2015 Tom Madell, Ph.D.

Jan. 2015: Updated: 1-19-15

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Comments on the Investing World as We Enter 2015

Since investing forecasts for relatively short periods of just a year or so, are just as likely to be wrong as correct, you should not count on any prediction you read to give you anything more than an inkling of what might happen in 2015, even when coming from me.

In fact, when I slightly trimmed down my Model Stock Portfolio allocation for Moderate Risk Investors (but not for Aggressive or Conservative Investors) last January, I had anticipated somewhat more modest returns from stocks in 2014 than we actually got. Luckily, I never became outright bearish, which we only now know would have be proven a mistake, at least with regard to 2014 returns.

But, it still seems to me that the fundamental longer-term theme that we were alluding to at the time remains intact. Most categories of stocks have become even more overvalued. At some point, investors will likely be jolted out of their seeming complacency about stocks, resulting in greater numbers of stock categories showing possibly extended mediocre, or even, negative returns.

In fact, the media and some investors may be misinterpreting the positiveness of current scene, as illustrated by what happened in mid-December. Stocks jumped big time as a result of the statement from the Federal Reserve they would be "patient" in deciding when to raise interest rates. This was apparently interpreted to mean a further continuation of long-standing near zero interest rate policy that has helped stocks since the financial crisis.

But a closer, more rational, analysis shows that the Fed was merely changing away from the words "considerable time" to "patient."

(continued on middle of page 7)

New Model Portfolios Beginning the 1st Quarter 2015

By Tom Madell

Year after year for 15 years now, my Newsletter has given investors specific suggestions as to how to construct a model portfolio which includes a diversified mix of stocks, ETFs, bonds, and cash. Sometimes, it might have appeared that the recommendations were like many other investment forecasts. That is, about half the time they might be right and half the time wrong, and perhaps therefore, of insignificant value.

But year by year, by constantly tracking how our Model Portfolios have performed, we have proven that these recommendations, if they were guesswork or only 50% likely to be helpful, must have been awfully lucky. Long-time readers, or anyone who wants to review how our Portfolios have done, will realize that our recommendations have been far more successful than would be expected by mere chance.

While readers will, with all assurity, continue as always to come and go from our site, we have enough loyal readers who have profited from our recommendations that we still find it worthwhile to publish our work. And once again, as the data we will present below should show, people who stuck with our recommendations, which are meant to be for the long term, have come out ahead. I know of no other source that provides this kind of valuable information to readers. Do you?

We wish all our readers success in 2015 but, more importantly, in the many years ahead.


From outward appearances, 2014 was another outstanding year for those who invest in funds and/or ETFs. But, upon closer examination, this was mainly true for investments that happened to be parked in the right places. Unfortunately, in quite a few instances, the otherwise excellent returns within a portfolio were lessened substantially by funds that did not perform nearly as well.

As we wrote about last month, funds invested in S&P 500-like products by far proved to be the best place to be, followed by other Large Cap funds. Investing anywhere else, except for a small number of sector funds, would have earned you middling returns at best (averaging at least 5% below the S&P 500 index), and piddling ones (averaging at least 10% less), or

(continued on page 2 below)

Page 2

Jan 2015

(New Model Portfolios Beginning the 1st Quarter 2015, continued from page 1)

even, at worst, negative returns, mainly in the case of international investments.

Even the much vaunted ETF world was not immune to the underperformance plight. A quick perusal of the performance of the 100 largest ETFs shows only a small percentage topping the typical S&P 500 index fund.

So how would readers of this Newsletter have done if they followed my specific Jan. 2014 fund recommendations? In summary, you might say that I was moderately on the right track in suggesting a somewhat reduced allocation to stocks (52.5% for Moderate Risk investors) at the beginning of 2014 along with only a small exposure to underperforming Small Caps and a nearly as small an exposure to volatile sector funds. Like many investors, I incorrectly assumed in my Jan. '14 portfolio that International stocks (but not Emerging Markets) would be a good place to be after several prior years of underperformance.

