A case for Active instead of Index

[NW-Bound]

I have redone the earlier work of looking up past performance on Morningstar. This time, I believe I got the numbers written down correctly for VFINX (S&P), Wellesley, and Wellington.

I did not use the Admiral shares for the latter 2, because one (or both?) did not exist in 1980. I was able to get the data to line up with Jan 1st of each decade. That will make it easier to compare data with another table that follows.

Looking at the table, we can see that during the boom tech stock decade of 1990-2000, any investor that held any bond would get pummeled by one who was 100% in stock. That's of course not surprising. But what I did not know was that Wellesley trailed behind by a huge amount. Same with Wellington, but to a lesser extent due to Wellesley holding 40% stock, vs. Wellington with 60% stock.

Since 2000, these two MFs made up their losses, due to the performance of fixed income assets.

So, what's new? If you hold bonds to temper volatility, you are going to trail the market when the latter is hot. The converse is going to be true. One cannot have his cake and eat it too.

Date	S&P	Wellesley	Wellington
1/1980	$10K	$10K	$10K
1/1990	$48K	$42K	$47K
1/2000	$254K	$115K	$154K
1/2010	$229K	$225K	$280K
1/2012	$269K	$273K	$322K

So far, other than the absolute returns, there has been no surprise. There has been a decade for stocks, followed by a decade for bonds, and depending on your AA, you either beat the S&P or trail it.

But to settle the score of whether you can do the same or better than the MF managers at Wellesley and Wellington, I used *****, a retirement calculator, to test 2 do-it-yourself portfolios: one with 40% stock, and the other with 60%. This should be representative of an investor who would maintain his own AA by balancing between S&P index and a bond index fund.

I set the expense ratio to 0.1% annual fee. The calculator rebalances on Jan 1st each year, I believe. I set the WR to 0, so that the portfolio keeps growing by compounding. And following are the numbers.

Date	S&P	DIY40/60	DIY60/40
1/1980	$10K	$10K	$10K
1/1990	$48K	$32K	$35K
1/2000	$254K	$91K	$129K
1/2010	$229K	$129K	$161K
1/2012	$269K	$146K	$188K

Comparing this table to the one above, I would say that the managers of Wellington and Wellesley earned their keep!

PS. Morningstar shows amounts in nominal dollars. *****, same as FIRECalc, shows amounts in 1980 dollars. Hence, I already looked up the cumulative inflation to correct for the dollar amounts in the 2nd table. In other words, all the amounts shown are in nominal dollars, at their respective indicated time.

 

[target2019]

As far as I know,this is ALL of their equity funds, for as long as they have been in existence, and there have been no "mistakes" covered up.
Again, as far as I can tell, my returns have been the same as the published numbers.
The fact that they are promoting their track record, I don't take as a negative, just a fact. That this record goes back so far, seems to lend more credence to it.
They do echo some of the themes of indexing, saying that expenses make a difference. Their A class shares, which I own, although higher than most indexes, are well below mutual fund averages.
I've considered blowing the funds up and investing directly in individual equities to eliminate this expense, but it would be very hard to do competently, especially w/r/t small cap and international securities.
They don't use a single manager, nor is their style to use a committee. They divide the portfolio up among several different individual managers, lessening the risk of having either a star manager leave, or one manager totally screw up. They pay the managers based on long term performance versus the indexes and their peers, I believe.
The advisor that set the plan up always said that if he had to disappear for a decade and wanted to have his money looked after, this is the investment management company he would use.

I think you've made a very good case for sticking with the portfolio based on American funds. You did not pay the load, and even if you did, that would be done. The performance is another issue, but very complex to evaluate.

I had one int'l American fund in my 401K but went with the extremely low cost Developed Market and Emerging Markets generic index offerings (not American). To each his own.

 

[samclem]

But to settle the score of whether you can do the same or better than the MF managers at Wellesley and Wellington, I used *****, a retirement calculator, to test 2 do-it-yourself portfolios: one with 40% stock, and the other with 60%. This should be representative of an investor who would maintain his own AA by balancing between S&P index and a bond index fund.

I set the expense ratio to 0.1% annual fee. The calculator rebalances on Jan 1st each year, I believe. I set the WR to 0, so that the portfolio keeps growing by compounding. And following are the numbers.

Date S&P  DIY40/60  DIY60/40

1/1980 $10K $10K $10K

1/1990 $48K $32K $35K

1/2000 $254K $91K $129K

1/2010 $229K $129K $161K

1/2012 $269K $146K $188K

Comparing this table to the one above, I would say that the managers of Wellington and Wellesley earned their keep!

