Archives For Asset Allocation

Given a dizzying number of features and restrictions, contracts for some annuities — variable and otherwise — can run 300 pages or more. And because each comes with its own small twists, these products can be very difficult to compare.

That—and the fact that annuities tend to pay a lot higher commissions than comparable mutual funds—is the main reason I’m not a fan of annuities.

That said, Barron’s has their annnual list of the 50 top annuities out today.

The market has changed:

“We’ve seen investment options in variable annuities diminished, guarantees brought down substantially and fees going up,” says Nigel Dally, an analyst at Morgan Stanley. “Protracted low interest rates and high volatility in the stock market have made it far more expensive for annuity companies to support their products.”

My thought: Stick with low-cost fixed immediate annuities. Put a portion of your assets in one or two fixed immediate annuities to give you some dependable monthly income and invest the rest of your assets in a conservative portfolio of stocks and bonds. It’s not rocket science but advisors try to make it that way to confuse and scare the hell out of people.

As far as the rest of annuities are concerned: BUYER BEWARE!

Happy Saturday!

Burton Malkeil on Bonds

December 8, 2011

Interesting piece in yesterday’s WSJ by Burton Malkiel (of Random Walk Down Wall Street fame).

The point of his piece is that bond yields will most likely fall below inflation for years to come due to excessive debt and low interest rates and that investors should take a look at their portfolios and make some changes. He recommends…

I think there are two reasonable strategies that investors should consider. The first is to look for bonds with moderate credit risk where the spreads over U.S. Treasury yields are generous. The second is to consider substituting a portfolio of dividend-paying blue chip stocks for a high-quality bond portfolio.

For the first, he recommends tax-exempt municipal bonds that get reliable revenues:

The first class is tax-exempt municipal bonds. The fiscal problems of state and local governments are well known, and the parlous state of municipal budgets has led to very high yield spreads on all tax-exempt bonds. Many revenue bonds with stable and growing sources of revenue sell at quite attractive yields relative to U.S. Treasurys.

For example, the New York/New Jersey Port Authority gets reliable revenues from airports, bridges and tunnels to support its debt. Long-term N.Y/N.J. Port Authority bonds currently yield close to 5%, and they are free of both federal and state and local taxes in the states in which they operate.

He also recommends foreign bonds in countries with low debt-to-GDP ratios like Australia.

Finally, he recommends investors consider a portfolio of bluc-chip stocks with generous dividends. One stock he highlights is AT&T.

All of this makes me wonder:

At what point does portfolio tweaking become market timing?

This is a continuation of yesterday’s post.

I ran the numbers under the following two scenarios:

• $500 per month with no rebalancing.

• $500 per month with annual rebalancing.

Here are what the numbers look like:

I have to say that this one surprised me until I considered everything that has happened over the last 19 years. So much of portfolio returns are due to timing. The equity portion of the portfolio grew nicely throughout the 90s but cratered with the bursting of the internet/tech bubble in the early 2000s and then again in 2007 and 2008.

So there you have it. Bonds beat stocks in this scenario so bonds are better, right? Not so fast. Take a look at the next graphic, which is like the first graphic only this time, the portfolio is rebalanced back to the original allocation at the end of each year.

Rebalancing was the difference maker. The sweet spot seems to be around a 50/50 split between stocks and bonds. Rebalancing is important because it adds a sense of discipline to the portfolio in that investors are selling appreciated assets and buying more of assets that have decreased in value. This was particularly important over the last 19 years due to the way the stock market behaved.

It’s important to note that we shouldn’t focus too much attention on a two asset portfolio. This was more of an exercise in seeing how stocks and bonds work together.

What does the future hold? Well, that’s anybody’s guess. If we have inflation (as many economists are expecting), U.S. bonds will not do well. If we don’t get our economy back under control, stocks won’t perform well either.

That’s why at this point in the game, I’m thinking a prudent portfolio is something like Craig Israelsen’s 7Twelve portfolio, which invests in 7 different asset classes via 12 different funds/ETFs. For those who are interested, I interviewed Dr. Israelsen recently.

