## Talk me out of a 60/40 AA

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Topic Author
nasrullah
Posts: 184
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### Re: Talk me out of a 60/40 AA

OkieIndexer wrote:
Wed Jan 03, 2018 7:46 pm
Historically, the earnings yield of the market has been a pretty good predictor of long-term (7-20 years, roughly) real returns. The earnings yield is simply the reciprocal of the P/E ratio. Currently the Shiller P/E ratio is 33, so the earnings yield of the S&P 500 right now is 1/33 = 3%. Thus over the next 7-20 years roughly you can expect around a 3% total real return from the S&P 500. That's assuming inflation stays relatively stable. If inflation goes up more than expected, you could easily have a negative real return, even out to 20 years. If we get a deflationary depression, real returns could end up negative. But let's assume pretty steady 2% inflation and go with 3% real returns.

For bonds, the current yield is pretty much what you can expect your nominal return to be. The Total Bond fund yield right now is only 2.5%, so if we assume 2% inflation, your real annualized return can be expected to be around 0.5-1% with Total Bond.

Thus a 60/40 portfolio's expected long term real return right now = 0.6(3%) + 0.4(1%) = 2.2% real annualized.

Is a 2% real annualized return over the next ~7-20 years enough to meet your goals? If so, then 60/40 will probably be fine. If not, and you think you can emotionally sit through a couple of 50% plunges in equities, then you need to go with a higher equity allocation.

If you want to factor in international equities, just do the calculations above with a 22 P/E ratio (i.e. 4.5% real expected return long term), which is approximately what the Shiller P/E is right now for World ex-U.S.

Edit: I see you mentioned you want 20% international equities, so your expected real return = (0.2*0.6)(4.5%) + (0.8*0.6)(3%) + 0.4(1%) = 2.4% real annualized. Is that enough to meet your goals? If not, you'll probably need more equities.
This is fascinating to me. Your examples expanded:

60/40 AA (0.2*0.6)(4.5%) + (0.8*0.6)(3%) + 0.4(1%) = 2.38%
70/30 AA (0.2*0.7)(4.5%) + (0.8*0.7)(3%) + 0.3(1%) = 2.61%
75/25 AA (0.2*0.75)(4.5%) + (0.8*0.75)(3%) + 0.25(1%) = 2.73%

Assuming I save \$8,500/month for the next 30 years each portfolio would return:

60/40 \$5,709,768.33
70/30 \$5,965,413.09
75/25 \$6,104,150.59

Assuming my wife outlives me to 89 would mean a 27 year target of funds. At \$15k/month (not counting additional returns during this period b/c I don't know the math) this is a portfolio value of \$4,860,000. In theory I "win" with any of these AA - why not take the road with less potential stress?

There's obviously more unknowns to this - what the actual market returns will be, my ability to continue saving, my actual life expectancy, etc... But even if I was working off of a target of \$5M at retirement, what % of buffer on this goal should be accounted for in my plan?
"We have a lot to do, and very little time, so we must work slowly." Liviu Ciulei | | Thanks vineviz (https://www.bogleheads.org/forum/memberlist.php?mode=viewprofile&u=134698) for the quote.

MotoTrojan
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### Re: Talk me out of a 60/40 AA

nasrullah wrote:
Thu Jan 04, 2018 12:35 am

Assuming I save \$8,500/month for the next 30 years each portfolio would return:

60/40 \$5,709,768.33
70/30 \$5,965,413.09
75/25 \$6,104,150.59

Assuming my wife outlives me to 89 would mean a 27 year target of funds. At \$15k/month (not counting additional returns during this period b/c I don't know the math) this is a portfolio value of \$4,860,000. In theory I "win" with any of these AA - why not take the road with less potential stress?

There's obviously more unknowns to this - what the actual market returns will be, my ability to continue saving, my actual life expectancy, etc... But even if I was working off of a target of \$5M at retirement, what % of buffer on this goal should be accounted for in my plan?
What about taxes and inflation? That will eat up your margin a good bit over 57 years.

Also with a 30 year accumulation horizon, if the market crashes (or earnings shoot up) and we get a P/E more in-line with historical returns, will you change your plan?

Beachdrinks
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### Re: Talk me out of a 60/40 AA

Sandtrap wrote:
Tue Jan 02, 2018 8:21 pm
Talk me out of a 60/40 AA
Mr. Bernstein has some thoughts on that allocation.
http://web.archive.org/web/20061214061 ... in6040.pdf

Is this a longer article or was it meant to be one page? Interested in reading the entire thing. Thanks!

Sandtrap
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### Re: Talk me out of a 60/40 AA

Beachdrinks wrote:
Thu Jan 04, 2018 2:25 pm
Sandtrap wrote:
Tue Jan 02, 2018 8:21 pm
Talk me out of a 60/40 AA
Mr. Bernstein has some thoughts on that allocation.
http://web.archive.org/web/20061214061 ... in6040.pdf

Is this a longer article or was it meant to be one page? Interested in reading the entire thing. Thanks!
Ferri on Bernstein's 60/40 allocation:
He has an interesting take on things you might find interesting.
http://www.etf.com/sections/index-inves ... nopaging=1
Bogleheads Wiki: Everything You Need to Know

randomizer
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### Re: Talk me out of a 60/40 AA

60/40 is a splendid allocation, but I prefer 75:25.
87.5:12.5, EM tilt — HODL the course!

Jerry55
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### Re: Talk me out of a 60/40 AA

I'm not here to talk you out of it, as it's a matter of personal preference.

I retired in 2012, and will be turning 63 in 5 months, and I'm 85/15. But, that's my personal preference.

No one knows your circumstances and comfort level better than you. Do what you feel is right. Good Luck !!!
Retired CSRS on 12/19/2012 @ age 57 w/39 years | Good Bye Tension, Hello Pension !!!

willthrill81
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### Re: Talk me out of a 60/40 AA

Random Walker wrote:
Wed Jan 03, 2018 10:41 am
About 90% of the risk in a 60/40 portfolio is concentrated in the equities. If the equity risk is all TSM, then all that risk is in a single factor, market beta.

Dave
+1

I'm a big stock proponent, but what you say is very true.

I would add that a 60/40 portfolio had a whopping 50% drawdown in the Great Depression in the U.S. Virtually every country has experienced a 50% or greater drawdown for a 60/40 portfolio at some point. I doubt that many 60/40 holders are cognizant of that.

For many investors, I think 30/70 is the 'ultimate' SWAN portfolio. It carries its own risks as well though in the form of lost purchasing power from the bond side. From 1960-1982, long-term Treasuries had a whopping 38% drawdown in real terms. The reason people tend to overlook this is because it happened over a period of many years rather than months as in most bear markets in stocks. Granted, TIPS now exist, but I don't see them as a panacea being that their real returns are at least currently so low.
“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: Talk me out of a 60/40 AA

nasrullah wrote:
Tue Jan 02, 2018 9:37 pm
But why not 100% stocks then? Heck why not lever up to 110%?

This is what I'm missing - increasing the stock AA from 60/40 to 80/20 has less than a 1% increase in CAGR in every 10+ year period I've looked at. You have to shorten the window to < 5 years before I've found a meaningful increase in CAGR. But even then does a 2% increase in CAGR justify a > 20% difference in Max Drawdown?

