Larry Swedroe: Managing Risk With Factors

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Random Walker
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Larry Swedroe: Managing Risk With Factors

Post by Random Walker » Mon Nov 20, 2017 10:15 am

http://www.etf.com/sections/index-inves ... nopaging=1

If you want to understand Larry Swedroe’s philosophy of diversification across factors / sources of return, this etf.com article is an excellent place to start. Note the substantial portfolio improvement when the SD is reduced by only about 3 near the start of the article. After reviewing the concept of tilting to factors and decreasing overall equity allocation, he then goes on to review an article displaying the benefits of factor diversification.
As Larry notes at the end of the article, he’s coming out with a new edition of Reducing The Risk Of Black Swans hopefully early next year. This book will detail the benefits of increasing tilt, decreasing overall equity allocation, and even adding alternatives to increase portfolio efficiency.

Dave

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Taylor Larimore
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Factor Investing

Post by Taylor Larimore » Mon Nov 20, 2017 10:42 am

Bogleheads:

I am not a fan of factor investing primarily because it is usually expensive and based almost entirely on past performance.
Jack Bogle: "The biggest mistake investors make is looking backward at performance and thinking it’ll recur in the future."
Morningstar:"If there's anything in the whole world of mutual funds that you can take to the bank, it's that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds."
What Experts Say About Past Performance

What Experts Say About Costs

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Larry Swedroe: Managing Risk With Factors

Post by Random Walker » Mon Nov 20, 2017 11:03 am

I agree costs are critical, and factor investing involves increased costs. The benefits are only potential, the costs are certain. That being said, I disagree with Taylor’s point that factor investing is based almost entirely on past performance. I think the factors (at least size, value, momentum, and market) are based on very intuitive forward looking risk and/or behavioral based explanations. In fact, we can only invest looking forward. So one should not invest in a factor without an intuitive belief in it to provide the necessary conviction during inevitable periods of poor performance. The past historical performance of the factors certainly can add lots of strength to one’s rationale and conviction for factor investing, but forward looking intuitive understanding and belief is necessary as well.
I’ve become especially a fan of value because it seems there are both good risk based and behavioral based explanations for its persistence.

Dave

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Re: Larry Swedroe: Managing Risk With Factors

Post by Random Walker » Mon Nov 20, 2017 11:45 am

Jack Bogle: "The biggest mistake investors make is looking backward at performance and thinking it’ll recur in the future."
This can apply as much to the market factor as to any of the other factors. Pretty sure Japanese investors would agree.

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Re: Larry Swedroe: Managing Risk With Factors

Post by azanon » Mon Nov 20, 2017 11:53 am

My thought is, if you're going to incorporate factors, at least hedge your bets a little bit. For instance, I like the thought of using large-cap value, because Warren B., Vanguard's wellington/wellesley, has had a lot of success with that. But something like Large-cap value is not going too far out on a limb from a factor perspective. You'll still be owning stalwart companies, and those types of stocks at least pay a nice dividend.

But substituting a 25% equity portfolio in place of a 60% one by loading heavy on both small and value factors, with the intent of maintaining expected return and greatly reducing risk is placing a tremendous amount of faith and confidence that the future will repeat the past, on factors to do their magic, and all the while in the process of trying to do this one will experience very high tracking error, even if it does eventually work.

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Re: Larry Swedroe: Managing Risk With Factors

Post by Random Walker » Mon Nov 20, 2017 12:06 pm

Azanon,
I agree that such a radical decrease in the overall equity allocation seems extreme. But given the fact that behavioral finance has shown that the pain of a loss is at least twice as much as the happiness from an equal sized gain, the trade off makes lots of sense to me. As one’s portfolio increases in size and he nears or lives in retirement, I think that 2:1 ratio increases tremendously.
Alternatively, one could increase expected return by keeping equity allocation high and still increasing tilt. In that case, the equity portion of the portfolio is still more diversified across factors.

Dave

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Re: Larry Swedroe: Managing Risk With Factors

Post by dcabler » Mon Nov 20, 2017 12:11 pm

Random Walker wrote:
Mon Nov 20, 2017 11:45 am
Jack Bogle: "The biggest mistake investors make is looking backward at performance and thinking it’ll recur in the future."
This can apply as much to the market factor as to any of the other factors. Pretty sure Japanese investors would agree.

Dave
A good point Dave - I don't understand how many of the arguments against factors don't also apply to the market factor (Beta).

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Re: Factor Investing

Post by Trader/Investor » Mon Nov 20, 2017 12:44 pm

Taylor Larimore wrote:
Mon Nov 20, 2017 10:42 am
Bogleheads:

I am not a fan of factor investing primarily because it is usually expensive and based almost entirely on past performance.
Jack Bogle: "The biggest mistake investors make is looking backward at performance and thinking it’ll recur in the future."
Morningstar:"If there's anything in the whole world of mutual funds that you can take to the bank, it's that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds."
What Experts Say About Past Performance

What Experts Say About Costs

Best wishes.
Taylor
Thanks Taylor for some sanity. Remember how it was once all about collateraized commodity futures ala PCRIX/PCRDX. Look how that turned out. Then it was managed futures via AQMIX/QMHIX and not looking good. More recently it has been about reinsurance interval funds via SRRIX - now negative 11% YTD. Stay the course and ignore the faddish academic research.

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Re: Larry Swedroe: Managing Risk With Factors

Post by psteinx » Mon Nov 20, 2017 1:20 pm

Yet another rehash of the same tilting argument.

Re: the linked article... I skimmed it, and didn't look up the paper(s) that Swedroe is referencing. But apparently, the considered downside is if the factor premiums, going forward, are 1/3 less than they have been.

In my opinion, the potential downside is not the factor premiums being 1/3 less than they've been, but rather, being NEGATIVE. There's certainly no guarantee that large and/or growth won't outperform small/value going forward.

