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Author: PhoolishPirate Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 6725  
Subject: new invester needs help with portfolio Date: 8/7/2005 5:02 AM
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Hi all,
    I am 32 years old, married, pretty new to investing. here is where I am at:

Own a house worth around 460K, have 250K principl balance.

have about 110k allocated as following:

stock/ETF:
6,500  Stock
11,000 VTI (VANGUARD INDEX TR STK MRK VIPERS)

Mutual Funds:
7,400  VBIIX (VANGUARD BD INDEX FDS INTER TRM FD)
10,500 VDMIX (VANGUARD FD DEVELOPED MKT INDEX FD)
11,400 VEiEX (VANGUARD FUNDS EMERGNG MKT PT)
8,400  VGSIX (VANGUARD SPECIALIZED PORTFOL REIT INDEX)
16,500 VIMSX (VANGUARD INDEX FDS MID CAP STK PORT INV)
23,803 VTSMX (VANGUARD INDEX FDS TOTAL STK MKT FD)

most of these were purchased 6-7 month ago except the VTI ETF. 

I can probably invest 6000 per month.

Does the portfolio make any sense to you experts?

Thanks in advance!
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Author: IllustratedMan Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5335 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/7/2005 1:11 PM
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(re-posted - so many typos before that I've asked Fool to delete my prior note)

These are just off-the-cuff comments and should be treated as such:

so - 4.5% stock, 6.7% bond, 9.5% intl, 10.4% emerg, 7.6% REIT, 15% Mid-Cap, 31.6% total stock market

Comments
*these numbers don't work out to 110k
*why own bonds at all at your age?
*your expense ratio is very tiny! for a fund portfolio, very impressive!
*is there some particular reason for the REIT allocation?
*how did you decide on the particular allocations?

If you are going to allocate among these indexes I would assume you've got the 1, 3, 5, and 10 year returns for each of them? If so, post them if you will.

At face value, I LIKE the portfolio (esp. for a newbie!), though as a personal choice I would do away w/the REITs and the bonds. Plus, I wouldn't be comfortable with the size of your emerging markets position, but it has worked out for you so far. I do like the emphasis on domestic larger cap stocks but am less sure why you don't opt for a straight small cap index fund, though I wouldn't put much in it at this point (and you are getting small cap exposure with the total funds, but it makes it a bit more confusing).

fwiw, the problem with commenting on a portfolio like this is you've got to have an opinion on each and every asset class. I don't have one and don't know the future, but at least you can choose to emphasize areas which have been lagging over those that have been strong (e.g., have a lot more in large caps right now than small caps).

Other than that, being diversified across asset classes and keeping expenses low is the way to go if you don't want to actively manage the portfolio, and you've done that!

just 2c


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Author: PhoolishPirate Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5336 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/7/2005 3:40 PM
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Thanks IllustratedMan for your comment,
    the number doesn't add up because I have about 10K locked in a CD 
account that forgot to mention.
    my current allocation is based on a recommendation in some magazine or book I read 6 month ago, based on the allocation ratio I found some low 
expense funds and bought them.
    The bond index is the only loser in my fortfolio so far, should I dump
 them or just hold since their value will surely go up?
    The total market allocation is high because last week I bought the VTI
 ETF, It seems to be easier to sell/buy than MF. I plan to move all index 
funds to corresponding ETF over the next year, does this make any sense 
for a $6000 monthly contribution?
   
funds     1         5        10      since inception
----------------------------------------------------
VBIIX   5.65     6.96      7.48      
VDMIX   38.61                        -4.67
VEIEX   56.09    10.44               3.79
VGSIX   30.76    21.18               14.60
VIMSX   34.14    9.19      9.74
VTSMX   31.35    0.46      10.48


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Author: IllustratedMan Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5337 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/7/2005 4:07 PM
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PP,

I wouldn't want to advise you. There are other sources for that you should consider. The Fool has a newsletter and I like the No-Load Fund Investor myself, and of course there are ideas in the various financial magazines including Kiplingers and Money. THAT SAID...

