Good reads from around the Web.
I have found a new website and it’s right up our street. Called Portfolio Charts, it’s dedicated to exploring asset allocation visually – and assuming all the maths is correct and the resultant graphs are accurate – it appears to be brilliant.
Now don’t get me wrong. I still think most people are best off not immersing themselves in the minutia of a dozen different asset allocations and wondering for six months whether the Coward’s Portfolio, the Merriman Ultimate, or the Golden Butterfly is the best allocation for them (or indeed whether they’re really finishing moves from Street Fighter III).
In truth, The Accumulator’s back of a blackboard graphs are about as spuriously precise as is required to overcome inertia and keep new investors focused on what matters.
But if you’ve been coming here for a while, there’s a good chance you’re not most people. And that while you know you should know better, you’ll also have plenty of fun clicking around the site looking at how adding 10% more Treasuries dampened volatility if you were power-shouldered 1980s New York executive buying stocks to fund a place in the Hamptons.
(Yes, it’s American of course. Perhaps that’s an advantage if it means we focus on the gist rather than the detail?)
Less risky but more rewarding
The latest post exploring whether an investor should go 100% equities is a good place to get started.
The author writes:
In investing, the concept of efficiency is most commonly discussed in terms of risk-adjusted returns. Basically, it’s all about trade-offs.
What are you willing to risk for your potential higher gain?
Sure you can invest in a portfolio with a higher average return, but with the trade-off that your odds of actually achieving that return with any certainty are much lower.
Portfolios that work towards good returns while minimizing downside risk tend to do quite well compared to pedal-to-the-metal portfolios.
Now that sounds great, but how is one to identify these magical portfolio unicorns with superior risk-adjusted returns to the stock market?
Surely they are quite rare, so why waste our time chasing the unattainable?
Here’s the thing — they’re not rare at all.
Then follows this graph, which goes straight into the Monevator Hall of Money Shots.
(Click to enlarge)
Source: PortfolioCharts.com
The square red box on the far left represents the performance of an all-stocks portfolio. The other symbols mark the same for a variety of lazy portfolios.
What this graphic shows is that over the period, adding other assets to your 100% stocks portfolio typically resulted in a less-steep worst year loss1 while also tending to increase the minimum long-term annual compound returns your portfolio earned.
It doesn’t mean you won’t do better with 100% stocks – it doesn’t prove anything will happen in the future, because it is only a study of the past – but it does indicate very clearly that for long-term investors, diversifying assets has historically done the business on the basis of risk versus reward.
There’s plenty more where that came from over at Portfolio Charts.
Enjoy!
From the blogs
Making good use of the things that we find…
Passive investing
- History for passive investors [Video] – The Evidence-Based Investor
Active investing
- Spot the red flags – A Wealth of Common Sense
- The fast and the furious income seekers – The Value Perspective
- 5 reasons why BT shares could be riskier than you think – UK Value Investor
Other articles
- Why do bond prices work the way they do? – Oblivious Investor
- The Whoosh! of exponential retirement – The Retirement Cafe
- Metropolitan myths that led to Brexit – Tim Harford
- My proposed wealth tax – FireVLondon
- Waste money now or waste money later – The Finance Buff
Product of the week: Would you lock away your money for seven years in a debenture touting an 8% return, asks The Guardian, after you’ve discovered it’s powered by recycled cooking oil from the local chippie? It sounds both ethical and righteous, and yet also a bit like the end of times – something that will be cited by historians of our low interest era in the years to come. The promoter – Abundance Energy – says it hasn’t had any investment failures yet, but the debenture clearly isn’t paying 8% for nothing. Do your own in-depth research (and personally I only invest a small single figure percentage of my net wealth into such alternative assets in total.)
