Feedback on a simple investment strategy

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krishnam
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Feedback on a simple investment strategy

Post by krishnam » Tue Jul 10, 2018 9:41 am

I am a passive investor in mutual funds and have invested in multiple index funds across Vanguard and Fidelity, with 25+ years (hopefully 35+ years :)) to go before retirement. I did not do much reading before starting to invest a few years ago as the initial amounts were in four figures only and have evolved my strategy with time. I am a bit concerned that the markets are unusually high now and a burst is round the corner and want to prepare for any headwinds. Rather than using the standard asset allocation strategy, my strategy for investment has been to do the following:

a) Consider only funds that have 4-star or 5-star morningstar ratings
b) Filter funds with approximately 10% or more returns across 1 year, 5 year and 10 year periods
c) From the list of funds, eliminate all funds with expense ratio > 0.2%
d) From this list, pick a random set of funds to invest.

My questions --
1) Is this strategy reasonable? If not, what are the potential issues with this strategy? How should I fix these issues?
2) Also, I have not always followed this strategy. A decade ago, I did not take expense ratio into account at all (as the pot was very small then) and have ended up with more than 100K in FBIOX. Now, the fund has a two-star rating on morningstar. While the fund has performed reasonably well, I have figured that the fund no longer satisfies any of the above rules other than (d). Does it make sense to swap it for some other fund (there are no tax implications as it is part of a retirement fund) even though it is trading for 50 USD less than the high it experienced two years ago (241 to 295)?
3) Also, any comments/suggestions on my current allocation will be helpful as [Numbers in bracket indicate percentage of funds]:
Brokerage account via Wells-Trade: VEIRX (32.5), VFIAX (23.8), VDIGX (13.7), VTMSX (10), VSMAX (10), VIGAX (10)
Retirement account via Fidelity: FBIOX (30), FNCMX (30), FUSVX (30), FSPTX (10)
4) Is 100% investment in equities dangerous given the time frame for my retirement?

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nedsaid
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Re: Feedback on a simple investment strategy

Post by nedsaid » Tue Jul 10, 2018 11:05 am

krishnam wrote:
Tue Jul 10, 2018 9:41 am
I am a passive investor in mutual funds and have invested in multiple index funds across Vanguard and Fidelity, with 25+ years (hopefully 35+ years :)) to go before retirement. I did not do much reading before starting to invest a few years ago as the initial amounts were in four figures only and have evolved my strategy with time. I am a bit concerned that the markets are unusually high now and a burst is round the corner and want to prepare for any headwinds. Rather than using the standard asset allocation strategy, my strategy for investment has been to do the following:

a) Consider only funds that have 4-star or 5-star morningstar ratings
b) Filter funds with approximately 10% or more returns across 1 year, 5 year and 10 year periods
c) From the list of funds, eliminate all funds with expense ratio > 0.2%
d) From this list, pick a random set of funds to invest.

My questions --
1) Is this strategy reasonable? If not, what are the potential issues with this strategy? How should I fix these issues?

Nedsaid: Morningstar Star Ratings do not have any predictive value for future results. There is a reversion to the mean. 5 star funds tend to revert to 3 star funds. Really what you are doing is performance chasing. That being said, it is amazing how many index funds that I see that have 4 and 5 star Morningstar ratings but that speaks about the efficiency and low costs of indexes.

What I would say is to pick the better indexes. A couple of problems you want to overcome are front running and also junky companies that might be in certain indexes. You want indexes that screen a bit for quality. For example, companies have to be profitable to be included in the S&P indexes. In other words, you want good index construction. For example, the Russell 2000 Index that tracks the mid-cap/small-cap has come under a lot of criticism. If you want Mid-Cap/Small-Cap, the S&P Mid-Cap 400 and the S&P Mid-Cap 600 are better bets. The better indexes take measures to prevent front running by traders.

2) Also, I have not always followed this strategy. A decade ago, I did not take expense ratio into account at all (as the pot was very small then) and have ended up with more than 100K in FBIOX. Now, the fund has a two-star rating on morningstar. While the fund has performed reasonably well, I have figured that the fund no longer satisfies any of the above rules other than (d). Does it make sense to swap it for some other fund (there are no tax implications as it is part of a retirement fund) even though it is trading for 50 USD less than the high it experienced two years ago (241 to 295)?
3) Also, any comments/suggestions on my current allocation will be helpful as [Numbers in bracket indicate percentage of funds]:
Brokerage account via Wells-Trade: VEIRX (32.5), VFIAX (23.8), VDIGX (13.7), VTMSX (10), VSMAX (10), VIGAX (10)
Retirement account via Fidelity: FBIOX (30), FNCMX (30), FUSVX (30), FSPTX (10)
4) Is 100% investment in equities dangerous given the time frame for my retirement?
A fool and his money are good for business.

