Inside the Level3 Passive Portfolio

Comments on “A Closer Look at the Level3 Passive Portfolio’s ETFs,” by John Bajkowski, in the November 2018 AAII Journal:

Maybe I’m not understanding something here, but it looks to me like the SPDR S&P 500 ETF (SPY) wholeheartedly thrashes the Level3 Passive Portfolio on every measure shown: average annual return, one-year, three-year … they all show me that SPY is the winner, and by a significant margin. What am I missing?
—Anton from Illinois

The last three years were a boom time for tech stocks. The five S&P 500 stocks listed—Apple Inc. (AAPL), Microsoft Corp. (MSFT), Amazon.com Inc. (AMZN), Berkshire Hathaway Inc. (BRK.B) and Facebook Inc. (FB)—have all gone up exponentially since then compared to the average stock, and I’ll bet the second five stocks in the index have as well. Those 10 make up about 25% of the SPY by market-cap weight and were probably only 15% of it three years ago. So, their growth kept spiking the SPY higher. Since those same 10 stocks only represent 2.3% of the Invesco S&P 500 Equal Weight ETF (RSP), they didn’t raise the fund’s return as high over the last one- and three-year period compared to the SPY.

If you believe that those five or 10 stocks will continue to blast higher than the average stock in the future, maybe it would be good to split the 30% RSP weighting in the Level3 Passive Portfolio to 15% RSP and 15% SPY.

If the other 490 stocks start catching up or the top 10 lose favor, then the RSP will outperform just like it has over the last 10-year period when some of the high-flying stocks collapsed, dragging down the SPY performance more than the RSP.
—eyedoc3 from Michigan

My question relates to the logic of including the Vanguard Real Estate ETF (VNQ) in the Level3 Passive Portfolio at all. In James Cloonan’s book [“Investing at Level3”; www.level3investing.com], it pegged VNQ at 20%. It has since been reduced to 10%. VNQ seems to underperform stock index funds in growing markets by a lot and has over a very long period of time. My question is why include it at all?
—John from Virginia

Charles Rotblut responds:
Over the long term, real estate has been shown to realize annualized returns close to that of small-cap stocks while providing diversification benefits at the same time.

Regarding the performance of the equal-weight S&P 500 versus the traditional market-capitalization-weighted S&P 500, the Invesco S&P 500 Equal Weight ETF had a 10-year annualized return of 14.5% at the end of October 2018 versus 13.1% for the SPDR S&P 500 ETF. Any time a strategy deviates from the broad and widely followed index, there will be risk of short-term underperformance. This is simply part of the price for achieving higher long-term returns.

Lower Withdrawal Rates for Portfolio Longevity

Comments on “Revisiting the Risks of Retirement Spending Rules,” by Charles Rotblut, CFA, in the November 2018 AAII Journal:

Retirees who can divide their budget into essential and optional spending (with the latter a significant amount, say 30%–50%) have another strategy available. They can spend a percentage of their portfolio every year (with no adjustment for inflation). Their budget will therefore fluctuate with the value of their portfolio, but with a reasonably balanced asset allocation it is unlikely that essential spending would need to be trimmed even in a severe bear market. The two significant benefits are that longevity risk is eliminated and that spending closely tracks market returns with no need to worry about adjustments to your spending strategy after a year of unusual returns (up or down).

The percentage that is used for spending can rise as life expectancy grows shorter over time, much like the required minimum distribution (RMD) percentage for traditional IRAs. For me, the RMD percentage is too high since it aims at depleting the IRA. Instead I use a fairly simple formula: % of Portfolio = Age ÷ [20 – ((Age – 60) ÷ 5)]. This formula that gives a 3% withdrawal rate at age 60 and a 5% withdrawal rate at age 80, which are more conservative than the RMD table.
—Dave C from OR