Does the 3 fund portfolio seem somewhat flawed?

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LiveSimple
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by LiveSimple » Sun Jan 07, 2018 2:31 pm

Was this answered ?

wouldn't it make more sense to own:

1/3 Large cap blend index fund
1/3 Mid cap blend index fund
1/3 Small cap blend index fund

The reason is I am thinking the same.
What is the flaw in this plan ?

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Taylor Larimore
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by Taylor Larimore » Sun Jan 07, 2018 2:35 pm

WIllthrill81:

I apologize if my reply upset you. I was simply responding to your statement that "I care about returns" by showing you actual returns compared with other professional portfolios.

Past performance does not guarantee future performance.

Let's move on.

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

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willthrill81
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by willthrill81 » Sun Jan 07, 2018 2:39 pm

nisiprius wrote:
Sun Jan 07, 2018 11:29 am
But you wouldn't want to beg the question by assuming that cap-weighted funds will give suboptimal returns... would you?
It isn't a blind assumption but an informed one based on history. The top companies in terms of market cap in a given market have historically underperformed the rest of the market by about 5%. Further, Guggenheim's equal weight S&P 500 ETF has indeed outperformed Vanguard's market cap S&P 500 fund for the past 14 years by over 1% annualized. I don't say that to say that it will always be so but only to provide a real world example that deviating from market cap-weighting can be beneficial to investors.
Last edited by willthrill81 on Sun Jan 07, 2018 3:00 pm, edited 1 time in total.
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columbia
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by columbia » Sun Jan 07, 2018 2:45 pm

I think this boils down to whether one can accurately forecast the optimal portfolio going forward.

I know that I cannot do that and don’t try to.

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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by drk » Sun Jan 07, 2018 2:47 pm

LiveSimple wrote:
Sun Jan 07, 2018 2:31 pm
Was this answered ?

wouldn't it make more sense to own:

1/3 Large cap blend index fund
1/3 Mid cap blend index fund
1/3 Small cap blend index fund

The reason is I am thinking the same.
What is the flaw in this plan ?
The flaw is that it is arbitrary. It may perform better than the market return, or it may lag it. You would also want to find equal-weighted offerings for each of those funds. Otherwise, you'll end up with a much larger holding of the largest company in the mid/small cap funds than in the smallest company in the large/mid cap funds, respectively, despite the likelihood that they are substantially similar companies. That rules out Vanguard funds if you want to avoid introducing such bizarre weightings.

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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by dbr » Sun Jan 07, 2018 2:52 pm

drk wrote:
Sun Jan 07, 2018 2:47 pm
LiveSimple wrote:
Sun Jan 07, 2018 2:31 pm
Was this answered ?

wouldn't it make more sense to own:

1/3 Large cap blend index fund
1/3 Mid cap blend index fund
1/3 Small cap blend index fund

The reason is I am thinking the same.
What is the flaw in this plan ?
The flaw is that it is arbitrary. It may perform better than the market return, or it may lag it. You would also want to find equal-weighted offerings for each of those funds. Otherwise, you'll end up with a much larger holding of the largest company in the mid/small cap funds than in the smallest company in the large/mid cap funds, respectively, despite the likelihood that they are substantially similar companies. That rules out Vanguard funds if you want to avoid introducing such bizarre weightings.
Exactly right. I made the comment earlier that the proposal has no rationale and in fact is based on the dividing line for size classes being completely arbitrary in the first place. If there is an argument about size distribution an example can be found in Fama-French factor analysis where the relevant parameter is size loading of the portfolio.

