Author Topic: If you can handle volatility and a 15+ year timeline, invest in 100% stocks?  (Read 28575 times)

AdrianC

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It's a point that gets repeated a lot that is not, in general, true:

Yes.

Plus, if you need the security blanket of bonds, are you really going to be able to sell bonds to buy stocks when stocks are crashing? Are you going to sell stocks to buy bonds when stocks are on a roll? Know thyself.

This is for accumulation. Retirement is different. Tyler has shown that the volatility of 100% stocks can lead to lower safe withdrawal rates.

beltim

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Here's another chart, showing that portfolios in most decades see reduced returns from any percentage in bonds:


Tyler

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It's a point that gets repeated a lot that is not, in general, true:



Between a high volatility option and a low volatility option (like large cap stocks and 10-year treasuries above), it's true that blending the two will generally reduce both volatility and returns below that of the high option alone.  However, one should note that the chart shows average returns and not compound returns, and the return you will see in your own investment account will be affected by volatility in a way the line does not account for.  The top performing portfolio on a chart like that may not necessarily always have the highest compound return.

Importantly, assuming that every portfolio falls nicely into a generic continuum between those two very specific assets is a major over-simplification that investors should be careful to avoid.  Every individual asset is different (large cap stocks are very different from emerging markets, and long term treasuries are very different than short term corporate bonds), and when you combine them intelligently the resulting portfolio performance can often be greater than the sum of its parts. 

William Bernstein studied this, and concluded that "rebalancing works best with volatile, uncorrelated assets whose returns are roughly similar."  It's fundamentally how portfolios like the Permanent Portfolio (with stocks, long term treasuries, and gold -- three very volatile uncorrelated assets) post the surprising results they do.  And it's why just balancing the total stock and bond markets doesn't have the same effect. 

Basically, as with most investment discussions, it's important to be specific and not lump all stocks and bonds together.
« Last Edit: February 04, 2016, 07:46:32 PM by Tyler »

beltim

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It's a point that gets repeated a lot that is not, in general, true:



Between a high volatility option and a low volatility option (like large cap stocks and 10-year treasuries above), it's true that blending the two will generally reduce both volatility and returns below that of the high option alone.  However, one should note that the chart shows average returns and not compound returns, and the return you will see in your own investment account will be affected by volatility in a way the line does not account for.  100% stocks may not necessarily always have the highest compound return.

It's been many, many years since I've seen anything reported as an arithmetic average return.  Almost everything is reported as a geometric average return, which is just another way of saying compound annual growth rate.  So no, this shows that 100% stocks (again, in general) will have a higher compound return than a portfolio that includes bonds.

Quote
Importantly, assuming that every portfolio falls nicely into a generic continuum between those two very specific assets is a major over-simplification that investors should be careful to avoid.  Every individual asset is different (large cap stocks are very different from emerging markets, and long term treasuries are very different than short term corporate bonds), and when you combine them intelligently the resulting portfolio performance can often be greater than the sum of its parts. 

This is true, but not really relevant to the statement that I was responding to.  Bonds do not in general increase portfolio returns.

Tyler

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It's been many, many years since I've seen anything reported as an arithmetic average return.  Almost everything is reported as a geometric average return, which is just another way of saying compound annual growth rate.  So no, this shows that 100% stocks (again, in general) will have a higher compound return than a portfolio that includes bonds.


The chart specifically says "Average of Annual Returns".  That sure sounds like an arithmetic average to me.  Perhaps the publisher provides more info elsewhere, but it's certainly not obvious the way it's presented.  More fundamentally, efficient frontier calculations (aka Mean Variance Optimizatons) are generally statistically determined based on averages, standard deviations, and correlations.  Sequence of returns is almost always ignored because the results are purely statistical.

In any case, I generally agree with your point between simple broad "stocks" and "bonds" over the very long run.  I've run my own analyses and come to the same conclusion.
« Last Edit: February 04, 2016, 02:36:46 PM by Tyler »

beltim

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It's been many, many years since I've seen anything reported as an arithmetic average return.  Almost everything is reported as a geometric average return, which is just another way of saying compound annual growth rate.  So no, this shows that 100% stocks (again, in general) will have a higher compound return than a portfolio that includes bonds.


The chart specifically says "Average of Annual Returns".  That sure sounds like an arithmetic average to me.  Perhaps the publisher provides more info elsewhere, but it's certainly not obvious the way it's presented.  More fundamentally, efficient frontier calculations (aka Mean Variance Optimizatons) are generally statistically determined based on averages, standard deviations, and correlations.  Sequence of returns is almost always ignored because the results are purely statistical.

In any case, I generally agree with your point between simple broad "stocks" and "bonds" over the very long run.  I've run my own analyses and come to the same conclusion.

We know it's geometric because the value of the 100% stock portfolio (9%) matches the geometric average reported elsewhere, rather than an arithmetic average that is I think ~2 percentage points higher.

