Efficient frontier by decade

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Murray Boyd
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Efficient frontier by decade

Post by Murray Boyd »

Now that we can post images I thought I'd post an image:

Image
BrianTH
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Post by BrianTH »

Very interesting--how were bonds and equity defined?

Incidentally, offhand it looks like somewhere between 10% and 40% in equity reduced volatility in each series (although it did cost return in 2000-04).
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Rick Ferri
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No frontier efficient

Post by Rick Ferri »

What the figures shows is that there is no efficient frontier. Or rather, it is very inconsistent, and the optimal portfolio allocation can only be known in retrospect.

Also, if you were to rerun the charts without rebalancing, just letting an allocation run, you will notice there is there is little benefit from rebalancing each year. Although there is slight risk reduction sometimes from rebalancing, there is also a return reduction.

Rick Ferri
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Cb
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Post by Cb »

Here are some 20 Year Efficient Frontiers I generated using the Tamasset returns for S&P 500 and 5 Yr T-Bills:

Cb

Image
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Random Musings
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Post by Random Musings »

Murray,

Question about efficient frontier by decade:

Looking at the 1960-1969 data - domestic large cap, domestic small cap and international EAFE all didn't do that poorly in the 1960's. And neither did intermediate bonds - at least in the nominal sense.

Same question as above: What data source(s) were you using. It looks like the 1960-69 data seems a little odd.

RM
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Post by MoreCowbell »

The most stunning feature of the graph to me is that for two decades, from 1960 to 1979, any combination of stocks and bonds yielded a negative return.

A couple of decades like that could really test your resolve!
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Post by BrianTH »

From Cb's chart, it looks like adding about 10% SP500 lowered the volatility in each series except 27-46.
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Post by jeober »

I'll bet if you add that latest two years data to the 2000-2004 curve you'll change its shape radically.
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Post by Drain »

I have a hard time believing bonds had a negative nominal return for two straight decades. I'm sure the yield was low in 1960, and I know where it ended up in '79, but still...well, I guess it's plausible.
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Re: No frontier efficient

Post by jeober »

Rick Ferri wrote: Also, if you were to rerun the charts without rebalancing, just letting an allocation run, you will notice there is there is little benefit from rebalancing each year. Although there is slight risk reduction sometimes from rebalancing, there is also a return reduction. Rick Ferri
Question here, slightly OT - Rick, rebalancing is beneficial to returns when your rebalancing components see-saw against each other, ideally alternating in money flow directions (forcing the sell high, buy low) Conversely, repetitively rebalancing components in the same direction [in a trending market] hurts your return. Risk management aside, am I right in this understanding?
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Post by Murray Boyd »

Aw, I forgot where I got it. I had posted it a long time ago on the other board. It was from a Rydex brochure or something.
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Re: No frontier efficient

Post by Trebor »

Rick Ferri wrote:What the figures shows is that there is no efficient frontier. Or rather, it is very inconsistent, and the optimal portfolio allocation can only be known in retrospect.
I couldn't agree more. Correlations are dynamic and change. The true optimal portfolio is a concept which can only be known historically. When we talk of findings tomorrow's optimal portfolio (efficient frontier), we are left only with educated guesses.

MoreCowbell said "The most stunning feature of the graph to me is that for two decades, from 1960 to 1979, any combination of stocks and bonds yielded a negative return.

A couple of decades like that could really test your resolve!
"

Yes that is a nice graphical reminder. I know one who struggled through investing in the 70's and has subsequently had a great deal of distrust and skepticism about equity investing. He has had a hard time sticking with equities over later years because of his experience during that decade. Wonder how well I would do with a similar period?

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Post by Randy »

Are these real or nominal returns?
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Efficient Frontiers

Post by bobcat2 »

Hi Murray,
Another way of showing that TIPS and Ibonds would have really enhanced portfolio returns in the 60's and 70's. And yet one more indication that markets are continuing their march to becoming more complete. :lol:

Bob K

PS - Murray, were you the person that recommended Reinventing the Bazaar? I've started reading it today after learning the author died last week. Odd incentive to begin reading a book, no?
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Post by Cb »

Randy wrote:Are these real or nominal returns?
My chart used nominal returns.

