Author Topic: PSA: Read Tyler of Portfolio Charts' recent blog post on portfolio construction?  (Read 11829 times)

Blender Bender

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I know that you don't like bonds, but this is a general statement:
Investing definition:
"Expend money with the expectation of achieving a profit or material result by putting it into financial plans, shares, or property, or by using it to develop a commercial venture."

Having bonds in general for the next foreseeable future does not fulfill the definition IMHO.


When you invest in property or commercial business you buy insurance to protect yourself from black swan events.  Having a diversified portfolio is just insurance, and done correctly, it actually enhances your return on investment.

There is no where else is attempting to justify further equity inflation. There is always somewhere else.  The debt market is multiple times the size of the stock market and can quickly soak up all the money floating around if there is another shock of some sort. If double digits returns in equities are guaranteed the next few years then we are all idiots if we don't go 100% UPRO tomorrow!

+1 to all above.
Thatís right. Not quarantined. The Gut has some say too.

SeattleCPA

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So many detailed charts from the past, ignoring the changed context.

Diversification is good for sure, unless it "ensures" underperformance. I'm assuming that we talk here about investing here, not SORR strategies.


I wonder if we're communicating here. Maybe not?

I think we're talking about a portfolio construction technique called "modern portfolio theory" (aka "MPT").

So we're all on the same page, MPT says or suggests investors can optimize their overall returns or overall risk by cleverly assembling their portfolios.

Here's a very simple example I explored in a simple blog post a few years ago...

Over the 25-year time frame I was able to look at at that point in time, stocks and reit indexes both returned basically 9.5%... so you could invest in either asset class and get a great return... stocks were lower risk btw...

But if you invested 50/50 in stocks and REITs, you would have earned 10%. So half a percent more. And this is the kicker: That 50/50 portfolio turned out to have basically the same risk as if you'd invested just in stocks.

BTW, I think you point to something else that's useful... Some folks use MPT to dial down their risk. E.g., if someone is okay with the return a 100% investment in stocks delivered over a 25-year time frame, if 9.5% is good enough in other words, MPT says they ought to ratchet down their risks. Why? Because they get that same 9.5% return with a significantly lower level of risk.

Final comment: I don't think anyone who believes the math of MPT thinks you can extrapolate past returns or assume historical risks or correlations...but I don't think you need that to make MPT work.

Quoting from Tyler's excellent blog post again, "Combinations of volatile complementary assets can have much more desirable performance than any one asset by itself."




Blender Bender

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So many detailed charts from the past, ignoring the changed context.

Diversification is good for sure, unless it "ensures" underperformance. I'm assuming that we talk here about investing here, not SORR strategies.


I wonder if we're communicating here. Maybe not?

I think we're talking about a portfolio construction technique called "modern portfolio theory" (aka "MPT").

So we're all on the same page, MPT says or suggests investors can optimize their overall returns or overall risk by cleverly assembling their portfolios.

Here's a very simple example I explored in a simple blog post a few years ago...

Over the 25-year time frame I was able to look at at that point in time, stocks and reit indexes both returned basically 9.5%... so you could invest in either asset class and get a great return... stocks were lower risk btw...

But if you invested 50/50 in stocks and REITs, you would have earned 10%. So half a percent more. And this is the kicker: That 50/50 portfolio turned out to have basically the same risk as if you'd invested just in stocks.

BTW, I think you point to something else that's useful... Some folks use MPT to dial down their risk. E.g., if someone is okay with the return a 100% investment in stocks delivered over a 25-year time frame, if 9.5% is good enough in other words, MPT says they ought to ratchet down their risks. Why? Because they get that same 9.5% return with a significantly lower level of risk.

Final comment: I don't think anyone who believes the math of MPT thinks you can extrapolate past returns or assume historical risks or correlations...but I don't think you need that to make MPT work.

Quoting from Tyler's excellent blog post again, "Combinations of volatile complementary assets can have much more desirable performance than any one asset by itself."

SeattleCPA, thank you for the context re-setting and the writeup.

It seems to me that MPT is a good tool for risk averse investors that normally would hold very conservative portfolios (seems like not me). "Combinations of volatile complementary assets can have much more desirable performance than any one asset by itself." Is that just the feature of AA rebalancing making the benefit? Seems to me that's the reason. Is this (or AA in general) so Modern?

But for more aggressive investors it _could_ help overall returns if they are lucky with the AA selection. If the investor did allocation of BRICK ETFs in the last 10 years then the outcome would not be so good. BRICK seems more risky (as REIT) compared with FANG.For this aggressive investor allocating Bonds going forward, would produce a likely not so good outcome too. So matter of selecting "proper" assets for diversification (in the context of next x years), what are they? 

Normally we read about "this AA allocation and strategy did good" in the last x years. We do not hear much about "that AA allocation did poorly" (e.g the BRICK). Same as we hear that _some_ bitcoin traders did well, but we don't hear much about those that did not well.

There is a criticism of MPT that does not address "bad times''. IMHO this does now work well with statements that MTP reduces risks.
But am I right or wrong? I don't know. At this stage of my investing, SORR is my primary concern.

SeattleCPA

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So many detailed charts from the past, ignoring the changed context.

Diversification is good for sure, unless it "ensures" underperformance. I'm assuming that we talk here about investing here, not SORR strategies.


I wonder if we're communicating here. Maybe not?

I think we're talking about a portfolio construction technique called "modern portfolio theory" (aka "MPT").

So we're all on the same page, MPT says or suggests investors can optimize their overall returns or overall risk by cleverly assembling their portfolios.

Here's a very simple example I explored in a simple blog post a few years ago...

Over the 25-year time frame I was able to look at at that point in time, stocks and reit indexes both returned basically 9.5%... so you could invest in either asset class and get a great return... stocks were lower risk btw...

But if you invested 50/50 in stocks and REITs, you would have earned 10%. So half a percent more. And this is the kicker: That 50/50 portfolio turned out to have basically the same risk as if you'd invested just in stocks.

BTW, I think you point to something else that's useful... Some folks use MPT to dial down their risk. E.g., if someone is okay with the return a 100% investment in stocks delivered over a 25-year time frame, if 9.5% is good enough in other words, MPT says they ought to ratchet down their risks. Why? Because they get that same 9.5% return with a significantly lower level of risk.

Final comment: I don't think anyone who believes the math of MPT thinks you can extrapolate past returns or assume historical risks or correlations...but I don't think you need that to make MPT work.

Quoting from Tyler's excellent blog post again, "Combinations of volatile complementary assets can have much more desirable performance than any one asset by itself."

SeattleCPA, thank you for the context re-setting and the writeup.

It seems to me that MPT is a good tool for risk averse investors that normally would hold very conservative portfolios (seems like not me). "Combinations of volatile complementary assets can have much more desirable performance than any one asset by itself." Is that just the feature of AA rebalancing making the benefit? Seems to me that's the reason. Is this (or AA in general) so Modern?

But for more aggressive investors it _could_ help overall returns if they are lucky with the AA selection. If the investor did allocation of BRICK ETFs in the last 10 years then the outcome would not be so good. BRICK seems more risky (as REIT) compared with FANG.For this aggressive investor allocating Bonds going forward, would produce a likely not so good outcome too. So matter of selecting "proper" assets for diversification (in the context of next x years), what are they?

Normally we read about "this AA allocation and strategy did good" in the last x years. We do not hear much about "that AA allocation did poorly" (e.g the BRICK). Same as we hear that _some_ bitcoin traders did well, but we don't hear much about those that did not well.

There is a criticism of MPT that does not address "bad times''. IMHO this does now work well with statements that MTP reduces risks.
But am I right or wrong? I don't know. At this stage of my investing, SORR is my primary concern.

I think the math of MPT is really hard to wrap our heads around. Means. Variances. Correlation coefficients. Yuck.

But the math says we can use it to improve returns without bearing additional risk. E.g., in the blog post I pointed to, combining two 9.5% returning investments to create a new 10% returning investment.

We won't know beforehand what the results will be. Just like when we invest in a particular index fund. But the math and history suggest we'll get a bump in returns and/or a reduction in variability.