Tyler

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Without seeing the source data or having any explanation of their methodology, I personally don't think you can assume that.  IMHO, the meaning of "standard deviation of annual returns" and "average of annual returns" is pretty clear, and matches the most common method for calculating efficient frontiers. 

That said, I see your point about the actual numbers.  You very well might be right about this particular chart, and maybe it's just mislabeled.  Either way, it's a minor issue that's tangential to the main thread topic and it's definitely not worth arguing about.  Peace!

Re-reading the post you initially replied to, I clearly zoned in on the bolded part (that I do agree with) but I missed the preceding part about the 80/20 portfolio posting higher returns than stocks in accumulation.  You're absolutely correct in challenging that.  Sorry for over-complicating it -- we're on the same page now. 
« Last Edit: February 05, 2016, 02:52:55 PM by Tyler »

beltim

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It's been many, many years since I've seen anything reported as an arithmetic average return.  Almost everything is reported as a geometric average return, which is just another way of saying compound annual growth rate.  So no, this shows that 100% stocks (again, in general) will have a higher compound return than a portfolio that includes bonds.


The chart specifically says "Average of Annual Returns".  That sure sounds like an arithmetic average to me.  Perhaps the publisher provides more info elsewhere, but it's certainly not obvious the way it's presented.  More fundamentally, efficient frontier calculations (aka Mean Variance Optimizatons) are generally statistically determined based on averages, standard deviations, and correlations.  Sequence of returns is almost always ignored because the results are purely statistical.

In any case, I generally agree with your point between simple broad "stocks" and "bonds" over the very long run.  I've run my own analyses and come to the same conclusion.

Your source says:
Quote
At the end of the calculation, the inverse relationship is used to convert the portfolio arithmetic means back to geometric means. This is the method used in MvoPlus.
An important feature of the methodology is the fact that, to a good approximation, the set of portfolios which optimize the rebalanced geometric mean are the SAME as the ones which optimize the arithmetic mean. This makes it possible for MvoPlus to display a combined plot of the Arithmetic Mean Frontier and the Geometric Mean Frontier.

That's just one quote that looks like the efficient frontiers plotted should always be reported as geometric means.  It's the only logical one to use from a financial point of view as well.

Tyler

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Your source says:
Quote
At the end of the calculation, the inverse relationship is used to convert the portfolio arithmetic means back to geometric means. This is the method used in MvoPlus.
An important feature of the methodology is the fact that, to a good approximation, the set of portfolios which optimize the rebalanced geometric mean are the SAME as the ones which optimize the arithmetic mean. This makes it possible for MvoPlus to display a combined plot of the Arithmetic Mean Frontier and the Geometric Mean Frontier.

That's just one quote that looks like the efficient frontiers plotted should always be reported as geometric means.  It's the only logical one to use from a financial point of view as well.

I totally agree!  Note that the link is selling a product that does this because many efficient frontier calculators do not.  Unfortunately, not everyone is as logical as you are.  ;)
« Last Edit: February 04, 2016, 03:00:44 PM by Tyler »

faramund

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An 80 stocks/20 bonds allocation will probably return more than 100% stocks! Because of diversification. That means when stocks plummet, you will rebalance your account to keep the 80/20 allocation. Because stocks fell, your portofolio looks more like 70/30 stocks/bonds now. Which means you will sell some bonds to buy CHEAP stocks. The market will recover, and you will be ahead of the 100% stocks portofolio. And now you rebalance again to buy some cheap bonds and so on.

There are portofolios that try to diversify as much as possible. Yale, Harvard use extremely diversified portofolios: they even buy lumber damn it :)

It's counterintuitive - because stocks have the highest return rates. But they also have huge volatility. And you can profit from that volatility using diversification.
A stock/bonds mix - at worse - will get you similar returns and MUCH less volatility.

There are some who have gold and cash in their portofolio for this reason alone. Diversification. If the market volatility is high - these permanent portofolio guys will be AHEAD of the 100% stocks portofolio EVEN THOUGH they have 50% of assets that DO NOTHING.
I'm not one of the permanent portofolio guys - but before going all in on stocks - I would read about diversification more.

I'm something like 17% bonds, 5% REITs and the rest stocks (60% US, 40% international). I'm also increasing my bond allocation as I approach my retirement date. (about 2% per year)

It seems generally accepted that 100% stocks, have historically had better return, but they also have the highest variability. The quote above stuck in my mind, as its counter to this, it seems to be saying 80/20 with rebalancing gives higher returns than 100%. Is that what's really meant, does anyone know of any studies that support this?

In any case, I often wonder about rebalancing, there's obviously a cost associated with it - in terms of capital gains tax - which for me is 20%. So I've always been a buy-and-hold forever sort of investor. So I wonder - if there is a study that supports this, does it correctly account for capital gains tax effects.

