Why isn't everyone using a 3-Fund portfolio?

Postmon · Post by **Postmon** » Tue Jan 24, 2012 11:08 am

I've been an active-fund investor for years but have finally seen the light of indexing.

I've been doing lots of research on lazy portfolios and tilting to determine what's right for me. But, what I keep coming back to is if you're truly a Boglehead and believe that you can't beat the market, why would anyone (including an Adviser) recommend anything other than a 3-Fund portfolio of Total US, Total International, a Bond Index, and maybe TIPS? Isn't anything else just an attempt to beat the market? But, we can't consistently beat the market, right? That's what I'm wrestling with. For those not using a 3-Fund portfolio by choice, I'd be very interested in understanding how and why you made your decision?

fire5soon · Post by **fire5soon** » Tue Jan 24, 2012 11:11 am

I may be a TSM disciple, but that doesn’t mean I don’t allow myself some tilts as an indiscretion.

Midpack · Post by **Midpack** » Tue Jan 24, 2012 11:15 am

Like many here I suspect, my portfolio includes 11 mostly index funds, not far removed from the 3 basic funds you mention. I do so because after a lot of study (Bogle, Bernstein & others) and 30 years experience, I believe I can get the same or slightly better returns with slightly lower risk/volatility. Doing so adds very little in terms of maintenance, I'm still just rebalancing albeit a few more funds to track (effortless with Excel). If I don't get better results, what have I lost for the effort? I am confident I won't get significantly worse results.

Nothing wrong with the 3 fund approach, history suggests our long term results will be very similar. If I wasn't interested in investing, economics, etc. - I hope I would have stumbled on the 3 fund approach, it would have served me well enough.

I have 8 asset classes: LCB, LCV, SCB, SCV, Intl, Emer Mkts, REIT, Energy (LC), Bonds

madbrain · Post by **madbrain** » Tue Jan 24, 2012 11:18 am

There are other assets which simply aren't part of those 3 funds : high-yield bonds, municipal bonds. Real estate is not well represented in TSM/TISM also in comparison to the global weight of RE assets. Thus some people will choose to own REITs also, or real property.

livesoft · Post by **livesoft** » Tue Jan 24, 2012 11:19 am

The reason is simple: I do not believe a 3-fund portfolio provides the best risk-adjusted rate of return that a small-cap and value-tilted portfolio provides.

Some folks might say that my Kool-Aid has a different flavor.

bob90245 · Post by **bob90245** » Tue Jan 24, 2012 11:21 am

You are hearing the words, but not understanding the meaning. It's not that no one can beat the market, aka TSM, but that no one can beat a benchmark index.[1] And there are other areas of the market that are tracked by indexes.

The other areas of the market that have higher risk and higher expected returns are value and small. For historical data, you can check out this chart and the website it is discussed:

Source: http://www.fundadvice.com/fehtml/bhstra ... 0309a.html

[1] rather, fewer and fewer active managers will beat a benchmark index the longer the timeframe measured.

Tim_in_GA · Post by **Tim_in_GA** » Tue Jan 24, 2012 11:25 am

Postmon wrote:... why would anyone (including an Adviser) recommend anything other than a 3-Fund portfolio of Total US, Total International, a Bond Index, and maybe TIPS?

Out of those, only the bond fund is available in my 401k. I have to piece together different funds in my 401k and IRA to approximate the same thing. Comes out to 5 funds but together they pretty much mimic Total US, Total International, and a Bond Index.

tadamsmar · Post by **tadamsmar** » Tue Jan 24, 2012 11:28 am

When I started dyi investing I started following Malkiel's Life-Cycle Investing Plan.

It involves a REIT allocation and a tilt to EM.

I now think that Malkiel does make some bets on beating the market. (Someone will probably post to dispute that claim.)

I did not have that view when I started, but I guess I am sticking with it out of inertia. His bets seem pretty modest to me.

BlueEars · Post by **BlueEars** » Tue Jan 24, 2012 11:34 am

Postmon wrote:...(snip)...
Isn't anything else just an attempt to beat the market? But, we can't consistently beat the market, right? That's what I'm wrestling with. For those not using a 3-Fund portfolio by choice, I'd be very interested in understanding how and why you made your decision?

