Some have questioned the advisability of using the 4% rule in all cases. It might be wise in most cases, but is it always wise? And on the other hand, are there some mutual funds and ETFs that one should limit to 4%?
In his November 22nd weekly newsletter which includes a summary of Brinker's Moneytalk program, David Korn wrote the following:
"Caller: This caller wanted to know whether Bob's recommendation of limiting an individual stock holding to 4% of a portfolio would apply to something like a mutual fund from Vanguard. Bob said the 4% rule applies to an individual company stock, not to a mutual fund that already has diversification built in. The reason for the 4% rule is to manage the risk involved. If you were talking about something like the S&P 500 or Total Stock Market Index or other index fund, the 4% rule would not apply.
[David Korn] EC: Ever wonder what the genesis for the 4% rule is? It really derives from modern portfolio theory and the concepts of systematic and non-systematic risk. Let's take a closer look for a moment at these important concepts.
Systematic Risk: Think of "systematic risk" as the risk of just being invested in the market. This risk is the risk that all stocks face, regardless of what industry, sector, or price-to-earnings ratio they have. It is simply the overall risk of being in the market. For example, terrorist attacks, recessions, world wars, alien invasions to earth, all would create risk for the entire market.
Nonsystematic Risk: This is the risk that individual stocks face. Companies face all kinds of specific risks, such as lawsuits, strikes by employees, changing attitudes about a product. For example, Microsoft faced the nonsystematic risk of being sued by the Federal Government and in that case, the risk turned real! Another example of a nonsystematic risk for a company would be in the case of a product that loses favor with the public -- say a study revealed that drinking Coke caused cancer. That would be a seriously bad problem for Coke and provides a clear example of the nonsystematic risk than one stock faces.
4% Rule: Here is where it gets interesting (that is if you find any of this stuff interesting). Academics point out that you can not avoid systematic risk if you are going to invest in the stock market (other than by hedging techniques which is for another day). HOWEVER, you can avoid nonsystematic risk through diversification of stock holdings. When you think it through, it is kind of obvious. How can you avoid the nonsystematic risk of holding one stock? Easy, try to make your holdings more similar to the overall market -- own more stocks!
Now, here is the neat part. Studies have shown that you don't need to buy every stock in the market to avoid nonsystematic risk. In fact, there have been several studies that show if you own 20-40 stocks in different sectors and industries, you will be able to diversify your way out of nonsystematic risk. You will still have systematic risk, but that's the risk you always take by being invested in the market as a whole. Bob's "4%" rule would permit someone to own 25 stocks, each weighted 4% of the total portfolio which is well within the range of owning 20-40 stocks that academics say is needed to avoid nonsystematic risk. So there you have it -- the foundation to the 4% rule. Realize that this is a pretty simplistic explanation of the nonsystematic and systematic risk, but I hope it helps explain things."__David Korn
David Korn's Stock Market Commentary, Interpretation of Moneytalk (Bob Brinker Host), Financial Education, Helpful Links, Guest Editorials, and Special Alert E-Mail Service. Copyright David Korn, L.L.C. 2010
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Bob Brinker's Marketimer off-the-books "Individual Issues" list has contained only two stocks (MSFT and VOD) for many years. However in May, 2009, Brinker added Suncor and GLD. Here is his explanation for adding SU:
Marketimer May 2009 issue, Bob Brinker said: "This month we have added Suncor to our coverage. Suncor is a leading Canadian oil sands producer with vast reserves in the Athbasca Tar Sands of Alberta.....We view Suncor as an excellent way to protect portfolios against the rising oil prices in the future. As with all individual stock issues, holdings should not exceeed four percent of equities."Unfortunately, Brinker has never offered any explanation as to why he added GLD to the list, and he has never said how much of it he recommends purchasing. Since he has made it clear that in his view, ETFs do not fit into the 4% rule, what category does GLD fit into? Subscribers have had to decide for themselves whether or not it's "to the moon, Alice." :)
Some of the ETFs that are on the Individual Issues List have taken a real beating over the past 5 years -- for instance, the ETF, DVY. Before the 2008-2009 megabear market, Brinker recommended DVY for those who wanted to own dividend-paying equities. He once told a Moneytalk caller that DVY could be used by conservative investors in place of the Total Stock Market because its dividends gave it a little more safety.
YIKES! What a ride those followers have had from October, 2007 in the $70 range, to March, 2009 in the $22 range. It's back up to the $48 range now. But the NAV is still down by about 1/3, even after the S&P 500 Index made some very nice gains in the past year and a half.
Brinker's DVY recommendation over the past 5 years compared to total market (VTI) and Dow (DIA). Don't hold your bref for any calls to get through to the program about this one -- like they used to when it was doing well. Brinker simply doesn't discuss his bombs:
Dixiegeezer's stunning photograph:
