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Scott Burns' Articles -- Recent and Archived

Portfolios Are About More than the Year You Retire

Q. Vanguard recently started a new fund class, Target Retirement funds. Each fund is pegged at a person's expected year of retirement. The funds automatically balance their holdings among U.S. stocks, foreign stocks and bonds in a mix appropriate to the retirement year. The expense ratio is 0.2 percent, which compares very well with its other index funds. My problem with being a Couch Potato is that I am too much of one. I forget to rebalance at the end of each year. This Vanguard product seems like a good thing to me. Any comments? ---E.F., by email from Dallas

A. Vanguard isn't alone in this game. The three biggest funds in this arena are Fidelity funds for 2010, 2020, and 2030. T. Rowe Price is in the game, too. A recent survey showed that this type of fund was popular with 401(k) plan sponsors. It will become more popular as plan sponsors deal with issue of default choices for these plans.

Basically, they are a good idea. They simplify your decision-making.

Different fund companies, however, have different ideas about what your asset allocation should be at different ages. The current total equity commitment of the year 2020 funds from Fidelity, T. Rowe Price, and Vanguard ranges from a low of 68.4 percent (Fidelity) to a high of 77.2 percent (T. Rowe Price).

I think risk-measured portfolios are a better choice. In those, you select a level of risk you are willing to take and then stick with it. You might, for example, pick the T. Rowe Price Capital Appreciation fund (ticker: PRWCX). In Morningstar language, this is a "moderate allocation" fund with a traditional 60/40 mix of equities and fixed-income. A more risk-averse investor might choose Vanguard Wellesley (ticker: VWINX), with only about 40 percent of the portfolio in equities.

Selecting your own allocation is important for two reasons. First, you might be more, or less, willing to take risk than the cookie-cutter asset allocation of your retirement year portfolio. Second, some people know they will be receiving a pension from their employer. With this additional source of retirement income, they can afford to take more risk than if their savings alone were responsible for their retirement security.

Q. I manage my own portfolio (I am a retired engineer, born in 1935), which is worth $1.2 million. As it gets larger, I am getting worried about asset allocation. By all accounts this seems to be very important, but neither you nor other writers discuss it very much. Do you know where I can get some help on this?

I prefer to buy only mutual funds, and I also prefer to pick my own funds. I am not willing to give up 1.5% to have others manage my money. ---H.B., by email from Nashville, TN

A. Just as you can get into plenty of arguments about how to select stocks, you can get into endless arguments about how to do asset allocation. When it comes to retirement income, however, pragmatic studies of portfolio survival indicate that you'll be able to take the largest amount of income for the longest time if your allocate 50 percent to 75 percent of your portfolio to equities.

A discipline called Modern Portfolio Theory (MPT) also suggests that your portfolio should be diversified with international equities, REITs, and funds that invest in both small-cap stocks and value stocks. The basic idea is to get the highest possible return with the lowest possible risk, measuring the risk by price fluctuations. Here is a partial list of asset classes that most financial planners use for portfolio construction:
  • Money market funds (cash)
  • Intermediate-term, domestic fixed-income funds
  • Large-cap domestic equities
  • Large-cap international equities
  • Small-cap domestic equities
  • Value-priced domestic equities
  • REITs
What portfolio designers look for are asset classes that are negatively correlated---i.e., when one goes up, the other goes down. Do this with two asset classes that have the same long-term return, but tend to move in opposite directions, and the risks will tend to cancel out--- but you'll capture the return.

Like most things in life, this is easier to say than do.

If you'd like to learn how others do it, you might start reading about funds that are called asset allocation funds. In Morningstar language, these funds are divided into three categories: conservative, moderate, and world allocation funds.

You'll find a lot to read on my website (www.scottburns.com) simply by using the search tool and entering "asset allocation." You should also explore the category called "The spenders' portfolio and portfolio survival."

Published Feb 21 2007, 06:00 PM by scottb
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Comments

 

ABModerator03 said:

You had a recent column on figuring the NPV of a pension.

How does one do this for social security with the annual cost of living increase? My intuition is that this should make it easier.

Thanks

John

  

From Scott Burns:

I think the quick and personal way to do it is to see what the equivalent inflation-adjusted life annuity would cost. I believe Vanguard is one of the only firms currently offering inflation adjusted annuities--- I've used their website for figures. The value difference, particularly for joint and survivor inflation adjusted annuities is striking--- close to 50 percent more than the fixed variety.

If you're interested in a broader look at the values, try this URL: http://www.urban.org/UploadedPDF/900746_USAToday.pdf

Eugene Stuerle is one of the old hands in this area. You might also check the work of Jim Poterba at MIT.
February 18, 2007 9:49 PM
 

ABModerator03 said:

H.B.,

In addition to Mr. Burns wonderful financial columns, here are some other sources about Asset Allocation.

William Bernstein author of "The Four Pillars of Investing" a book on portfolio allocation has a very interesting web site on Asset Allocation http://www.efficientfrontier.com The website is full of great ideas and has a suggested reading list for more info on allocation. His book "The Four Pillars...." is worth reading first.

The Motley Fool website www.motleyfool.com has a subscription service called Rule Your Retirement. I have subscribed since it was opened and found it very useful. There is an annual subscription fee that is around $100. I'm guessing on the fee but it's not excessive. It has a very good discussion board on retirement issues, including asset allocation. I think you can get a 30-day trial subscription with unlimited access.

Good hunting on your search for additional information.

