In my most recent article titled “Designing a Retirement Portfolio That’s Just Right for You” I opined that a retirement portfolio should be designed to meet the individual investor’s specific goals, objectives and risk tolerances.  I also suggested that the highest total return is not always the best approach because if the investor needs income to live off of, a focus on a consistent rising income stream makes more sense.  I continue to hold that position on the basis that there is no such thing as a one-size-fits-all when designing the appropriate retirement investment portfolio, or any type of portfolio for that matter.

My career in the financial services industry began in 1970, which was prior to the ubiquitous acceptance of Modern Portfolio Theory (MPT) within the financial services industry.  According to Wikipedia, MPT was developed in the 1950s through the early 1970s, and therefore, I feel fortunate that my original investing lessons were taught to me by experienced investors that had not yet embraced MPT.  Instead, my original teachers taught that investment selections should be based on a carefully researched assessment of the investment merits’ past, present and future of any asset class under consideration.  Simply stated, an asset class should only be included in a portfolio if it makes economic sense at the time.

Asset Allocation: The Guiding Principle of MPT

This is in stark contrast to the tenets of MPT that postulates that portfolios should be comprised of various asset classes that in theory will change in value in opposite ways.  Consequently, many practitioners of MPT routinely and automatically recommend standardized asset allocation strategies such as 60% equities and 40% bonds or fixed income.  These asset allocation mixes are routinely and adamantly recommended with usually no regard to prevailing economic circumstances.  In other words, you include these asset classes regardless.

If you think about it, it is easy to understand why the financial services industry has so ubiquitously embraced the broad asset allocation portfolio strategy.  Under MPT a portfolio needs to maintain its proper balance of X percent in equities and X percent in debt.  Consequently, portfolios require continuous rebalancing which generates activity.  Since there are usually fees and commissions associated with activity, rebalancing is good for business.  To the commission agent it generates revenues, and to the fee-based agent it provides a justification for charging their fees.  This is especially true if the advisor chooses funds with separate fees that come with a portfolio manager already attached.

[drizzle]As an old-school investment advisor, I have never been able to embrace or accept the MPT theories, but I understand why most of Wall Street has.  However, I will concede that under normal economic and market circumstances how a broadly diversified portfolio mix of stocks and bonds might work.  But these are not normal economic circumstances, especially on the fixed income side.  As the following 10 year Treasury graph clearly illustrates, interest rates have been in a significant downtrend since the 1980s.

Bond Duration


An extended period of falling interest rates as shown above creates the perfect environment for bonds and bond fund performance. There is an inverse relationship between bond prices and interest rates.  When interest rates are falling, the price of previously issued bonds will rise and vice versa.  With interest rates at record lows it is only logical to assume that interest rates will move higher sometime in the not too distant future.  Consequently, I believe that bonds, as an asset class, should temporarily at least be avoided, unless of course they were purchased a long time ago.  Older bonds that were issued when rates were higher might make sense to continue holding, especially if they are getting close to maturity.

For those that would like to learn more about the relationship between bond prices and interest rates here is a link to a Wells Fargo educational piece that summarizes things nicely.  If you have any confusion about how this all works, I believe the Wells Fargo investing basics explanation will clear things up.

Two Comments on My Last Article Were My Inspiration

I was inspired to write this article because of two comments that were made on my last article.  The first comment was made by fellow Seeking Alpha Contributor Dale Roberts who often visits and comments on my work.  Frankly, and with all due respect to Dale, he and I are at polar opposites when it comes to the subject of designing and managing retirement portfolios.  Dale is clearly a MPT practitioner and advocate, and as I previously stated – I am not.

Although this next comment is sure to raise the ire of many MPT supporters, I believe it is my solemn duty to state it regardless of who it might offend.  I have dedicated my career to countering the hypotheses of MPT because I believe it is a greatly flawed theory that does more harm than good.  However, rather than merely slinging barbs and arrows, my goal is to argue against MPT with logic and fact-based counter arguments.

Moreover, I intend to make my arguments respectfully and without condemnation or attacks on those who disagree.  Therefore, I offer no disrespect to Dale Roberts or his supporters, instead my objective is to simply state my case as clearly, logically and factually as I can.  I will let the readers draw their own conclusions and make their own judgments.  What follows next is the comment made by Dale Roberts in its entirety followed by my retort in the same comment stream:

Dale’s comment:

“Investment planning is about managing risk tolerance level and sequence of returns risk. Most investors will draw down at 4-5% of total holdings to fund their retirement. As we can see from the charts, with some very low to modest yields at various potential start dates for retirement, investors would have also been harvesting shares from these companies to fund retirement. That introduces sequence of returns risk.

Sequence of returns risk management means having assets that go up while others to down so that we do not have to sell too much of the equities (or other) as they go down in price.

Pick a retirement start date of January 2007. From that date to February of 2009 the three companies are down a collective 22.7% MMM leading the way as it really got hit hard in the recession, down almost 38%. Full recovery took a while.

If one held the broad based bond index AGG, it was up 5.2% annualized in the period. Long Term Treasuries were up 11.5% annualized. A retiree with a balanced portfolio would have been able to mostly fund this period with bond returns, leaving their equities alone. Or they could have cashed the dividends, sold no shares, and funded the rest (easily) from bonds.

Retirement planning is simple, but it must include a sequence of returns risk evaluation.

The sweet spot appears to be in that area of the 60% equities for those who will be selling down at 4% plus, inflation adjusted.

I do like the combination of lower volatility dividend growth companies with inversely correlated (there when you need ’em) bonds.”

My retort with emphasis added in bold:

“With all due respect, I once again have to take great exception to your comments. For starters,

1, 234  - View Full Page