Screening for Quick Picks

Comment on “Screening on Faber’s Unique Approach to Yield Investing,” by Derek J. Hageman, in the September 2020 AAII Journal:

Based on the 30 stocks listed, I see just one stock that I would spend time researching further. While this is a good and interesting approach, it would need to be expanded much further to be of quick utility to me. While I recognize that share buybacks have their place, I think they are overused and used too quickly by too many organizations.
—James L. from Tennessee

Reducing Volatility

Comments on “The Changes Being Made to AAII’s Asset Allocation Models,” by Charles Rotblut, CFA, in the September 2020 AAII Journal:

Although I understand that making the AAII Asset Allocation Models more conservative makes them less volatile, I question the impact on long-term returns. Rotblut noted previously that during very low-yield fixed-income return periods, equity returns have more than made up for the fixed-income shortfall; therefore, to sustain a meaningful return, especially for retirees on fixed incomes, a slight increase in tilt toward equities may be appropriate. This flies in the face of the proposed changes to the AAII Asset Allocation Models, where the relative weighting of equities is decreased rather than increased.
—Douglas Propp, M.D., from Illinois

It appears that you have used the words aggressive, moderate and conservative to describe the investor based on their overall total liquid portfolio composition. My guess is that many investors use those three words to label themselves based on the equity portions of their portfolio. In my opinion, the creation of only three labels is much too restrictive and ignores many variations of in-between cases and the distinctions between a total portfolio and equity use of those terms. For example, suppose an investor has 60% fixed income and 40% diversified stock. That implies a conservative investor model based on total liquid portfolio composition. Then further suppose that the 40% stock is evenly split percentage-wise into large/mid/small/international, implying an aggressive stance. Is this hypothetical investor aggressive, conservative, moderate or none of those?
—John Q. from Virginia

Charles Rotblut responds:

Thanks for your thoughtful comments.

Doug, while increasing equities has historically boosted long-term returns, realizing the excess return requires an investor to be able to withstand higher volatility. Giving up some upside return can be justified if the reduction in volatility makes it easier to stick with the allocation strategy during periods of market turbulence.

John, the labels aggressive, moderate and conservative reflect both the historical volatility of the allocation models and the risk of a loss of over short and intermediate time periods. These are just models—allocation is a personal decision and no single allocation works universally.

Small-Cap Value Results

Comments on “The Four Asset Classes With Great Long-Term Performance,” by Paul Merriman, in the September 2020 AAII Journal:

Craig Israelsen has written articles for the AAII Journal using his 7Twelve asset portfolio that includes the four asset classes recommended by Merriman, and it has worked well for me. Note that in the last decade, small cap and value have underperformed the market. I am guessing that trend will not last long, but one never knows. In any event, even despite the slightly poorer performance in small-cap and value stocks, their systems work well.
—Tony H. from Maryland

At www.portfoliovisualizer.com, you can check different asset mixes going back as far as 1972. You will find that Merriman’s analysis is correct, but the value benefit appears to be only dominant in the period of 1972–1985. If you run the analysis from 1985–2020, 35 years of results, the four-category system results in the exact same results as a pure large-cap blend. Are the value and small factors a quirk of a weird decade?
—Bruce B. from Massachusetts

In Table 3, didn’t you want to list Vanguard Small Cap Index (VSMAX) as your small-cap blend fund instead of Vanguard Total Stock Market Index (VTMSX)?
—Scott W. from Pennsylvania

Paul Merriman responds:

Tony and Bruce, my AAII webinar presentation on September 23 (at www.aaii.com/webinars) shows how often the small-cap and value stocks underperform. Literally, 78% of the 90 years found the four-fund strategy not producing the expected premium. I think most investors simply don’t have that much time or patience. Looking at the nine decade returns of interest at https://paulmerriman.com/90-years-of-evidence-shows-investor-patience-leads-to-better-returns, what you will find is that in most of the decades small cap and small-cap value produced the best results.

Scott, yes, thanks, we did mean to show the Vanguard Small Cap Index as our small-cap blend fund. The error has been fixed in the online article.