Gone Fishing

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+-60 days from FIRE and I'm 95% stocks including allocations to small caps and emerging markets.   I try not to look too closely, but I am probably off $100k+ over the past few months.  A little nerve racking but I think I am alright with it.  I'm not usually one to panic or make rash decisions.  I plan to stick with my current allocations or thereabout until I start getting too old to fix things by going back to work. So somewhere around 50, I'll probably start dialing things back. There's a good reason why folks nearing traditional retirement age (60-65) start losing their tolerance for volatility. If something goes wrong at that point, there is not much opportunity to right the ship.     

JustGettingStarted1980

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I've seen and read about that 100% Equities graph, and it's really interesting.

I see Bonds as a way to deal with the psychological toil of possibly losing MUCHO DINERO in a very small amount of time.... it gives people something to do in times of stress -> Buy more stocks. It's a reminder that you're in it for the long haul.



AZryan

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I see Bonds as a way to deal with the psychological toil of possibly losing MUCHO DINERO in a very small amount of time.... it gives people something to do in times of stress -> Buy more stocks. It's a reminder that you're in it for the long haul.

"But you didn't lose any money. It was just a potential loss," notes the financial psychiatrist.

You might end up screwing yourself if you rebalance based on whenever you felt stressed out -which would only be randomly sometimes within certain downturns.

Typically rebalancing is arranged as a once a year, same day/date type thing -not with like you describe at various moments of stressful market drops.

So take 2015. Stocks went up, then down, then up, then ended flat. What did the stressed out stock/bond investor do during all that with no actual set rules guiding them?

In '16, do they rebalance now? Or last week? Will it go down more, so maybe wait for that to rebalance? This is not a winning strategy or solution to alleviating stress.

Meanwhile, the person in 100% stocks follows the simple rule of "do nothing when up or down... but maybe throw some extra money in if you got it when it's down". That always pulls ahead after a decade or two at most over any vanilla stock/bond allocation and then never falls behind even during crashes.

Scandium

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An 80 stocks/20 bonds allocation will probably return more than 100% stocks! Because of diversification. That means when stocks plummet, you will rebalance your account to keep the 80/20 allocation. Because stocks fell, your portofolio looks more like 70/30 stocks/bonds now. Which means you will sell some bonds to buy CHEAP stocks. The market will recover, and you will be ahead of the 100% stocks portofolio. And now you rebalance again to buy some cheap bonds and so on.

There are portofolios that try to diversify as much as possible. Yale, Harvard use extremely diversified portofolios: they even buy lumber damn it :)

It's counterintuitive - because stocks have the highest return rates. But they also have huge volatility. And you can profit from that volatility using diversification.
A stock/bonds mix - at worse - will get you similar returns and MUCH less volatility.

There are some who have gold and cash in their portofolio for this reason alone. Diversification. If the market volatility is high - these permanent portofolio guys will be AHEAD of the 100% stocks portofolio EVEN THOUGH they have 50% of assets that DO NOTHING.
I'm not one of the permanent portofolio guys - but before going all in on stocks - I would read about diversification more.

I'm something like 17% bonds, 5% REITs and the rest stocks (60% US, 40% international). I'm also increasing my bond allocation as I approach my retirement date. (about 2% per year)

It seems generally accepted that 100% stocks, have historically had better return, but they also have the highest variability. The quote above stuck in my mind, as its counter to this, it seems to be saying 80/20 with rebalancing gives higher returns than 100%. Is that what's really meant, does anyone know of any studies that support this?

In any case, I often wonder about rebalancing, there's obviously a cost associated with it - in terms of capital gains tax - which for me is 20%. So I've always been a buy-and-hold forever sort of investor. So I wonder - if there is a study that supports this, does it correctly account for capital gains tax effects.
I have never seen anything that supports this, only the opposite. Unless you can do perfect market timing. There's a 20% drop, do you rebalance, or could it drop more? What if it goes back up while you wait.. Etc. I don't know if Sevenseas has any source to support it, or is it just speculation?

Bonds not to boost returns, they provide stability. Which is perfectly valid too.

see for example
https://www.kitces.com/blog/how-rebalancing-usually-reduces-long-term-returns-but-is-good-risk-management-anyway/

Quote
The conventional view of portfolio rebalancing is that it is a strategy to enhance long-term returns by periodically selling the investments that are up (and overweighted) to buy those that are down (and underweighted), in the process of realigning the portfolio to its original target allocation.

Yet the reality is that because most investments go up far more often than they go down, systematic rebalancing is actually more likely to just consistently liquidate the best-performing investments to buy ones with lower returns instead – especially when rebalancing across investments that have very significant return differences in the first place (e.g., rebalancing from stocks into bonds).
....
Ultimately, the fact that rebalancing may actually reduce long-term returns isn’t a reason to avoid it (even if returns are lower, risk-adjusted returns may be improved if the risk is reduced by even more), and sometimes returns really can be enhanced (when rebalancing across similar-return investments, such as amongst sub-categories of equities). Nonetheless, it’s crucial to recognize the role that rebalancing really does – and does not – play in a long-term portfolio!