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willthrill81
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by willthrill81 » Sun Jan 07, 2018 3:03 pm

dbr wrote:
Sun Jan 07, 2018 2:52 pm
drk wrote:
Sun Jan 07, 2018 2:47 pm
LiveSimple wrote:
Sun Jan 07, 2018 2:31 pm
Was this answered ?

wouldn't it make more sense to own:

1/3 Large cap blend index fund
1/3 Mid cap blend index fund
1/3 Small cap blend index fund

The reason is I am thinking the same.
What is the flaw in this plan ?
The flaw is that it is arbitrary. It may perform better than the market return, or it may lag it. You would also want to find equal-weighted offerings for each of those funds. Otherwise, you'll end up with a much larger holding of the largest company in the mid/small cap funds than in the smallest company in the large/mid cap funds, respectively, despite the likelihood that they are substantially similar companies. That rules out Vanguard funds if you want to avoid introducing such bizarre weightings.
Exactly right. I made the comment earlier that the proposal has no rationale and in fact is based on the dividing line for size classes being completely arbitrary in the first place. If there is an argument about size distribution an example can be found in Fama-French factor analysis where the relevant parameter is size loading of the portfolio.
Firm size (i.e. large cap, mid cap, etc.) in this fashion is inherently an arbitrary grouping, but that doesn't mean that returns do not vary across firms of different sizes in a systematic way.
“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

dbr
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by dbr » Sun Jan 07, 2018 3:09 pm

willthrill81 wrote:
Sun Jan 07, 2018 3:03 pm
dbr wrote:
Sun Jan 07, 2018 2:52 pm
drk wrote:
Sun Jan 07, 2018 2:47 pm
LiveSimple wrote:
Sun Jan 07, 2018 2:31 pm
Was this answered ?

wouldn't it make more sense to own:

1/3 Large cap blend index fund
1/3 Mid cap blend index fund
1/3 Small cap blend index fund

The reason is I am thinking the same.
What is the flaw in this plan ?
The flaw is that it is arbitrary. It may perform better than the market return, or it may lag it. You would also want to find equal-weighted offerings for each of those funds. Otherwise, you'll end up with a much larger holding of the largest company in the mid/small cap funds than in the smallest company in the large/mid cap funds, respectively, despite the likelihood that they are substantially similar companies. That rules out Vanguard funds if you want to avoid introducing such bizarre weightings.
Exactly right. I made the comment earlier that the proposal has no rationale and in fact is based on the dividing line for size classes being completely arbitrary in the first place. If there is an argument about size distribution an example can be found in Fama-French factor analysis where the relevant parameter is size loading of the portfolio.
Firm size (i.e. large cap, mid cap, etc.) in this fashion is inherently an arbitrary grouping, but that doesn't mean that returns do not vary across firms of different sizes in a systematic way.
That's what I said with documentation for how it might vary and a rationale for how to implement the fact, all of which was missing from the original comment you quoted.

Allan Roth
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by Allan Roth » Sun Jan 07, 2018 3:10 pm

willthrill81 wrote:
Sun Jan 07, 2018 2:21 pm

Further, I do not consider a 10 year period to be long-term. Factors can easily underperform the broad market for a decade. That being said, the equity side of some of those Market Watch portfolios has indeed outperformed TSM over the last decade.
You are correct on the fact that 10-years may not be long-term but arithmetic is very long-term. That is, investors in US stocks as a whole, must underperform TSM. Investors in international stocks as a whole must underperform Total Int'l stock index. I know I don't know which factors will outperform over the next ten years which is why I own total markets. Just when people said small cap and value were a free lunch, they badly lagged.

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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by willthrill81 » Sun Jan 07, 2018 3:12 pm

Allan Roth wrote:
Sun Jan 07, 2018 3:10 pm
willthrill81 wrote:
Sun Jan 07, 2018 2:21 pm

Further, I do not consider a 10 year period to be long-term. Factors can easily underperform the broad market for a decade. That being said, the equity side of some of those Market Watch portfolios has indeed outperformed TSM over the last decade.
You are correct on the fact that 10-years may not be long-term but arithmetic is very long-term. That is, investors in US stocks as a whole, must underperform TSM. Investors in international stocks as a whole must underperform Total Int'l stock index. I know I don't know which factors will outperform over the next ten years which is why I own total markets. Just when people said small cap and value were a free lunch, they badly lagged.
All of the weighted returns of the investors in a given market must, by definition, exactly replicate the returns of the TSM. They are the same. The same goes for the international crowd.
“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

