The Able to Pay calculators were updated in late May and early June, 2016, with an improved statistical model, built on a better method to evaluate whether stock-prices are cheap or expensive. The model currently estimates that U.S. stocks are expensive, and thus adjusts downward the percentage allocated to stocks. It does so more strongly than the previous calculators, which used good, but less robust methods. Depending on your inputs, the new calculators may adjust stock-percents by about 5% to 10% more than previously, and they may forecast lower future returns (in the current environment of relatively expensive stocks). The changes mainly effect two aspects of the calculators:

• Estimated future returns (and the future dollar values that depend on those estimates). 
• Value-adjusted percentages for portfolio composition. (Normal percentages for portfolio composition are not effected.)

Details on the new statistical model were described in other posts.

​CAPE is a paradoxical measure of over- or under-valuation of stock prices. It works best for long-term holdings, but makes the strongest predictions for short-term ones. Given the paradox, how can it best be used to craft an investment portfolio? And what is it telling us now?

About a year ago, I published a series of posts on CAPE, a metric of over- and under-valuation for U.S. stocks. It's one of the few indicators that has historically predicted future stock prices with some statistical reliability. Unfortunately, it's does so in a paradoxical manner. Over a few years, the prediction is strong but unreliable; over many years, up to 15 years or more, the prediction is weak but reliable. "Strong" means that low or high values of CAPE imply large future movements in stock prices, up or down; "reliable" means that the total movement, the cumulative rise or fall in stock prices over all the years, is very consistent. Thus, the paradox is that CAPE offers a big, high-risk bet for near term trades, and a small, low-risk bet for long-term buy-and-hold.

Since my original posts, CAPE hasn't changed much. It is still high, by historical standards, implying lower than normal returns on U.S. stocks in the future, maybe in the next year or two, or maybe not, but quite probably over the next decade or more.

In an effort to squeeze every last bit of predictive power from this paradoxical metric, I've recently completed a comprehensive re-analysis of CAPE and U.S. stock prices from 1881 through 2015. Among the questions answered by the analysis are these:

• CAPE is usually computed as a 10-year average. Would more or fewer years in the average offer better predictive power?
• Is there a holding-period for which CAPE is most useful? Does the trade-off between higher reliability and weaker effect-size mean that there's an optimal number of years to wait to capitalize on an investment decision motivated by CAPE?
• How can CAPE be used to inform the allocation to stocks in a complex portfolio? For example, in portfolios for college savings or retirement, where some investments may be spent in a few years and others perhaps a decade or more in the future, how can CAPE optimize the percentage invested in stocks?

Later posts addressed these questions, starting here. You can find an overview in Finding Value on the Portfolios tab, or by searching for "CAPE".

Does your adviser put your interests first? Are your adviser's recommendations colored by sales commissions he or she may get or by fees extracted from your account? Historically, the federal agencies responsible for overseeing the financial industry have imposed minimal requirements on investment advisers and financial professionals. Advisers were required to recommend reasonable products, not necessarily the ones that would be lowest in cost or otherwise best suited to your financial goals.

Then, early in 2015, the U.S. Department of Labor (DoL) announced a plan to tighten the requirements by imposing new regulations. The DoL drafted regulations whose objectives were to:

• Strengthen the responsibility of retirement plans and retirement advisers to act in their clients' best interest, and
• Extend fiduciary requirements to IRA providers and to rollovers between IRA and 401(k) or 403(b) plans.

The DoL solicited public comments and, after receiving nearly 400,000 of them, published the official new regulations on April 6, 2016.

Note that the DoL's jurisdiction extends only to retirement accounts. It does not cover ordinary brokerage and after-tax savings accounts. That, in itself, is an important limitation. Furthermore, the final regulations, while arguably an improvement, are weaker than the original proposal on several counts. Among the many commentaries appearing in the financial media, two articles that aptly describe the limitations of the new DoL regulations are here and here. Rather than reprise the skepticism evident in those articles, my aim in this post is to suggest how you can evaluate your own adviser, taking into consideration what the new regulations do and don't require.