The bond index is the only loser in my fortfolio so far, should I dump them or just hold since their value will surely go up?

fwiw, I objected to the bond fund on principle because you are so young and don't seem to need it. Otherwise, I am no fan of predicting interest rates but if someone forced me to be in fixed income I'd be in only short maturity durations. Something like a CD, for example, that didn't mature in more than 3 years, but again, I think fixed income is generally not something you need at your age - unless you like the way it reduces volatility in your portfolio.

The total market allocation is high because last week I bought the VTI ETF, It seems to be easier to sell/buy than MF. I plan to move all index funds to corresponding ETF over the next year, does this make any sense for a $6000 monthly contribution?

Using ETFs for funds seems ok with a 6k purchase but frankly it isn't clear cut since you've got to pay both brokerage commissions and there is a spread (difference between buy and ask price) involved, esp. with some of the Vanguard ETFs. If it were me, I might just go with Vanguard mutual funds directly, esp. if you don't plan on changing the allocations anytime soon. If you plan to switch things around, I'd use the ETFs, especially since there are comparable ETFs you could use too.

If it matters, you really should have the 1, 3, 5, and 10 year annualized returns for each of your selections handy. It might be helpful to know, for example, that one index has sucked in the last 5 years and another index has done really well. If you plan to index your portfolio, that's the time to allocate a bit MORE to the one that sucks over the one that has done well, figuring that returns will tend to converge over time. In general, the SP500 has done the worst of any index over the last five years so that's the one you might consider - again "consider" - putting a bit more money in (though the differences between the total index fund and the SP500 seem minimal).

Having said all this, you ought to know I am just responding to a Fool note cause it is fun to respond to a Fool note - I don't tend to use index funds in my portfolios (with a very recent exception) and thus haven't given this a lot more thought lately (though years ago I managed fund only portfolios with only so-so results).

Again, just 2c


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Author: 2old4bs Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5338 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/7/2005 10:57 PM
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Welcome Phoolish Pirate!

Two sources with slightly different perspectives on portfolio allocation are:

1. Either one of William Bernstein's books, "The Four Pillars of Investing" or "The Intelligent Asset Allocator", and
2. "The Coffeehouse Investor", by Bill Schultheis (new edition just published)

Both strategies involve index investing, but each recommends somewhat different allocation percentages. Bernstein's "Intelligent Asset Allocator" is quite detailed, if you like delving into the historical data and the math.

Coffeehouse basically suggests one should hold different segments of the equity market in equal proportions, rebalance regularly, and get on with living your life instead of trying to outperform the market. Coffeehouse Investor also has a website from which you could probably glean quite a bit without buying the book:

http://coffeehouseinvestor.com/

There is an index board on TMF and the subject of allocation often comes up there. You might want to post your question there as well. (Almost everyone there will be familiar with your fund choices.) Just a hint: Instead of posting the actual numbers, you might want to just post the actual percentages.

Regarding ETFs vs: MFs, the following is a thread from that board which discusses same:

http://boards.fool.com/Message.asp?mid=22803617

I agree with IM that you are probably too young to be holding much in bonds, unless you are specifically aiming for volatility reduction. I don't agree with IM that you should get rid of the REIT fund. Many are saying they are currently overpriced, buy they were already saying that in 2003 and early 2004, when I bought REIT funds, and I have since then realized gains of > 50%, so I have been very happy that I own them :-)

Mutual Funds:
7,400 VBIIX (VANGUARD BD INDEX FDS INTER TRM FD)
10,500 VDMIX (VANGUARD FD DEVELOPED MKT INDEX FD)
11,400 VEiEX (VANGUARD FUNDS EMERGNG MKT PT)
8,400 VGSIX (VANGUARD SPECIALIZED PORTFOL REIT INDEX)
16,500 VIMSX (VANGUARD INDEX FDS MID CAP STK PORT INV)
23,803 VTSMX (VANGUARD INDEX FDS TOTAL STK MKT FD)