We were also pretty close to correct so far when assuming in our Jan. '14 Newsletter

"that many well-chosen bond funds ... are still likely to produce positive, although relatively small, returns over the next several years provided that the Federal Reserve keeps its word and holds short term rates near zero, helping to anchor long-term rates."
In fact, the biggest surprise here was that many bond funds did as well as they did. Thus, those who avoided bond funds, and opted for cash instead, likely missed out on some performance enhancing opportunities. We at the time, on the other hand, recommended a 25% exposure to bonds for Moderate Risk investors.

As I have tried to point out many times in prior Newsletters, trying to make relatively short-term predictions is something that will always be fraught with about as many misses as hits. However, relatively longer-term ones can become able to capitalize on undervalued areas and "misperceptions" in the markets and better allow time for those variables to play themselves out to the fullest extent.

A complete report on how our Jan. '14 Model Portfolio performed, as well as our Portfolios from 3 and 5 years ago, appears later in this issue. These returns seem to confirm the need to allow enough time to come out ahead, especially with regard to stocks.

Overall Asset Allocations

For Moderate Risk Investors

Asset Current (Last Qtr.)
Stocks 50% (50%)
Bonds 25 (25)
Cash 25 (25)

For Aggressive Risk Investors

Asset Current (Last Qtr.)
Stocks 65% (67.5%)
Bonds 12.5 (10)
Cash 22.5 (22.5)

For Conservative Investors

Asset Current (Last Qtr.)
Stocks 15% (20%)
Bonds 40 (35)
Cash 45 (45)
Page 3

Jan 2015

While it may be tempting to "go with the flow" of rising stock prices, and the same for bond prices, I believe that many investors are perhaps expecting too much, buoyed by the relatively recent performance of the markets.

While it is impossible to know in advance what the "correct" allocation will have later proven to have been, our philosophy is to not go too far out on a limb in any direction.

Investors who are relatively younger and can take a very long perspective may have little reason to change their allocation from year to year. However, somewhat older investors might be well advised to take some of their gains out of the stock market. That way, in the event the market disappoints in the next few years, they will hopefully have at least some strong profits to show for their efforts.

Allocations to Specific Funds

Important note: It has always been our policy that when more than one fund is listed for a given category, as in the tables below, the first one shown is our current preference, This was explicitly stated in our Jan. 2012 issue, and perhaps in other issues as well. Any other funds listed under a single category should be regarded as listed in decreasing order of preference.

Model Stock Fund Portfolio

Our Specific
Fund Recommendations


 Category Weighting 
Now (vs Last Qtr.)

-Fidelity Low-Priced Stock (FLPSX)

   Small Cap

   7.5% (10.0%)

-Tweedy, Browne Global Value (TBGVX) (C & M)
-Vanguard Europe (VEURX) (M)
-DFA Internat Small Cap Value I (DISVX) (A) (new) 
-Vanguard Emerging Markets Index (VEIEX)  (A)
-Dodge & Cox International Stock (DODFX)  (A)
  (After publication, this fund closed.)
(See Notes 1 and 2.)


    30.0 (30.0)

-Vanguard 500 Index (VFINX)
-Fidelity Large Cap Stock (FLCSX)

   Large Blend 

    20.0 (17.5)

-Vanguard Growth Index (VIGRX)
-Fidelity Contra (FCNTX)

    12.5 (10.0)

-T Rowe Price Value (TRVLX) (M)
-Vanguard Windsor II (VWNFX) (M)
-Vanguard US Value (VUVLX) (A)


    22.5 (22.5)

-Vanguard Utilities ETF (VPU) (M)
-Vanguard Energy (VGENX) (A), or
-Vanguard Energy ETF (VDE) (A)
-Vanguard Precious Metals and Mining Inv (VGPMX) (A)


    7.5 (10.0)

1. Stock or bond funds with (C) are particularly recommended for Conservative investors; likewise, (M) for Moderate; (A) for Aggressive.
2. Highly similar ETFs (exchange traded funds) of the same category can often be substituted for any index mutual fund shown in this table; e.g. Vanguard FTSE Europe ETF (VGK) can be substituted for Vanguard Europe (VEURX).