Ask your adviser the following questions. Or review the website of the adviser's firm to see whether the answers are available there. A genuine fiduciary (one who puts your interests first) would answer "Yes" to all, or very nearly all, of these questions. Some of them are based on ideas in the original DoL proposal that were weakened, regrettably, after some investment firms objected.

1. Will you sign a written fiduciary oath, as recommended by National Association of Personal Financial Advisers and the Committee for the Fiduciary Standard? (Note: If the answer is, "I support the oath but my legal department won't let me sign it," that counts as a "No.")
2. Will you charge a flat fee or hourly rate for work delivered or a fixed percentage of the assets that you manage in my accounts, and not charge a sales commission of any kind? (Note: You should pay your financial adviser as you would pay your attorney or accountant.)
3. If your employer gets revenue or fees from any of the products you recommend to me, will you provide a detailed accounting of those charges, even if you personally get no commission? 
4. When you recommend products to me, will you provide a detailed list of all fees and charges I will pay for purchasing and owning those products, including total annual dollar amounts for current and future years?
5. When you recommend products to me, will you show me multiple firms that offer such products, comparing the merits of each firm?
6. When you provide financial advice about investments or savings, will you show me the potential future performance of my account, including a most-likely estimate and a worst-case estimate?
7. Will your advice show how the future performance of my investments or savings might be impacted if either inflation or deflation occurs?
8. If my financial goals or preferences change for any reason, will you be available to help me understand the impact of making the changes?

The point of asking these questions is that the federal regulations simply are not strong enough to guarantee that your adviser will put your interests first, even if he or she professes to be a fiduciary under current guidelines. To download a pdf copy of the questions, click below:

Earlier posts in this series reviewed possible explanations for what economists call "the annuity puzzle." The gist of the puzzle is that classical economic theory says retirees should buy more annuities than, in fact, they do. This series of posts can't claim to fully solve the puzzle. Instead, the more modest aim here is to use research by economists to help current and future retirees make good decisions about annuities.

A decision to buy or avoid an annuity is likely to be better made if it's properly framed. Being well framed means that the choice is stated in a way that counteracts common biases that could otherwise lead to a poor decision. That's the conclusion of a 2008 study published by Jeffrey R. Brown, J. R. Kling, S. Mullainathan, and M. V. Wrobel.

In the study, the authors surveyed 1,342 participants and asked them to evaluate decisions made by hypothetical retirees. The retirees were said to have "made permanent decisions on how to spend a portion of their money in retirement ... each person has some savings and can spend $1,000 each month from social security." Participants were told about the decisions that two such retirees had made and were asked which of the two had made a better choice.

For example, in one comparison, "Mr. Red" made a decision that allowed him to "spend $650 each month for as long as he lives in addition to social security. When he dies, there will be no more payments." He was compared to "Mr. Gray [who] invests $100,000 in an account which earns a 4% interest rate. He can withdraw some or all of the invested money at any time. When he dies, he may leave any remaining money to charity." Given this choice, most participants said Mr. Gray had made the better decision.

However, in another comparison, Mr. Red was the same, but Mr. Gray was described differently. He was able to "choose an amount to spend each month in addition to social security. How long his money lasts depends on how much he spends. If he spends only $400 per month, he has money for as long as he lives. When he dies, he may leave the remainder to charity. If he spends $650 per month, he has money only until age 85. He can spend down faster or slower than each of these options." In this case, most participants said Mr. Red had made the better decision.

Although described differently, these two cases were mathematically equivalent. In both of them, Mr. Red had a lifetime annuity, and Mr. Gray had a savings account earning 4% interest. When the savings account was characterized as in investment (the first case) it was favored over an annuity. However, when the savings account was characterized in terms of the spending pattern it would foster (the second case), it was disfavored.

The study was well designed in a manner that systematically compared a simple lifetime annuity to several other options, including interest-bearing investments and more complex annuities like the ones insurance companies may pitch to skeptical buyers. In every case, the simple lifetime annuity was logically and mathematically the better choice, but it was favored by the participants only when framed in language that clearly stated how each option would affect the retiree's budget and lifelong spending.

