Portfolio Charts - The Golden Butterfly

[Interest Compound]

It's not:

"The 3-fund portfolio performed well in the past, therefore I expect it to perform well in the future."

Which is what you're basing the entirety of your analysis on.

Sorry for the misunderstanding, but that is not what I'm basing my analysis on. I'm basing it on lower volatility, which reduces sequence of return risks in accumulation phase and in retirement.

Yes. Performance doesn't just have to mean returns. For you it means risk-adjusted returns.

[josstache]

Walmart is also somewhat uncorrelated from the US market.  What happens if we substitute it for gold? I give you the People of Walmart Portfolio:



How bout them risk-adjusted returns? 

Can we expect this portfolio have risk-adjusted returns that are superior to the golden butterfly?  Why or why not?

Disclaimers: Only goes back to 1988. Also, I had to modify the golden butterfly (40% large cap blend instead of 20 and 20 small cap value, money market instead of short term treasury) because portfolio visualizer doesn't have data going back very far for most asset classes.

[AdrianC]

That's why the majority of people on this forum, and the majority of people over at Bogleheads, are in the 3-fund portfolio. You ignore the noise, and accept market returns.

Of course Bernstein, Ferri, and Buffett all discuss their own alternative portfolios as well and have written books on the matter.  While all of them agree that the three-fund portfolio is an excellent option (as do I), I don't believe any of them uses the three-fund portfolio themselves. 

Malkiel recently said that the 60/40 portfolio he pioneered is "downright dangerous" and is now suggesting REITs, dividend growth stocks, and emerging market bonds.  His direct quote -- "Investors who let go of oversimplification and embrace a slightly more complex but still low-cost portfolio will be better prepared to meet changes in their lives and the economy."

Buffett wouldn't agree that the three-fund portfolio is an excellent option going forward.

Buffett:
“You shouldn’t be 40% in bonds…I would have productive assets. I would favor those enormously over fixed dollar investments now, and I think it’s silly to have some ratio like 30 or 40 or 50% in bonds. They’re terrible investments now…” Warren Buffett on CNBC May 2013

"If I had an easy way, and a non-risk way, of shorting a whole lot of 20- or 30-year bonds, I'd do it," he said. "But that's not my game, and it can't be done in the kind of quantity that would make sense for us," he said. "But I think that bonds are very overvalued. I'll put it that way." Warren Buffett on CNBC May 2015

And from your linked article, here's Malkiel:
"The investor in bonds is, I think, very likely to get badly hurt by sticking with the 60/40."

[Interest Compound]

That's why the majority of people on this forum, and the majority of people over at Bogleheads, are in the 3-fund portfolio. You ignore the noise, and accept market returns.

Of course Bernstein, Ferri, and Buffett all discuss their own alternative portfolios as well and have written books on the matter.  While all of them agree that the three-fund portfolio is an excellent option (as do I), I don't believe any of them uses the three-fund portfolio themselves. 

Malkiel recently said that the 60/40 portfolio he pioneered is "downright dangerous" and is now suggesting REITs, dividend growth stocks, and emerging market bonds.  His direct quote -- "Investors who let go of oversimplification and embrace a slightly more complex but still low-cost portfolio will be better prepared to meet changes in their lives and the economy."

Buffett wouldn't agree that the three-fund portfolio is an excellent option going forward.

Buffett:
“You shouldn’t be 40% in bonds…I would have productive assets. I would favor those enormously over fixed dollar investments now, and I think it’s silly to have some ratio like 30 or 40 or 50% in bonds. They’re terrible investments now…” Warren Buffett on CNBC May 2013

"If I had an easy way, and a non-risk way, of shorting a whole lot of 20- or 30-year bonds, I'd do it," he said. "But that's not my game, and it can't be done in the kind of quantity that would make sense for us," he said. "But I think that bonds are very overvalued. I'll put it that way." Warren Buffett on CNBC May 2015

And from your linked article, here's Malkiel:
"The investor in bonds is, I think, very likely to get badly hurt by sticking with the 60/40."

Nothing in your post contradicts the 3 fund portfolio.

[Radagast]

That's why the majority of people on this forum, and the majority of people over at Bogleheads, are in the 3-fund portfolio. You ignore the noise, and accept market returns.

Of course Bernstein, Ferri, and Buffett all discuss their own alternative portfolios as well and have written books on the matter.  While all of them agree that the three-fund portfolio is an excellent option (as do I), I don't believe any of them uses the three-fund portfolio themselves. 

Malkiel recently said that the 60/40 portfolio he pioneered is "downright dangerous" and is now suggesting REITs, dividend growth stocks, and emerging market bonds.  His direct quote -- "Investors who let go of oversimplification and embrace a slightly more complex but still low-cost portfolio will be better prepared to meet changes in their lives and the economy."

Buffett wouldn't agree that the three-fund portfolio is an excellent option going forward.

Buffett:
“You shouldn’t be 40% in bonds…I would have productive assets. I would favor those enormously over fixed dollar investments now, and I think it’s silly to have some ratio like 30 or 40 or 50% in bonds. They’re terrible investments now…” Warren Buffett on CNBC May 2013

"If I had an easy way, and a non-risk way, of shorting a whole lot of 20- or 30-year bonds, I'd do it," he said. "But that's not my game, and it can't be done in the kind of quantity that would make sense for us," he said. "But I think that bonds are very overvalued. I'll put it that way." Warren Buffett on CNBC May 2015

And from your linked article, here's Malkiel:
"The investor in bonds is, I think, very likely to get badly hurt by sticking with the 60/40."

