Portfolio Charts - The Golden Butterfly

[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. 

[Seppia]

I still like peaches better but thank you Tyler for the awesome post - as usual.
One can agree or disagree but the work you do is truly amazing.

[Radagast]

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.

If you think about logistics you narrow it down to precious metals pretty quickly. How many cows would you need to have $750,000? What is the shelf life of fuel? Even silver needs a room to hold the value of gold that can be stored in a safe deposit box. Specifically right now a liter of gold is worth $750,000, but you need 130 liters of silver to store that much. How many silos of grain?

Correlation throws out other precious metals because the primary uses are industrial, and thus well correlated with the economy, which makes them poor diversifiers. The primary uses of gold are not rational and thus poorly correlated with other investments.

So you arrive at gold through a process of elimination.

[arebelspy]

70% stocks
15% AK 47s and ammo
15% peach trees (I love peaches)

Unless you're very ERE, that's a LOT of peach trees.

Also rebalancing is a *.

:)

[JZinCO]

70% stocks
15% AK 47s and ammo
15% peach trees (I love peaches)

Unless you're very ERE, that's a LOT of peach trees.

Also rebalancing is a *.

:)

But if you're peaches are too high in value you can rebalance with some target practice...

[Interest Compound]

This is why it's so hard to stay the course. There's always a hook. For someone new to investing, as I suspect many people on this forum are, you might not have seen how these stories typically play out:

-------------------------------------
"Investing is risky, you have Inflation, Deflation, Prosperity, and Recession, and you never know which one is coming next. Therefore you should dedicate portions of your portfolio to each of these phases, by buying X, Y, Z, and V."
-------------------------------------

That's a great story. The trouble comes when choosing your X, Y, Z, and V. I've been reading about portfolios like this for years, and they always have one thing in common, they backtest well. Very well. Is this a coincidence? Could it be that only the portfolios which perform very well in backtesting, also have an interesting story behind them? Or is it possible that almost every portfolio has a market-beating story......it just has to beat the market first before you pay any attention to it.

It is easy to fall victim to the Survivorship Bias.  After any process that leaves behind survivors, the non-survivors are often destroyed or muted or removed from your view. If failures becomes invisible, then naturally you will pay more attention to successes. Not only do you fail to recognize that what is missing might have held important information, you fail to recognize that there is missing information at all. Here are some possible options for each phase you may have missed:

Prosperity:

• Total US Stock Market
• Large Cap Value
• Large Cap Growth
• Large Cap Blend
• Mid Cap Value
• Mid Cap Growth
• Mid Cap Blend
• Small Cap Value
• Small Cap Growth
• Small Cap Blend
• Micro Cap
• Total International Stock Market
• Emerging Market
• Pacific Market
• Europe Market
• International Value
• International Small
• S&P 500
• Dividend Appreciation
• High Dividend
• Value Index
• Growth Index
• FTSE Social Index
• Extended Market

Inflation:

• Short Term Tips
• Long Term Tips
• Gold?
• REITS?
• Silver?
• Coal?
• Platinum?
• Diamonds?
• Oil?
• Natural Gas?
• Coffee?
• Sugar?
• Copper?
• Wheat?
• Cotton?

(There are arguments for each one of these.)

Deflation:

• Long Term Bond Index
• Long Term Treasuries
• Long Term Government Bonds
• Long Term Corporate Bonds
• Long Term Municipal Bonds

Recession:

• Money Market
• Short Term Bond index
• Short Term Treasuries
• Short Term Tips
• Ultra Short Term Bonds
• CDs
• Savings accounts

Now for the fun part. No matter which combination of these (including those I didn't mention) ends up winning, there will be an enticing story behind it all, explaining why there must be a fundamental reason behind such success! We finally got an answer to why Gold fits in the "Inflation" bucket, despite the data showing it clearly does not track inflation, and the answer is "it's complicated". We're told that Gold and Small Cap Value aren't necessary components, yet without these components the portfolio under-performs the average.

What if I read some similar articles, and choose this portfolio in 1972, based on the same "fundamentals" here? These are reasonable choices, and from the perspective of the 1972 investor, make perfect sense. Growth has been beating Value for almost a decade, showed no signs of slowing up, and every article you could find was singing the praises of Growth.