Thus, looking at budgets and spending led to better decisions than looking at investment factors such as interest rates and earnings. Focusing on budgets and spending counteracted people's tendencies, described in the previous post in this series, to over-simplify and to miscalculate risks.

Summing up, two points stand out from the various studies reviewed in this series of posts:

1. Consider your future health costs (for the reasons described in the first post). If you have excellent health insurance, such as a strong Medigap policy and long-term care insurance, then a simple annuity may be a reasonable way to smooth and stabilize your retirement income. If not, then you may be wise to set aside a reserve fund before purchasing an annuity.
2. Lay out your retirement income and budget without an annuity. Then consider whether purchasing an annuity might improve your lifetime spending. Do this instead of focusing on interest rates, investment returns, or payback periods.

Of course, other factors will also come into play, including your desire to leave bequests to your heirs or charity and your shared income with a spouse or partner, if you have one. For a step-by-step method that incorporates all these considerations, along with specifics regarding the best types of annuities, see our article on annuities for retirees.

Classical economic theory says that retirees should prefer annuities over investing in stocks and bonds. But they don't. Why? An earlier post reviewed one explanation, citing a study that said classical theory overlooks how health shocks reduce lifespans and impose burdensome costs. This post reviews other studies offering a second explanation. It examines how retirees think when deciding whether to buy an annuity.

In 2014, Jeffrey R. Brown, A. Kapteyn, E.  F.  P. Luttmer, and O. S. Mitchell, published a study that examined decisions to buy steady, lifelong annuity payments or to take a one-time, lump-sum payment. They noted that much of the research about such decisions "assumes a rational and fully informed individual who knows ... mortality rates, market returns, inflation, future expenditures, and income, and who can use this knowledge to optimally choose the mix of financial products to smooth" one's future budget over many years. That's a tall order, even for the brightest among us. Most of us may compensate, according to the study, by over-simplifying the decision.

To conduct the study, Brown and his colleagues generated realistic but hypothetical choices between annuities and lump-sum payments, and presented the choices to 2,112 individuals. The data indicated that most participants in the study used "simple heuristics rather than full optimization." The tendency to simplify the decision was strongest for those who had low scores on financial literacy and numerical ability, and those with less education.

A very common method of simplification, even among the more shrewd participants, was to buy an annuity or to trade one for a lump sum only when it was "an exceptionally good deal." While it might seem rational to insist on a good deal, the typical price-points in the study were extreme. On average, the participants were willing to buy an annuity only if the price was marked down by about 75% from the amount they would accept when trading an annuity for a lump sum. That's like offering to buy a new home for $60,000 but, as the owner of the same house, refusing to accept any offer below $250,000. A modest difference between the offer and list prices might make sense, but at values this extreme, a rational sale at fair value won't happen. In short, annuity buyers may have expectations that preclude reasonably priced transactions.

Another recent study offers a systematic explanation of the decision process that may guide annuity buyers. Under review for possible publication in an academic journal, the study is by Daniel Gottleib. Using a mathematical model from behavioral economics called Prospect Theory, the study analyzed consumers' decisions to buy or avoid either an annuity or life insurance. Logically, annuities and life insurance are complementary. One pays if you die; the other, if you live. As Gottleib argues, a theory that explains why retirees buy fewer or smaller annuities than is optimal (which they do) may also explain why the same retirees buy more life insurance than is reasonable (which they also do).

Setting aside the sophisticated math of Prospect Theory, one of its core ideas, as Gottleib explains, is that "individuals are risk averse over gains and risk seeking over losses." This means that decisions are based on miscalculation of the true risks. Here are some plain-language examples:

• Consumers (retirees and younger individuals alike) avoid taking losses. If, for example, they own a stock listed below what they paid for it, they avoid selling the stock at a loss and instead hold onto it, hoping that the price may recover. In doing so, they risk an even greater loss. For an annuity, the irrevocable decision to buy one may seem like a loss, if the buyer worries about dying before receiving enough payments to recoup the original cost. Just as the owner of a losing stock will hold onto it at risk, potential annuity-buyers hold onto their cash at the risk of depleting it, should they live longer than expected.
• Consumers are also over-eager to take gains. Stock-owners who have a modest gain, for example, may be inclined to sell pre-emptively and not let their profits run. They are averse to the risk that modest gains might vanish. Similarly, one who has held an annuity long enough to receive payments equal to the original purchase price may be reluctant to buy more annuities, even when doing so might be optimal. Logically, for example, it might be wise to increase an annuity if inflation has eroded the value of the original payments or if the buyer's good health has boosted the odds of a very long life. But such wisdom is atypical for retirees.

