Question to Rick Ferri: Asset Allocation

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Question to Rick Ferri: Asset Allocation

Postby sps » Thu Mar 15, 2007 10:43 am

Hi Rick,

I'm currently reading your 'All About Asset Allocation'. I have read many books that are being suggested in this forum, still I can find new concepts to pick up from your book.

Now to the question:
Your early saver slice-dice portfolio recommendation is:

Asset Allocation for 70% Stocks/30% Bonds ratio
25% Total US
10% US Small Value
5% US Micro Cap
...
...


My question is specific to the US equity allocation: I'd like to know why you chose 25% of allocation for Total US and tilting towards Small Value (10%) and Micro (5%), instead of four equal portions of slice & dice of Large Core, Large Value, Small Core and Small Value? The question is not about Micro allocation but about why do you think TSM is better than a slice and dice of equal weight of Large Core, Large Value and Small Core.

Thanks in advance,

- SPS
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Postby orthros » Thu Mar 15, 2007 11:34 am

I have a follow up. I have your book but haven't read it yet (still reading the Bogleheads Guide and a Paul Merriman book :o ) so apologies if this is covered.

How do you invest in Micro Caps and International LV/SV within Vanguard funds?

TIA,

O
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Postby MattBrennan » Thu Mar 15, 2007 11:59 am

Hi Orthos,

If my recollection is correct, I believe that in the past Rick had referenced using DFA (or perhaps Bridgeway) for micro-cap. Vanguard does not have a micro-cap fund.

Regards,

Matt
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Postby yobria » Thu Mar 15, 2007 10:36 pm

SPS,

I'm guessing Rick's rationale would be:

-Micro, b/c the small premium exists mostly in the smallest stocks (at least according to some datasets). It's certainly shown up in the past few years.

-No small blend, since that contains small growth which the FF data shows you want to avoid

-Plenty of TSM, since the S/V premia may fail to show up during your time horizon, and an all SV port wouldn't be diversified (only 3% or so of the US market). Can also rebalance SV with TSM.

-No LV since you can get both small and value loads in a simpler more tax efficient package with just SV/TSM.

Much of this goes back to how much you believe in each premium going forward.

Nick
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Postby Pincher Martin » Thu Mar 15, 2007 10:59 pm

orthros wrote:I have a follow up. I have your book but haven't read it yet (still reading the Bogleheads Guide and a Paul Merriman book :o ) so apologies if this is covered.

How do you invest in Micro Caps and International LV/SV within Vanguard funds?

TIA,

O


Rick uses Bridgeway Ultra Small Company Market fund (BRSIX) for his examples in the book. See the chapter called "Building your Portfolio."
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Allocate and FORGETABOUTIT!

Postby Rick Ferri » Fri Mar 16, 2007 12:21 am

I suppose my first question back would be why a four equal slice & dice portfolio of Large Core, Large Value, Small Core and Small Value? Why do you think that is efficient? It is not.

My method is pretty simple. Using TSM as the core, I get some exposure to all market caps and can easily adjust the tilt to value and small cap using a small value fund and a micro cap fund (you can even drop the micro cap if you want).

Using the TSM as the starting point and adding small and value tilts as desired is the correct way to engineer a portfolio of index funds using the Fama/French three factor model. That is the way FF envisioned the method to work. A simple study of the FF research makes is point clear.

Let's face the facts. The 4X25 idea came about because DFA does not have a total stock market fund, so advisors could not build a classic FF portfolio using an All DFA portfolio. Nonetheless, a few enterprising investment advisors who are heavy promoters of DFA funds slapped together the 4x25 idea and sold that as "The Model".

The problem is, the 4x25 is not a good model. It is certainly not DFA's model, and the advisors who came up with it did not do any research on it, and from a practical standpoint and cost standpoint it does not make much sense. BUT, from a marketing standpoint, it makes great spin. It sells portfolio management services for those advisors who gain business by marketing their access to DFA, and that is what those advisors really care about.

Rick Ferri

PS. On this new forum, I am going to be brutally honest. Most of the stuff you see about optimal allocation is garbage. It is trash. In the long run, the best allocation is typically the lowest cost one. That is the truth. You only need a few asset classes in your portfolio, and after that there are diminishing returns. The mutual funds you choose to represent those asset classes should be the lowest cost funds you can buy.

