Copyright 2012 Tom Madell, PhD, Publisher
Jan. 2012. Updated Jan. 10, 2012


-Three Year Gains Dented by a Disappointing Year
-So Was 2011 a Harbinger or Merely a Pause?
-New Model Portfolios for Jan. 2012
-New Focus on Specific Fund Recommendations
-Model Portfolio Performance Update (1-10-12)   (on separate page - to view, click here)
-Tom Madell Interview with McGraw-Hill Financial Author Paul Petillo Available Online
-Treasury Rates In 2012. By Steve Shefler   (on separate page - to view, click here)


Three Year Gains Dented by a Disappointing Year

After the rather paltry, and in most instances negative, performance of the great majority of stock funds during 2011, investors might be tempted to think that these investments are headed nowhere fast. But that could easily overlook the fact that, for the most part, stock funds have still been an excellent place to be since 2009. As a year end summary of the S&P 500 Index for each of the past 3 years, as well as for the entire period demonstrate, returns show up well as compared to most equivalent stretches:

Calendar Year(s)

Total Return








14.7 (annualized)

However, over the last 5 and 10 year periods, the average annualized return for the Index have been -0.3 and +2.8%, respectively. This is one of the potential problems, then, of being a "buy-and-hold" stock investor. If, on the other hand (a very big if, of course), one can get a sense of relatively good and relatively poor performance ahead for the market mainly from economic fundamentals and existing trends, there might be the possibility of doing better: During such periods, one could perhaps sidestep stocks and profit more from being in bonds.

So how have people been doing who move out and/or in from the Index for whatever reason. (Eg. They might be trying to time the market, or, perhaps they merely needed to have additional cash on hand.) We were surprised to discover that while year over year, ending Nov. 30, 2011, the Vanguard 500 Index Fund (VFINX) returned 7.7%, investors returns within the fund based on monthly flows of cash out of and into the fund were 10.5% over the last year. Over the last 3 yrs., while the gap shrank, it was still a substantial 1.7% favoring shorter-term holders. Over longer periods, though, investor returns were generally less than buy-and-hold returns.

How about for small cap stocks as represented by NAESX, Vanguard's fund that aims to mirror the Russell 2000 Index? Once again, during the last year, there was about a 3% advantage to moving out and/or in vs. buy-and-hold (7.24 vs. 4.47%) The gap here persists as well over 3 years, and only begins to shrink over very long periods (ie. 15 years).

This seems to contradict prior evidence that stock investor returns usually run less than buy and hold returns. (If interested, see our Nov. 2009 article on the subject.) Perhaps the explanation for this is that, in general, investors have been pulling money out of stock funds over the last decade and this has finally started to work toward their advantage. Since returns have generally been mediocre at best, and weak especially in the latter part of this year, pulling out has proven to be slightly superior than holding on.

Unfortunately, investor returns in bond funds has continued to trail those investors who bought and held. Thus, if the intention was to decide when was a good time to either enter or exit from these funds, investors have still not been able to be successful.

Of course, if an investor is able to outperform the market, they can do so either by a) picking outstanding market-beating funds (see last month's Newsletter on the subject), b) successfully timing being in or "less in" the overall market, or, c) successfully selecting which categories or types of stock/bond funds will outperform the overall market over a given period, or some combination of each.

A recent academic research study shows that certain mutual fund managers can successfully outperform by both a) stock picking skill (including which sectors to select and when) and b) overall cash raising/lowering market timing skill. While the first skill has been shown through research to exist but only among the best managers, the research evidence for timing skill among managers has been hard to come by.

Mutual fund investors are obviously substituting picking managers (or passive indexing) for actually having to pick individual stocks. Those investors who base their fund choices on researching the field for the best managers may have a significant advantage. Additionally, it remains true that some mutual fund investors might also possess timing and advantageous category selection skills as well.

The above cited paper suggests that timing skills are particularly important during recessions. Successful fund managers (and we would suggest successful fund investors) "hold more cash in recessions, their portfolios have lower market betas (Editor's note: meaning less volatility as compared to an index), and they tend to engage in sector rotation by investing more money into defensive industries in recessions." (Editor's note: The percentage of fund's defensive allocation can be viewed using the Portfolio tab on The authors find the astute analysis of fundamental economic data, such as industrial production and non-farm employment growth, is one of the reasons that the most successful fund managers are able to outperform.