IMHO, your choice of Vanguard's low-cost funds was a good one. I am glad to see that you are exposed to the internationals (VDMIX). VTSMX is, for the most part, a large-cap fund, since large-caps weigh heavily in the total stock market index. Since that is the case, I would prefer to see a small cap holding like NAESX instead of VIMSX perhaps. (Note: I hold VIMSX myself, but I also hold NAESX)

I just recently sold VDMIX to buy a non-Vanguard international fund DODFX. It is a higher cost 'managed' fund, but it has performed above its benchmark pretty consistently. But that is merely my preference. I do not solely use index funds because in several of my accounts (annuity and 401k) they are just not available.

my current allocation is based on a recommendation in some magazine or book I read 6 month ago, based on the allocation ratio I found some low expense funds and bought them.

I would be interested in knowing what the reasoning was behind this recommendation. Perhaps you could include that in your post on the index board.

Hope this helped,

2old


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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5340 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/9/2005 9:27 PM
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Author: 2old4bs | Date: 8/7/05 10:57 PM | Number: 5338
Coffeehouse basically suggests one should hold different segments of the equity market in equal proportions, rebalance regularly, and get on with living your life instead of trying to outperform the market.


I don't mean to pick nits, but I see this statement over and over, and it is simply not accurate.

The purpose of Coffeehouse Portfolio is to BEAT the market. I know that is not what it says on the coffeehouse website, but if you want to match the market, you simply buy a total market index fund.

It makes no sense whatsoever to go through the considerable effort that it takes to accomplish the Coffee House Portfolio allocations (not to mention the rebalancing), if all you want to do is match the market.

I am not saying that the Coffee House Portfolio is bad. It may actually beat the market long term, but there is no way to know ahead of time.

Russ

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Author: 2old4bs Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5341 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/10/2005 9:00 AM
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Coffeehouse basically suggests one should hold different segments of the equity market in equal proportions, rebalance regularly, and get on with living your life instead of trying to outperform the market.
**********************
I don't mean to pick nits, but I see this statement over and over, and it is simply not accurate.


You're right--poor choice of wording on my part. Would have been more accurate if I said:

"...rebalance regularly, and get on with living your life instead of trying to time the market or chasing sectors, funds and/or stocks that have experienced recent high returns."

Better?

2old



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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5342 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/10/2005 10:45 AM
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The purpose of Coffeehouse Portfolio is to BEAT the market.

I thought the purpose of Coffeehouse Portfolio was to create a port that performed adequately while having much less risk than the market and capturing some of the rebalancing bonus.

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Author: ziggy29 Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5343 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/10/2005 10:58 AM
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>> I thought the purpose of Coffeehouse Portfolio was to create a port that performed adequately while having much less risk than the market and capturing some of the rebalancing bonus. <<

Well, yeah -- it's basically something designed to provide a little more than market level performance, the boost coming from the rebalancing that lets you buy low and sell high with some of your assets when it's time to rebalance.

#29

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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5344 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/10/2005 11:27 AM
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Author: jrr7 | Date: 8/10/05 10:45 AM | Number: 5342
I thought the purpose of Coffeehouse Portfolio was to create a port that performed adequately while having much less risk than the market and capturing some of the rebalancing bonus.


Well, the risk of the coffee house portfolio is still not known, because it will take many more years to gather enough data to verify the standard deviation (volatility). Backtesting has not been conducted properly, and the data are now tainted, so new data must be collected. I personally believe that the high percentage of small caps in the coffee house make it more risky (volatile) than the simple 60/40 Total Stock Market/Total Bond Market. The high percentage of REITs (compared to the total market) are another big unknown. And Foreign stocks are currently correlated tightly with the US market, so they don't help much either. Whether the higher volatility will translate into higher gains or not remains to be seen.

Remember that the main reason the coffee house has done so well lately is that small caps and REITs have performed extremely well over the last few years. That will change, however, as both revert to their means.