And the second downside is that the costs of implementing a factor tilted portfolio are noticeably higher than a more total market approach. There are levels to this. One could just tilt within Vanguard, and pay not TOO much more than total market equivalents. But many factor fans want DFA, which has higher still E.R.s, plus often AUM fees paid to an adviser. (Yes, advisers may provide other value, and yes there are some ways to minimize DFA access cost, but its still an issue.)

And finally, if one is going to implement this with a taxable portfolio, there will likely be additional tax drag from a factor tilted portfolio.

So, IMO, it's not really a "heads I win, tails I don't lose" scenario. There is a real probability that a small value tilted portfolio will underperform a total market portfolio for years or decades. And if an investor thinks that tilting to small value, while underweighting equity generally relative to what they'd otherwise have (i.e. a "Larry portfolio"), then there are further risks - even if SV, post costs and taxes, matches total market, that investor could still have significantly underperformed a more conventional allocation. That said, these are all possibilities, not certainties - SV could also match or exceed past outperformance levels, or the markets could crash such that a "Larry portfolio" looks relatively good, etc.
Last edited by psteinx on Tue Dec 05, 2017 9:02 pm, edited 1 time in total.

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Re: Larry Swedroe: Managing Risk With Factors

Post by psteinx » Mon Nov 20, 2017 1:29 pm

To summarize my post in shorter form:

In my opinion, using a small value tilt and/or "Larry portfolio" is not a relatively riskless way to improve expected outcomes, as some advocate. There is a real chance that if you do so, down the line you will be worse off, perhaps much worse off, than if you'd followed more conventional approaches.

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Re: Larry Swedroe: Managing Risk With Factors

Post by BrooklynInvest » Mon Nov 20, 2017 1:38 pm

I can't get my head around why this isn't just backtesting for what's worked previously and assuming it'll work going forward. Surely some factors have to add more than others to past performance?

If we're reducing equities in these hypothetical portfolios, aren't we also increasing fixed income and so overweighting during a large, lengthy bull market for bonds into the math? I don't wanna market time but absent a zombie holocaust I'm fairly sure 10 year dropped a good 20% from it's 1980s high, no? Does that not impact the efficacy of the approach?

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Re: Larry Swedroe: Managing Risk With Factors

Post by magneto » Mon Nov 20, 2017 1:47 pm

Random Walker wrote:
Mon Nov 20, 2017 11:03 am
I’ve become especially a fan of value because it seems there are both good risk based and behavioral based explanations for its persistence.
Value seems to involve decision making/stock selection on fundamentals at some level, which appears a deviation from passive.
Momentum would generally involve Technical Analysis, again a deviation from passive.
But as a self-confessed value investor with one eye open on momentum, esp thru market cycles, these observations are far from criticisms.

There is IMHO room in any portfolio for active and passive alongside each other without the intrusion of dogma.
However do find it surprising that some of the leading lights of the strictly passive movement are now going off-piste. :?
'There is a tide in the affairs of men ...', Brutus (Market Timer)

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Re: Larry Swedroe: Managing Risk With Factors

Post by Random Walker » Mon Nov 20, 2017 2:04 pm

Magneto,
I disagree. I think value and momentum can both be applied in a completely passive formulaic manner. For value, it can be as simple as only buying stocks with a certain BtM and holding within a range. For CS Momentum, simply buy the recent past best performers and sell the recent past worst performers. There are implementation issues, especially when factors are combined, but it can all still be formulaic and passive.

Dave

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Re: Larry Swedroe: Managing Risk With Factors

Post by digarei » Mon Nov 20, 2017 2:15 pm

Random Walker wrote:
Mon Nov 20, 2017 2:04 pm
Magneto,
I disagree. I think value and momentum can both be applied in a completely passive formulaic manner. For value, it can be as simple as only buying stocks with a certain BtM and holding within a range. For CS Momentum, simply buy the recent past best performers and sell the recent past worst performers. There are implementation issues, especially when factors are combined, but it can all still be formulaic and passive.

Dave
This doesn’t meet my own definition of passive but who am I to quibble over a definition?
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Re: Larry Swedroe: Managing Risk With Factors

Post by psteinx » Mon Nov 20, 2017 2:41 pm

Passive and active are really about degrees - not a strict black/white, binary thing. With passive, you still must decide how to allocate investments generally (high level), index methodologies, and other things. That said, a small/value tilted factor is, by a reasonable definition, IMO, a significantly more active strategy than market weighting. Not that that's necessarily bad. But yeah, there does seem to be a bit of pretzel-like contortion sometimes by some advocates...

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Re: Larry Swedroe: Managing Risk With Factors

Post by Random Walker » Mon Nov 20, 2017 3:15 pm

I would define passive as no individual stock selection, no market timing, completely agnostic to what the individual stocks are.

Dave

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Re: Larry Swedroe: Managing Risk With Factors

Post by jalbert » Mon Nov 20, 2017 3:22 pm

Due to data limitations, we’ll examine the 35-year period from 1982 through 2016.
What did treasury yields look like in 1982, and how would that affect a comparison of nominal returns of two portfolios, one of which is 75% treasuries and one of which is 40% treasuries? Just curious.
Risk is not a guarantor of return.

