The Modified (Golden) Butterfly

[mikeguima]

Hello everyone,

I came across Tyler's excellent website a year ago and could not help to be drawn to the pratical representations of asset and portfolio performance he offers there. Naturally, while browsing his website, I came across his Golden Butterfly portfolio and was instantly sold, more so by its cohesiveness and rationale (a balanced portfolio that follows Harry Browne and Ray Dalio's footsteps in that it seeks to perform well in diverse economic conditions) than its historical performance.

It seems, however, that most investors here and in other places where the GB has been discussed mostly dislike two thing about it.

The first and easiest to fix is the lack of international exposure, which can be fixed by replacing the US stock market fund by a World Fund and US SCV by World SCV or Multifactor.

The second, however, is what seems to put off most investors: the 20% allocation to Gold. The reasons against it are generally as follows:
1. Gold doesn't even track inflation that well. See here: https://inflationdata.com/Inflation/Inf ... lation.asp
2. Gold is not an investment since it generates no cash flows and doesn't have intrinsic value, being entirely dependent on supply/demand.

For these investors who want to implement a similar strategy but dislike gold for the aforementioned reasons, like me, here's my approach to it: replace the 20% in gold with 10% in Real Estate (REIT) and 10% in TIPS. Together, they not only offer yield and inflation protection (moderate in REITs, stronger in TIPS), but prospects for higher long term returns than gold.

The porfolio would look like this:
20% World Stocks
20% World SCV/Multifactor
10% REIT
10% TIPS
20% Long-Term Bonds
20% Short-Term Bonds/ Cash

The exposure of the portfolio to the different economic environments is the following:
1. Inflationary Boom (Growth Rising, Inflation Rising) - 20% (REITs and TIPS)
2. Desinflationary Boom (Growth Rising, Inflation Falling) - 50% (Stocks and REITs)
3. Stagflation (Growth Falling, Inflation Rising) - 30% (Cash/STB and TIPS)
4. Deflationary Bust (Growth Falling, Inflation Falling) - 40% (Long-Term Bonds and Cash/STB)

This is likely to become my portfolio a few years from now and I just wanted to share it with you guys

[aristotelian]

I am not a fan of long term bonds. I want stability from the bond side, but LT bonds can fluctuate dramatically depending on interest rates. I also do not think the 10% TIPS is enough to truly protect you from inflation, if that is a concern.

Consider something like:

20% TIPS
30% Intermediate Bond Index

[grok87]

Hello everyone,

I came across Tyler's excellent website a year ago and could not help to be drawn to the pratical representations of asset and portfolio performance he offers there. Naturally, while browsing his website, I came across his Golden Butterfly portfolio and was instantly sold, more so by its cohesiveness and rationale (a balanced portfolio that follows Harry Browne and Ray Dalio's footsteps in that it seeks to perform well in diverse economic conditions) than its historical performance.

It seems, however, that most investors here and in other places where the GB has been discussed mostly dislike two thing about it.

The first and easiest to fix is the lack of international exposure, which can be fixed by replacing the US stock market fund by a World Fund and US SCV by World SCV or Multifactor.

The second, however, is what seems to put off most investors: the 20% allocation to Gold. The reasons against it are generally as follows:
1. Gold doesn't even track inflation that well. See here: https://inflationdata.com/Inflation/Inf ... lation.asp
2. Gold is not an investment since it generates no cash flows and doesn't have intrinsic value, being entirely dependent on supply/demand.

For these investors who want to implement a similar strategy but dislike gold for the aforementioned reasons, like me, here's my approach to it: replace the 20% in gold with 10% in Real Estate (REIT) and 10% in TIPS. Together, they not only offer yield and inflation protection (moderate in REITs, stronger in TIPS), but prospects for higher long term returns than gold.