MarkBarb
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by MarkBarb » Sun Jan 07, 2018 3:23 pm

If a fund bought every share of every company - the entire stock market - it would be a market cap weighted fund. Since no fund owns everything, they might buy 1% of everything. If they want to keep the same proportion of each stock that they would have if they owned the whole market, they buy like market cap weighted indexes do. There are some advantages - no need to ever rebalance, no discretion or active management.

If you wanted equal shares of all stocks, you'd buy the same dollar amount of every stock in the market. That would leave you very, very skewed to small companies because there are many more of them than the big companies.

You want some sort of hybrid. You want to overweight small stocks compared with how the market values them, but not to the extreme of treating every stock equally. That's fine. Do whatever makes you happy.

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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by yarnandthread » Sun Jan 07, 2018 3:41 pm

MarkBarb wrote:
Sun Jan 07, 2018 3:23 pm
If a fund bought every share of every company - the entire stock market - it would be a market cap weighted fund. Since no fund owns everything, they might buy 1% of everything. If they want to keep the same proportion of each stock that they would have if they owned the whole market, they buy like market cap weighted indexes do. There are some advantages - no need to ever rebalance, no discretion or active management.

If you wanted equal shares of all stocks, you'd buy the same dollar amount of every stock in the market. That would leave you very, very skewed to small companies because there are many more of them than the big companies.

You want some sort of hybrid. You want to overweight small stocks compared with how the market values them, but not to the extreme of treating every stock equally. That's fine. Do whatever makes you happy.
Perhaps not owning every stock equally, but achieving a more "balanced" portfolio that isn't biased towards large cap stocks which is what the TSM does. Again based on backtesting from 1972-2017 using portfoliovisualizer.com which is 45 years of data a rather simple 1/3 large blend, 1/3 mid blend, and 1/3 small blend outperformed TSM by 1.15% annually. Sure it isn't as simple as the TSM, but the whole point of investing is to make money. 1.15% annually equates equates to MILLIONS more money if 1,000,000 was initially invested....actually 58 MILLION dollars more to be exact...yes you read that right. 153m vs 95m

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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by drk » Sun Jan 07, 2018 3:49 pm

MarkBarb wrote:
Sun Jan 07, 2018 3:23 pm
If a fund bought every share of every company - the entire stock market - it would be a market cap weighted fund.
I was toying around with this idea in my head, and technically I don't think that that's correct: if one fund owned every share of every company, then there would be no market and, by extension, no market capitalization. That's likely a distinction without a difference, though (e.g., I don't have an argument that Amazon's price doesn't reflect its reasonably expected future earnings).
MarkBarb wrote:
Sun Jan 07, 2018 3:23 pm
You want some sort of hybrid. You want to overweight small stocks compared with how the market values them, but not to the extreme of treating every stock equally. That's fine. Do whatever makes you happy.
At the end of the day, this is it. You can try to generate some extra alpha over the market return by tilting, or you can satisfy yourself with approximately the market return. If holding a potentially sub-optimal portfolio hinders your sleep, then go for the former, but recognize that it's tougher than it might look.

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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by edge » Sun Jan 07, 2018 4:27 pm

What the heck is ‘optimal’ in this context?
willthrill81 wrote:
Sat Jan 06, 2018 11:08 pm
edge wrote:
Sat Jan 06, 2018 10:57 pm
The market capitalization is what the market thinks the company is worth. Since the market determined the worth of these companies, then the market portfolio would reflect that.

Seems obvious?

The other metrics you mentioned: revenue, profits, or some other metric cannot adequately capture the market value of a company. Profitability may come at the expense of growth. Revenue may have low margins. The current quarter or annual financial results may not reflect future probabilities of lower or higher future returns etc, etc, etc.

