Rick Ferri's Portfolio

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what is the underlying rationale, though?

Postby happytrades » Tue Aug 10, 2010 9:55 pm

I see innumerable portfolios on this site: But, to me, many are just Rorschach projections. It would be much more helpful - and enlightening - if we knew what the underlying assumptions are for the assets and the weights assigned to them.

For example, if I said my equity portfolio was 60% domestic, 40% foreign with no emerging markets, that really doesn't tell you much. What you need to know is WHY I made those allocations. If I can explain that, then there is something to learn or criticize.
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Postby jeffyscott » Wed Aug 11, 2010 6:56 am

Rick Ferri wrote:PS. About the "priceless part of it is that you have the freedom of being your own boss", this has advantages and disadvantages. The advantage is never having to worry about being laid off, the disadvantage is having to worry about everything else the goes along with running a business. And THAT isn't getting any easier or cheaper these days!



I've never run a business and never would want to, I am far too lazy and risk averse for that, but I always laugh at the "be your own boss" mythology. The reality is that your customers are your boss, they have the power to determine your pay and to hire and fire you. My brother-in-law was fired from his job at his own business earlier this year after years of spending money from other sources in order keep this 50-60 hour per week job as "his own boss".
press on, regardless - John C. Bogle
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Postby KyleAAA » Wed Aug 11, 2010 7:56 am

jeffyscott wrote:
Rick Ferri wrote:PS. About the "priceless part of it is that you have the freedom of being your own boss", this has advantages and disadvantages. The advantage is never having to worry about being laid off, the disadvantage is having to worry about everything else the goes along with running a business. And THAT isn't getting any easier or cheaper these days!



I've never run a business and never would want to, I am far too lazy and risk averse for that, but I always laugh at the "be your own boss" mythology. The reality is that your customers are your boss, they have the power to determine your pay and to hire and fire you. My brother-in-law was fired from his job at his own business earlier this year after years of spending money from other sources in order keep this 50-60 hour per week job as "his own boss".


That's not true. You are your customers' boss. Only a poor business-owner lets his customers tell him what to do. Customers do not have the ability to determine your pay, hire, or fire you. You have that power. That most businesses operate this way doesn't mean that's the best way to operate. It just means most people who run businesses don't know what they're doing. Which is absolutely true, in my experience.

You are confusing being a business owner with being self-employed. Self-employed people work IN their business, business owners work ON their business.
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Postby arthurdawg » Wed Aug 11, 2010 10:06 am

I just compared my current portfolio which is fairly close to my sig, and if i take 5% of my visvx and move it to bridgeway I would be a true disciple of of the great Rick!!

Otherwise i have a little more bond exposure, but also lack any other retirement outside of any small checks from social security that might make my way....
Portfolio: TSM / SCV / FTSE Big World / FTSE Small World / TBM / REIT
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Postby jeffyscott » Wed Aug 11, 2010 10:32 am

KyleAAA wrote:That's not true. You are your customers' boss. Only a poor business-owner lets his customers tell him what to do. Customers do not have the ability to determine your pay, hire, or fire you. You have that power.



Yeah, I guess my brother-in-law was a just a dope for not dragging people into his restaurant, force feeding them, and then pulling whatever amount of money he felt he deserved out of their pockets...and it was all due to the wrong preposition. On not in, that's the ticket. :roll:
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Sell the customer what he wants

Postby Taylor Larimore » Wed Aug 11, 2010 10:35 am

Hi Kyle:

Only a poor business-owner lets his customers tell him what to do.


While working as a loan officer for the Small Business Administration, I received an application from a man who intended to open a "Pet Store" in Fort Lauderdale, Florida.

Upon investigating the applicant, I learned he worked for a tropical fish wholesaler and was probably the most knowledgeable person in South Florida on the subject of tropical fish and their diseases. He had all the qualifications needed by a new business owner. He was experienced, had a substantial personal investment, perfect credit rating, and a good location with a favorable lease. I recommended the loan.

Six months later, I learned my new business owner was late in his loan payment? This surprised me so I made a visit to his pet shop. Here's what I found: The front windows were 100% filled with aquariums and tropical fish despite a large sign on the roof advertising "Pet Shop." I went inside. 80% of the shop contained aquariums and fish supplies. 20% in the back was for dog & cat supplies. This was our conversation (paraphrased):

Taylor: "Why are you behind on your loan payments?"

Borrower: "Sales are slow."

Taylor: "Why"

Borrower: "Few of my customers are interested in tropical fish."

Taylor: "Why not replace most of your aquarium and tropical fish inventory with pet store supplies that your customers want?"

Borrower: "When people understand that raising tropical fish is a great hobby my sales will increase."

Six months later we were forced to liquidate the business.

Lesson learned: Successful business owners provide goods and service that customers want.
"Simplicity is the master key to financial success." -- Jack Bogle
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Re: Sell the customer what he wants

Postby KyleAAA » Wed Aug 11, 2010 10:41 am

Taylor Larimore wrote:Hi Kyle:

Only a poor business-owner lets his customers tell him what to do.


While working as a loan officer for the Small Business Administration, I received an application from a man who intended to open a "Pet Store" in Fort Lauderdale, Florida.

Upon investigating the applicant, I learned he worked for a tropical fish wholesaler and was probably the most knowledgeable person in South Florida on the subject of tropical fish and their diseases. He had all the qualifications needed by a new business owner. He was experienced, had a substantial personal investment, perfect credit rating, and a good location with a favorable lease. I recommended the loan.

