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Editor's Note

by Charles Rotblut, CFA

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Many AAII members have expressed their concerns to me about what could happen to interest rates in the future. Though every prediction made since the 2008 financial crisis about when the Federal Reserve will raise rates has been premature, sooner or later interest rates will rise. We simply do not know when or by how much.

Since the uncertainty of interest rates is a concern, I’m including two articles discussing what to do with bonds and bond funds. They appear here and here.

The first is by Craig Israelsen. Craig is an associate professor at Brigham Young University. Craig looked at the historical data to see how bonds performed during the last extended period of rising interest rates, 1948 through 1981. What he found was that bonds had an annualized gain—yes, a gain—of 3.83%. More importantly, he further found that having a properly diversified portfolio mattered more than the direction of interest rates.

The second article is by Stan Richelson and Hildy Richelson. They point out that though bond prices do fluctuate on a daily basis, the price fluctuations shouldn’t matter to an investor intent on holding a bond to maturity. The rationale is that when held to maturity, a bond provides a known return. Stan and Hildy further argue that the cash flows from a bond ladder can be reinvested at higher yields should interest rates rise in the future.

I realize not everyone will agree with the Richelsons’ viewpoint. In their defense, I will point out that while stocks offer return on capital, bonds, when held to maturity, provide preservation of capital. As such, both can play a role in a diversified portfolio.

Speaking of stocks, arguably no one has a better long-term record of picking stocks than Warren Buffett. To get insights on his approach, I spoke with Carol Loomis, who not only has written about Buffett for Fortune magazine, but also edits Buffett’s annual Berkshire Hathaway shareholder letter. (Her new book, “Tap Dancing to Work: Warren Buffett on Practically Everything, 1966–2012” (Portfolio Hardcover, 2012) is a must-read for Buffett fans.) Given Carol’s relationship with Buffett, I thought it would be interesting to get her insights about his approach to investing. You can see a transcript of our conversation here.

A commonly used ratio to determine if a manager or strategy is actually adding value is the Sharpe ratio. This ratio determines whether a higher return is simply related to higher risk or if excess profits are being realized on a risk-adjusted basis. AAII’s Wayne Thorp shows you how to calculate the ratio and points out both its strengths and weaknesses on here.

Quantitative analysis can tell you a lot, but financial statements and ratios don’t always reveal the entire story. This is why qualitative analysis is also an important part of investing. In his latest article on financial statement analysis, Joe Lan gives you practical guidance on how to look beyond the numbers to determine what is truly going on with a company. Joe’s article starts here.

Another important part of investing is properly managing your portfolio withdrawals throughout retirement. Though the 4% rule is often talked about, I realized there is not much written about how to actually implement it in a fund portfolio. So, I took the data I had on Vanguard funds and factored in a withdrawal rate that escalates for inflation. What I found is that pitfalls emerge for those who attempt to use a higher withdrawal rate or who don’t periodically rebalance. I walk you through the process and show you where the dangers lie here.

Finally, AAII Founder and Chairman James Cloonan made two changes to the Model Fund Portfolio. First, he replaced the real estate mutual fund with an ETF. Second, he added a suggested bond allocation for those who like the fund portfolio but want a more conservative approach. You can see both, and Jim’s latest market outlook, here.

Wishing you prosperity,
Charles Rotblut, CFA
Editor, AAII Journal
twitter.com/charlesrotblut

Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/charlesrotblut.


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