Had it gone well, we'd be seeing articles about The Growth Butterfly, not The Golden Butterfly. Instead I'm broke at 70 years old, cursing some article I read over 30 years ago.

The scariest part? This portfolio doesn't look so bad in backtesting:



It's squarely in the box of all the other portfolios with a similar philosophy:



Indeed, these hooks can seem promising, even exciting. But they clearly fall flat here. If you choose such a portfolio, acknowledge that it's based purely on backtesting, as the story simply doesn't check out. And if choosing a portfolio based purely on backtesting doesn't start ringing red alarm bells in your head...you really shouldn't be investing in a portfolio like this at all.

My advice to any newbies in this thread, don’t fall into the trap. You buy the market not because it backtested well during a specific phase, and will make you rich in the process. You buy the Total Stock Market Index, simply because you want to capture the market. You want a percentage ownership of all available companies across the globe. You want your share of the world's collective profits/production. Again, indexing beat or matched half of all invested dollars in the past, I do not expect mathematical laws to change, so I expect it to beat or match half of all invested dollars in the future.

You don’t buy the Total Bond Market Index because it was less volatile in the past, but because bonds are a written contract, where you are paid periodic interest payments, and in the end you get your full investment back. In most cases (70% of VBTLX) the contract is guaranteed by the government. This makes it a relatively safe place to put your money.

These aren't stories based on how it performed in the past. You won't get confused about why these options are included in the portfolio at all, when the story doesn't seem to follow reality, only to get an "it's too complicated so I'll just tell you inflation" answer from the expert. It's a simple definition of what these components are.

Sol put it perfectly in another thread:
-------------------------------------
People don't choose indexing because it backtests well against an index.  They choose indexing because they want to get market returns, good or bad, without taking on any additional risk by trying to beat the system.  I choose indexing because I'm prepared to play the game straight and accept average returns the same as everyone else is getting, at the lowest cost to me.  I'm not trying to win at anyone else's expense.
-------------------------------------

As did Brooklynguy:
-------------------------------------
If you use backtesting alone, you have proven nothing more than the fact that the strategy has worked in the past.  It is textbook survivorship bias to draw a conclusion solely from backtesting, because you are ignoring the infinite number of conceivable and backtestable strategies that failed to work in the past.  If you backtest enough strategies, you are bound to find one that worked through random chance alone.
-------------------------------------

My advice to any newbies would be to steer clear. Survivorship bias is the single greatest fallacy in investing, and it’s better to find out now, than after 16 years of under-performance. I will reiterate this for the newbies of the thread looking for a "consensus". I don't think newbies can responsibly handle the information on Tyler's site. Once you consider yourself an expert, have read a few books, and have watched your own portfolio in the market for a few years to know how you'll react, come back and see what you think.

You must remind yourself that when you start to pick apart winners and losers, successes and failures, the living and dead, that by paying attention to one side of that equation you are always neglecting the other. If you are thinking about opening a restaurant because there are so many successful restaurants in your hometown, you are ignoring the fact that only successful restaurants survive to become examples. Maybe on average 90 percent of restaurants in your city fail in the first year. You can’t see all those failures because when they fail they also disappear from view.

As Nassim Taleb writes in his book The Black Swan, “The cemetery of failed restaurants is very silent.” Of course the few that don’t fail in that deadly of an environment are wildly successful because only the very best and the very lucky can survive. All you are left with are super successes, and looking at them day after day you might think it’s a great business to get into when you are actually seeing evidence that you should avoid it.

[Tyler]

(Lots of talk about different assets not part of the portfolio)

Indeed, these hooks can seem promising, even exciting. But they clearly fall flat here. If you choose such a portfolio, acknowledge that it's based purely on backtesting, as the story simply doesn't check out.

Sorry, changing the asset allocation of The Golden Butterfly changes it's intended goal.

I disagree with your first comment, and agree with the second one.  ;)

I do also agree that it's absolutely not necessary to hold such a portfolio, that new investors might first want to consider starting simpler, and even that many experienced investors find it best to stay simpler.  The three-fund portfolio is a lot easier to understand and has worked well for many people.  As you can see from the other thread you linked earlier, I also support your personal decision to invest in 100% stocks.  Choosing an asset allocation does not require that one must dismiss all other portfolio options as not based in a valid investing strategy. 