Similar to the way when by investing in a cheap index fund, we'll probably beat active funds over time simply due to not paying the investment management fees. Both the math and history suggest this...

VanillaGorilla

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I love math!

Gold has nearly matched the SP500 over the last 15 years, so there's a strong bias there. Any combination of gold, REITs, and large and small cap funds has done extremely well for a long time.

Currently bonds are doing very poor and the idea that bonds offer much diversification is potentially misguided.

With current bond yields they don't diversity so much as de-risk the same way that cash would. Current nominal yields are <2% and inflation is 6%.

Finally, for me personally, my portfolio doesn't exist in a vacuum, I had a mortgage as well. Paying off a loan at 2.5% beats buying bonds at 1.8% all day. That adds another dimension. :)

Generally I subscribe to the idea that bonds are only useful for parking short term assets. Gold is nice as a sequence of returns mitigation.


mntnmn117

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It seems to me that MPT is a good tool for risk averse investors that normally would hold very conservative portfolios (seems like not me). "Combinations of volatile complementary assets can have much more desirable performance than any one asset by itself." Is that just the feature of AA rebalancing making the benefit? Seems to me that's the reason. Is this (or AA in general) so Modern?


That's MPT. It easier to think about theoretically than getting bogged down in the bonds/REIT/Gold debate. Think of two hypothetical businesses, one always makes gains in the spring, one always makes gains in the fall. Wouldn't you want to hold more business A in the Spring and hold more business B in the Fall? Rebalancing does that. In this hypothetical scenario you'd rebalance every winter/summer, each time selling the previous seasons high performer and buying the low performer. You're making money off the inverse relationship. It actually better to own part of two things and rebalance than to just hold the one higher performer. Risk has nothing to do with it. It's un-correlation that important.

Also, I think the point is lot of people don't understand the risk they are taking on right now with 100% equity portfolios. It's one thing to say you're risk averse or that there's no alternative. It's another thing to have your portfolio take 10 years to recover. That would definitely mess up my plans and its completely within the realm of historical possibility.

ChpBstrd

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4) At this point, it is highly improbable that a LT Treasury allocation would deliver a double-digit positive annual returns. The experience of the last 40 years of falling interest rates is not going to repeat - there's not another 13% for long duration interest rates to fall. Are long duration bonds still a secret ingredient if there is no plausible way for them to deliver the returns required to be a secret ingredient - or even positive real returns?
There actually is a plausible way for long term bonds to deliver significant real returns today, and it doesn't require that rates fall another 13%. I suggest reading this article on bond convexity.

Rates certainly could go lower, as they have done in Japan and Europe. But then what? After we hit 0% or -0.5% on the 10y treasury, could we go to -1% to -1.5% or is the long-duration bond allocation doomed? At some point mathematical theory hits a real-world wall where arbitrage* eliminates the point of lending one's money at such low rates.

Suppose that due to convexity, a 30y bond has 28% upside if rates fall 1%, and 19% downside if rates rise 1%. That sounds like a good gamble, but it's only a good gamble if the two outcomes have similar probabilities. As a hedge, it only works if rising rates would not also decimate one's other holdings, such as stocks with historically high PE's.

On the subject of probabilities, interest rates are now lower than they've been in hundreds of years.
https://www.visualcapitalist.com/the-history-of-interest-rates-over-670-years/

If we plotted a bell curve of the rates across years, we'd be on the very distant end of a tail, in a position previously thought to be extremely unlikely. Could this state of affairs persist for decades as it has in Japan? Sure. But as we continue to experience these unusual rates, their continuation becomes less and less likely. During all those zig-zags of the past, something caused the low points to move higher and the high points to move lower. I.e. some force of economics is causing reversion to the mean, even if it can take years to revert, and rates can't go lower and lower forever.

So before buying that 30y bond, or TLT, I suggest everyone think about the relative likelihood of yet another -1% change in interest rates vs. the opposite, which would be a step toward reversion to the mean. Maybe also think about what happens to the prices of stocks, real estate, and gold if interest rates rise. Imagine seeing 5% again. I think it would be a bloodbath across asset classes, and as @Tyler 's convexity chart demonstrates, bonds bought at today's low rates would not necessarily hedge a portfolio, even if there was lots of upside to an extremely improbable event like rates below -2%**.


*E.g. currency futures arbitrage, box spread arbitrage, cash in a safe deposit box, TIPS, receivables, laundering, hedged carry trades, lots of other ways to safely earn 0% if the alternative is negative. 

**Which is why I advocate using options rather than bonds.

boarder42

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I was just discovering the 90 SCV/ 10 TLT portfolio and do you think that it's performance is a fluke of past conditions/bias? It's peaks and valleys just happen to line up better than anything else or does it have a fundamental relationship causing the inverse correlation? 

Punching in 90/10 SCV/TLT gives an average return of 10.1 and Perpetual WR of 6.2. Same Ulcer# as 60/40, No-brainer, and Core 4 but with almost twice the Average, Baseline LT, and PerpWR.

I'm not going to pretend to be some macroeconomic expert, and I'm definitely NOT a financial adviser. But if you want to read the reasoning behind SCV, I recommend this book. It covers several of your questions and may help you decide whether that much SCV makes sense to you or not.

If you're going heavy into a single asset class you need to be aware you'll have sustained periods of loss or flat performance compared to other classes. I plan to be 80/20 scv to LTT.  As long as you understand you'll have a couple decades not outperforming the sp500 then a small window of large outperformance and you're comfortable sticking to that it's a reasonable strategy imo. I think Tyler's analysis here shows just how bad VTSAX is as a primary chunk of a portfolio. And there are many other options that will deliver better results with less risk.

In any decision someone makes it needs to be written in an IPS bc there will be large temptations to change it. Esp bc you don't have the backing of a large support community who made the same decision.

vand

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4) At this point, it is highly improbable that a LT Treasury allocation would deliver a double-digit positive annual returns. The experience of the last 40 years of falling interest rates is not going to repeat - there's not another 13% for long duration interest rates to fall. Are long duration bonds still a secret ingredient if there is no plausible way for them to deliver the returns required to be a secret ingredient - or even positive real returns?
There actually is a plausible way for long term bonds to deliver significant real returns today, and it doesn't require that rates fall another 13%. I suggest reading this article on bond convexity.

Rates certainly could go lower, as they have done in Japan and Europe. But then what? After we hit 0% or -0.5% on the 10y treasury, could we go to -1% to -1.5% or is the long-duration bond allocation doomed? At some point mathematical theory hits a real-world wall where arbitrage* eliminates the point of lending one's money at such low rates.

Suppose that due to convexity, a 30y bond has 28% upside if rates fall 1%, and 19% downside if rates rise 1%. That sounds like a good gamble, but it's only a good gamble if the two outcomes have similar probabilities. As a hedge, it only works if rising rates would not also decimate one's other holdings, such as stocks with historically high PE's.

On the subject of probabilities, interest rates are now lower than they've been in hundreds of years.
https://www.visualcapitalist.com/the-history-of-interest-rates-over-670-years/

If we plotted a bell curve of the rates across years, we'd be on the very distant end of a tail, in a position previously thought to be extremely unlikely. Could this state of affairs persist for decades as it has in Japan? Sure. But as we continue to experience these unusual rates, their continuation becomes less and less likely. During all those zig-zags of the past, something caused the low points to move higher and the high points to move lower. I.e. some force of economics is causing reversion to the mean, even if it can take years to revert, and rates can't go lower and lower forever.

So before buying that 30y bond, or TLT, I suggest everyone think about the relative likelihood of yet another -1% change in interest rates vs. the opposite, which would be a step toward reversion to the mean. Maybe also think about what happens to the prices of stocks, real estate, and gold if interest rates rise. Imagine seeing 5% again. I think it would be a bloodbath across asset classes, and as @Tyler 's convexity chart demonstrates, bonds bought at today's low rates would not necessarily hedge a portfolio, even if there was lots of upside to an extremely improbable event like rates below -2%**.


*E.g. currency futures arbitrage, box spread arbitrage, cash in a safe deposit box, TIPS, receivables, laundering, hedged carry trades, lots of other ways to safely earn 0% if the alternative is negative. 

**Which is why I advocate using options rather than bonds.

I saw this movie once where the investment thesis was to buy up lots of real estate because you could then rent them out for 5%, 6%, sometimes even 7%!  The problem was that as everyone did this and pushed prices higher, the rents you could command as a proportion of the purchase price inexorably dropped.. down to 4%, 3%, sometimes even 2%.

"No worries!!"  said the so-called investors... "What we're lacking in rent we'll just make up on capital appreciation! A house that goes from 3% yield to 2% yield means we've had 33% capital appreciation! But a house that moves from 2% yield down to 1% yields gives us a further 100% appreciation! How can it go wrong?!"

"What happens when yield reach zero?" said one of the more enlightening characters? Pah, what did they know!? Their argument was rebuffed as the calculations were spun out to prove that we could even afford to pay the tenants to live in our "investments", giving us negative yielding rents, but that didn't matter as it would mean that the house prices were going up up up!!

This movie did not end.

« Last Edit: December 23, 2021, 04:07:39 AM by vand »

SeattleCPA

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I think Tyler's analysis here shows just how bad VTSAX is as a primary chunk of a portfolio. And there are many other options that will deliver better results with less risk.

For what it's worth, I'm a semi-committed believer to modern portfolio theory (which as @ArnoldK points out, isn't actually very modern...) But I think having a big chunk in VTSAX is fine. I have 30%. My interpretation or understanding of MPT encourages me to believe I need to look at my portfolio as a whole. So the other stuff I've got in there dials down the risk.

Going 100% in VTSAX or anything else? I think that's really naive. And unnecessarily risky.

Also, btw ArnoldK? I think MPT isn't same thing as rebalancing benefit. And I think MPT can help with SORR because SORR is really all about variability in returns. E.g., encountering a bad patch at the start of your or my retirement. And MPT gives you and me a way to dial down variability without dialing down returns.
 
In any decision someone makes it needs to be written in an IPS bc there will be large temptations to change it. Esp bc you don't have the backing of a large support community who made the same decision.

Also for what it's worth, I think above comment from @boarder42 reflects great wisdom. Thank you boarder42 for this important reminder.

boarder42

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I think Tyler's analysis here shows just how bad VTSAX is as a primary chunk of a portfolio. And there are many other options that will deliver better results with less risk.

For what it's worth, I'm a semi-committed believer to modern portfolio theory (which as @ArnoldK points out, isn't actually very modern...) But I think having a big chunk in VTSAX is fine. I have 30%. My interpretation or understanding of MPT encourages me to believe I need to look at my portfolio as a whole. So the other stuff I've got in there dials down the risk.

Going 100% in VTSAX or anything else? I think that's really naive. And unnecessarily risky.

Also, btw ArnoldK? I think MPT isn't same thing as rebalancing benefit. And I think MPT can help with SORR because SORR is really all about variability in returns. E.g., encountering a bad patch at the start of your or my retirement. And MPT gives you and me a way to dial down variability without dialing down returns.
 
In any decision someone makes it needs to be written in an IPS bc there will be large temptations to change it. Esp bc you don't have the backing of a large support community who made the same decision.

Also for what it's worth, I think above comment from @boarder42 reflects great wisdom. Thank you boarder42 for this important reminder.

In general I agree that a diverse equity allocation that is not cap weighted greatly increases fire success mainly due to sorr risk and rebalancing. It also is easier to maintain long term as something is likely to be doing well

index

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In general I agree that a diverse equity allocation that is not cap weighted greatly increases fire success mainly due to sorr risk and rebalancing. It also is easier to maintain long term as something is likely to be doing well

According to some Fidelity research (https://www.etf.com/docs/The_Case_Sector_Based_Framework.pdf), market cap and style box (growth, value, balanced) are not great indicators of return variance:



And your chance of choosing the wrong market cap/style box can impact your results more than sector concentration:



The attachments show all sectors and style boxes as Vanguard ETFs. The first attachment shows the correlation between assets during the  GFC June 2008 to May of 2009 and the second shows the correlation between assets during the everything crash of the Covid crisis February 2020 to April 2020.  The third shows the contribution to risk of an equal weighted portfolio of all the funds during the covid crash. As you can see, sector diversification was much more indicative of risk than style or market cap.

I think it is interesting so much time and effort has been put into style and market cap tilts when sector tilts are more consistent in their behavior and correlation between individual sectors is much lower than the correlation between style and market cap. 

BicycleB

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PTL (posting to learn)

JJ-

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Before pulling the trigger I'll read more into the Swenson portfolio logic.

Swensen's book for individuals, Unconventional Success, is really well worth the read. Also, usefully, he wrote the book like 15 years ago so you can kinda "back test" his suggestions...

His basic logic, in a nutshell...

Improve the classic 60%/40% stock and bonds portfolio by just going with US treasuries but changing stock/bond percentages to 70%/30%...

He wants to have 30% of your portfolio in riskless assets (thus the 15% to intermediate term treasuries and 15% to TIPS)...

And he want to have 30% of your portfolio in real assets (thus 15% to REITs and 15% to TIPS)...

He noted in his book that if you already have a house (and so some inflation protection) that that dials down your need for 15% in REITs...

He also notes that if in your "job" you already already own part of a small business, that maybe suggests you dial down your equity percentage.

It's imminently readable. And should be valuable even if you use some other portfolio construction philosophy.

I'm making my way slowly through this book. It's pretty dense for me, but a lot of material presented in a fairly digestible manner for somebody who is not formally financially educated.

I just finished the early section on treasuries. In particular the compelling argument to pair TIPS with standard treasuries would have been great to know 6 months ago before inflation started climbing.

Before making decisions though we'll just have to get through this book.

mntnmn117

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Unconventional Success: A Fundamental Approach to Personal Investment - When a 2005 book about investing has 23 holds request on 5 copies at my library I wonder if that some sort of metric about the popularity of investing at the moment.

These calculators are great but it leads to tough questions, do I trust the historical averages or have fundamentals changed.  And how would you go about switching into one of these Less Risky portfolios when some of the safe things don't seem that safe right now. Looking at Bonds, REITs, or Gold that are all really high right now.

JJ-

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Unconventional Success: A Fundamental Approach to Personal Investment - When a 2005 book about investing has 23 holds request on 5 copies at my library I wonder if that some sort of metric about the popularity of investing at the moment.

These calculators are great but it leads to tough questions, do I trust the historical averages or have fundamentals changed.  And how would you go about switching into one of these Less Risky portfolios when some of the safe things don't seem that safe right now. Looking at Bonds, REITs, or Gold that are all really high right now.

I'm only halfway through so take this with a grain of salt.

I will say that a lot of this book was much more "unconventional" in 2005. A lot of his time is dedicated to establishing what I would consider common knowledge to those in this forum (e.g. active managed funds bad). There's a lot of discussion on the various options that people might be tempted to invest in, so it's been good to learn about that stuff (junk bonds, hedge funds, etc ).

He also explains how in various scenarios the individual investor benefits or suffers within each class.

SeattleCPA

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I will say that a lot of this book was much more "unconventional" in 2005. A lot of his time is dedicated to establishing what I would consider common knowledge to those in this forum (e.g. active managed funds bad). There's a lot of discussion on the various options that people might be tempted to invest in, so it's been good to learn about that stuff (junk bonds, hedge funds, etc ).

He also explains how in various scenarios the individual investor benefits or suffers within each class.

The compelling argument for passive approach is definitely a huge part of the book. (An aside: Not suggesting you read his book on active management, Pioneering Portfolio Management, but that's interesting and useful too since it explains how he thinks you need to do active approach... a TLDR summary of that book... sure some folks can succeed with active approach though most can't...)

But I feel like many investors and many pundits still don't get the portfolio construction stuff.

The 100% stocks guys I assume don't understand "modern portfolio theory".