I think "the market" is a convenient simplification. Once you define it then it is relatively easy to index. But the definition is somewhat arbitrary IMO.

FWIW, I do use the 3 fund portfolio as a benchmark to watch.

KyleAAA · Post by **KyleAAA** » Tue Jan 24, 2012 11:40 am

Postmon wrote:I've been an active-fund investor for years but have finally seen the light of indexing. I've been doing lots of research on lazy portfolios and tilting to determine what's right for me. But, what I keep coming back to is if you're truly a Boglehead and believe that you can't beat the market, why would anyone (including an Adviser) recommend anything other than a 3-Fund portfolio of Total US, Total International, a Bond Index, and maybe TIPS? Isn't anything else just an attempt to beat the market? But, we can't consistently beat the market, right? That's what I'm wrestling with. For those not using a 3-Fund portfolio by choice, I'd be very interested in understanding how and why you made your decision?

People who tilt aren't trying to beat the market. Rather, they are trying to move along the efficient frontier.

Taylor Larimore · Post by **Taylor Larimore** » Tue Jan 24, 2012 11:52 am

Hi Kyle:

People who tilt aren't trying to beat the market. Rather, they are trying to move along the efficient frontier.

The "market" is on the Efficient Frontier. You can read the proof's here:

Three Proofs that TSM is Efficient

Best wishes
Taylor

PreserveCapital · Post by **PreserveCapital** » Tue Jan 24, 2012 12:04 pm

Postmon wrote:I've been an active-fund investor for years but have finally seen the light of indexing. I've been doing lots of research on lazy portfolios and tilting to determine what's right for me. But, what I keep coming back to is if you're truly a Boglehead and believe that you can't beat the market, why would anyone (including an Adviser) recommend anything other than a 3-Fund portfolio of Total US, Total International, a Bond Index, and maybe TIPS? Isn't anything else just an attempt to beat the market? But, we can't consistently beat the market, right? That's what I'm wrestling with. For those not using a 3-Fund portfolio by choice, I'd be very interested in understanding how and why you made your decision?

Perhaps a better question might be, "Why are so few people using it?"

maxfax · Post by **maxfax** » Tue Jan 24, 2012 12:07 pm

I read all the posts so far without being convinced of anything other than ...
Indexing is borrowing, and lacking all the fun of active investing, of trying to 'beat the market'. So instead of 'stock picking' the people on this site 'index pick'.
Risk can be addressed by the asset allocation, so 'tilting' with small-cap and value has nothing to do with taking on more risk. It is about trying to bet a better return.
The argument that putting together a broader range of assets will move you above the CAPM line (higher return without higher risk) is discounted by the most common advice given here to NOT benchmark against a simple debt/equity weighted average, but against a personal benchmark using all the asset classes you own.

But then I am an active stock picker. And when I index because I have no high-confidence picks, I use just one large-cap ETF

baw703916 · Post by **baw703916** » Tue Jan 24, 2012 12:08 pm

Why I tilt:

1) One of the big arguments for the Total Market Portfolio is its simplicity. So, one question an investor should ask themselves is how much they value simplicity, vs. a fair chance, but no guarantee, of modest outperformance. In my case, I don't value simplicity for simplicty's sake that much.

2) Another argument for the Total Market Portolio is that by, definition, any portfolio that deviates from it will necessarily have tracking error. Some of the time that tracking error is bound to be negative. As the theory goes, investors may decide to abandon a tilted portfolio after it experiences a negative tracking error (the old buy high, sell low behavioral problem--at least on a relative basis). Again, this depends on the individual investor. In my case my innate psychological reaction to a big price drop is to buy, not sell.

3) Tilting a portfolio, I think, should only be done with a clear understanding of the theory behind it, and of the possible benefits and risks. SImply put, it's a pretty advanced topic in finance, and IMO an investor who adopts it without understanding the theory behind it may have a harder time staying the course when risk shows up (as it inevitably will). I find the work of Fama/French and others to be logical and reasonably well supported by evidence (I doubt it would ever be possible to have enough data to definitively prove or disprove it). But someone who isn't inclined to wade through all that might be better served by not tilting.