« Last Edit: February 05, 2016, 06:39:34 AM by Scandium »

Retire-Canada

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It's counterintuitive - because stocks have the highest return rates. But they also have huge volatility. And you can profit from that volatility using diversification.
I have never seen anything that supports this, only the opposite.

see for example
https://www.kitces.com/blog/how-rebalancing-usually-reduces-long-term-returns-but-is-good-risk-management-anyway/

The link you posted supports the bolded statement. The key is diversification amongst asset classes with similar rates of returns that are not well correlated. I assume from what he writes that the less correlation the more opportunity to benefit.

In terms of when to rebalance could you not set a trigger based on how much the returns diverge?

Rubic

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There's a good reason why folks nearing traditional retirement age (60-65) start losing their tolerance for volatility. If something goes wrong at that point, there is not much opportunity to right the ship.   

Ironically, the closer you get to age 65, the closer you are to qualifying for Medicare and Social Security benefits.  Perhaps for the retiree who requires $100K+ annual budget, market volatility will have a higher emotional impact.  Mortgage payments aside (which will be paid off by the time I FIRE), I could pretty much live on SS benefits exclusively.

P.S.  Congrats on your FIRE date, So Close.  Less than 2 months to go!

Scandium

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It's counterintuitive - because stocks have the highest return rates. But they also have huge volatility. And you can profit from that volatility using diversification.
I have never seen anything that supports this, only the opposite.

see for example
https://www.kitces.com/blog/how-rebalancing-usually-reduces-long-term-returns-but-is-good-risk-management-anyway/

The link you posted supports the bolded statement. The key is diversification amongst asset classes with similar rates of returns that are not well correlated. I assume from what he writes that the less correlation the more opportunity to benefit.

In terms of when to rebalance could you not set a trigger based on how much the returns diverge?

Yes the bolded is correct, meaning there is no benefit to diversifying into bonds as their return is not similar to stocks. He goes on to say that rebalancing between for example small and large cap could boot returns. But that was not what the person that started this discussion (SevenSeas) talked about. He/she said that rebalancing between stocks and bonds would boost returns, which I have not seen any evidence for.

Yes you could rebalance based on how much past return have diverged, but that may not hold for future returns.

Retire-Canada

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Yes the bolded is correct, meaning there is no benefit to diversifying into bonds as their return is not similar to stocks. He goes on to say that rebalancing between for example small and large cap could boot returns. But that was not what the person that started this discussion (SevenSeas) talked about. He/she said that rebalancing between stocks and bonds would boost returns, which I have not seen any evidence for.

Reading between the lines I think what SS was trying to say that diversifying between asset classes can support higher SWR by reducing volatility and providing opportunities to rebalance.

I think return was confused with SWR.

jhess002

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Correction on my TSP, there's more in bonds than I thought.
10% G (govt bonds)
20% F (fixed income index)
35% C (common stock index)
25% S (small cap index)
10% I (international stock index)
That's my current allocation, and total shares are within 1-2% by category.

IRAs:
HASI / PEGI / GLBL (appx 70/20/10)

Zephyr - I have a TSP account as well, and plan to stop working in about 20 years.  I have always put 100% into the longest range lifecycle fund (currently 2050) assuming this has a large share of equities. As I get closer to retirement, I would slowly move the assets into less risky lifecycle funds.  But I like your approach of doing my own asset allocation, any thoughts?     

Tyler

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The key is diversification amongst asset classes with similar rates of returns that are not well correlated.

Exactly. Your typical intermediate bond fund doesn't have the necessary punch, and corporate bonds are more correlated to stocks than you think. 

The closest type of bond to meet the criteria is long term treasuries.  They're volatile with high returns and low correlation to the stock market.  Even adding LTTs to a total stock market fund alone still won't necessarily increase returns, but the returns will be pretty close with notably less volatility.  You generally have to start looking at three or more uncorrelated assets in a portfolio to get the more interesting results.

Diversifying into bonds definitely helps with withdrawal rates, as volatility affects that multiple ways.  And I also believe wise money management in accumulation is about more than simply maximizing every last penny out of your theoretical long-term returns.  Bonds can make the journey a lot more enjoyable and predictable and provide real utility for people in all life stages (TIPS can be part of an inflation protection strategy, short term treasuries are great for near-term goals like saving for a house down payment, etc).  I definitely recommend that everyone consider the benefits of adding some bonds to their portfolios. 

« Last Edit: February 05, 2016, 08:34:50 AM by Tyler »

Retire-Canada

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Diversifying into bonds definitely helps with withdrawal rates, as volatility affects that multiple ways.  And I also believe wise money management in accumulation is about more than simply maximizing every last penny out of your theoretical long-term returns.  Bonds can make the journey a lot more enjoyable and predictable and provide real utility for people in all life stages (TIPS can be part of an inflation protection strategy, short term treasuries are great for near-term goals like saving for a house down payment, etc).  I definitely recommend that everyone consider the benefits of adding some bonds to their portfolios.