Nothing in your post contradicts the 3 fund portfolio.

Nothing you've posted in this thread contradicts Tyler's portfolio.

[steveo]

Nothing you've posted in this thread contradicts Tyler's portfolio.

The thing is that there is no right portfolio.

Option 1 - a PP or GB portfolio
Advantages

• fairly good asset diversification across different asset classes - basically stocks/bonds (include cash and treasuries in this) and commodities
• due to the diversification across asset classes it should have a propensity to have lower drawdowns

Disadvantages

• there is a chance that these portfolios work based on historical anomalies and hence people using these portfolios don't understand that there is a difference between historical performance and future performance - I personally think most people don't get this
• the concentration via various tilts (large cap/value within stocks) / treasuries rather than bonds / gold rather than commodities) may lead to some unforeseen performance returns - worst case for instance commodities perform well against stocks but gold gets trashed. Basically the portfolio may be a statistical anomaly.
• the potential long term returns may be less than a stock heavy asset allocation as stocks should be expected to outperform commodities over the long term

Option 2 - a 3 fund portfolio
Advantages

• broad diversification within asset classes - you won't pick a winner but at the same time you won't pick a loser
• there is the ability to tweak this portfolio easily based on your assessment of your ability to accept drawdowns and potentially increase long term returns (this is basically related to how much you allocate to stocks)

Disadvantages

• no exposure to commodities - this may be an advantage if commodities underperform stocks & bonds

I said this earlier but I'll repeat it. Personally I much prefer a 3 fund portfolio in my situation or any situation where you are looking to retire for a longer time period or on a higher WR. If you have a lower WR I think a portfolio like the PP or GB would work but I would make it broader within each asset class. So a broad stock index, a broad commodity index, a broad bond index (I would include cash in this) and a broad REIT (however if you own your own house I wouldn't get too concerned with this). If you choose the broad indexes you wouldn't get caught out if gold for instance never performs as it has in the past or underperforms commodities when commodities rally.

[Interest Compound]

Nothing you've posted in this thread contradicts Tyler's portfolio.

I see there's some confusion, so I'll explain. AdrianC's post contains quotes bashing high allocations to bonds. With "high" meaning anything over 30%. The 3 fund portfolio does not have a fixed allocation to bonds. The Golden Butterfly, however, does. It contains 40% bonds. Plus an additional 20% in "unproductive assets" (gold). So you see, AdrianC's post directly applies to The Golden Butterfly, but not the 3 fund portfolio.

[AdrianC]

Nothing you've posted in this thread contradicts Tyler's portfolio.

I see there's some confusion, so I'll explain. AdrianC's post contains quotes bashing high allocations to bonds. With "high" meaning anything over 30%. The 3 fund portfolio does not have a fixed allocation to bonds. The Golden Butterfly, however, does. It contains 40% bonds. Plus an additional 20% in "unproductive assets" (gold). So you see, AdrianC's post directly applies to The Golden Butterfly, but not the 3 fund portfolio.

What's the typical bond allocation in the three fund portfolio? I'm guessing it's in the 30% range.

"I think it’s silly to have some ratio like 30 or 40 or 50% in bonds. They’re terrible investments now…”

What is your allocation, if you don't mind sharing?

More Buffett:
http://fortune.com/2012/02/09/warren-buffett-why-stocks-beat-gold-and-bonds/

"Right now bonds should come with a warning label."

[AdrianC]

The believer in the PP or GB might say: "Yes, the average returns of the individual assets is relatively low, but we get to sell high and buy low through rebalancing between these non-correlated assets, and we make up for the low returns". Something like that.

Does it work?

I looked at the last 30 years for the PP and GB. Rebalancing all those non-correlated assets annually produced an extra 0.7% per year before taxes. Nice and well worth doing, but not earth shattering. Over some long periods rebalancing produced worse overall returns. And we have no idea if it will work during an investors' holding period.

Rebalancing is important, but it's not primarily to sell high and buy low. We rebalance to maintain the portfolio risk profile.

[Interest Compound]

Nothing you've posted in this thread contradicts Tyler's portfolio.

I see there's some confusion, so I'll explain. AdrianC's post contains quotes bashing high allocations to bonds. With "high" meaning anything over 30%. The 3 fund portfolio does not have a fixed allocation to bonds. The Golden Butterfly, however, does. It contains 40% bonds. Plus an additional 20% in "unproductive assets" (gold). So you see, AdrianC's post directly applies to The Golden Butterfly, but not the 3 fund portfolio.

What's the typical bond allocation in the three fund portfolio? I'm guessing it's in the 30% range.

"I think it’s silly to have some ratio like 30 or 40 or 50% in bonds. They’re terrible investments now…”

What is your allocation, if you don't mind sharing?

More Buffett:
http://fortune.com/2012/02/09/warren-buffett-why-stocks-beat-gold-and-bonds/

"Right now bonds should come with a warning label."