Because of the three Issues above, I sometimes recommend the Total Market Portfolio fo other investors even though I don't use it myself. The Total Market Portfolio is a very good way to invest. One can perhaps do a little better, but one can certainly do a lot worse.

My view on the EMH is that it's mostly true, most of the time. In other words, it's pretty hard to make a living by looking for mispricings. Not necessarily impossible, but hard. And it's even worse to pay someone else a significant expense ratio to look for mispricings for you. If you can't beat the market yourself, don't bother hiring someone else to do it for you. That said, I don't believe that there aren't mispricings--just that counting on identifying and exploiting them on a consistent basis isn't a very good strategy.

Brad

KyleAAA · Post by **KyleAAA** » Tue Jan 24, 2012 12:09 pm

maxfax wrote: The argument that putting together a broader range of assets will move you above the CAPM line (higher return without higher risk) is discounted by the most common advice given here to NOT benchmark against a simple debt/equity weighted average, but against a personal benchmark using all the asset classes you own.

But we aren't trying to earn a higher return with higher risk. Many of us actively want MORE risk in order to get a higher return. The goal is not to maximize return or to minimize risk, it's to find a balance between the two appropriate for our own circumstances.

Morgthorak · Post by **Morgthorak** » Tue Jan 24, 2012 12:11 pm

Postmon wrote:I've been an active-fund investor for years but have finally seen the light of indexing. I've been doing lots of research on lazy portfolios and tilting to determine what's right for me. But, what I keep coming back to is if you're truly a Boglehead and believe that you can't beat the market, why would anyone (including an Adviser) recommend anything other than a 3-Fund portfolio of Total US, Total International, a Bond Index, and maybe TIPS? Isn't anything else just an attempt to beat the market? But, we can't consistently beat the market, right? That's what I'm wrestling with. For those not using a 3-Fund portfolio by choice, I'd be very interested in understanding how and why you made your decision?

I like to value tilt, so I have half my money split evenly between Wellington and Wellesley. The other half is split between LifeStrategy Conservative Growth and LS Moderate Growth. This gives me a 50/50 split between stocks and bonds overall. It gives me the value tilt I prefer, along with the three fund portfolio you mentioned since the LS funds hold Total Stock, Total Bond and Total International.

bob90245 · Post by **bob90245** » Tue Jan 24, 2012 12:14 pm

Historical data shows that multi-asset class portfolios are more efficient than singe-asset class portfolios. This chart was created by Roger Gibson:

Source: http://www.tuveinvestments.com/pdf/Inve ... esting.pdf

maxfax · Post by **maxfax** » Tue Jan 24, 2012 12:18 pm

KyleAAA wrote:Many of us actively want MORE risk in order to get a higher return..

Which can be addresses better using a better asset allocation between debt/equity using the same two basic ETFs, rather than making your equity portion more risky with another ETF - (per my second point)

Taylor Larimore · Post by **Taylor Larimore** » Tue Jan 24, 2012 12:30 pm

Hi Kyle

Many of us actively want MORE risk in order to get a higher return.

The best way to get MORE risk of loss and possibly higher return is to increase your stock allocation. If you feel that is insufficient, consider using total market stock funds with leverage (which I don't recommend).

The stock market is not an actuarial table. More risk always means a greater likelihood of loss.

Best wishes.
Taylor

nisiprius · Post by **nisiprius** » Tue Jan 24, 2012 12:39 pm

"Why isn't everyone using a 3-Fund portfolio?"

In my case: I didn't know Taylor Larimore and his "stay the course" mantra, but, basically, because, at the time I decided to stay the course, I wasn't using a 3-fund portfolio!

