"Buy and Hold" is what we imagine if "for the duration" applies to investing. TV ads for brokerages and brain dead media writers are now advising people not to panic just because their accounts are down 50% from December 31, 2007. It "Bogles" the mind. "Stay the course", they say. But the course was unreliable and devastating in 2008. Buying and holding the indexes no matter what is a proven disaster course for most adult investors. For the past ten years through today, the total return of the low cost Vanguard S&P 500 Index Fund VFINX with all dividends reinvested and no taxes deducted was -1.47% per year annualized or -13.72% total. For the same ten years and same conditions, the Vanguard Prime Money Market Fund VMMXX was up 3.48% annualized or 40.66% total. It's not hard to understand why some people always stay in money market funds.
Over the same ten years and conditions the Vanguard Ginnie Mae fund VFIIX was up 5.87% annualized and 76.66% total. One of my favorites of 2007 and until July 2008, Loomis Sayles Bond Fund LSBDX, was up only 6.18% annualized and 81.92% total after a huge fall this autumn.
If you had been planning in January 1999 to retire in ten years, in which of those funds would you have likely invested? For the then preceding ten years from January 6, 1989 to January 6, 1999 VFINX (SP500) was up 19.26% annualized or 484.98% total. The money market fund was up only 5.62% annualized or 72.95% total for those past ten years. Let me guess which fund you or I might well have chosen.
Things change, markets change, and we need to change too. John Hussman's January 5 weekly comment shows a way to adapt to change which is based upon an investor's age and when that investor will need to begin drawdowns for family events ranging from college expenses to retirement. As I have written many times, the worst thing that can happen to someone expecting to retire in a year or two (or five or more) is to lose 40-50% of saved assets in a bear market year. That happened in 2002, and it happened to some folks in 2008, and it will happen again some other year.
Hussman shows how an annual re-balancing of investments can incorporate the concept of asset class "duration" as a way to limit over-exposure to volatile stocks which can lead to 40-50% losses. As discussed here often in evaluating bond funds, duration refers to price sensitivity to changes in interest rates. Duration for most bonds or funds is the time to when you get your total bond payment stream on a present value basis. (Read Hussman's 2004 discussion for the math.)
A money market fund theoretically has no price risk. It is pegged at $1 and never goes up or down, so its duration is zero. The Vanguard Short Term Municipal fund (VWSTX/VWSUX) has an average maturity of 1.2 years and an average duration of 1.1 years. One effect of this is that the bond fund will go up about 1.1% if general interest rates fall 1% or down about 1.1% if interest rates rise 1%. Compare that to the Vanguard Long Term Treasury Bond Fund (VUSTX/VUSUX) with an average maturity of 17.1 years and average duration of 11.2 years. In this case a 1% rise in general rates sends the fund down 11.2%! This is why we saw long Treasury bonds move up so far and fast in the past few months and fall so fast and far in the past week. They are ten times more volatile than the short term municipals fund. We all are more or less aware of this fact. You generally get paid a lot more to take on the ten-fold risk of a long term bond. But not this year.
As Hussman shows, stocks also have a duration factor. It's easier to do the math on the stock duration as it is price divided by dividend rate. A very simple way to approximate the S&P 500 duration is to use this helpful calculator. For these purposes enter a beginning date of January and ending date of December and take the ending dividend rate. Divide that into 1 (1/.0323 for 2008), round it, and you get 31 as the duration for the S&P at year's end. This is a rough estimate but gives you some idea for how much riskier stocks are than a one year duration short term municipal fund, namely 31 times riskier. At the end of June 2007 with a dividend rate of 1.73% the duration was 58 years, so it's only one-half as risky now to own stocks as it was then. At the end of 1999 with the S&P 500 dividend rate at 1.15% the duration was 87 years! At the end of 1974 the S&P 500 duration was 18.6 years.
OK, so what do you do with these numbers? Let's say you will be retiring in ten years. According to Hussman you'll want to match your total portfolio to your time to retirement, namely ten years. So if the stock duration is 31 you'd divide 10 years by that duration and get 32% as the maximum allocation of your 100% portfolio for stocks. That means you'd want to have 68% in money market funds with zero duration. Or, say, 25% in stocks and 75% in a bond fund or funds with a duration of 7 years.
If you had rebalanced your portfolio at the end of June 2007 last year for a ten year retirement duration, you would have reduced your stock allocation to a maximum of 17% of your portfolio with 83% in money market funds, or perhaps 10% stocks and 90% in a 7 year duration bond fund. If the latter you would have lost 28% of your 10% in VFINX (S&P 500), or 2.8% overall. And you would have made 8.33% on the 90% of your 7 year duration Vanguard Intermediate Term Bond Index Fund VBIIX, or 7.5% overall. Netted out 7.5%-2.8% = +4.7% annualized over the 18 month period. That sure beats losing 28% annualized by being 100% in VFINX for that period. Not spectacular but not a retirement buster.
I chose an ideal starting date, and these are only rough calculations, but they show what you can do without even trying to predict what the markets will do. With a simple spreadsheet, you could do this once a year as you get a year closer to when you will need your money. Check it out and do read the Hussman articles.
Despite all my efforts last year, and thanks to the end of December rallies in oil and gold and bonds, I came out up 0.19% for 2008 in my retirement accounts! Not nearly as well as I would have done just being in a Hussman-like duration match portfolio or even in a money market fund. Hmmmmmmm. :)
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