So Was 2011 a Harbinger or Merely a Pause?

Here is a riddle: What does a doctor need to have lots of to be successful? Answer: Patients (ie. patience) Here is a similar question which is not intended to be funny: What does an investor need to have lots of to be successful? The answer is the same - patience.

Just think about it. How many fund investors do well over a short period of time? My answer: Hardly any. In order to see your assets grow, it will more often than not seem as though you are not getting anywhere, even over multiple year periods, or at best, moving in very slow motion.

The reason why most people are not particularly successful as investors is they don't stick to their investment program for a long enough time to enable the sometimes minuscule gains to start to actually amount to something significant.

I have been observing lately that no matter what my mind wishes will be the day-to-day direction of my investments, not only don't I have any control over this aspect of my commitment to investing, but that any progress that I make is likely to be excruciatingly slow. While I may become highly frustrated that this is the case, in most instances, it will later be proven wrong to have given up on the quest merely because of these at times slow, and highly unpredictable, short-term results. (The exception, of course, is particular fund choices which were not good investments to begin with.)

While there may be times, such as back in the late 1990s when nearly every stock fund investment seemed to support one's sense of perpetual winningness, 2011's market is much more typical. The market might give you a little only to take it away in short order.

But while success as an investor may mostly seem like a near impossible task for those who expect to see measurable results within a year, two, or even more, there is little doubt that there will nearly always be some winning categories of investments regardless of the broader investment environment. But one must be open to this possibility and at least moderately vigilant enough to seek out these opportunities. This is why we endorse getting away from an "all or none" or mere buy and hold approach to investing. Most investing trends are clearly visible; investors should emphasize funds and categories that are doing well, while at the same time, keeping an eye out for overvaluation.

We began 2011 with a Jan. Newsletter entitled "We Remain Firmly Bullish". Therefore, we must fess up; things did not turn out at all as well as we had expected. Especially in 2009 and a little less so in 2010, stock fund investors had many opportunities to do quite well. Not so in 2011. While the return on the S&P 500 Index eked out a small gain, almost no other "mainstream" categories of stock funds were able to end the year in positive territory. Meanwhile, bonds, especially long-term ones, which many experts had felt were destined for mediocre to poor performance due to the possibility of rising rates and/or inflation, scored some of their best performances in at least a decade.

If you re-examine our above "bullish" newsletter, you will see that we said that our bullishness referred to "prospects over the next several years, and especially over the next 5 to 10 years." We suggested that most long-term investors not focus on what "might" happen over the next 6-12 mos., if that can even be predicted at all. More specifically, we stated one year ago that:

"your odds of success should be quite high whenever you elect to invest when conditions, especially undervaluation, suggest that an asset category is below where history suggests it should be and economic fundamentals are improving. We believe we are in such an environment now."

Fast forward to right now: The above quote remains just as valid, with the S&P 500 Index significantly below its long-term average P/E ratio, and thus showing undervaluation, and many recent US (but not foreign) economic data releases surprising well to the upside.

What concerns us the most is that at least for the time being, the bullish trend in stock prices stemming back to March 2009 appears to have been broken. That is, as stated above, over the last year almost all categories of stock fund returns are in negative territory. And almost all categories of foreign funds are actually in bear markets, having dropped over 20% from where they stood earlier in the year and yet to have regained these losses. For example, one measure of developed and emerging markets excluding the US still shows a drop of approximately 25% since the April 2011 high. US small and mid-cap funds should also still be considered in a bear market, although having recovered back about half of the lost ground since Oct. This suggests, to us, that until returns turn positive over the prior 12 mos., one is creating more risk if one adds to these holdings.

According to our research-based model for forecasting long-term category performance, nearly all stock fund categories should be regarded as HOLDs, but there are no outright SELLs.

New Model Portfolios for Jan. 2012

Overall Allocations

We are raising slightly our allocation to stocks in light of what we anticipate will eventually be only moderate prospects at best going forward for bonds.