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Jan 2015

Comments on Changes Since the Oct. '14 Stock Portfolio

Fidelity Low-Priced Stock has been disappointing. However, the performance has been adequate given the relatively low risk profile of the fund. We are lowering our allocation a notch especially since we believe that Mid- and Small-Cap stocks remain the most overvalued of the 9 major Morningstar US fund categories.

We are adding exposure to an International Small Cap Value fund, which is not overvalued. In order to limit our international stock funds to five, we are eliminating for now our recommendation of Vanguard International Growth (VWIGX). (Note: This does not mean long-term investors should necessarily abandon VWIGX; however, we think the above listed 5 international funds may do better.)

We are decreasing our allocation to now more risky sector funds while at the same time increasing allocations to Large Blend and Large Growth.

Model Bond Fund Portfolio

Our Specific
Fund Recommendations
Fund Category Recommended
Weighting Now
(vs Last Qtr.)

-PIMCO Total Return Instit (PTTRX)
 (High minimum investm. outside 401k), or 
-Harbor Bond Fund (HABDX) (1K min.) or
-PIMCO Total Return ETF (BOND)
-Metropolitan West Total Return Bond M (MWTRX) (new)


    30.0% (30.0%) 

-PIMCO Real Return (PRRIX)
 (High minimum investm. outside 401k), or
-Harbor Real Return (HARRX) (1K min.)


    5.0 (5.0)

-Vanguard Intermed. Term Tax-Ex.
 (VWITX) (see Note 1)

    17.5 (15.0)

-Vanguard Sh. Term Inv. Grade (VFSTX)


    5.0 (5.0)

-Loomis Sayles Retail
 (LSBRX) (A)


    10.0 (12.5)

-Vanguard High Yield (VWEHX) (new)
  (See Note 2)

  High Yield 

    10.0 (15.0)

-PIMCO Foreign Bond (USD-Hedged)
 Adm (PFRAX)


    22.5 (17.5)

  1. Select a fund, if available, that has your own state's bonds for double-tax exemption, such as, for example, the California Intermediate-Term Tax-Exempt Fund (VCAIX) if you live in California.
  2. Recent Model Portfolios recommended several other High Yield funds since VWEHX was closed although we continued to prefer it. We try not to recommend closed funds, necessitating our move away from the fund. The fund is now open so we can again recommend it.

Page 5

Jan 2015

Comments on Changes Since the Oct. '14 Bond Portfolio

We are adding the Metropolitan West Total Return Bond M (MWTRX) which has become one of the leading bond funds around. We still have confidence though that the PIMCO and Harbor funds are one's best choices.

We are increasing our allocation to muni bonds whose generally tax-free returns often make them superior in non-retirement accounts.

We are reducing exposure to the Multisector and High Yield categories which can tend to invest aggressively.

We are significantly increasing exposure to our International Bond fund (PFRAX). Weak economies overseas are good for these countries' bonds as compared to a stronger economy in the US which may hurt US bonds. However, US bonds may profit from increased buying by overseas investors seeking higher yields.

Prior Model Portfolio Recommendations:
Outperformance Is Most Likely Beyond One Year

Earlier, I suggested that my recommendations have a better chance of coming out ahead of their benchmarks if held beyond a single year. In other words, acting on a recommendation and then assuming outperformance within a year or less, akin to a rather short-term orientation, may be expecting too much from these Model Portfolios.

With that in mind, let's look at how Portfolios from 1, 3, and 5 year ago did.

Model Portfolios From One Year Ago

You can view our January 2014 recommendations here.