All of this nonsense about finding the ideal allocation is non-sense. The ideal portfolio can only be known in retrospect. We can only know what we should have done, not what will happen. So, choose a few low cost index funds in different asset classes, rebalance occasionally, and forgetaboutit.
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Postby 4th&Goal » Fri Mar 16, 2007 12:37 am

"So, choose a few low cost index funds in different asset classes, rebalance occasionally, and forgetaboutit." (Rick Ferri)

Rick,

If I rebalance occasionally can I forget about this portfolio:

20% Vanguard TIPS
20% Vanguard Short-Term Treasury
30% Vanguard Total Stock Market
15% Fidelity Spartan International Index
15% TIAA Real Estate

Semper Fi,
Mike
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Postby LH » Fri Mar 16, 2007 2:40 am

What constitutes a few? Would three classes be equivalent to 8? I cannot remember if it was Rick Ferri's book per se, I thought Rick stated that owning japan/asia index and a Euro fund is better than EAFE alone, because then you could rebalance? Where do the diminishing returns come in? I would think that 8 classes would be better than 3. But maybe not?

Thanks,

LH
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Postby bilperk » Fri Mar 16, 2007 7:30 am

Hi LH:

I think you are reading the first post too literally. It only shows 3 asset classes because that is what the poster wanted to discuss; the domestic equity part of the portfolio.

The total portfolio is 70% equities. it contained 8 equity classes/sub-classes and 4 bond sub-classes.

25% US Core
10% Sm Val
5% Micro-cap
10% REIT
5% each pacific rim-large, Europe-large, international small, and EM

10% investment Gr
10% High Yield
5% Inflation protected
5% EM bonds
Bill
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There are many roads to Dublin.

Postby Rick Ferri » Fri Mar 16, 2007 9:49 am

4th and Goal

That is a great portfolio to FORGETABOUT.

Semper Fi,
Rick Ferri
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Rick ..

Postby sps » Fri Mar 16, 2007 10:51 am

I suppose my first question back would be why a four equal slice & dice portfolio of Large Core, Large Value, Small Core and Small Value? Why do you think that is efficient? It is not.

Rick, Based on some of the stuff I read .. Coffeehouse portfolio, Paul Merriman's (FundAdvice.com) Portfolio and I have seen some others on this forum going with 4x25 equal weight Slice & Dice. So I was curious as to why you suggested a TSM and tilt towards small value.

Using the TSM as the starting point and adding small and value tilts as desired is the correct way to engineer a portfolio of index funds using the Fama/French three factor model. That is the way FF envisioned the method to work. A simple study of the FF research makes is point clear.

However I see that you have tilted only towards Small Value and not towards Large Value. Can you please explain your reasoning of leaving Large Value out?

On the same note, Nick in his response said
"No LV since you can get both small and value loads in a simpler more tax efficient package with just SV/TSM."

Rick/Nick, if there is a place in the tax sheltered accounts would you then recommend Large value?

Thanks to all,

- SPS
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Re: Allocate and FORGETABOUTIT!

Postby Bylo Selhi » Fri Mar 16, 2007 12:03 pm

Rick Ferri wrote:Most of the stuff you see about optimal allocation is garbage. It is trash. In the long run, the best allocation is typically the lowest cost one. That is the truth. You only need a few asset classes in your portfolio, and after that there are diminishing returns. The mutual funds you choose to represent those asset classes should be the lowest cost funds you can buy.

All of this nonsense about finding the ideal allocation is non-sense. The ideal portfolio can only be known in retrospect. We can only know what we should have done, not what will happen. So, choose a few low cost index funds in different asset classes, rebalance occasionally, and forgetaboutit.

I think all that bears repeating.

Moreover, even if someone wants to S&D it seems to me that TSM should be a core holding with LV and SV added to taste because that's both the lowest cost and the most tax-efficient way to implement either a TSM-only or an S&D strategy.
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Large Value

Postby Rick Ferri » Fri Mar 16, 2007 1:45 pm

SPS,

I am repeating what other people have already said. But it is all about the cost proposition. Size is size is size and value is value is value. How can you reduce portfolio cost and still get the same size and value exposure?

If I can kill two birds with one stone and buy a small cap value fund, then there is no reason to own a higher cost large cap value fund. I suppose if you wanted a very value heavy portfolio that you would need a LV fund, but as we speak, the TSM is large cap value heavy anyway. So at least today there is no need for LV.

There are many roads to Dublin.

Rick Ferri
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Tend to agree with Rick on this one

Postby SmallHi » Fri Mar 16, 2007 3:16 pm

A TSM/SV US portfolio will not cost you much, if any, over your lifetime versus a 4 corner portfolio. I don't think there is anything fundamentally wrong with a 4 fund US allocation, thats not what I am saying. Just, if I owned TSM, my second, and probably only addition would be SV in the US.

I am of the school that after you get past 5 funds, you really aren't doing much. Some periods will prove other additions helpful, or not.