For Moderate Risk Investors

Asset Current (Last Qtr.)
Stocks 62.5% (60%)
Bonds 32.5 (32.5)
Cash 5 (7.5)

For Aggressive Risk Investors

Asset Current (Last Qtr.)
Stocks 80% (75%)
Bonds 10 (10)
Cash 10 (15)

For Conservative Investors

Asset Current (Last Qtr.)
Stocks 35% (30%)
Bonds 50 (50)
Cash 15 (20)

New Focus on Specific Fund Recommendations

Since the inception of our Model Portfolios in Jan. 2000, we have always structured their presentation in terms of which categories of funds we recommended investors should emphasize in their portfolios. These categories were chosen because they appeared to us to have the best forward-looking potential over the next several years. We also reported the prior performance of these Portfolios by showing the average performance of the stock fund category we recommended from 1, 3, and 5 years ago. Average performance for the major fund categories are provided on a number of websites shortly after the close of each calendar quarter, or even on a daily basis.

Our intention has been to call to investors' attention that certain fund categories appear to be a much more strategic place to invest at a given point in time than other categories. (An example might be that it appears better to invest in small cap stocks at the start of a positive economic cycle than toward the end. And, of course, at any time during an economic cycle, certain categories can become highly undervalued while others overvalued. At such times, we believe it makes more sense to direct new or additional investments to the former than to the latter.)

So emphasizing fund categories, rather than specific funds, seemed like the best way for us to go. We also reasoned that a) not all investors have access to those specific funds we recommend, as for those with tax-deferred accounts that only have a limited number of choices, and b) many readers would have already selected their own choice of funds and fund families; therefore, emphasizing our favorite funds would leave these investors with perhaps a difficult choice - stick with their own picks, or throw them aside and switch to our picks.

While the above considerations still make sense, we have decided to now emphasize specific fund selections as opposed to broad fund categories. You will note the difference in the tables below which now are structured to highly suggest that you invest in our recommended funds, not just in any fund within our recommended category.

Why? Year after year, we have frequently seen the specific stock funds we recommend subsequently do significantly better than their category averages. After all, the performance shown by category averages, by definition, are not going to beat the performance of prior well-performing funds which continue to remain the higher echelons of their category average. Thus, since this has indeed been proven to be the case, we have been doing ourselves and our readers somewhat of a "disservice" to emphasize "average", and later, compare how our Model Stock Portfolio did in terms of these average funds. Readers should find the most benefit from this Newsletter by actually investing in our well-researched, and thus far proven, choice of specific funds.

While fund investors in a given type of account (eg. 401(k) ) may not be able to purchase one of our specifically recommended funds, anyone these days who meets the minimum purchase amount, ranging from about 1k to 3K for most funds, can invest in our recommended funds either directly from the fund or through many large brokerages, such as Vanguard, Schwab, etc.

Another factor leading us to switch to a focus on specific funds: It is often hard to classify a given fund into a specific category. And there may even be a discrepancy between what the fund says is the type of investments it focuses on and what the fund's portfolio is invested in at the current time. There is also something called "style drift" where a fund deliberately invests across category boundaries in order to attempt to maximize returns. So, if a fund that usually invests in the Large Value category now has a portfolio that more resembles a Large Blend fund, what should an investor who follows our category recommendations do? With a focus on specific funds, rather than specific categories, this is no longer an issue because by recommending the fund, we are expressing confidence that no matter what direction the manager takes, he/she will likely will give investors a rewarding level of long-term performance.

Given these considerations, going forward, we will now present our Stock Portfolio performance in terms of the specific funds we recommend, not the category averages. This too fits with the theme that to be most successful as a fund investor, one needs not only to recognize in which categories of funds the most opportunity appears to lie, but also, which specific funds within that category are most likely to be among your best choices. As we think we have shown down through the years, it not enough to be in the right category to do particularly well; you must also have selected one of the better specific funds within that category.