As Nassim Taleb writes in his book The Black Swan, “The cemetery of failed restaurants is very silent.” Of course the few that don’t fail in that deadly of an environment are wildly successful because only the very best and the very lucky can survive. All you are left with are super successes, and looking at them day after day you might think it’s a great business to get into when you are actually seeing evidence that you should avoid it.

"Abiding by his own "skin in the game" rule, Taleb detailed some of his personal investments for the audience. He said his portfolio includes gold, silver, commodities, Treasury bills, euros, income properties and stocks. ... By accepting the natural fluctuations in the economy and seeking out investments that benefit from them, it is possible to construct a more antifragile portfolio, he said."

[arebelspy]

The growth butterfly has done so poorly, it's due to perform well. And the story is great. I'm going all in!

[Interest Compound]

(Lots of talk about different assets not part of the portfolio)

Indeed, these hooks can seem promising, even exciting. But they clearly fall flat here. If you choose such a portfolio, acknowledge that it's based purely on backtesting, as the story simply doesn't check out.

Sorry, changing the asset allocation of The Golden Butterfly changes it's intended goal.

I disagree with your first comment, and agree with the second one.  ;)

I do also agree that it's absolutely not necessary to hold such a portfolio, that new investors might first want to consider starting simpler, and even that many experienced investors find it best to stay simpler.  The three-fund portfolio is a lot easier to understand and has worked great for many people.  As you can see from the other thread you linked earlier, I also support your personal decision to invest in 100% stocks.  Choosing an asset allocation does not require that one must dismiss all other portfolio options as not based in a valid investing strategy. 

As Nassim Taleb writes in his book The Black Swan, “The cemetery of failed restaurants is very silent.” Of course the few that don’t fail in that deadly of an environment are wildly successful because only the very best and the very lucky can survive. All you are left with are super successes, and looking at them day after day you might think it’s a great business to get into when you are actually seeing evidence that you should avoid it.

"Abiding by his own "skin in the game" rule, Taleb detailed some of his personal investments for the audience. He said his portfolio includes gold, silver, commodities, Treasury bills, euros, income properties and stocks. ... By accepting the natural fluctuations in the economy and seeking out investments that benefit from them, it is possible to construct a more antifragile portfolio, he said."

Please understand, I'm not looking for personal validation that my investing strategy is the best. The fact that I'm 100% stocks has nothing to do with my argument. I'm simply warning the newbies who see portfolios like The Golden Butterfly, that things aren't as rosy as they seem. The, "match or beat the total stock market in long-term real CAGR with fewer stocks and lower volatility" description of The Golden Butterfly is a very dangerous message to impart on financial newbies.

Note the scary links I supplied in my 100% stocks thread:

What was the 2008 crash like in real time?
http://www.livingafi.com/2014/05/drawdown-part-1-the-basics/
http://forum.mrmoneymustache.com/investor-alley/why-would-i-be-in-anything-other-than-100-stocks/msg541017/#msg541017
http://forum.mrmoneymustache.com/investor-alley/why-would-i-be-in-anything-other-than-100-stocks/msg541078/#msg541078

If you included The Growth Butterfly at the bottom of your Golden Butterfly page to explain the risks involved, your readers would be much better off.

[Tyler]

The, "match or beat the total stock market in long-term real CAGR with fewer stocks and lower volatility" description of The Golden Butterfly is a very dangerous message to impart on financial newbies.

You have mentioned this several times, and I appreciate your concern.  I believe your heart is in the right place, and you truly want to help people not get the wrong idea.  I support that.  In the spirit of your effort, I recognize that verb tense matters and I just edited the original post on my website to read (emphasis added):

"...the Portfolios section here contains several good portfolios that matched or surpassed the total stock market in long-term real CAGR with fewer stocks and lower volatility."

I'll simply point out that based on the best data we have available, this statement is factually correct.  It also applies to many more portfolios than just the Golden Butterfly, including more traditional ones like the Ferri Core Four and Coffeehouse. 

One should absolutely not assume they will continue to be that way in the future, but IMHO one should also not dismiss them all out of hand as if there's nothing to learn from them about asset allocation.  Doing that effectively does require wisdom, and new investors should proceed carefully.

