Bogleheads

[baw703916]

Hi Bogleheads,

A little over two years ago, on the M* board, I started a thread in which I proposed that the following portfolio might minimize fat tails, while giving similar returns to a more conventional portfolio with 60-70% equities:

30% TIPS
30% Long Treasury Bonds
10% REITS
30% "Equities with the highest (compensated!) risk you can find"

For this last, I originally proposed EM Small caps, and used DFA's fund DEMSX in the backtesting. I now think that 15% SV and 15% EMS would probably be a more diversified way to go. If one has DFA access, then DEMSX and DFSVX; if not, the ETFs DGS (WT EM small dividend--fairly valuey) and RZV (Rydex Pure SV).

I didn't realize at the time that Larry Swedroe actually has his portfolio set up something like this--smaller percentage of equities with lots of tilt.

There were only a couple of comments on the original thread. EmergDoc was a bit skeptical. It is a fair criticism that backtesting the last bear market doesn't necessarily prepare you for the next one... Which brings me to the point of this post: How did this portfolio do last year? Did it really provide any protection from the bear market of last year?

Here's the Swedroe-type portfolio and each of its components since 1995 (some backfilling in the first few years before all the funds came into existence).

[grayfox]

Thanks for this information.

30% TIPS
30% Long Treasury Bonds
10% REITS
30% "Equities with the highest (compensated!) risk you can find"

TIPS do well in INFLATION
LT TBONDS do well in DEFLATION and RECESSION
REITS do well in PROSPERITY
SM EQUITIES do well in PROSPERITY

Looking at it that way, it reminds me of like the Harry Brown Permanent Portfolio. Have one asset that does well in every kind of economy. He was 25% TSM, 25% LT BONDS, 25% GOLD, 25% CASH for prosperity, deflation, inflation and recession.

I'm not sure why the REITS are needed. Why not just make it simpler and get rid of it. You house equity is your real estate. Also, I would want to be able to do it all with Vanguard funds. But overall it sounds like a good idea.

1/3 TIP (VIPSX)
1/3 LT TBONDS (VUSTX)
1/3 SM EQUITIES (VEIEX+VINEX+NAESX or something)

key:
VIPSX=Inflation-Protected Securities
VUSTX=Long-Term Treasury
VEIEX=Emerging Markets
VINEX=International Explorer
NAESX=Small Cap Index

[haberd]

As far as LT Treasuries go, the small investor can get:
3.5% on a FDIC-insured 5 year CD and 2.14% on the highest quality 5 year tax-free muni (AAA GO), while a Treasury of the same maturity gets you 1.43%.
1.68% on a 10 year TIPS and 2.32% on a 20 year, while a nominal yields 2.17% for a 10 year and 2.92% for a 30 year.
Treasuries do have superior liquidity - right now, they're for institutions and traders.

[Paladin]

[G12]

....and if you bought those LT T's in June 2008 and experienced the 20+% uptick, who would really be put off by the current yield? Data mining, it's all good after the fact.....

[baw703916]

[Paladin]

[grayfox]

[james22]

Age in TIPS, the difference in SV.
_________________
...you might shift a modest percentage of your assets from the class judged less attractive to the class judged more attractive. Bogle

[richard]

[eurowizard]

[Gregory]

While the NAV for the VG long-term treas. fund has certainly appreciated, I see no reason to get excited about its actual dividend payout. http://tinyurl.com/8bkjdy

The only benefit I see from rising and falling NAV's is the potential to rebalance into other asset classes (and hope they do well in the future), or sell appreciated shares -- so you'll get cash for the shares but a lower total dividend payout after that cash is gone.
_________________
Pecuniae imperare oportet, non servire.
Fortuna vitrea est; tum cum splendit frangitur. -Syrus

[derringer]

I don't think the question is which is better in a deflationary environment, CASH or LT Treasuries, but more, which has the better risk-adjusted return, and the answer is CASH/ST Bonds.

I hedge against deflation with ST Bonds & Cash. I still don't think doing so in LT Treasuries is any better, as it adds so much more risk in normal economic times.

[bobcat2]

Hi Brad,
Why do you refer to this as a Swedroe-type portfolio? I am not aware of Swedroe every recommending people invest in LT nominal bonds. It seems to me his advice is to invest in high quality ST & IT nominal bonds (including muni's in taxable accounts) and TIPS. For the high quality ST & IT nominal bonds he recommends Treasuries in tax advantaged accounts. Where did you see that Swedroe instead recommends investing a large portion of your portfolio in LT nominal Treasuries?

Also it seems to me the basic difference in your portfolio returns is the amount devoted to bonds. If you apportioned the same amount to LT nominal Treasuries and TIPS and split the non-bond portion among US TSM (15%), Intl TSM (15%), and REITS (10%), instead of equity tilts, wouldn't you have gotten similar cumulative results from 1995-2008?