Also: inconsistency, lack of discipline, issues caused by multiple accounts (his 401(k), her 401(k), his Roth, her Roth, his Rollover IRA, etc.)--and the fact that at the time I made my first mutual fund investment selection, neither Vanguard Total Stock Market Fund (1992), Total International Stock Market Index (1996), nor Total Bond Market Fund (1986) was available. Quite seriously, I'm not sure what it even means to be a disciplined long-term investor when the best advice and the available investment vehicles seems to shift, decade by decade by decade.

Finally: I lack any strong convictions that there's one sharply defined "right" answer. I cling to John C. Bogle's dictum that "Successful investing involves doing just a few things right and avoiding serious mistakes." I have concentrated all along on "avoiding serious mistakes" and shrugged off any attempts to find the One Best Answer.

SSSS · Post by **SSSS** » Tue Jan 24, 2012 12:41 pm

Postmon wrote:recommend anything other than a 3-Fund portfolio of Total US, Total International, a Bond Index, and maybe TIPS?

If you're going to be that dogmatic about it, why not replace Total US and Total International with Total World Stock?

Next step would be to replace Total Bond and Total World Stock with a (as far as I know, currently non-existent) Total Everything fund. Your largest asset class would be foreign bonds (with the second I think being foreign real estate), but it would be a more accurate reflection of "the market".

ofcmetz · Post by **ofcmetz** » Tue Jan 24, 2012 1:00 pm

Two reasons I'm not using a 3 fund portfolio.

1. We have 4 employer retirement accounts plus 2 Roth IRA's.

2. I wish to have an overweight of REIT's as a part of my portfolio.

That being said our total portfolio resembles a Vanguard Target Retirement Fund plus a REIT Index fund.

FlyHi · Post by **FlyHi** » Tue Jan 24, 2012 1:06 pm

Over the years I have tracked the 3 fund portfolio and I have never found it able to beat the returns of my slice and dice method. The only fund I find that approximates the return of my 35/65 AA is Wellesley and I am loath to put all of my eggs in one basket. Maybe as I get older (now 73) and lose the interest or ability to manage on my own I will switch to a more simplistic approach.

Total Return 3yr 5yr 10yr
My current 15.4% 6.5% 7.3%
Wellesely 14% 6.4% 7%
3 Funds 12% 3.8 % 5.4%

Beagler · Post by **Beagler** » Tue Jan 24, 2012 1:19 pm

As Rick has stated, your portfolio can look like "the market," or it can look like the economy. The two are not synonymous.

investor.saver1 · Post by **investor.saver1** » Tue Jan 24, 2012 1:22 pm

FlyHi wrote:Over the years I have tracked the 3 fund portfolio and I have never found it able to beat the returns of my slice and dice method. The only fund I find that approximates the return of my 35/65 AA is Wellesley and I am loath to put all of my eggs in one basket. Maybe as I get older (now 73) and lose the interest or ability to manage on my own I will switch to a more simplistic approach.

Total Return 3yr 5yr 10yr
My current 15.4% 6.5% 7.3%
Wellesely 14% 6.4% 7%
3 Funds 12% 3.8 % 5.4%

FlyHi...would you be willing to share your AA?

KyleAAA · Post by **KyleAAA** » Tue Jan 24, 2012 1:30 pm

maxfax wrote:
KyleAAA wrote:Many of us actively want MORE risk in order to get a higher return..
Which can be addresses better using a better asset allocation between debt/equity using the same two basic ETFs, rather than making your equity portion more risky with another ETF - (per my second point)

Not really. A 100% stock portfolio isn't going to be more risky than a 90/10 portfolio with a strong small/value tilt. There are certain risk factors I want more exposure to just as there are other risk factors I DON'T want more exposure to. That's the entire reason rationale behind things like the barbel portfolio. So no, simply increasing stock exposure isn't the same thing, especially not if I am already mostly stocks anyway.

maxfax · Post by **maxfax** » Tue Jan 24, 2012 3:34 pm

I'm sorry but I just cannot buy that any one picks their investments according to "There are certain risk factors I want more exposure to". Risk is not something you are attracted to. People are attracted to returns. Of course I don't know you, but I can only think that you simply don't want to admit that you are picking securities in order to try to 'beat the market' --- Just like all the stock-pickers.

nisiprius · Post by **nisiprius** » Tue Jan 24, 2012 3:45 pm

maxfax wrote:I'm sorry but I just cannot buy that any one picks their investments according to "There are certain risk factors I want more exposure to". Risk is not something you are attracted to. People are attracted to returns. Of course I don't know you, but I can only think that you simply don't want to admit that you are picking securities in order to try to 'beat the market' --- Just like all the stock-pickers.

