Bernstein's new Efficient Frontier article on Harry Browne

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Robert T
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Bernstein's new Efficient Frontier article on Harry Browne

Post by Robert T » Wed Aug 25, 2010 9:52 pm


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Re: Bernstein's new Efficient Frontier article on Harry Brow

Post by Erwin » Wed Aug 25, 2010 10:09 pm

Robert T wrote:.
Staying the course is the problem for 99% of the people (including me). The composition of the portfolio, if it is well diversified is really not that important.
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Post by tetractys » Wed Aug 25, 2010 10:13 pm

Thank you Bill Bernstein for a well put together compendium of the PF conundrum.

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Post by steve roy » Wed Aug 25, 2010 10:18 pm

Dr. B. writes a witty article.

Paladin

Post by Paladin » Wed Aug 25, 2010 10:20 pm

Rather embarrassing since so many on this forum have said that the permanent portfolio just cannot work.

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Post by steve roy » Wed Aug 25, 2010 10:49 pm

After reading much of the PP thread, I think there's a solid case made that it works.

But working isn't the problem. It doesn't return 20% year after year, so for the folks who chase performance, it's never going to be the magical elixer they want to drink.

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Post by mortal » Wed Aug 25, 2010 10:58 pm

I like the intent of TPP. However, I don't like 'cash' and 'gold' as part of a portfolio. I think most people would be better served throwing short-term bonds and tips into the mix.

The only reason I would ever hold gold is as a hedge against the collapse of civil order. In such a case I think a few thousand dollars worth of gold might have a role getting you out of one country, and into a better one.

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Post by thepommel » Wed Aug 25, 2010 11:28 pm

mortal wrote:I like the intent of TPP. However, I don't like 'cash' and 'gold' as part of a portfolio. I think most people would be better served throwing short-term bonds and tips into the mix.

The only reason I would ever hold gold is as a hedge against the collapse of civil order. In such a case I think a few thousand dollars worth of gold might have a role getting you out of one country, and into a better one.
+1

25% each in stocks, st bond index, tips, and lt treasury is interesting... And simple 4-fund portfolio at VG.

regards,

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Post by Blue » Thu Aug 26, 2010 5:54 am

Investment success accrues not so much to the brilliant as to the disciplined
A great take home point.

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Post by Adrian Nenu » Thu Aug 26, 2010 7:11 am

It might work, everything works in bull markets. All depends on how great of a loss the investor can handle. Everybody is different. The suitability of the asset allocation is more obvious during bear markets. :wink:

Take away the gold, reinvest the money and you are left with 1/3 stocks and 2/3 bonds - Wellesley or close to it. Diversify the stock allocation globally, small value/emerging markets tilt, and add TIPS to the bond allocation. Rebalance and keep stocks under 50%:

Tolerable Loss x 2 = Equity Allocation < 50%

It's called conservative asset allocation to avoid large bear market losses. Where were these articles in 2000 and 2007?!

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Bill Bernstein's "Efficient Frontier" article.

Post by Taylor Larimore » Thu Aug 26, 2010 7:13 am

Hi Robert:

A wonderful article by Boglehead William Bernstein. Thank you for bringing it to our attention.

I have posted a similar link on the Harry Browne Conversation--now over 3,000 posts long. :shock:
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Post by jeffyscott » Thu Aug 26, 2010 7:29 am

I prefer Tobias' "prongs", which seem to me to be more general version of the same ideas that lead to the PP. Have some assets that will do well in each scenario: deflation, inflation, stagflation, prosperity. Doesn't have to be precisely 25% in each and the particular investments/commodities used are not rigidly prescribed.

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Post by nisiprius » Thu Aug 26, 2010 7:45 am

Very interesting, especially his point that "In many respects, this allocation is a thing of beauty. Not only does it provide some protection against all but the most dire of scenarios, but its correlation grid is one rarely seen in finance: four non-derivative assets populated entirely by near-zeros."

It's still just... not... for me--among other things, a long-term strategy is not a long-term strategy if you change long-term strategies every decade, but I remember being surprised, and to put it frankly a little dismayed or envious, when I first bothered to call up a growth chart for PRPFX. Although the whole history, when you call it up in Morningstar, is not nearly as impressive as the last ten years.
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Post by Tramper Al » Thu Aug 26, 2010 7:49 am

It seems to me that the strongest criticism we can validly level at the PP is that we as investors won't stick with it because we are so vulnerable to greed and fear, envy and regret. It is too different from what our peers are likely to be invested in. "Tracking error" now means performance different from more conventional AAs.