Also, all asset allocation strategies require rebalancing to maintain their percentages, and this results in 'capturing some of the rebalancing bonus'. Even the 60/40 TSM/TBM also needs to be rebalanced regularly.

My belief is that over the long term, the coffee house portfolio will perform just about the same as 60/40 TSM/TBM, except that it will have higher standard deviation (volatility). I say this because small cap stocks have very high betas, and they are correlated quite closely with the TSM (r squared = 0.78).

I think that if you are still in the accumulation phase of life, the Coffee House Portfolio might be a reasonable choice, but I would not recommend it to retirees due to the potentially higher volatility without significant increase in total return.

Russ

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Author: mrseabreeze Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5345 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/10/2005 9:27 PM
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Subject: Re: new invester needs help with portfolio
Author: rkmacdonald | Date: 8/9/05 9:27 PM | Number: 5340
"...The purpose of Coffeehouse Portfolio is to BEAT the market..."

Russ, I know you said that the coffeehouse website doesn't say they try to beat the market - but I have never come away with the impression that they even imply beating the market. My sense is the goal is to invest as much as possible; be somewhat reasonable - in terms of risk/reward - in one's asset allocation; enjoy life.

Page 7 of 20 of the below 1st chapter of their book states the three key issues: 1) asset allocation, 2) approximating the stock market average, and 3) saving.
http://www.coffeehouseinvestor.com/Chapter%201.pdf

The percentage one has in stocks, cash, bonds will distort annual or lifetime returns - but a 20-year old may have less in bonds than say a 70-year old.

I would like to hear what info that you read makes you feel that they are trying to beat the market. Just curious. I've been wrong many, many times - and this could be one of those times. :)


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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5346 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/11/2005 12:21 AM
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Author: mrseabreeze | Date: 8/10/05 9:27 PM | Number: 5345
Subject: Re: new invester needs help with portfolio
Author: rkmacdonald | Date: 8/9/05 9:27 PM | Number: 5340
"...The purpose of Coffeehouse Portfolio is to BEAT the market..."

Russ, I know you said that the coffeehouse website doesn't say they try to beat the market - but I have never come away with the impression that they even imply beating the market. My sense is the goal is to invest as much as possible; be somewhat reasonable - in terms of risk/reward - in one's asset allocation; enjoy life.

Page 7 of 20 of the below 1st chapter of their book states the three key issues: 1) asset allocation, 2) approximating the stock market average, and 3) saving.
http://www.coffeehouseinvestor.com/Chapter%201.pdf

The percentage one has in stocks, cash, bonds will distort annual or lifetime returns - but a 20-year old may have less in bonds than say a 70-year old.

I would like to hear what info that you read makes you feel that they are trying to beat the market. Just curious. I've been wrong many, many times - and this could be one of those times.


Well, it's not what I have read. My comment is based strictly on common sense.

Here's my reasoning:

There are only three things that will happen with any portfolio: 1) it will underperform the market, or 2) it will beat the market, or 3) it will match the market (ignoring expenses).

You obviously don't want a portfolio that underperforms the market, right? Therefore, there are only two logical choices for your portfolio: 1) you want to match the market or 2) you want to beat the market. Right?

So, if you want to match the market, why would you go through all the trouble of buying the various components of the coffee house portfolio? It would be far simpler to buy a market index fund. One that maintains 60% TSM (Total Stock Market) and 40% TBM (Total Bond Market). This would GUARANTEE that you would match the market, because it IS the market - by definition.

So, it is obvious to me that the primary reason you would want to own the coffee house portfolio is that you believe that holding those specific allocations will beat the simple 60/40 TSM/TBM (which IS the market by definition).

Now, a secondary reason might be that you believe that buying the coffee house portfolio will match the market at lower portfolio volatility. However, this reason doesn't seem too logical to me, because small cap stocks are far more volatile than large cap, and the coffee house portfolio heavily overweights small cap stocks compared to the TSM. This has worked out fine in the last few years as small caps outperformed large caps, but what about when they revert to their means?