Oh, I don't agree. Gamblers want the big win. They are attracted to volatility itself, because only volatility has the potential for the big win. They want individual stocks, because individual stocks can be "ten baggers" but mutual funds can never fee. And, they are attracted to the adrenaline rush.

Rudyard Kipling's definition of manliness include the requirement

If you can make one heap of all your winnings
And risk it on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breathe a word about your loss...

Some people want the opportunity to experience that.

KyleAAA · Post by **KyleAAA** » Tue Jan 24, 2012 3:46 pm

maxfax wrote:I'm sorry but I just cannot buy that any one picks their investments according to "There are certain risk factors I want more exposure to". Risk is not something you are attracted to. People are attracted to returns. Of course I don't know you, but I can only think that you simply don't want to admit that you are picking securities in order to try to 'beat the market' --- Just like all the stock-pickers.

To each his own. I can assure you, though, that plenty of people are attracted to certain risk factors over others. If more risk tends to lead to more return, then I want more risk. I don't care too much if I suffer large losses.

ruralavalon · Post by **ruralavalon** » Tue Jan 24, 2012 3:47 pm

For those not using a 3-Fund portfolio by choice, I'd be very interested in understanding how and why you made your decision?

We do use the 3 funds, Total Stock Market, Total Bond Market, and Total International as the core of our portfolio. The "how and why" of our deviation from a pure 3 fund portfolio:

we added 5% REIT as a proxy for owning more real estate, this was at the start of our index investing and at the suggestion of an advisor;

we added 5% Precious Metals and Mining because an advisor suggested some additional natural resources exposure, again at the start of our index investing; and

we added 5% Small Cap Value because of reading (and only half believing) posts on Fama/French on this forum. This was actually a simplification of a prior portfolio -- previously S&P 500, plus Mid Cap index, plus Small Cap index; we switched to Total Stock Market plus Small Cap Value index.

grap0013 · Post by **grap0013** » Tue Jan 24, 2012 3:56 pm

I like my 3-Fund portfolio for its simplicity. If I start adding total market or large cap funds it would require too much maintanence.

50% SCV
25% ISCV
25% EMV/ESCV

This mix has historically provided much better risk adjusted returns than your proposed 3-Fund portfolio. Worst 10 year period is 8%+. Worst 5 year period is even ~4%.

kenyan · Post by **kenyan** » Tue Jan 24, 2012 4:16 pm

KyleAAA wrote:
maxfax wrote:I'm sorry but I just cannot buy that any one picks their investments according to "There are certain risk factors I want more exposure to". Risk is not something you are attracted to. People are attracted to returns. Of course I don't know you, but I can only think that you simply don't want to admit that you are picking securities in order to try to 'beat the market' --- Just like all the stock-pickers.
To each his own. I can assure you, though, that plenty of people are attracted to certain risk factors over others. If more risk tends to lead to more return, then I want more risk. I don't care too much if I suffer large losses.

As he said, some people - myself included to some extent - do just that. Your example of being attracted to risk vs. returns is a different way of comparing compensated vs. uncompensated risk. If we aren't compensated adequately for the risk, then that investing instrument is inefficient and likely won't survive as such (or will drop in value until it is fairly enough priced to compensate for and/or lower its risk). The lottery does not work as an investing instrument.