Gottleib's study offers the cold logic of Prospect Theory to explain decisions like these and similar ones regarding life insurance, including consumers' proclivity to under-purchase life insurance when young and over-purchase it when old. A point in favor of Gottleib's analysis is, thus, the breadth of decisions it covers.

The foregoing studies imply that when thinking about annuities, we are prone to over-simplify complex decisions and to miscalculate the true risks. Are there ways to counteract these misguided tendencies? Other research suggests that there are, and that better informed choices may be possible. That's the subject of Part 3 in this series.

For step-by-step methods to evaluate whether an annuity would be right for you, including methods to find a good insurance company that sells annuities, read our article on annuities for retirees.

Since a ground-breaking study by Menachem Yaari in 1965, economists have called it "the annuity puzzle." Classical economic theory says that retirees should, in a perfectly rational world, prefer annuities over investments such as stocks and bonds.* But they don't. In fact, very few retirees hold annuities. Why? Is the theory wrong? Or are retirees making bad decisions?

There's been plenty of research on the topic since 1965, with no definitive resolution. Some recent studies tackle the problem from very different perspectives. While not written as advice to retirees, the studies do, as I read them, offer useful insights that can sharpen one's thinking about annuities. In this post, I'll explain the core idea from one study. In subsequent posts, I'll discuss additional studies and review what the new research may imply about whether and when a retiree may sensibly consider an annuity.

The first paper, published in the November 2015 issue of American Economic Review, is by Felix Reichling and Kent Smetters. It aims to resolve the annuity puzzle by examining "​health shocks that simultaneously affect longevity and increase uninsured health costs." Setting aside the elegant mathematics used in the paper, the core idea is quite plausible.

To illustrate the idea, suppose you had purchased a lifetime annuity at age 65. It has paid you a steady stream of income for a few years, just as promised. When you bought the annuity, you had good information about your health. You knew that people with similar health had only a small chance of dying right away and maybe a 50% chance of dying in their 70's. But now, at age 72, you've gotten what Reichling and Smetters call a "health shock." While on vacation in a tropical paradise, you contracted a local disease that nearly did you in. You survived, after a long stay in the hospital, and your future health, alas, now looks bleak. To put a number on it, your chance of dying in your 70's is approaching 90%.

Making matters worse, you had no Medigap coverage, and you needed care from some pricey specialists. Consequently, you've withdrawn much more than planned from your retirement savings. Your personal wealth is much diminished.

The core idea articulated by Reichling and Smetters, supported by mathematics and by data, is that when both these events occur, a health shock that increases the risk of dying plus costs not easily covered by insurance or savings, then annuities become less attractive than holding bonds or other safe investments. Should you live in a world where the combination of such events is plausible, you would, according to Reichling and Smetters, be rational to avoid annuities.

Nonetheless, in the Reichling-Smetters model, annuities continue to make sense if only one of the unhappy events occurs. Thus, in certain scenarios, annuities may still be attractive. Here are two such scenarios:

• You've already had a bad health shock. For you, the next shock would be if your health improves, or a medical miracle arrives in the nick of time, and you live longer than the few years you thought you had left. Or, as a less extreme case, your health may be weaker than average because of a chronic condition. Think about it. Wouldn't an annuity be helpful, just in case you find yourself greeting the sunrise far beyond what you pessimistically expect? That's essentially what Reichling and Smetters argue.
• Your savings and insurance are ample. You can afford to buy an annuity so generous that no health shock would devastate your finances. It might wreck your health, but you would remain financially secure. Alternatively, you may be so shrewd about health insurance and long-term care that you have sufficient coverage for all conceivable costs. Then, whether or not you ever suffer a health shock that actually triggers your insurance benefits, an annuity would be a sensible way to guarantee and stabilize your future income.