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Post by Lbill » Thu Aug 26, 2010 8:16 am

There’s nothing wrong with Harry’s portfolio—nothing at all
Quite a statement by the respected W. Bernstein. Larry Swedroe and Rick Ferri (to mention a couple of familiar forum experts) don't agree. They both hate the high allocation to gold and long bonds. Also an interesting contradiction of sorts to Bill's recent article warning that long-term Treasuries are an accident waiting to happen, since the PP holds 25% in long Treasuries. But the power of the PP is in the extremely low, or negative, correlations between assets which are quite stable. True to form, long Treasuries are way, way up this year, despite the fact everyone in the financial world was absolutely sure they were dogmeat. As HB might have said, "nobody knows nothin" so invest accordingly.

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Post by richard » Thu Aug 26, 2010 8:26 am

Bill typically favors "diversifying by asset class" and has great respect for the utility of past data. These two prejudices go a long way to explaining the article.

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Post by craigr » Thu Aug 26, 2010 8:39 am

Thanks for the link. This article was posted in the massive thread on the portfolio starting on page 68.

A few additional points I'll make here.

1) I don't think TIPS have any chance of matching gold performance if we get very serious inflation of the dollar. At best, TIPS will match inflation plus a couple percent. This is hardly enough performance to offset inflation damage happening to the rest of the non-TIPS allocation.

2) I don't think adjusting allocation based on age works very well. Nor do I think adjusting it based on nebulously defined "risk tolerance" works any better. There are risks that can affect bonds of all types and it is a mistake to just assume you are safe if you own lots of bonds regardless of type.

3) You must stay diversified across many asset classes and not concentrate any bet. I don't think it matters what asset it is or what anyone is telling you about how safe that asset is, stay diversified.

4) The portfolio concept has a couple decades now of empirical evidence and has survived good and bad markets. The worst loss it ever had was in 1981 where it took around a -4-6% loss. Other than that it has managed to pull down returns in the 9-10% range with after inflation returns in the 3-5% range regardless of time period chosen. It has never had a long multiple year stretch of zero, or near zero, real returns.

5) Many investors performance chase and this portfolio is not unique in that regard. But for those looking for something that has been pretty stable and able to withstand some very bad market events, it is an option to consider.


Here was my initial response on the other thread:
There's nothing wrong with Harry's portfolio nothing at all but there's everything wrong with his followers, who seem, on average, to chase performance the way dogs chase cars.

This statement could be said about any portfolio however. I've been on this forum for many years and have seen various strategies come and go. There is the DFA Value strategy that was popular when value investing was on fire after the 2000-2002 crash. Then there was the REIT heavy allocations like Swensen that became cold after the real estate bust. Recently I've seen threads about gold often enough to know that the clock is ticking on that asset. I've even seen threads about bond heavy allocations as the new cure-all.

But I do think Dr. Bernstein overlooked some parts of the portfolio that goes away from pure performance chasing. That is, Browne was a huge advocate of having a portfolio that didn't have wild gut wrenching swings in value and could grow money safely. His experience (as well as my own) is that a portfolio that is subject to wild upswings in value is also likely to be abandoned during inevitable market downturns. I refer to the infamous "Plan B" that took place in 2008 with stock heavy allocations. Many investors locked in serious losses and missed the partial recovery in 2009.

Not just this, but Browne has been shown right on many things he stated. For instance about not taking credit risk with your bonds. Holding cash is not a bad thing. Hard assets can diversify against risks in stocks and bonds. Anything can happen in the markets (including deflation which many thought couldn't happen here). Etc.