Cb
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From Rydex Brochure

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Post by wab »

Cb, I'm having trouble understanding your chart.

The long-term average return for the S&P500 is around 10%, but you show every 20-year period with 100% stocks above that, and you show the long-term average at around 12.5%.

I'm having an especially hard time with the 67-86 period. How could that possibly be anywhere close to 11%?
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Domestic and International?

Post by JohnYaker »

.
If someone has the data handy, I am curious to learn how the addition of international stocks (0% to 100%) has affected returns over the decades. Would someone kindly create a frontier chart of domestic and international stock mixes?

Thanks,
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Post by Randy »

Cb wrote:
Randy wrote:Are these real or nominal returns?
My chart used nominal returns.

Cb
In that case, I find your chart pretty depressing. Over the period 1960 to 2004 it seems equities returned only around 6%. A more diversified portfolio would return only about 5%. Bonds returned maybe 3%. This was during a period that experienced a great bull market, and it coveres a very long period of time, so that the period used shouldn't be a big problem. It makes me ask some questions:

1. If you can get close to 5% of zero coupon treasuries for the next 20 year, why bother investing in stocks?
2. In fact, why bother investing at all - these returns are pathetic! Maybe the "don't worry, be happy" crowd is onto something.
3. With long term returns like this, what's the basis for assuming that future equity returns will be 6-8%. How can the next 30-40 years be a better investment climate than the last 44 years? (This was a period of remarkable economic growth, technological innovation, etc.)

(OK, I am exagerating a little, but only to make a point. This chart really seems to call into question conventional wisdom.)
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Re: No frontier efficient

Post by bnwest »

Rick Ferri wrote:What the figures shows is that there is no efficient frontier. Or rather, it is very inconsistent, and the optimal portfolio allocation can only be known in retrospect.
Is this something you mention to your clients? ;) "And oh by the way, all these clever ideas I have about investing your money may not actually make you money over the next ten years."

This sums up my reluctance to embrace MPT (or any portfolio theory ftm). The foundation of all of these theories is based on historic data which has not guarantee of repeating itself. There is also a danger of viewing MPT as science and with that the expectation that history will repeat itself.
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Post by Cb »

wab wrote:Cb, I'm having trouble understanding your chart.

The long-term average return for the S&P500 is around 10%, but you show every 20-year period with 100% stocks above that, and you show the long-term average at around 12.5%.

I'm having an especially hard time with the 67-86 period. How could that possibly be anywhere close to 11%?

wab...feel free to check my work and let me know if I've got mistakes in the calculations / charting:

http://gnobility.com/ER/Tamasset_Effici ... ntiers.xls

Cb
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Post by Rick Ferri »

Rebalancing is beneficial to returns when your rebalancing components see-saw against each other, ideally alternating in money flow directions (forcing the sell high, buy low) Conversely, repetitively rebalancing components in the same direction [in a trending market] hurts your return. Risk management aside, am I right in this understanding?
Sorry, but I don't understand the question.

Here is the rebalancing dilemma:

1) In the long-term, rebalancing reduces risk and lowers return (it does not raise returns). That is acceptable because if a person did not lower risk, they may exceed their tolerance for risk without knowing it. That would eventually cause an emotional sellout of equity at the the wrong time, i.e. unintentional market timing.

2) In the short-term (10 years or less) rebalancing either lowers risk and return, or raises risk and return. From 2000 to 2002, portfolio rebalancing increased risk and lowered returns as more money was added into a declining equity market. Since 2003 rebalancing has reduced portfolio risk and reduced returns as money is taken out during a bull equity market.

3) There are costs to rebalancing: commissions, taxes, time, the risk of changing your allocation, and the emotional stress (the conscious decision when to do it if at all). If there is no rebalancing, all those costs go away.

