The New Level3 Passive Portfolio

Comments on “Model Fund Portfolio: Introducing the Level3 Passive Portfolio,” by James B. Cloonan, in the August 2016 AAII Journal.

The absence of a small-cap stock fund in the new Level3 Passive Portfolio is very glaring. Can you please clarify why you have excluded small-cap asset class?
— Sam Ribani from Illinois

No international. No emerging markets. Are you kidding me? Diversified? Not.
— Michael Farrell from California

James Cloonan responds:

A number of comments questioned the absence of small-cap and foreign stocks in the Level3 Passive Portfolio. There is, to my mind, a difference between a favored category of stocks and mutual funds investing in that category. I believe in the importance of micro- and small-cap stocks for individual investors. I question the ability of mutual funds to invest in them successfully. The cost of investing significant funds and the difficult behavior during fast markets hinders fund managers, and the few funds that manage to overcome these problems stay small and are closed.

Over the long run, foreign stocks as a group provide lower returns, and for the long-term investor I feel that there is no significant reduction in real risk. See my book “Investing at Level3” (www.level3investing.com) for more in-depth discussion on these issues.

On Corporate Redistribution of Cash

Comment on “Analyzing a Stock by Its Dividend and Shareholder Yield,” by Charles Rotblut, CFA, in the August 2016 AAII Journal.

Stocks are pieces of paper with perceived values. The only way to realize a positive return is to receive cash during ownership in the form of dividends and to receive cash when stock is sold for a capital gain. Everything else, including annualized return, buyback yield, stockholder yield, return of capital, etc., is a perception or outright manipulation.

Use of cash to repurchase shares is a way of increasing earnings per share without improving company operating performance. There seems to be an increased use of borrowed money to fund stock repurchases. This appears very risky and potentially damaging as it substitutes a discretionary action—stock repurchases—with a nondiscretionary action—debt repayment obligation—without improving company performance.

If corporate management wants to reward shareholders, they should distribute cash as regular or special dividends or use cash effectively in operations to be industry leaders in sales and operating margins.
—Dwight Dow from Hawaii

Clarification to IRA Rollover Rules

Response to questions on “IRA Rollover Chart: Rules Regarding Rollovers and Conversions,” by Charles Rotblut, CFA, in the July 2016 AAII Journal.

We contacted the IRS to get additional clarification on the rules regarding IRA rollovers and transferring a portion of an account’s assets to another brokerage firm. Here is what they said:

The only thing that triggers the one-per-year restriction on IRA rollovers is a “rollover,” which is the distribution of funds to the IRA owner followed by a contribution within 60 days to another IRA. A trustee-to-trustee transfer—which, by the way, can be accomplished by giving a check, made payable to the receiving IRA custodian, to the IRA owner for delivery to that custodian—is not a rollover, although the term is used to describe any movement of funds between plans and IRAs. Sometimes the term “60-day rollover” is used to distinguish a real rollover from a trustee-to-trustee transfer.

The article has been updated on AAII.com to reflect this clarification.