The just-three-funds guys at Bogleheads don't understand it.

Arguments of Swensen's like, "skip corporate bonds and just use treasuries" still seem pretty relevant. As well as the related argument that you want some riskless assets in your portfolio.

Also, the idea that you want some real assets (like TIPS and REITs) in your portfolio seems pretty relevant.

The other relevant factor, I think, is the MPT thinking probably doesn't have THAT much impact once you've already gone passive and lowered your costs. You're getting a little bump in returns. Or a little reduction in risks. Further, when we model results with portfolio visualizer or portfolio charts, I personally think that lots of the difference we see stems from start date sensitivity and then "law of small numbers" type noise.


boarder42

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I will say that a lot of this book was much more "unconventional" in 2005. A lot of his time is dedicated to establishing what I would consider common knowledge to those in this forum (e.g. active managed funds bad). There's a lot of discussion on the various options that people might be tempted to invest in, so it's been good to learn about that stuff (junk bonds, hedge funds, etc ).

He also explains how in various scenarios the individual investor benefits or suffers within each class.

The compelling argument for passive approach is definitely a huge part of the book. (An aside: Not suggesting you read his book on active management, Pioneering Portfolio Management, but that's interesting and useful too since it explains how he thinks you need to do active approach... a TLDR summary of that book... sure some folks can succeed with active approach though most can't...)

But I feel like many investors and many pundits still don't get the portfolio construction stuff.

The 100% stocks guys I assume don't understand "modern portfolio theory".

The just-three-funds guys at Bogleheads don't understand it.

Arguments of Swensen's like, "skip corporate bonds and just use treasuries" still seem pretty relevant. As well as the related argument that you want some riskless assets in your portfolio.

Also, the idea that you want some real assets (like TIPS and REITs) in your portfolio seems pretty relevant.

The other relevant factor, I think, is the MPT thinking probably doesn't have THAT much impact once you've already gone passive and lowered your costs. You're getting a little bump in returns. Or a little reduction in risks. Further, when we model results with portfolio visualizer or portfolio charts, I personally think that lots of the difference we see stems from start date sensitivity and then "law of small numbers" type noise.

I used to like REITs but SCV holds REITs in most cases and Big ERN has a whole write up on why they arent really necessary to hold as a stand alone asset class(he also has one on why he thinks SCV will only outperform its addtl fund cost by .5% not the 2-3% we see historically vs the sp500 but .5% is a ton still).  I still go back and forth on REITs though but when i use PC or PV it tells me historically i'm better off with bonds for that portion of my asset class and adding any extra REITs hurts my historical performance.
« Last Edit: January 06, 2022, 07:50:01 AM by boarder42 »

scantee

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PTF

JJ-

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The compelling argument for passive approach is definitely a huge part of the book. (An aside: Not suggesting you read his book on active management, Pioneering Portfolio Management, but that's interesting and useful too since it explains how he thinks you need to do active approach... a TLDR summary of that book... sure some folks can succeed with active approach though most can't...)

But I feel like many investors and many pundits still don't get the portfolio construction stuff.

The 100% stocks guys I assume don't understand "modern portfolio theory".

The just-three-funds guys at Bogleheads don't understand it.

Arguments of Swensen's like, "skip corporate bonds and just use treasuries" still seem pretty relevant. As well as the related argument that you want some riskless assets in your portfolio.

Also, the idea that you want some real assets (like TIPS and REITs) in your portfolio seems pretty relevant.

The other relevant factor, I think, is the MPT thinking probably doesn't have THAT much impact once you've already gone passive and lowered your costs. You're getting a little bump in returns. Or a little reduction in risks. Further, when we model results with portfolio visualizer or portfolio charts, I personally think that lots of the difference we see stems from start date sensitivity and then "law of small numbers" type noise.

The systematic, factual destruction of active managed funds and load fee funds is entertaining to read.

I hope he gets into portfolio construction and moreso the why a bit deeper through the rest of the book. The early part touched on it enough to make it seem convincing but didn't provide the analysis or discussion to fully flesh it out.

I used to like REITs but SCV holds REITs in most cases and Big ERN has a whole write up on why they arent really necessary to hold as a stand alone asset class(he also has one on why he thinks SCV will only outperform its addtl fund cost by .5% not the 2-3% we see historically vs the sp500 but .5% is a ton still).  I still go back and forth on REITs though but when i use PC or PV it tells me historically i'm better off with bonds for that portion of my asset class and adding any extra REITs hurts my historical performance.

One take on this is that he also goes through why past performance is not a reliable indicator of future performance, but this is in the context of how mutual fund managers show their 1 5 and 10 year performance. He argued that the fundamentals is what's important and how they do their fund selection. Also, the correlation with the broad market. REITs may be different enough than the rest of the equities market that concentration there provides diversification.

I would assume in this case that this is more the theory vs history on how to reduce risk at potentially the cost of some return for the sake of being as efficient as possible along the frontier.

As I've been going through this I've also been playing with portfolio charts and am seeing that while this broad set of slices doesn't perform as well as say your 80/20 SCV LTT or other portfolios to the tune of maybe 0.5% CAGR lower or have quite as high of a SWR (~0.2% dif), the ulcer index and drawdown metrics are vastly superior, in some cases 2%.

I don't know what all this means for me yet, but I'm still learning and seeing the power of broad diversification and sometimes sector concentration like REITs.
« Last Edit: January 06, 2022, 08:41:40 AM by JJ- »

boarder42

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@JJ-

what aa are you using for those numbers if I add 5% REIT and lower my LTTs my ulcer index goes from 9.5 to 10.1

JJ-

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@JJ-

what aa are you using for those numbers if I add 5% REIT and lower my LTTs my ulcer index goes from 9.5 to 10.1

I will have to reconstruct them back up again. I think the ones that had really low ulcer indexes were ones with Gold, REIT, and Intermediate & LTT.

Here is one compared to basic 80/20 SCV LTT.

Note the lower performance but higher SWR and lower ulcer index.

« Last Edit: January 06, 2022, 09:16:13 AM by JJ- »

boarder42

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@JJ-

what aa are you using for those numbers if I add 5% REIT and lower my LTTs my ulcer index goes from 9.5 to 10.1

I will have to reconstruct them back up again. I think the ones that had really low ulcer indexes were ones with Gold, REIT, and Intermediate & LTT.

Here is one compared to basic 80/20 SCV LTT.

Note the lower performance but higher SWR and lower ulcer index.

yeah i dont trust gold - and those links dont actually work haha.

JJ-

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@JJ-

what aa are you using for those numbers if I add 5% REIT and lower my LTTs my ulcer index goes from 9.5 to 10.1

I will have to reconstruct them back up again. I think the ones that had really low ulcer indexes were ones with Gold, REIT, and Intermediate & LTT.

Here is one compared to basic 80/20 SCV LTT.

Note the lower performance but higher SWR and lower ulcer index.

yeah i dont trust gold - and those links dont actually work haha.

Not sure why the link doesn't take you straight to the portfolio. You can type in all caps the unique ID of the portfolio in the black box near the top of portfolio entry screen to see it.

I'm curious to why you don't trust gold?

boarder42

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@JJ-

what aa are you using for those numbers if I add 5% REIT and lower my LTTs my ulcer index goes from 9.5 to 10.1

I will have to reconstruct them back up again. I think the ones that had really low ulcer indexes were ones with Gold, REIT, and Intermediate & LTT.

Here is one compared to basic 80/20 SCV LTT.

Note the lower performance but higher SWR and lower ulcer index.

yeah i dont trust gold - and those links dont actually work haha.

Not sure why the link doesn't take you straight to the portfolio. You can type in all caps the unique ID of the portfolio in the black box near the top of portfolio entry screen to see it.

I'm curious to why you don't trust gold?

same reason i dont trust bitcoin. - its a collectible. 

SeattleCPA

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Not to butt into the discussion @JJ- and @boarder42 are having, but though I love Tyler's work, I think it's a pretty small data set.

So for me, I'm choosing to follow Swensen's principles and do things like allocate chunks of portfolio to real assets and to riskless assets.