They are: US TSM (VTI), US SV (RPV), Int'l LV (EFV), Int'l SC (DLS), and ST Inv. Grade unless you are in the TOP tax bracket, then Ltd. Term Muni instead.

I maybe on the lookout for a slightly better Int'l Small offering (thats a bit smaller mkt cap wise), but I wouldn't loose a lot of sleep over it.

If you really like the value stuff, and have discipline and nerves of steel, I think you'd be OK with substituting VTI and RPV above for IWD and IWN.

Must have that SmallHi though!

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Re: Allocate and FORGETABOUTIT!

Postby Murray Boyd » Fri Mar 16, 2007 4:42 pm

Rick Ferri wrote:Most of the stuff you see about optimal allocation is garbage. It is trash. In the long run, the best allocation is typically the lowest cost one. That is the truth. You only need a few asset classes in your portfolio, and after that there are diminishing returns. The mutual funds you choose to represent those asset classes should be the lowest cost funds you can buy. ... choose a few low cost index funds in different asset classes, rebalance occasionally, and forgetaboutit.
Right on!
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Thanks! Rick

Postby sps » Fri Mar 16, 2007 7:59 pm

Rick, thank you for your responses, helped me understand the concept a bit better.

Thanks,

- SPS
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Re: Allocate and FORGETABOUTIT!

Postby NORTON » Sat Mar 17, 2007 12:13 am

Rick Ferri wrote:All of this nonsense about finding the ideal allocation is non-sense. The ideal portfolio can only be known in retrospect. We can only know what we should have done, not what will happen. So, choose a few low cost index funds in different asset classes, rebalance occasionally, and forgetaboutit.


BIG TIME THANKS RICK ... the above quote has finally turned on the light for me when it comes to long term investing :D

My golden rules of investing now read:

Rule #1: Choose a few low cost index funds in different asset classes, rebalance occasionally, and forgetaboutit

Rule #2: See Rule #1


Thanks Again, Stan
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Something to Remember

Postby FEDFERS » Sat Mar 17, 2007 4:14 am

Most of the stuff you see about optimal allocation is garbage. Trash. In the long run, the best allocation is typically the lowest cost one. That is the truth. You only need a few asset classes in your portfolio, and after that... diminishing returns. The mutual funds you choose... should be the lowest cost funds you can buy.

Finding the ideal allocation is non-sense. The ideal portfolio can only be known in retrospect. We can only know what we should have done, not what will happen. So, choose a few low cost index funds in different asset classes, rebalance occasionally, and forgetaboutit.
Wow! What an eye opening kick in the pants! If I ever wanted a quote for a sig, this would be it. Hmmm, maybe on a shirt for the DH meeting.
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Postby richard » Sat Mar 17, 2007 11:14 am

Fama-French said that exposure to market, size and value factors are all that matters. It doesn't matter whether you use TSM+SV or S+D or whatever. TSM+SV is better than something more complicated, due to costs (including tax costs) and simplicity. Fama has said TSM is fine unless you have some reason to want to try for more equity return at the cost of higher risk. Changing stock/bond ratio would also get more expected return at the cost of higher risk.

Add me as another supporter of Rick's statement.
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Re: Something to Remember

Postby NORTON » Sat Mar 17, 2007 12:09 pm

FEDFERS wrote:
Most of the stuff you see about optimal allocation is garbage. Trash. In the long run, the best allocation is typically the lowest cost one. That is the truth. You only need a few asset classes in your portfolio, and after that... diminishing returns. The mutual funds you choose... should be the lowest cost funds you can buy.

Finding the ideal allocation is non-sense. The ideal portfolio can only be known in retrospect. We can only know what we should have done, not what will happen. So, choose a few low cost index funds in different asset classes, rebalance occasionally, and forgetaboutit.
Wow! What an eye opening kick in the pants! If I ever wanted a quote for a sig, this would be it. Hmmm, maybe on a shirt for the DH meeting.


Put me down for two of those shirts in XL :D
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Re: Allocate and FORGETABOUTIT!

Postby craigr » Sat Mar 17, 2007 12:50 pm

Rick Ferri wrote:PS. On this new forum, I am going to be brutally honest. Most of the stuff you see about optimal allocation is garbage. It is trash. In the long run, the best allocation is typically the lowest cost one. That is the truth. You only need a few asset classes in your portfolio, and after that there are diminishing returns. The mutual funds you choose to represent those asset classes should be the lowest cost funds you can buy.

All of this nonsense about finding the ideal allocation is non-sense. The ideal portfolio can only be known in retrospect. We can only know what we should have done, not what will happen. So, choose a few low cost index funds in different asset classes, rebalance occasionally, and forgetaboutit.