I believe the addition of REITs and Foreign to the simple 60/40 TSM/TBM has a good chance of outperforming both the coffee house portfolio and the market over the long term, simply because it doesn't overweight small caps. That's my only real objection with the coffee house portfolio; that it overweights small cap stocks compared to the percentages in the TSM.

Incidently, Vanguard's VBINX is a single mutual fund that maintains 60/40 TSM/TBM automatically - with no rebalancing on your part. Holding this single fund plus REITs and Foreign seems a much simpler way to achieve at least as good results as the coffee house portfolio with much less rebalancing work.

Russ

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Author: yttire Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5347 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/11/2005 5:27 AM
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1) it will underperform the market, or 2) it will beat the market, or 3) it will match the market (ignoring expenses).

Let me point out some of the other alternatives to the above:

4) The investments generate an income of $XX per year for 30 years pacing inflation with a high probability regardless of market value without spending any principal

5) The investments will be able to have 4% drafted off every year without depleting principal in all historic scenarios run for the past 100 years of data

6) The investments will be able to have 6% drafted off every year for 10 years with a terminal withdrawal rate of 2% in perpetuity.

Each of the above statements reflects a different set of choices with the money- radically different choices. In 4 one would purchase all dividend achievers foreign and domestic, some inflation indexed bonds and REIT's and possibly some rental properties.

5 above would imply an asset allocation similar to the "retire early home page" with some 30% bonds and the rest in the market

6 implies laddered bonds with a stock component for the perpetuity part

In any event, the coffee house portfolio- to me- seems designed for maximizing return and reducing variance in a ten year time frame. That is- they have a healthy exposure to bonds which implies they are trying to avoid extreme downdrafts in the market, and historically down drafts can last up to around 10 years.

However, for many investors ten years of losing money in their investments may cause them to lose hope in them, and reduce their savings. Therefore I don't think it is a bad thing to have some exposure to bonds, even if one is young.

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Author: ziggy29 Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5348 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/11/2005 9:52 AM
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>> Now, a secondary reason might be that you believe that buying the coffee house portfolio will match the market at lower portfolio volatility. However, this reason doesn't seem too logical to me, because small cap stocks are far more volatile than large cap, and the coffee house portfolio heavily overweights small cap stocks compared to the TSM. This has worked out fine in the last few years as small caps outperformed large caps, but what about when they revert to their means? <<

Yes, but volatility of individual asset classes can be muted by holding other asset classes, perhaps equally volatile by themselves, that don't completely correlate in terms of their up and down movement.

#29

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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5349 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/11/2005 3:54 PM
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Author: yttire | Date: 8/11/05 5:27 AM | Number: 5347
1) it will underperform the market, or 2) it will beat the market, or 3) it will match the market (ignoring expenses).

Let me point out some of the other alternatives to the above:

4) The investments generate an income of $XX per year for 30 years pacing inflation with a high probability regardless of market value without spending any principal

5) The investments will be able to have 4% drafted off every year without depleting principal in all historic scenarios run for the past 100 years of data

6) The investments will be able to have 6% drafted off every year for 10 years with a terminal withdrawal rate of 2% in perpetuity.


I would argue that all of your statements relate to goals for safe withdrawal rates which is really a different subject than my original comments addressed.

In order to know how large a withdrawal you can safely make from your portfolio requires extensive backtesting under rigorous scientific conditions. It requires examination of sufficient 'clean' data using proper scientific principles to achieve a statistically valid answer. Of course this doesn't guarantee what this portfolio will actually do in the future, but most people feel it will give you some idea.

All of the proper historical backtesting for maximum safe withdrawal rates that I have reviewed has been conducted using various mixes of the S&P500 and high grade corporate bonds. There are other studies using TIPs, I-Bonds, as well as high grade corporates.

It is from these proper scientific studies that the maximum safe withdrawal rates have been determined. The Trinity study in 1997 was one of the best ever done. It was simple to understand and clearly showed the effects of using various withdrawal rates with different mixes of stocks and bonds. This study examined every historical payout period from 1926 through 1995, looking at all withdrawal rates from 3% to 12%, adjusted for inflation.