Six months later, I learned my new business owner was late in his loan payment? This surprised me so I made a visit to his pet shop. Here's what I found: The front windows were 100% filled with aquariums and tropical fish despite a large sign on the roof advertising "Pet Shop." I went inside. 80% of the shop contained aquariums and fish supplies. 20% in the back was for dog & cat supplies. This was our conversation (paraphrased):

Taylor: "Why are you behind on your loan payments?"

Borrower: "Sales are slow."

Taylor: "Why"

Borrower: "Few of my customers are interested in tropical fish."

Taylor: "Why not replace most of your aquarium and tropical fish inventory with pet store supplies that your customers want?"

Borrower: "When people understand that raising tropical fish is a great hobby my sales will increase."

Six months later we were forced to liquidate the business.

Lesson learned: Successful business owners provide goods and service that customers want.


Agreed, but this is not the same as letting customers tell you what to do. Finding profitable markets is the easy part. Executing in those markets is what matters. I was referring to the execution part whereas with the fish guy, I would say his problem was more in the market research arena.
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Postby Rick Ferri » Wed Aug 11, 2010 11:06 am

I believe one of the biggest mistakes that unsuccessful business owners make is that they try to convert everyone who walks through a door into a customer. That means trying to be all things to all people. It isn't possible. A good business person knows their market, concentrates on that market, and doesn't try to get into other markets they know little about just because a customer (or client) may want them do so.

This is the lesson Warren Buffett learned early on when he first bought Berkshire Hathaway (a textile mill at the time). He didn't know the textile business and didn't make money at it. He ended up closing the business, but kept the name Berkshire Hathaway.

In Taylor's example, with the information he provided, the business owner didn't appear to be marketing his company correctly. It wasn't a pet store owner; he was a tropical fish store owner that specialized in exotic species. If that's the way the business was promoted, perhaps people from all over the country and the world would have contacted him to do business, and he may have been successful.

The lesson is to know what you do well, stick with what you know, and market it correctly. Of course, businesses only make money if expenses are less than revenue. That's been the my key to business success. Although we charge a fraction of our competitors fee, our overhead has always been less that our revenue, and we have profitable every quarter.

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Postby TJAJ9 » Thu Aug 12, 2010 1:08 am

simplesimon wrote:I met Rick at Bogleheads 8. I would've never guessed he was 52 with 3 adult children. Looking good, dude.


I saw Rick in an interview. I thought he was in his mid-40's at the most.

It looks like Rick puts his money where his mouth is, when many others don't practice what they preach...

For example, I personally don't like junk-bonds. Rick recommends them and he actually holds them himself. Good for him.
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Keep it simple

Postby amv » Fri Aug 13, 2010 1:32 pm

I am not sure an investor with access to all available investment tools (including DFA) would want to opt for investment choices listed above.

The combo of total stock index, Bridgeway Ultra Small, and S&P 600 Value is redundant when you consider you can get the same approximate overall size and value exposure with greater simplicity using just the DFA US Core 2 fund. From 96-09, the weighted average returns of the TSM/Micro/SV mix above was +7.5% v +8.2% for the Core 2 index. Issues with Bridgeway's ability to track CRSP 10 (which I used for performance statistics) would further reduce returns.

The combo of MSCI Europe, MSCI Asia, and DFA Int'l Small Value can be replicated much more efficiently using just DFA Int'l Core fund. From 96-09, the 37.5/37.5/25 mix in the OP had a weighted ave. return of +5.3% v +7.0% for the Int'l Core index.

Also, I am not sure how great a substitute Vanguard EM Index is for DFA EM Core, which includes size and value tilts. From 96-09, MSCI EM Index returned +8.3% v +9.9% for the DFA EM Core Index. And, assuming you look to EM stocks for some portfolio diversification and higher expected returns, you are probably better off using developed int'l small value stocks instead, but this is a matter of personal preference.

On the fixed income side, it is questionable whether or not you would want to add longer term bonds (housed within the Total Bond Index) or low quality bonds (in the Vanguard HY Corporate fund). Structurally, you'd be better off taking your risk by holding a higher percentage of stocks (along with safer, shorter term bonds) or tilting the equity portfolio more to small and value stocks.

Finally, I am not sure how helpful it is to add sectors like REITS to a broadly diversified portfolio. If you want higher returns, you are generally better off tilting more towards a diversified basket of smaller and more value oriented stocks. In the case of DFA US and Int'l Core, use US and Int'l Vector instead. If you want lower risk, reduce your exposure to equities and instead increase your bond allocation.

For example, from 96-09, and 80/20 allocation that included 48% US Core 2, 24% Int'l Core, 8% REITS, and 20% 5YR Bonds had a compound return of +8.3% with a standard deviation of 15.8.

If you instead removed the REITS, adjusted your stock/bond split to 76/24, while adopting a 70/30 mix of US and Int'l Vector on the stock side, you'd see your return jump to +9.1% with a standard deviation of 16.0.

If you wanted to get cute, you could split your Int'l allocation evenly between Vector and small value for added diversification, increasing your return over this period to +9.4% with the same volatility.

In general, you are better served by keeping your allocation simple, and structuring your decisions around the Fama/French 3F model exclusively. In general, once you get beyond a US total stock and small value index, Int'l value and small index along with ST bonds, you aren't adding much more than unnecessary complexity.
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Postby Rick Ferri » Fri Aug 13, 2010 1:42 pm

All roads lead to Rome.

Although I will add that DFA Core funds didn't exit until a few years ago. So, what's the point of a hypothetical comparison going back to 1996 using fund returns that didn't happen?