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Re: Larry Swedroe: Managing Risk With Factors

Post by CULater » Mon Nov 20, 2017 3:52 pm

Factor investing seems to come a lot closer to "black box" investing. Swensen's recent comments seem relevant:
And if I don’t know what’s in the black box, and there’s underperformance, I don’t know if the black box is broken or if it’s out of favor. And if it’s broken, you want to stop. And if it’s out of favor, you want to increase your exposure.
That's what I'm afraid would happen to me if my "factor box" wasn't working.
May you have the hindsight to know where you've been, The foresight to know where you're going, And the insight to know when you've gone too far. ~ Irish Blessing

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Re: Larry Swedroe: Managing Risk With Factors

Post by Random Walker » Mon Nov 20, 2017 6:01 pm

CULater » Mon Nov 20, 2017 12:52 pm

Factor investing seems to come a lot closer to "black box" investing.
Is this a popular view of factor investing on this board? To me factor investing is just the opposite. It is passive rules based investing. Small funds target a certain market cap, value funds target BtM or some other defined metric, Momentum has clear definitions. Combining factors into one core fund clouds the issue a bit. A fund can end up compromising a bit to avoid buying an equity for one reason and selling the same equity for another reason. Nonetheless, passive and rules based seems very far from black box to me. Active management has the serious black box potential.

Dave

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Re: Larry Swedroe: Managing Risk With Factors

Post by willthrill81 » Mon Nov 20, 2017 6:12 pm

Random Walker wrote:
Mon Nov 20, 2017 11:03 am
I agree costs are critical, and factor investing involves increased costs. The benefits are only potential, the costs are certain. That being said, I disagree with Taylor’s point that factor investing is based almost entirely on past performance. I think the factors (at least size, value, momentum, and market) are based on very intuitive forward looking risk and/or behavioral based explanations. In fact, we can only invest looking forward. So one should not invest in a factor without an intuitive belief in it to provide the necessary conviction during inevitable periods of poor performance. The past historical performance of the factors certainly can add lots of strength to one’s rationale and conviction for factor investing, but forward looking intuitive understanding and belief is necessary as well.
I’ve become especially a fan of value because it seems there are both good risk based and behavioral based explanations for its persistence.

Dave
+1

I understand the arguments against putting too much confidence in past performance, but if we were all perfectly honest here, I don't think many of us would be invested as heavily as we are in stocks were it not for their past performance as an asset class across time and geography.

Even the famous "4% rule" is based on past performance, not a theoretical argument. Theory can be used to explain why a safe withdrawal rate seems to exist, but I've not seen any theory accounting for what that number should be.

To say that past performance should be ignored in one's investment plan is a bridge too far IMO.
“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: Larry Swedroe: Managing Risk With Factors

Post by betablocker » Mon Nov 20, 2017 9:30 pm

+1 for will. I doubt anyone on this board is passive in the sense of holding the market portfolio. Does anyone hold a 93 to 54 ratio of global debt to equity with real estate, farm land, commodities, etc all owned in proportion to their market weighting? Once you say no then what you do and what a factor investor does are just different kinds of active bets. Everyone uses past evidence to say that market beta outperforms bonds.

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Re: Larry Swedroe: Managing Risk With Factors

Post by GreatOdinsRaven » Mon Nov 20, 2017 10:11 pm

betablocker wrote:
Mon Nov 20, 2017 9:30 pm
+1 for will. I doubt anyone on this board is passive in the sense of holding the market portfolio. Does anyone hold a 93 to 54 ratio of global debt to equity with real estate, farm land, commodities, etc all owned in proportion to their market weighting? Once you say no then what you do and what a factor investor does are just different kinds of active bets. Everyone uses past evidence to say that market beta outperforms bonds.
Agreed. Anyone who tilts away from global market cap in equities and fixed income is by definition making an active decision. An active bet (but, whether one realizes it is another matter entirely). This doesn't even factor in hard assets or commodities.

Anyone who owns the S&P 500 is actively choosing to own a fund that owns stocks in companies that are actively chosen by a committee. Companies are actively added and actively removed from the index. That doesn't make it bad. An S&P 500 index fund is an amazing investment vehicle- but we kid ourselves if we think that there isn't an active component behind it.

It's all semantics. I'm not saying that it's wrong to make active decisions or that one should make active decisions. I have zero interest in owning Int'l hedged bonds in the Vanguard International Bond Index Fund. That's an active decision of me wanting to tilt away from global fixed income market-cap weighting.

But, I'm still a Boglehead. As Rick Ferri has said many times, most of us are Bogleheads. That's our philosophy. We like passive and index funds. We like low cost and low turnover. We often (?usually?) like static strategic allocations and buy and hold investing. How we implement our portfolio allocation is our individual strategy and with few exceptions none of us have the exact same strategy or portfolio. And, that's ok.

I love the factor of market beta. But I'm a tilter and I love the other factors as well. I have a huge SCV and MCV tilt via DFA/iShares and Vanguard. I overweight REITS relative to US market-cap using the Vanguard index fund. That said, I have a nice slug of the market beta factor via Vanguard Total Stock Market Index. I also use DFA for International LCV, SCV and EM beta, value, profitability and size factor exposures. It's ok. I'm not a heretic. Personally, I wouldn't ever own a CCF. Same goes for trend following/managed futures funds and gold. Ditto for Re-Insurance. That doesn't mean that they're inherently bad or that someone who chooses to use one or more of these funds in their portfolio construction is making a heretical decision- as long as he or she understands why he/she is using this strategy and has the fortitude to stick to the plan through thick and thin.

For example, now would be a great time for the individuals purchasing the reinsurance interval fund to rebalance into the fund (not cut and run). Personally, even though I have zero interest in the reinsurance fund I do understand the MPT behind it and I'm really looking forward to the people who have the guts to stay the course posting their fabulous returns in the years to follow (I'm serious). I think that they'll do just fine as long as they stick to the plan.
"The greatest enemies of the equity investor are expenses and emotions." -John C. Bogle, Little Book of Common Sense Investing. | | "Winter is coming." Lord Eddard Stark.

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Re: Larry Swedroe: Managing Risk With Factors

Post by Dead Man Walking » Mon Nov 20, 2017 10:38 pm

Random Walker wrote:
Mon Nov 20, 2017 3:15 pm
I would define passive as no individual stock selection, no market timing, completely agnostic to what the individual stocks are.