Let's revisit your hypothetical self, at age 65, before you took that disastrous vacation. If you were thinking like Reichling and Smetters, you would do one of two things, maybe both.

First, you would set aside some of your retirement savings as a reserve fund for uninsured medical costs. Or you would increase your insurance coverage for medical expenses and long-term care. Doing so would make you less vulnerable to the double-whammy of a health shock that reduces your longevity combined with uncovered costs that degrade your financial viability. To get started, read our article on reserve funds for retirees, and use our Retiree Reserves calculator.

Second, you would buy annuities only to the extent that, after setting aside some reserves or increasing your insurance, you still have ample savings. You would have to review your personal circumstances, perhaps in consultation with a financial professional who receives no compensation for selling annuities or possibly with sophisticated software like ESPlanner.

Aiming to set a benchmark, Reichling and Smetters presented a chart (their Figure 7) indicating that for a healthy 65-year-old, at least $500,000 in savings would be necessary before buying any annuity. With $1,000,000 in savings, the chart says that annuitizing half or more might be defensible. Smetters offered similar advice when interviewed by the New York Times. Given the level of savings available to most retirees, this advice would rule out annuities for a substantial majority.

You should, of course, make your own decisions and consult your own adviser. As one way to get a second opinion, Part 2 in this series reviews another recent study that took a different perspective. It examined the decision process that retirees may be using, perhaps unwisely, when they avoid annuities. You can also find a step-by-step process for evaluating annuities and insurance companies in our article on annuities for retirees, which was recently updated to incorporate ideas from this series of posts.

* To make the economic theory accessible, I am necessarily glossing over some technical details. For example, the classical model assumes that annuity buyers have no "bequest motive." They do not intend to set aside some assets to be inherited by a spouse, child, or charitable organization. To dig into the technical details on your own, you might start here and then consult the home page of Prof. Smetters.

Disclaimer: Historical data cannot guarantee future results. Although a mixture of bonds, stocks, and other investments may be safer than investing exclusively in one class of assets, diversification cannot guarantee a positive return. Losses are always possible with any investment strategy. Nothing here is intended as an endorsement, offer, or solicitation for any particular investment, security, firm, or type of insurance. You are responsible for your own investment decisions. Please read our full disclosures and Fiduciary Oath.

On February 2, 2016, we released an updated and improved version of Plan to Retire, one of our calculators. Whether you are 20 or 70 or any age between, the improved calculator will enable you to test out your retirement plans. You can ...

• See your forecasted income throughout the period between ages 60 and 70, when key dates occur for Social Security, pensions, and retirement withdrawals.
• Test different scenarios, and see how they will affect your savings and potential income.
• Study options for phased retirement by independently setting several key ages: when you start taking retirement benefits from Social Security, when you stop working, when a pension might start, and when you begin withdrawing from your retirement savings. You can make these dates all the same, all different, or any combination.
• See how your retirement savings will be affected if you increase or reduce the amounts you and your employer save each year, or if you start taking withdrawals.
• Test how investing more or less in stocks will affect the growth of your savings and the amount of your retirement income.

You can find this calculator and others on the Calculators menu, above.

This post is about the fiduciary duties of investment firms and advisers to represent their clients' best interests, and about the positions taken on this matter by the investment firms recently rated in our article Best Firms 2016.

In April 2015, the U.S. Department of Labor (DoL) proposed new regulations regarding conflicts of interest in retirement plans and the definition of investment advice. Among the most important objectives of the proposed regulations are to:

• Strengthen the responsibility of retirement plans and retirement advisers to act in their clients' best interest, and
• Extend fiduciary requirements to IRA providers and to rollovers between IRA and 401(k) plans.

The DoL solicited public comments on the proposal over the summer and held hearings in September. In December, Republicans in Congress failed in an effort to modify the omnibus spending bill with a rider that would have overridden the proposed new regulations. After reviewing the public comments, the DoL is expected to issue final standards this year.