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Re: Keep it simple

Postby amarone » Fri Aug 13, 2010 1:47 pm

Adjusted Market Value wrote:Finally, I am not sure how helpful it is to add sectors like REITS to a broadly diversified portfolio. If you want higher returns, you are generally better off tilting more towards a diversified basket of smaller and more value oriented stocks. In the case of DFA US and Int'l Core, use US and Int'l Vector instead. If you want lower risk, reduce your exposure to equities and instead increase your bond allocation.

For example, from 96-09, and 80/20 allocation that included 48% US Core 2, 24% Int'l Core, 8% REITS, and 20% 5YR Bonds had a compound return of +8.3% with a standard deviation of 15.8.

If you instead removed the REITS, adjusted your stock/bond split to 76/24, while adopting a 70/30 mix of US and Int'l Vector on the stock side, you'd see your return jump to +9.1% with a standard deviation of 16.0.


You are showing an increase in return with a slight increase in risk. According to the analysis in Rick's book, adding REITs gives an increase in return with a significant decrease in risk.
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Postby RaleighStClaire » Fri Aug 13, 2010 5:51 pm

15.8 vs 16.0 is irrelevant noise. 8.3% returns vs 9.1% is not just noise and that's his point.

AMV,

Rick may have large gains in the funds he holds and maybe that's why his portfolio is structured the way that it is. Just trying to rationalize it but overall I agree completely with your analysis on how Rick's portfolio could be optimized.
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Postby amarone » Fri Aug 13, 2010 6:01 pm

RaleighStClaire wrote:15.8 vs 16.0 is irrelevant noise. 8.3% returns vs 9.1% is not just noise and that's his point.

If you added REITs to the level that historically has added 0.8% return to a stock portfolio, you would still get a significant reduction in volatility.
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Postby Lbill » Fri Aug 13, 2010 7:13 pm

With the benefit of backtesting (using Simba's spreadsheet) I find the following with regard to Rick's portfolio for the period of 1985-2009. Since Int Small Cap Value is not available in the spreadsheet, I used 10% in Emerging Market instead of 5%:

1) There is no benefit (increased returns and/or reduced volatility) from splitting the EAFE allocation 50/50 between Europe and Pacific.

2) There is no benefit from putting 5% in microcap vs. adding 5% to SCV.

3) There is no benefit from 8% in REIT vs. adding 8% to SCV.

4) Portfolio performance is better if the 20% bond allocation is entirely in Intermediate Treasuries, rather than split between TBM, TIPS, and HY bonds.

It looks like the same results could have been achieved with a simpler portfolio.
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Postby Call_Me_Op » Fri Aug 13, 2010 7:19 pm

Rick,

What happened to "your age in bonds?" :wink:
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein
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Postby am » Fri Aug 13, 2010 7:40 pm

"It looks like the same results could have been achieved with a simpler portfolio."


How do you know going forward?
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Postby Rick Ferri » Fri Aug 13, 2010 7:49 pm

Lbill wrote:With the benefit of backtesting (using Simba's spreadsheet) I find the following with regard to Rick's portfolio for the period of 1985-2009. Since Int Small Cap Value is not available in the spreadsheet, I used 10% in Emerging Market instead of 5%:

1) There is no benefit (increased returns and/or reduced volatility) from splitting the EAFE allocation 50/50 between Europe and Pacific.

2) There is no benefit from putting 5% in microcap vs. adding 5% to SCV.

3) There is no benefit from 8% in REIT vs. adding 8% to SCV.

4) Portfolio performance is better if the 20% bond allocation is entirely in Intermediate Treasuries, rather than split between TBM, TIPS, and HY bonds.

It looks like the same results could have been achieved with a simpler portfolio.


May have, had you known 15 years ago that small-value was going to perform so well. But what about the NEXT 15 years? Who knows? Maybe SCV will undeperform. I think I'll stick with the more diversified portfolio.

BTW, TIPS didn't exist in 1996.

Rick Ferri

PS. (1) I don't own a plane. (2) I don't do age in bonds because of many reasons. Here is an article on the subject that I co-wrote with Craig L. Israelsen from Brigham Young University:

Is a Pension a Bond?
Unsure how to value a client's pension or social security? Use the liability reduction model.


BTW, Craig has a new book out:

7Twelve: A Diversified Investment Portfolio with a Plan
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Postby Lbill » Fri Aug 13, 2010 8:06 pm

Simpler is better, until proven otherwise. Doesn't make sense to have a more complex portfolio with higher expenses, unless it can be proved that more complex and more expensive = better results. Data have to support theory. Where is the data?
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Postby Rick Ferri » Fri Aug 13, 2010 8:14 pm

Lbill wrote:Simpler is better, until proven otherwise. Doesn't make sense to have a more complex portfolio with higher expenses, unless it can be proved that more complex and more expensive = better results. Data have to support theory. Where is the data?


Proof? If you think 15 years is proof that SCV will outperform micro-cap, REITs, and everything else in the future, then you should probably have 100% SCV in your portfolio. I'm not willing to make that bet.

You call it complex. I call it diversified.


Rick
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Postby nonnie » Fri Aug 13, 2010 8:17 pm

Rick Ferri wrote:All roads lead to Rome.

Although I will add that DFA Core funds didn't exit until a few years ago. So, what's the point of a hypothetical comparison going back to 1996 using fund returns that didn't happen?

Rick Ferri


Rick:
I understand that there may be some capital gain issues that dictate your positions. However, I'm curious about the small amount of DFA Funds in your own portfolio and in the nearly identical portfolios recommended in your books. Yes, DFA Funds expense ratio is generally 50bps higher than ETFs or Vanguard funds but isn't that made up for by the higher returns? Or is it because your books are written for those without access to DFA?