Dave
Random Walker wrote:
Mon Nov 20, 2017 2:04 pm
Magneto,
I disagree. I think value and momentum can both be applied in a completely passive formulaic manner. For value, it can be as simple as only buying stocks with a certain BtM and holding within a range. For CS Momentum, simply buy the recent past best performers and sell the recent past worst performers. There are implementation issues, especially when factors are combined, but it can all still be formulaic and passive.

Dave
Dave,

How can CS Momentum be implemented without market timing if it is based on recent past performance?

DMW

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Re: Larry Swedroe: Managing Risk With Factors

Post by Random Walker » Mon Nov 20, 2017 11:05 pm

Dead Man Walking,
Like all the factors, Cross Sectional Momentum is defined as a long-short portfolio to isolate the factor and exclude the market factor. CS Momentum is RELATIVE momentum.Within an asset class, at defined time intervals, one could simply look back at the last time period and buy the top 30% performers and sell the bottom 30% performers. If this occurs at defined intervals, there is no effort to time the market or time the performance of any individual security. Note that these sales and purchases occur whether the market is up or down, because what is being evaluated is relative momentum. The manager could be buying stocks that went down the least and selling what went down the most, or he could be buying what went up most and selling what went up least.
Even time series momentum can be passive and formulaic. Time series momentum is absolute momentum: buy what has gone up in past and sell what has gone down. This therefore is not market neutral and is trend following. Thus this perhaps can be considered a passive formulaic approach to market timing? In the equities markets, TS Mom will result in increased equity allocation when markets have been up and decreased equity allocation when equities have been down. But even this strategy is agnostic to the specific stocks and agnostic to the market direction; it will formulaicly buy and sell as prescribed.
I’m pretty much all in on factors. I find it fascinating that one of the factors I intuitively have the least confidence in TS Mom (100% behavioral), has some of the strongest data behind it.

Dave

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Re: Larry Swedroe: Managing Risk With Factors

Post by saltycaper » Mon Nov 20, 2017 11:15 pm

Random Walker wrote:
Mon Nov 20, 2017 6:01 pm
CULater » Mon Nov 20, 2017 12:52 pm

Factor investing seems to come a lot closer to "black box" investing.
Is this a popular view of factor investing on this board?
One way factor investing might be seen as black box investing is if the factor-investing proponent approaches the evidence strictly from a quantitative viewpoint, focusing on the "persistent, pervasive, and robust" qualifications and less so on the "intuitive" criteria. It may seem like what's in the box doesn't really matter as long as the inputs and outputs meet certain quantitative thresholds. That's not going to fly for many people. It may be unfair to characterize the process that way, but that's sometimes the way it can come across.

Furthermore, there may be skepticism over the limited data available for analysis and a lack of qualitative analysis or even plain common sense when using such data. This is a personal gripe of mine, and it doesn't just apply to factor investing. The study might read something like this: "To determine whether adding CCFs to a portfolio improved risk-adjusted return, we analyzed data from 19XX to 19XX, because that's what was available. Now, it just so happens that within our limited time period there was a major commodity price shock, the likes of which we've seen maybe once or twice in the past century, and it also happens that for the majority of the time period, it wasn't easy to invest in this space, but never mind either of those points. Let's look at the data..." I exaggerate, of course, but again, this is how skeptics might see things.
Quod vitae sectabor iter?

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Re: Larry Swedroe: Managing Risk With Factors

Post by Random Walker » Mon Nov 20, 2017 11:36 pm

Saltycaper,
I agree with your criticisms. With regard to timeframes for data, I think we need to look multiple different timeframes: longest available, timeframe since publication and widespread knowledge, timeframe since readily investable. In each case, longer is better. Although I agree with your criticisms, I don’t think they would fit in the black box category. The specific definable quantitative criteria are just what avoids black box nature.

Dave

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Re: Larry Swedroe: Managing Risk With Factors

Post by baw703916 » Mon Nov 20, 2017 11:42 pm

I think the statement that factor investing is expensive is a red herring. Like everything, it depends how it's implemented.

TSM has an expense ratio of 0.04% Small Value index has an ER of 0.07%

Total International has an ER of 0.11%. FTSE Smallcap has an ER of 0.13%

So the difference is all of 2-3 bp.
Tilting may or may not outperform, but it doesn't have to be expensive!
Most of my posts assume no behavioral errors.

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Re: Larry Swedroe: Managing Risk With Factors

Post by saltycaper » Mon Nov 20, 2017 11:48 pm

Random Walker wrote:
Mon Nov 20, 2017 11:36 pm

The specific definable quantitative criteria are just what avoids black box nature.
Picture a box where you know every quantitative measurement you can imagine, but you can't see inside. The data could be illuminating, if only you knew what was in there. So close--like holding the most powerful flashlight imaginable, but it has no batteries. I think that might be where the "black boxers" are coming from. They are waiting for someone to give them the batteries, and all the Radioshacks have closed!
Quod vitae sectabor iter?

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Re: Larry Swedroe: Managing Risk With Factors

Post by Random Walker » Mon Nov 20, 2017 11:57 pm

With regard to tilting/factor investing costs. It’s important to realize that not all factor funds are created equal. For example, if a less expensive fund also has less exposure to size and value, then the investor will need more of this fund than another SV fund to gain the same portfolio factor exposures. The goal of factor investing is to diversify across factors, but if the factor fund has lower factor exposure, then the investor will need to take on more market beta exposure to get the same SV exposure. It very well could be more efficient to use less of a more “tilted” and more expensive factor fund. It’s cost per unit factor exposure that matters, not just cost.

Dave

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Re: Larry Swedroe: Managing Risk With Factors

Post by magneto » Tue Nov 21, 2017 3:12 am

Random Walker wrote:
Mon Nov 20, 2017 3:15 pm
I would define passive as no individual stock selection, no market timing, completely agnostic to what the individual stocks are.