BTW, I think we do have a bigger dataset for sovereign bonds and housing--that "rate of return of everything" paper--and that it shows real estate did good things to portfolios in most locations over the last 150 years. Not that that's the same as sticking REITs in your portfolio. But still...

JJ-

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Not to butt into the discussion @JJ- and @boarder42 are having, but though I love Tyler's work, I think it's a pretty small data set.

So for me, I'm choosing to follow Swensen's principles and do things like allocate chunks of portfolio to real assets and to riskless assets.

BTW, I think we do have a bigger dataset for sovereign bonds and housing--that "rate of return of everything" paper--and that it shows real estate did good things to portfolios in most locations over the last 150 years. Not that that's the same as sticking REITs in your portfolio. But still...

Butt in all you want. I'm just throwing stuff out hoping to grab the attention of somebody who knows more than me to enlighten the collective masses.

JJ-

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Not to butt into the discussion @JJ- and @boarder42 are having, but though I love Tyler's work, I think it's a pretty small data set.

So for me, I'm choosing to follow Swensen's principles and do things like allocate chunks of portfolio to real assets and to riskless assets.

BTW, I think we do have a bigger dataset for sovereign bonds and housing--that "rate of return of everything" paper--and that it shows real estate did good things to portfolios in most locations over the last 150 years. Not that that's the same as sticking REITs in your portfolio. But still...

On a non butt in note, I'm also just realizing how powerful the TSP G fund is as a riskless asset that pays ~ long term interest rates without ever dropping value.

boarder42

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Not to butt into the discussion @JJ- and @boarder42 are having, but though I love Tyler's work, I think it's a pretty small data set.

So for me, I'm choosing to follow Swensen's principles and do things like allocate chunks of portfolio to real assets and to riskless assets.

BTW, I think we do have a bigger dataset for sovereign bonds and housing--that "rate of return of everything" paper--and that it shows real estate did good things to portfolios in most locations over the last 150 years. Not that that's the same as sticking REITs in your portfolio. But still...

Butt in all you want. I'm just throwing stuff out hoping to grab the attention of somebody who knows more than me to enlighten the collective masses.

i'm always up for more conversation about these things. and i'm open to learning and maybe it adjusts my AA but i've read thru lots of this and at the end of the day there are valid reasons to have or not have all sorts of different assets the key is sticking to what you pick and ignoring noise b/c in reality they all likely are successful.

JJ-

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Not to butt into the discussion @JJ- and @boarder42 are having, but though I love Tyler's work, I think it's a pretty small data set.

So for me, I'm choosing to follow Swensen's principles and do things like allocate chunks of portfolio to real assets and to riskless assets.

BTW, I think we do have a bigger dataset for sovereign bonds and housing--that "rate of return of everything" paper--and that it shows real estate did good things to portfolios in most locations over the last 150 years. Not that that's the same as sticking REITs in your portfolio. But still...

Butt in all you want. I'm just throwing stuff out hoping to grab the attention of somebody who knows more than me to enlighten the collective masses.

i'm always up for more conversation about these things. and i'm open to learning and maybe it adjusts my AA but i've read thru lots of this and at the end of the day there are valid reasons to have or not have all sorts of different assets the key is sticking to what you pick and ignoring noise b/c in reality they all likely are successful.

Same here. No personal preference or opinion here that I feel I need to be right on otherwise it's the end of my world. Genuinely want to learn and make informed decisions.

mntnmn117

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Not to butt into the discussion @JJ- and @boarder42 are having, but though I love Tyler's work, I think it's a pretty small data set.

So for me, I'm choosing to follow Swensen's principles and do things like allocate chunks of portfolio to real assets and to riskless assets.

BTW, I think we do have a bigger dataset for sovereign bonds and housing--that "rate of return of everything" paper--and that it shows real estate did good things to portfolios in most locations over the last 150 years. Not that that's the same as sticking REITs in your portfolio. But still...



Butt in all you want. I'm just throwing stuff out hoping to grab the attention of somebody who knows more than me to enlighten the collective masses.

i'm always up for more conversation about these things. and i'm open to learning and maybe it adjusts my AA but i've read thru lots of this and at the end of the day there are valid reasons to have or not have all sorts of different assets the key is sticking to what you pick and ignoring noise b/c in reality they all likely are successful.

Same here. No personal preference or opinion here that I feel I need to be right on otherwise it's the end of my world. Genuinely want to learn and make informed decisions.

I agree the learning on this thread is really valuable. There are a lot more compelling arguments here than the crypto threads.

What I wondered is, let say you find a good portfolio in portfolio charts, for example: TSM-30, SCV-30, ExUS-10, Int Bond-10, REIT-10, Gold-10. You can get a perpetual withdrawl rate of 5.5% with short drawdowns. That's an enormous improvement over the 3.5% of a TSM-90/Bond-10 portfolio. Is this evidence solid enough to FIRE 2yrs earlier and bank on that 5.5%?

Based on what I'm reading in "Your Complete Guide to Factor-based Investing" I think the answer no, as factors have declined somewhat.  How much is hard to say.

boarder42

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Not to butt into the discussion @JJ- and @boarder42 are having, but though I love Tyler's work, I think it's a pretty small data set.

So for me, I'm choosing to follow Swensen's principles and do things like allocate chunks of portfolio to real assets and to riskless assets.

BTW, I think we do have a bigger dataset for sovereign bonds and housing--that "rate of return of everything" paper--and that it shows real estate did good things to portfolios in most locations over the last 150 years. Not that that's the same as sticking REITs in your portfolio. But still...



Butt in all you want. I'm just throwing stuff out hoping to grab the attention of somebody who knows more than me to enlighten the collective masses.

i'm always up for more conversation about these things. and i'm open to learning and maybe it adjusts my AA but i've read thru lots of this and at the end of the day there are valid reasons to have or not have all sorts of different assets the key is sticking to what you pick and ignoring noise b/c in reality they all likely are successful.

Same here. No personal preference or opinion here that I feel I need to be right on otherwise it's the end of my world. Genuinely want to learn and make informed decisions.

I agree the learning on this thread is really valuable. There are a lot more compelling arguments here than the crypto threads.

What I wondered is, let say you find a good portfolio in portfolio charts, for example: TSM-30, SCV-30, ExUS-10, Int Bond-10, REIT-10, Gold-10. You can get a perpetual withdrawl rate of 5.5% with short drawdowns. That's an enormous improvement over the 3.5% of a TSM-90/Bond-10 portfolio. Is this evidence solid enough to FIRE 2yrs earlier and bank on that 5.5%?

Based on what I'm reading in "Your Complete Guide to Factor-based Investing" I think the answer no, as factors have declined somewhat.  How much is hard to say.

If factors have declined then why hasn't the tsm declined with it?  That's my biggest beef with this argument that markets are efficient so everything trends toward basically the tsm. This has never been true so what is actually making it more true now. It that theory were true then no one could retire on the 4% us tsm rule bc the world at large doesn't support it.

I see very selective views of opinions on why this will do better than that and why this part of history won't repeat but this other part will

To me you have to digest all of that your self and again be confident in your opinion of the past reflecting some similar version of the future to stick with it. To me if you bought VTSAX and forget it then you bought into likely the worst historical long-term performance and recovery times ever. So simply by finding comfort in any other allocation that has equities non cap weighted in the us will help everyone sleep better and perform better over their fire life.
« Last Edit: January 08, 2022, 05:45:51 AM by boarder42 »

VanillaGorilla

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It's very easy to go into a tool like portfolio charts and optimize for SWR. Just go 100% small cap value or REIT, kick back and withdraw 6% for the rest of your life, right?

Why wouldn't everybody do that? In my mind, it's because you're optimizing for three or four specific points in history. You're overfitting the data tremendously, and the odds of that working when extrapolated into the future are, well, low. The worst sequence of returns risks have always been induced by a black swan type event that will never be repeated in our lifetimes, so there's real danger in fine tuning your portfolio to give the best possible results under three historical conditions that will always be unique.