Thanks,
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Postby Rick Ferri » Fri Aug 13, 2010 8:34 pm

I'm curious about the small amount of DFA Funds in your own portfolio and in the nearly identical portfolios recommended in your books.


DFA changed their fund line-up a few years ago so the firm could add significantly more capacity to their advisor business. While doing this, they closed access to their US Small Cap Value and their microcap. That reduced the number of DFA funds we use from 4 to 2.

DFA Funds expense ratio is generally 50bps higher than ETFs or Vanguard funds but isn't that made up for by the higher returns.


That's the undying hope of all DFA investors and advisors. I don't subscribe to the idea the they can make up the higher fee AND add much extra in return, if any. In addition, ETFs are catching up. There's more value-tilted products coming out from the ETF community with far cheaper fees, and that undoubtedly will eat into DFAs market share.

Or is it because your books are written for those without access to DFA?


That's correct also. I assume in my books that do-it-yourself investors don't have DFA access. But as I said, in a couple of years it won't make any different. Similar product will be out there in ETF form that are just as good as anything DFA has in almost every category, net of fees.

Rick Ferri
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Re: Rick Ferri's Own (Index) Portfolio Revealed

Postby DA » Fri Aug 13, 2010 8:35 pm

Code: Select all
8% Vanguard REIT ETF (VNQ)

Rick, with the soon to be approved Vanguard Global ex-U.S. Real Estate ETF will you consider going 4% domestic/4% international real estate?
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Postby Rick Ferri » Fri Aug 13, 2010 8:40 pm

Or perhaps shift to 33% international from 30% by adding 3% to international real estate. I'd reduce elements of US equity by 3% to 67% rather than taking it all from US REITS. (assuming 100% equity).

It's a consideration. No decisions yet. One issue is how bad the foreign withholding tax will be on the int'l real estate ETF.

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Postby Blue » Fri Aug 13, 2010 10:22 pm

Lbill wrote:Simpler is better, until proven otherwise.



Rick Ferri wrote:Proof?


Occam's Razor
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Postby AzRunner » Fri Aug 13, 2010 10:38 pm

simplesimon,

I've met Rick at a couple of Super Bowl of Indexing Conferences and I also was surprised that he is 52. It must be a combination of good genes, clean living and working out.

Norm
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Postby Gmaloof » Fri Aug 13, 2010 10:38 pm

Rick,

For do-it-yourself investors who don't have DFA access is there an adequate Vanguard or ETF replacement for the

5% DFA International Small Cap Value ?

Or just overweight another international category?

TIA.....
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Postby stratton » Sat Aug 14, 2010 2:08 am

Gmaloof wrote:Rick,

For do-it-yourself investors who don't have DFA access is there an adequate Vanguard or ETF replacement for the

5% DFA International Small Cap Value ?

Or just overweight another international category?

TIA.....

No on Intl value. Vanguard's FTSE ex-US smal cap is about as close as it gets with emerging small cap included unlike the DFA fund.

Wisdomtree has a dividend tilted fund small/mid cap intl etf (DLS).

Paul
...and then Buffy staked Edward. The end.
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Postby Sammy_M » Sat Aug 14, 2010 5:49 am

stratton wrote:
Gmaloof wrote:Rick,

For do-it-yourself investors who don't have DFA access is there an adequate Vanguard or ETF replacement for the

5% DFA International Small Cap Value ?

Or just overweight another international category?

TIA.....

No on Intl value. Vanguard's FTSE ex-US smal cap is about as close as it gets with emerging small cap included unlike the DFA fund.

Wisdomtree has a dividend tilted fund small/mid cap intl etf (DLS).

Paul

Also Schwab's RAFI Intl Sm-Mid Index Fund (SFILX). Both have a price/book of about 1.1, but DLS is smaller -- avg mkt cap of 0.94B vs. SFILX at 1.52B.
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Postby dbonnett » Sat Aug 14, 2010 7:34 am

Rick:
You have been investing for quite some time yet you have some relatively new ETFs. There must have been some highly painful taxable events as you switched from funds to etfs. Also you don't seem to have a great fascination for DFA funds as do many other advisers.
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Postby Rick Ferri » Sat Aug 14, 2010 7:47 am

dbonnett wrote:Rick:
You have been investing for quite some time yet you have some relatively new ETFs. There must have been some highly painful taxable events as you switched from funds to etfs. Also you don't seem to have a great fascination for DFA funds as do many other advisers.


dbonnett,

Most of my liquid asset are in tax-sheltered accounts, so taxes weren't an issue. But taxes may not have been an issue anyway. Converting from Vanguard open-end funds to ETF shares are tax-free exchange because your not leaving the fund. In addition, sadly, the 11 year long bear market in US stocks hasn't produce much in long-term capital gains.

I have the same respect for DFA as I do for many fund companies that deliver low-cost passively managed funds. They're good people who work hard and have some fine products. But like the other fund companies I respect, DFA has several good products and then they have their 'filler' products. I learned a long time ago that no fund company is all things to all people in all asset classes. I'm not one-dimensional !

Gmaloof wrote:Rick, For do-it-yourself investors who don't have DFA access is there an adequate Vanguard or ETF replacement for the 5% DFA International Small Cap Value ? Or just overweight another international category? TIA.....

Gmaloof,

As Paul said, WisdomTree has the closest fund today with DLS. The Schwab fund that Sammy mentioned is also fine. Russell has filed with the SEC for an ETF that tracks the global small cap value ex-us benchmark that looks interesting. It covers both developed and emerging markets that will fill the gap for all international small value.

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Postby petrico » Sat Aug 14, 2010 8:00 am

Lbill wrote:With the benefit of backtesting...It looks like the same results could have been achieved with a simpler portfolio.