The typical bold allocation in the 3 fund portfolio changes with age:



I'm 100% stocks, global cap-weighted. Explanation here:

Revisiting the asset allocation question - The case for 100% stocks

[Tyler]

The typical bold allocation in the 3 fund portfolio changes with age:

To be clear, the chart is from a Bogleheads survey that does not specify what portfolio the person uses.  It only displays the percentage of stocks of any type, and not every dot is a three-fund portfolio. For all we know a few on the 40% line are Golden Butterflies.  ;)

https://www.bogleheads.org/forum/viewtopic.php?t=180480
Data from here: https://www.bogleheads.org/forum/viewtopic.php?t=154364

Interesting chart, though -- thanks for sharing.  I always find it fascinating how different people decide to invest.  Out of 1146 responses, the average percentage of stocks was 67%.  7% held nothing but stocks.  About one-in-four had 50% stocks or less.  Boglehead-style investing is a lot more diverse than many people realize. 

[Radagast]

The typical bold allocation in the 3 fund portfolio changes with age:

https://www.bogleheads.org/forum/viewtopic.php?t=180480
Data from here: https://www.bogleheads.org/forum/viewtopic.php?t=154364

Interesting chart, though -- thanks for sharing.  I always find it fascinating how different people decide to invest.  Out of 1146 responses, the average percentage of stocks was 67%.  I personally find the trend line a lot less interesting then the true scatter.  Boglehead-style investing is a lot more diverse than many people realize.

Does this mean your next calculator will do glide paths ;)?

[Tyler]

Does this mean your next calculator will do glide paths ;)?

:)

I've looked at that, but I guess I'm struggling with what a helpful glide path calculator might look like.  Send me a PM with a proposal of what inputs and outputs you'd find most helpful, and I'll be happy to give it a try!

[Interest Compound]

The typical bold allocation in the 3 fund portfolio changes with age:

To be clear, the chart is from a Bogleheads survey that does not specify what portfolio the person uses.  It only displays the percentage of stocks of any type, and not every dot is a three-fund portfolio. For all we know a few on the 40% line are Golden Butterflies.  ;)

https://www.bogleheads.org/forum/viewtopic.php?t=180480
Data from here: https://www.bogleheads.org/forum/viewtopic.php?t=154364

Interesting chart, though -- thanks for sharing.  I always find it fascinating how different people decide to invest.  Out of 1146 responses, the average percentage of stocks was 67%.  7% held nothing but stocks.  About one-in-four had 50% stocks or less.  Boglehead-style investing is a lot more diverse than many people realize.

You're right, I should've mentioned that. I assume the 3 fund portfolio Boglehead investors follow the same trend, but it's just that. An assumption.

[Radagast]

Nothing you've posted in this thread contradicts Tyler's portfolio.

I see there's some confusion, so I'll explain. AdrianC's post contains quotes bashing high allocations to bonds. With "high" meaning anything over 30%. The 3 fund portfolio does not have a fixed allocation to bonds. The Golden Butterfly, however, does. It contains 40% bonds. Plus an additional 20% in "unproductive assets" (gold). So you see, AdrianC's post directly applies to The Golden Butterfly, but not the 3 fund portfolio.

There is no reason Tyler's selected assets need to be equally weighted. They could just as easily be 35/35/10/10/10 to get 70% stock, or anything in between or more extreme. AdrianC's "bashing" of a particular asset or portfolio is as likely to be accurate as yours.

[Radagast]

Does this mean your next calculator will do glide paths ;)?

:)

I've looked at that, but I guess I'm struggling with what helpful glide path calculator might look like.  Send me a PM with a proposal of what inputs and outputs you'd find most helpful, and I'll be happy to give it a try!

I have not been thinking about investing recently, but I'll have a look at the charts you thought of so far. Maybe I can find one that can be easily changed to work with glide paths.

[Interest Compound]

Nothing you've posted in this thread contradicts Tyler's portfolio.

I see there's some confusion, so I'll explain. AdrianC's post contains quotes bashing high allocations to bonds. With "high" meaning anything over 30%. The 3 fund portfolio does not have a fixed allocation to bonds. The Golden Butterfly, however, does. It contains 40% bonds. Plus an additional 20% in "unproductive assets" (gold). So you see, AdrianC's post directly applies to The Golden Butterfly, but not the 3 fund portfolio.

There is no reason Tyler's selected assets need to be equally weighted. They could just as easily be 35/35/10/10/10 to get 70% stock, or anything in between or more extreme. AdrianC's "bashing" of a particular asset or portfolio is as likely to be accurate as yours.

Sorry, changing the asset allocation of The Golden Butterfly changes it's intended goal. While the 3 fund portfolio is intended to be flexible. This is not a valid comparison.

[Radagast]

Nothing you've posted in this thread contradicts Tyler's portfolio.

I see there's some confusion, so I'll explain. AdrianC's post contains quotes bashing high allocations to bonds. With "high" meaning anything over 30%. The 3 fund portfolio does not have a fixed allocation to bonds. The Golden Butterfly, however, does. It contains 40% bonds. Plus an additional 20% in "unproductive assets" (gold). So you see, AdrianC's post directly applies to The Golden Butterfly, but not the 3 fund portfolio.

There is no reason Tyler's selected assets need to be equally weighted. They could just as easily be 35/35/10/10/10 to get 70% stock, or anything in between or more extreme. AdrianC's "bashing" of a particular asset or portfolio is as likely to be accurate as yours.

Sorry, changing the asset allocation of The Golden Butterfly changes it's intended goal. While the 3 fund portfolio is intended to be flexible. This is not a valid comparison.

I tried to reduce quotes in quotes but it is too hard on a phone.

What is the goal of TGB and what is the new goal if it is weighted more towards stocks? Is an investor not allowed to adjust risk and reward to taste with any portfolio other than the 3 fund portfolio? It seems like false and unnecessary dogma. Especially when you consider TGB already did exactly that to the permanent portfolio dogma.