I believe that rebalancing is beneficial because it keeps a portfolio within a client's tolerance for risk. Thus, the investor should not make emotional decisions and blow-up their allocation in a severe down market.

Other than controlling risk, if a person truly believes that stocks will outperform bonds over their lifetime, there is not a good economic reason to rebalance.

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Post by wab »

Cb wrote:wab...feel free to check my work and let me know if I've got mistakes in the calculations / charting:

http://gnobility.com/ER/Tamasset_Effici ... ntiers.xls
Thanks, Cb. I'm not a statistics wiz, but I don't think you can take the arithmetic mean of returns to get the returns for a period.

Simple example:

If my port has sequential returns of 50% and -50%, the return over the two years is not 0%.
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Post by Randy »

Thanks for the xl file. So far it looks ok to me. I have computed 1960-2004. The results seem much higher than the original chart (Murray Boyd's) shown on this thread. I don't think they both can be right. Your chart shows pure equity return of around 11% for that period.
Last edited by Randy on Wed Mar 21, 2007 10:48 am, edited 1 time in total.
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Re: No frontier efficient

Post by DRiP Guy »

bnwest wrote:
Rick Ferri wrote:What the figures shows is that there is no efficient frontier. Or rather, it is very inconsistent, and the optimal portfolio allocation can only be known in retrospect.
Is this something you mention to your clients? ;) "And oh by the way, all these clever ideas I have about investing your money may not actually make you money over the next ten years."

This sums up my reluctance to embrace MPT (or any portfolio theory ftm). The foundation of all of these theories is based on historic data which has not guarantee of repeating itself. There is also a danger of viewing MPT as science and with that the expectation that history will repeat itself.
I just happen to be re-reviewing "The Four Pillars" and Bernstein makes that plain in his own writing:
"It is easy to obtain the... returns of various asset classes...and determine precisely which combinations of these worked the best. But we can only do this in the past tense; it tells us nearly nothing about the future portfolio strategy. If anyone tells you he knows the future's best allocation, nod slowly, slide back several steps, turn, and run like h***." [bold added]
I therefore agree with Bernstein, and disagree vehemently that the foundation of these strategies rely on historical data. People hoping to game the system may well be hoping (relying) on that, but the authors and those who try to understand them faithfully, do take the admonition seriously that the historical info is only one example. But the principles of:
*diversification, and of
*applying a pre-thought-out asset allocation, and of
*periodic rebalancing to maintain that initial allocation
(not chasing returns in hot sectors!), and of
* looking for uncorrelated components to build up your portfolio,

constitute the REAL message, and these are not at all dependent on any one particular string of data that might be used to illustrate the principle.

This one (rather obvious) distinction seems to cause much angst and misunderstanding. Perhaps due to wishful thinking?
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Post by yobria »

Rick-
Other than controlling risk, if a person truly believes that stocks will outperform bonds over their lifetime, there is not a good economic reason to rebalance.
Unfortunately the only reason stocks have a higher return than t-bills is uncertaintly. While you may earnestly believe stocks will beat bonds over your time horizon, the uncertainty is still there. Have to look at the standard deviation as well as mean. I expect driving 100 MPH to work will get me there faster, but there's plenty of reason to drive the speed limit, right?

Nick
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Post by BrianTH »

Randy,

I think Cb's chart was in nominal terms, and I suspect Murray's chart was in real terms. In fact, it would be nearly impossible for bonds to have negative returns in nominal terms for 20 straight years (unless the maturity of these bonds was absurdly long).
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Post by Rick Ferri »

Drip Guy
I said: What the figures shows is that there is no efficient frontier. Or rather, it is very inconsistent, and the optimal portfolio allocation can only be known in retrospect.

You said: Is this something you mention to your clients? "And oh by the way, all these clever ideas I have about investing your money may not actually make you money over the next ten years."
Yes, as a matter of fact. I say that all the time. You could ask any of my clients and they would confirm it.