Hi Lbill,

It's good to see that you got the tense right.

Maybe it's reflective of a generally disagreeable nature (:shock:) , but I tend toward a contrarian position when presented with back-tests showing some enormously tilted portfolio outperforming a market weighted portfolio. Isn't it possible that, through reversion to the mean, the dramatic skew could underperform the market weighting in some future time period? I've learned the hard way to avoid actively managed funds awarded a five-star rating by Morningstar. How different is chasing the best back-tested portfolio from chasing the latest five-star fund with a rock star manager?

Several references in the article noted Rick's intent to more closely match the general economy, which is only partly covered by the investable stock market. It seems like the focus was broadly diversifying, rather than narrowly cherry-picking sectors that have outperformed. Without the benefit of divine wisdom, being better diversified sounds like a safer approach to me (if you don't want to take the chance on actually underweighting the best back-tested sectors).

While the optimum portfolio for any one person's investing horizon cannot be known in advance (hope there's no disagreement on that), and many experts advise us to focus instead on establishing a proper risk profile and then sticking with whatever portfolio we can get comfortable with, it was still reassuring to see that Rick’s sub-allocations resembled my own.

Code: Select all
                          Rick’s Portfolio   petrico’s portfolio
                          ----------------   -------------------
           Total Stock Market Index 42.50%   47.14% Total Stock Market Index
       S&P SmallCap 600 Value Index 12.50%    7.14% Small Cap Blend Index
          Ultra-Small Company Market 6.25%
                               REIT 10.00%   14.29% REIT
                      Pacific Index 8.125%
                     European Index 8.125%   14.29% Developed Market Index
      International Small Cap Value 6.250%    8.57% International Small Cap Index
              Emerging Markets Core 6.250%    8.57% Emerging Markets Index

                                  18 18 17    20 20 19
                                   7  7  4     9  9  8
                                  11 11  6     6  5  5

                           No. America 72%    68% No. America
                       UK/West. Europe 12%    14% UK/West. Europe
                                  Japan 7%     6% Japan
                          Latin America 2%     2% Latin America
                          Asia ex-Japan 8%     8% Asia ex-Japan
                                  other 1%     2% other

                               Yield 2.24%    2.15% Yield
                           Price/Book 1.58    1.74 Price/Book
              Avg. Market Cap (mil) $8,062    $11,902 Avg. Market Cap (mil)

I designed my portfolio before reading anything by Rick. Some of you may be smart enough and knowledgeable enough to do your own research rivaling that of the published authors and experts in the field. But for me, this kind of thing helps me stay-the-course. (The 30% fixed income allocation doesn’t hurt, either.)

Again, thanks Rick! You didn't need to show us your portfolio, but I'm thankful you did.

--Pete
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Postby Rick Ferri » Sat Aug 14, 2010 8:05 am

Pete,

Great post! Thanks for your input.

Rick
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Postby tadamsmar » Sat Aug 14, 2010 8:30 am

Adrian Nenu wrote:Here's my current portfolio (rounded off, 100% in stocks):



US - 42.6%

Dreyfus Small Cap Index - 12% (tax deferred 457 plan)

Dreyfus Midcap Index - 9% (tax deferred 457 plan)

Dreyfus S&P 500 index - 7.2% (tax deferred 457 plan)

Vanguard Total Stock Market Index - 6.8% (taxable account)

Vanguard REIT Index - 7.6% (Roth IRA)




International - 57.4%

Dreyfus International Stock Index - 25% (tax deferred 457 plan)

Vanguard Emerging Markets Index - 22.8% (taxable account & Roth IRA)

Vanguard FTSE All World ex US - 4.6% (taxable account)

Vanguard FTSE All World ex US Small Cap - 5% (Roth IRA)



Adrian
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Do you preach not practicing what you preach, or do you just practice it?
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Postby Lbill » Sat Aug 14, 2010 8:36 am

Not enormously tilted. You would end up with 23% SCV instead of 10% SCV, 8% REIT, and 5% MC. But there is an enormous correlation between SCV, REIT, and MC. One reason is that SCV holds about 15% in REIT already. Another is that they share the same Fama-French risk factors: small and value, so you are exposed to the same risks either way; except holding one fund instead of 3 is an easier and cheaper way to do it. Simpler is better, until proven otherwise. (BTW, the time period I looked at was 25 years and not 15 years - which is good enough for me). Lots of convincing theories about what to invest in - I prefer to see some data to back up the theory. Otherwise, we can just argue theory until the most persuasive debater wins. Granted that backtesting isn't ideal, but I'd at least like some backtesting support for my theory as a minimum.
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Postby Adrian Nenu » Sat Aug 14, 2010 9:11 am

Do you preach not practicing what you preach, or do you just practice it?


You make a valid point and I'll attempt to explain my actions. My situation is very different than that of 99% of investors and I did not recommend that anyone follow my example for that reason. I did consider the consequences of a 50% drop in stock prices on my retirement plans and my 100% equity portfolio. I could have lied and stated that I hold 50/50 to avoid criticizm and accusations that I don't follow my own advice but that's not my character. I knew I was going to take some heat if I posted it here, which I did at that time.

FYI, my portfolio was 60/40 "buy & hold" from 1995 until late 2008. I decided to take advantage of the latest bear market and use the 40% bond allocation to DCA into stocks until it reached 100%. I reached 100% equity in mid March, 2009 and have continued to buy more via periodic contributions to my 457 plan and Roth IRA. This is a temporary asset allocation change. My plan is to DCA back into bonds to reach 50/50 once there are some definite signs the economy is starting to improve and interest rates begin heading up.