I have been looking for monthly total return history for bonds but haven’t had a lot of luck (unless I want to fork over some serious money). I asked Craig Israelsen and he was able to provide me with monthly bond returns going back to 1991. I’m still looking for monthly returns going back to 1926. If any of you can help me out, I would appreciate it.


I took the monthly total returns for the Barclays Aggregate Bond Index and combined them with the total returns for the S&P 500 Index and ran some numbers. I started with 100% in stocks and ran the numbers for the nineteen year period (1991-2009). Then, I re-ran the numbers, adjusting the allocations by 5% (you can see this in the following graphic). The results are here:

What I found interesting was the how adding bonds didn’t reduce the performance of the portfolio but did reduce the volatility. Granted, this is a very short-term look at returns. It was also a period in time that saw stocks get hammered in the early 2000’s and again in 2008. BUT…that’s the purpose of ASSET ALLOCATION!

From this study, it seems that the sweet spot was a portfolio of 85/15 stocks/bonds or 80/20 stocks/bonds. The ending values are nearly identical to the ending value of the 100% stock portfolio but weren’t nearly as volatile based on monthly standard deviation.

We’re not done looking at this. Tomorrow I’ll look at the same portfolio from a dollar-cost averaging point of view. The results are pretty interesting.

I received a copy of Larry’s latest book, The Only Guide You’ll Ever Need for the Right Financial Plan*, a week or so ago. This book is a part of his “The Only Guide” series (see bottom of post for list). In fact, the book refers the reader to the other books in the series. Although this is a tad annoying it makes sense in that it would be silly to reprint all that information in a new book.

Here’s a brief look at the book:

Part I Looks at investment strategy in an uncertain world. Chapter 2 is dedicated to the importance and creation of your investment policy statement. I would have preferred Larry spending more time on the IPS—perhaps giving an example or two of different statements or even a sample worksheet to help aid the reader in putting together their own IPS.

Part II is the meat and potatoes of the book: asset allocation. Part II has chapters dedicated to asset allocation in general, equities, fixed income, alternative investments, and liabilties and asset allocation. I really liked these chapters, particularly the chapter on alternative investments because Larry gives recommendations on whether or not each asset should be a part of most investors’s portfolios. Of the nineteen alternative investments discussed, only one of them get’s Larry’s recommendation (EE Bonds).

I also liked the chapter on equities because Larry lays out reasons why an investor would want to increase or decrease their equity exposure. Among the reasons to increase equity exposure:

• Longer time horizon

• High tolerance for risk (I prefer to call it volatility)

• High marginal utility for wealth (a technical way of saying that an increase in wealth is important to you)

Part III is about implementing the plan. It looks at things like whether or not to use individual stocks or mutual funds, active vs. passive management, where to hold assets, and portfolio maintenance.

Part IV addresses all the other areas of planning. Things like college savings plans, insurance, IRAs and retirement plans, social security, safe withdrawal ratess, and estate planning. The most interesting chapter in Part IV (in my opinion) was the one addressing safe withdrawal rates. Larry’s discussion of the usefulness of Monte Carlo simulations was interesting (and food for future AFM blog posts).

The book closes with several helpful Appendices that look at diversification, dollar cost averaging, reverse mortgages, and how to choose an advisor.

Overall, this is a great resource for everyone (beginner and those who are further down the investing and planning road).

Related books (affiliate links):

Wise Investing Made Simpler (Second in a series)

The Only Guide to a Winning Investment Strategy You’ll Ever Need: The Way Smart Money Invests Today

The Only Guide to a Winning Bond Strategy You’ll Ever Need: The Way Smart Money Preserves Wealth Today

The Only Guide to Alternative Investments You’ll Ever Need: The Good, the Flawed, the Bad, and the Ugly (Bloomberg)

*Affiliate Link

Considering the brutal market we have been through the last decade, which of the following two paths would you choose if you could go back to January 1990 and start over?