I'm 38, have \$650k in invested assets, and for the time being have a \$150k/year investment target. Hopefully I'll be able to maintain that, and even more hopefully increase it as time passes. In theory I have time and resources to be more aggressive but why?

Maybe the simple answer is I've finally found *my* AA.
I like to keep things really simple, though I do follow this site and love to tinker with my investments. On the Vanguard website I tested all stock allocations in 10% increments and found that to me, the probability of success percentage was only one or two percent (all in the 90's with a 4% WD rate) going from 40/60 to 60/40. The higher the bond allocation the lower the standard deviation or fluctuation in your account balance. I got this from a FA friend we went to once to get a 2nd opinion on early retirement. So basically it boils down to what is your appetite for risk and sleeping at night and how much confidence do you have in the Monte Carlo simulations. The future is unknown....so I just fluctuate between 50/50 and 70/30. It keeps me out of the bars and I can live with the 3% difference (94% vs 91%) as we have 10 years living expenses in bonds. Good luck!

Random Walker
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### Re: Talk me out of a 60/40 AA

ColorodoRick wrote
On the Vanguard website I tested all stock allocations in 10% increments and found that to me, the probability of success percentage was only one or two percent (all in the 90's with a 4% WD rate) going from 40/60 to 60/40.
To me this reflects one of the great values of Monte Carlo Analysis. When a person gets fairly clear on their goals, they can perform an analysis of the likelihood of reaching their goals with different changes to their asset allocation. For me a big find was that I could achieve what is really important to me with much less risk than I thought. There is frequently a trade off with asset allocation sensitivity analysis between likelihood of reaching goals and end terminal wealth. To me it is somewhat counter intuitive that the plan resulting in higher mean terminal wealth may actually have a lower likelihood of meeting the goals that are most important. This is because when the investor takes more risk, there is a greater dispersion of possible outcomes.

Dave

willthrill81
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### Re: Talk me out of a 60/40 AA

Random Walker wrote:
Fri Jan 05, 2018 2:34 pm
ColorodoRick wrote
On the Vanguard website I tested all stock allocations in 10% increments and found that to me, the probability of success percentage was only one or two percent (all in the 90's with a 4% WD rate) going from 40/60 to 60/40.
To me this reflects one of the great values of Monte Carlo Analysis. When a person gets fairly clear on their goals, they can perform an analysis of the likelihood of reaching their goals with different changes to their asset allocation. For me a big find was that I could achieve what is really important to me with much less risk than I thought. There is frequently a trade off with asset allocation sensitivity analysis between likelihood of reaching goals and end terminal wealth. To me it is somewhat counter intuitive that the plan resulting in higher mean terminal wealth may actually have a lower likelihood of meeting the goals that are most important. This is because when the investor takes more risk, there is a greater dispersion of possible outcomes.

Dave
MC analyses can indeed be useful, but be aware that many, perhaps most, of them do not incorporate mean reversion of returns. Consequently, they tend to significantly overestimate the size of the 'tails' (e.g. more extremely bad and good outcomes) compared to the historic record. The historic record has had smoother return sequences than what most MC analyses predict.
“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

dharrythomas
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### Re: Talk me out of a 60/40 AA

B. Wellington wrote:
Wed Jan 03, 2018 10:34 am
stemikger wrote:
Wed Jan 03, 2018 6:04 am
Talk you out of it? I'll talk you into it! IMHO it's the ultimate SWAN portfolio for all people at all ages.

Im 60/40 and I'm 53 and my wife is 57. My wife shows no interest at all in investing. After thinking about it for 20 plus years, upon retirement, I plan to put it all in the Vanguard Balanced Index Fund for life so in the event I predecease her, her only worry will be whether she will take 3%, 4% or in a really good year 5%. I will rest peacefully in the afterlife this way and sleep better while I'm still in this meat suit.
^^^+1 We are in the same age group and this works for us. Although a Wellington/Wellesley mix that we have held for years. We held a more aggressive portfolio in the past, however I find this to be the ultimate SWAN portfolio for us as well. YMMV.

I keep a printed copy of Peter Bernstein's 60/40 Solution near my desk. Arguably one of the Best papers written on this topic. Every now and then, I will review it just to remind myself to "stay the course".
It's a great paper but to be fair Peter Bernstein did not "stay the course"! Before his death, he repudiated this article and went back to tactical asset allocation.

Ben Newman said the default asset allocation should be 50/50 and that even the most aggressive or conservative investor should be somewhere between 75/25 and 25/75.

Going through a major economic upheaval, seems to refine one's understanding of risk.

I'd never try to talk anyone out of 60/40 or for that matter any allocation between 75/25 and 25/75. Instead of ramping up the risk, the safer courses of action are to either decrease required spending or increase savings.

Good luck

dharrythomas
Posts: 948
Joined: Tue Jun 19, 2007 4:46 pm

### Re: Talk me out of a 60/40 AA

Sandtrap wrote:
Thu Jan 04, 2018 9:56 pm
Ferri on Bernstein's 60/40 allocation:
He has an interesting take on things you might find interesting.
http://www.etf.com/sections/index-inves ... nopaging=1
[/quote]

+1

ThrustVectoring
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### Re: Talk me out of a 60/40 AA

dbr wrote:
Wed Jan 03, 2018 7:31 pm
MotoTrojan wrote:
Wed Jan 03, 2018 7:28 pm
I think you are simply underestimating the impact of a 1% increase in CAGR over a 30-40 year period.
Yes, the characterization of the drawdowns as huge and the return differences as negligible is a distortion in thinking.
Yup. People think about risks wrongly. A fifty percent drawdown does not matter so long as your investment timeframe is long enough. The entire risk is that your CAGR isn't high enough for your savings to support your future saving goals.

If you're saving for things other than retirement in 20+ years, you might need bonds. Otherwise, good portfolio performance during bear markets doesn't matter, only average performance over both bear and bull markets. And both historically and in expectation, equities perform better on average in both bear and bull markets.

If you know that you won't need the money, the ideal asset allocation is 100% equities. Well, technically, the ideal asset allocation is levered up somewhat, but that's a whole other discussion about the Kelley Criterion and whatnot.
Current portfolio: 60% VTI / 40% VXUS

Sandtrap
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### Re: Talk me out of a 60/40 AA

ThrustVectoring wrote:
Fri Jan 05, 2018 9:02 pm
dbr wrote:
Wed Jan 03, 2018 7:31 pm
MotoTrojan wrote:
Wed Jan 03, 2018 7:28 pm
I think you are simply underestimating the impact of a 1% increase in CAGR over a 30-40 year period.
Yes, the characterization of the drawdowns as huge and the return differences as negligible is a distortion in thinking.
Yup. People think about risks wrongly. A fifty percent drawdown does not matter so long as your investment timeframe is long enough. The entire risk is that your CAGR isn't high enough for your savings to support your future saving goals.

If you're saving for things other than retirement in 20+ years, you might need bonds. Otherwise, good portfolio performance during bear markets doesn't matter, only average performance over both bear and bull markets. And both historically and in expectation, equities perform better on average in both bear and bull markets.