Postmon · Post by **Postmon** » Tue Jan 24, 2012 5:09 pm

Thanks for all the info everyone. This article that Taylor suggested from Mr. Bogle on RTM (return to the mean) is what keeps bringing me back to the simple 3-Fund portfolio. The Telltale Chart: http://www.vanguard.com/bogle_site/sp20020626.html
I have some more thinking to do! I appreciate all your replies.

grap0013 · Post by **grap0013** » Tue Jan 24, 2012 5:17 pm

I wonder why everyone doesn't use my 3 fund portfolio. Google bogleheads and is the telltale chart accurate?

bob90245 · Post by **bob90245** » Tue Jan 24, 2012 5:28 pm

Postmon wrote:Thanks for all the info everyone. This article that Taylor suggested from Mr. Bogle on RTM (return to the mean) is what keeps bringing me back to the simple 3-Fund portfolio. The Telltale Chart: http://www.vanguard.com/bogle_site/sp20020626.html
I have some more thinking to do! I appreciate all your replies.

I think you already know that Bogle has bias. And everyone has their own bias.

But my reading from the linked article is that S&D, at worst, caused no harm matching the S&P 500 during certain periods. The other point to consider is that end points do matter. When the S&P 500 was in a bubble during the 1990's, most other asset classes looked tepid by comparison.

StoneReader · Post by **StoneReader** » Tue Jan 24, 2012 5:34 pm

bob90245,

Thanks for posting Gibson's chart and paper. Exhibit 7 in his paper caught my eye because of the minor losses in the 4-asset portfolio ABCD during the worst years from 1972 to 2005 despite the fact that ABCD had one of the highest returns.

Do you know if this ABCD portfolio or one like it did relatively well during the recent financial meltdown of 2008-2009 when assets became much more correlated?

Severe drawdowns are the hardest thing to live with psychologically since you never know if they will be semipermanent and last for decades, e.g. Japan.

So if something like ABCD had a low drawdown in 2008-2009, it would be impressive proof that this particular 4-asset portfolio (US Stocks, Foreign Stocks, Real Estate & Commodities) is not just another version of rear-view-mirror selection.

Taylor Larimore · Post by **Taylor Larimore** » Tue Jan 24, 2012 5:42 pm

Postmon wrote:This article that Taylor suggested from Mr. Bogle on RTM (return to the mean) is what keeps bringing me back to the simple 3-Fund portfolio. The Telltale Chart:
http://www.vanguard.com/bogle_site/sp20020626.html

Hi Postmon:

Mr. Bogle delivered that speech ten years ago. I sat beside him as he prepared the final version. Those who listened and adopted the 3-fund portfolio have enjoyed above average returns with minimum maintenance.

During the past ten years, Total Stock Market investors ranked in the top 17% of their category; Total International Stock Market investors were in the top 12% of their category; and Total Bond Fund investors were in the top 44% of their category. After taxes, the three funds ranked even better.

Mr. Bogle was right (as usual).

Best wishes.
Taylor

bob90245 · Post by **bob90245** » Tue Jan 24, 2012 5:45 pm

StoneReader wrote:Do you know if this ABCD portfolio or one like it did relatively well during the recent financial meltdown of 2008-2009 when assets became much more correlated?

I'm guessing the later. During times of crisis, you should assume that only the safest assets will hold up.

baw703916 · Post by **baw703916** » Tue Jan 24, 2012 7:01 pm

Taylor Larimore wrote:

Three Proofs that TSM is Efficient

We give three proofs that, under three different assumptions, TSM is efficient, in the sense that no other US stock portfolio can be more efficient than TSM (have lower risk and higher expected return).

The limitation is that this only considers U.S. stocks, and not the other things that a portfolio is likely to contain (international stocks, bonds, perhaps commodities).

Clearly_Irrational · Post by **Clearly_Irrational** » Tue Jan 24, 2012 7:09 pm

1) Because beta only answers 70% of the question, which opens the question of whether to tilt towards other risk factors

2) Because if you believe MPT (or one of it's successors) then adding an additional non-correlated asset class can improve your results

So for me, the combination of the above results in something like this:

30% Small Cap Value
20% Emerging Market
30% Long Term Treasuries
20% Gold

Basically we lowered portfolio beta by holding less stocks and made up for some of the expected returns by holding riskier assets. The small, value and duration risk factors will express themselves as tracking error but for me the downside stability is well worth it. Essentially this portfolio is maximized for Sortino ratio rather than Sharpe ratio. Call it Markowitz-Sortino flavored by Fama-French served Harry Browne style. No portfolio is bullet proof but the market where this one gets crushed seems pretty unlikely.