[steveo]

Nothing you've posted in this thread contradicts Tyler's portfolio.

I see there's some confusion, so I'll explain. AdrianC's post contains quotes bashing high allocations to bonds. With "high" meaning anything over 30%. The 3 fund portfolio does not have a fixed allocation to bonds. The Golden Butterfly, however, does. It contains 40% bonds. Plus an additional 20% in "unproductive assets" (gold). So you see, AdrianC's post directly applies to The Golden Butterfly, but not the 3 fund portfolio.

There is no reason Tyler's selected assets need to be equally weighted. They could just as easily be 35/35/10/10/10 to get 70% stock, or anything in between or more extreme. AdrianC's "bashing" of a particular asset or portfolio is as likely to be accurate as yours.

What is the goal of TGB and what is the new goal if it is weighted more towards stocks? Is an investor not allowed to adjust risk and reward to taste with any portfolio other than the 3 fund portfolio? It seems like false and unnecessary dogma. Especially when you consider TGB already did exactly that to the permanent portfolio dogma.

Those portfolio's though have that set allocation. The key point is that is what made them successful utilising historical data.

Once you change the allocation's between different asset classes the performance (volatility and returns) will change. A 3 fund portfolio is more likely to be aligned to your risk profile or maybe better put your propensity to emotionally handle drawdowns. The 3 fund portfolio isn't trying to get the best return (again risk compared to volatility). The 3 fund portfolio is more like stating all you need is these 3 funds. Assess your risk profile and invest accordingly.

The flexibility of the 3 fund portfolio is why I think it's more likely to provide the best average return over time. Other portfolios will beat it. The point is we don't know what those portfolio's will be in the future.

[Interest Compound]

What is the goal of TGB and what is the new goal if it is weighted more towards stocks?

Your posts show a lack of understanding. Both of The Golden Butterfly, and The 3 fund portfolio. I recommend doing some more reading. I suspect you'll soon find your answers.

[Radagast]

Those portfolio's though have that set allocation. The key point is that is what made them successful utilising historical data.

Lol. Can't argue with that.

However it could be adjusted to individual desire for risk as easily as any other portfolio.

[arebelspy]

At what point is it no longer GB though?  What if I did 96%/1%/1%/1%/1%?

[arebelspy]

The believer in the PP or GB might say: "Yes, the average returns of the individual assets is relatively low, but we get to sell high and buy low through rebalancing between these non-correlated assets, and we make up for the low returns". Something like that.

Does it work?

I looked at the last 30 years for the PP and GB. Rebalancing all those non-correlated assets annually produced an extra 0.7% per year before taxes. Nice and well worth doing, but not earth shattering. Over some long periods rebalancing produced worse overall returns. And we have no idea if it will work during an investors' holding period.

Rebalancing is important, but it's not primarily to sell high and buy low. We rebalance to maintain the portfolio risk profile.

This is interesting. Because that IS the key argument of the PP (and GB, by extension).

Take non-correlated assets that each do well in different environments, and then real ancestors between them, and you'll do well in all environments!

If the last few decades of good returns from PP/GB aren't from that rebalancing though, but from their assets just doing well, that's more problematic to the story.

[Interest Compound]

The believer in the PP or GB might say: "Yes, the average returns of the individual assets is relatively low, but we get to sell high and buy low through rebalancing between these non-correlated assets, and we make up for the low returns". Something like that.

Does it work?

I looked at the last 30 years for the PP and GB. Rebalancing all those non-correlated assets annually produced an extra 0.7% per year before taxes. Nice and well worth doing, but not earth shattering. Over some long periods rebalancing produced worse overall returns. And we have no idea if it will work during an investors' holding period.

Rebalancing is important, but it's not primarily to sell high and buy low. We rebalance to maintain the portfolio risk profile.

This is interesting. Because that IS the key argument of the PP (and GB, by extension).

Take non-correlated assets that each do well in different environments, and then real ancestors between them, and you'll do well in all environments!

If the last few decades of good returns from PP/GB aren't from that rebalancing though, but from their assets just doing well, that's more problematic to the story.

The Golden Butterfly (1972 - 2015) rebalanced annually:



Never rebalanced:

[arebelspy]

So rebalancing lowered the returns, but also the volatility (and worst return, etc.).  Not surprising, based on the PP results.

But it again indicates, to me, that the high return was due to the assets themselves performing well.  The rebalancing just lowered the volatility.

If you had assets that performed poorly, it would likewise perform poorly, just with lower volatility.

So you're banking on those assets performing well in the future.  And the story of "one will perform well in all environments and we'll capture that via rebalancing" seems less true when not rebalancing performs even better, CAGR-wise.

So if it is the case that those assets happened to do well over the last 30-40 years, and were found partially with data-mining, it seems less likely they will outperform in the future.

[Radagast]

What is the goal of TGB and what is the new goal if it is weighted more towards stocks?

Your posts show a lack of understanding. Both of The Golden Butterfly, and The 3 fund portfolio. I recommend doing some more reading. I suspect you'll soon find your answers.

I have done more than enough reading on these topics. I'd like to hear an argument about why the three fund portfolio can be flexible but TGB cannot be. It might not strictly fit Tyler's named allocation, but it could be modified to an individual tolerance for risk vs return.

[steveo]

Those portfolio's though have that set allocation. The key point is that is what made them successful utilising historical data.