Stock Funds

Here is a summary of how our recommendations did when held for the entire year in the percentage allocations we recommended, including what helped the portfolio and what hurt it:

Important note: When more than one fund was recommended for a given fund category, we have always divided the allocation equally between each of the funds when calculating Portfolio performance. Note however, that, as stated above, when more than one fund is listed for a given category, the first one shown has always been our own preference. Therefore, performance of these "equally-weighted" categories often understates how one would have done if one had emphasized our first choice within a category, since quite typically, our first choice has been a better performer than the average return of any remaining funds shown within the category.

Our Stock Model Portfolio, which includes both domestic and international stock funds, returned 6.64%; our benchmark portfolio returned 6.76%. Thus, we trailed the benchmark by a miniscule -0.12%. On the other hand, our 9 US stock funds returned an average of 10.03%; the average diversified US stock fund returned 7.56% as reported in the Wall Street Journal.

While we were not able to outperform the benchmark, it must be realized that the benchmark consists of broad indices, which are not available to investors and which do not reflect expense ratios that must be encountered in funds or ETFs. The benchmark is made up of 65% US stocks (DJ Total Stock Market index) and 35% developed country and emerging market stocks (Spliced International Index).

Helped Performance:
-Eight out of 9 of our U.S. stock funds beat US benchmark
-Keeping only a small weighting of underperforming US  Small/Mid-caps
-Overweighting Large Value fund
-Vanguard Consumer Staples ETF

Hurt Performance:
-Two of our 4 International stock funds did worse than our International benchmark.
-Fidelity Contra Fund
-Vanguard Energy ETF's negative return, but it performed much better than the average Energy fund.

Bond Funds

Our recommendations slightly underperformed the benchmark, Barclays Aggregate Bond (AGG), 5.74 to 6.00%, or by -0.26%. However, the average of all taxable US bond funds returned 2.77% as reported in the Wall Street Journal.

Page 6

Jan 2015

Helped Performance:
-International and Muni bond recommendations had double digit performance. (Note: the Muni fund performance was adjusted to reflect the after-tax return for investors in the 28% Fed. tax bracket.)
-Little emphasis given to Inflation Protection

Hurt Performance:
-Large weighting of PIMCO Total Return Instit and Harbor Bond
-The specific High Yield fund from Fidelity we recommended did poorly. (As noted above, we recommended the Fidelity fund because our prior choice, Vanguard High Yield, was closed to new investors; we do not knowingly include closed funds in our Portfolios.)

Model Portfolios From Three Years Ago

You can view our January 2012 recommendations here.

Stock Funds

The following is a summary of how these recommendations did when held for the entire year in the proportions we recommended.

Our Stock Model Portfolio, including International funds, returned 17.35% on an annualized basis; the benchmark portfolio returned 15.92% for a net outperformance of 1.43% annualized. Our 10 US stock funds returned an average of 18.36%; the average diversified US stock fund returned 17.49% as reported in the Wall Street Journal.

Helped Performance:
-Inclusion of our S&P 500 index fund
-Our Growth fund choices

Hurt Performance:
-Once again, international funds underperformed US funds. However, both of our International choices easily beat the benchmark. Also, our underweighting of this category at 20% prevented further Portfolio underperformance.
-Real Estate sector funds lagged US benchmark

Bond Funds

Our recommendations handily outperformed the benchmark (AGG), 3.96 to 2.54% annualized, or by 1.42% annualized. The average of all taxable US bond funds returned 3.37% as reported in the Wall Street Journal.

Helped Performance:
-PIMCO Total Return Instit and Harbor Bond
-Allocations to munis, long-term corporate and High Yield bonds
-International bonds, although T Rowe Price fund was our only negative performer in the entire Portfolio.

Hurt Performance:
-Allocation to Inflation funds
-US government bond funds

Model Portfolios From Five Years Ago

You can view our January 2010 recommendations here.

Stock Funds

Our Stock Model Portfolio returned 13.74% on an annualized basis; the benchmark portfolio returned 11.57% for a net outperformance of 2.17% annualized. Our 6 US stock funds returned an average of 16.21%; the average diversified US stock fund returned 13.25% as reported in the Wall Street Journal.