magicrat
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Re: Feedback on a simple investment strategy

Post by magicrat » Tue Jul 10, 2018 11:23 am

1. No, it is not reasonable. It is arbitrary and not strategic at all. For one thing, you will likely end up with a 100% stock portfolio using those screens. The way you should fix it is to develop an investment policy statement, decide on an asset allocation, and implement using a basic 3-fund portfolio (or similar). Total US Stock, Total Intl Stock, and Total Bond are all you need. Can go even simpler with target date or life strategy funds.
2. Yes, you should swap this fund for one of the funds you pick if you follow my first point. Why would you be tilting towards biotech anyway?
3. I cannot tell what your asset allocation is based on that list.
4. 100% equities is probably more dangerous because you don't have a solid plan and are at risk for behavioral errors.

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Taylor Larimore
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Re: Feedback on a simple investment strategy

Post by Taylor Larimore » Tue Jul 10, 2018 12:17 pm

krishman:

Welcome to the Bogleheads Forum!

Sorry, but your list includes funds based on past performance. This is what experts say about using past performance:
American Association of Individual Investors: "Top Performance lists are dangerous."

Frank Armstrong, financial author: "Rating services such as Morningstar's 'Star Awards' or the 'Forbes Honor Roll' attest to the futility of applying past performance to tomorrow."

Arnott and Bernstein (2002, p. 64): “The investment management industry thrives on the expedient of forecasting the future by extrapolating the past."

Barra Research: "There is no persistence of equity fund performance."

Christine Benz, Morningstar Director of Personal Finance: "When we look at our data, at the factors that are most predictive of good performance going forward, low costs are a much better predictor than is great past performance."

Wm. Bernstein, author of The Four Pillars of Investing: "For the 20 years from 1970 to 1989, the best performing stock assets were Japanese stocks, U.S. small stocks, and gold stocks. These turned out to be the worst performing assets over the next decade."

Jack Bogle: "The biggest mistake investors make is looking backward at performance and thinking it’ll recur in the future."

Bogleheads' Guide to Investing: "Using past performance to pick tomorrow's winning mutual funds is such a bad idea that the government requires a statement similar to this: "Past performance is no guarantee of future performance." Believe it!"

Jack Brennan, former Vanguard CEO: "Fund ranking is meaningless when based primarily on past performance, as most are."

Burns Advisory tracked the performance of Morningstar's five-star rated stock funds beginning January 1, 1999. Of the 248 stock funds, just four still kept that rank after ten years.

Ben Carlson, author of A Wealth of Common Sense : "Dow Jones looked at nearly 2,900 active mutual funds. Only 2 funds in the top quartile stayed in the top quartile of performance over the next four 1-year periods."

Andrew Clarke, author: "By the time an investment reaches the top of the performance tables, there's a good chance that its run is over. The past is not prologue."

Jonathan Clements, author & former Wall Street Journal columnist: "Suppose you picked stock funds that ranked in their category's top 25% over the past five years. A regular updated study suggests that less than a quarter of these funds will remain in the top 25% over the next five years--even worse than the result you would expect based purely on chance."

Prof. John Cochrane, author: "Past performance has almost no information about future performance."

S.T.Coleridge: "History is a lantern over the stern. It shows where you've been but not where you're going"

Dow Jones Indices Report, June 2015: "The data shows a stronger likelihood for the best-performing funds to become the worst performing funds than vice versa." -- June 2016: "Only 3.7% of large-cap funds maintained top-half performance over five-consecutive 12-month periods. For midcap funds, the comparable figure was 5.79%, and for small-cap funds, it was 7.82%."

Charles D. Ellis, author of 16 financial books: "Sadly, investors who rely on performance records are relying on useless data."

Eugene Fama, Nobel Laureate: "Our research on individual mutual funds says that it's impossible to identify true winners on a reliable basis, even if one ignores the costs that active funds impose on investors."

Forbes (2/2/04 issue): "Over the past decade, Morningstar's five-star equity funds have earned an average 5.7% against a 10.3% return for the Wilshire 5000 (Total Stock Market)."

Gensler & Bear, co-authors of The Great Mutual Fund Trap: "Of the fifty top-performing funds in 2000, not a single one appeared on the list in either 1999 or 1998."

Ken Hebner's CGM Focus Fund was the top U.S. equity fund in 2007. In November 2009, it ranked in the bottom 1% of its category.

Mark Hulbert (12-31-2014): "Consider a hypothetical portfolio that each year followed the investment newsletter portfolio that, among the more than 500 tracked by The Hulbert Financial Digest, had the best record during the previous calendar year. Over the past 20 years, that portfolio would have been a disaster, producing an annualized loss of more than -17%."