If you know that you won't need the money, the ideal asset allocation is 100% equities. Well, technically, the ideal asset allocation is levered up somewhat, but that's a whole other discussion about the Kelley Criterion and whatnot.
Absolutely true.
The problem for retired seniors is that they're running out of time
Many of the factors valuable in the accumulation phase are flipped in the "descending phase".
mahalo
j
Bogleheads Wiki: Everything You Need to Know

smesman
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### Re: Talk me out of a 60/40 AA

ThrustVectoring wrote:
Fri Jan 05, 2018 9:02 pm
If you're saving for things other than retirement in 20+ years, you might need bonds. Otherwise, good portfolio performance during bear markets doesn't matter, only average performance over both bear and bull markets. And both historically and in expectation, equities perform better on average in both bear and bull markets.
There is a nonzero chance that bonds (or safe equivalents like CDs, TIPS or savings) will outperform stocks over a long period. E.g. like what happened in Japan or because of the effects of an aging workforce/global warming or after a war/natural disaster.

There is also a chance you may need the money earlier than 20 years during a bear market.

You're right that stocks do have higher expectation and safe investments also have their risks (inflation, lack of growth). But it seems like the sharpe ratio and worst-case outcomes are improved by combining the two.
ThrustVectoring wrote:
Fri Jan 05, 2018 9:02 pm
If you know that you won't need the money, the ideal asset allocation is 100% equities. Well, technically, the ideal asset allocation is levered up somewhat, but that's a whole other discussion about the Kelley Criterion and whatnot.
If you currently already have more than enough money, why risk it trying to earn more money you don't need?

ThrustVectoring
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### Re: Talk me out of a 60/40 AA

smesman wrote:
Sat Jan 06, 2018 4:10 am
There is a nonzero chance that bonds (or safe equivalents like CDs, TIPS or savings) will outperform stocks over a long period. E.g. like what happened in Japan or because of the effects of an aging workforce/global warming or after a war/natural disaster.
Japan is an anomaly caused by terrible central bank policy.
smesman wrote:
Sat Jan 06, 2018 4:10 am
There is also a chance you may need the money earlier than 20 years during a bear market.
If you treat your non-retirement finances conservatively, this is fairly unlikely. I know people do in fact raid retirement accounts, but I literally plan on them not existing at all whatsoever.
smesman wrote:
Sat Jan 06, 2018 4:10 am
You're right that stocks do have higher expectation and safe investments also have their risks (inflation, lack of growth). But it seems like the sharpe ratio and worst-case outcomes are improved by combining the two.
Historically speaking, the asset allocation with the best worst-case outcome over any two-decade window in the US has been 100% equities. Market corrections are less important relative to CAGR the longer your timeframe is. Over a long enough timeframe, only CAGR matters.
smesman wrote:
Sat Jan 06, 2018 4:10 am
If you currently already have more than enough money, why risk it trying to earn more money you don't need?
Sorry for not being clear - I'm talking about relatively early in the accumulation phase, trying to get an even better growth rate so that the portfolio can grow big enough to weather bear markets.
Current portfolio: 60% VTI / 40% VXUS

willthrill81
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Location: USA

### Re: Talk me out of a 60/40 AA

Sandtrap wrote:
Fri Jan 05, 2018 11:05 pm
ThrustVectoring wrote:
Fri Jan 05, 2018 9:02 pm
dbr wrote:
Wed Jan 03, 2018 7:31 pm
MotoTrojan wrote:
Wed Jan 03, 2018 7:28 pm
I think you are simply underestimating the impact of a 1% increase in CAGR over a 30-40 year period.
Yes, the characterization of the drawdowns as huge and the return differences as negligible is a distortion in thinking.
Yup. People think about risks wrongly. A fifty percent drawdown does not matter so long as your investment timeframe is long enough. The entire risk is that your CAGR isn't high enough for your savings to support your future saving goals.

If you're saving for things other than retirement in 20+ years, you might need bonds. Otherwise, good portfolio performance during bear markets doesn't matter, only average performance over both bear and bull markets. And both historically and in expectation, equities perform better on average in both bear and bull markets.

If you know that you won't need the money, the ideal asset allocation is 100% equities. Well, technically, the ideal asset allocation is levered up somewhat, but that's a whole other discussion about the Kelley Criterion and whatnot.
Absolutely true.
The problem for retired seniors is that they're running out of time
Many of the factors valuable in the accumulation phase are flipped in the "descending phase".
mahalo
j
Right. Highly volatile returns are fine in the accumulation phase, as long as the investor can stomach them. But in the distribution phase, downside volatility can be a killer, particularly in the first 'third' of the retirement period. That's why safe withdrawal rates are much smaller than long-term return averages.
“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

letsgobobby
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### Re: Talk me out of a 60/40 AA

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Last edited by letsgobobby on Fri Jun 28, 2019 6:52 pm, edited 1 time in total.

willthrill81
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Location: USA

### Re: Talk me out of a 60/40 AA

letsgobobby wrote:
Sat Jan 06, 2018 4:21 pm
willthrill81 wrote:
Fri Jan 05, 2018 1:09 pm
Random Walker wrote:
Wed Jan 03, 2018 10:41 am
About 90% of the risk in a 60/40 portfolio is concentrated in the equities. If the equity risk is all TSM, then all that risk is in a single factor, market beta.

Dave
+1

I'm a big stock proponent, but what you say is very true.

I would add that a 60/40 portfolio had a whopping 50% drawdown in the Great Depression in the U.S. Virtually every country has experienced a 50% or greater drawdown for a 60/40 portfolio at some point. I doubt that many 60/40 holders are cognizant of that.

For many investors, I think 30/70 is the 'ultimate' SWAN portfolio. It carries its own risks as well though in the form of lost purchasing power from the bond side. From 1960-1982, long-term Treasuries had a whopping 38% drawdown in real terms. The reason people tend to overlook this is because it happened over a period of many years rather than months as in most bear markets in stocks. Granted, TIPS now exist, but I don't see them as a panacea being that their real returns are at least currently so low.
LTT /= TBM

What was the 60/40 drawdown during the depression in real terms? How well did the 40 buffer against the 75% real drawdown in the 60?
Not well enough for the typical investor to just ride it out. The maximum drawdown was actually worse than I remembered at -62.39%. I'm not sure what the inflation-adjusted drawdown was, but it was still absolutely brutal.
“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

letsgobobby
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### Re: Talk me out of a 60/40 AA

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Last edited by letsgobobby on Sat Jun 22, 2019 12:04 pm, edited 1 time in total.

smesman
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### Re: Talk me out of a 60/40 AA

ThrustVectoring wrote:
Sat Jan 06, 2018 2:11 pm
smesman wrote:
Sat Jan 06, 2018 4:10 am
There is a nonzero chance that bonds (or safe equivalents like CDs, TIPS or savings) will outperform stocks over a long period. E.g. like what happened in Japan or because of the effects of an aging workforce/global warming or after a war/natural disaster.
Japan is an anomaly caused by terrible central bank policy.
Such things are always easy to see in hindsight, but apparently most investors back then did not.