If you included The Growth Butterfly at the bottom of your Golden Butterfly page to explain the risks involved, your readers would be much better off.

A more appropriate disclaimer that I can get behind is that blindly substituting assets may have unintended consequences.  That applies to all portfolios.

BTW, I totally agree that leaning too heavily on backtesting can give you a false sense of security and should be avoided.  You can't see what will work by testing the past.   However, you can absolutely test the past to see what did not (withdrawal rates that failed, drawdowns that exceeded your investing horizon, etc.).  Neither theory nor backtesting can sustainably succeed without the other. 

[Stache it Away]

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).

I think Arebelspy put it together nicely.  I'm in the investment profession and I am constantly looking for assets that are not correlated to stocks to help reduce volatility which bonds and gold have certainly done in the past.  I don't think anyone is disputing that fact.  However, even though 40 years of data seems like a large span of time, the majority of that time we had lowering interest rates and a booming commodity super cycle which helped both gold and long-term Treasuries rise to the cream of the crop when back-testing. 

A portfolio that adds gold (or other commodities) and bonds is very likely to have lower volatility, but there is a very good chance that bonds especially will not perform over at least the next decade as they have over the past 30 or 40 years.  Gold is anyone's guess.  As with most arguments that I've see the answer can lie somewhere in the middle.  My take on this is that I'm fine with 100% stocks now (in the accumulation phase) but when we retire we might want to have a certain amount of money set aside so that if the market goes down for a while we don't have to pull from stocks at that time.  Most people I think allocate this to cash.  If we instead allocated this portion to lower correlated assets (though also likely lower returns as well) it might be better than keeping such a large amount in cash.  Just a thought I had to how we might handle the volatility in retirement. 


As a side note:  Tyler you've done some really cool work here that I'm going to spend some time looking at. 

[Radagast]

If you included The Growth Butterfly at the bottom of your Golden Butterfly page to explain the risks involved, your readers would be much better off.

Perhaps the Large Cap Growth index should be substituted for the entire stock allocations of all portfolios to remind investors to diversify.

Now I agree with your basic points that simplicity is likely to be better than complexity for most investors, and that reliance on backtesting and survivorship bias may badly mislead people (pretty much everyone still uses it though, including Vanguard). I also agree that stock indices should be considered the primary source of growth for all portfolios, and I do not own any gold except incidental amounts in electronic devices. But your own advice looks just as bad if one uses your own method to discredit it. How can you recommend 100% stocks or a 3-fund portfolio when substituting large growth stocks causes them to fail or perform poorly? Let's not have a double standard.

[Interest Compound]

If you included The Growth Butterfly at the bottom of your Golden Butterfly page to explain the risks involved, your readers would be much better off.

Perhaps the Large Cap Growth index should be substituted for the entire stock allocations of all portfolios to remind investors to diversify.

Now I agree with your basic points that simplicity is likely to be better than complexity for most investors, and that reliance on backtesting and survivorship bias may badly mislead people (pretty much everyone still uses it though, including Vanguard). I also agree that stock indices should be considered the primary source of growth for all portfolios, and I do not own any gold except incidental amounts in electronic devices. But your own advice looks just as bad if one uses your own method to discredit it. How can you recommend 100% stocks or a 3-fund portfolio when substituting large growth stocks causes them to fail or perform poorly? Let's not have a double standard.

The whole point of the 3 Fund portfolio, is to own the entire market. It has a deep humility at its core--the aim is not to separate winners from losers, but rather to hold the entire market. Large Cap Growth is not the entire market, therefore it could never be included in the 3 Fund portfolio. In contrast, The Golden Butterfly is reliant on picking tomorrow's outperformer. If Large Cap Growth were the top performer between 1972-today, it almost assuredly would be included in The Golden Butterfly, and you'd better hope that outperformance continues.

Again, if you understood the distinct difference between a portfolio like The Golden Butterfly, and The 3 Fund portfolio, you wouldn't be asking this. If you think the logic behind my method is "blindly replace the stock allocation with Large Cap Growth, and if it fails your portfolio is bad", you're seriously missing the point.