Lol. Can't argue with that.

However it could be adjusted to individual desire for risk as easily as any other portfolio.

Then though it's not those portfolios and you won't get that warm fuzzy feeling from stating it did well in the past. In stating that I reckon if people were doing that and using principles to guide their investment decisions they would have a more robust portfolio with a greater chance of doing well in the future.

In data mining/statistical analysis my understanding is that typically you get a data-set. You then split that data-set and come up with models on one sub-set of the data. You then test those models against the other data-set. The reason you do that is because you have a tendency to over-fit the model. I reckon that is exactly what people that use these portfolios are doing. They don't really understand what the analysis shows them.

So if they said something like these portfolios show that uncorrelated assets across multiple asset classes should provide greater diversification and therefore robustness across different economic conditions and then built a portfolio on that basis then I wouldn't feel that they were getting themselves into potential problems.

[steveo]

Take non-correlated assets that each do well in different environments, and then real ancestors between them, and you'll do well in all environments!

This is a good argument though. It makes sense.

If the last few decades of good returns from PP/GB aren't from that rebalancing though, but from their assets just doing well, that's more problematic to the story.

Exactly. The problem is though you don't know what assets are going to do well in the future. What if it's coffee or sugar. What if it's not treasuries but long term municipal bonds. What if it's growth stocks.

I think the key is stating - I don't have a clue what is going to do well but if I buy a broad index I will get average returns. If I minimise my fees I should beat the average investor who gets charged above average fees and probably will underperform and overperform the market over time but the overperformance typically won't compensate for the underperformance plus additional fees.

Then you can have a discussion about the asset classes - i.e. commodities, bonds, stocks and real estate and figure out what works for you.

[steveo]

So rebalancing lowered the returns, but also the volatility (and worst return, etc.).  Not surprising, based on the PP results.

But it again indicates, to me, that the high return was due to the assets themselves performing well.  The rebalancing just lowered the volatility.

If you had assets that performed poorly, it would likewise perform poorly, just with lower volatility.

So you're banking on those assets performing well in the future.  And the story of "one will perform well in all environments and we'll capture that via rebalancing" seems less true when not rebalancing performs even better, CAGR-wise.

So if it is the case that those assets happened to do well over the last 30-40 years, and were found partially with data-mining, it seems less likely they will outperform in the future.

I basically agree with your points but I think it's just as likely those assets outperform again. It's like flipping a coin 10 times and it comes up heads 9 times it's still a 50% chance to be heads the next flip.

We don't know what will outperform over the next 50 years.

[Radagast]

Those portfolio's though have that set allocation. The key point is that is what made them successful utilising historical data.

Lol. Can't argue with that.

However it could be adjusted to individual desire for risk as easily as any other portfolio.

Then though it's not those portfolios and you won't get that warm fuzzy feeling from stating it did well in the past. In stating that I reckon if people were doing that and using principles to guide their investment decisions they would have a more robust portfolio with a greater chance of doing well in the future.

In data mining/statistical analysis my understanding is that typically you get a data-set. You then split that data-set and come up with models on one sub-set of the data. You then test those models against the other data-set. The reason you do that is because you have a tendency to over-fit the model. I reckon that is exactly what people that use these portfolios are doing. They don't really understand what the analysis shows them.

So if they said something like these portfolios show that uncorrelated assets across multiple asset classes should provide greater diversification and therefore robustness across different economic conditions and then built a portfolio on that basis then I wouldn't feel that they were getting themselves into potential problems.

I can't tell whether you are arguing that Tyler's portfolio is an anomaly of backtesting, or whether you are arguing that it is based on a reasonable theory and thus is likely to be reasonably succesful in the future, or both. I could probably agree with both.

[Tyler]

It sounds like we're coming back around to a common theme of being worried about "outperforming" based on looking at only one timeframe.  I understand the temptation to simplify numbers in your head, but single CAGRs don't tell the whole story.  For reference, here's the Heat Map that shows every timeframe:



For comparison, here's the Three-Fund portfolio:



Which one has historically been more consistent?

Now one may genuinely believe that the future may be very different, and your opinion on that is as good as mine.  One may also not understand how or why a portfolio worked so well and fear that it is just a fluke.  I'd argue that it's easy to get lucky over a single timeframe but it's exceedingly difficult to stay lucky over the 990 timeframes, and that's reasonable evidence that the Golden Butterfly has hit on something pretty interesting whether it makes immediate sense to you or not.  But I recognize that others may not find that convincing.  To each his own.

One is free to prefer another portfolio if they choose.  But it's important to recognize that any alternatives are no more certain to repeat the past. It's also important to understand that some portfolios do fundamentally have better risk-adjusted returns than others.  That's the core concept of asset allocation, and it's about much more than just luck.

[arebelspy]

So rebalancing lowered the returns, but also the volatility (and worst return, etc.).  Not surprising, based on the PP results.

But it again indicates, to me, that the high return was due to the assets themselves performing well.  The rebalancing just lowered the volatility.

If you had assets that performed poorly, it would likewise perform poorly, just with lower volatility.

So you're banking on those assets performing well in the future.  And the story of "one will perform well in all environments and we'll capture that via rebalancing" seems less true when not rebalancing performs even better, CAGR-wise.

So if it is the case that those assets happened to do well over the last 30-40 years, and were found partially with data-mining, it seems less likely they will outperform in the future.