Mark Hebner, President, Index Fund Advisors: "From 1998 through 2013 only about 8 funds remained in the top 100 the following year."

JPMorgan Chase claimed that 97% of their alternate-asset mutual funds beat their benchmark during the 10-year period ending December, 2013. Morningstar reported that only 33% beat their benchmark during the same period (past-performance calculations differ).

Arthur Levitt, SEC Commissioner: "A mutual fund's past performance, which is the first feature that investors consider when choosing a fund, doesn't predict future performance."

Peter Lynch's Fidelity Magellan Fund (FMAGX), once the world's largest and most successful mutual fund, is now (Feb. 9, 2018) in the bottom 11% of its category for 15-year annualized return

Burton Malkiel, author of the classic Random Walk Down Wall Street: "I have examined the lack of persistency in fund returns over periods from the 1960s through the early 2000s.--There is no persistency to good performance. It is as random as the market."

Mercer Investment Consulting from a study of over 12,000 institutional managers: "Excellent recent performance not only doesn't guarantee future results but generally leads to under-performance in the subsequent period."

Bill Miller, former manager of Legg Mason Value Trust (LMVTX), was the only manager to outperform The S&P 500 Index for 15 consecutive years. On 9/7/2016 Miller’s fund is in the bottom 1% for 15 year returns.

Mark Miller, financial author and journalist: "Only 7.33% of domestic equity funds that were in the top quartile of performance in March 2014 were still there two years later."

Morningstar: "Over the long term, there is no meaningful relationship between past and future fund performance."

Ron Ross, author of The Unbeatable Market: "Extensive studies by Davis, Brown & Groetzman, Ibbotson, Elton et al, all confirmed there is no significant persistence in mutual fund performance. -- Wall Street’s favorite scam is pretending that luck is skill.”

Bill Schultheis, adviser and author of The Coffeehouse Investor: "Using past performance numbers as a method for choosing mutual funds is such a lousy idea that mutual fund companies are required by law to tell you it is a lousy idea."

Sequoia Fund was the top performing large-cap growth fund at the end of 2015 according to Morningstar. On 4/21/2017 it ranked in the bottom 1% for five year returns.

Standard & Poor's Persistence Scorecard (Dec-2014): "The data show a stronger likelihood for the best-performing funds to become the worst-performing funds than vice versa. Of 421 funds that were in the bottom quartile, 14.45% moved to the top quartile over the five year horizon, while 27.08% of the 421 funds that were in the top quartile moved into the bottom quartile during the same period."

Larry Swedroe, author of many finance books: "The 44 Wall Street Fund was the top performing fund over the decade of the 1970s. It ranked as the single worst performing fund of the 1980's losing 73%. -- If you are going to use past performance to predict the future winners, the evidence is strong that your approach is highly likely to fail."

David Swensen, Yale's Chief Investment Officer: "Chasing performance is the biggest mistake investors make. If anything, it is a perverse indicator."

Tweddell & Pierce, co-authors of Winning With Mutual Funds: "Numerous studies have shown that using superior past performance is no better than random selection."

Eric Tyson, author of Mutual Funds for Dummies (2010 edition): "Of the number one top-performing stock and bond funds in each of the last 20 years, a whopping 80% of them subsequently performed worse than the average fund in their peer group over the next 5 to 10 years! Some of these former #1 funds actually went on to become the worst-performing funds in their particular category."

Value Line selected Garret Van Wagoner "Mutual fund Manager of the Year" in 1999. In August 2009, Van Wagoner's Emerging Growth Fund was the worst performing U.S. stock fund over the past 10 years.

Vanguard Study: "Persistence of performance among past winners is no more predictable than a flip of a coin."

Jason Zweig, author and Wall Street Journal columnist: "Buying funds based purely on their past performance is one of the stupidest things an investor can do."
Consider The Three-Fund Portfolio

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

krishnam
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Re: Feedback on a simple investment strategy

Post by krishnam » Tue Jul 10, 2018 5:34 pm

Thanks everyone. But, if I have to do the re-investment (say using the three fund portfolio strategy), won't this result in capital gains tax for the brokerage account (the 401K should be fine)? Is it worth taking the possible tax hit to fix up the portfolio?

mcraepat9
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Re: Feedback on a simple investment strategy

Post by mcraepat9 » Tue Jul 10, 2018 10:50 pm

krishnam wrote:
Tue Jul 10, 2018 5:34 pm
Thanks everyone. But, if I have to do the re-investment (say using the three fund portfolio strategy), won't this result in capital gains tax for the brokerage account (the 401K should be fine)? Is it worth taking the possible tax hit to fix up the portfolio?
You will have to pay tax on the gains, the question is whether the risk reduction and tax efficiency benefits are worth it. The longer you let gains accumulate, the more capital gains will prevent you from making the best risk/tax efficiency decision for you.