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Postby stratton » Sat Aug 14, 2010 9:45 am

Adrian Nenu wrote:
Do you preach not practicing what you preach, or do you just practice it?


You make a valid point and I'll attempt to explain my actions. My situation is very different than that of 99% of investors and I did not recommend that anyone follow my example for that reason. I did consider the consequences of a 50% drop in stock prices on my retirement plans and my 100% equity portfolio. I could have lied and stated that I hold 50/50 to avoid criticizm and accusations that I don't follow my own advice but that's not my character. I knew I was going to take some heat if I posted it here, which I did at that time.

FYI, my portfolio was 60/40 "buy & hold" from 1995 until late 2008. I decided to take advantage of the latest bear market and use the 40% bond allocation to DCA into stocks until it reached 100%. I reached 100% equity in mid March, 2009 and have continued to buy more via periodic contributions to my 457 plan and Roth IRA. This is a temporary asset allocation change. My plan is to DCA back into bonds to reach 50/50 once there are some definite signs the economy is starting to improve and interest rates begin heading up.

Then you've probably done quite well and captured most of the potential upside.

Good guess on the "back up the truck stocks are on SALE!"

Paul
...and then Buffy staked Edward. The end.
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Postby Adrian Nenu » Sat Aug 14, 2010 10:06 am

Good guess on the "back up the truck stocks are on SALE!"


That's basically what I did. Back in late 2008/early 2009, the whole world seemed to be collapsing and unfortunately some people were not able to stay with their plans and sold at the worst possible time, locking in their losses. In all fairness, nobody suspected back then that the markets would recover some of the loses as fast as they did. Goes to show that stocks are very, very risky and point of entry/valuations matter.

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Postby Lbill » Sat Aug 14, 2010 10:17 am

Adrian - will you reduce your 100% stock allocation before the next crash too?
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Postby Adrian Nenu » Sat Aug 14, 2010 10:29 am

Adrian - will you reduce your 100% stock allocation before the next crash too?


I wish I knew when the next crash will happen! The risk is that there will be another major crash before I reach 50/50. I'll post when I start DCAing back into bonds.

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Postby amv » Sat Aug 14, 2010 11:09 am

Rick Ferri wrote:All roads lead to Rome.

Although I will add that DFA Core funds didn't exit until a few years ago. So, what's the point of a hypothetical comparison going back to 1996 using fund returns that didn't happen?
Rick Ferri


It doesn't matter if the fund was "available" in 1996. The index and its general approach is simply trying to offer broad based exposure to the market with an increased emphasis on small cap and value risks and expected returns--something that was well documented back then. The S&P 600 Value's current methodology wasn't in place in 1996 either, nor was BRSIX around. Yet by studying the behavior of the indexes they attempt to track, we can measure over longer (but still inadequate) periods of time their relative success/failure in achieving their targeted objectives. The alternative I guess, which is using 36 months or so of "live" data is simply unacceptable for most reasonable investors.

Rick Ferri wrote:...had you known 15 years ago that small-value was going to perform so well. But what about the NEXT 15 years? Who knows? Maybe SCV will undeperform. I think I'll stick with the more diversified portfolio.
Rick Ferri

No 15 year period guarantees us of anything, but history provides a worthwhile guide. To that extent, the average 15 year outperformance of small value over a total stock index from 1928-1995 was 4.9%. Since 1996, DFAs Small Value fund has outstripped the Russell 3000 by 4.4%. A pretty average 15 year period by historical perspectives.

Also, for someone who is willing to put an 80% "bet" on the equity risk premium, it is a curious stance to take to seem so uncertain of the other two "risks" in the Fama/French 3 Factor model. The fact is, since 1928 over all 15 year calendar periods (68 total), small value has outpaced TSM during 60 of them. Over these same 68 periods, TSM has bested 5YR bonds 61 times. On an annualized basis, TSM has outperformed (5YR) bonds by 4% per year. Small value has outperformed TSM by 3.8% per year.

Treating these decisions as anything other than different considerations with equal importance within the same general framework is very contradictory of the academic research, real world evidence, and just plain common sense.

Rick Ferri wrote:...DFA changed their fund line-up a few years ago so the firm could add significantly more capacity to their advisor business. While doing this, they closed access to their US Small Cap Value and their microcap. That reduced the number of DFA funds we use from 4 to 2.
Rick Ferri


The first part of this quote is purely speculation on your part. The later is just wrong: DFSVX and DFSCX are only closed to new advisors that gained access to DFA after the funds closed.

Rick Ferri wrote:... assume in my books that do-it-yourself investors don't have DFA access. But as I said, in a couple of years it won't make any different. Similar product will be out there in ETF form that are just as good as anything DFA has in almost every category, net of fees.
Rick Ferri


For someone who has such an irrational pessimism of how markets really work (your obvious sketicism of the FF 3 Factor model), you seem very sure of these as-of-yet seen, make believe investment products and their ability to deliver these hypothetical results.
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Postby rustymutt » Sat Aug 14, 2010 11:14 am

Adrian Nenu wrote:
Adrian - will you reduce your 100% stock allocation before the next crash too?


I wish I knew when the next crash will happen! The risk is that there will be another major crash before I reach 50/50. I'll post when I start DCAing back into bonds.

Adrian
anenu@tampabay.rr.com


Are we now investing to avoid crashes? Are crashes the norm now? How many major crashes has our market suffered since 1933? I'm thinking about the next major bull market myself.
At the Very Least, Work Hard, Do Your Best, Know the Truth and the Facts and Always Be Honest!
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Postby amv » Sat Aug 14, 2010 11:24 am

petrico wrote:
Lbill wrote:With the benefit of backtesting...It looks like the same results could have been achieved with a simpler portfolio.