Basically, safe investments protect you against any event seriously impacting companies but not the government.
ThrustVectoring wrote:
Sat Jan 06, 2018 2:11 pm
smesman wrote:
Sat Jan 06, 2018 4:10 am
There is also a chance you may need the money earlier than 20 years during a bear market.
If you treat your non-retirement finances conservatively, this is fairly unlikely. I know people do in fact raid retirement accounts, but I literally plan on them not existing at all whatsoever.
I suppose if your emergency funds are large enough this is correct. Although this may be blurring the line of what are retirement investments. E.g. If I say I'm 100% in stocks but actually only have 60% of my savings in my "retirement" bucket and 40% in my "emergency" bucket, am I 100/0 or 60/40.
ThrustVectoring wrote:
Sat Jan 06, 2018 2:11 pm
Historically speaking, the asset allocation with the best worst-case outcome over any two-decade window in the US has been 100% equities. Market corrections are less important relative to CAGR the longer your timeframe is. Over a long enough timeframe, only CAGR matters.
You are correct but you're also assuming that the (amazing) US stock history will persist and any bear markets will correct themselves within 20 years (or any investment horizon which are, in real life, limited).

The number of unique 20 year time spans we have in history is very limited, and they occurred in an unprecedented time of innovation and expansion. We know that at some point in the future it must slow down as the number of meaningful things to innovate on is limited, although we don't know whether that will be 1 year in the future or 1000 years in the future.

willthrill81
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### Re: Talk me out of a 60/40 AA

letsgobobby wrote:
Sat Jan 06, 2018 4:44 pm
I don't see the specific figure, but I do see you are talking about only US stocks. I agree that international diversification is essential. My 60 stocks is 60/40 intl/domestic.
Yes, an international allocation would have helped in the GD. A 60/40 portfolio of global equities and bonds would have a drawdown of about -52%, which is still terrible, but better than -62%.
“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

Topic Author
nasrullah
Posts: 184
Joined: Fri Feb 10, 2017 11:40 am

### Re: Talk me out of a 60/40 AA

ThrustVectoring wrote:
Fri Jan 05, 2018 9:02 pm
dbr wrote:
Wed Jan 03, 2018 7:31 pm
MotoTrojan wrote:
Wed Jan 03, 2018 7:28 pm
I think you are simply underestimating the impact of a 1% increase in CAGR over a 30-40 year period.
Yes, the characterization of the drawdowns as huge and the return differences as negligible is a distortion in thinking.
Yup. People think about risks wrongly. A fifty percent drawdown does not matter so long as your investment timeframe is long enough. The entire risk is that your CAGR isn't high enough for your savings to support your future saving goals.

If you're saving for things other than retirement in 20+ years, you might need bonds. Otherwise, good portfolio performance during bear markets doesn't matter, only average performance over both bear and bull markets. And both historically and in expectation, equities perform better on average in both bear and bull markets.

If you know that you won't need the money, the ideal asset allocation is 100% equities. Well, technically, the ideal asset allocation is levered up somewhat, but that's a whole other discussion about the Kelley Criterion and whatnot.
But doesn't this just become the justification for a 90/10 portfolio (which by the way is what Vanguard's tool recommends for me at my age, and what their target retirement fund allocation is)? There's no way of knowing if/when I'm going to need the money. Life makes that part interesting.

Just to work through this, at what size (relative to annual cash needs) would an AA of Bonds decrease? If you have 20x your annual cash need in a 90/10 portfolio and are 70 years old, why ratchet down the equities?
"We have a lot to do, and very little time, so we must work slowly." Liviu Ciulei | | Thanks vineviz (https://www.bogleheads.org/forum/memberlist.php?mode=viewprofile&u=134698) for the quote.

wander
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### Re: Talk me out of a 60/40 AA

Actually, you can have any asset allocation you want and I have no business to talk you out of it. I have a different AA that suits me.

Topic Author
nasrullah
Posts: 184
Joined: Fri Feb 10, 2017 11:40 am

### Re: Talk me out of a 60/40 AA

Until this discussion, the key point I understood in picking an AA was in essence to protect the investor from doing something stupid during a market downturn. This quoted all over the place with an expectation of 50% reduction in value in equities with bonds in theory maintaining value. Based on that assumption, relative risk for 90/10, 80/20, 60/40, etc... can be assumed. On this forum multiple threads turn into "what did you do in 08/00, would you stay the course or sell"? It's easy to optimize for the upside, the real trick is optimizing for assumed behavior on the downside right?

I like to think that I'm a pretty levelheaded, rational based person. But I have no way of knowing how I would react to a 50% drop in the market. I have to believe that the potential to do something stupid is going to be high, so I need to put myself in the best position to defend against that now. I view that as:

1. Keep debt to zero (excluding Mortgage)
2. Seed emergency fund,
3. AA that will enable me to sleep

I used to partition off accounts into different mental buckets and only look at my AA in my investment, not emergency funds. I've been educated into correcting that thinking and to look at my portfolio and AA as a whole, which is what has driven me to this question of AA. Reading this thread I'm coming to a different conclusion that I originally had, and that my AA really should be split into:

1. Enough Cash/TIPS/Bonds to make me feel safe at night (at this phase of life I'm thinking that's ~2 years of cash)
2. Everything else in Equities for maximum growth and accumulation.

Is it crazy to fund at a 60/40 split until Bonds hit the magic number for me and then only invest in Equities? Or should I just solely invest in Bonds until I hit the number and then go only into Equities?

I have no expectation of needing the money in the short term, I do have an obligation of protecting my family as best as I can.
"We have a lot to do, and very little time, so we must work slowly." Liviu Ciulei | | Thanks vineviz (https://www.bogleheads.org/forum/memberlist.php?mode=viewprofile&u=134698) for the quote.

dbr
Posts: 29798
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### Re: Talk me out of a 60/40 AA

nasrullah wrote:
Sun Jan 07, 2018 1:08 pm

Just to work through this, at what size (relative to annual cash needs) would an AA of Bonds decrease? If you have 20x your annual cash need in a 90/10 portfolio and are 70 years old, why ratchet down the equities?
Asset allocation is determined by your judgement and preference for what you want to do. The thought process of need/ability/willingness to take risk is one useful point of view to inform your judgement and preference. In the end you are responsible for your own decisions.

If you want to know a technical reason to ratchet down equities in the situation you describe it is that the investor can meet his withdrawal needs just as well with less stock without having to experience so much ups and downs in wealth or an extreme chance that something might go badly wrong in the stock market. On the other hand if, in addition to funding his income, he also wants to maximize the wealth he hands on to others he would not ratchet down his equity allocation. But this is a preference to be arrived at by each person and tells you nothing about what you want to do. That has to come from you.

ThrustVectoring
Posts: 753
Joined: Wed Jul 12, 2017 2:51 pm

### Re: Talk me out of a 60/40 AA

nasrullah wrote:
Sun Jan 07, 2018 1:08 pm
But doesn't this just become the justification for a 90/10 portfolio (which by the way is what Vanguard's tool recommends for me at my age, and what their target retirement fund allocation is)? There's no way of knowing if/when I'm going to need the money. Life makes that part interesting.

Just to work through this, at what size (relative to annual cash needs) would an AA of Bonds decrease? If you have 20x your annual cash need in a 90/10 portfolio and are 70 years old, why ratchet down the equities?
This is an argument for something in the style of liability-matching. Your "life happens" cash needs are independent of your retirement portfolio size; if you save an extra \$300k, that doesn't make getting thyroid surgery any more expensive.