Finally, I don't like looking at assets in isolation. It could be that one or more of the assets in the portfolio goes south. It's happened before. But only overall portfolio value matters and in that regard the Permanent Portfolio has performed as designed: Delivering moderate returns with comparatively little risk to other approaches. If that's what an investor wants then it's a good choice for them. There's always a (large) part of the investing world that performance chases. It's not unique to the Permanent Portfolio.
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Post by matt » Thu Aug 26, 2010 8:56 am

nisiprius wrote:to put it frankly a little dismayed or envious, when I first bothered to call up a growth chart for PRPFX
Almost none of the DIY investors use PRPFX, which has meaningfully underperformed the 4x25 PP allocation over the life of the fund. Passive management of the PP is preferred over the active management of PRPFX, just like any Boglehead would agree.

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Post by jeffyscott » Thu Aug 26, 2010 9:15 am

craigr wrote: A few additional points I'll make here.

1) I don't think TIPS have any chance of matching gold performance if we get very serious inflation of the dollar. At best, TIPS will match inflation plus a couple percent. This is hardly enough performance to offset inflation damage happening to the rest of the non-TIPS allocation.
OTOH, is it necessary to match the extreme performance of gold if one is stashing 25% in an inflation hedge? Or in other words, isn't 25% gold far too much?

Inflation should not hurt cash, as short term interest rates would follow inflation, inflation should not hurt stocks over longer time frames, so the real damage is really only to long term bonds. But long term bonds should be far less volatile in response to changes in inflation than gold is. So the 25% in each seems to, perhaps, be out of balance.
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Post by Lbill » Thu Aug 26, 2010 9:33 am

If one thing seems clear to me (at least through the glass darkly), it is that sticking with a portfolio allocation - or "staying the course" - is likely to work out better for most investors, most of the time, with most portfolio allocations. It is well to remember that those backtesting performance data for Portfolio X or Portfolio Y over the last 20 or 30 years only mean something if you happened to hold that exact portfolio for the last 20 or 30 years. Studies show that most investors stick with their portfolio allocation for an average of only three years before messing with it. The importance of having an allocation that you can stick with for longer than an eyeblink is woefully underestimated and underdiscussed. Whatever you do, try to figure out what portfolio that is for you. At least over the last 40 years or so, the data show that you didn't get mugged and left for dead at any point if you had held the PP, so it might have been easier to hang on (if you didn't succumb to "tracking error" and go chasing stocks). You can't say that about a portfolio that was 60% or more in stocks. So, at least for some folks, they might have some hope of staying the course with the PP. But if you can hold on with another allocation that's OK too. Holding a large allocation to stocks did a fine job over the last 40 years, if you had held onto that allocation during the times that stocks tanked and your portfolio was getting killed. Investor know thyself!

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Thoughts on the Permanent Portfolio

Post by shawcroft » Thu Aug 26, 2010 9:45 am

Another great article worthy of contemplation....I am still "conflicted" about gold as an "investment". This helps my thinking about cautious placement of our savings and investments..
Shawcroft

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Post by yobria » Thu Aug 26, 2010 9:48 am

mortal wrote:I like the intent of TPP. However, I don't like 'cash' and 'gold' as part of a portfolio. I think most people would be better served throwing short-term bonds and tips into the mix.
Agreed. There's a reason w_bern takes pains to note that people will have a hard time sticking to this fund going forward - the expected return is so low.

Nick

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Post by matt » Thu Aug 26, 2010 9:58 am

yobria wrote:Agreed. There's a reason w_bern takes pains to note that people will have a hard time sticking to this fund going forward - the expected return is so low.
If the expected return of the well diversified PP is so low, what makes you think your portfolio's expected return is much better? An efficient market would imply that expected returns on all assets are low at this time.

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Also Note That

Post by Bill Bernstein » Thu Aug 26, 2010 10:04 am

Yes, in 1981, the PP, the way I calculate it, had its worst year with a 4.96% loss.

Just one problem with that: inflation that year ran 8.94%, so your real loss was double digits.

I got the response from the enthusiasts I expected: "Yes, others are chasing the high recent returns that came from the past decade's return of gold and long bonds and will not keep the faith, but *I'll* stick with it through thick and thin. Promise"

We shall see.