A) $5,000 lump sum in Vanguard’s 500 Index Fund and $5,000 lump sum in Vanguard’s Total Bond Index Fund


B) $10,000 lump sum invested Vanguard’s 500 Index Fund

If you chose A, and reinvested all dividends, your account value at the beginning of July would have been $35,125.

If you chose B, your account value would have been $50,743 (again, assuming all dividends were reinvested).

Now, the picture changes drastically if the beginning period is January 2000. The 50/50 portfolio would have grown to $12,278 while the 100% stock portfolio would have been worth $9,418.

What’s the point?

First off, hindsight is 20/20. Second, diversification is insurance. It looks like expensive insurance when the stock market performs well and it makes you look like a genius when times are tough (like the last decade). I realize a 50/50 portfolio is pretty conservative. In a future post, I’ll look at other portfolio weightings.

I received the following email the other day from an AFM reader (summarized from several emails):


Greetings! Yours is an awesome website, and it has proved to be very helpful ministry to me as of late. I had a quick question for you.

My wife and I are in our 20’s. We have no kids, but I have recently curiously contemplated maybe buying a new, bigger, more expensive home in order to take advantage of the current real estate situation. The house is in the best school district in the state, and nicely situated close enough to some nice restaurants and shops, etc.

In 2006, when the neighborhood broke ground (it’s in the Birmingham, Alabama area), the houses were listed for pre-sale at $689,000 or so. I know for a fact that one of the residents in that neighborhood with a similar house to the one that I want paid taxes on $707,000 last time around. This particular house has been listed for 13 months, with the price slowly falling. The home currently says $569,000. I asked the sales agent / realtor about her coming down and she told me that they are very negotiable, of course. I can get in the low 500’s, I’m pretty sure. It is a very impressive home.

The down payment of $450,000 is nearly all of my net worth. It is a large inheritance, and it will cover about 80% of the purchase price of the home. Besides that, I would have my cars, possessions and a $15 or $20 thousand savings portfolio. I would, however, be debt free. So, I guess a major part of my question is, is a luxury home a good investment vehicle in these troubled times? I’d look to sell in 10 or 15 years, hopefully making a good bit of money on the house.

I do not have a retirement account or anything along those lines. My “career” will officially start when I finish law school and pass the bar, one year from now.

My question: Is it time to move, or wait for the market to drop even more, or stay put? If I don’t buy this house, the money will probably just be sitting in a CD of some sort.

All the best,


Wow! Lots of things to think about. Unlike lots of people, I look at a house as an investment—afterall, it IS an asset. So, I would look at this from an investing point of view. You have to decide for yourself whether or not you want to allocate your entire net worth (at least right now it would be your entire net worth) to one asset. Lack of diversification is something to think about.

It could be years before housing prices start to recover so I wouldn’t plan on any more than a 3% to 3.5% appreciation rate on the house over the next five to ten years. Based on that, you could expect the house to be worth somewhere in the neighborhood of $700,000 – $740,000 in ten years. Keep in mind that there are no guarantees that housing prices will move up. If things don’t turn around in this country soon, we could be facing a long-term recession. That would not help housing prices.

Personally, I don’t think the worst is over for housing prices. There are more foreclosures looming out there and they are only going to put downward pressure on housing prices. Sure, some areas will be hit harder than others but how bad it will get is anybody’s guess.

In addition to the purchase price, you’ll also have to pay more property taxes and the upkeep on a larger home will naturally be higher. Will you be able to afford those expenses? I know in my town, a $500,000 house probably has a $12,000 per year tax bill.

If it were my money, I think I would hold off on buying the house. I would keep an eye on housing prices and if you think they are turning around, you could jump then. You have one huge advantage over most people in that you have a hunk of cash sitting around waiting to be used. Other people don’t have that luxury.

Since you have plans for using the money for the purchase of a house, I would keep it fairly liquid. Shop around for CD rates but be careful.

That’s my opinion. You can take it for what it’s worth.

Now I’d like to open it up to AFM readers and see what they think.