Like, my overall strategy during accumulation is to set a limit to my cash buffer and immediately invest 100% of any overflow. When "will I be able to retire in the next 5 years" becomes a "maybe", I'll start purchasing intermediate-term bonds with savings and stock dividends, and see how things pan out closer to my planned retirement date. I'm not all that concerned about this phase, though, since there's a good chance I'll continue working past the point at which I have way too much money, and just stay 100% equities with a sub-2% withdrawal rate.
Current portfolio: 60% VTI / 40% VXUS

BogleBoogie
Posts: 635
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Location: AK

### Re: Talk me out of a 60/40 AA

Same AA here using same logic. I am close in age, though behind you considerably with total saved and savings rate. I like 60/40!

fire4fun
Posts: 91
Joined: Tue Dec 25, 2018 2:29 am

### Re: Talk me out of a 60/40 AA

Alexa9 wrote:
Tue Jan 02, 2018 8:23 pm
I read online that The Big Crash is coming THIS YEAR! Now that I think about it, I read that the last 10 years. I think they were right in 2008. The truth is nobody knows nothing, so protect your butt with bonds.
Peter Schiff WAS RIGHT AGAIN !!

qwertyjazz
Posts: 1129
Joined: Tue Feb 23, 2016 4:24 am

### Re: Talk me out of a 60/40 AA

nasrullah wrote:
Sun Jan 07, 2018 1:32 pm
Until this discussion, the key point I understood in picking an AA was in essence to protect the investor from doing something stupid during a market downturn. This quoted all over the place with an expectation of 50% reduction in value in equities with bonds in theory maintaining value. Based on that assumption, relative risk for 90/10, 80/20, 60/40, etc... can be assumed. On this forum multiple threads turn into "what did you do in 08/00, would you stay the course or sell"? It's easy to optimize for the upside, the real trick is optimizing for assumed behavior on the downside right?

I like to think that I'm a pretty levelheaded, rational based person. But I have no way of knowing how I would react to a 50% drop in the market. I have to believe that the potential to do something stupid is going to be high, so I need to put myself in the best position to defend against that now. I view that as:

1. Keep debt to zero (excluding Mortgage)
2. Seed emergency fund,
3. AA that will enable me to sleep

I used to partition off accounts into different mental buckets and only look at my AA in my investment, not emergency funds. I've been educated into correcting that thinking and to look at my portfolio and AA as a whole, which is what has driven me to this question of AA. Reading this thread I'm coming to a different conclusion that I originally had, and that my AA really should be split into:

1. Enough Cash/TIPS/Bonds to make me feel safe at night (at this phase of life I'm thinking that's ~2 years of cash)
2. Everything else in Equities for maximum growth and accumulation.

Is it crazy to fund at a 60/40 split until Bonds hit the magic number for me and then only invest in Equities? Or should I just solely invest in Bonds until I hit the number and then go only into Equities?

I have no expectation of needing the money in the short term, I do have an obligation of protecting my family as best as I can.
I do not understand percentages as a risk strategy either emotionally or financially. A 40 percent drawdown or a 70 percent drawdown would be equally likely to make me panic if I was tempted to panic - possibly even a 5 percent drawdown. I spend cash not percentages so I need to secure the amount in safe funds. I think that is the most likely to not have me panic and also provide. Given diminishing utility of increasing money, I also think an AA model would be flawed if ever analyzed formally - although I have not seen a definitive paper on that.
Your mental accounting model initially and your ‘bucket-like’ approach now make more sense to me. The key questions are though why do you pick 2 years of cash and are you sure of when you will need your ‘investments’ - major expense/decreased income etc
The other thing to think about is sequence of returns risk of how you get to your final portfolio - there will be good and bad period of years and there is not a good way a priori to predict that - so going bonds then equities could be either a good or bad strategy based on luck of timing
G.E. Box "All models are wrong, but some are useful."

Posts: 713
Joined: Sat Jan 02, 2016 6:20 pm

### Re: Talk me out of a 60/40 AA

willthrill81 wrote:
Sat Jan 06, 2018 6:02 pm
letsgobobby wrote:
Sat Jan 06, 2018 4:44 pm
I don't see the specific figure, but I do see you are talking about only US stocks. I agree that international diversification is essential. My 60 stocks is 60/40 intl/domestic.
Yes, an international allocation would have helped in the GD. A 60/40 portfolio of global equities and bonds would have a drawdown of about -52%, which is still terrible, but better than -62%.
Hi willthrill81,

Might you share your data set on international returns from the Great Depression era? I was told that the international data didnt go that far back.

aristotelian
Posts: 5931
Joined: Wed Jan 11, 2017 8:05 pm

### Re: Talk me out of a 60/40 AA

I think 60/40 is a fine allocation. A couple arguments to consider if you want to be talked out if it.

Regarding risk adjusted returns, that is true but absolute returns matter too. Even if you are giving up "only" 1% of return annually in exchange for reduced volatility, that can have a dramatic impact when compounded over time. Think of the conniption fits people would have if you went with a financial advisor charging that much.

Depending on the length of your retirement and your withdrawal rate, more stock could needed to stay ahead of inflation. If your withdrawal rate is under 4% you should be fine, but for anything higher, more stock improves your success chances, especially over long periods. To make 60/40 pass the back tests, you are probably going to need to save a bit more than with a more aggressive portfolio.

X528
Posts: 55
Joined: Fri Nov 30, 2018 8:51 am

### Re: Talk me out of a 60/40 AA

Wed Jan 09, 2019 7:14 am
willthrill81 wrote:
Sat Jan 06, 2018 6:02 pm
letsgobobby wrote:
Sat Jan 06, 2018 4:44 pm
I don't see the specific figure, but I do see you are talking about only US stocks. I agree that international diversification is essential. My 60 stocks is 60/40 intl/domestic.
Yes, an international allocation would have helped in the GD. A 60/40 portfolio of global equities and bonds would have a drawdown of about -52%, which is still terrible, but better than -62%.
Hi willthrill81,

Might you share your data set on international returns from the Great Depression era? I was told that the international data didnt go that far back.
According to the Vanguard model portfolios website:

https://personal.vanguard.com/us/insigh ... ns?lang=en

For 1926 - 2017, a 60/40 portfolio had a worst loss of a mere -26.6% (although with no foreign stock).

michaeljc70
Posts: 5347
Joined: Thu Oct 15, 2015 3:53 pm

### Re: Talk me out of a 60/40 AA

nasrullah wrote:
Tue Jan 02, 2018 9:37 pm
But why not 100% stocks then? Heck why not lever up to 110%?

This is what I'm missing - increasing the stock AA from 60/40 to 80/20 has less than a 1% increase in CAGR in every 10+ year period I've looked at. You have to shorten the window to < 5 years before I've found a meaningful increase in CAGR. But even then does a 2% increase in CAGR justify a > 20% difference in Max Drawdown?

I'm 38, have \$650k in invested assets, and for the time being have a \$150k/year investment target. Hopefully I'll be able to maintain that, and even more hopefully increase it as time passes. In theory I have time and resources to be more aggressive but why?