Bill

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Post by Lbill » Thu Aug 26, 2010 10:06 am

I like the intent of TPP. However, I don't like 'cash' and 'gold' as part of a portfolio. I think most people would be better served throwing short-term bonds and tips into the mix.
One can think of the PP as the "mistake" portfolio. In any given year, or maybe even over a few years, it's probably likely that a couple of the four assets in the PP will be mistakes. Maybe it will be cash and gold. Cash is yielding zero and gold may be too bubble-icious. Maybe it will be long bonds - everyone knows that bonds are the Mother of All Bubbles since they've been on a tear for 30 years now. Stocks could be on the cusp of a gigantic multi-year bull market because they've been the dogs of the last decade, and one of these days Regression to Mean has got to kick in doesn't it? But it's OK to make lousy investments if you are holding other investments that are almost sure to do well during their lousiness. In fact, you want to make lousy investments in this way. It has been said that if you don't have at least some investments that are making you sick, you're not properly diversified. :)

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Post by Alex Frakt » Thu Aug 26, 2010 10:14 am

Diversifying asset classes, as Harry Browne knew well, can benefit a portfolio. The secret is deploying them before those diversifying assets shoot the lights out. Harry certainly did so by moving away from gold and into poorly performing stocks and bonds in the late 1970s. Sadly, this is the opposite of what the legions of new TPP adherents and PRPFX owners have been doing recently—effectively increasing their allocations to red-hot long Treasuries and gold. Consider: over the long sweep of financial history, the annual real return of long bonds and gold have been 2% and 0%, respectively; over the decade ending 2009, they were 5% and 11%.
Herein lies the rub. IMO, there is no difference between moving into the PP today and moving into a 75% VFINX 25% short bond portfolio in 1999. Sure the past performance was spectacular, but the only way it can achieve the same returns over the next two decades is for gold to quintuple (sextuple?) in price again.

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Post by matt » Thu Aug 26, 2010 10:32 am

Alex Frakt wrote:...the only way it can achieve the same returns over the next two decades is for gold to quintuple (sextuple?) in price again.
Again, for those arguing that the PP was okay in the past, but today the expected returns are too low...where exactly are the returns for YOUR portfolio going to come from? With the yield to maturity on Total Bond Market at 2.3% net of expenses, the best case scenario if interest continue falling is maybe a 4% annualized return over the next five years. Of course, if that happens, the following five years will start with very pitiful yields. The worse case scenario, of course, is that interest rates start rising and you end up with losses in TBM over the next five years.

How about stocks? They are a better value than bonds, but they are by no means cheap. I hope you're not expecting 10% per year returns there. Assuming that valuations drop a bit by the end of the next decade, you might get a 5-6% return on stocks.

So a simple 50/50 stock/bond portfolio has a likely return of about 4%, but could do much worse and will only do better if those assets become more overvalued than they already are. Even assuming a 0% return on gold, the PP's likely return is probably 2% ignoring rebalancing benefits, but in my opinion has potentially better upside (in either deflation or rising inflation) and better downside protection than the 50/50 if the economy remains volatile.

So really, what is it that the non-PPers think is so hot about what they've got? The truth is that this is not likely to be a great starting date for any passive investment strategy.

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Re: Also Note That

Post by Indices » Thu Aug 26, 2010 10:42 am

wbern wrote:Yes, in 1981, the PP, the way I calculate it, had its worst year with a 4.96% loss.

Just one problem with that: inflation that year ran 8.94%, so your real loss was double digits.

I got the response from the enthusiasts I expected: "Yes, others are chasing the high recent returns that came from the past decade's return of gold and long bonds and will not keep the faith, but *I'll* stick with it through thick and thin. Promise"

We shall see.

Bill
This is a criticism of PP holders not the PP itself.

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Re: Also Note That

Post by Tramper Al » Thu Aug 26, 2010 10:45 am

Indices wrote:
wbern wrote:Yes, in 1981, the PP, the way I calculate it, had its worst year with a 4.96% loss.

Just one problem with that: inflation that year ran 8.94%, so your real loss was double digits.

I got the response from the enthusiasts I expected: "Yes, others are chasing the high recent returns that came from the past decade's return of gold and long bonds and will not keep the faith, but *I'll* stick with it through thick and thin. Promise"

We shall see.

Bill
This is a criticism of PP holders not the PP itself.
Yes, though I agree it speaks to the utility.