Mainstream media money
Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.2
Passive investing
- Swedroe: The cost of socially responsible investing – ETF.com
- Global asset allocation versus home bias [PDF] – Vanguard
- Smart Beta ETFs enjoy a popularity surge in Europe – Institutional Investor
- Who bought US stocks after 2008? – Morningstar
- Asset management: Actively failing [Search result, two weeks old] – FT
Active investing
- Buffett’s Superinvestors speech revisited – Advisor Perspectives
- M&G and Aberdeen howlers top ‘Spot the Dog’ list [Search result] – FT
- Maybe negative yields are a sign of prosperity? – Bloomberg
- Why Masayoshi Son bought ARM Holdings – Institutional Investor
- Apple’s new normal – Bloomberg
A word from a broker
- What is the outlook for the commodities sector? – TD Direct
- Barclays may finally be turning around – Hargreaves Lansdown
Other stuff worth reading
- Leasehold flats: What estate agents won’t tell you [Search result] – FT
- Doubts grow over ‘totemic’ triple-lock pension – Guardian
- A nice pension problem to have: £40K for life or £1.3m now? – Telegraph
- How to get a good mortgage if you’re self-employed – ThisIsMoney
- Renting in your 40s and 50s is on the rise [Search result] – FT
- The incalculable value of finding a job you love – New York Times
- Carl Richards is hopping off the hedonic treadmill – New York Times
- How I learned to love the economic blogosphere [Search result] – FT
Timewaster of the week: Blame the hot summer in London or digital distractions, but I’m reading fewer books than usual. I did however play a neat card-based quiz game in a pub garden in Hampstead yesterday called Timeline, which made me feel momentarily smart. Just don’t ever ask me when “the language of bees” was invented again. That stung.
Like these links? Subscribe to get them every week!
- i.e. Maximum drawdown – the fall in the value of your portfolio from peak to trough. [↩]
- Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. [↩]
Comments on this entry are closed.
Eyeballing that chart and I see 13 different diversified portfolios (ex the TSM) with minimum real annual returns of >=2.5%. It’s going to be interesting to see how the much hyped 4% rule will play out in the FIRE community in years to come if we get one of those minimums again and once sequence of returns risk is bolted onto that.
I know I’m certainly glad I’ve picked 2.5% as a drawdown number but I’m starting to think I’m a little conservative.
@RIT. Agree with you. The question we are all struggling with is has the world economy changed fundamentally enough to mean we should not trust 100+ years of history. I think it probably has, but could be completely wrong.
Big economic waves have usually been associated with shifts in the energy available per capita. With books like “The Switch” suggesting renewables are hitting costs per MWh that are another energy revolution, perhaps our current assumptions will prove wrong again.
I remember reading an article a while ago about a dynamic drawdown strategy that factored in actual market performance that I thought was complicated but interesting. Perhaps that is the way forward rather than simple percentages. I probably reached it via the Monevator weekend reading list, but I can’t dredge it up at the moment. It should be possible to use a Monte Carlo approach with some similar model to look at sequence of returns risks as well as current performance.
Like many people I am looking for a robust rather than optimal strategy.
Interesting post from the telegraph regarding £40k annually vs £1.3mm lump sum. Surely it makes sense to take the lump sum in that instance with a. 3% withdrawal rate.
Regarding equities vs bonds, I’m in the 100pc equities camp (though still 25y from retirement), I see no point investing in 10y government bonds below 1%, far too much downside risk, would rather chance negative rates becoming entrenched, which would likely be bullish equities anyway.
@Old_eyes
I think this is the research you want:
Kitces – Dynamic Asset Allocation and Safe Withdrawal Rates
https://www.kitces.com/april-2009-issue-of-the-kitces-report-dynamic-asset-allocation-and-safe-withdrawal-rates/
@Miles -that’s the one. Thanks!
@Old_eyes
Glad that helps. Also worth study is Guyton and Klinger’s decision rules
https://retirementresearcher.com/jonathan-guyton-tames-a-gorilla/
Both Kitces and Guyton have published research on dynamic approaches to withdrawal rates which can produce higher sustainable withdrawal rates.
@old_eyes
You may find this useful also:
https://retirementresearcher.com/sustainable-spending-rate-retirees-2016/?utm_campaign=Retirement+Researcher+Weekly+Email&utm_source=hs_email&utm_medium=email&utm_content=31552119&_hsenc=p2ANqtz–gjSFLKjFBmZqPsTyKIJVR5PNmjnZwwAsZoPYqcPbadn-7WhcOvvoDU6blznpIOy7llR1UWwVm5OI84msYyNnPif34jA&_hsmi=31552119
Hello all. Portfolio Charts was created by Tyler9000 on the ERE forum. You can check out a deep discussion here…
http://forum.earlyretirementextreme.com/viewtopic.php?f=3&t=6635
£1.3m sounds better than £40k, but you do have the complication of going over the £1m limit, thought there might still be time to get protection. Certainly converting part of it to get just under £1m, and getting the lump sum our to diffuse any threatened growth would seem good. The x20 multiplier for DB assesment really isn’t appropriate in the modern annuity scenarios.