Rick, are you converting to the dark side? If you're not careful DFA will take your secret decoder ring away.
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Re: Allocate and FORGETABOUTIT!

Postby Hydroman » Sat Mar 17, 2007 2:24 pm

Rick Ferri wrote:I

PS. On this new forum, I am going to be brutally honest. Most of the stuff you see about optimal allocation is garbage. It is trash. In the long run, the best allocation is typically the lowest cost one. That is the truth. You only need a few asset classes in your portfolio, and after that there are diminishing returns. The mutual funds you choose to represent those asset classes should be the lowest cost funds you can buy.



I do not see anything wrong with the recommended portfolios in your book, but I do not see them as any more or less cost efficient then the Coffeehouse portfolio. Why don't you apply the same simplicity to the international? Instead of investing in 4 funds, why not just invest in VG Total International or maybe Total International and International Value. One international fund will be more cost efficient then 4 funds. Same thing on the bond side. I think you recommend splitting it 4 ways. Why not go with something like VG Total Bond Market or split it between TBM and TIPS?

Thanks
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Postby Rick Ferri » Sat Mar 17, 2007 2:37 pm

VG Total International or maybe Total International and International Value. One international fund will be more cost efficient then 4 funds


In All About Asset Allocation I have several examples of using one fund. It is convenient, but if you have more time, here are a few reasons for slice and dice:

1) Using Vanguard ETFs is less costly than one investor class fund, plus no redemption fees or loss of foreign withholding taxes.
2) Having fixed allocations between Europe, Pacific, EM diversifies currencies better than one fund.
3) The rebalancing of those currencies could provide a diversification benefit in the future as it has in the past.

For complete information, see Chapter 7 of All About Asset Allocation.

Rick Ferri
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More Questions

Postby tetractys » Sat Mar 17, 2007 5:09 pm

Came up with these numbers in M* using BRSX for a micro cap to compare 4 corners using my own fund choices with Rick's suggestions.

FOUR CORNERS W/ MICRO CAP; ER = 0.29
1/4 VLACX Large Blend Index
1/4 VIVAX Large Value Index
1/8 VSTCX Small Blend Quant
1/8 BRSIX Micro Blend Quant
1/4 VISVX Small Value Index
21-15-06
13-08-03
15-11-07

FOUR CORNERS ONLY; ER = 0.26
1/4 VLACX Large Blend Index
1/4 VIVAX Large Value Index
1/4 VSTCX Small Blend Quant
1/4 VISVX Small Value Index
21-15-06
15-10-04
15-10-04

RICK'S SIMPLIFIED W/ MICRO CAP & TSM; ER = 0.26
5/8 VTSMX Total Market Index
1/4 VISVX Small Value Index
1/8 BRSIX Micro Blend Quant
15-17-13
11-08-04
14-10-07


Rick, I'm still left with some questions:

Does a 3 basis point extra expense out way the potential benefit of more value premium and rebalancing opportunity?

If Fama & French don't advocate 4 corners, why would they build DFA funds without a total market index fund?

And finally, am I totally off base? ':shock:'

BTW Rick, I sure like your All About A.A. book; it's been a huge help! Wasn't able to renew my checkout this time around though, so I'm waiting in line again!

Tet
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Postby Rick Ferri » Sat Mar 17, 2007 9:46 pm

Does a 3 basis point extra expense out way the potential benefit of more value premium and rebalancing opportunity?

Value funds cost more than TSM funds. If you want to add more value exposure and pay the price, then that is fine. I would be more inclined to add more small/value and maybe catch two risks with one fund. I will also remind you that the TSM is large cap value heavy right now, so all the above portfolios already have a lot of value exposure.

If Fama & French don't advocate 4 corners, why would they build DFA funds without a total market index fund?

I have asked that question 100 times and my DFA rep has no idea (and he has been there for ten years). Remember that DFA was formed in the early 1980s, but F/F research and the 3-factor model did not enter the picture until the mid-1990s. I think that had a lot to do with it.

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A DFA Total Market fund?

Postby SmallHi » Sat Mar 17, 2007 10:17 pm

Rick,

do you think DFA didn't come out with a total market fund because it was totally unnecessary? Vanguard already had one, and, lets face it, whether you go Large, Large Value, Small, Small Value

OR

Total Market, Small Value, it ain't gonna matter all that much? And they knew it even back then?

One problem that I do see with the TSM/SV approach is you are placing a mighty big bet that the value premium will show up significantly in the smallest 8% of the market or so.