Beagler · Post by **Beagler** » Tue Jan 24, 2012 7:18 pm

Postmon wrote:Thanks for all the info everyone. This article that Taylor suggested from Mr. Bogle on RTM (return to the mean) is what keeps bringing me back to the simple 3-Fund portfolio. The Telltale Chart: http://www.vanguard.com/bogle_site/sp20020626.html
I have some more thinking to do! I appreciate all your replies.

There are some questions about the methodology used in that article. You can read more about it here: http://tinyurl.com/6tlo8ea

baw703916 · Post by **baw703916** » Tue Jan 24, 2012 7:23 pm

bob90245 wrote:
StoneReader wrote:Do you know if this ABCD portfolio or one like it did relatively well during the recent financial meltdown of 2008-2009 when assets became much more correlated?
I'm guessing the later. During times of crisis, you should assume that only the safest assets will hold up.

Here are the numbers for 2008:

U.S. stocks (VTSMX): -37.04%
International Stocks (VGTSX): -44.1%
Real Estate Securities (VGSIX): -37.05%
Commodities (PCRIX): -43.33%

The problem is the ABCD portfolio's construction backtested all of the previous bear markets from the 1970s on (which were all either inflationary or during a strong real estate market). It never considered a deflationary financial panic caused by a collapse of a real estate bubble. In 2008 you needed Treasuries, and only Treasuries (the longer the duration, the better). And guess what, this portfolio doesn't have any.

I would give this one an F in live returns.

Brad

StoneReader · Post by **StoneReader** » Tue Jan 24, 2012 8:06 pm

ABCD Drawdown in 2008-2009 Financial Crisis; individual drawdowns for this period are in parenthesis.

I did a rough calculation of the ABCD Four-Asset Fund drawdown using VTSAX as the US Stock Fund (-46%), VFWIX as the Foreign Stock Fund (-63%), VGSLX as the Real Estate Fund (-70%) and GLD as the Commodity Fund (+38%) to get an overall drawdown of 35%.

If instead of using GLD, the Energy Fund VGENX (-59%) and the Precious Metal Fund VGPMX (-75%) are used for the Commodity Asset, the overall drawdown for ABCD was 61%.

You would have to go to at least a six asset fund by adding VMSSX Cash (0%) and Bonds VBTLX (0%) to get a lower but still disturbing large drawdown.

So the ABCD four-asset fund may be another case of sophisticated rear-view-mirror investing. What seem to work in the past to minimize severe drawdowns failed in our recent financial crisis.

Interestingly, none of the assets represented by the above funds with the exception of cash and bonds have yet recovered to their former 2007-2008 highs. A bloodied Japanese investor might suggest to his American counterpart that "stay the course" also could be a rear-view-mirror paradigm born from a long bull market starting from 1932. Let's hope not.

Postmon · Post by **Postmon** » Tue Jan 24, 2012 8:12 pm

Clearly_Irrational wrote: 30% Small Cap Value
20% Emerging Market
30% Long Term Treasuries
20% Gold

Basically we lowered portfolio beta by holding less stocks and made up for some of the expected returns by holding riskier assets. The small, value and duration risk factors will express themselves as tracking error but for me the downside stability is well worth it. Essentially this portfolio is maximized for Sortino ratio rather than Sharpe ratio. Call it Markowitz-Sortino flavored by Fama-French served Harry Browne style. No portfolio is bullet proof but the market where this one gets crushed seems pretty unlikely.

Wow! I just ran this through Simba's backtest spreadsheet and the results from 1972-2010 are amazing. What's the catch?

