In the article “Optimizing Your Retirement Income: What Works Best and Why,” by Christine Fahlund, Monte Carlo analysis was used as the basis for the recommendations [August 2008 AAII Journal]. However, Monte Carlo for stock analysis does not predict the future. It only says what the statistics were for the past. Even then, it does that wrong when it assumes inflation was constant over the whole period and there is no serial correlation. It makes no sense to have a scenario where one moment the input may be from 1933 and the next input may be from 1999. It would be better to admit that the statistics only reflect past history and use actual scenarios with the correct inflation and returns of each period.
H. K. Hebeler
James Cloonan errs in discussing the PowerShares FTSE RAFI US 1000 exchange-traded fund (PRF) [“AAII Model ETF Portfolio Review and How to Take Advantage of ETFs” November 2008 AAII Journal]. This ETF tracks the Fundamental Index devised by Research Associates and maintained by FTSE—1,000 large-capitalization U.S. stocks compose the index. Dr. Cloonan states that the index weights its components with proprietary fundamental factors. However, these factors are publicly and plainly disclosed in the book “The Fundamental Index: A Better Way to Invest.” The four metrics employed by the authors—Arnott, Hsu, and West—are the last quarter’s book value and trailing five-year sales, cash flows, and dividends. These authors, who are also the inventors of the method, explain how they weight companies that pay no dividends. They give enough information for any investor—institutional or individual—to learn to weight his own portfolio by their scheme.
Dr. Richard Friary
James Cloonan Responds:
I am sorry if my use of “proprietary” was confusing. I meant it to mean they own the trademark on their particular weighting approach, not that it was secret. It certainly has been disclosed and discussed.
In “Your Portfolio: Maintaining Perspective,” by John Markese and Maria Crawford Scott [November 2008 AAII Journal], I feel that, while the authors are correct in pointing out that there have been worse market drops and that investors engaging in panic trading rarely if ever do well, they do readers little service in advocating a long-term perspective focus.
The authors compare, for example, average annual rates of return from 1945–2007. Why? Since the article is illustrating ‘long-term’ results, why not start in 1926 (the S&P 500 inception year)? I suspect the comparison would be less favorable.
Also, what does the 1945–2007 period represent (other than a favorable ‘equity vs. everything else’ comparison period)? Surely not a typical AAII reader’s investment horizon. It seems an analysis of rolling periods of 10, 20 or 30 years in length would be far more revealing and relevant to individual investors.
While market timing is frowned upon by most ‘responsible’ market observers/commentators, it remains the primary tool of professional traders seeking an edge. Readers’ asset allocation (let’s not call it ‘timing’ now) models might be better assisted by publishing some articles on technical analysis that point out, for example, the value of using a longer-term (20- or 15-week) exponential moving average to determine the general trend.
AAII could ambitiously even explain how combining such a tool with other indicators/oscillators (such as MACD or stochastics) can give asset allocation guidance as to whether to at least be long or flat (never mind being short) the equity (or other) markets.
Lastly, I feel a couple of the fundamental rules listed at the close of the article are of partial value at best. Diversification will generally keep you from major losses, but will also ensure (at best) uninspiring results—unlikely to meet retirement goals unless contributions are high. A somewhat accurate dynamic asset allocation strategy using technical analysis tools to evaluate general market conditions will usually leave it in the dust.