In mid-March, 2005, I posted to my wiki and sent to e-mail subscribers a piece on risk. One well-meaning reader posted the piece to another web message board without my knowledge, and I heard a couple of days later that I was being trashed for my remarks by various posters. Most people I know treat me with far too much deference, and I enjoy reading critical comments to help sharpen and improve my understanding of my field, so I headed to the board to read what was being said. The most intelligent of the criticism suggested that my piece could be misinterpreted as a blanket endorsement of a 100% equity policy for everyone, and that my reference to the use of international stocks, real estate, and commodity futures to reduce the risk of a stock portfolio might lead someone to believe that I was saying all risk could be eliminated.
While I question some of the criticism, and saw none that offered a serious challenge to the principal thesis about the dangers of bonds, I do take seriously the concern that a careless reader without the proper background might misinterpret parts of it (and, in fact, have edited the piece since, which you can always find in its most up-to-date form on my wiki). But the damage is done, and I am now left to contemplate the manner in which some silly observer could be hurt by my article (since such a person wasn’t bright enough to sign up for my newsletter, they’ll never see this one).
Today, March 31, 2005, I am officially launching the Dumb Observer Portfolio Exercise, or DOPE. First, I will describe the worst possible manner in which my words might have been interpreted, the type of action the reader in question might have carelessly taken, and then keep track of the consequences. We’ll do this in real time, so I have no idea how things will turn out, but I have a duty to live with the consequences of my action. I’ll update my DOPE page quarterly to follow the progress of the poor sap whose life I ruined. Let’s describe the situation:
He is undoubtedly a male who bought a computer for its principal intended purpose of finding pictures of naked women, and accidentally found my article on the unauthorized board through a google search, since one of my critics referred to my piece as “financial pornography.” It came at an opportune time, because he had just retired after spending his life as a laborer working for a large corporation, and outside of social security his only assets are those he accidentally accumulated in his 401k plan, which he joined only because he thought it would be interesting to run in a 250-mile race. Another lucky break is that he kept his 401k in the company’s Model 6 portfolio, which was invested entirely in equities for his working lifetime. He chose it because he thought he was choosing accommodations for the 401k race, and figured he’d save money staying at Motel 6. He is married to a long-suffering woman who never said a word when their savings account disappeared shortly after he got his computer and tried to help a Nigerian official who contacted him by e-mail to get his money out of the country. The man never could understand how the wire that was supposed to transfer the funds from Nigeria into his account accidentally went the wrong way, and he wasn't able to get back in contact with the official after the mix-up. He concluded that the official had met a bad fate and not managed to escape. Surely, the man felt, the loss of his savings account was not as bad as the loss of the life of that kind and desperate Nigerian politician.
Thankfully, he never had control of that 401K. Although he never made a particularly big salary, all those years of unconscious saving and investing did add up to a gigantic-looking $640,035 balance. His wife figured they needed $50,000 a year to pay their income taxes and live in modest comfort, plus have some reserves for unforeseen expenses. With social security working out to about $18,000, he needed another $32,000 from the 401k, and knew enough about the world to know prices usually went up and rarely went down. Only 30 years ago, a first class postage stamp cost 10 cents, and if it costs 37 today, who knows what it will cost 30 years from now, when he hopes that either he or his wife will still be alive and still have enough on which to live? So he knew he needed to be able to take out 5% of his assets now, and have it go up as prices went up. But how could he earn a safe 5% plus inflation? Then he accidentally saw my article, and interpreted everything I wrote in the most dangerous possible way:
Since I used an example of a retiree drawing 5% per year, increasing with inflation, he assumes that I was saying he could draw 5% safely. My fault: I chose 5% because it has been generally agreed that drawing 4% or less is okay using a wide variety of allocations, and the purpose was to show the difference when there was some risk of failure. But I DID say there was a 15% risk of going broke with a 100% equity portfolio, so I thought it was clear I wasn’t calling it safe. I’d be off the hook except for the next misunderstanding.
He read the part about the 15% risk of going broke, which sounded scary, but then I said that the way to address that risk was to expand the equity portfolio beyond US stocks to include international stocks, real estate, and commodities. He assumed that meant we could totally eliminate the risk. I never said that, but I never said what risk would remain. So he assumed I meant it would be completely free of risk. My fault again.
Since I never mentioned the appropriate allocation, he thought I must have meant to put the exact same amount in each of the 4. Or if I didn’t say that, he figures it should at least be close to what I would have recommended if he had asked. I have no defense to this one, either: the “coffeehouse allocation” of equal amounts in everything is the natural way for people having no idea how to allocate to choose to allocate.
Since I posted to a site filled with people who like Vanguard, he figured I must be recommending Vanguard mutual funds. Of course, I didn’t post the article at all, but since it has my name in it, he assumes I must have approved of it being posted there. I don't accept any blame for this one: readers are encouraged to forward my e-mail letter or provide links to my wiki, but please don't post my articles on unrelated web sites and message boards without my knowledge. On the other hand, Vanguard is actually a pretty good fund company, so no real harm done.