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Post by jeffyscott » Thu Aug 26, 2010 10:47 am

matt wrote:So a simple 50/50 stock/bond portfolio has a likely return of about 4%, but could do much worse and will only do better if those assets become more overvalued than they already are. Even assuming a 0% return on gold...
What if your 0% for gold is too optimistic. Why assume 0% from here, rather than 0% (real) from, say, 2000-2020? If that happens the returns for the next 10 years will maybe be something like -50% cumulative.

Gold has been very volatile, I'd assume it will continue to be. If it goes back down to the production cost of <$500 per ounce that will also make the return a large negative number.
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Post by Indices » Thu Aug 26, 2010 10:47 am

richard wrote:Bill typically favors "diversifying by asset class" and has great respect for the utility of past data. These two prejudices go a long way to explaining the article.
All Bogleheads respect the utility of past data. Past data allowed for indexing to be discovered in the first place. The key difference between Bogleheads and others is that Bogleheads use the past data of several centuries whereas others use the past data of several days or weeks.

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Post by tms » Thu Aug 26, 2010 10:48 am

[political comment deleted by admin alex - you can PM wbern if you think his characterization of Harry Browne is inaccurate]

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Re: Also Note That

Post by Indices » Thu Aug 26, 2010 10:50 am

Tramper Al wrote:
Indices wrote:
wbern wrote:Yes, in 1981, the PP, the way I calculate it, had its worst year with a 4.96% loss.

Just one problem with that: inflation that year ran 8.94%, so your real loss was double digits.

I got the response from the enthusiasts I expected: "Yes, others are chasing the high recent returns that came from the past decade's return of gold and long bonds and will not keep the faith, but *I'll* stick with it through thick and thin. Promise"

We shall see.

Bill


This is a criticism of PP holders not the PP itself.
Yes, though I agree it speaks to the utility.
The same could be said of a standard Boglhead portfolio. How many times on this board have we seen the words "stay the course". It is a common refrain of John Bogle himself. It takes discipline to stay with any buy and hold strategy. Most will fail and invest in exotic instruments like REITs, bizarre ETFs or something else along the way and pay for it. Whether the PP requires more discipline is anyone's guess and depends entirely on the psychology of individual investors which is largely unpredictable.

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Post by Lbill » Thu Aug 26, 2010 10:54 am

Herein lies the rub. IMO, there is no difference between moving into the PP today and moving into a 75% VFINX 25% short bond portfolio in 1999. Sure the past performance was spectacular, but the only way it can achieve the same returns over the next two decades is for gold to quintuple (sextuple?) in price again.
Alex - at first I agreed with you. Then I decided to look at some historical data that might be instructive, using Simba's spreadsheet which has returns from 1972-2009.

We all recall that Gold was on a tear from 1972-1980. During that time it had a shocking compound annual return of 33.05%. The PP had a CAGR of 14.64% with an annualized SD of 9.98%. This was surely persuasive and all the car-chasing PPers would have been piling into the PP in 1980 just in time for Gold to crash. So, what happened to them? Well, over the next same-lengthed time period of nine years, 1981 to 1989, Gold had a compound annual return (er, loss) of (-4.64)% - the scenario you envision but even worse. Our hapless PP investors, however, had a compound annual return of 8.77% with an annualized SD of 8.83%. Surely the PPers must have had "stock envy," but they hardly went broke. Those returns are in line with the long-term returns of the PP over the entire 1972-2009 time period (9.53%). Over that some time period of 38 years, stocks returned 9.73% with an SD of 18.79% over this 38-year period, with some bone-jarring losses that made mothers weep and small children cry. As HB said, the PP is less about getting rich than it is about securing your wealth and growing it slowly.
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Re: Also Note That

Post by dbr » Thu Aug 26, 2010 10:56 am

Indices wrote:[
The same could be said of a standard Boglhead portfolio. How many times on this board have we seen the words "stay the course". It is a common refrain of John Bogle himself. It takes discipline to stay with any buy and hold strategy. Most will fail and invest in exotic instruments like REITs, bizarre ETFs or something else along the way and pay for it. Whether the PP requires more discipline is anyone's guess and depends entirely on the psychology of individual investors which is largely unpredictable.
I agree. Responding irrationally to events in some one asset class in the portfolio is a problem endemic to all investors. The assets in the PP are in no way unique in this regard.

This forum is full of angst surrounding issues about behavior of some asset class or another that are considered without any context regarding total portfolios, a plan, and staying the course.