Maybe the simple answer is I've finally found *my* AA.
I'd play with the sim tools indicated above and look at the chart from the revised Trinity Study (https://www.forbes.com/sites/wadepfau/2 ... d-to-2018/). Looking at a 30 year retirement and a 4% SWR you can see your chance of success looks like this: (% stocks/% success) 100%/94%, 75%/98%, 50%/100%, 25%/87%. Where you'll see a bigger difference is if you go to a higher swr (or longer retirement). For 5%, 30 years: 100%/78%, 75%/78%, 50%/70%, 25%/44%. There will also be differences in remaining assets at death.

I have a very similar AA to you (78/22). For retirement I am planning on 75/25 or 70/30. The fixed income are just to get me through bad periods of stock performance and I think those percents are sufficient to do that. I don't think there are many people that think fixed income will outperform stocks over the long term (30+ years).

WoodSpinner
Posts: 786
Joined: Mon Feb 27, 2017 1:15 pm

### Re: Talk me out of a 60/40 AA

Wombatty wrote:
Wed Jan 03, 2018 5:47 am
I would highly recommend reading this series of Asset Allocation articles.
The link below goes to the third post.

http://idiosyncraticwhisk.blogspot.com. ... short.html
I need some help understanding the logic and graphs in this article. The conclusions seem so contrary to my “limited” understanding of best practices that I am not sure what to think.

Can anyone help me bridge the gap?

WoodSpinner

willthrill81
Posts: 11939
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

### Re: Talk me out of a 60/40 AA

Wed Jan 09, 2019 7:14 am
willthrill81 wrote:
Sat Jan 06, 2018 6:02 pm
letsgobobby wrote:
Sat Jan 06, 2018 4:44 pm
I don't see the specific figure, but I do see you are talking about only US stocks. I agree that international diversification is essential. My 60 stocks is 60/40 intl/domestic.
Yes, an international allocation would have helped in the GD. A 60/40 portfolio of global equities and bonds would have a drawdown of about -52%, which is still terrible, but better than -62%.
Hi willthrill81,

Might you share your data set on international returns from the Great Depression era? I was told that the international data didnt go that far back.
Unfortunately, I can't locate the source of my information now. But this post from Meb Faber gives some useful info on 60/40 AA during the GD.
“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

ThrustVectoring
Posts: 753
Joined: Wed Jul 12, 2017 2:51 pm

### Re: Talk me out of a 60/40 AA

nasrullah wrote:
Tue Jan 02, 2018 9:37 pm
This is what I'm missing - increasing the stock AA from 60/40 to 80/20 has less than a 1% increase in CAGR in every 10+ year period I've looked at. You have to shorten the window to < 5 years before I've found a meaningful increase in CAGR. But even then does a 2% increase in CAGR justify a > 20% difference in Max Drawdown?
If you're investing over long enough time periods, there's exactly two things that matter: CAGR, and avoiding financial ruin. CAGR determines how much money today's investment ends up at, and avoiding financial ruin determines whether or not you make it long enough to realize your investing goals.

Adding CAGR is always worthwhile so long as your investment strategy does not get so aggressive that it will eventually suffer a near-100% drawdown. Fortunately, a 100% stock allocation to global cap-weighted equities (like I have) is conservative enough that the money you invest today will almost certainly be worth some amount of money thirty years from now. Reducing my stock exposure and adding bonds makes little sense: it's a strategy that gets your portfolio further away from possible financial ruin at the cost of CAGR. I'm already far enough away from financial ruin that I don't have to worry about stock market losses causing one, so all it'd really do is give me less money at retirement.

NB: There are non-stock-market sources of financial ruin, and if you're relying on your savings to protect yourself from those then you can't afford to be 100% stocks, since then a combination of needing your savings and a stock market collapse would wipe you out. I have good own-occupation disability insurance, term life insurance for my dependents, and have highly sought-after career skills. This helps me a lot when it comes to sleeping well at night with a 100% stock allocation.
Current portfolio: 60% VTI / 40% VXUS

EfficientInvestor
Posts: 163
Joined: Thu Nov 01, 2018 7:02 pm

### Re: Talk me out of a 60/40 AA

Sandtrap wrote:
Thu Jan 04, 2018 9:56 pm
Beachdrinks wrote:
Thu Jan 04, 2018 2:25 pm
Sandtrap wrote:
Tue Jan 02, 2018 8:21 pm
Talk me out of a 60/40 AA
Mr. Bernstein has some thoughts on that allocation.
http://web.archive.org/web/20061214061 ... in6040.pdf

Is this a longer article or was it meant to be one page? Interested in reading the entire thing. Thanks!
Ferri on Bernstein's 60/40 allocation:
He has an interesting take on things you might find interesting.
http://www.etf.com/sections/index-inves ... nopaging=1
As Ferri's article suggests, a 30/70 portfolio is very near the tangency point of the efficient frontier and therefore provides the best Sharpe ratio. In other words, you have your most efficient use of capital by investing at this point on the curve. Here is a recreation of that efficient frontier (using total stock market and int. term treasuries) showing that the tangency portfolio is just about 30/70:

https://www.portfoliovisualizer.com/eff ... teTreasury

While the 30/70 point represents the most efficient use of capital, it is unwise for someone in the wealth building phase to invest here because you would be leaving too much potential return on the table. Therefore, due to lack of better options, we invest in a 60/40 portfolio or beyond. The further you go toward all stock, the less efficient you become. However, over time, you do get better returns, however marginal they may be. This brings us to the heart of the OP's original question...does it make sense to go beyond 60/40 to get that marginal additional return if it means drastically greater risk?

My answer to the question would be no. It does not make sense to do so. However, people do it all the time due to lack of other options. However, instead of making a decision to go further out on the curve, I think it makes more sense to stick with the most efficient allocation and then apply leverage. For instance, what if you apply 2X leverage to a 30/70 portfolio instead of using a 60/40 unleveraged portfolio? The backtest below shows that since 2006 (inception of SSO), you would have generated better returns with less risk than the 60/40 portfolio. In fact, you would have generated better returns than a 100/0 portfolio with less risk than a 60/40 portfolio. (Note...VUSTX is used as a proxy for the 2X bond fund (UBT). See the second link for a comparison of those two funds.)

https://www.portfoliovisualizer.com/bac ... tion4_3=70

https://www.portfoliovisualizer.com/bac ... ion2_2=100

Jul 2006 - Dec 2018
Portfolio 1 (30/70) - CAGR = 6.4%, Max DD = -8.6%, Sharpe Ratio = 1.04
Portfolio 2 (60/40) - CAGR = 7.3%, Max DD = -26.8%, Sharpe Ratio = 0.80
Portfolio 3 (2X 30/70) - CAGR = 9.4%, Max DD = -21.6%, Sharpe Ratio = 0.87
S&P 500 - CAGR = 7.7%, Max DD = -51.0%, Sharpe Ratio = 0.52

The leveraged fund is not as efficient as the unleveraged 30/70 fund due to additional fund fees and volatility drag. However, over this time period, it would have been a better alternative than 60/40 or 100/0. Therefore, I would chose the inefficiencies of fees and volatility drag over the inefficiencies of increased stock allocation beyond 30/70.