Helped Performance:
-5 out of 6 of our US funds beat the S&P 500, with the 6th just a hair behind, with annualized performance in the 15.5 to 16.5% range annualized.

Hurt Performance:
-International funds still drastically underperformed US funds so our 25% weighting hurt performance. However, once again, our International fund did much better than the benchmark.

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Jan 2015

Bond Funds

Our recommendations outperformed the benchmark (AGG), 4.60 to 4.31% annualized, or by 0.29% annualized. The average of all taxable US bond funds returned 4.54% as reported in the Wall Street Journal.

Helped Performance:
-15% allocation to muni bonds
-Heavy weighting (40% combined) of PIMCO Total Return Instit and Harbor Bond
-High Yield bond choice

Hurt Performance:
-Poor choice of T Rowe Price International bond fund
-Inclusion of short-term corporate bond fund

To summarize: The above data show that this Newsletter's Model Portfolios from the beginning of a calendar year cannot always be expected to do better than comparable indices over this relatively short time period.

But the true value of the Portfolios tends to be realized when nearly all of our funds within the Portfolios are held for more than just one year. This has been especially true for our stock fund recommendations. So, for example, when holding our Model Stock Portfolio from one year ago, you would have almost exactly equaled our benchmark. But, by holding the Jan. 2012 Stock Portfolio, you would have beaten the benchmark by 1.43% annualized. And, by holding the Jan. 2010 Stock Portfolio, you would have beaten the benchmark by 2.17% ann.

These results are highly consistent with previous data we have collected on our Model Portfolio performance down through 15 years of tracking these results and publishing them here. You can examine these results for yourself by finding past quarterly Model Portfolios performance reports using the links on our site.

The implications for readers should be clear: While holding our Portfolio recommendations will typically lead to as good (or better) outcomes as investing in a portfolio constructed of diversified index funds, you will tend to do better than the benchmarks if you hold our recommended funds for periods ranging from 3 to 5 years.

---------- Comments on the Investing World as We Enter 2015 (continued from page 1) -------

Why did they make that change? Because they were concerned investors might assume "considerable time" locked in a guaranteed, extended period of holding off. "Patient," on the other hand implies a somewhat more flexible time period which depends on intervening events to maintain the patience.

Since the majority of Fed members believe that interest rates need to start rising, they did not want to give investors the false impression that near zero rates have that much further to go. So, rather than giving investors a new reason for near zero interest rate optimism, they were actually taking a step to prepare investors for raising rates. But, likely to even the Fed's own surprise, investors didn't seem to get the message.

As some, including me see it, the Fed is caught in a bind. They worry about keeping rates low for too long, but are seemingly afraid of what might happen if investors don't react well to an increase. As usual, and this is strictly my own opinion, they are catering to (or perhaps, "cratering to") the power of the country's most influential investors to possibly send the stock market down, and the economic expansion along with it. They are also afraid that inflation is "too low," somehow putting the Fed's ability to do their job in the event of another downturn at risk. So they are being as slow as molasses in raising rates.

Yes, indeed, the Fed should be regarded as the ally of big investors, and not average savers who count on money market, CD, and bond interest rates to help them make ends meet. But, of course, you and I have had the option of aligning ourselves with big investors, by participating, and thus enjoying the big rally over the last 5+ years.

Just don't get the idea that the Fed's "timidity" and "benevolence" to big investors is going to last forever. I would guess that it will last just a little longer. Then the Fed will likely be forced to take more action other than just changing the wording on what they tell these big investors.

Of course, the first rise or two in interest rates from near zero to 0.50 or even 0.75% shouldn't make a big difference in the overall economy. And it may even stimulate the economy, such as if people who take out loans to make large purchases rush to make purchases before they anticipate rates will go even higher.

But, psychologically, many investors, especially the big investors referred to above, will recognize that one of the biggest props to higher stock prices is beginning to be withdrawn. Therefore, it is reasonable to expect at least a temporary long-awaited correction in stock prices, if not a longer-term leveling out.

Tom Madell, Publisher


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