NW, is it possible you've got an error somewhere? The underperformance level of the DIY portfolios seem suspiciously high. For example, at the end of the 1980-2000 period, the 60/40 investor had a total portfolio value that was less than 60% of that of the S&P investor (i.e. he would have been better off to have burned the 40% of the money rather than to have put it into bonds?) . Maybe dividends weren't invested in the DIY case, or one of the inflation conversions was not quite right?

 

[NW-Bound]

NW, is it possible you've got an error somewhere? The underperformance level of the DIY portfolios seem suspiciously high...

I will readily agree that the DYI performance is so disappointing, and needs looking further into.

Here's the info for people to doublecheck my work. The financial calculator I used was ********, but I think you can coax the same info out of FIRECalc.

There are many web based inflation calculators. I usually use inflationdata.com, but it acted up yesterday. So, I used usinflationcalculator.com. The first lets me specify the month of the starting and ending years, so there's no confusion. The latter only allows the entry of years, and I have to assume that it computes whole year inflation.

 

[nun]

NW, is it possible you've got an error somewhere? The underperformance level of the DIY portfolios seem suspiciously high. For example, at the end of the 1980-2000 period, the 60/40 investor had a total portfolio value that was less than 60% of that of the S&P investor (i.e. he would have been better off to have burned the 40% of the money rather than to have put it into bonds?) . Maybe dividends weren't invested in the DIY case, or one of the inflation conversions was not quite right?

I agree. From 1/1980 to 1/2012 $10k in the Vanguard 500 fund grew to $268k and $10k in the Total Bond fund grew to $252k......wouldn't a 60/40 portfolio have grown to $261k?

 

[NW-Bound]

I agree. From 1/1980 to 1/2012 $10k in the Vanguard 500 fund grew to $268k and $10k in the Total Bond fund grew to $252k......wouldn't a 60/40 portfolio have grown to $261k?

If one puts a certain percentage into each, then never rebalances, then the end result would be easily computed.

If one trades between them, then it will be different, although intuitively, I would hope to be ahead, because I would be selling high, buying low. But that only works in case the market jumps up/down, not when it is trending for 10 years or more.

If stocks keep rising for 10 years like it did, and you keep selling it to buy bonds, by the time bonds turn around, you do not have as much money. In fact for the next 10 years, you would keep selling bond which was rising now. Rebalancing in a secular bull market works against you.

 

[samclem]

I agree. From 1/1980 to 1/2012 $10k in the Vanguard 500 fund grew to $268k and $10k in the Total Bond fund grew to $252k......wouldn't a 60/40 portfolio have grown to $261k?

Not necessarily. Because of the annual rebalancing that NW was modeling it's not accurate to just do a ratio of the ending amounts. But no matter what, the 60/40 portfolio should have done better than if the "40" had been flushed down the toilet on day 1.

 

[nun]

If one puts a certain percentage into each, then never rebalances, then the end result would be easily computed.

If one trades between them, then it will be different, although intuitively, I would hope to be ahead, because I would be selling high, buying low. But that only works in case the market jumps up/down, not when it is trending for 10 years or more.

If stocks keep rising for 10 years like it did, and you keep selling it to buy bonds, by the time bonds turn around, you do not have as much money to buy it. In fact for the next 10 years, you would keep selling bond which was rising now. Rebalancing in a secular bull market works against you.

Sure I took a simplistic approach......but I can't believe that the performance of a 60/40 portfolio with rebalancing is as bad as NW-Bound indicates, there must be an error somewhere. If not it's a very persuasive argument against rebalancing.

 

[NW-Bound]

Sure I took a simplistic approach......but I can't believe that the performance of a 60/40 portfolio with rebalancing is as bad as NW-Bound indicates, there must be an error somewhere. If not it's a very persuasive argument against rebalancing.

In the past, I provided a link to an interview where Mr. Bogle said he "was not much of a rebalancer" for the same reason: you are selling out of a rising asset too soon.

About possible errors in the info I presented, they are quite possible. I named the web based tools that I used in a post above. If not I, the authors of these software might have made programming errors too.

Another way to check this is to get annual returns of index funds from Morningstar, then run a historical rebalanced portfolio using Excel. I am a bit too lazy to do that now.

 

[nun]

In the past, I provided a link to an interview where Mr. Bogle said he "was not much of a rebalancer" for the same reason: you are selling out of a rising asset too soon.

About possible errors in the info I presented, they are quite possible. I provided the web based tools that I used in a post above. If not I, the authors of these software might have made programming errors too.

Another way to check this is to get annual returns of index funds from Morningstar, then run a historical rebalanced portfolio using Excel. I am a bit too lazy to do that now.

What results do you get if you don't rebalance? It should be $261k from 1/1980 to 1/2012.