I never mentioned what funds to use, but everybody on the site with my unauthorized posting talks about using low cost index funds (good choice, since I use low cost index funds and ETFs as much as possible). For my domestic stocks, he figures I would recommend the Vanguard Total Stock Market Index Fund (I don’t think that is the best choice, by the way, but that is for another piece). Actually, he almost made the mistake of thinking that would take care of both the domestic AND international parts, since the “Total Stock Market” obviously means the whole world doesn’t it? (Here, Vanguard is the dope, because that name IS misleading). Fortunately, when he found that fund, he saw the Vanguard Total International Index Fund (which is not my preferred way of investing internationally) next to it, and seeing one was listed as domestic and the other international, he got it straight. He had to search a while for real estate, but eventually found the Vanguard REIT Index Fund (which I do not think fully covers the real estate category in the best way) and figured it out from the description. But try as he might, he couldn’t find commodity futures. Vanguard has NO commodity futures index fund. So might this guy e-mail me to find out the right fund, thereby giving me the chance to correct his misreading of my entire article?
No such luck. The Vanguard site has a “search” box, and since he is searching for commodity futures, he types in the word commodity and finds out about their Fund Access program and the funds of other companies. There are a few commodity funds, and he assumes he should buy the cheapest one, PIMCO Commodity Real Return Institutional Fund, with a 0.74% annual expense ratio. That is actually the first thing he has gotten totally right: it is a terrific choice for many reasons (which I'll also discuss in another piece), and is the one I most often recommend to people today. But he isn’t sure because it says something about a $35 transaction fee, and there were other funds that were free to buy, but with higher annual expenses. He had no idea how to figure out which was better. Okay, one last chance, e-mail me for advice, please, and I’ll have the chance to avoid my worst nightmare.
Nuts. He notices that his account has $640,035 in it, and figures the $35 was there just so he could pay for the fund. That must be what I wanted. I’m sunk.
Okay, let’s review. As many times as I reread my original piece, I cannot figure out any worse way to interpret it than the above. These are NOT my recommendations, but they aren’t so horribly misguided that I wouldn’t feel some responsibility for the interpretation. And someone who wanted to check further would find out that Roger Gibson, author of Asset Allocation, is mentioned in many different places on the Internet, and several different web sites have listed an example of his that shows the hypothetical results of an equal split between domestic stocks, international stocks, real estate investment trusts, and commodity futures. In the book recommendations section of my wiki, I mentioned Gibson’s book as one of my all-time favorites, so it is quite reasonable to conclude that I have enormous respect for Roger Gibson, as I do. What isn’t reasonable is to conclude that his example is any more of a portfolio recommendation than my article, since it is not, and in his various writings, I’ve never once seen him recommend that portfolio (if I missed a case where he did so, I’d certainly appreciate a reference to the source). But there you have it: Roger and Me, being irresponsible enough to want to share our knowledge online without realizing the danger.
So here is my punishment: I’m going to post the results of the DOPE in real time as they happen, assuming that he starts with an equal allocation between VTSMX (Vanguard Total Stock Market Index Fund), VGTSX (Vanguard Total International Index Fund), VGSIX (Vanguard REIT Index Fund), and PCRIX (PIMCO Commodity Real Return Institutional Fund). There isn’t a single client of mine whose total wealth is allocated in this manner, NOT ONE, but by offering free advice on the web, I recognize I might have induced someone to do so.
The retired DOPE will take out money at the end of each quarter (since this represents his entire net worth) and then rebalance (I don't even like THAT arrangement, since I believe quarterly rebalancing is far too frequent). Since the $640,000 after the transaction fee is the starting amount at 3/31/2005, and 5% of that is $32,000, the first quarterly payment will be $8,000, and since his bank recently notified him by e-mail that his checking account has been suspended until he goes to their web site to reenter all his personal data (something he'll be taking care of as soon as he is done following my advice), he needs to take his first draw today . At the end of each year we will find out the rate of inflation and increase the subsequent year payment (beginning 3/31/2006) for the annual inflation of the preceding year. Close enough to know what would happen to the victim of my misinterpreted advice.
I’ll prepare a page on my wiki for the DOPE results sometime in April, starting with the March 31, 2005 investments, but I’m sending out this letter today so that, in coming years, everyone will remember that I didn’t design this after the fact, but in real time.
For those frustrated individuals who would like to know what I REALLY think is the perfect selection of investments, the answer is that it is different for every single person, that general information about finances is general information and not advice for specific action, and that the way I earn my fee is by learning everything I can about someone’s goals, finances, health, family situation, and emotions to allow me to tailor my advice. And that reading financial books, newsletters, and web sites is no more a substitute for personal financial planning than is reading medical books, newsletters, and web sites a substitute for going to a qualified doctor for a checkup.