Dave
Precisely.
But a fund that might churn in excess of 100% underlying stocks turnover annually, dependent on the movement of individual stocks into and out of value or the +ve momentum categories, is still stretching the definition of 'passive' just a touch :!:
One of the key sellling points for 'passives' was the zero churn.

Whether factor investing is a useful approach is another issue; a decision each investor will make for themselves.
Would not like to close down any original thinking.
'There is a tide in the affairs of men ...', Brutus (Market Timer)

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Re: Larry Swedroe: Managing Risk With Factors

Post by digarei » Tue Nov 21, 2017 3:26 am

Random Walker wrote:
Mon Nov 20, 2017 11:05 pm
Dead Man Walking,
Like all the factors, Cross Sectional Momentum is defined as a long-short portfolio to isolate the factor and exclude the market factor. CS Momentum is RELATIVE momentum. Within an asset class, at defined time intervals, one could simply look back at the last time period and buy the top 30% performers and sell the bottom 30% performers. If this occurs at defined intervals, there is no effort to time the market or time the performance of any individual security. Note that these sales and purchases occur whether the market is up or down, because what is being evaluated is relative momentum. The manager could be buying stocks that went down the least and selling what went down the most, or he could be buying what went up most and selling what went up least.
Even time series momentum can be passive and formulaic. Time series momentum is absolute momentum: buy what has gone up in past and sell what has gone down. This therefore is not market neutral and is trend following. Thus this perhaps can be considered a passive formulaic approach to market timing? In the equities markets, TS Mom will result in increased equity allocation when markets have been up and decreased equity allocation when equities have been down. But even this strategy is agnostic to the specific stocks and agnostic to the market direction; it will formulaicly buy and sell as prescribed.
I’m pretty much all in on factors. I find it fascinating that one of the factors I intuitively have the least confidence in TS Mom (100% behavioral), has some of the strongest data behind it.

Dave

  • This seems to be the inverse of rebalancing. But not market timing? Longtime Bogleheads perhaps employ a different use of the phrase market timing than I am accustomed to:

What is 'Market Timing'

Market timing is the act of moving in and out of the market or switching between asset classes based on using predictive methods such as technical indicators or economic data.

Because it is extremely difficult to predict the future direction of the stock market, investors who try to time the market, especially mutual fund investors, tend to underperform investors who remain invested.

Connect with Bogleheads in Northern California! Click the link under my user info/avatar.

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Re: Larry Swedroe: Managing Risk With Factors

Post by Rick Ferri » Tue Nov 21, 2017 4:34 pm

GreatOdinsRaven wrote:
Mon Nov 20, 2017 10:11 pm
But, I'm still a Boglehead. As Rick Ferri has said many times, most of us are Bogleheads. That's our philosophy. We like passive and index funds. We like low cost and low turnover. We often (?usually?) like static strategic allocations and buy and hold investing. How we implement our portfolio allocation is our individual strategy and with few exceptions none of us have the exact same strategy or portfolio. And, that's ok.
I'm happy this concept is being discussed. I call it “The Anatomy of Successful Index Investing." The process works when three important elements are present:

1) Philosophy: be a Boglehead, i.e. believe in low fees, low turnover, passive concepts meaning don’t try to beat the market. This is universal – we’re all Bogleheads’.
2) Strategy: how you apply the philosophy to your unique situation. It’s about creating and implement a strategy the works well for you (there’s no perfect strategy). I’ve never found two Bogleheads who have the exact same portfolio. Everyone needs to figure this out for themselves.
3) Discipline: stay the course, don’t be swayed to chase whatever the flavor of the day is (which is often discussed on this forum). Discipline requires a set a rules to follow called an Investment Policy, and a way to stay focused on the philosophy. This forum is a good way to stay focused.

Rick Ferri
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Taylor Larimore
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Re: Larry Swedroe: Managing Risk With Factors

Post by Taylor Larimore » Tue Nov 21, 2017 6:41 pm

Rick:

Thank you for coming by. Anything you have to say is highly valued on this forum.

Best wishes.
Taylor
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Re: Larry Swedroe: Managing Risk With Factors

Post by GreatOdinsRaven » Tue Nov 21, 2017 7:52 pm

Rick Ferri wrote:
Tue Nov 21, 2017 4:34 pm
GreatOdinsRaven wrote:
Mon Nov 20, 2017 10:11 pm
But, I'm still a Boglehead. As Rick Ferri has said many times, most of us are Bogleheads. That's our philosophy. We like passive and index funds. We like low cost and low turnover. We often (?usually?) like static strategic allocations and buy and hold investing. How we implement our portfolio allocation is our individual strategy and with few exceptions none of us have the exact same strategy or portfolio. And, that's ok.
I'm happy this concept is being discussed. I call it “The Anatomy of Successful Index Investing." The process works when three important elements are present:

1) Philosophy: be a Boglehead, i.e. believe in low fees, low turnover, passive concepts meaning don’t try to beat the market. This is universal – we’re all Bogleheads’.
2) Strategy: how you apply the philosophy to your unique situation. It’s about creating and implement a strategy the works well for you (there’s no perfect strategy). I’ve never found two Bogleheads who have the exact same portfolio. Everyone needs to figure this out for themselves.
3) Discipline: stay the course, don’t be swayed to chase whatever the flavor of the day is (which is often discussed on this forum). Discipline requires a set a rules to follow called an Investment Policy, and a way to stay focused on the philosophy. This forum is a good way to stay focused.

Rick Ferri
Rick,
Great to see you on the forum. Hope You think I paraphrased you reasonably well.

GOR
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Re: Larry Swedroe: Managing Risk With Factors

Post by arcticpineapplecorp. » Tue Nov 21, 2017 8:17 pm

Welcome back Rick! Hope you're enjoying life.