Best,
Bob K
_________________
The real difficulty in changing any enterprise lies not in developing new ideas, but in escaping from the old ones. - JM Keynes
Good questions outrank easy answers. - PA Samuelson

[baw703916]

[Rodc]

[baw703916]

[baw703916]

[Rodc]

One of the intellectual difficulties I have with a portfolio like this is it seems to me to in part be predicated on the notion that high risk is always rewarded. Perhaps only implicitly, but there nonetheless. Not even diversified risk, but fairly concentrated risk.

But to believe that is to believe that risk is not real.

Granted, in many cases risk does get rewarded. See the test period above for just such an example.

Or it must be predicated on having enough in bonds that it does not matter if you get rewarded on the risky stuff. But, if that is true, why bother with the extra risk?
_________________
"all standard caveats apply"

[Rodc]

[heyyou]

It is a preservation portfolio for those who have enough but are still dabbling in equities. That is not for your average accumulator. If you own 40 or 50 multiples of your expenses, you invest differently than someone with 5 multiples hoping to get to 25 by retirement age.

Consider the tracking error. It is a terrible portfolio for the average investor. It is fine for someone with Larry's background. That is why it is not touted in his books written for the public. It is not a secret, it just doesn't fit how the average investor thinks.

There needs to be an acronym for labelling this situation--what worked/works for one but isn't suitable for general advice to the public.

Note that VG does not offer the funds with the highly volitile returns that Larry is using. What is VG's wildest fund? There is a running joke about Turkish small caps on another forum.

[epilnk]

[haberd]

Those recommending LT Treasuries here miss the point entirely. Why buy them now when you can get new FDIC-insured IT CDs of the same maturity at two or three times the yield? Or for that matter long term TIPS with a real yield less than .5% of the nominal yield of the Treasury of the same maturity? (This is a little more risky especially if you buy on the secondary market.)
The fact that nominal Treasuries have returned so much recently is all the more reason to expect a decline. If we have sudden inflation over the next 5 or 10 years where will that leave you? With the economy so volatile, buying much of any asset over 10 years maturity is a gamble.

[RaleighStClaire]

[baw703916]

[baw703916]

[Gregory]

[larryswedroe]

For the record
My portfolio is TIPS (no RE due to limited space in tax advantaged accounts) and intermediate munis (about 5 years duration) for the fixed income and then about 50% US SV, 35% ISV and 15% EMV

Though I have gone in and out of TIPS-now 100% TIPS with that money and I have moved more to 60% international because of other assets I own have higher domestic loading than 50% and I would like 50% total

[baw703916]

Hi Larry,

Thanks for giving us the correct details of your portfolio. Again, I didn't mean to imply that you were recommending LT Treasuries; mostly the portfolio I analyzed resembles yours on the equity side.

Best wishes,
Brad
_________________
I don't foresee any Black Swans appearing in the future

[Robert T]

[larryswedroe]

Further

My own research shows that LT treasuries are more efficient if the equity allocation is high (e.g. 80%) but not if the equity allocation is low.

[ilan1h]

I adopted a Swedroe-like portfolio a few years ago with 70% bonds and 30% equity. The equity is all in SV, ISV, EM. Since my tax advantaged space is extremely limited I have to hold almost the entire bond portfolio in munis. This made me nervous and I have subsequently taken some of the table and am holding it in money market. The problem with this type of portfolio is that the initial concept was that most of your money was "safe" and the rest would be in the riskiest equity. Eventually, however, I realized that the "safe" component ie:munis may not be that safe anymore. This may have not been correct but I couldn't chance it. Had I had more tax advantaged space I would have loaded up on TIPS. I'm not sure how Larry has as much tax advantaged space as he does but most high net worth individuals will have the majority of their assets in taxable.

[stratton]

[Mitchell777]

Larry: I may be reading this wrong. Is 85% of your equity investment in Small Cap Value? I've read your "The Only Winning Guide" book and that seems very different. Have you changed what you feel is the right equity allocation or is your allocation very different due to your personal financial situation
Thanks

[larryswedroe]

few things
First about 1/2 of my equity is US SV. Actually bit less as I moved to 60% int'l

Second, as noted the vast majority of portfolio is munis, in taxable account so I don't know what Ilan is talking about. And if you bought the right type munis and diversified them well you did fine last year--my muni portfolio was up over 4% and is off to a great start this year. But I only buy the very highest rated bonds and have even tightened standards and sold a few bonds as soon as they went below AA. Discipline.