To avoid this effect of overfitting, we can only consider the broadest of historical trends applied to the broadest of portfolio allocations - that's pretty much where the 4% idea came from.

If you take 60% total stock market and 40% total bond market then you have a very broad portfolio - it's probably not overfit. If you consider all the historical performance figures and extrapolate to a safe withdrawal rate, maybe that's a generalized enough approach that it can be reasonably applied to the future. If you take 100% SCV (or 100% TSLA, for that matter) I cannot imagine that's a statistically relevant set of data to extrapolate future returns from.

A glidepath-based approach is also so generalized and non-specific in a historical context that it seems like one of the few tricks that appeals to me.

Personally, I read all these analyses, and while they're great fun to think through, test, and debate, in the end I conclude that simplicity rules. REITs are too correlated with the equity market, so I'm not interested. I can't imagine the SCV tilt will perpetuate, so I'm not interested. Bond returns are awful and the future looks bleak, I'm not interested. Commodities and gold and bitcoin, not interested.

So I'm 100% large cap equities, I save 65% of my income, and I have a paid off house. Market downturn? Invest more. Market bull run? Invest more. Desired withdrawal rate? 95th percentile historical worst minus a 10% buffer, so, academically, maybe 3.3%. Maybe I've read ERN a few too many times - after all he has a side hustle now and probably didn't need to work so long. :)
 


JJ-

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Unconventional Success: A Fundamental Approach to Personal Investment - When a 2005 book about investing has 23 holds request on 5 copies at my library I wonder if that some sort of metric about the popularity of investing at the moment.

These calculators are great but it leads to tough questions, do I trust the historical averages or have fundamentals changed.  And how would you go about switching into one of these Less Risky portfolios when some of the safe things don't seem that safe right now. Looking at Bonds, REITs, or Gold that are all really high right now.

I'm only halfway through so take this with a grain of salt.

I will say that a lot of this book was much more "unconventional" in 2005. A lot of his time is dedicated to establishing what I would consider common knowledge to those in this forum (e.g. active managed funds bad). There's a lot of discussion on the various options that people might be tempted to invest in, so it's been good to learn about that stuff (junk bonds, hedge funds, etc ).

He also explains how in various scenarios the individual investor benefits or suffers within each class.

So I finished the book last night or the night before, and the majority of the second half of the book was about how many mutual funds fail compared to indexes, and the rare story of how certain funds get it right.

The moral of the book was basically it's really hard for the individual investor to win with active managed funds in order to beat indexes. There are two reasons. A, it's really hard to beat the market every year, and B, when you beat the market, you still have to make up for all the fees. Individual investors using active funds almost always lose out.

There was not much more discussion on the "core" asset classes (e.g., REITs, TIPS, Treasuries, equities) or the why he suggests his portfolio %'s.

I will admit I've learned a lot about the mutual fund industry. The one thing I'm missing is the detailed discussion behind it all, but even that would probably make my head hurt. If I had gotten the detailed dive, I'd probably be wanting just the summary which is in this book of what to do. Win / win or lose/lose however you want to look at it. It is also a very good explanation of the various core and non core asset classes, so it's definitely worth the time. Thanks @SeattleCPA

One of the things I appreciated was how he used real examples of funds and/or companies and showed just how hard it is to win consistently, or how the individual investor gets screwed.

I'm still in the same boat, scratching my head how to shore up our portfolio behind our current 80/20 allocation. I'm still wondering if it's gold, or a combo of treasuries and TIPS. I now also understand on a more rational level the appeal of the more common lazy portfolios or Target Date fund portfolios.
« Last Edit: January 11, 2022, 07:52:52 PM by JJ- »

SeattleCPA

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Unconventional Success: A Fundamental Approach to Personal Investment - When a 2005 book about investing has 23 holds request on 5 copies at my library I wonder if that some sort of metric about the popularity of investing at the moment.

These calculators are great but it leads to tough questions, do I trust the historical averages or have fundamentals changed.  And how would you go about switching into one of these Less Risky portfolios when some of the safe things don't seem that safe right now. Looking at Bonds, REITs, or Gold that are all really high right now.

I'm only halfway through so take this with a grain of salt.

I will say that a lot of this book was much more "unconventional" in 2005. A lot of his time is dedicated to establishing what I would consider common knowledge to those in this forum (e.g. active managed funds bad). There's a lot of discussion on the various options that people might be tempted to invest in, so it's been good to learn about that stuff (junk bonds, hedge funds, etc ).

He also explains how in various scenarios the individual investor benefits or suffers within each class.

So I finished the book last night or the night before, and the majority of the second half of the book was about how many mutual funds fail compared to indexes, and the rare story of how certain funds get it right.

The moral of the book was basically it's really hard for the individual investor to win with active managed funds in order to beat indexes. There are two reasons. A, it's really hard to beat the market every year, and B, when you beat the market, you still have to make up for all the fees. Individual investors using active funds almost always lose out.

There was not much more discussion on the "core" asset classes (e.g., REITs, TIPS, Treasuries, equities) or the why he suggests his portfolio %'s.

I will admit I've learned a lot about the mutual fund industry. The one thing I'm missing is the detailed discussion behind it all, but even that would probably make my head hurt. If I had gotten the detailed dive, I'd probably be wanting just the summary which is in this book of what to do. Win / win or lose/lose however you want to look at it. It is also a very good explanation of the various core and non core asset classes, so it's definitely worth the time. Thanks @SeattleCPA

One of the things I appreciated was how he used real examples of funds and/or companies and showed just how hard it is to win consistently, or how the individual investor gets screwed.

I'm still in the same boat, scratching my head how to shore up our portfolio behind our current 80/20 allocation. I'm still wondering if it's gold, or a combo of treasuries and TIPS. I now also understand on a more rational level the appeal of the more common lazy portfolios or Target Date fund portfolios.

Glad you enjoyed it, @JJ- !

The one thing I'd repeat from my earlier comments about Swensen's ideas--and I've read that book at least a couple of times probably three times over last 15 years--is he has pretty simple logic for why 30% in riskless assets and why 30% in real assets.

You want a chunk in riskless assets so in that true worst case scenario, you survive. You've maybe already seen the study, but a while back I charted the country-by-country data from the "Rate of Return of Everything" paper and in relatively recent history, there are a number of situations where all equities investors just got KILLED.

Here's a link to the blog post with the charts: https://evergreensmallbusiness.com/rate-of-return-of-everything-study-in-line-charts/

And then related to the real asset thing. In my own investing history (which is actually about 50 years if I go back to the money my parents saved for college), I've had the experience of just getting pummeled by inflation. That pummeling changed the trajectory of my future and scrambled my college funding. And the thing is, the 1966 scenario I would say is an inflation worst case scenario.

RobertFromTX

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It seems that from this forum post, relaying an email, that Swensen would suggest using a combination for long-term treasuries and short-term treasuries (barbell strategy) with an allocation to mimic the market's average duration of treasuries.He has the calculation for that time, and it hasn't changed much. 

https://socialize.morningstar.com/NewSocialize/asp/FullConv.asp?forumId=F100000015&lastConvSeq=53479

Quote
The easiest way to match the market would be to own some of the 1-3 Treasury (70%) and some of the 20+ Treasury (30%) so the weighted average duration matches the market's 5.07 years -

I was close to doing this already as I use 15% LTT's and 15% STT's to keep it simple. He doesn't seem to mention TIPS though.  Any thoughts on that, SeattleCPA?
« Last Edit: January 12, 2022, 12:38:03 PM by RobertFromTX »

HeadedWest2029

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Reading this thread from the beginning.  Not to derail back into taxes, but doesn't the tax efficiency of international vs domestic in a taxable account require a lot more nuance?  @SeattleCPA please correct me on this.  I've long questioned whether I'm doing this correct or not for someone with a larger portfolio, but low income.  Some numbers from this post which is 2020 data, but good enough - credit Physician On Fire https://www.physicianonfire.com/international-stock/

If you are in retirement you could very likely be in the 0% tax bracket for qualified dividends.  So even though international pays out a higher dividend yield and has a lower % of qualified dividends, the qualified dividends go to 0% at the federal level.  In my case I still pay a state tax of 4.95% regardless. 