willthrill81
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Location: USA

### Re: Talk me out of a 60/40 AA

EfficientInvestor wrote:
Wed Jan 09, 2019 2:18 pm
My answer to the question would be no. It does not make sense to do so. However, people do it all the time due to lack of other options. However, instead of making a decision to go further out on the curve, I think it makes more sense to stick with the most efficient allocation and then apply leverage. For instance, what if you apply 2X leverage to a 30/70 portfolio instead of using a 60/40 unleveraged portfolio? The backtest below shows that since 2006 (inception of SSO), you would have generated better returns with less risk than the 60/40 portfolio. In fact, you would have generated better returns than a 100/0 portfolio with less risk than a 60/40 portfolio. (Note...VUSTX is used as a proxy for the 2X bond fund (UBT).
Be very careful with trying to make conclusions like this on the basis of 13 years of data. Further, leverage can be difficult or impossible to use in common account types like 401k plans.
“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

TheTimeLord
Posts: 6294
Joined: Fri Jul 26, 2013 2:05 pm

### Re: Talk me out of a 60/40 AA

nasrullah wrote:
Tue Jan 02, 2018 8:18 pm
Past performance doesn't guarantee future results - blah, blah, blah.

Assuming a three fund portfolio (VTSMX, VGTSX, VBMFX) with 20% of equities in International I've been looking to justify an Age-10/15 in Bonds portfolio. I haven't been able to find any combination (even messing with the International allocation) of Asset Allocation, rebalancing period, etc... where the CAGR/IRR is more than 1% off between them, but with MASSIVELY different Worst Year / Max Drawdown percentages?

Seriously though, how do you justify an extremely minimal difference in the return over a 10% difference in the max drawdown for the period? If you're willing to take a -40% ride, why not just go 100% VFINX and at least get something in the end to justify the ulcers along the way?

https://www.portfoliovisualizer.com/bac ... ation7_3=0
Talk me into trying to talk you out of something, not going to happen. Why would you want a stranger to talk you out of something or into something? They are not going to have to live with the consequences, you are. They don't really understand your situation, you do. They aren't really invested in your success and failure, you are. So no, I won't try to talk you into or out of something but I will discuss issues and share my thoughts.
IMHO, Investing should be about living the life you want, not avoiding the life you fear. | Run, You Clever Boy! [9085]

EfficientInvestor
Posts: 163
Joined: Thu Nov 01, 2018 7:02 pm

### Re: Talk me out of a 60/40 AA

willthrill81 wrote:
Wed Jan 09, 2019 2:22 pm
EfficientInvestor wrote:
Wed Jan 09, 2019 2:18 pm
My answer to the question would be no. It does not make sense to do so. However, people do it all the time due to lack of other options. However, instead of making a decision to go further out on the curve, I think it makes more sense to stick with the most efficient allocation and then apply leverage. For instance, what if you apply 2X leverage to a 30/70 portfolio instead of using a 60/40 unleveraged portfolio? The backtest below shows that since 2006 (inception of SSO), you would have generated better returns with less risk than the 60/40 portfolio. In fact, you would have generated better returns than a 100/0 portfolio with less risk than a 60/40 portfolio. (Note...VUSTX is used as a proxy for the 2X bond fund (UBT).
Be very careful with trying to make conclusions like this on the basis of 13 years of data. Further, leverage can be difficult or impossible to use in common account types like 401k plans.
I agree that this strategy would not be possible in certain account types. I also agree that 13 years of data is not nearly enough. I was just limited by the lifetime of SSO. However, I have performed similar backtests going back to Jan 1987 using daily data from indexes and the pattern still remains. That pattern being that the use of leverage on an efficient allocation like 30/70 provides better returns than a more inefficient allocation like 60/40 and beyond. For instance, here are some screen shots of results using 3X S&P 500 (UPRO) and 3X LT Treasury (UPRO). I used daily data from VFINX and VUSTX to create proxy funds and uploaded them to PV. For Portfolio 2, I added an amount of total bonds until max drawdown approximately equaled that of the 60/40 portoflio. The last two pics show my proxy fund vs the actual fund to serve as sufficient proof that the proxy funds represent what the real funds would have done had they been around. I would go further back in time if I had more daily data.

UPRO vs UPRO1980 (proxy)

TMF vs TMF1987 (proxy)

ThrustVectoring
Posts: 753
Joined: Wed Jul 12, 2017 2:51 pm

### Re: Talk me out of a 60/40 AA

EfficientInvestor wrote:
Wed Jan 09, 2019 2:18 pm

My answer to the question would be no. It does not make sense to do so. However, people do it all the time due to lack of other options. However, instead of making a decision to go further out on the curve, I think it makes more sense to stick with the most efficient allocation and then apply leverage. For instance, what if you apply 2X leverage to a 30/70 portfolio instead of using a 60/40 unleveraged portfolio? The backtest below shows that since 2006 (inception of SSO), you would have generated better returns with less risk than the 60/40 portfolio. In fact, you would have generated better returns than a 100/0 portfolio with less risk than a 60/40 portfolio. (Note...VUSTX is used as a proxy for the 2X bond fund (UBT). See the second link for a comparison of those two funds.)
You want to use the cheapest source of leverage you can find. The 2x stock and bond ETFs are not that, due to the fairly large expense ratios involved and daily rebalancing (realizes capital gains). It's almost certainly better to roll things yourself via the embedded leverage in options and/or futures. Treasury futures in particular look attractive - the market is extraordinarily liquid, the contract ties up extremely little capital (a 2-year treasury futures contract is \$200k of notional value and requires roughly \$500 of margin committed, though longer-term treasuries are more risky per dollar face value and as such offer less leverage), and the cost of leverage tends to be around the 3-month treasury bill rate due to arbitrage.

Also, for what it's worth, 2006 is a really favorable starting point for adding levered bonds to a stock portfolio. Depending on how aggressively you add leverage to your bonds (and relatedly, how short-term they are), you wind up with a portfolio that gained value in the 2008 crisis due to profiting off the fed's quantitative easing program. The real test for the portfolio is something like the stagflation of the 70's.
Current portfolio: 60% VTI / 40% VXUS

2pedals
Posts: 852
Joined: Wed Dec 31, 2014 12:31 pm

### Re: Talk me out of a 60/40 AA

A 40/60 AA in early retirement before SS, no pension or annuity, portfolio protection in the first few years of early retirement to limit your sequence of return risks seems prudent to me. You can let your stock investments grow and AA change gradually increasing to 60/40 after your sequence of return risks are gone when you start to take SS.

michaeljc70
Posts: 5347
Joined: Thu Oct 15, 2015 3:53 pm

### Re: Talk me out of a 60/40 AA

There was a thread in the last few months about a new fund that did leverage bonds and also had equities. It is by WisdomTree and is 90/60. It uses futures and the ER is .2%. I'm not endorsing it, I just saw several posts about leveraging FI.

viewtopic.php?f=10&t=256020

EfficientInvestor
Posts: 163
Joined: Thu Nov 01, 2018 7:02 pm

### Re: Talk me out of a 60/40 AA

ThrustVectoring wrote:
Wed Jan 09, 2019 2:53 pm
EfficientInvestor wrote:
Wed Jan 09, 2019 2:18 pm