This study showed that using a mix of 75% stocks with 25% bonds would allow the highest safe withdrawal rate over all periods of time. It showed that for periods up to 25 years, 4% was 100% safe; ie, no portfolio would have become exhausted. Then, at 30 years, it was 98% safe; ie, there was one period where the portfolio would not have survived.

Another key point about safe withdrawals concerns volatility. Safe withdrawal rates are greatly affected by both the growth rate of the portfolio and the volatility. Lots of portfolios have historical growth rates much higher than the 60/40 mix of stocks and bonds that we often discuss. However, due to the volatility of those portfolios, they will not support as high a safe withdrawal rate.

Anyway, my point is that we know absolutely nothing about the safe withdrawal rate of the coffee house portfolio. In fact, it has not even been scientifically compared with the market. The backtesting shown on the website is not statistically significant, because it doesn't go back far enough. It takes about 30 years of data to even approach significance.

So, if my goal were to maximize my withdrawal rate from my portfolio, I would set my portfolio up based on some historical proof that it would actually work. I would certainly not use the coffee house portfolio. If my goal were maximum growth, then the coffee house portfolio may achieve it, but there are lots of easier ways to maximize potential growth when risk is not an issue.

Each of the above statements reflects a different set of choices with the money- radically different choices. In 4 one would purchase all dividend achievers foreign and domestic, some inflation indexed bonds and REIT's and possibly some rental properties.

I agree, but none of these things has ever been backtested to see if it will actually work. For instance, if you choose high dividend stocks, you must also be careful to choose ones whose underlying price grows fast enough to offset inflation, or you will fall slowly behind until it is too late to do anything about it. One of the worst mistakes a young retiree can make is to choose dividend payers whose yield is too high to allow price growth of the underlying stock. Sure, the principle will remain intact, assuming the stocks don't go bankrupt, but the value of the dividend will have eroded to less than half of its initial buying power after 30 years. REITs concern me in this manner.

5 above would imply an asset allocation similar to the "retire early home page" with some 30% bonds and the rest in the market

The asset allocation strategy of the Retire Early Home Page is heavily influenced by data from the Trinity study and others like it. This is very solid information, and much more reliable (IMO) than the coffee house data.

6 implies laddered bonds with a stock component for the perpetuity part

This is also one of the scenarios that was backtested in the Trinity study. You can cover a 10 years period with just about any allocation strategy you want. However, even in a 10 year period, if you want to take the MAXIMUM safe withdrawal, you need to set your mix to somewhere around 60/40 stocks/bonds.

In any event, the coffee house portfolio- to me- seems designed for maximizing return and reducing variance in a ten year time frame. That is- they have a healthy exposure to bonds which implies they are trying to avoid extreme downdrafts in the market, and historically down drafts can last up to around 10 years.

The coffee house portfolio uses 60/40 stocks/bonds, and should be quite safe, and should grow about the same as the market (maybe a little better). However, by overweighting small cap stocks, it increases the volatility of the portfolio and potentially decreases the maximum safe withdrawal rate. In the past few years, the growth rate of small caps and REITs have been so spectacular that nearly any portfolio with a healthy dose of one or both will have beaten the market. However, in the long run no one knows what the safe withdrawal rate is for the coffee house portfolio, because there has never been any proper statistical work done.

From my own personal work, I estimate that by adding 10% REITs to the 60/40 TSM/TBM will increase the 30 year 100% safe withdrawal rate to slightly above 4%, maybe as high as 4.5%. However, this cannot be a conclusion, because in the 90's REITs changed the amount of their profits they had to return via dividend to the stockholders. This means that all REIT data prior to that point is useless. We only have about 15 years of clean REIT data, and we need at least 30 for statistical significance.

