The "Secrets" to Investment Success That Shouldn't Be Secrets At All

By Tom Madell

It seems that, thanks to the current popularity of index funds, there are now essentially two types of investors: those still with the goal of trying to earn market-beating returns and those who would be content just earning market-equaling returns.

I realize that not all my readers these days are still interested in trying to come out ahead of the stock and bond markets. This has come about for a variety of reasons. The number one reason would be that, especially for stocks, just earning market-equaling returns can be satisfying enough, and anyway, such returns have proven to be extremely hard to beat, so why even try? Whichever camp you fall into, or maybe you, like me, maintain a belief in the merits of each approach, the following briefly attempts to explain some of my own thoughts on assembling, and occasionally altering, what I hope will prove to be a successful portfolio, one that at times comes out ahead of the markets, but at other times, comes out at least equal, or very close to equal, to the overall markets.

As long time readers will recognize, the main purpose of my free monthly Newsletters is to not just to discuss fund investing in general, but to uncover and recommend specific portfolios of funds as well as occasional ETFs, that my research suggests have a high degree of potential for doing well, and over the longer term, can even beat the indexes. To see how well the portfolios do indeed perform, I therefore at a later date, review the results of my overall recommended stock and bond portfolios, comparing their subsequent returns with that of a benchmark made up of one or a few indexes, and to published data on average stock and bond fund performance over the same periods.

Down through the 17 plus years I have been making these comparisons, my portfolio recommendations have had a very good track record of either beating these benchmarks, or at least coming very close to beating them. You will see these outcomes illustrated once again in my most recent Model Portfolio report shown below. It should be noted that this has become all the more difficult in recent years when index funds, which now receive the lion's share of new investment money, have quite regularly beaten a large percentage of their competition.

Of course, it would be highly unrealistic to expect each and every one of our individual fund selections to always beat their competition. But when included as part of an overall portfolio, our fund outperformances usually, at a minimum, cancel out our "misses," and as a result, our portfolios have almost always been highly successful against these benchmarks when they are held for a number of years. Shorter term, such as over one year or less, this is not always the case. And while I nearly always make small tweaks along the way each calendar quarter, each Model Portfolio's performance can be judged to see how much above or below it wound up against these hard to beat standards, if held exactly as I originally recommended.

So this raises the question: "Is there a 'secret' to our successful track record"? No, there probably isn't. But there are some basic underlying principles which guide our choices. None of these principles separately are likely to be exclusive to my way of putting together each Portfolio as opposed to how others might do it. But when applied all together, they probably go beyond what the average investor, or even advisor, does in putting together theirs. Briefly, here are a few of these principles:

• The investment world seems almost totally preoccupied these days with rather small differences in how much per year an investment costs as the primary reason for choosing a fund or ETF. But does it really make that much difference whether an investment has a yearly expense ratio of 0.10 vs. say, one of 0.30%? In this example, you would be paying 0.20% more a year for the latter one. (Sometimes the differences emphasized are far less, like a few hundredths of a percentage point.) If other things were equal, lower costs might always be preferable. But far more important is whether the more expensive fund has a better long-term track record that can more than make up for the extra cost. While such outstanding funds are indeed more difficult to find, easily accessible data on websites such as morningstar.com, can help greatly in making these comparisons.

• Performance conscious investors should periodically update their portfolio to include funds that are currently exhibiting strong on-going momentum that has not yet become excessive. This, what I call a 'nuanced' principle, should be one of your primary guides, not past performance alone, nor how "popular" or highly recommended a given fund is. In other words, I believe you want to emphasize/overweight funds in your portfolio that have been doing well for at least the last year or two, but not ones that may be attracting investors solely due to unrealistically high performance. I believe that, while the specific timing cannot accurately be pinned down, the latter funds will prove to be more likely than not to fall off their perch as compared to more realistically priced ones. Thus, while the last 7 or 8 years have been good times for many funds, including index funds, eventually big excesses are almost always purged out of the markets.

• Obviously, it would be idyllic if one could receive near maximum rewards in their investing by doing "one-stop shopping" for their fund choices, and "set it and forget it." In a forever rising market, that might be frequently true. But, at times, risk avoidance plays an important role in investing. Therefore, while paying little attention to, or even potentially more important, making very few changes to one's investments, say over 15 to 20 years, can be extremely rewarding and perhaps even the best way to invest most of the time, if you are able to use relevant data to emphasize which investments are likely to do the best and which worst over say the next five years or so, you can likely lower risk while maximizing returns. A collorary is that it is a rare investor who doesn't get on board an investment at just the wrong time. If one fails to eventually jettison such an investment, one is often stuck with portfolio-robbing performance for a long time.

With these principles in mind, let's look at how an investor would have done by investing over what I would consider the short term (one year) in both our Model Stock and Bond Portfolios. Then, we'll look at results for two relatively long-term periods, over three and five years.

Note: In case you only glance at the specific details below, here is a one sentence summary: For the 3 Model Stock Portfolios examined, the short-term one trailed its benchmark, while the longer-term two wound up equal to it; for the 3 Model Bond Portfolios, all three beat their benchmark.

First Quarter 2017 Portfolio Review

How Model Portfolios From One Year Ago Have Been Doing

Our Model Stock Portfolio from one year ago (April 2016) recommended 14 funds. (Since you may not wish to own as many funds as I recommend, your job might be one of selecting a subset of these funds. Since these funds are not given equal weight in my recommendations, you may wish to choose only those with the highest recommended percentages shown, which represent those that I have the most confidence in.)