To evaluate each firm's position on the proposal, I read their official submissions to the DoL and looked for news or commentary on the firm's website. The submissions ranged from brief to profuse, making it difficult to compare, for example, one that was limited but vaguely supportive versus another that detailed its clear support in some areas and constructive opposition in others. I've opted, therefore, to judge them by comparison to comments submitted by Alicia H. Munnell and Anthony Webb of the Center for Retirement Research at Boston College. The comments of Munnell and Webb are both strongly supportive of the DoL proposal and lucidly explained. I recommend reading them.

In the list below, I've ordered the firms from best to worst according to my own judgment of the degree to which they conformed to the Munnell-Webb analysis. I also gave a firm credit for disclosing its position on its own website, in a manner retail investors would could easily find and understand.

1. Betterment submitted strongly supportive comments, covering certain aspects of the proposal applicable to individual investors and 401(k) plans. They fully disclosed the firm's position on their own website.
2. Wealthfront submitted very limited comments, mainly supporting low-fee automated services for small investors. They fully disclosed the firm's position on their own website.
3. Fidelity submitted modest comments here and here, requesting revision of some aspects of the DoL proposal, largely on grounds of compliance cost and administrative complexity, grounds that Munnell and Webb explicitly reject. Fidelity did not disclose any information about the DoL proposal or the firm's position anywhere on their retail client website.
4. Charles Schwab submitted extensive comments here and here. They supported the intent and some specifics of the DoL proposal, and constructively offered clarifications, while conforming mostly but not fully to the main points advocated by Munnell and Webb. Schwab did not disclose any information about the DoL proposal or the firm's position anywhere on their retail client website.
5. Vanguard submitted extensive comments here, here, and here. They responded constructively when in opposition but rejected some significant constraints favored by Munnell and Webb. Vanguard did not disclose any information about the DoL proposal or the firm's position anywhere on their retail client website.
6. TIAA-CREF submitted very extensive comments here and some follow-on comments here, agreeing in concept with the need for clearer fiduciary standards but opposing many significant constraints favored by Munnell and Webb. TIAA-CREF posted an article about the DoL proposal on the firm's main website but disclosed no information about the firm's position.
7. BlackRock submitted extensive comments here. They objected to the DoL proposal, including many significant constraints favored by Munnell and Webb, yet they allowed a generally favorable blog-post on the website of their subsidiary, Future Advisor, in conflict with the parent firm's strongly opposing comments to the DoL.

A full appreciation of the proposed standard requires some willingness to delve into legal and financial technicalities. That said, if you want to learn more, here are some ways to get started:

• Pensions & Investments, a publication for executives who manage pension accounts and institutional investments, reviewed the DoL proposal in August 2015, explaining who's a supporter, who's not, and why.
• The Board of Certified Financial Planners and the Financial Planning Coalition have articulated their reasons for being strong supporters. 
• A complete list of the public comments is published on the DoL website. Using control-F in your browser, you can search for the comments of a particular firm or individual.

Disclaimer: Nothing here is intended as an endorsement or solicitation of any security or product from any particular firm or financial adviser. Please read our full disclosures.

​Within categories, different firms had different strengths. The highlights are listed below. For full reviews of each individual firm, see Best Firms 2016, on the Investing menu above.

• For services, Vanguard took top honors, scoring Excellent or Good for each of the component areas. Betterment was a close second, with strong scores on all components except college savings.
• On portfolios, Betterment and Wealthfront were tied at the top, because both offer well designed, indexed solutions, with best-in-class rebalancing, and at least some element of factor investing.
• Fees were rated best at Betterment and Wealthfront, thanks to their low-cost funds, fully transparent expenses, and automated advisory tools. Vanguard lagged slightly because their recently introduced advisory fees, while low compared to traditional financial advisers, are higher than the costs for comparable advice at automated firms.
• All investors, new and experienced, whether they seek to make their own decisions or get guidance, are well served at Vanguard. Betterment was next best in this category.
• For online content, including articles, graphics, and calculators, three firms achieved perfect scores: TIAA, Vanguard, and Betterment. Their websites are excellent places to find sensible ideas on a wide variety of personal financial goals and concerns.

When reviewing this information, please be aware of our disclosures and Fiduciary Oath.

