Letters to the Editor

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To the Editors:

I would like to thank Jonathan Guyton for suggesting a portfolio allocation strategy that makes a lot more sense to me than the typical retirement portfolio proposed by various investment advisors and fund companies with their heavy emphasis on fixed investments [“Withdrawal Rules: Squeezing More From Your Retirement Portfolio,” August 2005 AAII Journal].

The thinking seems to be that as you approach retirement, you need to become more conservative by investing ever more of the portfolio in fixed income. This is supposedly because of the need to access investment principal in a shortened time horizon. But a 30-year horizon is hardly short. Yes, the portfolio investor is withdrawing from the portfolio, but the withdrawals are at a measured and planned pace. So it seems to me that the strategy should be to allocate the portfolio in a way that maximizes its return over the expected time period with less emphasis on short-term safety. Mr. Guyton’s approach addresses strategies to deal with the increased risk associated with higher equity allocation while reducing the loss of performance associated with safety.

Finally, Mr. Guyton is suggesting a fairly rigorous approach to maintaining the allocation once it’s set. I have the sense that this may be one of the primary benefits of allocation; that is, maintaining allocation forces one to cash winners and let losers ride even though this may be counter-intuitive.

Joseph Dolben
Via E-mail

To the Editors:

In advising us to cut our losses, William J. O’Neil repeats a common market canard: that it is harder for a stock to go up through a given price range than to go down through it [“When to Sell Stocks to Cut Your Losses,” September 2005 AAII Journal]. He notes that if a stock declines 20%, it needs to advance 25% to recover, or if it falls 50%, it needs to go up 100%. The figures are correct, but the suggestion that it’s a further distance going up than going down is not correct.

A 50% decline is equivalent to about 69 successive mini-declines of 1%. A 100% advance is like an equal succession of about 69 mini-advances of 1%. The same equivalence holds for a 20% decline and a 25% advance (22 successive 1% drops versus 22 successive 1% ups). Because of compounding on the way up and “decompounding” on the way down, an advance and decline through the same range are equivalent in proportional “distance” traveled.

This is not to quarrel with O’Neil’s advice to cut losses early. But the logic should not rest on the faulty premise that a recovery has to be bigger than the loss it reverses.

Robin L. Carpenter
Via E-mail

To the Editors:

James Cloonan has never adequately responded to reader comments on problems with the AAII Model Fund Portfolio [for more on the portfolio, see the article on page 29 of this issue or visit the AAII Model Portfolios area of AAII.com]. Although there are rules for selecting the funds, nothing is stated regarding the strategy for developing the portfolio. You can screen according to the rules to find mutual funds that meet the criteria but that is only half the job.

Specifically, nothing is said about whether this is an aggressive, moderate, or conservative allocation.

It would be better to develop an asset allocation model based on risk—i.e., aggressive, moderate, conservative—and then pick mutual funds that meet that criteria. It is not clear what the breakdown of cash, bonds, and stocks is in the model fund portfolio or what the percentage of each fund is compared to the total.

Finally, nothing is said regarding a portfolio that allocates cash, bonds, and stocks according to various asset allocation models based on risk.

I find that the Model Fund Portfolio is not very useful without a solid rational foundation for developing the portfolio.

Barry A. Bertani
Via E-mail

Jim Cloonan Responds:

While I agree with the issues you raise, it is important to point out that the Mutual Fund Portfolio coverage is not intended to be a complete advisory service. In addition, I am only dealing with the equity part of a portfolio and not necessarily the complete equity part. While we show the RiskGrade of the model portfolio, it would be meaningful only if the portfolio were an investor’s sole investment. Individuals must calculate their overall risk level based on all of their holdings. I will spend more time on asset allocation but don’t intend to get into recommending bond funds or REITs—even though I believe a proper portfolio consists of equities, real estate, and debt.

Barry A. Bertani
Via E-mail

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