Asset Allocation Dilemma – Contradicting Historical Data

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mahesh.kanth
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Asset Allocation Dilemma – Contradicting Historical Data

Post by mahesh.kanth » Sat May 23, 2020 10:59 pm

I’m trying to find the right asset allocation mix for our long term investing strategy (20+ Years) and keep getting back and forth between the pendulum of 90/10 to 60/40 (Stocks / Bonds). Sometime I feel that 90/10 is the right mix given that we have a long term horizon and a stable income source, and sometimes I feel that, may be we are exposing ourselves to unnecessary risk. But by lowering the stock positioning I also feel that we may be loosing out on the up-side potential.

So I started compiling historical data (1970 to 2019) to get a sense of what the data would suggest, and here is the data snapshot

90/10 - Avg Ret. 7.2%, Std Dev 15.6%, Deepest Draw Down 44%, Longest 10 Yrs, Ulcer Index 14.5, LTerm Ret.- Min(2.0%) Baseline (3.7%) Avg (6.5%)
80/20 - Avg Ret. 6.8%, Std Dev 14.1%, Deepest Draw Down 41%, Longest 10 Yrs, Ulcer Index 12.8, LTerm Ret.- Min(1.9%) Baseline (3.9%) Avg (6.4%)
70/30 - Avg Ret. 6.4%, Std Dev 12.7%, Deepest Draw Down 37%, Longest 10 Yrs, Ulcer Index 11.1, LTerm Ret.- Min(1.8%) Baseline (4.1%) Avg (6.3%)
60/40 - Avg Ret. 6.1%, Std Dev 11.3%, Deepest Draw Down 34%, Longest 10 Yrs, Ulcer Index 9.7, LTerm Ret.- Min(1.7%) Baseline (4.2%) Avg (6.2%)


Here are my questions based on the interpretation of the data.

1. If anyone has time on their side (20+ years) where they do not need the invested capital at all – is it worth the risk to keep the Asset Allocations at 90/10 given that the historical baseline returns are increasing with reducing equity positions and the average returns are well within 30 basis points between 90/10 & 60/40.

2. If the goal is to stay the course, wouldn’t it make sense to keep the asset allocation at a conservative level, to reduce volatility and smoothen the ride. As you can see that the deepest draw downs have a 10% variation (-44% for 90/10 Vs. -34% for 60/40) but the Avg Returns are in the same ballpark with just a variation of 30 basis points.

3. How important is to get the Asset Allocation right so we can stay the course and make use of the time / compounding in our favor. Does it really matter if we start with 90/10 or 70/30 or 60/40.

4. Lastly, am I missing anything obvious that is not captured in the data above that favors taking more risk to capture upside potential.

Would love to hear some feedback and advise on what’s the optimal Asset Allocation.

Notes:
Source for the Data: Portfolio Chars - https://portfoliocharts.com/portfolios/
Asset Allocation – Use Vanguard Personal Advisory Service (PAS) approach / formula - Stocks (60% US, 40% Intl) Bonds (7% US, 3% Intl) - 4 FUND PORTFOLIO.

Terms

Baseline Return
The baseline return is the 15th percentile return – It is a conservative return excluding the worst outliers.

Ulcer Index
The Ulcer Index was first described in The Investor’s Guide to Fidelity Funds: Winning Strategies for Mutual Fund Investors, by Peter Martin and Byron McCann. The basic idea is to find a single number that can serve as a reference point for historical portfolio pain that 1) is far more informative than the standard deviation number most often quoted as a proxy for risk; and 2) accounts for both the depth and length of a drawdown. After all, a shallow drawdown that persists for a long time is not necessarily any less painful than a sharp one that recovers relatively quickly.

dru808
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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by dru808 » Sat May 23, 2020 11:13 pm

How about 75/25? right down the middle.

I too went through this, between 70/30-100/0, so I split it right down the middle at 85/15.
60% US equity | 25% International equity | 15% US Treasury bonds

LeeMKE
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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by LeeMKE » Sat May 23, 2020 11:27 pm

You say that your expenses are covered by other sources of income. If so, what it the end purpose for the portfolio?

