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New Model Portfolios for April 2012

For over 12 years, I have been providing Model Stock and Bond Portfolios on my website. Since many investors seem to need help in making not only their allocation decisions, but in selecting specific funds, here is the same kind of information I provide to my site's readers.

Overall Allocations to Stocks, Bonds, and Cash

In our quarterly updating of our Model Portfolios (see below), we are recommending our highest allocation to stocks for Moderate Risk investors going all the way back to April 2002, exactly 10 years ago, when we recommended a 70% allocation. So it follows that, overall, we haven't been as positive about stocks' relative performance vs. bonds and/or cash for an entire decade!

At that time, we were still suffering within the last decade's first bear market, a time when many investors would have shied away from stocks. While it didn't turn out well during the following 6 months of that year, by Oct. 2002 stocks began turning around and investors averaged excellent returns for the following 5 years. By the end of Sept. '07, the average stock fund had returned 16.1% annualized vs. only 5.0% ann. for the average bond fund. We cite this to show that while our overall recommended allocations might easily not pan out well for periods of up to 6 mos. or even a year, and thus are not intended for market timers nor for those looking for sure, secure bets without short-term risks, they are made with the idea of capturing good long-term performance, that is, up to 5 years later, or at times, even longer.

It is also important to realize that our allocation to stocks isn't meant to be used as a proxy for how the stock market as a whole will do, using for example, the S&P 500 Index as a point of reference. Back in early 2002, our Model Stock Portfolio was only 25% invested in the kind of large cap stocks that make up the Index. Rather, we saw excellent opportunities elsewhere such as in small and mid-cap funds (35%), international and emerging market funds (30%), and real estate funds (10%). Those opportunities contributed to our bullish stance at that time. As it turned out, our favored categories were highly on target. By exactly 5 years later (end of Mar. '07), while the S&P had returned 6.3% annualized (vs. 5.4% for a bond index), small and mid-caps were at 10.9 and 10.7 respectively, international and emerging market funds at 14.3 and 24.1 respectively, and real estate at 22.2. As a result, our Model Stock Portfolio returned approximately 12% per year, or double the Index.

Indeed, while much of the 2000 through 2009 period is sometimes referred to as a lost decade for stocks, it really could instead be viewed as a golden half-decade for investors. But obviously, this only occurred after a period of miserable returns, and mainly for investors who allocated carefully into undervalued corners of the market. Could now be another such period? Only time will tell, but we remain nearly as optimistic for the longer term, that is, for the next five years, as we were then.

You should also be careful to note that our high allocation to stocks comes with another "heads up." In setting our overall allocations, we are not just weighting how well we think stocks will do, but also, how well (or poorly) we think bonds (and cash) will do. In other words, stocks, we feel, should do relatively better than bonds or cash over the next half-decade with a high degree of confidence. In spite of this, we are fully aware that some investors, after reviewing historical data, are of the opinion that the risk/reward ratio suggests stocks will continue to underperform their historical averages for up to another full decade. We ourselves have frequently suggested that stocks may average somewhere in the 6 to 8% range per year over perhaps the next few years. But even if stocks only return say 4% per year, something we think is highly unlikely, such lower than usual returns are still reasonably attractive if the alternative is getting even less return in bonds or cash.

The following tables show how we recommend one divides one's assets depending on one's self-assessed view of the type of investor they are. Since not all investors are the same, we break our assessment into three categories. Experience suggests that most investors would fall into the Moderate Risk area. Note that, perhaps for the first time ever, we are recommending a higher allocation to stocks than bonds even for investors who consider themselves conservative.

For Moderate Risk Investors

Asset Current (Last Qtr.)
Stocks 67.5% (62.5%)
Bonds 25 (32.5)
Cash 7.5 (5)


For Aggressive Risk Investors

Asset Current (Last Qtr.)
Stocks 85% (80%)
Bonds 10 (10)
Cash 5 (10)


For Conservative Investors

Asset Current (Last Qtr.)
Stocks 45% (35%)
Bonds 35 (50)
Cash 20 (15)

Allocations to Specific Fund Categories/Funds

While 10 years ago, the majority of our stock portfolio was invested in categories away from the type of large cap stocks found in the S&P 500 Index, our current Model Stock Portfolio, shown below, is tilted in a much different direction. Now we recommend that roughly half the portfolio is tilted toward such stocks. While none of the stock funds shown below along with our recommended percentage allocations appear overvalued, small- and mid-cap stocks appear less attractive in terms of our research model than large-cap stocks. We continue to recommend the real estate and financial sectors for a small portion of your portfolio. Both should continue to do well in what we think will be a continuing-to-recover economy.

Although many US-based investors may not pay attention to this, it is a fact that most international funds will suffer adverse effects if the US dollar continues strengthening as it has lately. For the last 11 months, the dollar has gained approximately 9% vs. a basket of foreign currencies. This may represent a reversal of the phenomena of a significantly weaker dollar over more than a decade that has been one of the reasons most international funds have outperformed over the last 10 years with an international index returning nearly 6% ann. vs a little over 4% for the S&P 500 Index. Of course, a 2% difference in annualized returns over 10 years means a 20% difference in total cumulative returns.