Market capitalization captures the aggregate market opinion on the value of the company and its future prospects.
willthrill81 wrote:
Sat Jan 06, 2018 10:53 pm
edge wrote:
Sat Jan 06, 2018 10:17 pm
Because the point of the market portfolio is to achieve market returns.
But "market returns" are determined by how you define the market. I've yet to hear a compelling argument that market capitalization is the best means of defining a market.
So basically, you're saying that market cap-weighting an index is a popularity contest. On that point I agree with you. However, that doesn't mean that it's the optimal approach for investors. I've never seen it mentioned here, but the #1 market cap weighted firm in any given market tends to underperform the entire market cap-weighted market by 5%. Yet that is the top holding in a market cap-weighted index.

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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by willthrill81 » Sun Jan 07, 2018 4:35 pm

edge wrote:
Sun Jan 07, 2018 4:27 pm
What the heck is ‘optimal’ in this context?
willthrill81 wrote:
Sat Jan 06, 2018 11:08 pm
edge wrote:
Sat Jan 06, 2018 10:57 pm
The market capitalization is what the market thinks the company is worth. Since the market determined the worth of these companies, then the market portfolio would reflect that.

Seems obvious?

The other metrics you mentioned: revenue, profits, or some other metric cannot adequately capture the market value of a company. Profitability may come at the expense of growth. Revenue may have low margins. The current quarter or annual financial results may not reflect future probabilities of lower or higher future returns etc, etc, etc.

Market capitalization captures the aggregate market opinion on the value of the company and its future prospects.
willthrill81 wrote:
Sat Jan 06, 2018 10:53 pm
edge wrote:
Sat Jan 06, 2018 10:17 pm
Because the point of the market portfolio is to achieve market returns.
But "market returns" are determined by how you define the market. I've yet to hear a compelling argument that market capitalization is the best means of defining a market.
So basically, you're saying that market cap-weighting an index is a popularity contest. On that point I agree with you. However, that doesn't mean that it's the optimal approach for investors. I've never seen it mentioned here, but the #1 market cap weighted firm in any given market tends to underperform the entire market cap-weighted market by 5%. Yet that is the top holding in a market cap-weighted index.
By optimal, I'm referring to long-term returns.
“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: Does the 3 fund portfolio seem somewhat flawed?

Post by drk » Sun Jan 07, 2018 4:44 pm

edge wrote:
Sun Jan 07, 2018 4:27 pm
What the heck is ‘optimal’ in this context?
I've been reading it in the mathematical sense.

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JoMoney
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by JoMoney » Sun Jan 07, 2018 4:49 pm

Nope.

... well, ok, you can find something to criticize in just about everything, but a cap-weighted portfolio makes more sense than a multitude of other options.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by nisiprius » Sun Jan 07, 2018 4:54 pm

LiveSimple wrote:
Sun Jan 07, 2018 2:31 pm
wouldn't it make more sense to own:

1/3 Large cap blend index fund
1/3 Mid cap blend index fund
1/3 Small cap blend index fund

The reason is I am thinking the same.
What is the flaw in this plan ?
Since nobody seems to have done it yet, I'm going to try the obvious thing. Before I try it, let me state what I expect. I will then post the results whether or not they confirm my expectation. Let me start by saying that one of the commonest misleading presentations by advocates of some strategy is to suggest a strategy that is slightly riskier than Total Stock, and point to slightly higher return. This takes us down the rabbithole of "what is risk," etc. but you need to account for risk somehow. One measurement of risk is standard deviation, another which I personally like is "maximum 'drawdown'" which usually means 2008-2009, and two common measurements of risk-adjusted return are the Sharpe ratio and the Sortino ratio.