Hi Lbill,

It's good to see that you got the tense right.

Maybe it's reflective of a generally disagreeable nature (:shock:) , but I tend toward a contrarian position when presented with back-tests showing some enormously tilted portfolio outperforming a market weighted portfolio. Isn't it possible that, through reversion to the mean, the dramatic skew could underperform the market weighting in some future time period? I've learned the hard way to avoid actively managed funds awarded a five-star rating by Morningstar. How different is chasing the best back-tested portfolio from chasing the latest five-star fund with a rock star manager?

Several references in the article noted Rick's intent to more closely match the general economy, which is only partly covered by the investable stock market. It seems like the focus was broadly diversifying, rather than narrowly cherry-picking sectors that have outperformed. Without the benefit of divine wisdom, being better diversified sounds like a safer approach to me (if you don't want to take the chance on actually underweighting the best back-tested sectors).

While the optimum portfolio for any one person's investing horizon cannot be known in advance (hope there's no disagreement on that), and many experts advise us to focus instead on establishing a proper risk profile and then sticking with whatever portfolio we can get comfortable with, it was still reassuring to see that Rick’s sub-allocations resembled my own.

Code: Select all
                          Rick’s Portfolio   petrico’s portfolio
                          ----------------   -------------------
           Total Stock Market Index 42.50%   47.14% Total Stock Market Index
       S&P SmallCap 600 Value Index 12.50%    7.14% Small Cap Blend Index
          Ultra-Small Company Market 6.25%
                               REIT 10.00%   14.29% REIT
                      Pacific Index 8.125%
                     European Index 8.125%   14.29% Developed Market Index
      International Small Cap Value 6.250%    8.57% International Small Cap Index
              Emerging Markets Core 6.250%    8.57% Emerging Markets Index

                                  18 18 17    20 20 19
                                   7  7  4     9  9  8
                                  11 11  6     6  5  5

                           No. America 72%    68% No. America
                       UK/West. Europe 12%    14% UK/West. Europe
                                  Japan 7%     6% Japan
                          Latin America 2%     2% Latin America
                          Asia ex-Japan 8%     8% Asia ex-Japan
                                  other 1%     2% other

                               Yield 2.24%    2.15% Yield
                           Price/Book 1.58    1.74 Price/Book
              Avg. Market Cap (mil) $8,062    $11,902 Avg. Market Cap (mil)

I designed my portfolio before reading anything by Rick. Some of you may be smart enough and knowledgeable enough to do your own research rivaling that of the published authors and experts in the field. But for me, this kind of thing helps me stay-the-course. (The 30% fixed income allocation doesn’t hurt, either.)

Again, thanks Rick! You didn't need to show us your portfolio, but I'm thankful you did.

--Pete


Pete,

You are making a few mistakes (IMO) in your post above. Equating the luck of some random active manager to select superior securities within a defined universe of holdings or to move in/out of the markets at the perfect time are very, very different considerations than studying the long term nature of risk and return across global stocks and bonds and allocating capital passively according to the findings.

In the former example, you are letting 'lady luck' dictate most of your outcome. In the later, you acknowledge the long term relationship between risk and return, and develop a portfolio that most closely matches your need for real accumulation with your tolerance for uncertainty. Doing so in a passive, methodical way is called investing, not the speculation you seem to want to lump in with it.

Also, what is the benefit or usefullness of structuring a portfolio to match the general characteristics of the economy? We know that relative economic growth is a poor indicator of future relative returns, so why build a portfolio to match an outline with so liltte relevance to actual investment results?

Instead, as I mentioned above, use a combination of academic research, historical perspective, and common sense to measure how markets work (i.e. the dimensions of risk and return) and build a simple structured allocation based on a few key/timeless considerations that provide you with the highest likelyhood of achieving your targets. The Fama/French 3 Factor model should be the compass of choice.
Last edited by amv on Sat Aug 14, 2010 11:27 am, edited 2 times in total.
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Postby Adrian Nenu » Sat Aug 14, 2010 11:26 am

Are we now investing to avoid crashes?


All investors should account for market crashes when deciding their specific stock/bond mix. The standard deviation risk of loss formula is:

(1- SD) to the power of the years in question.

Are crashes the norm now?


Crashes have, are, and will always be the norm. People in the financial industry don't like to talk about them because it hurts sales.

How many major crashes has our market suffered since 1933?


The noteworthy ones are 1929-1932 (89% loss), 1973-1974 (48% loss), 2000-2003 (45% loss), 2008-2009 (57% loss).

Based on these bear market losses, I created my risk of loss asset allocation formula:

Tolerable Loss x 2 = Equity Allocation < 50%

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Re: Keep it simple

Postby amv » Sat Aug 14, 2010 11:49 am

amarone wrote:
Adjusted Market Value wrote:Finally, I am not sure how helpful it is to add sectors like REITS to a broadly diversified portfolio. If you want higher returns, you are generally better off tilting more towards a diversified basket of smaller and more value oriented stocks. In the case of DFA US and Int'l Core, use US and Int'l Vector instead. If you want lower risk, reduce your exposure to equities and instead increase your bond allocation.

For example, from 96-09, and 80/20 allocation that included 48% US Core 2, 24% Int'l Core, 8% REITS, and 20% 5YR Bonds had a compound return of +8.3% with a standard deviation of 15.8.

If you instead removed the REITS, adjusted your stock/bond split to 76/24, while adopting a 70/30 mix of US and Int'l Vector on the stock side, you'd see your return jump to +9.1% with a standard deviation of 16.0.


