ITA Wealth Management

The link in this blog entry contains some of the most informative reading you will find in the investment world.  Read a few articles and then see if you do not agree with me that this is a launching point for many hours of reading.

Geoff Considine provides a tremendous service to “do-it-yourself” investors.

Photograph:  Central Station in Amsterdam, Holland

Readers interested in downloading the Power Point presentation on Asset Allocation will find it at this location.  Download the file Sept4-AA.ppt.

If you have problems, drop me a note in the comment section of this entry and I will try to provide a solution everyone can use.

Readers interested in portfolio development, management, and tracking using a customized spreadsheet will find details over on Premium Content.  Monthly cost is $6.99 for subscribers.

Lowell Herr

Gaining access to small investor portfolio information is difficult, making it almost impossible to compare how well stock pickers perform vs. index or passive investors.  Investors don’t like researchers poking around in their broker accounts and one can understand why.  There are a few studies on the performance of the small investor, but they are dated.  Here is current information that makes a strong case for asset allocation and passive investing, our philosophy on this blog.

On the Internet there is a site that tracks over 7,000 investment clubs.  These clubs are made up of individuals that pick stocks to populate their portfolios.  Right now their top picks are: GE, JNJ, MSFT, WAG, SYK, CSCO, HD, PG, SBUX, and AFL.  These are excellent companies and I’ve held shares in most of them over the last ten years.  The average portfolio for these clubs is a little over $61,000 so they are sufficiently large to be well diversified.  The data goes back to 12/31/2000 or just one month different from my passive portfolio data.  Here are the results.

The Internal Rate of Return (IRR), for what is known as a Club Index, is negative 4.0% (-4.0%) while the IRR for the VTSMX benchmark is 2.9%.  The passive portfolio (PP) that began on 12/01/2000 or 30 days earlier than the Club Index has an IRR of 5.4% compared to the VTSMX index of 2.8%.  The 0.1% difference in the benchmark is due to the slight difference in the starting dates and the cash flow that occurred in the PP.

The 9.4% (5.4% vs. -4.0%) difference between stock picking and index or passive investing is startling.  The Passive Portfolio (PP) is constructed of ETFs.  We used iShare ETFs to build this portfolio since Vanguard did not have ETFs at the time this portfolio was launched.

If anyone has any questions related to the makeup of the PP, just ask.  Once the August broker statement is available, I will post additional information on the Passive Portfolio over on the Premium Content side of the blog.  One amazing bit of information on the PP is its low risk.  As a result, the Information Ratio (IR) is quite high for this portfolio. I consider the IR value to be the “gold standard” measurement for any portfolio as it takes into account both return and risk.

Premium Content is available for $6.99 per month.

Photograph:  Preparation for national holiday in Tiananmen Square, Beijing, China

What does it take in savings to live during retirement? Here is  data that readers may find of interest as they think about portfolio development and eventual retirement.

A couple nearing retirement anticipate they will need $80,000 after taxes per year to live during their first year without employment. Between them they will receive a pension of $2,000 per month or $24,000 per year. These are all after tax dollars used in this example. Social security will provide another $2,500 per month or $30,000 per year. Eighty thousand minus $54,000 leaves them $26,000 short and this money needs to come from a savings plan.

The question then comes down to what will it take to generate $26,000 in after taxes money each year. I tend to be quite conservative when it comes to thinking through these numbers. Many advisors will tell clients they can withdrawal 5% per year from their retirement funds. My preference is to lower it to 2% so the portfolio has a greater chance to grow and fight off inflation should it raise its ugly head during an anticipated 30 years of retirement.

$26,000 = X * 0.02 or X = $1,300,000. To some, this is a shocking figure. This simple calculation helps one think of the value of a $24,000 pension or a $30,000 social security benefit.  There is a considerable amount of money sitting behind those payouts, even if one uses a 6% figure.  William Bernstein writes about this in his “Four Pillars” book.

If withdrawing only 2% seems too conservative, then move up to 3% or 4%, but my recommendation is to not plan on withdrawing a higher percentage. If one pulls out 4% of the savings, then the required amount of savings is $650,000, still a substantial amount.

If one does not have a pension, it places a greater burden on the individual to save more during a lifetime or cut down their living style, or both.

The next issue facing this couple is to lay out an asset allocation and savings plan that will put them in a position to withdrawal the equivalent of $26,000 to $30,000 in today’s money sometime in the future.

Planning for retirement becomes very complex when one adds in inflation and taxes as both are going to vary a great deal.  This is why I tell couples to plan on saving between 1.2 million and 1.5 million in todays dollars.  That seems like a very high bar to meet, but it can be done with discipline and frugal living.

These sample numbers should provide grist for a discussion.

Lowell Herr

Photograph:  Lighthouse on the northern shore of Kauai, Hawaii

Here is an exercise that will prove informative to investors who construct portfolios using stocks. Follow these instructions.

