Archives For December 2007
I saw this in this week’s Barron’s and thought I would pass it along. Good luck!
WANT TO PRETEND YOU’RE a bigtime wall street strategist? Then take our seventh annual forecasting quiz. The 2007 contest drew well over 1,000 responses. We’ll announce a winner for that one in January. Circle your answers; only one answer per question is allowed. No one from News Corp., our parent, may participate. The winner gets a one-year Barron’s subscription and lunch with me in Manhattan (or a $100 check for lunch).
1. Which U.S. equity index will fare best in 2008?
A. Dow Jones Industrials
B. S&P 500
D. Russell 2000
2. Which market will perform best?
A. U.S. (S&P 500)
B. Japan (Nikkei)
C. U.K. (FTSE)
D. Germany (DAX)
3. Which S&P 500 sector will be No. 1?
A. Health Care
F. Basic Materials
4. 2008’s biggest financial surprise:
A. S&P 500 drops over 10%
B. Emerging stock mkts rise another 20%
C. Gold ends above $1,000 an ounce
D. Dollar up 10% vs. Euro
E. None of the above
5. Which laggard industry group will do best in 2008?
A. Brokerage stocks (BSC, MER. MS)
B. Cable TV (CMCSA, TWC, CVC)
C. Homebuilders (KBH, CTX, TOL)
D. Retailers (M, TGT, JCP)
E. Airlines (AMR, CAL, UAUA)
6. Which CEO will no longer be at the helm at the end of 2008?
A. GM’s Rick Wagoner
B. Apple’s Steve Jobs
C. Morgan Stanley’s John Mack
D. Lehman Brothers’ Dick Fuld
E. Pfizer’s Jeff Kindler
F. All will still be on their jobs
7. Which top stock from 2007 will do worst in 2008?
C. Potash Corp.
8. Which of these companies will agree to be taken over in 2008?
C. U.S. Steel
D. Suntrust Banks
F. Bear Stearns
G. None of the above
9. Which winning industry group from 2007 will fare best in 2008?
A. Mining (BHP, FCX, AA)
B. Offshore Drillers (RIG, DO, NE)
C. Beverages (KO, PEP, TAP)
D. Household Products (CL, PG, UN)
10. Name the top-performing stock in the Dow Industrials in 2008. (Including dividends)
Worth 2 points
11. Name the worst-performing Dow stock for 2008 (Including dividends).
Worth 2 points
12. Who will be the Democratic presidential candidate?
A. Hillary Clinton
B. Barack Obama
C. John Edwards
D. Someone else
13. Who will be the Republican presidential candidate?
A. Rudy Giuliani
B. Mitt Romney
C. Mike Huckabee
D. Someone else
14. Who will be the next U.S. president?
Worth 2 points
15. What will be the top-performing commodity?
16. Where will the key federal funds rate end 2008?
A. 3% or lower
B. 3.25% to 4%
C. 4.25% (current level)
D. 4.50% or higher
17. Tie-breaker. At what level will the Dow Industrials end 2008?
My (Andrew Bary’s) choices are:
1. A, 2. B, 3. E, 4. C, 5. E, 6. A, 7. D, 8. E, 9. A, 10. Disney 11. Honeywell, 12. B, 13. B, 14. Obama, 15. E, 16. B, 17. 15,501
We’ll name a winner at the start of 2009. All entries must be postmarked by Jan. 2 or received by e-mail by then. E-mail entries to firstname.lastname@example.org.
Mail entries to:
200 Liberty Street
New York, N.Y. 10281
I received permission from Larry Swedroe to post this.
The performance of emerging market equities has attracted the attention of individual investors. From 1989 through 2005, while the S&P 500 Index returned 11.7 percent per annum, large-cap emerging market equities returned 13.5 percent per annum. In addition, the small-cap and value stocks of the emerging markets provided even higher returns, 14.3 percent and 17.7 percent, respectively. The difference in returns is more compelling if we look at just the last six years of the period, 2000–2005. While the S&P was losing 1.1 percent per annum, large, small and value emerging market stocks returned 8.5, 7.6, and 13.4 percent per annum, respectively.1
As we would expect, the marketing machines of Wall Street respond to the increased attention by rolling out new products. In 1991 there were just nine diversified emerging market funds listed in Morningstar’s database. By 2006 that figure had increased to over two hundred.2 The question an investor faces is: How do I choose from the wide array of choices? Because we believe that passive investing is the winner’s game, we think the answer is simple: You should choose one of the passive investment vehicles available to you, either the Vanguard Emerging Markets Index Fund, a comparable exchange-traded fund, or one of the three emerging market funds offered by Dimensional Fund Advisors (DFA), large, small, or value. DFA also offers an Emerging Market Core Fund that incorporates exposure to these three emerging market asset classes.