Thanks for introducing me to the Portfolio Charts website. I spent a very absorbed hour comparing all the portfolios and charts. The Merriman Ultimate portfolio is the one that strikes me as most attractive, although replicating it for a UK investor might need a little creativity and a bit of rough and ready simplification here and there. On the whole, I come away from comparing the portfolios with the general impression that starting with a global 60% equities/40% gilts split and then diversifying the 60% equities by apportioning judiciously sized slices of it to small caps, property (or REITS), emerging markets and value stocks puts you in pretty much as good a position as anyone else. Monevator’s own Slow and steady portfolio springs to mind for some reason.
@John B. I might be going against the grain here but as part of a couple with no DB pension but a decent sized investment portfolio, I’d pay £1.3mm for a £40k index-linked annuity. The ability to floor my retirement income and hedge longevity risk would be a real safety net (this ignores the credit risk I might be taking to the pension provider). Moreover, given my current view that real returns above 2%/annum are unlikely to be sustained, a liveable floor on my income would make it easier for to take more risk with my remaining pot of capital.
It’s about time people were allowed to trades these things! P2P lending is nice but I want P2P annuity trading!
@zxspectrum48k don’t hold your breath…. One major issue with annuity secondary trading is adverse selection. If you’re richer, you’re more likely to live longer and to want to purchase a bigger annuity. Conversely, if you’re in ill health you’re more likely to want to sell your annuity for full value. The insurer doesn’t know your circumstances and therefore they will offer adjusted (worse) quotes to reflect this risk when buying or selling annuities. In addition you have poor transparency, plenty of additional transaction costs, and legal risk for the insurer and advisor ( lawsuits years after, in hindsight ). All this makes secondary trading of annuities expensive and poor value, and likely even more for p2p annuity trading !
In the situation of the Telegraph guy I would take the transfer value on just under half, to stay under the £1m tax threshold : this leaves a 20k index linked annuity, plus state pension, for a comfortable retirement, the possibility to take 300k tax free now and give it to his sons for estate planning, and another 300k in a tax sheltered investment draw down for a little extra in silver years and care home costs in twilight years.
@proequities
I’m also near 100% equity, beyond a cash reserve, but for a different reason : I overpay my mortgage instead of allocating money to bonds. No point in investing in gilts at 1.4% and take duration risk while paying a mortgage at 1.5%. Sadly most investment portfolio literature doesn’t take this into account.
Thanks for the list! I especially like the finance buff’s post, money is all about tradeoffs and it’s up to people to realize when spending money will provide them with the most value.
This is a great website for back testing asset allocations going back to 1972: https://www.portfoliovisualizer.com
Interestingly emerging markets seem to trump all other equities, including small caps. I thought that they had historically underperformed developed markets. Or maybe the time period is too short.
@THE_INVESTOR: Could you, or one of your readers whose understood this better than me, help by putting this into actionable terms.
My reading is that this chart shows that based on a 15 year window a TSM portfolio has historically worked out worse than a mixed lazy portfolio. I checked on there site and over longer periods the the TSM and top performing mixed porfolios were all averaging around 5.9% CAGR. At which point the question for longer term investors (30+ years) seems quite unclear:
1/ Clearly if you’d picked the right mixed portfolio you’d have matched a TSM portfolio without all the timing risk.
2/ A mixed portfolio inherently means making judgments about what mix will work best. The 60/40 portfolio is often suggested as a really simple model, but it under-performed by 0.8%pa vs TSM longterm. Can we really predict which mixed portfolio will match the TSM over the next 40 years but with less risk? My guy feel is not.
3/ It seems like the portfolios that most effectively avoid major falls are doing so because of gold rather than bond/equity mix.
In short. I finished the article thinking that moving from a TSM strategy to a mixed might make sense, but by now am back to thinking that a TSM strategy is probably still the way to go (and diversifying when I get nearer to the point where I might need it).
JOHN
The issue with all back tests is that you see the whole picture from a viewpoint of recency. Bonds have done great over the last 30 years but they started from high initial yields. (There have been many periods when bond returns have been awful….I make no prediction except that the outlook for the future will be unlike recent times!)
Meb Fabers, E book Global Asset Allocation looked at the returns of numerous portfolios over recent years and came to the conclusion that that provided you stayed the course over a long period , they all worked out about the same and the effect of charges was potentially more significant.
Another thing to consider with asset allocation is what any likely inheritance is currently in. If you have an elderly relative who is very sensibly in cash, or has a property, then you are investing in those markets by proxy.
It’s always struck me as odd that people seem happy that Cyclical PE tells us something useful about *long term* future equity returns, but don’t feel as comfortable doing the same with bonds.
However, I rejiggled our portfolios pretty heavily in 2010/2011, with a big move to passive (thanks to Monevator and Smarter Investing by Hale) and a change of platform. I was *very* cautious with bonds then due to low yields but have seen 20% capital gains since, which wasn’t expected at all!