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Post by richard » Thu Aug 26, 2010 10:57 am

Indices wrote:All Bogleheads respect the utility of past data. Past data allowed for indexing to be discovered in the first place. The key difference between Bogleheads and others is that Bogleheads use the past data of several centuries whereas others use the past data of several days or weeks.
Indexing should be based on the fact that it will equal the average fund before costs and beat it after costs and that we have no good way of picking winning funds.

Market data more than one century old is not very reliable. We don't have enough date for anything useful to be statistically significant. Even more fundamental, the market reacts to data, which means conditions change and the conditions underlying old data may no longer apply.

Think of statistics as drawing red and blue balls from a barrel to predict the underlying distribution. Think of market statistics as drawing from a different barrel each time. Makes it harder to judge the underlying distribution.

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Post by Tramper Al » Thu Aug 26, 2010 10:58 am

jeffyscott wrote:
matt wrote:So a simple 50/50 stock/bond portfolio has a likely return of about 4%, but could do much worse and will only do better if those assets become more overvalued than they already are. Even assuming a 0% return on gold...
What if your 0% for gold is too optimistic. Why assume 0% from here, rather than 0% (real) from, say, 2000-2020? If that happens the returns for the next 10 years will maybe be something like -50% cumulative.
One thing I have learned from reading authors like WB, as well as reading here, is that it doesn't make a lot of sense to look at individual assets like this in isolation, but rather as the whole portfolio. I think it is particularly silly to take a whole portfolio like the PP and say we like it, but now let's put out 1 or 2 of its parts that we don't like so much.

I think everyone agrees that expected returns are good, and diversifying with low- or negatively correlated assets within a whole portfolio is good. Then much disagreement follows as to how low an expected return you'll accept from a very diversifying asset. For some people, looking at an asset in isolation and deciding it should have a zero or slightly negative real return is already too much to bear. It doesn't matter how well it has behaved within portfolios, its already out. I get that. Others like to look at the history ABC portfolio and see what happens when you make it ABCD. I think it's a matter of what price you'll pay for those near zero correlations.

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Post by Lbill » Thu Aug 26, 2010 11:14 am

Tramper - you make an excellent point. Everybody seems to like the PP viewed as a whole. Imagine a "synthetic asset" you could have bought in 1972 and earned a compounded 9.5% a year, with only 8% average annual volatility, only 3 "down" years of 4.1% (1981), 2.6% (1994), and 0.7% (2008). How much can I buy? But most everybody hates the individual assets: gold, long treasuries, cash. I happen to hate stocks, but that's just me. Interesting, eh? I keep challenging Larry Swedroe to resolve his contradictory view that you should only view the portfolio and not assets in isolation (which is his main justification for commodities), but he eschews gold and for the most part doesn't like a high allocation to long bonds or cash either. All for good reasons, if you view individual assets in isolation. Can't have it both ways.

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Post by Alex Frakt » Thu Aug 26, 2010 11:39 am

Lbill wrote:Well, over the next same-lengthed time period of nine years, 1981 to 1989, Gold had a compound annual return (er, loss) of (-4.64)% - the scenario you envision but even worse. Our hapless PP investors, however, had a compound annual return of 8.77% with an annualized SD of 8.83%.
I'd guess this is due to falling interest rates boosting the LT bonds returns. That's not repeatable at current rates.

Anyway, now give us the numbers for PP and stocks for the next 9 years - 90-99. How many people were beating the drum for PP then? That's my point. The time to buy into a strategy is not after it has has world-beating performance for a decade or two. As I said above, IMO PP in 2010 is equivalent to 75/25 VFINX/ST Bonds in 1999.

If you want to preserve your wealth, the only real difference between PP and a traditional approach is the gold holdings. Replace them with TIPS and you'll keep your money intact - well the paper value of your LT bonds will decline if interest rates rise, but you'll still be getting the same interest payments so the purchasing power is a wash. But obviously you can't expect much in terms of growth.

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Post by yobria » Thu Aug 26, 2010 11:39 am

matt wrote:If the expected return of the well diversified PP is so low, what makes you think your portfolio's expected return is much better? An efficient market would imply that expected returns on all assets are low at this time.
It would be hard to construct a portfolio with a lower expected return than one composed mainly of cash (0% return), bonds (2.5%), gold (inflation, call it 2%).

