Author Topic: Is a simple 80/20 asset allocation naive?  (Read 9270 times)

CrankAddict

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Is a simple 80/20 asset allocation naive?
« on: December 07, 2016, 11:07:55 AM »
I've completed reading a Random Walk Down Wall Street and the Intelligent Asset Allocator (as well as MMM posts of course!) and it was definitely impressed upon me the importance of picking a good AA.  But as I sit here backtesting portfolios, I'm finding it difficult to find any combinations that beat 80% Vanguard Total Stock Market and 20% Vanguard Total Bond over the last 15 years (gets tough to do time periods longer than that due to data not being available on the specific funds, etc).

The other two components that I've been trying to inject are a Vanguard REIT and a Vanguard Total International Stock Index.  But as I add those I seem to simply be increasing standard deviation with no or little increase in return.

I've recently moved everything to Vanguard and currently I have 30% in TSM admiral shares and the rest in a money market (this was just a side effect of how the different funds transferred, I wasn't specifically opting for cash).  I've been sitting on the fence for the last month partially waiting to see if the world implodes post-election, but more so because I'm trying to convince myself I have a good enough AA to jump in.  So along those lines, is there any harm in at least starting with the 80/20 while I spend perhaps 6 months developing a more nuanced strategy?

And no, I don't have a formal IPS.  I'm self-employed, age 42, currently working 110 hours a week, and my retirement date could be 2 years from now or 22 years from now depending on how my business does or doesn't take off.  I've moved to a house that is 1/3 the size/cost (and thus no mortgage), sold my fancy car, canceled cable, and started cooking all meals at home.  As far as the market, all I can realistically hope to do is invest as much as I can in middle-of-the-road instruments and hope that the last 18 years doesn't repeat itself.  At least this time I'm controlling things myself instead of trusting a "professional".  My '98 - '16 returns using a pro are on par with a checking account.  A lot of that is due to the unfortunate timings of the big crashes, but certainly some is due to poor AA, fees, etc.

Anyway, didn't intend this to turn into such a long post, sorry for that but to the one guy that has made it this far - thanks for reading!

steveo

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Re: Is a simple 80/20 asset allocation naive?
« Reply #1 on: December 07, 2016, 02:10:10 PM »
I think it's really really hard to beat a simple stock/bonds portfolio utilising low cost index funds based upon your risk profile. If you are a US based investor I think that you could have all your stocks within a US domiciled fund. For an international investor I think you shouldn't go higher than sat 50% in your domiciled countries fund.

So if you choose to go 80/20 with it all in the US index personally I think you'd be fine and by fine you will probably beat 99% of investors out there. Personally I would probably use an international index but that is your call.

The only proviso I'd make is will you stick with it over the longer term. If so then you are good to go.


CrankAddict

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Re: Is a simple 80/20 asset allocation naive?
« Reply #2 on: December 07, 2016, 02:17:08 PM »
Thanks for the reply!

I am US based, so the terminology that I'm used to is "international" means "everything but the US".  When you say you'd probably go for an international index, I assume you mean the whole world including the US, right?

Goat

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Re: Is a simple 80/20 asset allocation naive?
« Reply #3 on: December 07, 2016, 02:39:14 PM »
I am not an expert but my answer is no.

Everyone defines risk differently, but a lot of people argue that the standard deviation itself is not a risk, the behavior as a result of the fluctuations is the risk

1. A lot of the proponents of a 60/40 split think it is risky to have a high standard deviation because you will bail out if you have a 40% drop in your portfolio. The risks aren't in the market but in the person reacting to it.

2. Warren Buffet thinks the biggest risk is inflation, which will eat up your bonds. He advocates for a 90-10 split (although people have parsed his missive endlessly, I think the consensus is 10) probably because he has weathered so much and he cannot fathom there are people out there that would be selling, and not buying, on a dip. JLCollins thinks similarly and he is 88 total market / 12 cash...

3. Swedroe looks at matching the risks of your investments to the risks of your income. He looks at people who have "bond-like" salaries and "equity-like" salaries. According to him, bond like salaries belong to people whose salaries aren't affected by the economy (a teacher with ten, a doctor) and equity-like salaries belong to those very tied into the economy (salesman, entrepreneurs)... He advocates less risk for the people with "equity-like" salaries because their success is tied to the market which means they are at risk of a double loss in the even of a depression/recession/event. (the risk is measured both as large vs. small and growth vs value... Large Growth which the TSM/S&P500 funds tilt toward are less volatile than Small Cap Value indexes. It sounds like you are an entrepreneur so I believe Swedroe's book ("The only Guide You'll Ever Need To..." would urge you to avoid small and value factors and stick with a Total Market index... )

4. There is also a Buffet/Bogles vs. Bernstein/Swedroe decision on the need for international holdings. This debates involves a lot of factors but I think the question I always come back to is whether the international holding increases return or merely eases volatility. Nobody knows that answer, but a lot of people have ideas.

