SWR in bad times

[cute fuzzy bunny]

Yeah, I've owned the dodge and cox balanced and the oakmark balanced. Both have done well even through the last 5 years rollercoaster ride. I liked both but would probably give the nod there to DODBX over OAKBX due to the lower fees and slightly better performance, but both invest in fairly different things in different proportions, so owning both gave me some further diversification.

The Wellesley and Wellington are tough to beat on track record and costs though. My current plan is to wait until stocks get beaten down (hopefully later this year) and shift a large portion from wellesley to wellington, then after bonds take their interest rate/inflation pasting (hopefully not until next year), shift some money back and hold both. Their top 10 stock holdings dont overlap substantially but the bond portions have the same management.

That would put my primary holdings at roughly 50/50 stocks and bonds, but the rest of my holdings are mostly stocks and will tip the balance back to a roughly traditional 60/40 stock/bond split. Since these are fairly conservative offerings and my mandatory withdrawal rate is low, I'm pretty aggressive on the remainder stock options...emerging markets, domestic and foreign small cap, REIT, Health Care, and I'll be buying some Energy and possibly Windsor shortly.

Wellesley is a good "tough times" holding. The historic record is very good through even the bad bond years. The terminal portfolio size with Wellesley alone isnt as sexy as an 80/20 stock/bond port, but the juicing up from the other stock holdings should bolster that a little.

 

[Ted]

TH,

Although it's hard to go wrong with practically any selection of Vanguard funds that include stocks and bonds, it sounds to me as if you could achieve the same results more simply, and at slightly less expense, by simply dividing your assets between one or a couple of Vanguard's stock index funds, and one of its corporate bond funds and/or its inflation protected securities fund.

 

[cute fuzzy bunny]

Entirely probable.

But what fun is that?!? I aint working, I need something to do!

 

[Ted]

The problem with some people who make a hobby out of moving money around is that they actually believe that they are improving their investment returns, when typically the opposite is true.

One thing that increases my level of interest is to invest relatively small amounts in managed small cap (mostly value) funds. So far, they have outperformed the overall stock market.

 

[unclemick]

I think wabmester is on the right track - probably has to with brain chemicals and receptors - also probably male species dominated.

Hence my 'hobby stocks' - perhaps a cure will discovered someday.

In the meantime I'll keep 70-80% in balanced index untouched and let the computers in Valley Forge do their thing.

 

[cute fuzzy bunny]

Of course I kidded Ted.

The Wellesley fund is 60% bond, half of which is short to intermediate term corporate leaning towards higher yields without compromising credit quality. The other half of the bonds are short to intermediate term financial and government/agency/treasury type of very high quality.

The remainder of the fund is hand picked high dividend large cap value.

The active management piece of this fund appeals to me simply because while I agree that in many markets a typical balanced index outperforms, I also believe that in choppy mixed markets where perhaps both stocks and bonds perform poorly (see: the mid 60's to late 70's), such a fund isnt going to give me what I need. In this low cost fund I get a manager that reduces bond duration/maturity during times when thats prudent to do and lengthens them when thats prudent to do, and alters the stock/bond mix by up to 10% if that seems prudent. A bond index fund wont do that for me, and without piecemealing my funds into a half dozen indexes in the right proportion and then reproportioning them manually, I cant get that.

The rest of the funds I'm in *are* indexes, excepting actively managed domestic and foreign small cap funds because I like the returns they've offered, and in my analysis they historically yinged when some other stuff yanged, at the time I wanted ying instead of yang. That having been said, my small cap holdings may devolve into a small cap value index some day. Just not right now.

And again, my end state portfolio may turn out to be a mix of indexes once I feel I've gotten the right entry points for certain asset classes. Thats still that Bargain Shopper in me. With most asset classes selling at fair or higher than fair value (yeah I know, efficient markets, those can become suddenly very inefficient), I like a largish chunk of my assets in a relatively safe haven where someone is watching the store. A year or two from now, probably a different story. Once allocated, I may not change that allocation again for some time.