The porfolio would look like this:
20% World Stocks
20% World SCV/Multifactor
10% REIT
10% TIPS
20% Long-Term Bonds
20% Short-Term Bonds/ Cash

The exposure of the portfolio to the different economic environments is the following:
1. Inflationary Boom (Growth Rising, Inflation Rising) - 20% (REITs and TIPS)
2. Desinflationary Boom (Growth Rising, Inflation Falling) - 50% (Stocks and REITs)
3. Stagflation (Growth Falling, Inflation Rising) - 30% (Cash/STB and TIPS)
4. Deflationary Bust (Growth Falling, Inflation Falling) - 40% (Long-Term Bonds and Cash/STB)

This is likely to become my portfolio a few years from now and I just wanted to share it with you guys

i like it.

you have soundly reasoned your way into a portfolio that is somewhat similar to David Swensen's long term portfolio:
https://www.amazon.com/Unconventional-S ... 0743228383
30% US Stocks
20% International Stocks
20% Real Estate
15% [Intermediate] Treasuries
15% TIPS

Some thoughts (again from a Swensen perspective):

1) There are two ways that Swensen would likely think about the role of cash in your portfolio:

a) as being paired with the Long term treasuries as you have done in your "4. Deflationary Bust" Scenario. So basically = 40% in Intermediate Treasuries but barbelled. Barbelling is a good strategy IMHO as it has more convexity so it is less sensitive to interest rate rises. Framed this way, Swensen might say 40% is a bit much- he thinks asset classes should have allocations of between 5%-30%. So again framed this way he might agree with Aristotelian who suggests dropping the nominal bonds to 30%.

b) As a general risk reducer. Swensen is careful not to claim that his 30/20/20/15/15 portfolio is right for everyone. He says that if folks want less or more risk they should add in cash or leverage up- basically the capital markets line approach
https://en.wikipedia.org/wiki/Capital_market_line
looked at from this perspective, you would have 20% in cash and 80% in a long term portfolio that looks like this:

25% World Stocks
25% World stocks SCV Multifactor
12.5% REITS
12.5% TIPS
25% Long Term Bonds

2) Let's say we think about your portfolio with the second of the approaches above. Then I would make the following comments:

a) You are less equity oriented than Swensen having 62.5% in Stocks/Real-Estate vs his 70%
b) But in a sense this is fine as you are putting 25% in SCV Multifactor which has higher risk (and hopefully higher returns)
c) SCV tends to do poorly in deflationary/depression scenario.
d) you may want to better hedge this by putting your 25% Long Term Bonds all in Long Term Treasuries
e) or maybe 15% TIPS, 20% Long Term Treasuries or something like that....

hope this helps
cheers,
grok

[David Jay]

Mike:

I am sure that this portfolio can "work".

My concern, following your last few posts, is that you seem to be chasing various portfolios and "fads". The absolute first priority for your portfolio is the ability to stay the course. Chasing theory and/or performance will destroy your portfolio performance.

You must hold a portfolio that you believe in enough to convince yourself to stay the course through a decade or more of underperformance.

[mikeguima]

I am not a fan of long term bonds. I want stability from the bond side, but LT bonds can fluctuate dramatically depending on interest rates. I also do not think the 10% TIPS is enough to truly protect you from inflation, if that is a concern.

Consider something like:

20% TIPS
30% Intermediate Bond Index

The idea is to barbell cash and long-term bonds in order to achieve similar risk to intermediate bonds with slightly higher return. Also, long-term bonds are the best performing asset in a scenario similar to 4, of falling growth and deflation (think the great depression or even the 2008 crisis, which was not deflationary but would have been if not handled well) and may offer some stability in such scenario.

Regarding inflation, under a low inflation/price stability environment as we're in now, stocks and REITs perform the best. I believe this low inflation scenario is the most likely for the upcoming decades (assuming no major disaster happens), as it's what major central banks (at least the FED and the ECB) are aiming for. Therefore, since I expect low inflation to be considerably more common in the upcoming years than soaring inflation or deflation, the portfolio is naturally tilted for assets that perform best under that scenario. 10% TIPS should provide some cushioning under soaring inflation although not much) and 20% LTB under deflation.