I'm going to use PortfolioVisualizer to compare the portfolio above with a straight cap-weighted Total Stock portfolio. For the index funds I'll use the obvious Vanguard index funds, which I think are among the oldest available and thus have the longest run of data. And for the time period I'll use "all data available to PortfolioVisualizer," which may not be a representative time period, but is, at least, a time period I didn't personally choose.

I expect the equal large-mid-small portfolio to have slightly higher return, slightly higher risk (measured by standard deviation and drawdown), and almost the same Sharpe and Sortino ratios as Total Stock.

The reason I expect this is that despite talk of low correlation, stocks are stocks and big representative groups of stocks, as far as I know, never have really low correlation. And, although the "size" factor was the first discovered (in 1981), the paper that announced it had problems in the data set that was used... and over time, the magnitude and importance of the size factor have been gradually downplayed more and more by the "factor" community. I don't think people are now claiming that small-caps has much higher risk-adjusted reward, the premium is just the result of investors demanding more return for more risk.

So, that's what I expect. Now, let's go look.
Portfolio 1 (blue) is VTSMX, total stock, the whole market, cap-weighted.
Portfolio 2 (red) is yarnandthread's proposal, implement with the obvious Vanguard funds; rebalanced annually.
VLACX Vanguard Large Cap Index Investor 33.34%
VIMSX Vanguard Mid Cap Index Investor 33.33%
NAESX Vanguard Small Cap Index Inv 33.33%

And, indeed, everything I said turned out to be true over this fourteen-year time period. Portfolio 2 outperformed portfolio 1, but by every measure of risk it was riskier, and by both measures of risk-adjusted return it had just a microskosh lower risk-adjusted return. The higher return was simply reward for taking more risk.

Source
Image

Since in real life many investors would not be 100% stocks, but would have perhaps a 60/40 stock/bond portfolio, the next step would be to compare 60% total stock / 40% total bond with the result of replacing total stock with yarnandthread's portfolio and then cutting the stock allocation so as to equalize the portfolio's risk with the original. I'll leave that as an exercise for the reader.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

edge
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by edge » Sun Jan 07, 2018 5:00 pm

Ok so just have a portfolio of micro cap value. That will probably work.
willthrill81 wrote:
Sun Jan 07, 2018 4:35 pm
edge wrote:
Sun Jan 07, 2018 4:27 pm
What the heck is ‘optimal’ in this context?
willthrill81 wrote:
Sat Jan 06, 2018 11:08 pm
edge wrote:
Sat Jan 06, 2018 10:57 pm
The market capitalization is what the market thinks the company is worth. Since the market determined the worth of these companies, then the market portfolio would reflect that.

Seems obvious?

The other metrics you mentioned: revenue, profits, or some other metric cannot adequately capture the market value of a company. Profitability may come at the expense of growth. Revenue may have low margins. The current quarter or annual financial results may not reflect future probabilities of lower or higher future returns etc, etc, etc.

Market capitalization captures the aggregate market opinion on the value of the company and its future prospects.
willthrill81 wrote:
Sat Jan 06, 2018 10:53 pm


But "market returns" are determined by how you define the market. I've yet to hear a compelling argument that market capitalization is the best means of defining a market.
So basically, you're saying that market cap-weighting an index is a popularity contest. On that point I agree with you. However, that doesn't mean that it's the optimal approach for investors. I've never seen it mentioned here, but the #1 market cap weighted firm in any given market tends to underperform the entire market cap-weighted market by 5%. Yet that is the top holding in a market cap-weighted index.
By optimal, I'm referring to long-term returns.

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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by dbr » Sun Jan 07, 2018 5:01 pm

drk wrote:
Sun Jan 07, 2018 4:44 pm
edge wrote:
Sun Jan 07, 2018 4:27 pm
What the heck is ‘optimal’ in this context?
I've been reading it in the mathematical sense.
That is correct. There is no such thing as "optimum" in general and anyone who references such a thing is either in a conversation where everybody already knows what the discussion is or he is blowing smoke. One thing one could "optimize" is the expected return, meaning to get the highest return possible with no other considerations. It is almost certainly true that the expected return of the total market should be estimated to be less than that of a portfolio that is tilted to small and value stocks. As with all estimates of theoretical properties of stock portfolios one can debate whether or not this is a supportable or valid estimate to make.

