Letters

Cap Size in Model Fund Portfolio

Comments posted to “Model Mutual Fund and ETF Portfolios: Value and Small Stocks Impact Returns” by James B. Cloonan in the March 2012 AAII Journal:

I am surprised that your Model Mutual Fund Portfolio is so heavy to small- and mid-cap funds. This seems different from most other investment advice. Could you explain this?

Rodney from Idaho

I too noticed that the portfolio seems heavy in small and mid caps.

Matthew from Wisconsin

James Cloonan responds:

Thanks for your comments. Given that individuals do not have assets they need within four years invested in stocks, I believe investments should be long-term oriented. In the long run, micro-cap stocks outperform small stocks, which outperform mid caps, which outperform large caps; giant caps are the worst of all. I believe in going for the greatest gain. We mix up the market caps a bit to reduce shorter-term volatility. Micro-cap stocks, the best of all (see performance of the Shadow Stock Portfolio in the April AAII Journal), don’t work as well in mutual funds because of poor liquidity in down markets, when funds must sell because investors are getting out when they should be getting in.

Rebalancing Alternatives & Questions

Comments posted to “Portfolio Rebalancing: Diversification, Risk Control and Withdrawals” by Charles Rotblut, CFA, in the March 2012 AAII Journal:

Just curious: How would $100,000 invested in Vanguard Wellington fund VWELX, or some other balanced fund, have compared to your hypothetical portfolio? Eliminate all the trading and let the fund do the rebalancing.

Roger from Kentucky

I ran the analysis again using the same time frame as AAII (24 years, from 1988 through 2011). The Vanguard Wellington fund produced a total return of 863.8% and an annualized return of 9.9%. The ending value was $963,849, or $157,724 more than AAII’s indexing and rebalancing analysis. As Roger from Kentucky astutely observed, it is a lot simpler and generates a lot less headaches, plus less expense for my spouse. I might add that year-to-year up and down swings are a lot less. So when my “buzzer” sounds, I think my spouse would be better off, or at least no worse off, than if I had indexed and rebalanced. This may not be an apples-to-apples comparison, but I think it is a valid dollar-to-dollar return comparison.

Joseph from Virginia

Charles Rotblut responds:

Comparisons with the Vanguard Wellington fund are not apples to apples, because Wellington primarily invests in U.S. large-cap stocks (in addition to its bond holdings). This said, holding a balanced fund that adheres to a targeted allocation is an alternative to portfolio rebalancing. Look at the fund’s allocation target, however, and make sure that it makes sense for your personal situation. And if you hold more than one fund, you may still have to rebalance.

Could someone explain how the rebalancing strategy using average position size works? If I have 400 shares of GE, how does that determine how many shares of stock XYZ I should buy?

Charles from New York

Charles Rotblut responds:

Say you invested $10,000 in 10 stocks. After a year, your positions in eight of them are now $11,000 per stock (a 10% gain). The ninth stock jumps in price and your position in it is now worth $15,000. The 10th one falls in value and your position is now worth $9,000. You sell stocks nine and 10, freeing up $24,000 in cash as part of a portfolio now worth $112,000 (your average position would now be $11,200 per stock ($112,000 ÷ 10). To rebalance, you could invest $11,200 in each of the two new stocks you purchase. (You could also increase the amount to $12,000 if you would rather not keep any cash in portfolio.) The logic is that you prevent any single stock from occupying too large a position in your portfolio.