Of course, this is also a low risk portfolio, but the apparent free lunch provided by the historical data should in no way be expected to continue.

Bit like buying Microsoft stock in 2000.

Nick

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Wrong

Post by Bill Bernstein » Thu Aug 26, 2010 11:56 am

LBill:

The fact is, as I pointed out in the article, Harry's acolytes *did* bail from the strategy in the 1990s, as evidenced by the fact that PRPFX's assets fell by 50% during a period when the fund had a total return of +70%; ergo, it lost about two-thirds of its assets, and this during a period when total mutual fund assets increased seven-fold!

But who knows, maybe the current generation of Harry Browners is made of sterner stuff ;-)

Bill

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Post by matt » Thu Aug 26, 2010 11:58 am

yobria wrote:It would be hard to construct a portfolio with a lower expected return than one composed mainly of cash (0% return), bonds (2.5%), gold (inflation, call it 2%).

Of course, this is also a low risk portfolio, but the apparent free lunch provided by the historical data should in no way be expected to continue.
I'll try this one last time: I think most of us acknowledge that the PP will not match its prior returns in the near future. That point of discussion is covered.

The relevant point still in need of discussion is whether you think the same lowered return expectations do not apply to a simpler stock/bond portfolio. I believe the exact argument applies; the historical returns on such a portfolio will also not be matched in the near future and are likely to fall well short. If you disagree, show me the math you're using to come up with your expected return.

So the comparison seems quite simple. The lower risk portfolio has a lower expected return than the higher risk portfolio, as expected. But both portfolios have much lower expected returns than they have achieved over the past 30-40 years. So really, who is fooling themselves: the ones who are investing in the capital preservation portfolio or the growth portfolio?

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Post by Lbill » Thu Aug 26, 2010 12:15 pm

Alex wrote:
Anyway, now give us the numbers for PP and stocks for the next 9 years - 90-99. How many people were beating the drum for PP then? That's my point. The time to buy into a strategy is not after it has has world-beating performance for a decade or two.
OK.
1990 thru 1998 (9 yrs): CAGR = 7.3%, SD = 6.0%
1999 thru 2007 (9 yrs): CAGR = 7.0%, SD = 4.7%
2000 thru 2009 ("lost decade"): CAGR = 6.6%, SD = 5.4%

Not exactly what I would call "world beating performance." If anything, if the PP is underperforming it's long term average. The decade of world-beating performance was back in the 1970s, and PP investors did OK after that (except for "stock envy"). Gotta remember, if Gold doesn't do well, then it will probably be due to the conditions in which stocks and/or bonds and/or cash might do well. The four assets have low or negative correlations that have been pretty stable. It's not just what one of them does.

You might well be right about holding TIPS. I favor them myself. The only caveat is that TIPS haven't been around that long and haven't been "stress-tested" yet. Who knows what they will do if a really scary financial scenario shows up in the U.S.

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Post by Lbill » Thu Aug 26, 2010 12:31 pm

wbern wrote:
The fact is, as I pointed out in the article, Harry's acolytes *did* bail from the strategy in the 1990s, as evidenced by the fact that PRPFX's assets fell by 50% during a period when the fund had a total return of +70%; ergo, it lost about two-thirds of its assets, and this during a period when total mutual fund assets increased seven-fold!

But who knows, maybe the current generation of Harry Browners is made of sterner stuff
Thank you, Bill. I feel honored that you would bother to respond to my rantings. It's certainly true that the PP is enjoying a rebirth of popularity these days of fear and loathing of more conventional investment approaches. That after at least two decades of being reviled because of the moonshot for equities. I guess back in the 1990s, the only way most investors could get exposure to something resembling the PP was via PRPFX, which really isn't the PP at all. Now, as you point out in your article, everybody can invest in the real thing because there are now available ETFs for gold and long Treasuries, for example. Now whether that will make any difference for car-chasers is debatable. It will be harder to measure the ebb and flow of enthusiasm for the PP, however, unless one is willing to still accept PRPFX as a valid proxy. I think you are quite right to caution all the newly-minted converts to the PP that there are likely to be some "feeling wrong and alone" times in the future. No-one in his right mind should invest a lot of money in the PP, or any other formula, that they aren't willing to stick with for the long run, IMO.