Russ

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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5350 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/11/2005 4:16 PM
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Author: ziggy29 | Date: 8/11/05 9:52 AM | Number: 5348
>> Now, a secondary reason might be that you believe that buying the coffee house portfolio will match the market at lower portfolio volatility. However, this reason doesn't seem too logical to me, because small cap stocks are far more volatile than large cap, and the coffee house portfolio heavily overweights small cap stocks compared to the TSM. This has worked out fine in the last few years as small caps outperformed large caps, but what about when they revert to their means? <<

Yes, but volatility of individual asset classes can be muted by holding other asset classes, perhaps equally volatile by themselves, that don't completely correlate in terms of their up and down movement.


You will only achieve this effect if the asset classes are very very weakly correlated. For instance stocks and bond are correlated at only 0.10. This means that stocks and bonds move together only 10% of the time. This makes these two asset classes excellent diversifiers.

However, in the case of the TSM vs. Small Caps, for instance, they are correlated at 0.78. That means that they move together 78 percent of the time. They are NOT good diversifiers.

Then looking at TSM vs. foreign, we see they are correlated at 0.80. Again, not a very good diversifier (but I suspect bad data here).

Now, REITs vs. TSM is is only 0.15. And, REITs vs. bonds are an incredibly low 0.04. This means REITs are an outstanding diversifier, especially when their historical growth rates are around 10%.

This is why I currently estimate that adding 10% REITs to a 60/40 TSM/TBM mix will increase the 100% safe withdrawal rate significantly, maybe as high as 4.5%. It is also why I see no reason to overweight small caps vs the percentage already in the TSM.

However, some caution is advised, because there is not enough clean REIT data to assure statistical significance, which means these results should be considered preliminary and could be wrong.

Foreign is still a big mystery, however, because I think the world is changing so rapidly that none of the historical data is valid for statistical purposes. It could well be that adding 10% or more of foreign to the mix would be a very smart move. In fact, Jeremy Siegel in his latest book, 'The Future for Investors', now recommends up to 30% foreign for this very reason.

Russ

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Author: ziggy29 Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5351 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/11/2005 4:28 PM
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>> Then looking at TSM vs. foreign, we see they are correlated at 0.80. Again, not a very good diversifier (but I suspect bad data here). <<

I suspect this doesn't take currency fluctuation into account. I have a feeling the correlation would be a fair bit lower if it did.

#29

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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5352 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/11/2005 5:02 PM
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I suspect this doesn't take currency fluctuation into account. I have a feeling the correlation would be a fair bit lower if it did.

I suspect you're right.

Russ


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Author: yttire Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5353 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/11/2005 11:20 PM
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This is why I currently estimate that adding 10% REITs to a 60/40 TSM/TBM mix will increase the 100% safe withdrawal rate significantly, maybe as high as 4.5%. It is also why I see no reason to overweight small caps vs the percentage already in the TSM.

Russ, what is your opinion on utilizing a strategy of dividend growth stocks and REITS as a hedge against volatility?

The theory being that the value of the equities do not matter if your dividend stream is significant enough.

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Author: blackjs One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5354 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/13/2005 1:53 AM
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Russ, I know you said that the coffeehouse website doesn't say they try to beat the market - but I have never come away with the impression that they even imply beating the market. My sense is the goal is to invest as much as possible; be somewhat reasonable - in terms of risk/reward - in one's asset allocation; enjoy life.

Page 7 of 20 of the below 1st chapter of their book states the three key issues: 1) asset allocation, 2) approximating the stock market average, and 3) saving.
http://www.coffeehouseinvestor.com/Chapter%201.pdf

The percentage one has in stocks, cash, bonds will distort annual or lifetime returns - but a 20-year old may have less in bonds than say a 70-year old.

I would like to hear what info that you read makes you feel that they are trying to beat the market. Just curious. I've been wrong many, many times - and this could be one of those times.

Well, it's not what I have read. My comment is based strictly on common sense. . . .