2) Let's say we go with the second of the approaches above. Then I would make the following comments:

a) You are less equity oriented than Swensen having 62.5% in Stocks/Real-Estate vs his 70%
b) But in a sense this is fine as you are putting 25% in SCV Multifactor which has higher risk (and hopefully higher returns)
c) SCV tends to do poorly in deflationary/depression scenario.
d) you may want to better hedge this by putting your 25% Long Term Bonds all in Long Term Treasuries
e) or maybe 15% TIPS, 20% Long Term Treasuries or something like that....

Thanks for the feedback. Yeah, the equity allocation looks low but it should provide similar returns to a higher equity allocation of just market-cap weighted funds due to the factor based allocation. I also plan to put the long-term bonds as 100% Government bonds.

Mike:

I am sure that this portfolio can "work".

My concern, following your last few posts, is that you seem to be chasing various portfolios and "fads". The absolute first priority for your portfolio is the ability to stay the course. Chasing theory and/or performance will destroy your portfolio performance.

You must hold a portfolio that you believe in enough to convince yourself to stay the course through a decade or more of underperformance.

I'm aware I've been "spamming" the forum with many different ideas This is generally my approach when trying to learn a lot in a short amount of time, I sort of brainstorm and look to learn a lot from those who are more experienced than me (i.e you guys) and how you feel about different approaches.

I understand the importance of that. Unfortunately, I still haven't found that fully convincing portfolio (although this one is pretty close!!). This may also be because I'm reading a lot about the subject and am sort of suffering from paralysis by analysis, but I think once I stop absorbing as much information I'll be able to stick to one thing more easily But since I'm still very young, I think the time to learn as much as possible is now.

But thanks for the feedback!

[grok87]

2) Let's say we go with the second of the approaches above. Then I would make the following comments:

a) You are less equity oriented than Swensen having 62.5% in Stocks/Real-Estate vs his 70%
b) But in a sense this is fine as you are putting 25% in SCV Multifactor which has higher risk (and hopefully higher returns)
c) SCV tends to do poorly in deflationary/depression scenario.
d) you may want to better hedge this by putting your 25% Long Term Bonds all in Long Term Treasuries
e) or maybe 15% TIPS, 20% Long Term Treasuries or something like that....

Thanks for the feedback. Yeah, the equity allocation looks low but it should provide similar returns to a higher equity allocation of just market-cap weighted funds due to the factor based allocation. I also plan to put the long-term bonds as 100% Government bonds.

what international small cap value fund are you thinking about using since I don't think Vanguard has one?

[David Jay]

Mike:

I am sure that this portfolio can "work".

My concern, following your last few posts, is that you seem to be chasing various portfolios and "fads". The absolute first priority for your portfolio is the ability to stay the course. Chasing theory and/or performance will destroy your portfolio performance.

You must hold a portfolio that you believe in enough to convince yourself to stay the course through a decade or more of underperformance.

I'm aware I've been "spamming" the forum with many different ideas This is generally my approach when trying to learn a lot in a short amount of time, I sort of brainstorm and look to learn a lot from those who are more experienced than me (i.e you guys) and how you feel about different approaches.

I understand the importance of that. Unfortunately, I still haven't found that fully convincing portfolio (although this one is pretty close!!). This may also be because I'm reading a lot about the subject and am sort of suffering from paralysis by analysis, but I think once I stop absorbing as much information I'll be able to stick to one thing more easily But since I'm still very young, I think the time to learn as much as possible is now.

But thanks for the feedback!

I started with "Coffeehouse" and kept simplifying, dropping funds and integrating towards Total Stock. I am down to 6 funds now, just got rid of REIT. My only tilt is small/value (domestic and intl.)

[Fryxell]

For these investors who want to implement a similar strategy but dislike gold for the aforementioned reasons, like me, here's my approach to it: replace the 20% in gold with 10% in Real Estate (REIT) and 10% in TIPS. Together, they not only offer yield and inflation protection (moderate in REITs, stronger in TIPS), but prospects for higher long term returns than gold.