BTW, I have no clever ideas how to make money, except many to marry it. A friend of mine hit the nail on the head when he explained to my daughter that, "You can marry more money in a minute than you can make in a lifetime."
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Post by DRiP Guy »

Rick Ferri wrote:it.

BTW, I have no clever ideas how to make money, except many to marry it. A friend of mine hit the nail on the head when he explained to my daughter that, "You can marry more money in a minute than you can make in a lifetime."
:lol: :lol:
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Post by Cb »

wab wrote:
Cb wrote:wab...feel free to check my work and let me know if I've got mistakes in the calculations / charting:

http://gnobility.com/ER/Tamasset_Effici ... ntiers.xls
Thanks, Cb. I'm not a statistics wiz, but I don't think you can take the arithmetic mean of returns to get the returns for a period.

Simple example:

If my port has sequential returns of 50% and -50%, the return over the two years is not 0%.
wab...I believe you are correct...I should have used CAGR rather than Arithmetic Mean. I'll redo the chart sometime over the next few days using the following approach to calculating CAGR of a series of returns that I just found:

"You can quickly figure out Compouned Annual Growth Rate in Excel using the GEOMEAN function (for geometric mean)

Suppose I have a spreadsheet with the following numbers (row and column numbers)

...........A
1.......22.00%
2.......73.00%
3.......21.00%
4.......45.00%
5......-10.00%

To calculated the CAGR for this series of returns I use the following formula in Excel:

{=GEOMEAN(1+A1:A5)-1}

It's a bit tricky to get the brackets on the outside (you must have brackets).

Type:
=GEOMEAN(1+A1:A5)-1
in a cell...
but don't hit the Enter key ... yet!!
Hold down the Ctrl and Shift keys and NOW hit the Enter key.
It changes to {=GEOMEAN(1+A1:A25)-1} giving the CAGR of 27.22%"
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Re: No frontier efficient

Post by mptfan »

Rick Ferri wrote:What the figures shows is that there is no efficient frontier. Or rather, it is very inconsistent, and the optimal portfolio allocation can only be known in retrospect.

Rick Ferri
Rick, I agree. But I would take it one step further...if you knew in advance which asset class would peform the best over a given period of time, there would be no need for diversification among different asset classes because the optimum strategy would be to simply own the best performing asset class and ignore the rest.
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Post by Cb »

OK...I've reworked my 20 Year Efficient Frontiers chart using Compounded Annual Growth Rate rather than the simple average I used in the version above. Here's the updated chart, following by a link to the revised Excel file for those who might want to check my homework: :wink:

(thanks wab!)

Image

http://gnobility.com/ER/Tamasset_Effici ... ntiers.xls

Cb
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Elvis and the Easter Bunny

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.
"Anybody who tells you that their portfolio recommendations are "on the efficient frontier" also talks to Elvis and frolics with the Easter Bunny"... "Its like trying to generate electrical power by placing a battery and a lightning rod at the last place you saw lightning strike. It isn't likely to strike there again. In other words, next year's efficient frontier will be nowhere near last year's"..."Still, if you're trying to capture lightning in a jar you are better off in Texas than Alaska. There are certain asset combinations and portfolios which are likely (but not certain) to do reasonably well."

Bill Bernstein - The Intelligent Asset Allocator
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Re: Efficient frontier by decade

Post by Kenkat »

This is a purely anecdotal observation. I have been posting on this forum and it's predecessor on Morningstar for a long time. The 100% equity posts seem to become much more prevalent when the market is hitting new highs. They pretty much completely disappear when the market hits a correction or, even worse, a crash.

