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Letters to the Editor

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To the Editors:

Regarding AAII’s Model Shadow Stock Portfolio [see Matter of Opinion article], I tracked how the Actual Portfolio and the list of Passing Companies [shown in the Model Portfolios area of AAII.com] performed, and there seemed to be a difference in their performance as a group. It seemed to me that there were more, and larger, losers in the Passing Companies list. Granted, I did not track them for a long period of time, but nevertheless, there seemed to be a pattern. Is there more research done on Passing Companies before they are added to the Shadow Stock Portfolio? —Hubert Barker
Via E-mail

James Cloonan Responds:
All of the passing stocks would be bought for the portfolio if it was a buy month (February, May, August, November) and we had money available. Since the Shadow Stock Portfolio is a real portfolio, we can only add stocks when we sell. Most of the passing stocks wind up in the portfolio, but our waiting sometimes avoids a stock that suddenly passes the criteria but then has an earnings decrease.

Additionally, the portfolio stocks have been held for much longer and have had time for any potential to be realized. The passing stocks are generally newer and may not have adjusted to their potential. We chose our buy months because most of the latest quarterly earnings are in. If you buy a passing stock just before an earnings release there is a chance for a disappointment. Of course, there is also the chance for a positive surprise.

To the Editors:

I would like to see an article that explains the relationship between RiskGrades [used in AAII Model Portfolios; see Matter of Opinion article and the Model Portfolios area of AAII.com] and asset allocation. For example, I created a portfolio of eight funds consisting of 19% in the Ariel fund (ARGFX), 10% in the Artisan Mid-Cap Value fund (ARTQX), 21% in Causeway International Value fund (CIVVX), 11% in Dodge & Cox Stock fund (DODGX), 9% in Fidelity Value fund (FDVLX), 10% in Strong Mid-Cap Disciplined (SMCDX), 10% in SSgA International Stock Selection fund (SSAIX), and 10% in Excelsior International fund UMINX). This portfolio results in a RiskGrade of 45, which places it in the “balanced” category of the RiskGrades Suitability Scale, similar to a portfolio comprised of 60% stocks, 35% bonds and 5% cash. However, when this same portfolio is entered into Morningstar’s Portfolio Manager, the Portfolio X-Ray diagnostics indicate it is an aggressive portfolio because its asset allocation consists of more than 90% stocks. I’m having difficulty reconciling a low RiskGrade with a supposedly aggressive asset allocation strategy.

—Rick Spillane
Via E-mail

James Cloonan Responds:
The difference comes from two different ways of estimating risk: Asset allocation is an approach that tries to estimate portfolio risk from broad categories, while the RiskGrade or volatility approach measures the risk directly. Asset allocation is like trying to estimate a person’s weight from their height. It gives a reasonable estimate on average, but it is kind of silly when we have scales. I can develop a bond portfolio and a stock portfolio where the bond portfolio is much riskier than the stock portfolio. Allocation approaches are based on using market averages of bond risk and stock risk. It is easier to determine the risk of any investment directly rather than use averages that are inaccurate for all but index portfolios. [Go to RiskGrades.com for more on this measure.]

To the Editors:

I’d like to expand further on a few points made in AAII’s 2004 Personal Tax and Financial Planning Guide:

  • In 2005, the maximum annual contribution for qualified plans is $42,000.

     

  • One also will not be assessed an underpayment penalty if the total tax due minus the amount withheld is less than $1,000. (This would apply when 10% of the total tax due is less than $1,000.)

     

  • Instead of electing to tax qualified dividends and long-term capital gains at ordinary tax rates in order to fully deduct investment interest expense, one can carry forward excess investment interest expense to future years.

—Ray Somers
Via E-mail

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To the Editors:

The January AAII Journal was excellent, especially “Stock Return Outlook: Not-So-Great Expectations,” by Steve Norwitz. The analysis was based on historical returns that include a price-earnings ratio going from 7.2 to 20.6, which might overstate projections. Also, if the price-earnings ratio, profit margins, and interest rates regress to the mean, returns over the next five to 10 years might be quite lower than you have estimated.

—Leo Scully
Via E-mail

 

 


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