Despite the negative effect of the May-June pullback, the Model Mutual Fund Portfolio had an excellent year in 2010.
The model portfolio had a return of 20.3% last year compared to 17.1% for the overall market, as represented by the Vanguard Total Stock Market Index Fund (VTSMX). During January the benchmark fund got a head start over the model portfolio, 2.2% to 1.0%.
The Three-Year Rule
As we have previously discussed, the year 2008 presents a problem in applying our existing criteria. Mutual funds’ returns that year have caused virtually all to fail the three-year positive return criterion, and those that don’t fail are commodity or bear-market oriented. What we have done in applying our rules is simply ignore 2008 in all our calculations. We will do this for a while longer and then adjust the three-year positive return rule to meet the reality that disastrous downturns happen, and they happen more often than would be predicted by standard deviations of returns based on normal curves.
One way of dealing with real-world risk is to increase the required horizon for equity investments. I have expressed the opinion that capital that is needed in less than three years should not be in common stocks. The three-year positive return rule was based on this thinking, and we wanted mutual funds that would never have a negative return for anyone with a three-year holding period. But the possibility of bear markets like the one we experienced in 2008 makes it seem likely that a holding horizon of four or five years for common stocks makes more sense. This approach would require funds to have positive returns over any four- or five-year period rather than the three years currently required. We will wait and see how long it takes for the market—and, more specifically, our chosen funds—to recover to their highs reached before the “great recession” before we adjust the rules.
Portfolio Changes
We have sold Stratton Multi-Cap Fund (STRGX) and replaced it with Aston/Optimum Mid Cap Fund (CHTTX). STRGX seems to have changed direction over the last few years. Despite its name, it is dominated by large-cap stocks, and I feel its risk-adjusted return is too low. It’s five-year Sharpe ratio is negative.
Looking Ahead
Over the past three years I have heard more and more comments and advertisements for investment services saying that the market has proven that “buy and hold” is dead—that you have to trade in and out to survive. However, the stock market is looking somewhat stronger and all of our funds are approaching their highs from before the recession. I don’t know how well the “in and outers” did, but if this year approaches the 21.7% increase that is the average of the pre-presidential election year since the depression era, the market will be back to 2007 highs. The market, of course, may not go up 21.7%, but this year in the election cycle has never been negative. In fact, the most frightening thing about the coming year is the preponderance of bullishness.
The next review of the Model Mutual Fund Portfolio will be in the August 2011 AAII Journal, but you may keep up with all the model portfolios at AAII.com.
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