I was curious so went to their site. Unbelievable as it may be, they don't seem to be trying to outperform the market:

"The Coffeehouse Credo
--------------------------------------------------------------------------------

Once you remove yourself from Wall Street's complete and total obsession with trying to beat the stock market average, and accept the fact that equaling the stock market average is a rather sophisticated approach to the whole thing, building a common stock portfolio becomes an immensely gratifying experience.

Wall Street has conclusively proven to us that pursuit of performance above a benchmark is an unproductive use of our time, our talent and our money. By trying to beat the stock market average, it's easy to forget that the stock market has historically provided an excellent investment return, and by trying to beat an already good thing, investors are virtually guaranteed to end up below it."

http://coffeehouseinvestor.com/Quote.htm



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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5355 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/13/2005 2:01 AM
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Author: blackjs | Date: 8/13/05 1:53 AM | Number: 5354
I was curious so went to their site. Unbelievable as it may be, they don't seem to be trying to outperform the market:


I know!! It really is absurd when you think about it. They want you to go through all the trouble to balance five different asset classes when their goal is to match the market!!! Huh???

What's wrong with this picture???

Russ

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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5356 of 6725
Subject: Re: new invester needs help with portfolio Date: 8/13/2005 2:31 AM
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Author: yttire | Date: 8/11/05 11:20 PM | Number: 5353
>>This is why I currently estimate that adding 10% REITs to a 60/40 TSM/TBM mix will increase the 100% safe withdrawal rate significantly, maybe as high as 4.5%. It is also why I see no reason to overweight small caps vs the percentage already in the TSM.<<

Russ, what is your opinion on utilizing a strategy of dividend growth stocks and REITS as a hedge against volatility?

The theory being that the value of the equities do not matter if your dividend stream is significant enough.


There is no doubt that dividend stocks have lower standard deviation (ie, volatility) than non-dividend stocks. This coupled with the fact that REITs are very weakly correlated with the TSM is why I believe that adding REITs to a 60/40 TSM/TBM mix works so well. Even regular non-REIT dividend paying stocks are good stabilizers for a 60/40 portfolio.

However, there are a few very important things about dividend stocks that you have to understand.

First of all you can't pick just any high dividend stock and expect it to work well for lowering volatility. You may succeed in lowering volatility by sacrificing a large amount of potential return to get it.

You have to pick dividend stocks that have a long history of dividend growth, and a likelyhood that it will continue. And the easiest way to find those is to look for stocks with a long history of steady price growth.

It turns out that in the long run, dividend growth always equals price growth which always equals earnings growth, but dividend growth is usually delayed slightly behind price. So, a good way to find a stock that is ripe for a dividend increase is to look for a stock with an historically low dividend yield, that has fallen behind a strong price run-up. A stock that fits this description perfectly right now is XOM (ExxonMobil). It's historical dividend yield has been around 2.5 - 3.0%. Today it is at 1.9%. I believe that in the next few years they will drastically increase their dividend or do massive stock buybacks - either one would be good for the stockholder. If you add XOM growth added to XOM dividend growth you find that XOM has provided a very good 12% per year return over the last 50 years with a beta of 0.6 (meaning it is only 60% as volatile as the S&P 500.

You have to be very careful of stocks that pay high dividends, after a long period of price decreases. They are ripe for a dividend cut or elimination. And, if they bolster their dividend artificially, with return of capital (ROC), their earnings and their price will not be able to increase, and thus, their dividend will not be able to increase either. It will eventually have to be cut.

So, if you buy a stock that pays a high dividend, like a REIT, you have to be very careful to check the price history as well as the FFO (funds from operations) growth. If it has an extraordinarily high dividend, and slow price or FFO growth, look out. However, REITs can go for a very long time holding up their dividends with ROC, because they own so much real estate (check out EOP (Equity Office Properties) to see what I mean).

Also, there is no long term evidence that you can withdraw more than about 4% from a pure REIT portfolio. This means that if your REITs pay an average dividend higher than 4%, which most do, you should consider reinvesting some of it to try to make sure your REIT portfolio will survive long term with it's inflation adjusted income intact.

Russ

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