Third, the only guide charts (AA) are meant only to be guidelines or starting points--there is no one right equity allocation. Another big mistake I see so many advisors make, using simple cookie cutter solutions and applying them everyone, so all clients have same allocations. How much you tilt to domestic and int'l and small and value should be an individual decision. I have in mind to do that book one day--in fact have the entire outline done and most of the writing. Just have to decide to do it--An Investment Strategy Reference Manual if you will.

[RTR2006]

[stratton]

[larryswedroe]

Paul
While it is possible my sample is small and misleading I see it done rarely. And from what the people here have told me about Vanguard's service they dont even ask.

Failing to do so is a major error IMO as it fails to take into account whether someone's labor capital is bond like or equity like. The labor capital should also be considered in terms of how much longer one will be working and what percent of the assets it is.

Larry

[ilan1h]

[larryswedroe]

ilan
First, I would not own REITs if had to own fixed income in taxable accounts.

Second, your "mistake" IMO was the type of munis you bought--First, concentrating all risk in Cal and second we don't know the quality of the bonds in those funds. And even if the ratings were high on the surface, they might have been based on insurance ratings not underlying ratings.

My munis did fine, and up something like 4% already this year, because of the very high credit ratings. That is why it is so important to stay at the very highest end of the credit curve, avoiding or minimizing any equity like risks. And my portfolio was diversified by state as well. And also by issuer. Buying individual bonds when one has the size portfolio to do so provides major advantages in being able to control these risks

[ilan1h]

[larryswedroe]

Ilan
I like REITs as good equity diversifier, but only if you can hold in tax advantaged accounts without crowding out other fixed income--so have to hold munis in taxable.

This is how a good advisor adds value--helping to find more efficient ways to accomplish the same objective. I would prefer to own more say international small or small value in tax efficient form, or more US SV in TM form and then own TIPS in tax advantaged.

Or another way to get the higher returns of holding REITs is to tilt more to size and value in the equity portion, which means you don't have to hold as much equity risk and that may mean you dont have to own equities in tax advantaged account, can own the fixed income only.

[Sammy_M]

Larry,
Is this a fair summary of your thoughts on priorities for tax advantaged space?

1. First put in CCF up to desired allocation. Around 10% of equities is a good starting place.

2. Next put in fixed income, predominantly TIPS (unless inflation premium is too high, and then go with ST nominal treasuries or CDs).

3. If still have room, put in REIT. Around 10% of equities is a good starting place.

4. If still have room, put in S/V equities b/c less tax efficient.

5. Put domestic equities in tax advantaged before foreign equities otherwise lose FTC.

If tax advantaged room is scarce...

- Add very high grade munis in taxable to get to desired fixed income allocation.

- Tilt more toward S/V if can't get in REIT allocation.

p.s. Sorry I was editing when you responded. I originally had TIPS before CCF but then considered that you've put CCF ahead of TIPS for tax advantaged space in your own portfolio and then just added munis in taxable.

[larryswedroe]

Sammy
Yes
I would add this, consider strongly tilting more to size and value and lowering equity allocation. That will produce lower potential dispersion of returns without lowering expected returns.

[Sam2]

Larry,

In your book on Winning Bonds Strategy you are recommending to use a shifting-maturity approach, by comparing Treasury yields with VG ST, IT and LT bond funds. Are you still recommending this approach?
I'm looking into rebalancing to get my bond allocation to 40%, and the IT bond funds looks very attractive


Thank you,

Sam

[larryswedroe]

Sam

There are two ways that are fine

You can simply stick with the asset allocation you decide is correct--whatever maturity bond fund you use, or you can adopt the strategy DFA does which is based on Fama and Bliss paper which found that the best estimate of tomorrow's yield curve is today's. Thus when yield curve positively sloped you should extend if highest yield is objective. To compensate for the extra risk though DFA uses a rule of thumb of 20bp a year extra yield before extending

[Sammy_M]

[james22]

Were you younger/accumulating, Larry, would your AA be any different but for the equity/fixed ratio? Something like age in TIPS, the difference in SV? Or would you add other asset classes (L and/or G)?
_________________
...you might shift a modest percentage of your assets from the class judged less attractive to the class judged more attractive. Bogle

[larryswedroe]

Sammy
Yes you can take more duration risk because there is no inflation risk.
To me the issue is not the yield curve per se but the level of rates--the higher the level the longer I would want to go.
In other words, even if it was inverted but the longer end was high and it allowed me to achieve my goal I would lock it in. That would eliminate the reinvestment risk.

James
One mistake people make is that they only consider age and perhaps willingness to take risk. But need is also very important---often the dominant factor (IMO it should be for those with low need to take risk).

Personally I was 100% equities for long time when I was young and had stronger stomach (and less to lose) and high need, Gradually over time reduced it as the issues changed for me

[Henry Sadovsky]

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