Kitces posts this graph ^^^ to illustrate why rebalancing to bonds 50/50 is a drag on a portfolio. Taking your point above into account about having reduced volatility in mind the issue I see is that the need for % bonds would decrease as the portfolio value grows as a function of the individual's cost of living. Once you have reached say 5 or 10 times your COL there is not much point adding more bonds if you are comfortable with that safety margin. At that point holding the inflation adjusted value of bonds constant would make sense and allow your portfolio's performance to increase.

Kaspian

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My kneejerk reaction was to instantly disagree with that.  I'm what (most here people here anyway) would call bond heavy at 40% and rebalance semi-annual if the portfolio calls for it.    However, yeah, I can see that on and after the 20-year mark there would be very little point and I'd probably come to that realization at the time--the bond income portion would be huge enough already.  (...And as a Canadian, because that income is fully taxed (if outside a shleter) verus capital gains, I would seriously no longer bother with the rebalancing.)  Just hope I'm not senile by then. 

zephyr911

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Zephyr - I have a TSP account as well, and plan to stop working in about 20 years.  I have always put 100% into the longest range lifecycle fund (currently 2050) assuming this has a large share of equities. As I get closer to retirement, I would slowly move the assets into less risky lifecycle funds.  But I like your approach of doing my own asset allocation, any thoughts?     
TBH, I'm pretty sure I arbitrarily assigned this AA based on a couple of readings and a feeling that "moderately aggressive" or something like that was a good description of my desired approach, and never changed it after Day 1.

If I were doing it today I'd probably go even heavier on stocks. The only reason I don't put more thought into it is that the meat and potatoes of my retirement is in residential rental property, backed by PT work and eventual pensions (FERS, ANG). Under Plan A, my TSP/IRA will just sit there as a safety buffer until I die and leave it to (whoever/whatever).

You can see the results of that in my stock picking, which is more risk-tolerant and activist than most here. So, by no means should my approach guide yours! But working out your own AA is not a bad idea, if you use a sound rationale for it.

SevenSeas

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Average returns don't tell the whole story:

"However, an investor would have actually made slightly MORE money (measured by the more accurate CAGR) with the Swensen portfolio than with the total stock market over the long run, with shorter and less severe drawdowns along the way:
http://portfoliocharts.com/2015/08/24/avoiding-the-volatility-trap/


"Modern portfolio theory has opened the gates for simple but sophisticated portfolio concepts that defy conventional investing wisdom, and the Portfolios section here contains several good portfolios that match or beat the total stock market in long-term real CAGR"
http://portfoliocharts.com/2015/09/22/catching-a-golden-butterfly/

This graph shows that there are quite a few popular portofolios that have achieved higher CAGR for less volatility:
https://portfoliocharts.files.wordpress.com/2015/09/golden-butterfly-sd-vs-cagr.jpg?w=840
« Last Edit: February 08, 2016, 09:09:46 AM by SevenSeas »

nobodyspecial

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It is easy to decide which strategies did better than the market looking back.
My buy "tech companies that begin with the letter A strategy" is doing rather well, my other 25 strategies not so good.
   
« Last Edit: February 08, 2016, 02:39:43 PM by nobodyspecial »

AdrianC

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It is easy to decide which strategies did better than the market looking back.

Exactly!

Bond heavy portfolios did well as interest rates went down and down. No surprise there.

I'm interested in what will do well going forward, and from where we are with bond yields at historic lows I'd rather own productive assets, which means stocks and real estate, with a good amount of cash to take advantage of any opportunities that come along.


index

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Take note most of the posters here that are over 35-40 and actually have some experience are advising you to maintain an allocation of bonds in your portfolio. The 100% equity advice appears to be a case of the blind leading the blind.

faramund

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Take note most of the posters here that are over 35-40 and actually have some experience are advising you to maintain an allocation of bonds in your portfolio. The 100% equity advice appears to be a case of the blind leading the blind.
Well, I'm 46, and have been directly investing 100% stocks outside my retirement portfolio since 2000, and inside my retirement portfolio since 2009 (I only realized I could do this in about 2006, and my "bubble sense" was tingling, so I waited until after the crash). Just to put things in perspective.

faramund

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Average returns don't tell the whole story:

"However, an investor would have actually made slightly MORE money (measured by the more accurate CAGR) with the Swensen portfolio than with the total stock market over the long run, with shorter and less severe drawdowns along the way:
http://portfoliocharts.com/2015/08/24/avoiding-the-volatility-trap/


"Modern portfolio theory has opened the gates for simple but sophisticated portfolio concepts that defy conventional investing wisdom, and the Portfolios section here contains several good portfolios that match or beat the total stock market in long-term real CAGR"
http://portfoliocharts.com/2015/09/22/catching-a-golden-butterfly/

This graph shows that there are quite a few popular portofolios that have achieved higher CAGR for less volatility:
https://portfoliocharts.files.wordpress.com/2015/09/golden-butterfly-sd-vs-cagr.jpg?w=840
I thought I'd already posted in reply to this, but it doesn't appear here (I guess I got distracted and didn't actually press post).