5. Everyone loves the Total Stock Market vehicle, but you will find a lot of critics of the Total Bond market index funds. 1) They have some corporate bonds which are correlated to the stock market. 2) They carry some risk. Bernstein, Buffet and Swedroe all prefer an ultra-safe Short Term Treasury fund instead. There isn't much return, but even though the three have a different percentage allocated to the Treasury fund, they all peg that percentage to money you will absolutely need. So Buffet (and Collins) think you need about 10-12% or so of your invested money specifically to weather a 3-5 year period when the stocks are down. Bernstein likes 25%. But they all advocate not thinking of bonds as an investment but rather as a safeguard, while the stock side does the work. Only you can know what percentage of your portfolio that would be.

If you do want the added value from the fixed income side, one quick tweak to your 80/20 TSM /TBM would be to substitute an intermediate term treasury fund for the total bond fund.

They look almost the same in a vacuum (per portfolio visualizer 1987-2016:

TBM 6.18% return, 3.83%  STDDev
ITT 6.37% return,  4.85% STDDev

Pretty similar... But because when stocks drop the money moves to Treasuries, it pairs better 80/20 with TSM:

TSM/TBM 9.31% return, 12.38%  STDDev
TSM/ITT 9.41% return,  12.22% STDDev

The Treasuries are less volatile when paired, have better return, and I don't pay California state tax on them which means it is worth considering holding them in taxable accounts. No way to measure it but I would guess that getting to put more equities in tax-advantaged accounts will increase the old number fast.

So, super long... Sorry. I would:
1. Evaluate how capable you are of completely ignoring the market (the more ignorance the less of a danger you pose to yourself...)
2. Figure out how much you need to ride out a 3-5 year drop.
3. Figure out how safe your income stream is.

Those three make up your fixed income term/type and percentage.

4. Make a decision on international.

5. Evaluate Total Bond....

If you're like me you'll think all that through and then circle back anyway, but at least you'll have confidence in your decision since you thought it out.

« Last Edit: December 07, 2016, 02:41:42 PM by Goat »

SeattleCPA

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Re: Is a simple 80/20 asset allocation naive?
« Reply #4 on: December 07, 2016, 02:51:08 PM »
You can test your portfolio (actually backtest your portfolio) against a bunch of common AAs using this tool:

https://www.portfoliovisualizer.com/backtest-asset-class-allocation

BTW, I think you'll find that as you move the date range, different AAs produce different optimas.

For what it's worth, I've been using index funds for as long as they've been available to individual investors and have been recommending them in my books for more than two decades... and I use David Swensen's model. It's 70% stocks and 30% bonds (treasuries)...
« Last Edit: December 07, 2016, 03:54:50 PM by SeattleCPA »

steveo

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Re: Is a simple 80/20 asset allocation naive?
« Reply #5 on: December 07, 2016, 03:34:47 PM »
Thanks for the reply!

I am US based, so the terminology that I'm used to is "international" means "everything but the US".  When you say you'd probably go for an international index, I assume you mean the whole world including the US, right?

Yes. I like the idea of the whole world including the US.

One other point I'd make is that you no one knows what the future will be like. So using a really solid and simple asset allocation ala stocks/bonds and using broad low cost index funds means that you are in as good a position in my opinion than any optimised asset allocation that is achieved via backtesting.

I think backtesting can lead to data mining an asset allocation that is optimised for prior conditions.
« Last Edit: December 07, 2016, 03:37:52 PM by steveo »

Retire-Canada

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Re: Is a simple 80/20 asset allocation naive?
« Reply #6 on: December 07, 2016, 04:33:01 PM »
So along those lines, is there any harm in at least starting with the 80/20 while I spend perhaps 6 months developing a more nuanced strategy?

That sounds reasonable.

CrankAddict

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Re: Is a simple 80/20 asset allocation naive?
« Reply #7 on: December 07, 2016, 10:40:41 PM »
Thank you for all of the great input!

Radagast

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Re: Is a simple 80/20 asset allocation naive?
« Reply #8 on: December 07, 2016, 11:02:29 PM »
Vanguard makes a pretty sweet 80/20 fund as well.

Kaspian

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Re: Is a simple 80/20 asset allocation naive?
« Reply #9 on: December 08, 2016, 10:02:08 AM »
So along those lines, is there any harm in at least starting with the 80/20 while I spend perhaps 6 months developing a more nuanced strategy?