So the picture painted here isnt that I'm "moving money around" willy nilly chasing returns or trying to "beat the market". I'm concerned with current valuations and have (I believe) prudently placed a large cash position into a conservative place where it can grow but wont get significantly hurt if the market takes a tumble. Later I'll reallocate and leave it.

By the way, my overall portfolio is up roughly 8.5% YTD. I'm estimating my quarterly dividend income from this mix to be roughly 8k per quarter, which is slightly more than I need to live on. Bearing in mind that this will be the lowest historical dividend year for this mix in quite some time...historically this mix would throw off roughly 10-12k per quarter and will likely do do again once interest rates pick back up a little.

Further historical analysis (with all the discussion and whatnot regarding historical returns in mind), the worst one year loss I would suffer in modern times (1950-present) is 9-11% in one year. There were never two consecutive losing years; in fact in all but one instance the gain in the year following a loss wiped out the loss and then some. The average one year loss was in the 1-4% range. There were eight losing years in that 54 year time period. The firecalc numbers using a withdrawal rate 20% higher than my most conservative budget are 97% and my terminal portfolio will be between 4 and 6 million at age 85, 43 years from now.

As you can see, I havent chosen foolishly, from the hip or without considerable analysis. Could I do better or cheaper? Perhaps. Would it matter? I dont think so. Would I sleep better at night? Nope.

 

[Ted]

To me, it doesn't make sense to be allocating one part of your assets yourself, while you are leaving the allocation of another part to the active managers of a balanced fund. If you want to maintain control of your overall asset allocation, you need to consider what the active managers are doing, decide whether you are in agreement with it, and if you are not, take action with your other assets to neutralize it.

John Bogle and I also think that it sort of defeats the purpose of stock index funds to hold a whole bunch of specialized index funds, and to be shifting money between them in an effort to emphasize whichever one is "best valued," i.e., time the market. Having a whole bunch of specialized funds is a form of "closet indexing."

If you want to do that (and I'm not totally knocking it because I do it myself to some degree) the "cleanest" way to do so is to hold the bulk of your stock investment in the 500 Index Fund or the Total Market Index Fund, and then have the rest in a fund representing the one market segment (such as small cap value) that you expect to outperform the others. If you think that the pendulum has swung to favor, say, small cap growth stocks, you switch your one specialized fund to that segment.

As long as TH is investing in Vanguard Funds, he will probably beat most other investors because of the low expenses, so I'm not saying that his approach is "bad." But since this forum addresses the "fine points" of investing, I think that others should recognize that there is a lot of unnecessary complexity in this approach that could cause a person to lose track of the way that their assets are actually allocated at any particular time.

 

[John Galt]

As usual, I think Ted is correct. Avoiding unnecessary complexity is high on my list. Almost always agree with
Ted, except on handgun policy

John Galt

 

[cute fuzzy bunny]

Well I think the reasoning is simple. If I bought and owned principally just the vanguard balanced index fund, my average annual returns for the past 3 and 5 years would have been 1.7 and 3.2% . For the total stock market fund they would have been -2.59 and .46%. While there has been good recovery this year, for the past five I would have been eating my principal (and my fingernails) and taking losses. The fund I'm in turned out 7.21% for 3 years and 6.53% for 5.

Over the past 10 years, the Wellesley funds return is a half point higher than the balanced index and just a half point below the total stock market index. With far less volatility and at a comparable cost. Over the 35 years since inception of the fund, its also beaten both of those funds on an average annual basis.

Having the bulk of your assets in a total stock market fund or balanced index fund certainly simplifies things, but it doesnt provide much diversification. Hence the other half dozen funds I own. I dont plan on shifting money back and forth between those either.

Let me (I think again) reclarify the "shifting money back and forth" comment because thats not what I'm doing, nor what I plan to do. My primary intention is to do absolutely nothing with my current investment mix except spend the dividend checks. However, should stocks overall tumble 15-20+%, I would consider moving some money there, then leaving it indefinitely. Should energy stocks come off about 10-15%, I would consider buying into that asset class as well because I think it has long term legs. But I wouldnt be making more than one, perhaps two changes to my current portfolio in the medium to long term.