I’m due a big rebalance during August, which will automatically find “cheap” things for me, so I just need to hold my nerve!
@John I’m at the beginning of my investing journey towards financial independence and have quite a high risk tolerance. I was all for going 100% equities knowing that over the long haul you will generally get better returns. I didn’t see much sense in bonds but have since opted for 30-40% bonds as my rationales is that the journey to get you there will be a lot smoother, and far less emotionally traumatic (I’d take a 25% loss as opposed to a 50% loss in a downturn for example). My other reason was that if the stock market does crash you will be able to re-balance and have cash to buy more stocks at a discounted price. One of my biggest fear about a market crash is that I then won’t have the funds to get in when the market is likely to be cheap. Having a slug of bonds could be a good way to ensure that.
Interesting to see the discussions around whether or not to go 100% Stocks continuing.
How much of a drag is a non-Stocks holding?
Could/will ‘Dry Powder’ come to the rescue thereby adding to portfolio performance?
So much depends on :-
+ The Sequence of Returns
+ Rebalancing Method (part/full/frequency/Value v Momentum)
Data Mining can take us only so far.
The only truly free lunches are Diversification and Rebalancing.
Article, para 2, IMHO says it all!!!
Thanks for the various responses.
@hariseldon – Good insight on the performance of bonds historically.
@jimmywill – Thanks. I think I understand the principle that re-balancing is intended to move value into undervalued investments. I think my issue there is that if you take the view that stocks are generally better performing over long time scales, why not go all stocks except for an investment buffer that you build when markets appear to be high (by some measure, performance vs bonds could be one) and then investment when the market appears low? Generally passive proponents caution against this kind of behaviour as trying to time the market.
@ Olivier: That makes sense, I don’t overpay my mortgage although am not interest only, however if I could access a 30y fixed rate like in US/Europe would be tempted to. My fixed income allocation is £20k in Santander 123, gilts may have kept pace with equities for the last 10y but am fairly sure they won’t for the next 10y.
In general I think the next stock market crash will likely be caused by a large increase in government yields, rather than a large increase in the spread of equity yields to gilts, hence don’t like owning government debt as am not convinced it will protect me in a downturn.
OMG (I have to say that I’m under 30 it is in my student loan contract) I think I witnessed you playing a card game in my local on Saturday.
The Garden Gate? Big mob in the middle? Birthday? Girl with green/blue hair had an adorable pug?
You all were having a party. Which one were you!?!
Ha, yes, that was us. Small world (or not!)
I was the pug. 😉
Portfolio Charts is an amazing site. The big lesson is: diversify, diversify, diversify. Across equities, property, high-quality bonds of different durations, a bit of gold, perhaps some commodities. Picking out one portfolio cos it’s topped the charts for 20-years, or throwing your lot in with a set of assumptions (e.g. stocks will outperform in the long-term or bonds can only go down from here) is making the biggest mistake of all – believing you can predict the future.
What I find interesting is that while most of the portfolios don’t diversify massively in terms of total returns (and its a crapshoot anyway), a properly diversified portfolio can radically cut the drawdown time (i.e. time you’re under water). That’s a big win considering the number of readers here who are FI or aiming to be so.
Really like the portfolio charts site, but we could do with something that can access UK data.
I’ve been pleased with the effect of gold in my portfolio recently, but I think I need more gilts. What’s the UK equivalent of long term and short term treasuries?
Long term and short term gilts.
If you look at available index funds, short-term UK gov bond funds have 0-5 years maturity.
Long-term are generally thought of as bonds with maturities of 20-years plus.
Then you have intermediate bond funds in between.
What most seem to forget is that there has been an almighty bond rally for the last 30 years. This is an historical anomaly unlikely to be repeated anytime soon and will undoubtedly affect the results of any backwards looking analysis especially one starting from the 1970’s+
The likelihood that bonds will provide any positive support going forward is highly uncertain and mathematically improbable. Any gains are looking to come from capital gains rather than coupons. And for those gains you need to sell to the greater fool. Why not compare to earlier periods.. Bad data? No data?
So what we are really saying is that in the history of mankind we only have reliable data for a period in which bonds have gone from the mid teens down to zero and we are using that to determine our asset allocations. Or perhaps its because any earlier data is excluded because it does not support our propositions.. At the very least the results will be hugely different.
Hmm, ok. Does that sound dodgy to anyone!?
I know it does to me.
@Richard
+1
@richard — I don’t think many people forget that there’s been a huge bond rally, at least not anyone writing here.