Just heard Roger Ibbotson on James Lange's Retire Secure podcast. He was talking about factors, mostly profitability. But what struck me the most was he said (paraphrasing) that the reason size (small) outperformed (in the past) was because of liquidity. Not liquidity as in--these companies don't always have access to capital in a downturn and therefore are not as well capitalized/liquid as larger companies which therefore makes them risker and investors demand a higher premium for the risk...but more simply these companies are more thinly traded, that is, illiquid from an investor perspective (you can't buy and sell as frequently as one might want) and investors demand a premium because of the lack of liquidity or access to buy and sell as freely.

I hadn't heard the risk premium for small cap stocks ever explained in that way before. Did anyone else hear this podcast and have the same or different takeaways? If not you can listen here:

http://paytaxeslater.com/radioshow/lang ... ur_205.mp3

http://paytaxeslater.com/radio-show/
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Re: Larry Swedroe: Managing Risk With Factors

Post by randomizer » Tue Nov 21, 2017 10:12 pm

How do you do it, Random Walker? It's like Larry never left!
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Re: Larry Swedroe: Managing Risk With Factors

Post by Random Walker » Tue Nov 21, 2017 10:33 pm

How do you do it, Random Walker? It's like Larry never left!
It’s pretty easy to read and post an article :-) unfortunately, Larry’s absence is very much felt! I think whole threads die too early because of his absence. I think I was as hardcore efficient market, low ER, low turnover, tax efficient, TSM Boglehead as anyone on the board 2000-2009. I kept reading; have pretty much read all the Boglehead books mentioned on this board, most more than once. Over time, mainly influenced by Gibson’s Asset Allocation, Bernstein’s Intelligent Asset Allocator, and Larry’s books, I evolved Into an asset class junkie and ultimately into a factor/source of return junkie. I may be heading towards risk parity junkie. After feeling the pain of seeing what can happen to market beta in 2000-2001 and 2007-2008, I’ve come to believe that paying extra for a more efficient portfolio could well be worth it. So I like to keep discussing Larry’s writings. Note! There could be substantial confirmation bias here, just trying to support my decision to leave TSM land. But as I sometimes say to patients “Just because I’m biased doesn’t mean I’m not right” :-)

Dave

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Re: Larry Swedroe: Managing Risk With Factors

Post by Taylor Larimore » Tue Nov 21, 2017 11:02 pm

I’ve come to believe that paying extra for a more efficient portfolio could well be worth it.
Random Walker:

Your quote will make advisors happy.

Best wishes.
Taylor
Last edited by Taylor Larimore on Tue Nov 21, 2017 11:34 pm, edited 1 time in total.
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Re: Larry Swedroe: Managing Risk With Factors

Post by Tim Bachmann » Tue Nov 21, 2017 11:04 pm

Random Walker wrote:
Tue Nov 21, 2017 10:33 pm

:-) unfortunately, Larry’s absence is very much felt! I think whole threads die too early because of his absence. I think I was as hardcore efficient market, low ER, low turnover, tax efficient, TSM Boglehead as anyone on the board 2000-2009. I kept reading; have pretty much read all the Boglehead books mentioned on this board, most more than once. Over time, mainly influenced by Gibson’s Asset Allocation, Bernstein’s Intelligent Asset Allocator, and Larry’s books, I evolved Into an asset class junkie and ultimately into a factor/source of return junkie. I may be heading towards risk parity junkie. After feeling the pain of seeing what can happen to market beta in 2000-2001 and 2007-2008, I’ve come to believe that paying extra for a more efficient portfolio could well be worth it. So I like to keep discussing Larry’s writings.
Dave - I agree totally. Larry was the most influential member on this board to me. I'm all in with factor-based investing, although it seems to be the minority around here. I appreciate the links to Swedroe's articles. I don't always have time to look on etf.com, then Advisor Perspectives, and then anything BAM/Buckingham puts out to read Larry's writings. I'm glad that he is publishing an updated book to his "Black Swans" book. I just hope that he doesn't push the alts too much.

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Re: Larry Swedroe: Managing Risk With Factors

Post by triceratop » Tue Nov 21, 2017 11:08 pm

Taylor Larimore wrote:
Tue Nov 21, 2017 11:02 pm
I’ve come to believe that paying extra for a more efficient portfolio could well be worth it.
Random Walker:

You could be right, but your quote will make 135 Advisors in Larry's BAM Advisory Service happy.

Best wishes.
Taylor
Why? I don't believe Dave uses any of the advisors in Larry's group. This reads like a stretched way to attack ideas based on who is advocating for them, and it's a stretch because it isn't Larry here advocating them but a disinterested individual. To my knowledge Random Walker uses index funds and some AQR alt funds, none of which make any money for BAM.

You could as well say that advice to use a 3-fund portfolio with Vanguard funds would make people are Vanguard very happy. It doesn't mean the advice is poor.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Larry Swedroe: Managing Risk With Factors

Post by Tim Bachmann » Tue Nov 21, 2017 11:15 pm

Taylor Larimore wrote:
Tue Nov 21, 2017 11:02 pm
I’ve come to believe that paying extra for a more efficient portfolio could well be worth it.
Random Walker:

You could be right, but your quote will make 135 Advisors in Larry's BAM Advisory Service happy.

Best wishes.
Taylor
I think that's a cheap shot at Dave and Larry. The moderators have kicked people off of the board for less than this. Please don't use your stature on this board to denigrate others (Larry is still a member, albeit not active).

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Re: Larry Swedroe: Managing Risk With Factors

Post by Taylor Larimore » Tue Nov 21, 2017 11:32 pm

Tim:

I did not intend to take a "cheap shot" at Larry Swedroe.

I will edit my post.

