAX.
35% US Market / S&P -- VTSAX, VFIAX, VTMFX (1/2), FSSVX, FXSIX, FSEVX.
I didn't decode the fund ticker symbols, but the allocation seems like one consistent with someone of your age and goals. I wouldn't go any higher on the bonds in your situation.

Now, your next step might be to assure you've got the right assets in the right types of accounts for tax purposes. I haven't found a better, easier-to-understand guide than this one from the Bogleheads wiki: Principles of tax-efficient fund placement - Bogleheads
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Old 09-04-2013, 10:07 PM   #12
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I feel pretty good about these choices, but I'm keenly aware that I've only read one book on investing -- and I missed a lot the first time thru it. So I thought I'd throw it out there for a sanity check. Nobody screamed, so that's good.

I've heard a rule-of-thumb about investing your "age in bonds." Samclem, you must not subscribe to that since you mentioned 30% bonds for a 40 year old is high enough.

Thanks for the link about taxes. I'll read that next. So far, I figured out how to apply this AA by only moving money already inside a 401k or Roth.
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Old 09-04-2013, 10:50 PM   #13
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I've heard a rule-of-thumb about investing your "age in bonds." Samclem, you must not subscribe to that since you mentioned 30% bonds for a 40 year old is high enough.
We've had some recent threads here regarding bonds. I'm among those who are concerned about rising interest rates and the impact that will have on bonds, especially long-term ones. We're not in a "normal" situation now--the federal reserve is artificially depressing interest rates and that results in low yields for short-term bonds and a risk to the value of long term bonds. Given these (temporary) factors, I'd recommend a lower allocation to bonds than "normal" and that shorter duration bonds be the bulk of any bond holdings. But, many people will disagree with this.
Regarding the "age in bonds" rule of thumb: every situation is different. As a 50+ year old trying to make his portfolio provide for 40+ years of spending and survive the effects of inflation, I would not choose to have 50% of my assets in bonds. In retirement, I think a case can be made that those with secure pensions, SS, an annuity, etc that can provide for a substantial part of their living expenses can probably reduce the % they devote to bonds.

You seem to be on your way--good luck!
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Old 09-05-2013, 06:42 AM   #14
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"age in bonds" is a rule of thumb and not a rule. Very few folks use age in bonds to determine their bond allocation. And it works best for folks who are enormously wealthy like Jack Bogle. It doesn't work so well for folks who are not wealthy.
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Old 09-05-2013, 06:51 AM   #15
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The age in bonds rule/guideline is based on equity markets making sudden and terrifying plunges every couple of years. I have seen a few 2008 type drops where 50% of equities disappear in a few months. I have seen many 25% drops. The 10% drops occur almost every year and sometimes more often. As you age, your ability to recover from these drops while you continue to drain your portfolio is reduced.

When I've looked at 30 year FireCalc success rates, there seems to be a 40 to 50% equities sweet spot. It's an easy option to run.

Currently, my fixed income is in 2 year and less CDs. I was burned badly with a long term bond fund in the 1980s and don't wish to repeat the experience.
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Old 09-05-2013, 12:02 PM   #16
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Thanks again for recommending rereading the 'perfect portfolio' chapter. That helped.

Given I already have a bunch of investments in random funds, I feel like I should clean it up soon. I'm somewhat limited by what my 401k allows and also some taxable investments I don't want to move. Does the following target overall AA seem like a good enough plan? I'm 39 and not really trying to retire early, but would like to be FI in my 50's.

30% Bonds -- TD iBonds, VTMFX (1/2), VBTSX, FSITX.
05% REIT -- VGSNX.
10% Foreign -- VTSNX, FSIVX.
10% US - Small Value -- VSIAX, FSSVX.
10% US - Large Value -- VDIGX, VVIAX.
35% US Market / S&P -- VTSAX, VFIAX, VTMFX (1/2), FSSVX, FXSIX, FSEVX.

I realize there is a lot of annoying duplication of funds here, but I have two 401ks at Fidelity (different options), and the Roth (and Taxable investments) at Vanguard.

Thanks for any opinions....
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Originally Posted by Midpack View Post
Without knowing how much "room" you have in sheltered/deferred vs taxable, it's hard to meaningfully critique your allocations. That's another aspect of The Four Pillars that has not been discussed so far on this thread, choosing cost & tax efficient funds and tax efficient placement (deferred vs taxable). But I am NOT qualified to critique anyone's choices. IMHO I think this forum is best used as a 'place to learn to fish, not a place to be given a fish' - though it's used in the latter mode often enough. OTOH, the Bogleheads forum will critique your asset allocation if you present it in their somewhat extensive format, if you're interested.

But the book is not meant to provide a handy-dandy recipe for portfolios a reader just plugs into. The whole point of the book is to make a case for choosing your own asset allocation, foreign vs domestic, small & value tilt vs no tilts from TSM and REIT & precious metals vs no sector funds. That's why Bernstein walks the reader through Charlie Cringe, Wendy Wonk, Sheltered Sam, Taxable Ted, In-between Ida and Young Yvonne. My portfolio looks very much like one of them, but not identical.

The book should allow you to define your asset allocation by asset class. From there you follow their fund suggestions or find substitutes available to you (ie, 401k restrictions).

It's a worthwhile exercise to do on your own, so the asset allocation is yours and you fully understand why you've chosen each fund. If you don't, odds are you'll panic during market gyrations, and defeat the underlying purpose of The Four Pillars.

Best of luck...you can do this.
Slowsaver,

Midpack answered with infinite wisdom... I will not rephrase,this was simply very well said.

I would just add a couple of things:
- take your time (give yourself AT LEAST until the end of the year) to make your decision about AA. Read a lot, think a lot, don't overreact. Sticking to the plan is probably the most important part of it, so make sure this isn't a rushed decision.
- it's a personal decision, but do ponder about increasing the international portfolio, and separate total-international from emerging markets. Read Bernstein again, as well as one or two Asset Allocation books, and you might want to revisit this part.
- the age-in-bonds is a VERY coarse rule of thumb, and its wisdom is dubious at best (as recently discussed on Bogleheads). Again, it's a personal decision which Mr Bernstein explains very well, but 30% at your age... Yeah, this already sounds a lot.
- I find hard to believe you truly need so many distinct funds. I have a fairly complicated situation myself, and I am nowhere near the complexity you're showing. There has to be something you can simplify. The Asset Allocation is across all your investment vehicles, by the way, just to be clear.

Good luck!
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