Example using a $100k taxable brokerage, 0% federal tax on qualified dividends, 12% federal tax rate on ordinary, and 4.95% state on both.
VTI - $58.46 qualified dividends (state only), $8.30 ordinary dividends (fed + state) = $66.76 tax burden
VXUS - $87.07 qualified (state only), $115.43 ordinary dividends (fed + state), minus foreign tax credit of $228 = negative $25.50 tax burden

Of course if you are in the accumulation phase and 2 high income earners the numbers look a lot different.
« Last Edit: January 12, 2022, 01:07:44 PM by HeadedWest2029 »

SeattleCPA

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It seems that from this forum post, relaying an email, that Swensen would suggest using a combination for long-term treasuries and short-term treasuries (barbell strategy) with an allocation to mimic the market's average duration of treasuries.He has the calculation for that time, and it hasn't changed much. 

https://socialize.morningstar.com/NewSocialize/asp/FullConv.asp?forumId=F100000015&lastConvSeq=53479

Quote
The easiest way to match the market would be to own some of the 1-3 Treasury (70%) and some of the 20+ Treasury (30%) so the weighted average duration matches the market's 5.07 years -

I was close to doing this already as I use 15% LTT's and 15% STT's to keep it simple. He doesn't seem to mention TIPS though.  Any thoughts on that, SeattleCPA?

So, in Unconventional Success (in Chapter 3, page 84), Swensen after a discussion of how to construct a portfolio, says, "Table 3.1 contains an asset-class combination that serves as a reference portfolio for investors to consider."

So a first thing I'd point out is that language isn't exactly canonical.

And then that table he references, Table 3.1, shows U.S. Treasury bonds 15% and US Treasury Inflation Protected Securities 15%.

The example portfolio recipe, then, does use TIPS.

The book does not specify which U.S. Treasury bonds though. But online sources like the one you mention and then a Boglehead user who says he just emailed Mr. Swensen and received a reply indicated that you want the duration of the U.S. Treasuries in your portfolio to match the duration of the market. Further, apparently in both of those sources, Swensen gave an example of how to do that by buying X percentage of short-term Treasuries and Y percentage of longer-term treasuries.

What I do, in case you're interested. I just buy (and think I'm correct to use) the Vanguard intermediate term treasuries fund. Their duration roughly matches the duration of U.S. Treasuries. E.g. maybe intermediate treasuries show a duration of 5.2 years and then treasuries as a whole show a duration of 5.5 years? It seems close enough to me.

One thing I'll again mention. Because I have a compulsive personality. Swensen's language clearly doesn't say we must use the exact percentages from Table 3.1. He gives them an example. And he notes that, yeah, someone would want to nudge them around, following his thinking, for your personal situation. E.g., if you own a home, you maybe dial down your REIT percentage. Or if you hold a bunch of equity in a job or business, you maybe dial down your equity percentage.

BTW another personal note: I've always thought about nudging the percentages around because I do own a home and because I own a part of a small business. And, gosh, probably I should. And then I think, I'm probably close enough...

P.S. The Swensen percentages again for anyone following this discussion:
US stocks 30%
Developed markets (so international) 15%
Emerging markets (so international) 10%
REITs 15%
U.S Treasuries (intermediate term, I say) 15%
TIPS 15%


SeattleCPA

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Reading this thread from the beginning.  Not to derail back into taxes, but doesn't the tax efficiency of international vs domestic in a taxable account require a lot more nuance?  @SeattleCPA please correct me on this.  I've long questioned whether I'm doing this correct or not for someone with a larger portfolio, but low income.  Some numbers from this post which is 2020 data, but good enough - credit Physician On Fire https://www.physicianonfire.com/international-stock/

If you are in retirement you could very likely be in the 0% tax bracket for qualified dividends.  So even though international pays out a higher dividend yield and has a lower % of qualified dividends, the qualified dividends go to 0% at the federal level.  In my case I still pay a state tax of 4.95% regardless. 

Example using a $100k taxable brokerage, 0% federal tax on qualified dividends, 12% federal tax rate on ordinary, and 4.95% state on both.
VTI - $58.46 qualified dividends (state only), $8.30 ordinary dividends (fed + state) = $66.76 tax burden
VXUS - $87.07 qualified (state only), $115.43 ordinary dividends (fed + state), minus foreign tax credit of $228 = negative $25.50 tax burden

Of course if you are in the accumulation phase and 2 high income earners the numbers look a lot different.

@HeadedWest2029,

Yeah, so I skimmed Leif's article. And it looks pretty thorough. I agree asset location is something to consider if someone has substantial taxable account balances.

The obvious thing to have in a taxable account is US stocks or a US stock index fund you are just buying and holding because you can have a lot of dividend income and pay either zero or a very low tax.

Example: You can $5M in US stocks in a taxable account paying dividends and avoid paying federal income taxes...

The next obvious thing to have in a taxable account are international stocks because you get the foreign tax credit onto your tax return that way. What I don't like (as a tax accountant) about that, though, is you need to deal with the credit on your tax return once your credits bump up over the de minimis thresholds. That's a headache for someone.

BTW, the other asset class to hold in a taxable account would be direct real estate. So not REITs but a rental property. One loses all sorts of tax benefits by doing that inside a tax-deferred account.

Also I think you'd want to think about how you rebalance. But that would be very situation specific.

JJ-

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P.S. The Swensen percentages again for anyone following this discussion:
US stocks 30%
Developed markets (so international) 15%
Emerging markets (so international) 10%
REITs 15%
U.S Treasuries (intermediate term, I say) 15%
TIPS 15%

Staying true to topic title, I think the following is worth an investigation at minimum:

What I'm considering a Tyler-ized Swensen might look something like this:
20% Large Cap US stocks,
15% LT treasuries,
15% developed markets,
10% TIPS,
10% REITs,
10% small cap value, and
10% gold.
This formulation retains 30% in real assets and close to the Swensen's percentages in riskless assets (25% instead of 30%) and equity (65% instead of 70%).

The thing to note here is that it also meets the definition of Swensen's need to have asset classes having a meaningful allocation (at minimum 5% of the portfolio).

index

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I think the take away from Swenson and Tyler's paper is more asset classes are better than less with regard to risk adjusted return. This is all very similar to all the research around risk parity portfolios.



Try to have a meaningful weight in each of the 4 economic conditions. You can weight toward the conditions you think are most likely.

SeattleCPA

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P.S. The Swensen percentages again for anyone following this discussion:
US stocks 30%
Developed markets (so international) 15%
Emerging markets (so international) 10%
REITs 15%
U.S Treasuries (intermediate term, I say) 15%
TIPS 15%


Staying true to topic title, I think the following is worth an investigation at minimum:

What I'm considering a Tyler-ized Swensen might look something like this:
20% Large Cap US stocks,
15% LT treasuries,
15% developed markets,
10% TIPS,
10% REITs,
10% small cap value, and
10% gold.
This formulation retains 30% in real assets and close to the Swensen's percentages in riskless assets (25% instead of 30%) and equity (65% instead of 70%).

The thing to note here is that it also meets the definition of Swensen's need to have asset classes having a meaningful allocation (at minimum 5% of the portfolio).

@JJ- it's going to be really hard for me to debate you or disagree with you if you're quoting comments I've made. Especially comments in the same thread!  :-)

Here's what I'm thinking though as I've reflected personally on the idea of tweaking Swensen for the insights from Tyler.

The reason for Gold, I think, is to have a real asset that protects against inflation and something that has really low correlation with other stuff in your portfolio.

The reason for small cap is to inject more risk and return into portfolio.

The reason for LT treasuries as compared to intermediate term treasuries, I worry, is because it backtests so well due to steadily declining interest rates since that hot mess that was the 1970s. (Lyndon Johnson and Richard Nixon and Jimmy Carter and Paul Volcker.)

In my personal situation--which I mention because applying Swensen means also tweaking his percentages for your personal situation--I think I'm pretty hedged for inflation and also through entrepreneurship and small business ownership taking that extra risk in hopes of an extra return.