You could very well run into a situation like we have seen in the foreign markets for the last 25 years, where the value premium has been robust, but almost as large in big caps as it has been in small caps -- and you could have gotten a bit of value boost for a lower cost as large funds generally cost less than small funds...

1982-2006

EAFE = +11.8%
LV = +17.2%
Small = +14.5%
SV = +17.8%

Finally, another issue if you want a signficant amount of expsoure to value and size, you need a TON of SV added to your TSM to get there. Assume you want a typical portfolio that mimics a 30% S&P, 30% Large Value, 20% Micro, 20% Small Value allocation. Going back 80 years, it would have required almost 50% in small value added to your TSM fund!

If you are comfortable going that far, you might as well just go all-value.

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Hey Rick, thanks

Postby tetractys » Sat Mar 17, 2007 10:19 pm

I guess since the value and small premiums don't get diversified away, then I don't mind being heavy there. Lot's of unknowns in the market, we poke at 'em, yet try not to get too stuck on 'em.

Learning more every day; finding cheap ways to diversify...thanks. :D
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Postby SmallHi » Sat Mar 17, 2007 10:24 pm

To follow up on my last point (Int'l), guess what it took using a 2 fund Int'l solution (Market and SV) to get a normal 30% EAFE, 30% Int'l Large Value, 20% Int'l Small, 20% Int'l Small Value result since 82?

45% Int'l Large Blend
55% Int'l Small Value

(!)

Thats a lot of heavy lifting to ask of such as small section (SV) of the market if you ask me. Just a thought.
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Postby LH » Sat Mar 17, 2007 11:00 pm

bilperk wrote:Hi LH:

I think you are reading the first post too literally. It only shows 3 asset classes because that is what the poster wanted to discuss; the domestic equity part of the portfolio.

The total portfolio is 70% equities. it contained 8 equity classes/sub-classes and 4 bond sub-classes.

25% US Core
10% Sm Val
5% Micro-cap
10% REIT
5% each pacific rim-large, Europe-large, international small, and EM

10% investment Gr
10% High Yield
5% Inflation protected
5% EM bonds


Nah, the 3 was just a number I pulled out of the air, did not refer to the original post, sorry to not be more specific. I was responding to Rick stating that he could get exposure to all USA market caps with TSM and only use small cap (maybe a micro but he said that really is not neccessary), instead of slicing and dicing amongst 4 USA different categories.

This confused me because I thought that was part of the point, the rebalancing effect, and I wanted to know if my portfolio based on reading Ferri's books more or less was based on a misunderstanding of what he meant, as I split up euro and pacific to gain a therorectical rebalancing advantage, versus just using EAFE, at the expense of a definite extra cost of rebalancing them yearly, ie commissions. Rick has seemingly already answered this above in stating that he still thinks euro+pacific is better than EAFE because of rebalancing (I think thats what he is saying at least).

I think I have heard others say, in regards to my somewhat arbitrary choice of SPY and VBR only for US stock representation, that its actually sufficent, and that I do not need to add a mid cap, or anything else to it for rebalancing purposes. It does seem pretty close close to Ricks TSM + small anyway statistically?

In terms of efficiencies versus costs of rebalancing, do all those bond funds(now I am refering to the example) really have any rebalancing benefit? It would seem they would usually be highly correlated with each other to me, but I really do not know much.

Thanks for the reply,

LH
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Postby Xile F Investor » Mon Aug 29, 2011 10:56 am

Rick Ferri wrote:
VG Total International or maybe Total International and International Value. One international fund will be more cost efficient then 4 funds


In All About Asset Allocation I have several examples of using one fund. It is convenient, but if you have more time, here are a few reasons for slice and dice:

1) Using Vanguard ETFs is less costly than one investor class fund, plus no redemption fees or loss of foreign withholding taxes.
2) Having fixed allocations between Europe, Pacific, EM diversifies currencies better than one fund.
3) The rebalancing of those currencies could provide a diversification benefit in the future as it has in the past.

For complete information, see Chapter 7 of All About Asset Allocation.

Rick Ferri



Rick (or anybody who follows him closely enough to feel comfortable answering my question). I've read "All About Asset Allocation", and loosely based my current AA on examples from that book. Now in 2011, do you still stand by your quote above in 2007? Or do you believe a Vanguard International Fund (Mutual or ETF) is a better option?

This somewhat relates to another thread where I discuss this very matter with another forum member:
viewtopic.php?p=1165048#1165048

Thanks in advance for any response.
~Xile | | ______________________________________ | "What you must do is, speak so loud that I can not hear you" | "Those who say it can not be done should not interrupt the people doing it."
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