The question for investors is does the evidence support our beliefs? The study, “Predicting Emerging Market Mutual Fund Performance (Download),” looked at the question of how to choose an emerging markets fund. The authors examined if fund attributes such as expense ratios, portfolio turnover, manager tenure, recent past performance, fund size and the Morningstar mutual fund ratings can predict performance. They also examined if passive management outperforms active management. The following is a summary of their results:
- The only attribute that was able to significantly predict future fund performance was the expense ratio. The expense ratio was found to be generally negatively and significantly related to fund performance. Specifically, they found that lower fund expense ratios predict better future fund performance. This is exactly the finding believers in efficient markets expect to find.
- The majority of actively managed underperformed the Vanguard Emerging Markets Fund, a passively managed index fund. Again, the finding we expect.
The underperformance by the majority of actively managed funds was found despite the acknowledged presence of some survivorship bias in the data—a bias that produces artificially high returns because poorly performing funds disappear from the database. There is another bias in the data, however, that was not acknowledged. The passive benchmark used was the Vanguard Emerging Markets Fund. Using that index fund as the sole benchmark creates a problem of comparing apples to oranges. The hurdle for actively managed funds is simply too low. Let’s explore why this is the case.
The Vanguard Emerging Markets Fund is a large-cap fund. Just as is the case in developed markets, riskier small and value stocks produce higher returns than large-cap stocks over the long term. Thus actively managed emerging market funds that have at least some exposure to small and value have a tailwind at their back, making the comparisons look artificially favorable. We can see this bias at work by looking at the following table that presents the returns of the actively managed GMO Emerging Markets Fund and the aforementioned four passively managed funds. The period covered is the five years ending December 6, 2006.2 The important point to note is that the GMO fund is a value fund, while the Vanguard and DFA Emerging Markets Funds are large-cap funds.
GMO Emerging Markets
Vanguard Emerging Markets
DFA Emerging Markets
DFA Emerging Markets Small
DFA Emerging Markets Value
Note that if we use the Vanguard fund (a large cap fund) for the benchmark (as did the study) against which the GMO fund (a value fund) is judged, it looks as if the fund outperformed. However, when we benchmark the GMO fund against the appropriate passively managed benchmark (the DFA Emerging Markets Value Fund) the large outperformance (5.28 percent per annum) becomes a large underperformance (4.05 percent per annum). The GMO fund underperformed its appropriate benchmark. And since it is likely that at least some (if not most) of the actively managed emerging market funds in the study had at more exposure to small and value stocks than did the benchmark index fund, their performance is overstated unless you adjust for risk (exposure to size and value).
For taxable investors (and the preferred location is to own equities in taxable accounts) there is likely yet another bias in the data that favors actively managed funds. All the returns are pretax. The generally greater turnover of actively managed funds is likely to result in greater tax inefficiency, and, therefore, lower after-tax returns—the only kind we get to spend.
The evidence demonstrates that “active management in inefficient markets like small-caps and emerging markets is the winner’s game” is just another canard hoisted on the public by Wall Street. They need you to believe that myth because active management is the winning strategy for them (they collect large fees), while it is the losing strategy for you (you are likely to earn below benchmark results).
1 Fama-French return series provided by Dimensional Fund Advisors.
2 Aron A. Gottesman and Matthew R. Morey, “Predicting Emerging Market Mutual Fund Performance,” April 11, 2006.
Larry Swedroe is the author of Wise Investing Made Simple (2007), The Only Guide to a Winning Investment Strategy You’ll Ever Need (2005), What Wall Street Doesn’t Want You to Know (2000), Rational Investing in Irrational Times – How to Avoid the Costly Mistakes Even Smart People Make Today (2002), and The Successful Investor Today: 14 Simple Truths You Must Know When You Invest (2003), and co-author of The Only Guide to a Winning Bond Strategy You’ll Ever Need (2006) (All Affiliate Links). He is also a Principal and Director of both Research of Buckingham Asset Management and BAM Advisor Services — a Turnkey Asset Management Provider serving CPA-based Registered Investment Advisor (RIA) practices — in Clayton, Missouri (www.bamservices.com).
His opinions and comments expressed within this column are his own, and may not accurately reflect those of the firm.
It’s interesting how something can look good until it’s compared to something else. It’s kind of like the 6’0″ kid on the small town basketball team. He’s big until he has to go up against the 6’6″ players from a larger town.
Anyway, I appreciate Larry allowing me to post this. I hope to post some more of these in the future.