Average 14.00%
Std. Dev. 11.35%
Down SD 4.06%
Up SD 8.04%
CAGR 13.43%
Sharpe 0.74
Sortino 2.22
US Mkt. Corr. 0.64
Intl. Corr. 0.71
Total - Rebalanced (N) 1,363,008
Total-Unbalanced (N) 1,535,163
Total - Rebalanced (Real) 255,581

1972 23.30%
1973 3.16%
1974 5.00%
1975 22.11%
1976 21.40%
1977 20.59%
1978 23.90%
1979 35.65%
1980 14.46%
1981 -0.86%
1982 23.07%
1983 14.70%
1984 3.24%
1985 31.51%
1986 25.97%
1987 8.62%
1988 16.35%
1989 21.24%
1990 -7.43%
1991 27.40%
1992 11.82%
1993 30.35%
1994 -4.68%
1995 16.83%
1996 8.13%
1997 5.91%
1998 -1.97%
1999 10.74%
2000 5.80%
2001 4.91%
2002 4.25%
2003 27.32%
2004 15.32%
2005 13.77%
2006 16.56%
2007 14.65%
2008 -12.42%
2009 25.49%
2010 19.75%

StoneReader · Post by **StoneReader** » Tue Jan 24, 2012 8:22 pm

Postmon: What's the catch? Probably just another case of backtesting which now includes the 2007-2009 financial meltdown. For example, Small Cap Value and Emerging Market Mutual Funds did not exist for much of this period.

What I would like to know is the asset mix that will both give good returns going forward as well as get us through the 20XX crash that is coming with a minimal drawdown?

nisiprius · Post by **nisiprius** » Tue Jan 24, 2012 8:33 pm

If clearly_irrational says that he, personally, has actually been invested in this portfolio since 1972, then my hat's off to him.

Otherwise, the catch is probably just "backtesting." SirHorace did an amazing thing a few years ago. He took a huge set of Vanguard mutual funds, and ran them through a bunch of math to find the mixture that gave the best fit to a perfect, smooth, 8%/annualized growth rate. He describes it here. This is how that backtested portfolio performed:

I reduced it to fit; if you can't read the composition, it's
48% VFITX, 3% VHGCX, 10% VGPMX, 1% VHCOX, 2% VIGRX, and 36% VUSTX.

I've been after SirHorace to update this to show how it has performed since, "out of sample." He hasn't done it for the "8% solution" portfolio, but he did create one that was a fit for the Permanent Portfolio mutual fund, PRPFX, and he updated the results here. It went off the rails immediately, going forward.

baw703916 · Post by **baw703916** » Tue Jan 24, 2012 8:42 pm

StoneReader wrote:Postmon: What's the catch? Probably just another case of backtesting which now includes the 2007-2009 financial meltdown. For example, Small Cap Value and Emerging Market Mutual Funds did not exist for much of this period.

What I would like to know is the asset mix that will both give good returns going forward as well as get us through the 20XX crash that is coming with a minimal drawdown?

The catch with that portfolio, I'd say, is that the period from the 1970s to the present has been one of falling interest rates. Also, gold started from an artificially low baseline (1972) and now is kind of bubbly. So two of the asset classes have had a judiciously chosen time period.

baw703916 · Post by **baw703916** » Tue Jan 24, 2012 8:46 pm

nisiprius wrote:If clearly_irrational says that he, personally, has actually been invested in this portfolio since 1972, then my hat's off to him.

How did he own 20% gold in 1972? That would only have worked if he isn't a U.S. citizen.

musbane · Post by **musbane** » Tue Jan 24, 2012 9:03 pm

But their were loophole on gold ownership.
One was numismatic gold coins, many of which were worth only a little over spot gold value.(what, you want to confiscate my coin collection?)
Another was jewelry, (what, you want to confiscate my wedding ring?!??!!) Leading to a mini industry manufacturing hideous18 to 24 carat heavy gold necklaces and bracelets.

baw703916 · Post by **baw703916** » Tue Jan 24, 2012 9:12 pm

musbane wrote:But their were loophole on gold ownership.
One was numismatic gold coins, many of which were worth only a little over spot gold value.(what, you want to confiscate my coin collection?)
Another was jewelry, (what, you want to confiscate my wedding ring?!??!!) Leading to a mini industry manufacturing hideous18 to 24 carat heavy gold necklaces and bracelets.

Ah, the Mr. T portfolio!