VEIRX (32.5) <-- tax inefficient (dividends)
VFIAX (23.8) <--- leave as core US equity position
VDIGX (13.7) <-- tax inefficient (dividends)
VTMSX (10) <--- leave if you want small cap tilt, though I would ditch it.
VSMAX (10) <--- leave if you want small cap tilt, though I would ditch it.
VIGAX (10) <--- ditch this, tilting to growth is performance chasing (most of growth's outperformance over recent periods is attributable to Apple, Google, Facebook and Amazon).
Amateur investors are not cool-headed logicians.

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CaliJim
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Re: Feedback on a simple investment strategy

Post by CaliJim » Tue Jul 10, 2018 11:07 pm

Welcome to the forum!

Taylor has given you some good advice. For more fantastic advice read his books!
https://www.amazon.com/Bogleheads-Guide ... 1119487331

You can’t out strategize the market. Market timing is HARD. You can diversify, and maximize risk adjusted expected return. Diversity, AA, and low fees are your friends.

Behavioral mistakes kill long term returns. And...you are exhibiting the signs. Avoid mistakes by educating yourself deeply in how bogleheads do it.

Start here: https://www.bogleheads.org/wiki/Getting_started
Last edited by CaliJim on Tue Jul 10, 2018 11:16 pm, edited 2 times in total.
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danielc
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Re: Feedback on a simple investment strategy

Post by danielc » Tue Jul 10, 2018 11:09 pm

krishnam wrote:
Tue Jul 10, 2018 9:41 am
a) Consider only funds that have 4-star or 5-star morningstar ratings
Morningstar's own research has shown that the expense ratio of a fund is a better predictor of future returns than their own star ratings. Therefore, I suggest you ditch "(a)" and replace it with:

a) Consider only index funds that have rock-bottom expense ratios.

krishnam wrote:
Tue Jul 10, 2018 9:41 am
b) Filter funds with approximately 10% or more returns across 1 year, 5 year and 10 year periods
Past performance is negatively correlated with future performance. Evidence for managerial skill is slim to none. Please understand that if everyone is just picking stocks randomly it is necessarily true that that some of them will outperform the market for 10 years in a row. But the fact is that a cat is as good at picking stocks as fund managers. In this experiment, three groups of people were given 5,000 GBP to invest. One group was made of three money managers, the second group was given to school children, and the third fund was "managed" by a cat playing throwing his favorite toy mouse on a grid of stock companies. Of these three funds, the cat had the highest return. Therefore, I suggest:

b) Ignore past performance (or hire that cat).

krishnam wrote:
Tue Jul 10, 2018 9:41 am
c) From the list of funds, eliminate all funds with expense ratio > 0.2%
I agree with this one.
krishnam wrote:
Tue Jul 10, 2018 9:41 am
d) From this list, pick a random set of funds to invest.
Bad idea. It will be impossible for you to know what your asset allocation is. How will you know that your bond allocation is reasonable? Or your US vs International equity? Instead, I would suggest:

d) Pick a "target date" or "life strategy" balanced fund from Vanguard. Alternatively, use a Boglehead 3-fund portfolio.
krishnam wrote:
Tue Jul 10, 2018 9:41 am
My questions --
1) Is this strategy reasonable? If not, what are the potential issues with this strategy? How should I fix these issues?
See above.
krishnam wrote:
Tue Jul 10, 2018 9:41 am
2) Also, I have not always followed this strategy. A decade ago, I did not take expense ratio into account at all (as the pot was very small then) and have ended up with more than 100K in FBIOX. Now, the fund has a two-star rating on morningstar. While the fund has performed reasonably well, I have figured that the fund no longer satisfies any of the above rules other than (d). Does it make sense to swap it for some other fund (there are no tax implications as it is part of a retirement fund) even though it is trading for 50 USD less than the high it experienced two years ago (241 to 295)?
Ditch it and swap it with a low-cost broad market index fund.

krishnam wrote:
Tue Jul 10, 2018 9:41 am
4) Is 100% investment in equities dangerous given the time frame for my retirement?
My own opinion: As long as you have enough money set aside to cover emergencies (e.g. you lose your job during a market crash and it takes you 6 months to find a new job) and that money is in a safe instrument (e.g. high-yield savings account, money market, cancellable CDs, treasury bills) I think a 100% allocation is fine. But you should definitely read some books on finance to understand what you are getting into. The wiki has a list of recommended books.

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EDIT:
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CaliJim
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Re: Feedback on a simple investment strategy

Post by CaliJim » Tue Jul 10, 2018 11:20 pm

Good comic. LOL

Oh yeah, also, 100% stocks is hard too. When one is “all in”, the temptation to sell low in a recession or depression is HUGE. 80/20 max!
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