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Portfolio Income: A Test of a Formula Plan**
Published online by Cambridge University Press: 19 October 2009
Extract
One of the difficulties of evaluating formula plans by testing them in the light of past experience is the fact that there is no index of bond experience which simulates typical portfolio performance. Bond indices are stated in terms of yields with constant maturities, but the capital values of bonds vary according to their maturities given the same yield. Cottle and Whitman used elaborate techniques to make their bond portion of the total portfolio realistic, but were only partially successful. This writer also attempted to eliminate the problem of simulating the bond portfolio in a previous paper by assuming that the defensive portion of the portfolio was invested in a Savings and Loan account receiving the national average return. This procedure thus ignored the problem of bond maturities and variation in capital values due to changes in interest rates.
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- Research Article
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- Copyright © School of Business Administration, University of Washington 1966
References
1 Cottle, C. S. and Whitman, W. T., Investment Timing, The Formula Plan Approach (New York: McGraw-Hill, 1953), p. 13Google Scholar.
2 Dince, Robert R., “Another View of Formula Planning,” Journal of Finance, December, 1964, p. 685.Google Scholar
3 Sprinkel, Beryl, Money and Stock Prices (Homewood, Ill.: Irwin, 1964)Google Scholar.
4 Friedman, Milton, “The Supply of Money Changes in Prices and Output,” in the Relationship of Prices of Economic Stability, Joint Economic Committee, 1958, pp. 249–25OGoogle Scholar; and Sprinkel, Beryl, “Monetary Growth as a Cyclical Predictor,” Journal of Finance, September, 1959, pp. 333–346Google Scholar.
5 Sprinkel, op. cit., p. 119.
6 Ibid.
7 Ibid., pp. 166–67 (Italics supplied).
8 In the tests that follow, every attempt was made to follow Sprinkel's methodology precisely. Nevertheless, slight differences in totals resulted. These differences probably occur from certain arbitrary decisions made in this study to insure strict comparability between the tests that follow.
9 Cottle and Whitman show only one plan, the Vassar plan, which allows a complete switch out of stocks or bonds. (Op. cit., pp. 191–92).
10 Sprinkel, op. cit., p. 147.
11 ibid., p. 150.
12 Sauvain, Harry, Investment Management (2nd. ed.)(Englewood Cliffs, N. J.: Prentice-Hall, 1959), pp. 378–380, 475–76Google Scholar.
13 Ibid., pp. 378–80, 523.
14 Sprinkel, op. cit., p. 206.
15 Standard and Poor's Stock Index yields do not exist prior to 1926. In order to accomplish this, the Research Department of Standard and Poor's Stock recommended applying the Cowles Commission annual yields to the Stock Price Index. In a letter of November 9, 1964, Mr. G. W. Olsen of Standard and Poor's Research Department suggests a very close fit results.
16 The adjustment of the Standard and Poor's Bond Yield Index tends to maintain a constant period of maturity. (Letter from G. W. Olsen, November 9, 1964).
17 Malkiel, Burton J., “Expectations, Bond Prices, and the Term Structure of Interest Rates,” Quarterly Journal of Economics, May 1962, p. 202Google Scholar.
18 Ibid., pp. 202–03.
19 The full quote is, “Unless reasons are believed to exist why future experience will be very different from past experience, a longterm rate of interest or (say) 2 percent leaves more to fear than to hope, and offers, at the same time, a running yield which is only sufficient to offset a very small measure of fear.” Keynes, J. M., The General Theory of Employment, Interest, and Money (New York: Macmillan, 1949), p. 202Google Scholar.
20 Malkiel, op. cit., p. 203.
21 An attempt was made to convert the Standard and Poor's Index into a more accurate index for the 5-, 10-, and 15-year maturities by converting the end-of-year yields given in Homer's, SidneyHistory of of Interest Rates (Rutgers University Press, 1963, pp. 211–212Google Scholar) into equivalents of the Standard and Poor's Index. In terms of total income plus portfolio value, a minuscule 0.2 percent separated the ladder values and 0.5 percent was the difference for the pyramids.
22 Malkiel, op. cit., p. 206.
23 The difference in the value of the cash versus the ladder portfolio as of 1950 was taken as the initial investment. Then the difference between the cash income for each year and the ending portfolio capital value were taken as the income of the cash plan. This value had a positive time discounted rate of return of 4.6 percent.