I basically agree with your points but I think it's just as likely those assets outperform again. It's like flipping a coin 10 times and it comes up heads 9 times it's still a 50% chance to be heads the next flip.

We don't know what will outperform over the next 50 years.

No, it's like rolling a 20 sided dice and getting a 15 and thinking you're equally likely to get 15 next time.

Only the number of different asset classes is a lot higher than 20.

What makes you think those assets are 50/50 to outperform?  If I took 100 assets, and each had a 20% chance to outperform, and I then took the 20 that did, and looked at which of those outperformed the next year, I'd be left with 4 assets.

But to then say "each of these has a 50/50 chance to outperform next year" is wrong. They only had a 20% chance to begin with, and that didn't change just because they were left due to survivorship bias.  The underlying odds is what's important, and those odds aren't improved because they did well in the past.

Unless you have reason to believe they will outperform, them doing so in the past is not necessarily indicative of the future, or of them even being a coin flip to do so.

[Radagast]

I just looked and noted that US stocks, gold, and long term treasuries have had negative or low correlations for the past two years in addition to typical volatility. I first became aware of the PP two years ago, so 2014 me feels this data supports the underlying theory, though 2016 me still claims to be unable to predict the future.

[arebelspy]

It sounds like we're coming back around to a common theme of being worried about "outperforming" based on looking at only one timeframe.

I don't think it's that simple.  In fact, the latest criticism has nothing to do with timeframes at all.

It's more about looking at outperforming based on the fact that the rebalancing story didn't actually cause the good returns, but rather the low volatility.

I would expect the GB to have low volatility in the future, but not necessarily high return.  This is because the high return came from the assets themselves outperforming, rather than from the rebalancing. 

If the assets have low returns in the future, the GB will have low returns (with a low volatility).

The GB (and PP) idea of rebalancing between assets so no matter what environment you're in only works if you're rebalancing between assets that have high returns.

And how do you know those particular assets will have high returns in the future?

If it was merely a "they don't need to, cause rebalancing" that would be neat. But it's not, the GB relies on the assets having a high return (and the rebalancing causes low volatility).

But to go to the timeframe stuff, since you brought it up:

For reference, here's the Heat Map that shows every timeframe

That's just one set of correlated timeframes.  Not 900 independent timeframes.

But it's important to recognize that any alternatives are no more certain to repeat the past.

Indeed. So why do you think the GB will?

It's also important to understand that some portfolios do fundamentally have better risk-adjusted returns than others. 

They do, but can we predict which ones will, in the future?

[Tyler]

I would expect the GB to have low volatility in the future, but not necessarily high return.  This is because the high return came from the assets themselves outperforming, rather than from the rebalancing. 

If the assets have low returns in the future, the GB will have low returns (with a low volatility).

The GB (and PP) idea of rebalancing between assets so no matter what environment you're in only works if you're rebalancing between assets that have high returns.

This may help visualize the assets.  Compare the red zones in each asset to the consistency of the total portfolio.




To believe that the Golden Butterfly had high returns simply because its more unusual assets like short term treasuries and gold did particularly well misses the fact that they drastically underperformed stocks over a big part of this period by design.  (I'll concede that SCV outperformed traditional stocks, and Fama-French have done tons of research on that if you're interested). 

A rebalanced portfolio is more than just the sum of its assets.  Gold, long term treasuries, and short term treasuries work so well in the GB not because they're great investments on their own (they're obviously not) but because they complement stocks so well, picking up the slack and carrying the portfolio specifically when the stock market inevitably struggles.  It's not simple random correlations that may disappear.  The assets are picked based on economic conditions and flow with the markets. 

The "C" in CAGR stands for "compound", which benefits tremendously from that lower total volatility.  So it's more than just averaging the long-term averages and adding an extra rebalancing bonus.  Portfolio theory is a lot more sophisticated than that, and I admit it's highly unintuitive.  I find that fascinating and empowering, but it makes other people very uncomfortable.  Not that there's anything wrong with that reaction -- it's just human nature.

To answer your last question, the Golden Butterfly has generated very consistent risk-adjusted returns no matter what period you look at using as much data as we have access to -- 44 years spanning all kinds of economic environments that have made most other portfolios look very bad at times.  I have no idea if it will continue to do that in the future, but I'm personally more confident in its outlook-neutral approach and highly consistent track record than I am with alternative options. 

Most importantly, I'm not trying to champion this portfolio over all others.  Lacking a crystal ball, every investing decision ultimately requires a personal leap of faith.  We all have to make that choice for ourselves and be comfortable with it.

[steveo]

I can't tell whether you are arguing that Tyler's portfolio is an anomaly of backtesting, or whether you are arguing that it is based on a reasonable theory and thus is likely to be reasonably succesful in the future, or both. I could probably agree with both.

I think the portfolio may be an anomaly of backtesting but if people looked at why it was successful they might get some insights to help them build a portfolio that works for them.

It might just have been successful because the underlying assets performed better than expected. It might be that uncorrelated assets do create a more stable portfolio - i.e. lower volatility. At the same time I think having 60% allocated to gold and treasuries is really risky over the long term.

[steveo]

I'll just state that this is a really interesting discussion and what is interesting is that I can see and agree with the different points of view.

If it was merely a "they don't need to, cause rebalancing" that would be neat. But it's not, the GB relies on the assets having a high return (and the rebalancing causes low volatility).

