Off balance?

Three years ago on this blog, I introduced the Amish Portfolio — essentially a bare-bones, low-cost portfolio for those who get a little buggy by complex investment recommendations. If you have a wood-burning computer to track it, all the better.

The portfolio consists of three funds:

* Vanguard Total World Stock Index fund (ticker: VTWSX). The beauty of this fund is that you don’t have to fret about how much to have in international stocks and how much to keep at home. It’s all in there, according to market capitalization: 56.5% North America, 21.5% Europe, 20.8% Asia, and 8.0% emerging markets. Cost for the investor shares: 0.19% a year, or $1.90 per $1,000 invested.

* Vanguard Total Bond Index fund (VBMFX). You get broad exposure most types of U.S. bonds. Current yield: 2.54%. Cost: 0.15%, or $1.50 per $1,000.

* Vanguard Prime Money Market (VMMXX). Hey, it’s a money fund. It yields 2.03% after its 0.16% expenses.

The suggestion for conservative investors: 20% Vanguard Total Bond, 20% Vanguard Prime Money Market and 60% Vanguard Total World stock. You can add to stocks (and reduce cash or bonds) depending on your personal risk profile.

A mix of stocks, bonds and money market funds is remarkably self-balancing: Despite the stock market’s runup, the conservative blend above is at 65% stocks, 18% bonds and 18% money market funds. It probably doesn’t need to be rebalanced now.

Had this been your portfolio for the past five years, however, you’d now be 76% in stocks — far more than your initial target. In this case, you’d want to sell enough from your stock fund and add to your money fund and bond fund to get to your original 60% stocks, 20% bonds, 20% money fund allocation.

Rebalancing too frequently means that you’ll be cutting off your gains too quickly. (In a taxable account, it means you could be triggering taxes, too). Using the 10% rule typically means occasional rebalancing, and often when one market — stocks or bonds — are a bit frothy. If you’ve been in the market for a while, and you have a set allocation to stocks, now might be the time to rebalance.



Why buy bonds?

Why do economists continue to give interest-rate forecasts, despite the fact that they’re generally awful at predicting interest rates? Probably because people ask them to. But if you’re thinking of investing in a bond fund now, it would help to have a forecast in mind – if only to give you an idea of the risks you’re incurring.

People ask economists to give interest rate forecast because so many things depend upon your assumption for rates, and that’s especially true for bonds. Bond prices fall when interest rates rise and they rise when interest rates fall.

Just how vulnerable is your fund to interest-rate changes? You can get a good idea by looking at the fund’s duration, which tells you how much a bond’s price will fall, given a rise in interest rates of one percentage point. Consider the Vanguard Total Bond Market Index Fund ETF (BND), the largest bond ETF, which is also a good proxy for, well, the total U.S. bond market.

The Vanguard ETF, for example, has a duration of 6.09 years, meaning a rise in rates of one percentage point would mean a principal loss of about 6.09%. That loss would be offset, somewhat, by the interest investors receive from the bonds. The ETF has a yield of 3.13%, according to Morningstar Direct. If you were to assume that rates will rise by a percentage point, your total return – price decline plus interest – would about a 3% loss.

Interest rates have been rising since July 2016, when the bellwether 10-year Treasury note hit an all-time low of 1.38%. It’s trading at 2.85% now. Since that date, Vanguard Total Bond Market Index Fund ETF has lost 1.75%, including reinvested interest. While interest payments have certainly offset most of the fund’s losses, it hasn’t been enough to eliminate them entirely. The past 12 months, the fund has lost 0.82%.

Army ants.

Here’s where the forecast comes in. If you were to assume that interest rates will rise a percentage point in the next year, you should brace yourself for roughly a 3% loss. That’s not a catastrophic loss – bond bear markets are like getting attacked by very mean ants – but you might consider a few other options.

One is a money market fund. Just as the 10-year T-note yield has been rising, so has the yield on money market funds. Vanguard Prime Money Market Fund Investor Shares (VMMXX) has a yield of 2.02% and – assuming the fund maintains its constant price of $1 per share – it has very little potential for a principal loss.

Another is a fund with a tolerable track record of managing interest-rate risk. (Typically, these funds are also deft with credit risk – buying bonds from shaky companies that are getting better). One is Dodge & Cox Income (DODIX). It has a duration of 4.2 years, a 3.02% yield, and an expense ratio of 0.43%.  The past two years, the fund has averaged a 2.94% gain – not much, but better than the average fund.

Bear in mind if bonds are a part of a long-term plan, you shouldn’t dump your bond funds because you’ve got a feeling rates will rise.  Over the long term, bonds have a great record in dampening the effects of stock downturns. But if you’re trying to figure out where to invest money now, a money fund or Dodge & Cox Income are two good places to start.

A blue chip by any other name

When it comes to mutual fund marketing, the glass is never half empty: It’s always full. This is why we don’t see funds with names like “The Occasional Outperformance Growth Fund” or “The Somewhat Erratic Income Fund.”

We do, however, have several funds with the words “blue chip” in them. Unfortunately, they may not have the blue-chip attributes you’re looking for.

First of all: What’s a blue-chip stock? The term “blue chip” comes from poker, where blue chips are traditionally the most valuable. “I think of it as a large-cap company that has been around for decades, pays an attractive yield and has an above-average record of raising earnings and dividends for an extended period of time,” said Sam Stovall, chief investment strategist of U.S. Equity Strategy at CFRA. It’s a fairly exalted status that few stocks earn, and fewer keep.  They’re the kind of stocks you’d imagine Uncle Pennybags from Monopoly would buy.

The term “blue chip” has become so popular that there are 15 stock funds with “blue chip” in the Morningstar database. Elizabeth Laprade, research analyst at  Adviser Investments, notes that three of the largest blue-chip funds – T. Rowe Price Blue Chip Growth ($54 billion), Fidelity Blue Chip Growth ($25 billion) and John Hancock Blue Chip Growth ($3 billion) – have between 122 and 429 stocks.

Whether there are 429 or even 122 blue-chip stocks is debatable, at best, and all three funds seem to stretch the definition. T. Rowe Price Blue Chip Growth, for example, has stakes in true blue-chip companies like Boeing and JPMorgan Chase. But its third-largest holding is Tencent Holdings, the Chinese internet advertising company. It also had stakes in Tesla, Monster Beverage and Norwegian Cruise Lines, which are probably not blue-chip companies, at least by Mr. Stovall’s definition.  All three funds own Alibaba.

Distressingly, all three funds have more volatility than the Standard & Poor’s 500 and lower dividend yields, too. This may be because all three are growth funds, and growth stocks often sneer at the notion of dividends. It may also be because of the funds’ expense ratios, which range from -0.78% for the John Hancock fund and O.69% for the Fidelity offering. Those aren’t excessive by large-company growth fund standards, but they do take a bite out of the funds’ dividend payouts.

Even worse is the funds’ maximum drawdown – the most the funds lost from peak to trough during downturns in the past five years. Here again, they didn’t beat the S&P 500, Ms. Laprade notes. “People need to be careful,” she said. “If they’re looking for blue-chip stocks, that may not be the case.”