While a strong dollar has been touted by politicians for years as a good thing, and it certainly would be somewhat beneficial to US citizens who travel abroad and want to get the most for their money spent overseas, a stronger dollar usually doesn't benefit US investors. For one thing, a stronger dollar means that US exports become more expensive against their foreign competitors, thus presumably reducing sales for US companies doing business overseas, and likely, profits as well.

But of even more "out of the pocket" significance to fund investors, it means that whatever returns you would have achieved in most international funds over the past year would have been reduced by approximately the amount the dollar has strengthened. On the other hand, some funds, so-called "currency-hedged" ones, are structured as to reduce or eliminate this effect. So, for the two international funds listed below, the hedged fund (TBGVX) has outperformed the more traditionally structured fund (VWIGX) by about 8% over the last year. We think that this strengthening may continue as the US recovery, as mediocre as it may be, still outstrips growth prospects in major developed countries, attracting great foreign flows into the US currency.

Stock Funds

Model Stock Fund Portfolio
Our Fund Recommendations Fund Category Recommended Weighting Now
(vs Last Qtr.)
Fidelity Low Priced Stock (FLPSX) Mid-Cap/Small-Cap 17.5% (20%)
Tweedy Brown Global Value (TBGVX)
Vanguard Internat. Growth (VWIGX)
(see text above)
International 22.5 (20)
Vanguard 500 Index (VFINX)
Yacktman (YACKX)
Large Blend 17.5 (17.5)
Vanguard Growth Index (VIGRX)
Fidelity Contra (FCNTX)
Large Growth 12.5 (15)
Vanguard Windsor II (VWNFX) Large Value 15 (12.5)
Vanguard REIT Index (VGSIX)
Amer. Cnt. Real Est. (REACX)
Real Estate (REITs) 10 (10)
Vanguard Financials ETF (VFH) Sector 5 (0)
Note: ETFs (exchange traded funds) of the same category can be substituted for any of the above 3 index funds; eg. Vanguard S&P 500 ETF (VOO) can be substituted for Vanguard 500 Index.


Bond Funds

Our reduced overall allocation to bonds is, once again, because we believe that the US economy is recovering and will continue to do so over the years ahead. This means that interest rates will, at best, remain unappealing, and at worst, will rise. In particular, in the event of the latter, most bond funds will not do particularly well, except perhaps for the high yield ("junk"), multisector, and possibly, corporate categories.

PIMCO Total Return has started to redeem itself from its mediocre performance last year and therefore still merits what we feel should be a significant chunk of your bond portfolio. However, Bill Gross's fund is not really a fund you can rely on for a significant degree of outperformance, but maybe at best, for just about a percent or so. For more than that, one needs to try to identify which areas within the bond market can outperform by a significant degree while still allowing one to remain well-diversified. Currently, we recognize several such areas (and managers), mainly inflation-protected, high yield, and generally, funds with a corporate emphasis. For the latter area, we highly recommended Loomis Sayles Retail (LSBRX) which we feel will continue to do well so long as the stock market holds up - their emphasis on somewhat risky corporate bonds tends to do well in an improving economy. This fund has returned nearly 20% annualized over the last 3 years, close on the heels of the 24% ann. return of the S&P 500; PTTRX, on the other hand, has return "only" about 9.5% ann. Obviously, though, no one should be complacent enough to expect forward returns anywhere near these levels.

Of course, the path that inflation takes going forward will have a significant impact on bond returns. For the time being, we are prone to believe the Fed's most recent take that inflation will only rise temporarily as a result of high oil prices, but will otherwise tend to stay in a quiescent state. However, maintaining a position in inflation-protected US government bond funds should continue to do better than other positions within the government bond arena. Our recommended such fund has returned nearly 12% over the last year, although frankly, if it can return 6% this year, it will be still be a reasonably good achievement.

Note: If, as we discussed above, the dollar continues its new strengthening trend, international bond funds that hedge their currency exposure will likely do better than unhedged such funds. Therefore, we suggest that if investors choose to hold an international bond fund, they strongly consider the hedged variety. Our recommended fund below, PFRAX, has returned approximately 9% over the last year, while a typical non-hedged fund such as RPIBX has returned only about 3%.

Model Bond Fund Portfolio
Our Fund Recommendations Fund Category Recommended Weighting Now
(vs Last Qtr.)
PIMCO Total Return Instit (PTTRX) or
Harbor Bond Fund (HABDX)
Intermediate Term 32.5% (32.5%)
PIMCO Real Return (PRRIX) or
Harbor Real Return (HARRX)
Inflation-Protected 15 (15)
Vang. Interm. Tm. Treas. (VFITX)
Intermed. Govt. 7.5 (12.5)
Vang. state specific muni (see Note)
Vang. Intermed. Term Tax-Ex. (VWITX)
Intermed. Term Muni. 12.5 (15)
Loomis Sayles Retail (LSBRX) Multisector 12.5 (0)
Vang High Yield (VWEHX) High Yield 15 (10)
PIMCO Foreign Bond (USD-Hedged) Adm (PFRAX) International 5 (5)
Note: Select a fund, if available, that has your own state's bonds for double-tax exemption.


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