I would try to focus on setting an allocation across multiple asset classes that you think you can commit to over the next 50 years. That might be 100% stock, but I believe that for most people, that will feel too volatile and risky at some future point in time.
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Re: No frontier efficient

Post by Epsilon Delta »

Rick Ferri wrote:What the figures shows is that there is no efficient frontier. Or rather, it is very inconsistent, and the optimal portfolio allocation can only be known in retrospect.
The efficient frontier is simply the Pareto-optimal subset of the investment universe. Since the investment universe is finite the efficient frontier must exists. But to use it for asset allocation it's not enough to know it exists. You need to know where it is. That's what gets people into trouble. Those curves in the first post are not the efficient frontier, they are simply guesses about where it is. Overwhelmingly incorrect guesses. To put it another way: What DRIP Guy said.
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Re: Efficient frontier by decade

Post by pkcrafter »

Thanks, good observation, Ken.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
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Re: Efficient frontier by decade

Post by gkaplan »

kenschmidt wrote:This is a purely anecdotal observation. I have been posting on this forum and it's predecessor on Morningstar for a long time. The 100% equity posts seem to become much more prevalent when the market is hitting new highs. They pretty much completely disappear when the market hits a correction or, even worse, a crash.

I would try to focus on setting an allocation across multiple asset classes that you think you can commit to over the next 50 years. That might be 100% stock, but I believe that for most people, that will feel too volatile and risky at some future point in time.
You do realize that your post revived a thread that was over seven years old, do you not?
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Re: Efficient frontier by decade

Post by RetiredinKaty »

Well, I am retired for a couple of years now and am fairly well funded. I am most interested in a survival pod portfolio. I look at the original posting on this thread and it seems to support my conclusion that 35 to 40% stock is best in good times or bad. Am I right or is this just confirmation bias on my part?
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Re: Efficient frontier by decade

Post by JoMoney »

If the chart was showing decades from 1940-1980 it might look even more wildly different. I prefer just to ignore the "efficient frontier" charts and look at my need and ability to assume the risks in stock investing. I'll base my fixed-income portfolio on how much certainty I want in things like stable income (long-term bonds, pension, SS, SPIA, etc..) or stable value (short-term bonds, CD's, savings, etc..)
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
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Re: Efficient frontier by decade

Post by nedsaid »

This shows why I am not obsessed with getting my asset allocation exactly right. As you can see, the efficient frontiers are all over the map. Investing is more like cooking from scratch than following a precise recipe or formula. A dash of this and a dribble of that. Hmm, that looks good, I'll put some of that in there. There are general principles to follow but the route to investing success is not exact. What we see is that markets are always changing.
A fool and his money are good for business.
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Re: Efficient frontier by decade

Post by YoungSisyphus »

I thought I might resurrect this post from 2007 because I found it posted on other websites as I was researching the efficient frontier and deciding on (finally) landing my allocations and IPS after procrastinating over a couple of years. It was found while I was continuing to research my question I posted recently which had a few helpful replies (viewtopic.php?f=10&t=364876)

What I am finding is the following.. that I think I can find conviction on:
1. The "efficient frontier" exists in theory, but we will never actually be on it or know only in retrospect.
2. Re-balancing and managing allocations actually does not increase returns. There can be very little benefit to reduced risk, and inconsistently so.
3. Because of #1, it is difficult (impossible?) to actually land an asset allocation outside of the US that actually increases returns and reduces volatility.
4. It is hard to know that we are making good investment decisions even when ignoring or tying decisions to returns. This uncertainty exists in all markets.
5. I think what JoMoney said here is apt: what really matters is the ability / need to manage certainty in the face of uncertainty through stable income sources. And investors should have a plan to remain solvent for prolonged periods of drought.

I think what this all boils down to me is: the US is as good as any when it comes to diversification. I'm not sure that adding exUS will really do anything (it might, it might not), and what I would be best to do is land on stable income sources and test my comfort for certain # of years of security (e.g. cash for year1, iBond redemption through year2-4, up to certain period) and just throw the rest into US index funds with no re-balancing ever.

Is there anything to add to these findings that would further refine my IPS?