Is it going to a large charity that has an endowment (or would be an endowment)? That would suggest 90/10 among your choices.

Is the portfolio needed to support other living beings or a charity with immediate cash flow needs? That would suggest some middle ground, 80/20 or 70/30 among your choices.

Bernstein makes a good case for not taking on risk once you have won the game. If the portfolio will be used in your lifetime, the ulcer index would become the leading indicator. That would suggest 60/40 among your choices.
The mightiest Oak is just a nut who stayed the course.

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galeno
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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by galeno » Sun May 24, 2020 6:32 am

This is what we did/do.

First 12 yr 100/0
Next 11 yr 80/20
Next 11 yr 60/20
Next 03 yr 40/60

This year 45/55
Next year 50/50

You should hold 80-90% equities. Several years before retirement reduce to 40-60% equites.
USA-NRA. TER = 0.28%. Expected real CAGR = 2.00%. AWR = 4.00%.: Port: 50% World Stocks + 15% TIPS + 15% Corps + 15% US Treas + 5% CASH.

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tvubpwcisla
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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by tvubpwcisla » Sun May 24, 2020 6:40 am

If you can't decide, do both. Take half of your portfolio and do the 90/10 and take the other half and do 60/40. Honestly, I think you are overthinking it. Keep things simple. At the end of the day it probably doesn't matter what you choose. With your long time horizon, I would lean more towards equities. What is more important than AA is that you don't jump in and out of the market. Stay invested.
Stay invested my friends.

JimmyD
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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by JimmyD » Sun May 24, 2020 7:05 am

Similar time horizon here and we are doing:

Age 35: 80/20
Age 40: 75/25
Age 45: 70/30
Age 50: 65/35
Age 55: 60/40
Age 60: 55/45
Age 70+: 50/50

Three fund portfolio with International comprising about 20% of equities. Planning to retire at age 60. Probably a touch on the conservative side, but we save a lot and will likely receive a sizable inheritance, so not as much need to take risk.

rkhusky
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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by rkhusky » Sun May 24, 2020 7:12 am

No one can tell you what the right AA is for you. Or which will do the best in the future.

dbr
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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by dbr » Sun May 24, 2020 7:21 am

As also mentioned by a previous poster you don't say even once what you want. You get to choose among the options according to what you want to do. Do you want to try to grow more wealth at the cost of more uncertainty, including even a possibilities that you will have less wealth than a less aggressive choice? Or do you want more certainty at the cost of less chance to grow more wealth? The numbers for expected return and standard deviation of annual returns that you got are a good enough picture of the properties* of those choices, but you need to contemplate what those numbers imply for you. What people want is different for everyone. There is no "best" portfolio regarding these options.

*The properties are the ex ante statistical distribution of the wealth you will accumulate. That means both how big those numbers are on average and how widely the possibilities range around the average. In fact those distributions overlap considerably. You will draw one single outcome out of all the possibilities. The result is highly unpredictable and the range within each choice is large compared to the differences among the choices.

heyyou
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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by heyyou » Sun May 24, 2020 8:19 am

The future stock market returns will maintain randomness beyond whatever mere humans devise from using the historical averages. Do not expect your singular future to match the averages of the past. Consider choosing a somewhat conservative path because you are now trying to dodge future losses that are the inevitable risks of stock investing. Those same random losses are also why stocks pay more than safer investments.
The better way to a larger portfolio is to just save more to invest, even when stocks prices and your portfolio value have fallen the furthest. The procedure is very simple, but following it during and after severe losses, is very stressful.

retired@50
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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by retired@50 » Sun May 24, 2020 8:41 am

mahesh.kanth wrote:
Sat May 23, 2020 10:59 pm
1. If anyone has time on their side (20+ years) where they do not need the invested capital at all
This claim may not come true.

You may not expect to need the invested capital, but you theoretically could need it in a hardship situation.

I'd suggest 70/30 as a nice compromise.

