and Portfolio Tweaking

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Spent some time this weekend reading many of the articles at The website is the educational arm of Merriman Capital Management, an investment management firm that is heavily into DFA funds. They promote no-load, asset-specific, low-cost funds (which often end up as index funds), and have a lot of interesting things to say on both active and passive investing.

I naturally gravitated towards the passive investing articles, and favorite article so far is ‘The ultimate buy-and-hold strategy’, which agrees with why I want to slice-and-dice my portfolio. I was also intrigued by their ideas for investors with small portfolios. Instead of picking an all-in-one fund or a cash fund until you have enough to invest, they advise you to pick the asset class with the most potential return but highest volatility (U.S. small-cap value to begin with) and build upwards.

I don’t know about that, but I do like their Vanguard model portfolio:

($30,000 minimum)
12.5% Vanguard 500 Index (VFINX)
12.5% Vanguard Value Index (VIVAX)
12.5% Vanguard Small Cap Index (NAESX)
12.5% Vanguard Small Cap Value Index (VISVX)
20.0% Vanguard Developed Markets Index (VDMIX)
20.0% Vanguard International Value (VTRIX)
10.0% Vanguard Emerging Market Index (VEIEX)

(For bonds, he pretty much recommends a short-term bond fund.)

I don’t know why, but that portfolio above just looks nice. Maybe it’s just the nice even proportions, like the nice 50/50 balance between domestic/international. I couldn’t find why he doesn’t consider REITs as an asset class to be included, though. My current portfolio isn’t as heavy on the international stocks – I agree somewhat with Bogle that nowadays most corporations are multi-national, so you are getting some international exposure even with “domestic” funds. But maybe my 75/25 split is too domestic. And I probably listen to everyone and keep my bonds conservative with the short-term bonds vs. reaching with the intermediate-term ones.

It’s been less than 4 months since setting up this portfolio, maybe I’ll wait until the 6-month mark to start tweaking again 🙂 As Jack Bogle (and the Prussian General Karl von Clausewitz) says:

“The greatest enemy of a good plan is the dream of a perfect plan.”

As for the active management side, their market-timing articles use a similar technique to the one proposed in “Yes, You Can Beat The Market!” by Stein and Demuth [my book review]. But instead of comparing against a 15-year moving historical average, they propose a much shorter timeframe of 100 to 200 days. The method still suffers from the same drawbacks however – you have to calculate that moving average constantly, you have to be in cash for extended amounts of time, and stick to the plan during long periods of underperformance. It just takes way too much effort and discipline with not enough payoff for me.

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  1. I also like his portfolio and I do think he might be too heavy on international, but I would rather seem 10% of international reduced and add 10% to REIT, but that’s just my opinion.
    Paul Merriman does change his allocation sometimes. Go to his blog, he has the reaosn he doesn’t add REIT there if you are intrested, but he’s not against REIT at all.
    I think TIPS should be added as well as short-term bonds personally.

  2. I follow the Vanguard equity portfolio and have been a fan of Mr. Merriman’s website for about a year now. I point investing newbies there.

  3. Ah, I found it – from the Merriman Blog:

    Real estate investment trusts are an asset class that is non correlated with the S&P 500. If you changed the US portion of our portfolios from 25% each in large blend, large value, small blend and micro cap to 20% each to those four asset classes plus and additional 20% to REITs, both the risk and return decline a small amount. I have no problem with adding REITs but they should be held in the tax deferred portion of your portfolio.

  4. I thought REITs were correlated like 95% with small value which was correlated like 80% with large cap.

  5. Commodities futures are a better diversifier from the research I’ve seen.

  6. From the limited amount that I’ve read, I got that commodities are currently expensive to get into, which basically negates the diversification benefit. If some really low-cost funds came out, that would make things interesting.

  7. Jonathon:
    That’s the problem that I disagree with Paul Merriman, he considers REIT as a domestic asset class and I agree with many others that REIT is a completely different asset class. Historically the S&P500 and REIT have very similar returns and very similar risk, yet if you split the S&P500 and REIT and rebalanced your risk decreases and your return increases. Paul Merriman is selecting to decrease all domestic funds in order to add REIT, which as he’s mentioned will slightly lower the “expected” return and decrease the risk. Personally as I’ve mentioned I’d take away from International myself 10% and give it to REIT. Larry Swedroe has commented on Paul Merriman’s thoughts on REIT on the diehard board.

    This is not correct
    Small cap value to REIT is 60% correlation and REIT to large cap has a correlation of 45%, therefore it’s an excellent diversifier. Correlation is hard to track though and it does change over time. REIT and other asset classes you’ve mentioned may be more correlated:

    Another note is that you can read about the benefits of short-term bonds over long-term bonds, that the longer the duration the higher the correlation to equities. Many use short-term bonds instead of the TBM (Total Bond Market), because TBM holds around 33% mortgage back securies and most have a longer duration than the short-term bond index. Larry Swedroe over and over says that we should only use bonds to lower or risk if we want higher returns then we should increase equity portion. Strange thing is that for the past 10 years the TBM has beaten short-term bonds, but then we say we’ll it’s not about the 10 year return, but about the low correlation to equities. Well in the last bear market of 2000-2002 the TBM also beat the short-term bond index every year. Thus, it seems that correlation isn’t always what it seems to be. I personally split TBM, TIPS and Short-term bonds with some of my more conservative accounts. Taylor Larimore does 50% tips and 50% TBM.

  8. In Paul’s Vanguard model he suggests splitting money 20% VDMIX, 20% VTRIX and 10% VEIEX. VDMIX is 69% VEURX and 31% VPACX. VEIEX charges a 0.5% redemption when you buy & sell (payable to the fund).

    VGTSX (Total International Stock Index) is made up of 58% VEURX, 28% VPACX & 14% VEIEX and charges no redemption fee, so I have replaced VDMIX/VEIEX with VGTSX.

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