Best wishes.
Taylor
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Re: Larry Swedroe: Managing Risk With Factors

Post by Random Walker » Wed Nov 22, 2017 12:01 am

As I’ve written many times in the past, costs are certain and potential benefits are only just that, potential. So it’s hard to go wrong with a low cost tax efficient TSM approach. I would consider that the benchmark for comparison. But take a look at my thread on volatility drag, or Larry’s short essay Efficient Diversification In A 3 Factor World, or the central chart in Gibson’s Asset Allocation. Volatility inflicts a real cost on a portfolio. (And this ignores perhaps the bigger issue of investor behavior in the face of a grueling equity bear market.). Whether one looks at a more efficient portfolio as one that lessens portfolio standard deviation and increases Sharpe ratio, one that lessens maximal drawdown, one that brings geometric return closer to average annual return, the conclusion is the same. A more efficient portfolio is worth some increased cost compared to the rock bottom cost of TSM/TBM. Is it possible the advisor/DFA/AQR/factor route increases the cost too much? The answer quite possibly is yes. But after a lot of ongoing thought, I chose that route because I saw the number and size of potential benefits start to look large compared to the certain costs.
Unfortunately, as I have learned, there is no way to directly compare the two paths. The sample period would be too short as well. They are apples and oranges. My overall stock/bond split is much different than I would have likely put together on my own, I doubt I would have ever used alternatives on my own, and I’m sure I would have made tweaks in my all VG portfolio over time as well. I think my behavior as an investor is pretty solid, but I nonetheless have an extra level of protection from myself with an advisor.
Currently we have had an 8-9 year bull market. We all look like investing superstars. A 100% equity growthy TSM portfolio looks like the MVP. Let’s see what the conversations look like when we have a bear like 1972-4 or worse yet Japan for a generation. There are many potential alternative histories, but only one will play out. Investing is about putting the odds of success in our favor. Starting with rock bottom costs is about as strong a start as one could ask for. Betting on the US economic engine is certainly pretty good as well. But academic research has shown we can diversify way beyond that in multiple dimensions. That diversification is worth something.

Dave

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Re: Larry Swedroe: Managing Risk With Factors

Post by packer16 » Wed Nov 22, 2017 8:25 am

One aspect of factors versus market beta is that some factors are not fundamentally based but based upon the price Mr. Market puts on a security & thus IMO are different. Equity beta is based upon the fundamentals of equity being subordinate the debt in firm's capital structures & thus over the long term (if economics is correct) will outperform bonds. Value & momentum are observation based factors with no direct economics behind them. Some say value stocks are poorer quality but if that is where you think the risk is why not directly develop a portfolio of low quality stocks versus value stocks?

The other questions I have is about the value add of a less volatile portfolio for individual investors. I understand the concept if you have a fixed outlay per year (like a charity) but how many retirees have a fixed outlay in the sense the volatility matters to point where you would sacrifice performance for a less volatile portfolio. To me it appears that learning flexible spending techniques in retirement & examining variable withdraw techniques can offset some volatility that folks are paying to reduce using expensive alternatives. I would like to hear how valid this is from current retirees using flexible spending or variable withdraw techniques. TIA.

As for re-insurance, I would wait to see if prices firm up. Given how lose money is today, the anticipated increase in premiums may not materialize to the extent required to offset risk incurred & if so then re-insurance will continue to bleed red ink while you pay 2%+ in fees. Given the riskiness in this space a more appealing & cheaper alternative IMO is to buy Berkshire Hathaway & Markel. You do get some equity exposure here but given the riskiness of re-insurance, I would think any exposure would come out of equity bucket in the first place.

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Managing Risk With Factors ?

Post by Taylor Larimore » Wed Nov 22, 2017 9:09 am

Dave:

Nice post!

I am aware of bear markets as much as anyone. I've been through Eleven Bear Markets, losing our home in one of them.

It is a mistake to assume that owning different type stock funds is effective for reducing losses in a bear market. The list below shows the 2008 returns of various Vanguard funds during the last bear market:

+6.7% Short-Term Treasury
+5.1% Total Bond Market
+2.8% Prime Money Market

-21.3% Hi-Yield Corporate
-26.6% Dividend Appreciation Index
-32.1% Small-Cap Value Index
-34.8% U.S. Value
-36.0% Small-Cap Index
-36.6% Mid-Cap Value Index
-37.0% 500 Index
-37.0% Total U.S. Stock Market
-37.1% REIT Index
-40.0% Small Cap Growth Index
-41.7% International Value
-41.8% Mid-Cap Index
-44.1% Total International Index
-52.8% Emerging Markets Stock Index
-56.0% Precious Metals and Mining
Source: 2014 Independent Guide to the Vanguard Funds

The above figures do not show the full extent of a bear market because bear markets usually last more than one year. For example, Vanguard Small-Cap Value Index Fund plunged -56.1% by February 2009 and did not recover until 24 months later.

Bottom line: Bonds are a much better diversifier than factors for reducing risk in bear markets

Best wishes.
Taylor
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Re: Larry Swedroe: Managing Risk With Factors

Post by Random Walker » Wed Nov 22, 2017 9:55 am

Taylor,
Totally agree. Not only are high quality bonds the best protection, they are the cheapest as well. Everything else I discuss is decreasing marginal benefit and increasing marginal cost. This is especially true since the allocations are all quite small.

Dave

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Re: Managing Risk With Factors ?

Post by triceratop » Wed Nov 22, 2017 10:44 am

Taylor Larimore wrote:
Wed Nov 22, 2017 9:09 am
Dave:

Nice post!

I am aware of bear markets as much as anyone. I've been through Eleven Bear Markets, losing our home in one of them.