A common optimization sought in financial theory is mean variance optimization: http://www.effisols.com/basics/MVO.htm In that case one is considering return contingent on how much risk is allowed.

It is possible to try to optimize other things. In this paper by Reichenstein http://www.efficientfrontier.com/ef/704 ... arkOpt.pdf the figure of merit that is optimized is

"The study examines two utility functions:
U = ER – SD/RT and U = ER – SD2/RT.
U denotes utility; also,
it is the portfolio’s certainty-equivalent return, meaning
it is the risk-free return that would provide the same
utility as the portfolio. ER is the portfolio’s after-tax
expected returns. SD is after-tax standard deviation. RT
denotes the investor’s risk tolerance.

Note that optimization is with respect to something that can be varied. In the example of return and size it is the distribution over size classes of stocks. If one does that in the context of the Fama-French analysis of investment returns it would be with respect to the factor loadings on size and value. In MVO the optimization is over proportions of investments in instruments representing different asset classes, stocks and bonds at the simplest but there can be much more complex. In Reichenstein's example the variation is over how different asset classes are located with respect to tax burden of taxable and tax deferred accounts.

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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by drk » Sun Jan 07, 2018 5:07 pm

nisiprius wrote:
Sun Jan 07, 2018 4:54 pm
And, indeed, everything I said turned out to be true over this fourteen-year time period. Portfolio 2 outperformed portfolio 1, but by every measure of risk it was riskier, and by both measures of risk-adjusted return it had just a microskosh lower risk-adjusted return. The higher return was simply reward for taking more risk.
Given that part of the impetus for this question was that companies' performance and capitalization change over time, I added a $500 monthly contribution, which brought the difference to $4,400 ($254,739 vs. $250,350) and a 15 bp advantage in CAGR.

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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by arcticpineapplecorp. » Sun Jan 07, 2018 5:08 pm

edge wrote:
Sun Jan 07, 2018 5:00 pm
Ok so just have a portfolio of micro cap value. That will probably work.
willthrill81 wrote:
Sun Jan 07, 2018 4:35 pm
By optimal, I'm referring to long-term returns.
More specifically, you mean emerging market micro cap value stocks, right?
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by edge » Sun Jan 07, 2018 5:09 pm

Why not both? Then we can take advantage of the rebalancing bonus (the one that hardly anybody actually understands).
arcticpineapplecorp. wrote:
Sun Jan 07, 2018 5:08 pm
edge wrote:
Sun Jan 07, 2018 5:00 pm
Ok so just have a portfolio of micro cap value. That will probably work.
willthrill81 wrote:
Sun Jan 07, 2018 4:35 pm
By optimal, I'm referring to long-term returns.
More specifically, you mean emerging market micro cap value stocks, right?

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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by Mountain Doc » Sun Jan 07, 2018 5:39 pm

OP, you're totally neglecting micro caps. If you truly want to own the whole market and not pick favorites, why don't you buy the following?

20% Mega Cap
20% Large Cap
20% Mid Cap
20% Small Cap
20% Micro Cap

Oops, that neglects the ultra micro caps. Never mind, please buy this for true diversification:

16.7% Mega Cap
16.7% Large Cap
16.7% Mid Cap
16.7% Small Cap
16.7% Micro Cap
16.7% Ultra Micro Cap

:D

(obviously written tongue-in-cheek to point out how arbitrary these categories are)

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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by willthrill81 » Sun Jan 07, 2018 6:33 pm

edge wrote:
Sun Jan 07, 2018 5:09 pm
Why not both? Then we can take advantage of the rebalancing bonus (the one that hardly anybody actually understands).
Rebalancing bonus? When I'm looking at historic data, rebalancing has reduced returns at least as often as it has improved them. Over the last 46 years, an annually rebalanced portfolio of 60% microcaps and 40% ITT had an annual return more than .5% smaller than the same portfolio with no rebalancing. If you're talking about risk-adjusted returns, then yes, rebalancing has improved the situation. Perhaps you can enlighten us with specifics.
Last edited by willthrill81 on Sun Jan 07, 2018 6:36 pm, edited 1 time in total.
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by bottlecap » Sun Jan 07, 2018 6:35 pm

Interesting discussion.

