Annual Review: The Gone Fishin’ Portfolio

The Oxford Communiqué Portfolio Update

2015 was one of those rare years when diversifying your portfolio added little value.

U.S. large and small cap stocks were flat. Most foreign equity markets fell. Emerging markets swooned more than 15%. Junk bonds and inflation-adjusted Treasurys declined slightly. And commodities really got whacked. (The Alerian Master Limited Partnership Index dropped 26%.)

Gold declined for the third consecutive year, along with gold shares. Silver fell 13%. Copper ended the year down 25%. Platinum sank 26%. Brent oil, the global crude benchmark, dropped 36%. And iron ore plunged 43%.

In short, 2015 was a year most investors, including Warren Buffett, would just as soon forget. (His holding company Berkshire Hathaway finished the year down

12%.)

With the Gone Fishin’ Portfolio – our most conservative investment portfolio – success isn’t measured quarter by quarter or even year by year.

From its inception 13 years ago through December 31, it outperformed the S&P 500 while having considerably less risk than being fully invested in stocks.

It’s not realistic, however, to expect high returns in a year when virtually every asset class is flat or down. The total return for the Gone Fishin’ Portfolio in 2015 was -3.57% vs. 1.19% for the S&P 500, dividends included.

We calculate the Gone Fishin’ Portfolio’s annual returns using the original 10 Vanguard funds that represent the 10 asset classes in the portfolio: large cap U.S. stocks, small cap U.S. stocks, European stocks, Asian stocks, emerging market stocks, high-yield bonds, high-grade bonds, Treasury inflation-protected securities (TIPS), precious metal mining companies and real estate investment trusts (REITs).

All returns are quoted net of expenses, and we rebalance the portfolio on the last day of each calendar year.

We use the regular Vanguard funds, not the Admiral Shares that are available to shareholders with larger balances. (If you’re using Admiral Shares, your net returns are higher.)

We also use the annual return of our benchmark – the S&P 500 – without deducting any trading costs or annual expenses. That’s not possible in the real world, of course, but we want to make the comparison as stark and unprejudiced as possible.

With asset diversification providing little benefit over the last few years, some might consider chucking this approach, and either plunking everything into a handful of stocks (or a few funds) or taking a stab at market timing.

History shows that would be a mistake, however.

Yes, a particular asset class can outperform for years at a time, as U.S. large cap stocks have done since the market bottom in early 2009. But eventually the winning class falters and underperforming assets start to outperform.

It’s only a matter of when.

As for market timing, this may sound great in theory, but it invariably fails in practice.

Your serious money should be handled in a serious way. That means the foundation of your investment approach should be to own a broadly diversified portfolio of uncorrelated assets that are rebalanced annually.

Rebalancing means returning to our original target percentages by cutting back on what has appreciated the most and adding to what has lagged the most. (The discipline forces you to sell high and buy low.) Studies show this not only adds about a percentage point a year to returns, but also reduces portfolio risk.

(While it is essential that you rebalance each year, you should not do it more often. Studies show that quarterly rebalancing, for example, doesn’t improve performance, can raise costs and often generates short-term capital gains tax liabilities.)

When I first unveiled our Gone Fishin’ strategy 13 years ago, the idea of creating an investment foundation of low-cost, tax-efficient index funds was fairly novel.

It is much less so now. Investors poured $236 billion – a record inflow for any mutual-fund group – into Vanguard in 2015. That flow represents a growing trend away from active fund managers and toward so-called passive strategies that mimic indexes for a fraction of the cost of the typical mutual fund.

Index funds charge lower fees because they don’t analyze individual stocks and bonds, and their stable portfolios lead to fewer trading costs.

According to Morningstar, investors pay just $0.18 for every hundred dollars they invest with Vanguard, compared with $1.23 for the average actively managed fund and $0.77 for the average index fund.

You heard that right. Other mutual fund families are four to seven times as expensive as Vanguard. That’s one reason it now has $3.1 trillion in assets under management, the most of any mutual fund group.

Exchange-traded funds (ETFs) are also growing in popularity. U.S.-listed ETFs now hold more than $2 trillion in assets, and investors are adding hundreds of billions in net new investments each year.

You can easily construct the Gone Fishin’ Portfolio using ETFs instead of Vanguard funds. (Vanguard itself is a major sponsor of ETFs.) It’s the specific asset allocation – not the name on the fund – that is important.

At the strategy’s inception in 2003, Vanguard mutual funds and ETFs had roughly the same investment expenses. Those costs have come down over the last 13 years, but they have dropped more for ETFs. If you’re using a deep discount broker, ETFs are now the least expensive way to own this already ultra-low-cost portfolio.

One of the primary reasons our Gone Fishin’ Portfolio has beaten the S&P 500 over the last 13 years is its somewhat unorthodox asset allocation.

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A 10% allocation to investment-grade bonds seems low to many, for example. But these bonds are short term – meaning they are the least sensitive to rising interest rates – and corporates rather than governments, so you earn a higher yield as well.

Don’t make the mistake of avoiding bonds just because yields are meager and the Fed has tightened rates. Bonds act as ballast to your equity holdings and, by reinvesting your dividends, you will quickly capture higher yields when they materialize.

Recall too that our investment-grade bond allocation is low because we also have a 10% allocation in both high-yield bonds – which generate equity-like returns over the long haul – and TIPS, which help protect your portfolio from the ravages of inflation. (That hasn’t been a big risk in recent years, but never underestimate its potential to erode your purchasing power over time.)

Likewise, a 10% allocation to emerging markets may seem high to some, especially with these looking more like “submerging” markets in recent years. But Latin America, Southeast Asia and Eastern Europe are home to 85% of the world’s population and 90% of those under age 30. This will be a major engine of global growth in the decades ahead.

Here is a brief summary of the real-world philosophy that underpins this investment system:

1. It is not possible to consistently predict the economy or the stock market. (For this reason, you should not use an approach based on economic forecasting or market timing.)

2. Asset allocation is your single most important investment decision, responsible for 90% of your portfolio’s long-term return. (The balance is due to security selection, expenses and taxes.)

3. Over periods of a decade or more, more than 95% of all actively managed funds do not outperform their unmanaged benchmarks. That’s why index funds should make up your core portfolio.

4. All asset classes have periods of outperformance and underperformance. The smart investor takes advantage of this by owning a wide variety of assets and rebalancing annually.

5. All else being equal, the lower your costs, the higher your net returns. You should use the lowest-cost vehicles available, ETFs and Vanguard mutual funds.

6. You can further enhance your net returns by tax-managing your portfolio. Hold your tax-inefficient assets – like bonds and REITs – in your qualified retirement account whenever possible, and hold your tax-efficient assets – like equity index funds – in nonretirement accounts. This way you can legally stiff-arm the IRS.

In sum, the serious investor asset allocates properly, diversifies broadly, rebalances annually, and minimizes taxes and expenses.

He recognizes that long-term investing is a marathon, not a sprint, and not every quarter – or year – needs to be a barn burner.

The Gone Fishin’ Portfolio provides a solid foundation – and continues to offer modest risk, low volatility and a high probability of long-term success.

Good investing,

Alex

P.S. For help setting up or running this portfolio, feel free to contact Pillar One Advisor Josh Newman. (Minimum account: $50,000.) Josh offers a special discounted rate for Oxford Club Members and will customize the portfolio based on your age, risk tolerance and time horizon. He also offers Members a complimentary portfolio review and retirement planning analysis. For more information, contact Josh at 770.673.2142, 866.299.0123 or Josh.Newman@RaymondJames.com.

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