I agree. The thing is though that commodities do tend to have massive upticks. Stocks definitely do. Bonds/Cash/Treasuries tend to be much more stable. Commodities including gold also tend to have returns that are uncorrelated to stocks.

A rebalanced portfolio is more than just the sum of its assets.  Gold, long term treasuries, and short term treasuries work so well in the GB not because they're great investments on their own (they're obviously not) but because they complement stocks so well, picking up the slack and carrying the portfolio specifically when the stock market inevitably struggles.  It's not simple random correlations that may disappear.  The assets are picked based on economic conditions and flow with the markets. 

The "C" in CAGR stands for "compound", which benefits tremendously from that lower total volatility.  So it's more than just averaging the long-term averages and adding an extra rebalancing bonus.  Portfolio theory is a lot more sophisticated than that, and I admit it's highly unintuitive.

I also agree with these points.

I come back though to not liking choosing specific commodities and specific stocks and specific bond/cash assets. I also think over a longer time frame you may better off with more stocks in your portfolio however this is more of a risk profile type question. Personally I think over the longer term especially with people that FIRE you may be taking on more risk in that your portfolio has a greater chance of failing if you have too many defensive assets. When you add to that the concern about using tilts that have previously outperformed but may not outperform in the future I think it's risky.

I wonder if a broad portfolio with something like 30% domestic stocks, 30% international stocks, 20% commodities & 20% bonds would be more likely to achieve the results that those that utilise the GB and the PP are trying to achieve. You could adjust your stock allocation down or up as required.

[Tyler]

I come back though to not liking choosing specific commodities and specific stocks and specific bond/cash assets. I also think over a longer time frame you may better off with more stocks in your portfolio however this is more of a risk profile type question. Personally I think over the longer term especially with people that FIRE you may be taking on more risk in that your portfolio has a greater chance of failing if you have too many defensive assets. When you add to that the concern about using tilts that have previously outperformed but may not outperform in the future I think it's risky.

I wonder if a broad portfolio with something like 30% domestic stocks, 30% international stocks, 20% commodities & 20% bonds would be more likely to achieve the results that those that utilise the GB and the PP are trying to achieve. You could adjust your stock allocation down or up as required.

Good point.  The Golden Butterfly idea is actually not unique, and the Ivy and Swensen portfolios operate on similar principles.  For those who like the idea of the Golden Butterfly but don't care for the individual assets or simply want a different perspective other than mine, check them out.  You can also read the books for way more information on the subject than I can do justice. 

[steveo]

I come back though to not liking choosing specific commodities and specific stocks and specific bond/cash assets. I also think over a longer time frame you may better off with more stocks in your portfolio however this is more of a risk profile type question. Personally I think over the longer term especially with people that FIRE you may be taking on more risk in that your portfolio has a greater chance of failing if you have too many defensive assets. When you add to that the concern about using tilts that have previously outperformed but may not outperform in the future I think it's risky.

I wonder if a broad portfolio with something like 30% domestic stocks, 30% international stocks, 20% commodities & 20% bonds would be more likely to achieve the results that those that utilise the GB and the PP are trying to achieve. You could adjust your stock allocation down or up as required.

Good point.  The Golden Butterfly idea is actually not unique, and the Ivy and Swensen portfolios operate on similar principles.  For those who like the idea of the Golden Butterfly but don't care for the individual assets or simply want a different perspective other than mine, check them out.  You can also read the books for way more information on the subject than I can do justice.

The thing with asset allocation is that there isn't really a right or wrong answer however one of the theories is that diversification across asset classes is basically a free ride. At the same time I can see the advantage of a 100% stock allocation.

[BattlaP]

One point I've not seen adequately responded to is the question raised about gold being used a deflation hedge. Isn't that like a data non-sequitur, in that the two things have nothing to do with each other?

Doesn't this graph show gold as just going on random walks that have nothing to do with inflation at the time? It seems like the actual reason for choosing gold in the portfolio is "because it makes the graph look like this!"

[steveo]

BattlaP - it's a good question to ask. When does gold actually perform well ? I'm honestly not sure.

[josstache]

Gold is one asset (woah lack of diversification if it's 20% of your portfolio), and its price is subject to extreme speculation-driven swings.

If you bought gold around 1980-1981, you are still significantly in the red in real terms after fees or storage costs. By way of contrast, if you bought US stocks just before Black Tuesday in 1929, you made it back into positive territory in real terms during 1944.

I think most people agree that gold's intrinsic value hasn't changed, and foreseeably won't change, much.  Indeed, that's why it's called a "store of value", "inflation hedge", etc.  If that's the case, then what does it tell us when its market value is nearer to historic highs than to the long-term average, as it is now?  Perhaps we're in another speculative bubble?

http://graphics.thomsonreuters.com/11/07/CMD_GLDNFLT0711_VF.html

Stocks, we can feel comfortable buying even if it's possible they're currently overvalued because, as long as we hold onto them and society continues to function, we should eventually get a positive real return.  People (and their descendants) who bought gold around 1980-1981 might never see a positive real return for the remainder of human history, though I'd be glad to hear arguments to the contrary.

[arebelspy]

I'll just state that this is a really interesting discussion and what is interesting is that I can see and agree with the different points of view.

Me too.  I keep going back and forth.  :)

[BattlaP]

I think most people agree that gold's intrinsic value hasn't changed, and foreseeably won't change, much.

What does that actually mean? Who agrees? What value are they agreeing on?

Indeed, that's why it's called a "store of value", "inflation hedge", etc.