Anyway. These websites are very interesting, but I wish it had the CAGR of the subcomponents, I can't find it on the website, i.e. does Swensen outperform by 0.1% because, say International Developed has a higher CAGR, then total stockmarket? I really would like to know...

Retire-Canada

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These websites are very interesting, but I wish it had the CAGR of the subcomponents, I can't find it on the website, i.e. does Swensen outperform by 0.1% because, say International Developed has a higher CAGR, then total stockmarket? I really would like to know...

http://portfoliocharts.com/assets/

Tyler

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You can always use the calculators to study each asset independently.  For the CAGR, try this.
 
While higher returns certainly help, portfolio performance is definitely more complicated than just adding up the returns of the individual components.  Sometimes adding an asset with a much lower CAGR can actually increase the combined return over the same period. 
« Last Edit: February 08, 2016, 09:42:07 PM by Tyler »

faramund

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These websites are very interesting, but I wish it had the CAGR of the subcomponents, I can't find it on the website, i.e. does Swensen outperform by 0.1% because, say International Developed has a higher CAGR, then total stockmarket? I really would like to know...

http://portfoliocharts.com/assets/
I still, don't see it - that page has a list of the different classes, you can then pick one, and it shows you a table of their returns, but it doesn't tell you the CAGR. Compare the chart of say International Developed (http://portfoliocharts.com/portfolio/i-dev/) to say the Swensen chart (http://portfoliocharts.com/portfolio/swensen-portfolio/). The Swensen chart has a panel that tells you the CAGR, that's not there for the other one.

I find it surprising, that these both aren't presented in the same way.

steveo

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Taking your point above into account about having reduced volatility in mind the issue I see is that the need for % bonds would decrease as the portfolio value grows as a function of the individual's cost of living.

I understand this may be true theoretically but I have a goal that is more like get to a certain level of equity investments and then increase my bond allocation. The reason is simple - I don't want or need to have the most money but I do want to have a high safety margin if that is possible.

I think a higher level of equities will result in the largest portfolio over time however I'd rather once I have enough simply increase my safety margin.

zephyr911

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Take note most of the posters here that are over 35-40 and actually have some experience are advising you to maintain an allocation of bonds in your portfolio. The 100% equity advice appears to be a case of the blind leading the blind.
That's civil of you. :P

Kaspian

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It's counterintuitive - because stocks have the highest return rates. But they also have huge volatility. And you can profit from that volatility using diversification.

Yes! Excellent point that gets overlooked.

It's a point that gets repeated a lot that is not, in general, true:


Does that chart account for rebalancing?

Anyway, doesn't matter--I like to think of that 1% less return as very cheap insurance against doing something stupid.  It would be interesting to someday see a chart of how 100% equity people behave in a downspin versus what someone who is diversified does.  It's been my experience in the past that the 100%-ers back slowly to the door and re-do their strategy to diversify at the worst possible time.  ...Or they do the Irish goodbye to investing and never come back.

SevenSeas

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It is easy to decide which strategies did better than the market looking back.
My buy "tech companies that begin with the letter A strategy" is doing rather well, my other 25 strategies not so good.
 

Yes, but these aren't just some portofolios that someone threw together after some backtracking. If that was the case than I would agree with you.
Anyway - many people don't REALLY understand volatility and they over appreciate their endurance to its effects. The brain only uses averages to calculate, people will go on and on about the expected return, but we could get 15 years of negative returns from the stock market. What then? Do most people really have the fortitude to lose money for years and years? Again most people have problems to stomach even a -3% day. But when evaluating their strategy they want to go all in on risk...
« Last Edit: February 09, 2016, 12:40:02 AM by SevenSeas »

faramund

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Anyway - many people don't REALLY understand volatility and they over appreciate their endurance to its effects. The brain only uses averages to calculate, people will go on and on about the expected return, but we could get 15 years of negative returns from the stock market. What then? Do most people really have the fortitude to lose money for years and years? Again most people have problems to stomach even a -3% day. But when evaluating their strategy they want to go all in on risk...
True, and there have been several threads recently that have really discussed this to death. The topic here is, "If you can handle volatility" - the most interesting thing in this thread (at least for me), is the suggestion that diversity can reduce volatility and increase CAGR, and I have trouble seeing how mathematically this can be possible, but I have an open mind.

I can see the argument, if there's a bunch of investment options that all seem to have similarly high CAGRs, then its good to have a range of them, particularly if they're not correlated.

Down here in Australia, historically real estate and shares seem to have grown at similar rates. I don't want to hold real estate investments directly, but about 20% of my shares are in real estate related activities, and I try to have shares across different sectors, as well as those that are focused internationally, as well as those that are domestic.