As a group, and using my recommended percentage allocations to each, the Model Stock Portfolio returned 15.1% thru March 31 of this year. This result, while excellent in an absolute sense, trailed the benchmark I use of Vanguard index funds by 1.3%. In fact, the average diversified US stock returned 16.5% as reported in the Wall Street Journal. However, the average International fund, also as reported in the Wall Street Journal, returned only 10.5% and my 6 Portfolio's International funds, when weighted as I recommended returned 14.9%. Only two of the remaining 8 domestic funds did significantly below par, namely Fidelity Low Priced Stock (FLPSX) and Vanguard Dividend Growth (VDIGX).

Our Model Bond Portfolio from one year ago recommended 11 funds. The entire portfolio, weighted as I recommended, returned 3.0%. I use the Bloomberg Barclays US Aggregate Bond Index as my benchmark. It returned a mere 0.4%, so our outperformance against it was 2.6%. Surprisingly though, the average taxable bond fund returned 4.8% as reported in the Wall Street Journal, perhaps because many may have focused on low quality "junk" (high yield) bonds. Our Portfolio recommended only 10% of its investments in such bonds, accounting for most of this underperformance.

How Model Portfolios From Three Years Ago Have Been Doing

Three years ago (April 2014), I recommended 13 stock funds, including ETFs. Thru Mar. 2017, using my recommended percentage allocations to each, the Portfolio returned 6.7% annualized. The benchmark index funds I use also returned 6.7% annualized. The average diversified US stock returned 6.3% as reported in the Wall Street Journal. The only fund with a negative return was the Vanguard Energy ETF (VDE). The average Wall St. Journal International fund returned only 0.4%. However, my Portfolio's 4 International funds averaged a return of 2.9% annualized.

The Model Bond Portfolio from three years ago recommended 9 funds. The Portfolio, as of Mar. 31, returned 3.3% annualized vs. the Bloomberg Barclays US Aggregate Bond Index which returned 2.7%. The average taxable bond fund, as reported in the Wall Street Journal, returned 2.0% annualized.

How Model Portfolios From Five Years Ago Have Been Doing

Once again, there was a dead heat between my Model Stock Portfolios 11 funds from April 2012 and the return for my benchmark index portfolio. Both were at 10.75% annualized as of Mar. 31. The average diversified US stock fund returned 10.4% while the average International fund returned only 5.1% annualized, as reported in the Wall Street Journal. Several of our domestic stock funds had disappointing returns, including two REIT funds, although our Vanguard Financials ETF (VFH) as well as our two International stock funds did better than their corresponding benchmark indices.

Our Model Bond Portfolio from five years ago with 10 funds outperformed our bond benchmark 3.5% vs. 2.3% annualized, as of Mar. 31 of this year. The average taxable bond fund returned 2.5% as reported in the Wall Street Journal.

Our Jan. 2017 Model Portfolios Are Off to a Good Start

Here are the results year-to-date for my 16 recommended stock funds from Jan. of this year. These returns could easily be confused with those earned over an entire year but are actually only for the first 4 months of this year.

Fund Name (Symbol)	YTD Return
Vang. International Growth (VWIGX)	17.4%
Fidelity Overseas (FOSFX)	14.1
Fidelity Contra (FCNTX)	13.2
Vang. Emerging Markets Idx (VEIEX)	12.4
Vang. Growth Index (VIGRX)	12.1
DFA Internat Small Cap Val I (DISVX)	10.5
Vang. Pacific Index (VPACX)	9.7
Tweedy Browne Global Val (TBGVX)	7.9
AMG Yacktman Fund Service Class (YACKX)	7.7
Vang. Dividend Growth (VDIGX)	7.2
Vang. 500 Index (VFINX)	7.1
Vang. Equity Inc (VEIPX)	4.8
T. Rowe Price Eq. Inc (PRFDX)	3.7
Vanguard Small Cap Value Index Fund (VISVX)	2.4
Vang. US Value (VUVLX)	1.8
Vang. Energy (VGENX)	-6.6

(Data thru 4/28/2017, not annualized)

Here are the results year-to-date for my 12 recommended bond funds, also from Jan. of this year. Since these results too are for 4 months only, they aren't as bad as one might have expected given the rising interest rate environment we are in, which is often bad for bonds.

Fund Name (Symbol)	YTD Return
Vang. High Yield (VWEHX)	3.5%
PIMCO Total Return Instit (PTTRX)	2.5
Harbor Bond Fund (HABDX)	2.3
Vang. Intermed.-Tm Tax-Ex (VWITX)	2.1
Vang. Inflation Prot. Sec (VIPSX)	1.9
Dodge & Cox Income (DODIX)	1.9
DoubleLine Tot Ret Bond I (DBLTX)	1.8
DoubleLine Tot Ret Bond N (DLTNX)	1.7
Vanguard Total Bond Market ETF (BND)	1.6
Vang. Sh. Term Inv. Grade (VFSTX)	1.2
Vang. GNMA (VFIIX)	0.8
PIMCO For. Bd (USD-Hdged) Adm (PFRAX)	0.8

(Data thru 4/28/2017, not annualized)

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