Also, I did check with LadyGeek on resurrecting this since it was so old. It was resurrected seven years ago as well. I am glad to carry the torch and revive it after another 7. :mrgreen:

I also found these additional resources that I will dig into later:
https://www.portfoliovisualizer.com/eff ... sisResults
https://www.madfientist.com/my-portfolio/
http://thoughtful-investor.com/pdfs/Eff ... ontier.pdf
https://www.raymondjames.com/weisswealt ... decade.pdf
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Re: Efficient frontier by decade

Post by garlandwhizzer »

Rick Ferri wrote:

What the figures shows is that there is no efficient frontier. Or rather, it is very inconsistent, and the optimal portfolio allocation can only be known in retrospect.

Also, if you were to rerun the charts without rebalancing, just letting an allocation run, you will notice there is there is little benefit from rebalancing each year. Although there is slight risk reduction sometimes from rebalancing, there is also a return reduction.
1+

It's very helpful for a knowledgeable student of the market to show us the hard facts and bring us back from the world of theory into stubborn reality. Many prefer their theories on rebalancing or anything else to the simple hard facts about whether it has worked or not for them in the real world of investing. For more than a decade I have been rebalancing from outperforming TSM into underperforming INTL. I am getting a bit tired of throwing good money after bad. Jo Money has described this rebalancing practice as "pulling the flowers and watering the weeds." That is how it has worked out for me over the last 10+ years.

I bought into the risk reduction idea of INTL diversification which certainly looked good on backtesting. Also, a decade ago many experts were warning about overpriced US equity and suggesting that INTL and especially EM were destined to outperform going forward due to much more attractive valuations. The exact opposite happened, much lower returns with more risk and volatility. So far, the opportunity cost of holding cap weight 40% - 50% INTL equity over the last 10 or 15 years has been massive. Interestingly the most experts continue to say the same thing now. At some point, they may be right, but It is important to remember that a broken clock gives the right time twice every day.

Somehow Bogle had this persistent habit of often being right in practice--low cost index funds over active management, bailing out of expensive equity in favor of bonds just before tech collapse of 2000, no INTL exposure, skepticism about the benefits of rebalancing and about the benefits of factor approaches. That advice has worked very well for the past 15 years. On the other hand, I bought into INTL diversification big time and what I got was an opportunity cost and ever deepening skepticism about the reliability of investing theory. The future is as always uncertain. What worked optimally in one decade may be the opposite in the next one. Maybe my benefit will occur in the next 15 years. I just wish that when experts promoted optimal investing approaches they inserted the word maybe more often.

Garland Whizzer
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Re: Efficient frontier by decade

Post by TheoLeo »

garlandwhizzer wrote: Fri Dec 17, 2021 2:59 pm
Somehow Bogle had this persistent habit of often being right in practice
He even reduced his equity allocation to pretty much exactly the efficient frontier of the original post for the time between 2000 and 2004. Spooky.
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Re: Efficient frontier by decade

Post by pseudoiterative »

garlandwhizzer wrote: Fri Dec 17, 2021 2:59 pm I bought into the risk reduction idea of INTL diversification which certainly looked good on backtesting. Also, a decade ago many experts were warning about overpriced US equity and suggesting that INTL and especially EM were destined to outperform going forward due to much more attractive valuations. The exact opposite happened, much lower returns with more risk and volatility.
one tricky aspect to evaluating this is that you can't judge the quality of the decision purely from the single observed result. if you could rewind history and watch all the alternate futures play out that might have happened but didn't, you could get a better feel for the real space of possible outcomes , and the risk and return of different strategies. but we only see one realised outcome. maybe in some of those other possible worlds you went all-in on US equity and did even worse, and regret not diversifying more.
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Re: Efficient frontier by decade

Post by NoRoboGuy »

TheoLeo wrote: Fri Dec 17, 2021 6:59 pm
garlandwhizzer wrote: Fri Dec 17, 2021 2:59 pm
Somehow Bogle had this persistent habit of often being right in practice
He even reduced his equity allocation to pretty much exactly the efficient frontier of the original post for the time between 2000 and 2004. Spooky.
Just coincidence. The changes Bogle made were for personal considerations.
There is no free lunch.
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