My answer to the question would be no. It does not make sense to do so. However, people do it all the time due to lack of other options. However, instead of making a decision to go further out on the curve, I think it makes more sense to stick with the most efficient allocation and then apply leverage. For instance, what if you apply 2X leverage to a 30/70 portfolio instead of using a 60/40 unleveraged portfolio? The backtest below shows that since 2006 (inception of SSO), you would have generated better returns with less risk than the 60/40 portfolio. In fact, you would have generated better returns than a 100/0 portfolio with less risk than a 60/40 portfolio. (Note...VUSTX is used as a proxy for the 2X bond fund (UBT). See the second link for a comparison of those two funds.)
You want to use the cheapest source of leverage you can find. The 2x stock and bond ETFs are not that, due to the fairly large expense ratios involved and daily rebalancing (realizes capital gains). It's almost certainly better to roll things yourself via the embedded leverage in options and/or futures. Treasury futures in particular look attractive - the market is extraordinarily liquid, the contract ties up extremely little capital (a 2-year treasury futures contract is \$200k of notional value and requires roughly \$500 of margin committed, though longer-term treasuries are more risky per dollar face value and as such offer less leverage), and the cost of leverage tends to be around the 3-month treasury bill rate due to arbitrage.

Also, for what it's worth, 2006 is a really favorable starting point for adding levered bonds to a stock portfolio. Depending on how aggressively you add leverage to your bonds (and relatedly, how short-term they are), you wind up with a portfolio that gained value in the 2008 crisis due to profiting off the fed's quantitative easing program. The real test for the portfolio is something like the stagflation of the 70's.
I agree that futures would be ideal in terms of cost and avoidance of volatility drag from daily leverage resetting. However, for the purposes of the average investor making use of these concepts, I think leveraged ETFs make more sense. Also, as you discussed in another post, leveraged ETFs have a built-in downside protection due to the daily resetting, so I like that as well. I believe you called it "convexity". Also, during up, stable years, the leveraged ETFs outperform their stated goal. Overall, between the expense ratio of around 1% and the volatility drag, which probably adds another 1-2%, you are looking at around ~3% for your "borrowing cost". As for options...it looks like the current cost for a 1-year SPY call 33% ITM (3X leverage) is such that the extrinsic value is about 2.3% of the total cost. There isn't much extrinsic value at all for a bond fund like TLT, so there wouldn't be much cost there. If you average it all out, you may be around a 1% borrowing cost. However, if you are holding options on SPY and TLT instead of holding UPRO and TMF outright, you miss out on the dividends. Current yield for UPRO is 0.63% and for TMF it is 1.5%.

ThrustVectoring
Posts: 753
Joined: Wed Jul 12, 2017 2:51 pm

### Re: Talk me out of a 60/40 AA

EfficientInvestor wrote:
Wed Jan 09, 2019 8:30 pm
ThrustVectoring wrote:
Wed Jan 09, 2019 2:53 pm
EfficientInvestor wrote:
Wed Jan 09, 2019 2:18 pm

My answer to the question would be no. It does not make sense to do so. However, people do it all the time due to lack of other options. However, instead of making a decision to go further out on the curve, I think it makes more sense to stick with the most efficient allocation and then apply leverage. For instance, what if you apply 2X leverage to a 30/70 portfolio instead of using a 60/40 unleveraged portfolio? The backtest below shows that since 2006 (inception of SSO), you would have generated better returns with less risk than the 60/40 portfolio. In fact, you would have generated better returns than a 100/0 portfolio with less risk than a 60/40 portfolio. (Note...VUSTX is used as a proxy for the 2X bond fund (UBT). See the second link for a comparison of those two funds.)
You want to use the cheapest source of leverage you can find. The 2x stock and bond ETFs are not that, due to the fairly large expense ratios involved and daily rebalancing (realizes capital gains). It's almost certainly better to roll things yourself via the embedded leverage in options and/or futures. Treasury futures in particular look attractive - the market is extraordinarily liquid, the contract ties up extremely little capital (a 2-year treasury futures contract is \$200k of notional value and requires roughly \$500 of margin committed, though longer-term treasuries are more risky per dollar face value and as such offer less leverage), and the cost of leverage tends to be around the 3-month treasury bill rate due to arbitrage.

Also, for what it's worth, 2006 is a really favorable starting point for adding levered bonds to a stock portfolio. Depending on how aggressively you add leverage to your bonds (and relatedly, how short-term they are), you wind up with a portfolio that gained value in the 2008 crisis due to profiting off the fed's quantitative easing program. The real test for the portfolio is something like the stagflation of the 70's.
I agree that futures would be ideal in terms of cost and avoidance of volatility drag from daily leverage resetting. However, for the purposes of the average investor making use of these concepts, I think leveraged ETFs make more sense. Also, as you discussed in another post, leveraged ETFs have a built-in downside protection due to the daily resetting, so I like that as well. I believe you called it "convexity". Also, during up, stable years, the leveraged ETFs outperform their stated goal. Overall, between the expense ratio of around 1% and the volatility drag, which probably adds another 1-2%, you are looking at around ~3% for your "borrowing cost". As for options...it looks like the current cost for a 1-year SPY call 33% ITM (3X leverage) is such that the extrinsic value is about 2.3% of the total cost. There isn't much extrinsic value at all for a bond fund like TLT, so there wouldn't be much cost there. If you average it all out, you may be around a 1% borrowing cost. However, if you are holding options on SPY and TLT instead of holding UPRO and TMF outright, you miss out on the dividends. Current yield for UPRO is 0.63% and for TMF it is 1.5%.
AFAIK the 1% expense ratio of these funds is management fees only and does not include the direct costs the fund incurs for borrowing money, which may be embedded in the S&P 500 futures contracts that they use to target a 2x daily return. So that's 1% plus volatility drag on top of the 3-mo treasury rate that's the approximate cost to go long treasury futures.
Current portfolio: 60% VTI / 40% VXUS

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### Re: Talk me out of a 60/40 AA

Because nobody knows nothing, I’m in the 50/50 camp. You can’t go wrong, half in and half out. How’s that for a reason? Lol

michaeljc70
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### Re: Talk me out of a 60/40 AA

Thu Jan 10, 2019 4:30 pm
Because nobody knows nothing, I’m in the 50/50 camp. You can’t go wrong, half in and half out. How’s that for an argument?
I know that stocks have outperformed bonds over the long haul.....

Since the 1920s, only during two decades (the 1930s and the 2000s) did bonds outperform stocks. And even then, the difference in returns weren't that much higher in favor of bonds.

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### Re: Talk me out of a 60/40 AA

michaeljc70 wrote:
Thu Jan 10, 2019 4:37 pm
Thu Jan 10, 2019 4:30 pm
Because nobody knows nothing, I’m in the 50/50 camp. You can’t go wrong, half in and half out. How’s that for an argument?
I know that stocks have outperformed bonds over the long haul.....

Since the 1920s, only during two decades (the 1930s and the 2000s) did bonds outperform stocks. And even then, the difference in returns weren't that much higher in favor of bonds.
Well it depends on how long of a long haul you have. If you have very long haul then why not 100%, why even bother with bonds. For people who are over a certain age, our long haul is limited.

28fe6
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