But I don't buy bonds or deposit money in banks, as they're historical CAGR is really very low.

SevenSeas

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Anyway - many people don't REALLY understand volatility and they over appreciate their endurance to its effects. The brain only uses averages to calculate, people will go on and on about the expected return, but we could get 15 years of negative returns from the stock market. What then? Do most people really have the fortitude to lose money for years and years? Again most people have problems to stomach even a -3% day. But when evaluating their strategy they want to go all in on risk...
True, and there have been several threads recently that have really discussed this to death. The topic here is, "If you can handle volatility" - the most interesting thing in this thread (at least for me), is the suggestion that diversity can reduce volatility and increase CAGR, and I have trouble seeing how mathematically this can be possible, but I have an open mind.

I can see the argument, if there's a bunch of investment options that all seem to have similarly high CAGRs, then its good to have a range of them, particularly if they're not correlated.

Down here in Australia, historically real estate and shares seem to have grown at similar rates. I don't want to hold real estate investments directly, but about 20% of my shares are in real estate related activities, and I try to have shares across different sectors, as well as those that are focused internationally, as well as those that are domestic.

But I don't buy bonds or deposit money in banks, as they're historical CAGR is really very low.

Many people have issues wrapping their heads around this. The key aspect that you are probably missing is rebalancing.

I would recommend reading: The Ivy Portofolio - by Mebane T. Faber. You will see how having a diversified portofolio can beat the stock market. It's the whole - the sum of its parts in action :)

faramund

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Many people have issues wrapping their heads around this. The key aspect that you are probably missing is rebalancing.

I would recommend reading: The Ivy Portofolio - by Mebane T. Faber. You will see how having a diversified portofolio can beat the stock market. It's the whole - the sum of its parts in action :)
It may not be applicable to me, it costs me 40% in capital gains to rebalance after a year, and 20% if its after a year.


faramund

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Well, The free portion of Ivy Portfolio portfolio wasn't very long, but it suggested people should read asset allocation first.

In asset allocation, it has the period 2000-2009 (which is really selectively picking a bad patch for shares).

It has, over that period, bond 6.33%, stocks -0.95%, REITS 10.63%, and then shows
that having 1/3 of each of these has a 6.13% return.

I'm really starting to become convinced that this diversity can improve returns is a mirage. It seems like its just  saying, ok, if shares give X, and there's some other class that gives Y (and Y>X), then a blended combination of Y and X is better than X.

If that's all this argument is, then dahhh.. either just buy the higher earning class if its expected to be bigger, or if its just a weird anomaly, just ignore it - in my mind, the hopes that diversity can improve CAGR, is lapsing back to just smoke and mirrors.

beltim

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It's counterintuitive - because stocks have the highest return rates. But they also have huge volatility. And you can profit from that volatility using diversification.

Yes! Excellent point that gets overlooked.

It's a point that gets repeated a lot that is not, in general, true:


Does that chart account for rebalancing?

Yes.  All efficient frontier graphs do – otherwise the graph would be exactly linear instead of curved.

Quote
Anyway, doesn't matter--I like to think of that 1% less return as very cheap insurance against doing something stupid.  It would be interesting to someday see a chart of how 100% equity people behave in a downspin versus what someone who is diversified does.  It's been my experience in the past that the 100%-ers back slowly to the door and re-do their strategy to diversify at the worst possible time.  ...Or they do the Irish goodbye to investing and never come back.

An entirely reasonable strategy.  And based on facts – a portfolio with, say, 30% bonds is much less volatile, and is a valid choice for many people.  It just doesn't magically give higher returns.  I posted the graph to counter this common misconception.

AdrianC

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Many people have issues wrapping their heads around this. The key aspect that you are probably missing is rebalancing.

I would recommend reading: The Ivy Portofolio - by Mebane T. Faber. You will see how having a diversified portofolio can beat the stock market. It's the whole - the sum of its parts in action :)
It may not be applicable to me, it costs me 40% in capital gains to rebalance after a year, and 20% if its after a year.

The back test portfolios referenced in this thread do not account for taxes on dividends, interest or cap gains when rebalancing, and the prospective early retiree will have a substantial portion of assets in taxable accounts during their peak tax paying years. Plus, the rebalancing is one time at the end of each year. Is this the right time to rebalance? No one knows.

For these reasons I'm skeptical that these low volatility portfolios will beat 100% stocks over the long term for the accumulating prospective early retiree.


Tyler

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I'm really starting to become convinced that this diversity can improve returns is a mirage. It seems like its just  saying, ok, if shares give X, and there's some other class that gives Y (and Y>X), then a blended combination of Y and X is better than X.

If that's all this argument is, then dahhh.. either just buy the higher earning class if its expected to be bigger, or if its just a weird anomaly, just ignore it - in my mind, the hopes that diversity can improve CAGR, is lapsing back to just smoke and mirrors.