BigOil1

  

From Scott Burns:

"The Four Pillars" should be on everyone's core reading list.
February 22, 2007 7:04 AM
 

ABModerator03 said:

Lest you think that I disagree with everything you write, I think your article today was right on. A lot of mutual fund manufacturers seem to be enamored with target date funds. To use those correctly, a practitioner or investor must target his date of death rather than date of retirement, but no one says that in articles, advertising or product brochures. Unfortunately, my favorite American Funds has chosen to jump on that bandwagon too, but I doubt I'll ever suggest them as alternatives.

I wish, as it sounds like you do, that there were more target risk portfolios available...as, by the way, there are in VARIABLE ANNUITIES from all the better manufacturers.

Sincerely,

Leonard

From Scott Burns:

Your "date of death" distinction is right on. Amazing that it hasn't been discussed or considered.
February 22, 2007 10:36 AM
 

ABModerator03 said:

HB-

I have four suggestions for places to look for asset allocation information.

First, William Bernstein's first book, "The Intelligent Asset Allocator", offers an allocation strategy using mostly Vanguard funds.

Second, Frank Armstrong's website www.investorsolutions.com and his book "The Informed Investor", both offer good asset allocation information.

Third, if you transfer $100,000 to open a Vanguard acount, a financial planner will work with you for free to devise an allocation strategy.

And still another option is hiring a fee-only advisor to set up an allocation for you. In that scenario, you pay the advisor a fixed fee for the set up, and then you manage it yourself thereafter. You can find an advisor near you through the their professional website www.napfa.org.
February 25, 2007 8:12 PM
 

ABModerator03 said:

Hi Scott,

I've read with great delight your articles in the Globe. Most recently, your article on Target Funds talks about Modern Portfolio Theory (MFT). Without a theoretical background in the subject, I too am coming to the conclusion that this is about the only thing that makes sense. So with this in mind, would you comment on the following 3 questions —

1) Would you agree that re-balancing amongst different asset classes based on MFT would give better performance with reduced risk (standard deviation) when compared to the simple approach of investing in say the Wilshire 5000.

2) What do you think about Index Fund Advisors (www.ifa.com). Hebner's (founder) book is well written. The problem with these folks is a) they tack on a 0.9% fee on top of the trading costs by Scwab which for small portfolio could add 0.5% more to the cost. Unless you disagree, I would claim that they have the best approach to MFT. Also, would you know of anyone else doing similar things?

3) Where would I find an advisor who would tell me which 8 or 10 ETFs I should use to allocate a portfolio and more importantly tell me that with a specific allocation in these ETFs, the expected and standard deviation of my returns over 1, 3, 5, 25 years (based on historical data). The intention here is to self-implement what IFA does but with ETFs and still have access to a) expected return and b) risk numbers available.

PS — In the above questions I am not looking for guidance on picking the asset allocation as that depends on a number of factors; only for where I should go to get help based on MFT.

Regards,

Arun

From Scott Burns:

That's a lot of questions so I'll have to give thumbnail answers.
  1. Rebalancing among asset classes will almost always give a lower standard deviation than holding a single asset class unless, of course, it is a very low risk asset class such as short term Treasury obligations. The hard part in the portfolio construction exercise is that globalization appears to be reducing the negative correlation opportunities that do so much to reduce overall portfolio risk. So even as more asset classes are identified, their behaviors appear to be closer.
  2. Hebner's "Index Funds" may be the only coffee table book ever written about portfolio management and it is a very good primer on Modern Portfolio Theory. He's put a great deal of thought into the issue of risk/return and it shows. The expense issue you mention is real but at least the Schwab transaction cost piece of it is much diminished at moderate asset levels. His fees are on the low side for industry norms which is good--- but the industry norm is still far too high. Our goal at AssetBuilder, the company that sponsors this website, is to challenge the industry.
  3. Start with the Building Block portfolios which will be regularly updated on this website. The specific allocation will vary from advisor to advisor. Getting standard deviations back 25 years isn't too likely because many of the indexes now in use haven't be in existence for that long. What you want to be careful of, however, is assuming that standard deviations of the last few years will automatically be seen in the future. They won't. Indeed, the biggest danger in current portfolio construction is that we've had unusually low volatility in the past few years and are likely to see much higher volatility in the future--- that means more ups and downs, more risk. William Bernstein, www.efficientfrontier.com, is a primo source for allocations. You might also check other index portfolios such as the CoffeeHouse portfolio regularly reported on by Paul Farrell.
February 27, 2007 5:16 AM

About scottb

Scott Burns has covered the changing world of personal finance and investments for nearly 40 years. Today, he ranks as one of the five most widely read personal finance writers in the country. Scott began his career as a newspaper columnist at the Boston Herald in 1977 where he was also the financial editor. Nationally syndicated in 1981 and now distributed by Universal Press, the column appears in newspapers from Boston to Seattle. In 1985 he joined the staff of the Dallas Morning News where his column quickly became one of the most widely read features in the paper. He left the Dallas Morning News in 2006 to become one of the founders of AssetBuilder and its Chief Investment Strategist. Burns is a graduate of Massachusetts Institute of Technology (1962). He has written four books, including "The Coming Generational Storm" (MIT Press, 2004) coauthored with economist Laurence J. Kotlikoff. His fourth book, also coauthored with Kotlikoff, will be published this spring by Simon & Schuster. "Spend Til' the End" uses consumption smoothing to demonstrate the errors of conventional financial planning. His business experience includes working as a staffer for a major consulting company and service as a director and audit chairman of a NASDAQ listed manufacturing company. He and his wife divide their time between Dallas and Santa Fe, New Mexico.
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