Finally, I think the LT treasuries thing is very possibly an assumption that rates will continue to decline. Which they might. But I don't think there's necessarily something systematic about that. (BTW, I acknowledge that interest rates do seem to be on a long-term trend of decline.)

Other investors, I think, could decide to tweak Swensen's example percentages. And as noted earlier, I think that's what he would have wanted.
« Last Edit: January 14, 2022, 07:35:16 AM by SeattleCPA »

SeattleCPA

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I think the take away from Swenson and Tyler's paper is more asset classes are better than less with regard to risk adjusted return. This is all very similar to all the research around risk parity portfolios...

Try to have a meaningful weight in each of the 4 economic conditions. You can weight toward the conditions you think are most likely.

I don't think the first sentence above is necessarily right. As I understand it, the goal is to have asset classes that lack correlation. I.e., to apply modern portfolio theory or if you like post-modern portfolio theory to get a little bump in your return or a slight dialing down of your risks.

Regarding your second and third sentences above, I possess only a basic understanding of risk parity strategy and try in these forums to avoid commenting when I'm only working with a basic understanding... but I think risk parity is more than that. So modern portfolio theory plus some other stuff.

AdrianC

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So I finished the book [Unconventional Success] last night or the night before, and the majority of the second half of the book was about how many mutual funds fail compared to indexes, and the rare story of how certain funds get it right.
IIRC Swenson presents Southeastern Asset Management as an example of a manager doing it right - disciplined approach, eat their own cooking, etc.

Check out the performance of their flagship fund, Longleaf Partners LLPFX.
https://southeasternasset.com/investment-offerings/longleaf-partners-fund/

It's been pretty awful.

JJ-

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So I finished the book [Unconventional Success] last night or the night before, and the majority of the second half of the book was about how many mutual funds fail compared to indexes, and the rare story of how certain funds get it right.
IIRC Swenson presents Southeastern Asset Management as an example of a manager doing it right - disciplined approach, eat their own cooking, etc.

Check out the performance of their flagship fund, Longleaf Partners LLPFX.
https://southeasternasset.com/investment-offerings/longleaf-partners-fund/

It's been pretty awful.

Yeah that's the company. The section was like yeah they trail the index but beat it by 30% over one of the bust periods for a few years so it all worked out for those that stuck with them. Not everybody stuck with them though due to the underperformance during good times though so they all lost $$$.

boarder42

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So I finished the book [Unconventional Success] last night or the night before, and the majority of the second half of the book was about how many mutual funds fail compared to indexes, and the rare story of how certain funds get it right.
IIRC Swenson presents Southeastern Asset Management as an example of a manager doing it right - disciplined approach, eat their own cooking, etc.

Check out the performance of their flagship fund, Longleaf Partners LLPFX.
https://southeasternasset.com/investment-offerings/longleaf-partners-fund/

It's been pretty awful.

Yeah that's the company. The section was like yeah they trail the index but beat it by 30% over one of the bust periods for a few years so it all worked out for those that stuck with them. Not everybody stuck with them though due to the underperformance during good times though so they all lost $$$.

Again. I'll reiterate. You have to write down your plan and stick with it. They all will succeed and likely outperforman the sp500. But you have to be willing to underperform it for considerable periods of time.  See another poster here who turned away from small value after 5 years on it bc it wasn't performing. Which was to be expected. And arguably this is the most consistent flat to even performance it's ever had against the sp500.

Pick something better than all tsm or sp500 for your equity allocation that you believe in and stick to it. That's really the moral of all of this.

JJ-

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So I finished the book [Unconventional Success] last night or the night before, and the majority of the second half of the book was about how many mutual funds fail compared to indexes, and the rare story of how certain funds get it right.
IIRC Swenson presents Southeastern Asset Management as an example of a manager doing it right - disciplined approach, eat their own cooking, etc.

Check out the performance of their flagship fund, Longleaf Partners LLPFX.
https://southeasternasset.com/investment-offerings/longleaf-partners-fund/

It's been pretty awful.

Yeah that's the company. The section was like yeah they trail the index but beat it by 30% over one of the bust periods for a few years so it all worked out for those that stuck with them. Not everybody stuck with them though due to the underperformance during good times though so they all lost $$$.

Again. I'll reiterate. You have to write down your plan and stick with it. They all will succeed and likely outperforman the sp500. But you have to be willing to underperform it for considerable periods of time.  See another poster here who turned away from small value after 5 years on it bc it wasn't performing. Which was to be expected. And arguably this is the most consistent flat to even performance it's ever had against the sp500.

Pick something better than all tsm or sp500 for your equity allocation that you believe in and stick to it. That's really the moral of all of this.

100%

RobertFromTX

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I feel like I could have just set my AA to be 70% VT and 30% VGIT and gone about my life just fine.
« Last Edit: January 31, 2022, 03:28:28 PM by RobertFromTX »

FLBiker

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Thanks all for this exchange.  I've long been a Boglehead 4-funder (now 3, no REITs) but this conversation has given me something to think about.  I've toyed with "factor-based" before, but it always seemed too complicated to me.  I've also worried that the benefits of SCV might no longer be there.  The idea, though, of breaking off some of my existing US and ROW equity to be SCV, shifting my (admittedly quite limited) bonds to LTT / TIPS, and bringing in a bit of gold does seem pretty straightforward.  At the same time, like @boarder42, gold fundamentally seems like a collectible to me, and thus doesn't hold much appeal.

I'm also a bit daunted about implementing such a change -- both in terms of the timing and in terms of which assets to put where.  I'd likely want to leave my taxable alone, so as not to realize any capital gains (but most of my investments are in tax sheltered places).

I'm going to check out Swenson's book, though.

Edited to add -- I play around with Portfolio Charts a bit (amazing work, @Tyler) and I can see now that my portfolio has had a bit better average return than the Golden Butterfly, but WAY more ups and downs.  I also think I've been quite lucky.  And as I head towards retirement, shifting to something more consistent makes a lot of sense.  Thanks again for all this food for thought!
« Last Edit: February 02, 2022, 10:18:37 AM by FLBiker »

JJ-

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Thanks all for this exchange.  I've long been a Boglehead 4-funder (now 3, no REITs) but this conversation has given me something to think about.  I've toyed with "factor-based" before, but it always seemed too complicated to me.  I've also worried that the benefits of SCV might no longer be there.  The idea, though, of breaking off some of my existing US and ROW equity to be SCV, shifting my (admittedly quite limited) bonds to LTT / TIPS, and bringing in a bit of gold does seem pretty straightforward.  At the same time, like @boarder42, gold fundamentally seems like a collectible to me, and thus doesn't hold much appeal.

I'm also a bit daunted about implementing such a change -- both in terms of the timing and in terms of which assets to put where.  I'd likely want to leave my taxable alone, so as not to realize any capital gains (but most of my investments are in tax sheltered places).

I'm going to check out Swenson's book, though.

Edited to add -- I play around with Portfolio Charts a bit (amazing work, @Tyler) and I can see now that my portfolio has had a bit better average return than the Golden Butterfly, but WAY more ups and downs.  I also think I've been quite lucky.  And as I head towards retirement, shifting to something more consistent makes a lot of sense.  Thanks again for all this food for thought!

I'm still musing on this as well. I've gone back and forth on timing and approach especially in regards to current volatility, but I think I'm settling on it doesn't really matter even though it probably does.

The account allocation is interesting. With 5-6 different accounts for our family, keeping track of proportions to meet total allocations is kind of a headache, and makes the whole keep the same allocations across all accounts approach more appealing despite tax inefficiency.

Re gold, I still don't know enough about it. I kind of wish Swensen talked about it a bit. I think @SeattleCPA 's proposed breakdown is probably the most reasonable of an allocation, but I can't find much to support it nor to argue against it.

All in all, I think the thing I'm unsure about is big changes in AA. I'll probably slowly work toward something 5% at a time. But - do I pull from all allocations proportionally or do I yank 5% from one class to another?