Stock markets across the globe have been plunging lately, prompting all the news media and investment firms to speculate on reasons why and what to do. One sensible journalist, for example, concluded that the reasons are, alas, unknowable. And good investment firms like Betterment and Vanguard have sprinkled their websites with reassuring advice to stay on plan and not sell in a panic.

My take on the matter centers on this line of argument:

1. Volatility is a factor intrinsic to markets and economies. They occasionally suffer steep plunges, so-called "corrections" in markets and recessions in economies, sometimes in concert, sometimes not. Between the drastic dives, they more commonly grow in a positive and orderly fashion. But the dives will happen, sooner or later.
2. Predicting when they will happen, in advance, is hard. Maybe a few prescient souls can do it accurately for a while, but logically, if many of us could do it consistently, our collective actions would neutralize the effect or at least diminish it. We would be richer than we are.
3. Although we can't predict in advance, we can respond intelligently after the fact. One rational response is to rebalance. As Andrew Ang explains in his fine textbook, Asset Management, rebalancing a portfolio is, for strictly mathematical reasons, a counterweight to volatility. One good way to implement a rebalancing strategy is to monitor your portfolio monthly or quarterly, and realign it to your target allocations if the overall percentage of stocks has drifted 3% to 5% from your objective. Another way is to invest at a low-cost firm like Betterment or Wealthfront that does so automatically. (Learn more by reading our article on rebalancing.)
4. Additionally, volatility can be countered, somewhat, by investing in funds that specialize in finding low-risk stocks. Ang's book has more on this topic, and you'll find an overview in our article on factor investing.

To illustrate these ideas, consider the chart below. It shows three portfolios, all for the period from December 31, 2013, to January 20, 2016 (essentially, the last two years, up to the day before this post).

• Custom RB3% is a custom set of five low-cost mutual funds, rebalanced at the end of the month, if the portfolio's allocations drift by 3% from their targets. It was rebalanced twice previously, at the end of January and May 2015, and meets the criterion for rebalancing now.
• Custom RB5% is the same mutual funds, rebalanced monthly if the drift is more extreme, 5% or more beyond the target allocations. It was never rebalanced over the two-year period, but just now meets its 5% criterion for the first time.
• VSMGX is an all-in-one fund similar in composition to the custom fund. It has even lower costs than the custom portfolios, and is constantly rebalanced.

One implication from the chart is that rebalancing was effective when the custom portfolio drifted more than 3% to 5%, as compared to the VSMGX baseline. Granted, this one example would scarcely be adequate evidence, by itself. It aligns, however, with extensive historical analysis as reviewed in our article on rebalancing and with mathematical analysis as explained in Ang's textbook.

A second implication from the chart is about factor investing, which was the strategy used to select funds for the custom portfolios. Employing ideas outlined in two articles, Diversify! and Factor Investing (both on the Portfolios menu above), the custom portfolios consisted of:

• Vanguard Global Minimum Volatility (15%)
• iShares All-Country World Minimum Volatility ETF (15%)
• Vanguard Strategic Equity (15%)
• Vanguard U.S. Value (15%)
• Vanguard Long-Term Government Bond Index (40%)

This combination of funds is weighted for low-risk and for value and momentum, especially in smaller companies. Overall it is invested 15% in international stocks, 45% in U.S. stocks, and 40% in long-term Treasuries. Although well diversified, it is more selective than a broadly indexed strategy, as represented by VSMGX, Vanguard's LifeStrategy Moderate Growth fund. That fund currently invests 24% in a total index of international stocks, 36% in a total index of U.S. stocks, and 40% in two bond indexes representing all U.S. bonds and international government bonds. (In 2014 and early 2015, it had somewhat smaller international allocations.)

Although both the custom and VSMGX portfolios have a 60-40 split between stocks and bonds, and both implement a rebalancing strategy, their results in the recent two-year period were quite different, as the chart illustrates. Don't jump to conclusions, however. Future years may turn out differently than the last two, and the usual cautions apply: Diversification does not guarantee a positive return; any investment strategy can lose money; and your results may differ from those depicted here. The ideas in this post are presented for information only and are not meant to endorse a particular firm or security. Please read our full disclosures.