Regards,
This is one person's opinion. Nothing more.

remomnyc
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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by remomnyc » Sun May 24, 2020 9:20 am

Your asset allocation depends on your willingness, ability and need to take risk. This is what I did.

Age 30-50: 80/20 (money I did not need for 20+ years)
Age 51: 70/30 (started reducing risk when I reached my #)
Age 52: 55/45 (retired)

Current plan is to go to 60/40 at around age 60 or 65 and to 70/30 at age 70.

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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by willthrill81 » Sun May 24, 2020 10:19 am

On the basis of historical data, it makes sense for investors to have the highest equity allocation that they can tolerate for nearly all of their time in the accumulation phase.

The key phrase there is "that they can tolerate." Investors tend to overestimate their risk tolerance, and the consequences of making this error can be significant.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by galawdawg » Sun May 24, 2020 10:48 am

During our accumulation years, we were 100% stock index fund until a few years before my anticipated retirement when we moved to an 80/20 allocation by adding VBTLX. We were aggressive in our allocation while working as I anticipated retiring with a full pension that would meet our spending needs, as well as excellent retiree health coverage. As a result, our plan was that if our portfolio did well, I might be able to retire earlier than expected with extra funds for giving, travel, leisure and such. And if our portfolio did less well, I could work a few more years if desired.

For us, our portfolio performed much better than expected during our thirty year accumulating and investing period and I was able to retire at age 54, a few years before we had forecast, with a portfolio about 30% greater than we had hoped to have when we entered retirement.

Others in similar situations as ours whose portfolio won't be the primary source of retirement income would choose to take a much more conservative approach. Since we don't know what future market performance will look like, all you can do is look at your own willingness, ability and need to take risk and set your allocation accordingly. Whatever you decide, it should be an allocation where you will be able to tune out the noise and stay the course. If you can't stay the course, your allocation is likely too aggressive and needs to be reviewed.

Good luck!

nanameg
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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by nanameg » Sun May 24, 2020 10:59 am

I keep seeing the trio..need, willingness and ability to take risk. I understand need....U need more money and so must risk to get more return.

How are willingness and ability different?

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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by galawdawg » Sun May 24, 2020 12:04 pm

nanameg wrote:
Sun May 24, 2020 10:59 am
I keep seeing the trio..need, willingness and ability to take risk. I understand need....U need more money and so must risk to get more return.

How are willingness and ability different?
From the Bogleheads Wiki (https://www.bogleheads.org/wiki/Asset_allocation)

An investor’s ability to take risk is determined by four factors:
  • Investment horizon - when will the money be needed.
  • The stability of your earned income.
  • The need for liquidity - if you need the money in a hurry.
  • Options that can be exercised should your existing plan fail to meet your objectives.
Your willingness to take risk: Do you have the fortitude and discipline to stick with your predetermined investment strategy when the going gets rough?

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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by Fallible » Sun May 24, 2020 1:01 pm

mahesh.kanth wrote:
Sat May 23, 2020 10:59 pm
I’m trying to find the right asset allocation mix for our long term investing strategy (20+ Years) and keep getting back and forth between the pendulum of 90/10 to 60/40 (Stocks / Bonds). Sometime I feel that 90/10 is the right mix given that we have a long term horizon and a stable income source, and sometimes I feel that, may be we are exposing ourselves to unnecessary risk. But by lowering the stock positioning I also feel that we may be loosing out on the up-side potential.

So I started compiling historical data (1970 to 2019) to get a sense of what the data would suggest, and here is the data snapshot ...
You have delved into data; now delve into yourself, where you can learn more about how much risk you can tolerate personally and emotionally when the market drops or crashes, and where you can find what is needed most to stay the course: an asset allocation that is right for YOU.