1. I’m sick of the Patriots. I’m sick of Tom Brady. I’m sick of Bill Belichick.
2. Shannon Sharpe’s voice pains my ears.
3. My beloved Raiders stunk it up again this season. Will they ever be good again?
4. Although the Raiders are my team, I find myself rooting for the Colts.
5. I like Tony Dungy. The man shows no emotion.
6. If Brett Favre and I are same age and Brett is considered “old,” what does that make me?…
7. The Vikings’ Adrian Peterson – WOW! (although he hasn’t done much the last couple of games)
8. NBC’s “Football Night in America” needs a different name.
9. Super Bowl Prediction: Colts over the Packers.
That was fun.
Housing prices are going down, going down, going down,…
In some markets, the picture looks pretty grim:
Of course the markets that are down so much are the same markets that were going through the roof just a few years ago. Things are fairly normal in my boring old town. How about your locale?
You can read the press release from S&P here (PDF).
Let me start this post off by saying that this idea isn’t for everyone. Some retirees are comfortable spending down their assets during retirement and would therefore find this idea to be way too conservative. I’m not necessarily against spending down assets, but I do think it is important to exercise caution because future income is dependent upon the asset base (also called a capital base). The smaller the base, the smaller the income.
As long-time readers probably know, I have been tracking a few model portfolios over the last several years. With 2007 coming to a close, I have been updating the portfolios over the last couple of days. These portfolios consist solely of exchange-traded funds. Unfortunately, the exchange-traded funds in the portfolios have only been around since mid-2001 (some of the ETFs are even newer than that). Such a short history makes it difficult to really judge the prudence of a strategy. So,… this year I went back and assembled a hypothetical portfolio going back as far as I could using index data. I then organized the annual returns into the following table and then computed the annual returns of the portfolio based on the allocation. Here’s the annual results since 1992:
This particular portfolio is allocated 50-50 between stocks (both domestic and international) and bonds. I think this allocation is both conservative and worthy of consideration for a retirement portfolio. Notice the returns for the years beginning in 2004 are shaded grey. Those years represent the returns for the actual exchange-traded funds that represent those asset classes (the bond class is represented by equal parts in the iShares Lehman Brothers Aggregate Bond Index Fund (AGG) and the iBoxx $ Investment Grade Corporate Bond Fund (LQD)).
After I assembled the above table of returns, I was able to run scenarios using different withdrawal rates, assuming a beginning retirement balance of $1,000,000. The results were interesting. For example, take a look at what happens with a 5% withdrawal rate:
In order to make this hypothetical as realistic as possible, I assumed that the index returns had management expenses of .48%, which is equivalent of most of the iShares ETFs used in the portfolio. I also assumed portfolio management expenses, which include both a FOLIOfn advisor fee and an advisor fee. A do-it-yourselfer could definitely reduce those expenses if they wanted to handle their account on their own.
Anyway, notice how the initial withdrawal was $50,000 at the beginning of 1992 and $69,079 at the beginning of 2007 for an average annual increase of 2.18%*, which did not keep pace with inflation. Also note that the asset base grew from $1,000,000 to $1,411,799 at the close of 2007.
Now, what happens if we adjust the withdrawal rate to 4%?
Agreeing to withdraw a smaller amount each year, makes a sizeable difference over the years:
So, although the initial withdrawal was $10,000 less in 1992, it was only about $5,000 less at the beginning of 2007. Why is this so? Because a smaller withdrawal rate left more money to compound over the years. The retirement balance at the end of 2007 was $258,818 higher under the 4% withdrawal strategy.
What’s the point of all this?
I think this example shows that if you can afford to withdraw less from your retirement account, you should (at least in the beginning). You can always take out a greater percentage later if the need arises. On the other hand, if your goal is to spend down your assets during retirement, you can ignore this post. Just remember that once it’s gone, it’s gone.
*Calculated using the following formula:
[($69,079 ÷ $50,000)1/15] – 1
Christmas is over and now 2008 is upon us. The beginning of a new year is a great time to do things like rebalance your portfolio, re-configure your budget and set goals. Today, we’re going to talk about goals. I would like to know what some of your goals are for 2008. Here are a few of my goals for the coming year (I’m not going to bother you with my gameplan for each goal):
1. Read two books per month.
2. Read to my kids for 15 minutes each night.
3. Go to bed by 10 PM and get up by 5 AM. – I’m typically a night owl, which messes up my morning schedule. It’s time I grew up!
4. Stick to our budget. – Although we don’t “blow” money per se, we could do a much better job sticking to our budget.
5. Eat better. – I need to consistently eat healthier meals and add more fruits and vegetables to my diet.
6. Take my wife out on a date at LEAST once a month.
7. Have fun and enjoy life. – I tend to be a negative person. Why that is, I do not know. All I know is that I want to change.
Those are a few of the more general goals I have for my life. I’ll take each of these goals and break them down into steps so that I have a plan for reaching them.
Now it’s your turn. What are 5 goals (or more) you want to accomplish in 2008.