• Make up a list of the stocks in your portfolio.
• Go to Morningstar and determine which asset class or style box each stock occupies. Type MSFT in the Quotes option and then click on Snapshot. In the example we see MSFT is a Large-Cap Growth stock.
• Now find an ETF for each style box that contains at least one stock in your portfolio. Since Barclay’s iShares have been around longer than Vanguard’s ETFs, one would do better to go with the iShare. For example, the iShare to compare with the Microsoft stock is IVW as it is a Large-Cap Growth ETF.
• Now open up the Yahoo Finance page. Using a five-year period, compare the stock with the appropriate ETF. In the example, you will see that IVW outperformed MSFT by a little over 20% over five years.
• Perform this comparison with every stock in your portfolio and write down your results. If you held the stocks over a different period, use a comparison that is closest to the holding time.
• There is one more thing you need to examine. Does your portfolio include stocks in all of the “Big Nine” Morningstar style boxes? Does the portfolio include international stocks from developed countries or areas such as Europe? Does the portfolio include stocks from emerging markets? Are there any REITs or commodities in the portfolio? If not, why not?

If most of your stocks outperformed the appropriate ETF, you are a fine stock picker and you should continue to build your portfolio the way you always have. If, however, your portfolio is not well diversified and/or the stocks are not performing as well as the benchmark ETF, then questions arise as to how one is going to change the construction of the portfolio.

Lowell Herr

Photograph: Art aboard Celebrity cruise ship.

Lest this repetition get old, it is still important to be reminded of the fundamentals behind the Wealth Management blog and portfolio construction.

• Continue saving for investment.
• Develop a plan for asset allocation.
• Use a minimum of eight asset classes and a maximum of 20. We are currently working with fourteen in the AA-Mosaic Portfolio, although we do not have capital working in all asset classes.
• Develop the percentage to allocate to each asset class of interest. Search “Table” and you will find our percentages for the Mosaic Portfolio.  I will be writing more on the new allocations later this week.
• Concentrate on value and small asset classes as they perform better than growth and large asset classes over the long run.
• Rebalance the portfolio when necessary. This will likely not happen more than once a year.
• Keep expenses low. Therefore purchase ETFs in sufficient size so expenses are below 50 basis points for each trade. The lower, the better.

Lowell Herr

Photograph: Entering Venice, Italy early morning.

With over 100 entries on this blog, how does one go about finding the essential information. While I would like to think all entries are informative and useful, I know that is not the case. Interests differ for different investors. Here are a few suggestions.

• On the right-hand side of the blog page, you will find different categories. One place to start is to click on Beginning Investors. Then go to the oldest post and read from oldest to most recent. Unfortunately, this software does not permit me to reverse the order of the dates.
• The second hint is to use the Search option found in the upper right-hand corner of every entry page. Search for items such as Asset Allocation, Swensen, Surz, and Ibbotson & Associates.
• Two other recommended searches are Portfolio Construction and Portfolio Management. Note that any search for the recommended items will also bring up this entry.

From time to time I will post a review of the philosophy of this blog. Setting up an investment plan is something you will see me write over and over again. Also, save and follow “The Golden Rule of Investing.” When you begin to doubt your investment plan, click on the Research category and review that material.

This blog emphasizes index investing vehicles over individual stocks, although stocks are not forbidden. Stocks should not take priority, particularly in asset class were you, the investor, are not skilled in making such selections. ETFs are highly recommended over actively managed mutual funds. Value equities takes precedence over growth equities. International markets need to be part of the portfolio mix.

Take your time to read the material. The entries are not long so the total amount of reading is not all that daunting. Enjoy the photographs.

Lowell Herr

Photograph: Entering Venice, Italy

While researching the “Investment Policy Explains All” paper, I ran into this Internet source of information. Here are some of the articles I highly recommend.

• The Importance of Investment Policy: A Simple Answer To A Contentious Question
• The Truth About Diversification by the Numbers
• Getting to the Core of Model Portfolios
• Style Analysis

Start with these white papers and then pick up others of interest.

Lowell Herr

Photograph: Saint Paul, France

I understand why mutual fund managers, newsletter writers, brokers, CNBC etc. don’t want the small investor to know the truth about index mutual funds or ETFs. After all, their lively hood depends on active stock pickers. It is at the very heart of the investing industry to push stock picking, market timing, and active management. Missing the mark or the benchmark keeps active investors coming back to the gaming table.

Mark Hebner writes, “If investors consciously want to gamble, then that is a different story. They can try to outperform the index and their fellow investors if they wish. But, they must realize they will not be able to outperform the indexes for any lengthy period of time. Although they may win a few times at the roulette wheel, they will count themselves lucky, but hardly skillful. After all, if a majority of the gamblers in Vegas actually won, who would pay for all the fancy lights?”

When an active investor tells you they are beating the market, ask them the following questions. They should be able to answer all questions clearly or tell you they have the information available. Even passive portfolio investors need to be able to answer these questions.

• How do you define “the market?” If they use the VTSMX index or the Wilshire 5000, then fine. Be sure to push them beyond the S&P 500, although that is not too shabby a standard.
• Do you measure the Internal Rate of Return (IRR) for the portfolio and if so, what software is used to make the calculation?
• Now here comes the first tough question. How is the IRR measured for the portfolio benchmark (VTSMX index fund for example)? Does the software correctly handle cash flowing in and out of the benchmark? If the investor can not answer this question with sufficient clarity then the original argument of “beating the market” falls apart as they do not have an accurate method for comparing portfolio performance with benchmark performance.
• How is risk measured for the portfolio? What risk is the investor taking to “outperform the market or benchmark?”
• Over how many years has the managed portfolio sustained a lead over the market? Is this true for various five or ten-year rolling periods?

Photograph: London, England