Here is the blog on "willingness" (risk tolerance) by Larry Swedroe, followed by links to the other two of his series on "ability, willingness, and need" (vs. desire) to take risk. Note that one can have the ability and need to take risk, but not the willingness.

https://www.cbsnews.com/news/asset-allo ... tolerance/

https://www.cbsnews.com/news/asset-allo ... -you-take/

https://www.cbsnews.com/news/asset-allo ... -you-need/

Other good AA sources besides those mentioned here (e.g., the BH wiki on AA, etc.) are Rick Ferri's book, All About Asset Allocation, 2nd ed., and The Bogleheads' Guide to Investing."
The first principle is that you must not fool yourself – and you are the easiest person to fool. ~Richard Feynman

nanameg
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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by nanameg » Sun May 24, 2020 6:17 pm

galawdawg wrote:
Sun May 24, 2020 12:04 pm
nanameg wrote:
Sun May 24, 2020 10:59 am
I keep seeing the trio..need, willingness and ability to take risk. I understand need....U need more money and so must risk to get more return.

How are willingness and ability different?
From the Bogleheads Wiki (https://www.bogleheads.org/wiki/Asset_allocation)

An investor’s ability to take risk is determined by four factors:
  • Investment horizon - when will the money be needed.
  • The stability of your earned income.
  • The need for liquidity - if you need the money in a hurry.
  • Options that can be exercised should your existing plan fail to meet your objectives.
Your willingness to take risk: Do you have the fortitude and discipline to stick with your predetermined investment strategy when the going gets rough?
Thank you!

dbr
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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by dbr » Sun May 24, 2020 6:44 pm

Just to add to the chain of comments, need really means "what are your objectives" and ability relates to "what is your situation." But the important characteristic of both is that it takes the analysis back a step to consider the why's and wherefore's of who one is and what one is trying to do.

I remember years ago taking a course in project management where one rolled more general objectives down to specific tasks and schedules, but the point made there that has stuck with me was to point out that if there is a dilemma at any stage in a project plan the resolution is always in the step higher up. Go back and see what is leading to something that can't be resolved.

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Re: Asset Allocation Dilemma – Contradicting Historical Data

Post by pkcrafter » Sun May 24, 2020 7:51 pm

mahesh.kanth

The following crashes have occurred, and there is absolutely nothing that says this cannot happen again. When you make a decision on asset allocation, the small but possible devastating dangers of risk are always lurking behind the door.

Ability to take risk usually refers to financial ability. If you have 10 million and you only need 1 million, you have a lot of ability to take risk. This would also mean you don't have much need to take risk. If you are way behind on building enough for retirement, you have a lot of need, but not much ability. Willingness is your psychological feelings about risk. Some people have a risk-taking gene and are not bothered much by going with 100% stocks. Others may have strong fears about taking financial risk and losing money. These attitudes are hard to change.

Also, many newer investors may take a risk test to determine an acceptable asset allocation, but these tests are usually taken when the market has been having a strong run and the new investor is excited and confident about getting in the the money and the fun. So the test results show some high risk ability and equity allocation that the new investor cannot hold when the going gets tough.

Every investing decision involves some sort of compromise - you want highest possible returns, you have to take high risk, and sometimes the risk can show up and wipe you out. The other problem we've seen recently is investors who thought they had an allocation they could/would hold ended up panicking and selling low.

Usually, the best asset allocation is a compromise between potential good returns and risk of loss.


September 1929 to June 1932

The stock market crash of Oct. 29, 1929, marked the start of the Great Depression and sparked America's most famous bear market. The S&P 500 fell 86 percent in less than three years and did not regain its previous peak until 1954.

S&P 500 high: 31.86

Low: 4.4

Loss: 86.1 percent

Duration: 34 months



October 2007 to March 2009

A long-feared bursting of the housing bubble became a reality beginning in 2007, and the rising mortgage delinquency rate quickly spilled over into the credit market. By 2008, Wall Street giants like Bear Stearns and Lehman Bros. were toppling, and the financial crisis erupted into a full-fledged panic. By February the market had fallen to its lowest levels since 1997.

S&P 500 high: 1565.15, Oct. 9, 2007

Low: 682.55, March 5, 2009

S&P 500 loss: 56.4 percent

Duration: 17 months


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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