It's admittedly not very intuitive, but it's definitely not a mirage.  Modern portfolio theory is a widely studied economic concept dedicated to maximizing returns and minimizing volatility by using intelligent diversification.  I provided a link earlier that gave a specific example with stocks and gold, but explaining how it works in detail will require a lengthy dedicated post on its own.  Short story -- the way volatility and correlations affect compound returns is more sophisticated than just adding a few individual weighted averages together.   Some assets complement each other better than others.  When the strength and timing of one asset picks up the slack for another, the team is stronger than the individual. 

Also, it helps to think about this topic not simply in terms of combining assets to increase returns, but also in terms of risk management compared to alternatives.  For example, the Golden Butterfly matches (within 0.1%) the CAGR of the total stock market but with the volatility of a very conservative 30-70 portfolio.  When you think about how diversification can greatly improve your return for a given amount of volatility (or alternatively, minimize the volatility for a given adequate return), that's an appealing approach for many investors.  So don't just compare the combined CAGR to those of the individual assets.  Compare it to the CAGR of a portfolio of similar risk. 

The back test portfolios referenced in this thread do not account for taxes on dividends, interest or cap gains when rebalancing, and the prospective early retiree will have a substantial portion of assets in taxable accounts during their peak tax paying years. Plus, the rebalancing is one time at the end of each year. Is this the right time to rebalance? No one knows.

For these reasons I'm skeptical that these low volatility portfolios will beat 100% stocks over the long term for the accumulating prospective early retiree.

True.  Some portfolios are more tax efficient than others.  I'm especially skeptical of things like the Merriman portfolio in a taxable account with a ton of assets to rebalance, but others are pretty simple and tax efficient. 

In accumulation, selling an asset to rebalance and taking a capital gains hit is actually quite rare because you can accomplish the same thing by always putting new money into the lagging asset (the one below its target percentage and currently "on sale").  And when you do have to sell something, lots of people use techniques like tax loss harvesting to minimize or eliminate capital gains taxes very effectively (having multiple uncorrelated assets actually makes this easier).   

I totally agree that taxes are a very important factor to consider, and different portfolios might work better for different people. 
« Last Edit: February 09, 2016, 08:18:20 PM by Tyler »

AdrianC

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In accumulation, selling an asset to rebalance and taking a capital gains hit is actually quite rare because you can accomplish the same thing by always putting new money into the lagging asset (the one below its target percentage and currently "on sale").  And when you do have to sell something, lots of people use techniques like tax loss harvesting to minimize or eliminate capital gains taxes very effectively (having multiple uncorrelated assets actually makes this easier).   

I totally agree that taxes are a very important factor to consider, and different portfolios might work better for different people.

Does anyone really do it this way? What I hear most is put spare cash every month into funds in some predetermined mix. People don't change it each month to keep things in balance. Rebalancing is an annual event.

Retire-Canada

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Does anyone really do it this way? What I hear most is put spare cash every month into funds in some predetermined mix. People don't change it each month to keep things in balance. Rebalancing is an annual event.

I rebalance [as much as I can] monthly or any time I put money in. I also plan to rebalance when I take money out in FIRE.

It seems logical to do so if you are going to the trouble of putting money into your accounts.

So far that process has worked well enough I have not done an annual rebalance.
« Last Edit: February 10, 2016, 09:14:06 AM by Retire-Canada »

Tyler

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Does anyone really do it this way? What I hear most is put spare cash every month into funds in some predetermined mix. People don't change it each month to keep things in balance. Rebalancing is an annual event.

Well that's what I did (and still do when I have the opportunity).  I can't speak for everyone else, but to me it makes sense for a few reasons:

1) It minimizes taxes (I paid no capital gains taxes for years, but the AA stayed exactly where I wanted).
2) It always buys low (relatively speaking).  No need to sell at all.
3) By only buying the lowest one or two assets rather than spreading income out over many, it minimizes trading costs.

It's true that different people have different strategies.  Do whatever makes you comfortable, and plan your AA accordingly. 
« Last Edit: February 10, 2016, 09:41:15 AM by Tyler »

Le Barbu

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It's counterintuitive - because stocks have the highest return rates. But they also have huge volatility. And you can profit from that volatility using diversification.

Yes! Excellent point that gets overlooked.

It's a point that gets repeated a lot that is not, in general, true:



But it's a very good reason for an extreme conservative portfolio to hold 20-30% stocks instead of ZERO!

chucklesmcgee

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You guys/gals with 100 equity. Are you invested in index funds? What equity classes?

VTI, Vanguard's Total Market ETF.

Jeremy

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The 100% equity advice appears to be a case of the blind leading the blind.

I'm having a hard time *seeing* what you are saying ;)

faramund

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You guys/gals with 100 equity. Are you invested in index funds? What equity classes?


A wide range of individual, mainly value-based, holdings