That sounds reasonable.

^^ This.  You probably also don't have to go for more "nuanced".  At a certain point further diversification isn't really necessary.  It's not sexy and it's counterintuitive, but a very simple portfolio will win the game with an easy equity/bond mix.  And you won't have all that rebalancing to do.  So, in answer to your question, "Is a simple 80/20 asset allocation naive?"  No, not at all--it's probably great!  :)
« Last Edit: December 08, 2016, 10:08:31 AM by Kaspian »

steveo

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Re: Is a simple 80/20 asset allocation naive?
« Reply #10 on: December 08, 2016, 02:13:04 PM »
So along those lines, is there any harm in at least starting with the 80/20 while I spend perhaps 6 months developing a more nuanced strategy?

That sounds reasonable.

^^ This.  You probably also don't have to go for more "nuanced".  At a certain point further diversification isn't really necessary.  It's not sexy and it's counterintuitive, but a very simple portfolio will win the game with an easy equity/bond mix.  And you won't have all that rebalancing to do.  So, in answer to your question, "Is a simple 80/20 asset allocation naive?"  No, not at all--it's probably great!  :)

I think that the 80/20 portfolio has more chance of beating the nuanced portfolio than the other way around.

CrankAddict

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Re: Is a simple 80/20 asset allocation naive?
« Reply #11 on: December 08, 2016, 05:53:49 PM »
I'm relieved, but honestly a little surprised to hear such praise for the butt-simple approach.  I know KISS often prevails but even the sources inline with what many around here espouse seem to recommend a bare minimum of 3 asset classes, with 4-5 being preferred.  In any case, stocks and bonds appear to be pretty much universally agreed upon as the first two classes... is there a consensus on what the 3rd most popular would be if and when I get to the point of adding a third?

Thanks again for the input, definitely appreciated!

steveo

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Re: Is a simple 80/20 asset allocation naive?
« Reply #12 on: December 08, 2016, 06:33:40 PM »
I'm Australian and I have two groupings of assets simply because that is how it works in Australia.

I have Super which I can't access until I'm 60. I have that all placed in a generic high growth fund. It's basically an all in one diversified fund.
Outside of Super I have an asset allocation of 50% domestic stocks, 25% international stocks & 25% australian bonds.

I don't know what is the most popular asset to add. Lot's of people like gold. Personally if I was going to add another class I think it would be commodities. I don't consider property because within the stock market there are property companies but most importantly I own my house and it's way too heavily weighted within my overall portfolio. There is no way my total portfolio will equal my house price for many many years.

Retire-Canada

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Re: Is a simple 80/20 asset allocation naive?
« Reply #13 on: December 08, 2016, 07:09:11 PM »
In any case, stocks and bonds appear to be pretty much universally agreed upon as the first two classes... is there a consensus on what the 3rd most popular would be if and when I get to the point of adding a third?

Hopefully by stocks you also mean international stocks. If not I would add them as your third asset class. Once you've got that covered I don't think you need to get more complicated.

Do you own or have a mortgage on a home of substantial value? If so you may have a big chunk of your wealth tied up in real estate, which could be an additional asset class.

somers515

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Re: Is a simple 80/20 asset allocation naive?
« Reply #14 on: December 08, 2016, 07:55:54 PM »
In any case, stocks and bonds appear to be pretty much universally agreed upon as the first two classes... is there a consensus on what the 3rd most popular would be if and when I get to the point of adding a third?

Hopefully by stocks you also mean international stocks. If not I would add them as your third asset class. Once you've got that covered I don't think you need to get more complicated.

Do you own or have a mortgage on a home of substantial value? If so you may have a big chunk of your wealth tied up in real estate, which could be an additional asset class.

+1 Great advice here and throughout this thread.

US index fund equity, International index fund equity, total US bond fund - 3 good asset classes as you build your stache.  As you approach your FIRE date and you prepare your funds for the drawdown phase you might then want to consider diversifying further (during drawdown phase a reduction in volatility can lead to a greater safe withdrawal rate).  Things to consider would be adding an International bond fund, TIPS, REIT, even a small gold position.

But I really think you are on the right path.  Good luck!

Kaspian

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Re: Is a simple 80/20 asset allocation naive?
« Reply #15 on: December 09, 2016, 10:07:12 AM »
I'm relieved, but honestly a little surprised to hear such praise for the butt-simple approach.  I know KISS often prevails but even the sources inline with what many around here espouse seem to recommend a bare minimum of 3 asset classes, with 4-5 being preferred.  In any case, stocks and bonds appear to be pretty much universally agreed upon as the first two classes... is there a consensus on what the 3rd most popular would be if and when I get to the point of adding a third?