You are showing an increase in return with a slight increase in risk. According to the analysis in Rick's book, adding REITs gives an increase in return with a significant decrease in risk.


Its a common misconception a lot of people have. When you add just about any sector to a total stock index portfolio, it may improve historical portfolio efficiency assuming the sector tends towards a smaller or more value oriented tilt. Same is true of heathcare, utilities, or many other groups. That doesn't mean it should be done. What drives returns is your stock/bond split, and within the stock market, your size and value orientation.

The truth is, using sectors (like techonology in the 90s or real estate in the 00s), overweighting the riskiest and most underdeveloped emerging economies, or dicing up the fixed income market into low quality or longer duration holdings are part of a general trend that was adopted by independent financial advisors over the last 10 to 15 years who otherwise do the right thing for their clients by embracing passive principals.

Unfortunately, simple/straightforward portfolios don't "sell", and telling an investor the primary reason to hire an advisor is to promote good behavior is a tough ticket for the average individual that struggles with overoptimism in all walks of life. The result? Developing very complicated passive portfolios with a dozen or more "asset classes" designed to confuse/overwhelm the average investor into thinking they need to hire a professional to achieve such elegant (read: redundant) "diversification".

Don't believe the hype.
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Postby Lbill » Sat Aug 14, 2010 12:35 pm

This REIT vs. SCV has been debated many times before on the forum. I recall specifically the discussion between Rick and SmallHi in this thread:

http://www.bogleheads.org/forum/viewtopic.php?t=10413&highlight=

SmallHi took the position that once your small and value tilt is taken care of, adding REITS per se doesn't do much. I was impressed with his arguments and came to feel that tilting to SCV was enough and the added trouble and expense of buying and rebalancing a REIT holding probably wasn't worth it. I sorta feel the same way about microcap. These would be way down at the bottom of my list of things that impact on overall portfolio results.
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Postby petrico » Sat Aug 14, 2010 1:06 pm

Adjusted Market Value wrote:Pete,

You are making a few mistakes (IMO) in your post above. Equating the luck of some random active manager to select superior securities within a defined universe of holdings or to move in/out of the markets at the perfect time are very, very different considerations than studying the long term nature of risk and return across global stocks and bonds and allocating capital passively according to the findings.

In the former example, you are letting 'lady luck' dictate most of your outcome. In the later, you acknowledge the long term relationship between risk and return, and develop a portfolio that most closely matches your need for real accumulation with your tolerance for uncertainty. Doing so in a passive, methodical way is called investing, not the speculation you seem to want to lump in with it.

Also, what is the benefit or usefullness of structuring a portfolio to match the general characteristics of the economy? We know that relative economic growth is a poor indicator of future relative returns, so why build a portfolio to match an outline with so liltte relevance to actual investment results?

Instead, as I mentioned above, use a combination of academic research, historical perspective, and common sense to measure how markets work (i.e. the dimensions of risk and return) and build a simple structured allocation based on a few key/timeless considerations that provide you with the highest likelyhood of achieving your targets. The Fama/French 3 Factor model should be the compass of choice.
Hi AMV.

First, thanks for your consideration of my thoughts.

On the comparison made to chasing the latest hot fund, I'm not sure we're talking about the same thing. I was referring to allocating based on back-testing, not the more comprehensive "studying the long term nature of risk and return across global stocks and bonds and allocating capital passively according to the findings" you described. I wasn't intending to imply that Lbill misuses back-testing either, just that I've seen it done here. ("Adding x% of this sector, and y% of that sector produces -- with an "s", not produced, with a "d" -- z% return with v volatility.) Back-testing should be thoroughly qualified whenever it is used to justify an allocation. I still think an over-reliance on back-tested portfolios is a seriously flawed approach.

On matching the characteristics of the economy, again, we might be thinking about different things. Maybe I'm reading too much into the brief phrases used in the article, but my interpretation was that Rick was talking about the difference between the publicly traded market, and the complete universe of combined public and private equity that exists. Let's take REITs as an example. Vanguard published a paper on the use of REITs that included a quantification of the amount of privately held real estate. If memory serves, total real estate holdings amounted to roughly 12% of the combined public and private markets of stocks, bonds and real estate. By that metric, the measly share of the public market dedicated to real estate significantly underweights its overall share of the complete market.

On the FF 3 Factor model, I'm sorry to admit that I haven't read extensively on that yet. From what I have read, the explanation for the value premium remains elusive. One thing to ask is, "What would happen if it turns out to be wrong?" For the time being, I'm far more comfortable with a portfolio that more closely follows market weightings, with a conscious but limited small cap tilt.

--Pete

PS: I'm sure I'm making more than a few mistakes. But I like to remember what my favorite, most engaging math teacher used to say: "If you're not making mistakes, you're not doing anything!"
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Postby Lbill » Sat Aug 14, 2010 1:50 pm

But I like to remember what my favorite, most engaging math teacher used to say: "If you're not making mistakes, you're not doing anything!

Thanks Petrico for the considerate tone of your comments. You reminded me of what a favorite teacher of mine once said to help me from getting lost in small details (which I typically do): "If a man running for his life wouldn't notice, then it probably isn't really that important." I gotta remember that. :)
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Postby Beagler » Sat Aug 14, 2010 4:18 pm

Rick Ferri wrote:You call it complex. I call it diversified.


Now that's a great line.
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Postby Beagler » Sat Aug 14, 2010 4:23 pm

jeffyscott wrote:I've never run a business and never would want to, I am far too lazy and risk averse for that, but I always laugh at the "be your own boss" mythology.


jeffyscott wrote:I guess I'm destitute and probably should switch to eating cat food by the standards around here.


It was interesting to see these two posts within the same thread.
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