In our Dec '11 Newsletter, we showed our "all weather" long-term fund choices. In general, our new Model Portfolio recommended funds will tend to come from that list. However, on occasion, our quarterly Model Portfolios will highlight other funds we have reason to believe may also be good choices, especially if your investment commitment to them may not always be for the 5+ year period we usually suggest. When more than one fund is listed of a given type, as in the tables below, the first one shown is our current preference. It should also be noted that index funds tend to be "safer" choices than managed funds. Managed funds will at times underperform index funds within their categories. However, we still believe that there are some exceptional managers that can, more often than not, outperform the indices.

Stock Funds

Stock Fund Model Portfolio

Our Fund Recommendations

Fund Category

 Recommended Weighting Now 
(vs Last Qtr.)
 Fidelity Low Priced Stock (FLPSX) 
 Nicholas Equity Income Fund I (NSEIX) 


20% (27.5%)

 Tweedy Brown Global Value  (TBGVX) 
 Vanguard Internat. Growth (VWIGX)
(See Note 1)


20 (22.5)

 Vanguard 500 Index (VFINX)
 Yacktman (YACKX)

 Large Blend 

17.5 (15)

 Vanguard Growth Index (VIGRX) 
Fidelity Contra (FCNTX) 
 Large Growth 
15 (17.5%)

 Vanguard Windsor II (VWNFX)

 Large Value 

12.5 (12.5)

 Vanguard REIT Index (VGSIX) 
(See Note 2)
 Amer. Cnt. Real Est. (REACX) 

 Real Estate (REITs) 

10 (5)

 Vanguard Equity Inc (VEIPX) 

 Equity Income 

5 (0)

Note 1: Be aware that International funds may have losses if the US dollar continues strengthening as it has lately; TBGVX is structured as to not have this problem ("hedged").
Note 2: If an ETF (exchange traded fund) is available as a substitute, it will generally give about the same return as a non-ETF (eg. Vanguard REIT EFT (VNQ) can be substituted for Vanguard REIT Index.)
General Note: Just as a year ago, sector funds consisting of Financial stocks are so beaten down that an aggressive long-term investor who is willing to "bottom fish" might accept our admittedly high risk BUY signal for this category, along with one for funds that focus on Japan and Global Real Estate; we do not have specific funds to recommend for these categories.

Bond Funds

As was shown again rather dramatically in 2011, which specific bond funds and categories one chose was crucial to achieving noteworthy results. For at least the time being, I would avoid all short-term bond funds, but otherwise remain highly diversified.

Bond Fund Model Portfolio

Our Fund Recommendations

Fund Category

 Recommended Weighting Now 
(vs Last Qtr.)
 PIMCO Total Return Instit (PTTRX) or 
 Harbor Bond Fund (HABDX)
 Vang. Total Bond Mkt. (VBMFX)

 Intermediate Term 

32.5% (50%)

 PIMCO Real Return (PRRIX) or 
 Harbor Real Return (HARRX)


15 (15)

 Vang. Interm. Tm. Treas. (VFITX)

 Intermed. Govt. 

12.5 (10)

 Vang. (state specific - see Note)  
Vang. Intermed. Term Tax-Ex. (VWITX) 
 Intermed. Term Muni. 
15 (5)

 Vang. Long-Term Inv. Gr. (VWESX)

 Long-Term Corporate 

10 (0)

 Vang High Yield Index (VWEHX) 

 High Yield 

10 (12.5)

 PIMCO Foreign Bond (USD-Hedged) Adm (PFRAX) 
 T Rowe Price Intl. Bond (RPIBX)


5 (7.5)

Note: Select a fund, if available, that has your state's bonds for double-tax exemption.

An update of how our prior model portfolios have performed can be accessed by clicking here.

We at hope you have a happy, peaceful, and prosperous New Year!


Tom Madell Interview with McGraw-Hill Financial Author Paul Petillo Available Online

On Jan. 6th, Tom Madell was interviewed on a live internet radio broadcast. Interested readers can listen to the archived half-hour discussion of pros and cons of mutual funds and ETFs by clicking here.


Readers can sign up to receive notification of new Newsletter postings as well as infrequent, but crucial, investment Alerts by emailing Subject: free subscription


Continue on to Treasury Rates In 2012 by Steve Shefler