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Post by yobria » Thu Aug 26, 2010 12:55 pm

matt wrote:The relevant point still in need of discussion is whether you think the same lowered return expectations do not apply to a simpler stock/bond portfolio.
I don't expect future returns for the PP to be anywhere near the 8.53% wbern says a theoretical PP has performed historically.

I do expect returns of a globally diversified 100% stock portfolio to return about what they have historically.

If that answers your question.

Nick

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Post by Maestro G » Thu Aug 26, 2010 12:59 pm

yobria wrote:
matt wrote:If the expected return of the well diversified PP is so low, what makes you think your portfolio's expected return is much better? An efficient market would imply that expected returns on all assets are low at this time.
It would be hard to construct a portfolio with a lower expected return than one composed mainly of cash (0% return), bonds (2.5%), gold (inflation, call it 2%).

Of course, this is also a low risk portfolio, but the apparent free lunch provided by the historical data should in no way be expected to continue.

Bit like buying Microsoft stock in 2000.

Nick
Yes, perhaps. However as HB is often quoted and to paraphrase: investment behavior does not always turn out as "expected".

As I understand it, the two critical points of the PP are:

1) Do not evaluate the merits of assets in isolation. One could argue this for any truly non-correlated diversified portfolio.

2) Stay disciplined as to the recommended re-balancing bands or at least some kind of re-balancing.

Stocks, gold and LT can be, of course, extremely volatile assets in isolation at any given time. This is the point: exploit those periods through disciplined re-balancing, save regularly, and "stay the course."

Will this be as successful a strategy as a conventional 60/40 or 50/50 portfolio if we have a 20 yr. stock bull market from here? Certainly not.

However, it might be as successful if not more so if we have another gut wrenching draw down in stocks, or some sort of global monetary or political crisis in which gold and/or LT treasuries soar etc...particularly with disciplined re-balancing.

All of these decisions are, of course, greatly time dependent. The PP is designed (not guaranteed) for safety and moderate growth. Whether or not your implementation of the PP will help you achieve your objectives in your investment time horizon is unknowable in advance. One could say the same for any strategy decision.

Essentially, we assess our needs and risks as well as we can, place our bets, strive to meet our lifestyle objectives, adjust as necessary and hope for the best.

No amount of empirical historic data or backtesting is definitive relative to the future.

The future is not predictable and uncertain.

Maestro G
Yesterday is history, tomorrow is a mystery, today is a gift, that's why it's called the present. Most daily market noise is "a tale told by an idiot, full of sound and fury, signifying nothing."

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Post by matt » Thu Aug 26, 2010 1:08 pm

yobria wrote:I do expect returns of a globally diversified 100% stock portfolio to return about what they have historically.
It does answer the question. Unfortunately for you, that belief is irrational both based on current valuations and finance theory (CAPM).

I believe the majority of investors will be disappointed with their returns over the next decade. But the decade after that...maybe things will start looking up.

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Post by Lbill » Thu Aug 26, 2010 1:12 pm

yobria wrote:
I don't expect future returns for the PP to be anywhere near the 8.53% wbern says a theoretical PP has performed historically.

I do expect returns of a globally diversified 100% stock portfolio to return about what they have historically.
You must be getting your crystal balls from a better manufacturer than where I've been getting them. Care to share the name of that firm? :)

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Post by yobria » Thu Aug 26, 2010 1:22 pm

Maestro G,

Those are certainly fair points. My only point is the unique set of events that makes the PP look so attractive

Bonds - a long bull market, some would say now a bubble.

Stocks - languishing due to a couple of recent recessions

Gold - big recent run up

are unlikely (but not impossible) to repeat. Low risk asset classes don't produce high returns forever.

Nick

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Post by yobria » Thu Aug 26, 2010 1:27 pm

Lbill wrote:You must be getting your crystal balls from a better manufacturer than where I've been getting them. Care to share the name of that firm? :)
I actually use a magic mirror (also tells me I'm the fairest of them all).

Maker is Rational Expectations, S.A. Romanian firm run by some of the nicest Gypsies you'll ever meet. Rumor has it Jeremy Grantham is a client!

Nick

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