Question:

I don't understand why the annualized return and standard deviation for the "Ultimate Buy-and-Hold Strategy" for 1970 through 2009 are different from the results shown in the 60/40 portfolio in the article "Fine-Tuning Your Asset Allocation."  As far as I can tell, these are the same assets and this is the same 40-year period.

Click here to read Merriman's answer!

RICHARD BUCK:

You are right, and you have raised a very good question.

By definition, the Ultimate Buy-and-Hold Strategy is invested 60 percent in equities and 40 percent in fixed income. That same allocation applies to the 60/40 column in our fine-tuning table.

So if we have the same assets and the same time period, why would their returns be different? The answer lies in how those assets are managed. The details are contained in the footnotes to the two articles.

The Ultimate Buy-and-Hold Strategy had a return of 12 percent and a standard deviation of 12 percent from 1970 through 2009. The 60/40 portfolio in the fine-tuning table had a return of 10.5 percent and a standard deviation of 9.5 percent.

The difference comes from two assumptions we made when we did the calculations. One assumption involves rebalancing, the other involves the matter of management fees.

First, in the Ultimate Buy-and-Hold Strategy, we assume the portfolio is rebalanced annually, at the beginning of every calendar year. In the fine-tuning tables, we assume the portfolio is rebalanced at the start of every month. We don’t recommend rebalancing that frequently, and we don’t think many investors do that. But we must make that assumption in order to calculate the worst one-month, 12-month and 60-month periods.

The stock market has a long-term upward bias, and monthly rebalancing tends to reduce returns, because gains are taken frequently instead of being left to grow. Therefore, we expect monthly rebalancing to result in lower long-term returns – and in this 40-year period that was the case.

Second, the Ultimate Buy-and-Hold Strategy returns were calculated without assuming a management fee. In our fine-tuning table, we assume a 1 percent management fee, which would obviously reduce the return. And because this fee is taken out every month on a pro-rata basis, it winds up being slightly higher than 1 percent on an annual basis (just as 3.10 percent interest in a certificate of deposit may compound to a yield of 3.15 percent after five years).

Both of these articles are valid. Each is important to understand.

The point of the Ultimate Buy-and-Hold Strategy article is to show what’s theoretically possible when asset classes are carefully blended in a thoughtful way. The point of the fine-tuning table is to show the different results (both favorable and unfavorable) that investors might expect from various combinations of equity funds and fixed-income funds.

Richard Buck is publications manager of Merriman.