I think everyone who has looked at the data can see it plainly.
The issue is people (including me) have been expressing views like yours for the past seven years (and in the professional markets long before that…) but acting on it has been suboptimal at best.
The problem with any sampling behaviour is you need to observe many cycles. The worst case is when you observe half a cycle aligned with your start point, and report that an asset can only go up (or down). If people act on that advice, the cycle and its magnitude is artificially lengthened and heightened, and you have a bubble.
We all observe bubbles and say “but surely it can’t go higher”, and the niggling doubts creep in when it does, so we join the rush.
What would be helpful is to estimate the cycle times for different asset classes. I think stocks are mainly fractal, so have a range of superimposed cycles, but I don’t know whether bonds, property or commodities are too. Certainly the lack of property liquidity suggests it must have fewer and longer patterns.
Bonds used to have higher yields than equities to reflect the fact that the coupon and redemption were fixed sums rather than (hopefully!) rising with inflation as you see with equities. Then things changed and people started talking about a “risk premium” for equities.
Maybe yields could keep on falling on fixed income, but they don’t have much further to go!
I’m glad that I’m holding a 10% bond allocation, but I’m also glad that I put 15% into infrastructure funds alongside it.
@johnb — If you can reliably estimate the cycle times of different asset classes with recourse to fractal theory than good luck to you, but this isn’t going to be the site for such discussions. 🙂
I am confident such attempts will prove the opposite of “helpful” for the majority of investors, just as throughout market history.
@Richard
Good article here :-
http://monevator.com/bond-price-falls-in-bond-market-crash/
If we have outright deflation (not impossible), then Gilts will ride to the rescue.
But any inflation above about 0.9% (currently CPI 0.5%, RPI 1.6%), pick your measure; then the investor must be ready to hold a wasting position in real terms, for the sake of -ve correlation with Stocks (not always guaranteed).
As TI points out we do have the option of cash, but this has become even less rewarding since the article was first published.
Putting to one side for one moment Infrastructure as highlighted by GM, there are always Corporates. Neither is expected to offer -ve correlation with Stocks, but Short IG Corps offer low volatility due to shorter duration, and a +ve real yield unless inflation hits 2.6% plus.
The Fixed Income side is certainly quite challenging at present, more challenging than Stocks!
Good Luck to us All
@ Richard – have you read much on the site? If you have then you’ll know why its author – Tyler – chose a start date of 1972. It’s because he can’t find reliable data to compare all asset classes before that date. He’s also not trying to sell you anything, rendering cherry-picking redundant, nor does he have one key proposition, rendering cherry picking redundant. He’s placed in our hands an incredible set of tools to learn from – I think cos he enjoyed the challenge.
He’s not a bond salesman and neither am I, but high quality government bonds are incredibly important diversifiers. If stocks spend the next 20 years doing a Japan then bonds won’t look so daft. Have a risk tolerance that can’t handle 50% plunges in stock values and 10 years underwater (not many can) then gov bonds are your best friend. Shorten the duration by all means but don’t write bonds off and always judge an asset class on its role in the portfolio as a whole:
https://portfoliocharts.com/2016/01/25/how-to-build-a-portfolio-one-asset-at-a-time/
Fractal market theories are hardly new, see Mandelbrot’s article from 1999. http://www.scientificamerican.com/article/multifractals-explain-wall-street/
I’m not proposing using these theories, indeed as a private investor without Maths PhDs in your backroom, you’d be very unwise to adopt any timing strategy by doing any simplistic analysis of price histories. I worry that these sites give too much data for unsophisticated users like us, giving us false confidence in our decisions.
Have no confidence in your decisions and diversify! Sorry 😉
@JohnB — I’m familiar with his work applied to markets (I think I even skim read his market memoir or similar while staying at a friend’s a few years ago). And for what it’s worth (little — it’s easy, as you probably know!) I used to program various fractals for fun as an undergrad. 🙂
In my early 20s, I slapped together a small bit of code that put an IBM PC into VGA mode and (quickly!) drew a 320×200 256 colour Mandelbrot diagram. When I say small, I got it to less the 256 bytes. No, not kilobytes ormegabytes, but 256 bytes.
Kids today, yadda, mutter …
So bold on the Internet and so scaredy in real-life… 🙂
I’d say it was sweet but I wouldn’t know who to say it was sweet to.
Don’t mind me, I was the ULTRA cute blonde bob behind the potted olive tree spying on you (and winning your games in my head world!)
IF ONLY I’D KNOWN!
Real life seems to be intruding and it’s making me nervous!
Downright weird, if you ask me.