Edit....oops my numbers are wrong because the Vanguard Bond and 500 funds weren't around in 1980, overlaying them on Morningstar against Wellesley lead be wrong. Still I can't believe that a 60/40 portfolio would have performed so poorly from 1980 to 2012.

 

[ERD50]

In the past, I provided a link to an interview where Mr. Bogle said he "was not much of a rebalancer" for the same reason: you are selling out of a rising asset too soon.

About possible errors in the info I presented, they are quite possible. I named the web based tools that I used in a post above. If not I, the authors of these software might have made programming errors too.

Another way to check this is to get annual returns of index funds from Morningstar, then run a historical rebalanced portfolio using Excel. I am a bit too lazy to do that now.

I'm guessing that some of the problem is from mixing/matching different tools, inflation numbers, etc. I don't have time now either, but if we can get the growth numbers of the two indexes by themselves, divs/dist re-invested, and keep inflation out of it for any intermediate calculations, I think we have a good basis. We can then calc the straight 60/40 & 40/60 mixes from there.

With the strong 90's bull in this time-frame, I actually think that the rebalancing will hurt much more than most would assume.

-ERD50

 

[NW-Bound]

I'm guessing that some of the problem is from mixing/matching different tools, inflation numbers, etc. I don't have time now either, but if we can get the growth numbers of the two indexes by themselves, divs/dist re-invested, and keep inflation out of it for any intermediate calculations, I think we have a good basis. We can then calc the straight 60/40 & 40/60 mixes from there.

Aw, come on ERD50! It's about time someone else steps up and does some community service.

I remember a sign someone hung up at megacorp that read something like "It's something anyone could have done, but no one bothered to do it..." or something like that.

With the strong 90's bull in this time-frame, I actually think that the rebalancing will hurt much more than most would assume.

Looking at the balanced portfolios vs the pure stock portfolio in the time frame of 1990 to 2000, one may notice the dismal performance at the end point after 10 years, and forgets that he has been selling his rising stocks for rebalancing in 1991, 1992, 1993, 1994, 1995, 1996, etc...

So, at the end of the boom period in 2000, he only has a few shares left.

 

[samclem]

Aw, come on ERD50! It's about time someone else steps up and does some community service.

Hey, I may be too lazy to do real work, but I'm never too lazy to be a critic!

Everybody wants to be a sniper, nobody wants to be an infantryman.

 

[NW-Bound]

Hey, I may be too lazy to do real work, but I'm never too lazy to be a critic!

Everybody wants to be a sniper, nobody wants to be an infantryman.

Fine. That's usually the case.

Now, do I need to start another thread entitled "The case for not rebalancing"?

I searched and found the interview that I linked, where Bogle himself said rebalancing could hurt you.

It's here: http://www.early-retirement.org/forums/f28/bogle-on-future-returns-63470.html#post1242925.

A snippet of the transcript follow.

"Well, I am not basically a rebalancer. In the long run, rebalancing is going to cost you because the higher-yielding, the higher-returning, asset is going to get to be a bigger and bigger part of the portfolio, and if you suppress it by rebalancing, you will almost definitely have a lower return over the long run.

In the short run, that's something else, and I think if people want to rebalance, that's fine."​

 

[samclem]

Now, do I need to start another thread entitled "The case for not rebalancing"?
I

No, it's well known and understood that rebalancing, over time, lowers returns. The purpose of rebalancing is not to improve returns, it is to reduce portfolio volatility.
Rebalancing hurts returns because, in general, riskier assets (e.g. emerging market stocks) have higher returns than less risky assets (e.g. govt bonds). Since the riskier assets will be growing more (in general), a rebalancing investor is more often selling high-return assets to buy lower-return assets.
So, if an investor didn't care about volatility of the overall portfolio, he would never rebalance. Moreover, he would own only the very riskiest assets to begin with, since their expected return is higher. Most of us don't do that.

Jack's interview answer misses the point of rebalancing.

 

[NW-Bound]

No, it's well known and understood that rebalancing, over time, lowers returns. The purpose of rebalancing is not to improve returns, it is to reduce portfolio volatility.

We all know that, or are supposed to.

Yet, when the market rises smoothly over a long period of time (what volatility? In hindsight of course) as it did in the past, we later looked back and asked ourselves why we sold. And secretly regret it.

Jack's interview answer misses the point of rebalancing.

Eh, be careful there...

 

[GrayHare]

Unless done formulaically, both active investing and rebalancing easily fall prey to emotion, and emotional decisions about numbers rarely beat the math. Housel talks about it in Investing Like a Psychopath http://www.fool.com/investing/general/2013/10/15/investing-like-a-psychopath.aspx

 

[ERD50]

Aw, come on ERD50! It's about time someone else steps up and does some community service. ....