I think the problem is that the OP considers a large cap company and a mid and small cap company as three different types of companies.

The are not. If fact, they could be the same company at different stages of its existence. Or they could be very similar companies in the same industry.

The large, mid, and small cap designations are artificial and merely refer to how valuable the company is. Much of the time, a stock price is a forward-looking metric.

If the market thinks a company has a certain future value reflected by it's stock price, the only reason to overweight that stock is if you know something the market doesn't.

So really, if you believe the market knows better than you, the true 3 fund portfolio isn't really flawed at all from a theoretical prospective.

JT

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LiveSimple
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by LiveSimple » Sun Jan 07, 2018 6:41 pm

Nice discussion, appreciate all the contributors.

In summary, from my prespective, to gain a higher return than the total market (?) , do need to have risker assets, hence tilt towards, Mid / Small Caps.

edge
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by edge » Sun Jan 07, 2018 8:38 pm

I don’t know what ITT is supposed to be.

Try doing a thought exercise with a portfolio with two asset classes with equal yet negatively correlated returns.

Anyway this forum is full of information much more technical than this thread. Use the search button.
willthrill81 wrote:
Sun Jan 07, 2018 6:33 pm
edge wrote:
Sun Jan 07, 2018 5:09 pm
Why not both? Then we can take advantage of the rebalancing bonus (the one that hardly anybody actually understands).
Rebalancing bonus? When I'm looking at historic data, rebalancing has reduced returns at least as often as it has improved them. Over the last 46 years, an annually rebalanced portfolio of 60% microcaps and 40% ITT had an annual return more than .5% smaller than the same portfolio with no rebalancing. If you're talking about risk-adjusted returns, then yes, rebalancing has improved the situation. Perhaps you can enlighten us with specifics.

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willthrill81
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by willthrill81 » Sun Jan 07, 2018 8:47 pm

edge wrote:
Sun Jan 07, 2018 8:38 pm
I don’t know what ITT is supposed to be.

Try doing a thought exercise with a portfolio with two asset classes with equal yet negatively correlated returns.

Anyway this forum is full of information much more technical than this thread. Use the search button.
willthrill81 wrote:
Sun Jan 07, 2018 6:33 pm
edge wrote:
Sun Jan 07, 2018 5:09 pm
Why not both? Then we can take advantage of the rebalancing bonus (the one that hardly anybody actually understands).
Rebalancing bonus? When I'm looking at historic data, rebalancing has reduced returns at least as often as it has improved them. Over the last 46 years, an annually rebalanced portfolio of 60% microcaps and 40% ITT had an annual return more than .5% smaller than the same portfolio with no rebalancing. If you're talking about risk-adjusted returns, then yes, rebalancing has improved the situation. Perhaps you can enlighten us with specifics.
ITT = Intermediate term treasuries.

There have been many threads debunking the myth of the rebalancing bonus.
“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

MrPotatoHead
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Re: Does the 3 fund portfolio seem somewhat flawed?

Post by MrPotatoHead » Sun Jan 07, 2018 8:59 pm

2pedals wrote:
Sat Jan 06, 2018 1:22 pm
nisiprius wrote:
Sat Jan 06, 2018 8:12 am
But a sane person could also decide to own the market, in the same proportions as the market itself owns them.
+1, nisprius thank you, your post was amazing. :beer
Ditto and +2

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