The porfolio would look like this:
20% World Stocks
20% World SCV/Multifactor
10% REIT
10% TIPS
20% Long-Term Bonds
20% Short-Term Bonds/ d REITs)

The problem I see with this is that REITs and TIPS are not good substitutes for gold. REITs are still stocks and are subject to general stock market fluctuations. They dropped in 2008 (and so did commodities, by the way) while gold held up in value. TIPS do not offer inflation protection per se, they are just denominated in inflation-adjusted dollars. TIPS could even decline in value during an inflationary situation if the real interest rate were increasing at the same time. TIPS also wouldn't have skyrocketed like gold did during the 70s. TIPS are not leveraged, whereas in the 70s gold seemed to respond disproportionately to what was going on.

[willthrill81]

TIPS do not offer inflation protection per se, they are just denominated in inflation-adjusted dollars.

That is inflation protection.

[Fryxell]

TIPS do not offer inflation protection per se, they are just denominated in inflation-adjusted dollars.

That is inflation protection.

What if real interest rates rise along with rising inflation? Then, the value of the bonds goes down during the inflationary period. That is not what people have in mind when they think of 'inflation protection.'

[nisiprius]

I would say that if someone gives a portfolio the name "Golden Butterfly," it indicates that that person feels that gold is not at all incidental, and not just some random asset class, but that it is intrinsically important to the portfolio. According to the anonymous or pseudonymous "Tyler,"

One wing with two segments is made of stocks, the other is made of bonds, and the stabilizing head is gold.

Assuming you don't just tune out when you hear purple prose like that, gold is "the stabilizing head." So, a Golden Butterfly without gold is like... a ship without a rudder, a bicycle without handlebars, a fidget spinner without a ceramic bearing, an analogy without an analog.

Or maybe not.

But it does seem weird to accept the strategy but reject one of its central premises.

[willthrill81]

TIPS do not offer inflation protection per se, they are just denominated in inflation-adjusted dollars.

That is inflation protection.

What if real interest rates rise along with rising inflation? Then, the value of the bonds goes down during the inflationary period. That is not what people have in mind when they think of 'inflation protection.'

If you want to address interest rate risk, that is a different animal than inflation risk. TIPS address the latter, but the former is a risk with any fixed rate bond.

[willthrill81]

I would say that if someone gives a portfolio the name "Golden Butterfly," it indicates that that person feels that gold is not at all incidental, and not just some random asset class, but that it is intrinsically important to the portfolio. According to the anonymous or pseudonymous "Tyler,"

One wing with two segments is made of stocks, the other is made of bonds, and the stabilizing head is gold.

Assuming you don't just tune out when you hear purple prose like that, gold is "the stabilizing head." So, a Golden Butterfly without gold is like... a ship without a rudder, a bicycle without handlebars, a fidget spinner without a ceramic bearing, an analogy without an analog.

Or maybe not.

But it does seem weird to accept the strategy but reject one of its central premises.

I agree. The OP's portfolio would be more aptly named something like a "modified Swensen" portfolio.

[2pedals]

I understand the importance of that. Unfortunately, I still haven't found that fully convincing portfolio (although this one is pretty close!!). This may also be because I'm reading a lot about the subject and am sort of suffering from paralysis by analysis, but I think once I stop absorbing as much information I'll be able to stick to one thing more easily But since I'm still very young, I think the time to learn as much as possible is now.

There is no fully convincing portfolio looking out into the future. The closest thing to me is the 3 fund portfolio. If you want to tilt okay fine but I would start 3 fund portfolio first.

[heyyou]

During a stock crash, owning gold and bonds are good pacifiers, distracting you from selling out of your stocks.
Long term, equities have out-grown inflation but the owner has to be patient and stay the course. Buy whatever you will stay with during stock crashes, but not everyone needs every type of pacifier.

[watchnerd]

20% World SCV/Multifactor

What would you use for this piece?

As far as I can tell, there is no single fund / ETF that covers this; you'd have to slice it between 2 options from folks like Vanguard, Wisdom Tree, or iShares.