Aw, c'mon yourself!

Geez, I said "I don't have time now either," ...

I'm going out for a family gathering, just wanted to acknowledge what I thought the problem might be. I will look at it later when I have some time, if no one else has by then.

Despite the amount of posting I do here, I do need to step away once in a while for other things! Give a guy a break!

-ERD50

 

[NW-Bound]

Unless done formulaically, both active investing and rebalancing easily fall prey to emotion, and emotional decisions about numbers rarely beat the math. Housel talks about it in Investing Like a Psychopath Investing Like a Psychopath

I went there, but did not want to give up an email to register in order to read the article. Never mind. I found a back door.

And I have to agree with the following honest quote from the author.

I often write about how wonderful market crashes are to long-term investors looking for buying opportunities. I pretend like I can’t wait for the next one to arrive. But when I go back and see what I wrote in 2008, I can’t help but notice how worried and nervous I was. I worried the banking system would collapse. I worried about a lost decade. And when I review what I did with my money back then, I can only conclude that I was much more scared than I now think I was. It’s far easier to say, “I’ll be greedy when others are fearful” than it is to actually do it.​

I can point back to past posts in 2009 when I was calling "Buy, buy, buy", which later became "Buy, buy, buy" when the market went even lower. I did buy a lot, but I then sold too soon, because I was afraid of losing that gain. Hence, I did not do as well as if I just sat on my purchases until now.

It ain't easy...

I will look at it later when I have some time, if no one else has by then...

Why do you have to include that caveat? I think the problem will still be here, waiting for you.

 

[Animorph]

Not rebalancing equities/bonds should be like a rising equity allocation over time. That should, on average, do better. Even if it's not what you want.

I think rebalancing comes off much better when performed between assets that have gains that are similar. Such as within the equity portion of your portfolio. Leave it alone, you get the same gains for everything. But sell high and buy low between the equity components and you can add a little extra to the nominal gains.

Two different things.

 

[rodi]

Just a comment on the OP's American funds...

My hubby's 401k is with them. I wrote about it here and described it as CRAPTASTIC... mainly because of the ER and the loads. Especially the loads.

OP - you're in a special position to not have the cost of loads. Hard to say American Funds are fantastic when they're charging loads to the majority of the folks who invest with them. I wish my husband's employer would eat the load cost... but they don't... so we have crappy loaded american funds. I stand by my description of them as craptastic.

 

[gcgang]

Just a comment on the OP's American funds...

My hubby's 401k is with them. I wrote about it here and described it as CRAPTASTIC... mainly because of the ER and the loads. Especially the loads.

OP - you're in a special position to not have the cost of loads. Hard to say American Funds are fantastic when they're charging loads to the majority of the folks who invest with them. I wish my husband's employer would eat the load cost... but they don't... so we have crappy loaded american funds. I stand by my description of them as craptastic.

Loads are definitely craptastic. They have break points, however, based on the amount you hold, which reduce, or eliminate, the load significantly. Ours was based on total assets of the entire plan, not per each participant. Hopefully your employer or agent can help.

 

[MRG]

I've know of American Funds for many years. They were always on my don't go near list due to the loads. Since the OP didn't have to pay the normal loads, their in a unique position. I would agree, sign up for loads, not the best idea.

MRG

 

[Surfs_Up]

Date S&P Wellesley Wellington

1/1980 $10K $10K $10K

1/1990 $48K $42K $47K

1/2000 $254K $115K $154K

1/2010 $229K $225K $280K

1/2012 $269K $273K $322K

Interesting data, thanks. I've been a fan and have owned some Wellesley and Wellington for most of the past decade. I think owning these funds (may) help me simply navigate the course as rates normalize (if and when).

Many smart folks here have reduced their bond exposure and reduced their bond portfolio average duration over the past few years.

Looking at the Vanguard website, I had a few questions that stood out:

Why would Wellesley and Wellington both have an average duration of their bond portfolios at 6.2 years?

Why would they not have a far shorter average duration after a 30 year bull market in bonds?

 

[haha]

Why would Wellesley and Wellington both have an average duration of their bond portfolios at 6.2 years?

Why would they not have a far shorter average duration after a 30 year bull market in bonds?

Desire for yield for competitive reasons. 6.2 is not all that long; there are many respectable arguments for why the US could not afford much higher T bond interest than what it now has. I cannot figure out what might happen, but to me it is far from a slam dunk that a meaningful bear market in bond price quotations will come anytime soon. The more debt treasury must deal with, the stronger are the arguments for why rates must be kept low, by hook or by crook.

Ha