I get that it is called that, sure. But doesn't the data absolutely fly in the face of that? I don't believe them. Gold's price seems to wildly swing based on nothing except human emotion.

[josstache]

The price of stocks swing wildly based mostly on human emotion, but over very long periods of time we should see total real return be positive. 

I was suggesting gold's long term trend line should be flat.  The existence of speculative bubbles doesn't really say anything one way or the other about what the long-term trend line looks like.  Nor do people need to agree on a specific value for gold in order to agree with the proposition that its trend line is flat.  After fees, then, it would not be possible for gold to give you a positive return other than changes in value due to speculation.

Rebalancing complicates things, because in the PP or GB, you rebalance into gold after a catastrophic crash, and that gold allocation eventually rises in value.  I think the fundamental flaw in understanding these portfolios is due to the short sample.  Is there any reason we should expect gold's speculative bubbles to be timed and shaped such that they smooth out the portfolio's returns?  They did in recent history, but that doesn't mean they will continue to do so.

And, as I pointed out earlier in the thread, you have political risk with gold that governments will decide to directly mess with its value.

[BattlaP]

Ok, a flat trend-line. That makes a lot more sense.

However wouldn't this be true of other commodities that retain their usefulness over long timespans? I'm thinking other metals, fuels, wood, grains, livestock, etc. Why just gold and not a mix of these things? Seems like golds complicated history as and with currency, and also political complications as you suggest, would actually make it less appropriate as a logical choice for a large chunk of a portfolio.

[steveo]

Indeed, that's why it's called a "store of value", "inflation hedge", etc.

I get that it is called that, sure. But doesn't the data absolutely fly in the face of that? I don't believe them. Gold's price seems to wildly swing based on nothing except human emotion.

This is the issue isn't it. My gut feel is that gold does exactly what you are stating. I'd like to see the data that shows when it spikes and some analysis of why. I don't think it's a good store against inflation. I think stocks will handle that scenario a lot better.

[Seppia]

Objectively speaking I believe there's no other possible idea of gold than Buffett's

It's an inanimate object that does not produce anything and has no use whatsoever (other than maybe some vague aesthetic virtue).
It's not even the rarest of things.

Why would one own gold?

Well, for some reason, it seems to be a "refuge" in panic times, that's the most immediate explanation I would give to the fact that it's value seems to go up when everything else goes down (and vice versa).

If we were certain that this virtue of its would be kept in the future, then it could very well serve a purpose.

Personally, in case of a very dramatic turn of events I would rather own guns, ammo and some farmland.

So here's my projected FIRE portfolio
 
70% stocks
15% AK 47s and ammo
15% peach trees (I love peaches)

Main issue seems to be poor winter time returns.

:)

[steveo]

Ok, a flat trend-line. That makes a lot more sense.

However wouldn't this be true of other commodities that retain their usefulness over long timespans? I'm thinking other metals, fuels, wood, grains, livestock, etc. Why just gold and not a mix of these things? Seems like golds complicated history as and with currency, and also political complications as you suggest, would actually make it less appropriate as a logical choice for a large chunk of a portfolio.

This is my point. It's like buying a single stock and hoping that stock is the one with the best performance for what you require.

[Tyler]

When does gold actually perform well ? I'm honestly not sure.

It's true that "gold is an inflation hedge" is an over-simplification that hides a ton of other factors.  But the common statement that it's "just a piece of metal" depending on another greater fool to buy it at a higher price neglects economic history and how money works.  Honestly it's a complicated macroeconomic topic that I'm not sure I'm capable of doing justice.

You know how people have pointed out that gold really spiked in 1972 after the US changed the law?  Well it wasn't really a law but a treaty.  Bretton Woods was an economic system set up in WWII where all the world superpowers agreed to price their currencies in dollars, and that the US dollar would be backed by a certain amount of physical gold.  The entire system was put together by various central banks to protect individual currencies from relative pricing discrepancies (simply put -- relative currency inflation).  Breaking Bretton Woods and letting the dollar float relative to gold so that the government can print whatever they please started the "fiat money" era, but gold remains highly connected to global monetary policy.  There's a reason the largest holders of gold are still the central banks. 

However, with that change in policy and rapidly increasing globalization, other factors also started to play very important roles in the gold price.  I think I read somewhere that the International Monetary Fund estimates that these days gold is driven about 50% by inflation and 50% by other factors.  I won't even try to explain all of that.  For those interested, this link is very thorough and balanced.  But be warned that the topic is complicated.

So yes, gold responds to inflation because of its special place in the world monetary system.  Critics who note that the gold data relative to US inflation levels doesn't always indicate that are also correct, as there are many other factors that also influence the price.  It's better to think of gold as a complex alternative world currency where inflation is only one piece of the puzzle. IMHO portfolios can still benefit from that. 

Does that all sound way too complicated and make your eyes glaze over?  That's why most people stick to the inflation story when explaining it to others.  ;)  It's the easiest part to understand.

However wouldn't this be true of other commodities that retain their usefulness over long timespans? I'm thinking other metals, fuels, wood, grains, livestock, etc. Why just gold and not a mix of these things?

Good point!

Any cursory Google search will show you that gold is a highly controversial topic, and if it makes you uncomfortable that's fine.  As I mentioned before -- check out the Ivy and Swensen portfolios.  They mirror the way the Harvard and Yale endowments invest.  They still follow a lot of the same basic theory of the Golden Butterfly but use commodities and REITs instead of gold.