It is a mistake to assume that owning different type stock funds is effective for reducing losses in a bear market. The list below shows the 2008 returns of various Vanguard funds during the last bear market:

+6.7% Short-Term Treasury
+5.1% Total Bond Market
+2.8% Prime Money Market

-21.3% Hi-Yield Corporate
-26.6% Dividend Appreciation Index
-32.1% Small-Cap Value Index
-34.8% U.S. Value
-36.0% Small-Cap Index
-36.6% Mid-Cap Value Index
-37.0% 500 Index
-37.0% Total U.S. Stock Market
-37.1% REIT Index
-40.0% Small Cap Growth Index
-41.7% International Value
-41.8% Mid-Cap Index
-44.1% Total International Index
-52.8% Emerging Markets Stock Index
-56.0% Precious Metals and Mining
Source: 2014 Independent Guide to the Vanguard Funds

The above figures do not show the full extent of a bear market because bear markets usually last more than one year. For example, Vanguard Small-Cap Value Index Fund plunged -56.1% by February 2009 and did not recover until 24 months later.

Bottom line: Bonds are a much better diversifier than factors for reducing risk in bear markets

Best wishes.
Taylor
I don't think I saw Dave claim Factor-tilted equities with beta=1 will have less downside in a bear market (as an aside: it's dangerous to read too much from any single bear market -- small+value performed much differently in the 2001 bear market). However, if you use equities with higher expected return (and yes, higher risk), you can increase the amount of high-quality bonds in your portfolio since you hopefully achieved higher return with lower volatility so as to get a more efficient portfolio. That's the idea, anyway; it's perfectly reasonable to disagree! However, it's always helpful to engage with those you disagree with on their own terms.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Larry Swedroe: Managing Risk With Factors

Post by azanon » Wed Nov 22, 2017 10:51 am

The biggest risk with that extreme 25/75 portfolio being substituted for a traditional 60/40, where the 25 is extreme factor tilt to small/value, is that your returns might end up really sucking, if the future doesn't equal the past.

The alternative is to accept the larger fat tails, ~ 30% higher volatility, and probably have a much better assurance that your actual return will come close to your expected return because you're only relying on market beta to produce that return with a traditional 60/40. And the cherry on top is that you get the best "factor" of all, which is extremely low cost because those market-cap weighted funds at Vanguard are dirt cheap. Or maybe something a little in-between, since I mentioned my preference for large-cap value earlier (which is also dirt cheap).

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Re: Larry Swedroe: Managing Risk With Factors

Post by whodidntante » Wed Nov 22, 2017 11:10 am

It is a mistake to go down to Edward Jones and pay an advisor fee, only to get placed into high cost actively managed funds that essentially expose you to beta. The three fund beta portfolio implemented without an advisor is far superior to that.

It is a mistake to assume that factor investing does not have merit because it adds costs. For one, it need not add much cost. You can implement it yourself, and there are low cost passive factor funds available now. There are good reasons to implement factor investing over a beta portfolio after adjusting for costs.

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Re: Larry Swedroe: Managing Risk With Factors

Post by willthrill81 » Wed Nov 22, 2017 11:15 am

digarei wrote:
Tue Nov 21, 2017 3:26 am
Random Walker wrote:
Mon Nov 20, 2017 11:05 pm
Dead Man Walking,
Like all the factors, Cross Sectional Momentum is defined as a long-short portfolio to isolate the factor and exclude the market factor. CS Momentum is RELATIVE momentum. Within an asset class, at defined time intervals, one could simply look back at the last time period and buy the top 30% performers and sell the bottom 30% performers. If this occurs at defined intervals, there is no effort to time the market or time the performance of any individual security. Note that these sales and purchases occur whether the market is up or down, because what is being evaluated is relative momentum. The manager could be buying stocks that went down the least and selling what went down the most, or he could be buying what went up most and selling what went up least.
Even time series momentum can be passive and formulaic. Time series momentum is absolute momentum: buy what has gone up in past and sell what has gone down. This therefore is not market neutral and is trend following. Thus this perhaps can be considered a passive formulaic approach to market timing? In the equities markets, TS Mom will result in increased equity allocation when markets have been up and decreased equity allocation when equities have been down. But even this strategy is agnostic to the specific stocks and agnostic to the market direction; it will formulaicly buy and sell as prescribed.
I’m pretty much all in on factors. I find it fascinating that one of the factors I intuitively have the least confidence in TS Mom (100% behavioral), has some of the strongest data behind it.

Dave

  • This seems to be the inverse of rebalancing. But not market timing? Longtime Bogleheads perhaps employ a different use of the phrase market timing than I am accustomed to:

What is 'Market Timing'

Market timing is the act of moving in and out of the market or switching between asset classes based on using predictive methods such as technical indicators or economic data.

Because it is extremely difficult to predict the future direction of the stock market, investors who try to time the market, especially mutual fund investors, tend to underperform investors who remain invested.

Upon investigation of the major marketing timing strategies (most investors who practice market timing seem to do so based on feelings), it seems that they tend to underperform buy-and-hold during bull markets and outperform during bear markets and, potentially, over long-term periods.

For instance, if one employed a 200 day moving average strategy where you invested in VTSMX (Vanguard Total Stock Market) when it was above the 200 DMA and switched to VBMFX (Vanguard Total Bond Market) otherwise, your return from 2009 until today would 14.42%, compared to 15.17% for buy-and-hold of VTSMX. But if we change the period of analysis to 1993 so that two major bear markets are included in the analysis, the timing model had a return of 11.76%, whereas buy-and-hold returned 9.51%. On top of that, the timing model had far lower volatility; the worst year for it was -5.89% with a max drawdown of -17.57%, compared to -37.04% and -50.89%, respectively, for buy-and-hold. Many were recommending this very simple approach 50 years ago, and it seems that those who practiced it rigidly did very well.

Mainly due to the seeming ability of market timing strategies to reduce downside volatility, it seems that they could hold substantial promise for retirees in the withdrawal phase. The reduction of downside risk could go a very long way to dramatically reducing sequence of returns risk, which is what has historically held safe withdrawal rates significantly below 'average' withdrawal rates.
“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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