Thanks again for the input, definitely appreciated!

The more things you add, the greater the temptation to tinker around with the portfolio.  ...And tinkering is what results in many index investors underperforming the very indexes they invested in.  :(

NoStacheOhio

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Re: Is a simple 80/20 asset allocation naive?
« Reply #16 on: December 09, 2016, 12:16:44 PM »
In any case, stocks and bonds appear to be pretty much universally agreed upon as the first two classes... is there a consensus on what the 3rd most popular would be if and when I get to the point of adding a third?

Hopefully by stocks you also mean international stocks. If not I would add them as your third asset class. Once you've got that covered I don't think you need to get more complicated.

Do you own or have a mortgage on a home of substantial value? If so you may have a big chunk of your wealth tied up in real estate, which could be an additional asset class.

+1 Great advice here and throughout this thread.

US index fund equity, International index fund equity, total US bond fund - 3 good asset classes as you build your stache.  As you approach your FIRE date and you prepare your funds for the drawdown phase you might then want to consider diversifying further (during drawdown phase a reduction in volatility can lead to a greater safe withdrawal rate).  Things to consider would be adding an International bond fund, TIPS, REIT, even a small gold position.

But I really think you are on the right path.  Good luck!

Just to tack on, while there are all-world funds, you're usually better off using at least three funds for cost reasons. The ERs on global funds are going to be higher than what you're paying for a total US fund.

Something like:
Total US index (VTI's ER is 0.05%)
Global index, ex-US (VXUS's ER is 0.13%)
Total US bond index (BND's ER is 0.06%)

VT would be the comparable full global index, and has an ER of 0.14%

CrankAddict

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Re: Is a simple 80/20 asset allocation naive?
« Reply #17 on: December 11, 2016, 06:43:22 PM »
Hopefully by stocks you also mean international stocks. If not I would add them as your third asset class. Once you've got that covered I don't think you need to get more complicated.

Do you own or have a mortgage on a home of substantial value? If so you may have a big chunk of your wealth tied up in real estate, which could be an additional asset class.

Great points.  Not sure why but wasn't really thinking about the house.  I do own my house outright, but it's worth a little less than my stocks/bonds, and the combination of everything is only about 25% of what I estimate I need to actually retire.  So... long way to go ;)

One somewhat related follow-up question for all of you.  Let's say I've got my existing money into the allocations that we've discussed.  Now it's time to start making small monthly contributions.  If you guys were making a contribution tomorrow and had to choose between stocks and bonds would you go for one in particular? 

My thought would be that since the bond index is currently sitting at 52-week lows and the stock index is sitting at 52 week highs, it would seem to make sense to buy bonds at value pricing.  Then again if bonds will keep going down for a while and stocks will keep going up maybe I should be buying stocks.  Or finally, maybe this proves that I should just keep 80/20'ing it and not ever do anything differently.  I suspect that would be the answer but just wanted to see if any of you suggest varying purchases based on current conditions.

somers515

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Re: Is a simple 80/20 asset allocation naive?
« Reply #18 on: December 11, 2016, 07:34:05 PM »
Hopefully by stocks you also mean international stocks. If not I would add them as your third asset class. Once you've got that covered I don't think you need to get more complicated.

Do you own or have a mortgage on a home of substantial value? If so you may have a big chunk of your wealth tied up in real estate, which could be an additional asset class.

Great points.  Not sure why but wasn't really thinking about the house.  I do own my house outright, but it's worth a little less than my stocks/bonds, and the combination of everything is only about 25% of what I estimate I need to actually retire.  So... long way to go ;)

One somewhat related follow-up question for all of you.  Let's say I've got my existing money into the allocations that we've discussed.  Now it's time to start making small monthly contributions.  If you guys were making a contribution tomorrow and had to choose between stocks and bonds would you go for one in particular? 

My thought would be that since the bond index is currently sitting at 52-week lows and the stock index is sitting at 52 week highs, it would seem to make sense to buy bonds at value pricing.  Then again if bonds will keep going down for a while and stocks will keep going up maybe I should be buying stocks.  Or finally, maybe this proves that I should just keep 80/20'ing it and not ever do anything differently.  I suspect that would be the answer but just wanted to see if any of you suggest varying purchases based on current conditions.

Your current investment plan is to be 80/20 stocks/bonds with your liquid assets.  So you set up your contributions to be 80/20.  What you are suggesting instead is a version of market timing.  I wouldn't recommend you do anything different then your investment plan.

One thing you can do, if your see your portfolio tilt, due to market conditions, toward 75/25, then switch your contributions more toward stocks to get things back to 80/20.

Hope this helps.