So what I have (I think) is a core holding that provides me the quarterly dividend payouts I want, plus growth to exceed inflation, and about a third of my other assets in foreign stock, REIT, small caps and the health care area. In the core holding I have low volatility and high income, with good moderate growth. In the ancilliary holdings I have diversification and potential for high long term growth that I can tap or reallocate later on, but I dont even need to look at them right now.

I think thats the ultimate in simplicity and for answering the question of "SWR in bad times". I spend what gets thrown off. No more. No less. Historically the throw off has ALWAYS been more than I'll need. Using historical data as a guide, I also wont ever run out of money.

The "tweaking" is fairly simple. Cash the checks and every now and then make sure the main fund is still keeping up with inflation+, and if its slipping, drain some money from one of the other funds thats raced ahead.

I'm not knocking the "buy and hold balanced index funds from vanguard" mantra. Over very long time periods and during relatively stable markets (you know, the ones that dont go up 400% and then down 400% in a 7 year period like what just happened), they're a smart choice. But if I had bought and held them throughout the last 10 years, my ER nestegg would have appeared and then disappeared, and I'd still be in some meeting watching people vehemently argue over whether to name a program after a mountain or a river, all the while knowing the program will end up being cut in the 3rd round of re-budgeting.

 

[unclemick]

TH

You forgot to mention Fama and French, the University of Chicago, and Berstein's Efficient Frontier struggles to explain the persistance of the 'value premiem'.

Wellington,Wellesley,Dodge and Cox have mined this mother lode for years - Wellington since 1928.

My left handed, INTJ fling at this is my Hobby stocks - almost all low P/E, dividend paying stocks.

 

[Ted]

From the various academic studies that I have read, I have come to the belief that the "value premium" is attributable to value stocks having a higher "beta." Thus, it really isn't a premium at all.

I also believe, however (based on data by Ibbotson Associates) that there is a "size premium" -- that is, that small cap stocks (especially micro cap) generate a long-term return that is more than explainable by their greater "beta" values. That is why I overweight small cap stocks in my stock holdings.

 

[unclemick]

I mis-spoke - It's book to market(aka low book value) and the funds I mentioned generally mine the upper left corner of the Moringstar box(large value) which usually are good dividend stocks also.

If you go to Efficient Frontier and do a Fama and French site search - the articles - among other things support small cap value - but small growth is suspect.

If you read carefully 4X25 and the barbell(large cap/sm cap/no middle) portfolios are deduced from the same data sets. Me - I'm with Bogle (and De Gaul) - but the whole thing(Wilshire 5000).

1966 - 1982 may not repeat but I hope/pray dividends/interest aquit themselves adequitely in a balanced portfolio going forward. 66-mid seventies( go-go plus nifty fifty) would have made value stock players feel like smucks until the dividends looked better in the 70's but still low versus interest rates. I still remember the no stocks - live off interest agruments - but I never read the famous 'stocks are dead' article at the start of 80's bull market.

 

[cute fuzzy bunny]

Aye, the value stock premium is simply a factor of perceived increased risk and the fact that such stocks tend to pay higher dividend rates as a function of having been "beaten down".

However, the reality from a historical perspective is that for the most part these stocks do not exhibit higher volatility than growth stocks over periods of time, nor do they bankrupt or flame out at any higher rate than a growth stock.

When I played the game of buying individual stocks I tended to favor the beaten down high dividend payers and sold them once they'd risen to a fair valued status. I actually produced a 337% return in one year doing this, and not by trading stocks like amazon and yahoo, but rather caterpillar, 3m, philip morris and the like. Unfortunately I also had a stack of stock buy/sell sheets that nearly reached my knees and that was before I used quicken. Three days to do just the capital gains/losses section of the tax return.

The days of such volatility and relative disinterest in "good" stocks is unfortunately no longer here.

It was sort of fun looking at my portfolio then and thinking "hmm, I'm basically a diversified stock fund manager right now, with several hundred companies in my portfolio and spending several hours a day trading".