[Radagast]

The whole point of the 3 Fund portfolio, is to own the entire market. It has a deep humility at its core--the aim is not to separate winners from losers, but rather to hold the entire market. Large Cap Growth is not the entire market, therefore it could never be included in the 3 Fund portfolio. In contrast, The Golden Butterfly is reliant on picking tomorrow's outperformer. If Large Cap Growth were the top performer between 1972-today, it almost assuredly would be included in The Golden Butterfly, and you'd better hope that outperformance continues.

Again, if you understood the distinct difference between a portfolio like The Golden Butterfly, and The 3 Fund portfolio, you wouldn't be asking this. If you think the logic behind my method is "blindly replace the stock allocation with Large Cap Growth, and if it fails your portfolio is bad", you're seriously missing the point.

In that case you should have substituted assets representing the total market and said "look I made it better" instead of eliminating the TSM slice and saying "not so pretty now!". Saying owning everything is preferable and then going and removing the aspect that contained everything (at least in terms of US stocks) as a form of critique is a double standard. Perhaps you could have said "here's a way to really own everything: all world index!"

[Interest Compound]

The whole point of the 3 Fund portfolio, is to own the entire market. It has a deep humility at its core--the aim is not to separate winners from losers, but rather to hold the entire market. Large Cap Growth is not the entire market, therefore it could never be included in the 3 Fund portfolio. In contrast, The Golden Butterfly is reliant on picking tomorrow's outperformer. If Large Cap Growth were the top performer between 1972-today, it almost assuredly would be included in The Golden Butterfly, and you'd better hope that outperformance continues.

Again, if you understood the distinct difference between a portfolio like The Golden Butterfly, and The 3 Fund portfolio, you wouldn't be asking this. If you think the logic behind my method is "blindly replace the stock allocation with Large Cap Growth, and if it fails your portfolio is bad", you're seriously missing the point.

In that case you should have substituted assets representing the total market and said "look I made it better" instead of eliminating the TSM slice and saying "not so pretty now!". Saying owning everything is preferable and then going and removing the aspect that contained everything (at least in terms of US stocks) as a form of critique is a double standard. Perhaps you could have said "here's a way to really own everything: all world index!"

Huh? I'm sorry Radagast, but you're so far off base here the only way to respond would be to explain everything again from the beginning. Maybe someone else can help you understand.

[Interest Compound]

The, "match or beat the total stock market in long-term real CAGR with fewer stocks and lower volatility" description of The Golden Butterfly is a very dangerous message to impart on financial newbies.

You have mentioned this several times, and I appreciate your concern.  I believe your heart is in the right place, and you truly want to help people not get the wrong idea.  I support that.  In the spirit of your effort, I recognize that verb tense matters and I just edited the original post on my website to read (emphasis added):

"...the Portfolios section here contains several good portfolios that matched or surpassed the total stock market in long-term real CAGR with fewer stocks and lower volatility."

I'll simply point out that based on the best data we have available, this statement is factually correct.  It also applies to many more portfolios than just the Golden Butterfly, including more traditional ones like the Ferri Core Four and Coffeehouse. 

One should absolutely not assume they will continue to be that way in the future, but IMHO one should also not dismiss them all out of hand as if there's nothing to learn from them about asset allocation.  Doing that effectively does require wisdom, and new investors should proceed carefully.

If you included The Growth Butterfly at the bottom of your Golden Butterfly page to explain the risks involved, your readers would be much better off.

A more appropriate disclaimer that I can get behind is that blindly substituting assets may have unintended consequences.  That applies to all portfolios.

BTW, I totally agree that leaning too heavily on backtesting can give you a false sense of security and should be avoided.  You can't see what will work by testing the past.   However, you can absolutely test the past to see what did not (withdrawal rates that failed, drawdowns that exceeded your investing horizon, etc.).  Neither theory nor backtesting can sustainably succeed without the other.

Great! I think we're on the same page :)

[Monkey Uncle]

I think Arebelspy put it together nicely.  I'm in the investment profession and I am constantly looking for assets that are not correlated to stocks to help reduce volatility which bonds and gold have certainly done in the past.  I don't think anyone is disputing that fact.  However, even though 40 years of data seems like a large span of time, the majority of that time we had lowering interest rates and a booming commodity super cycle which helped both gold and long-term Treasuries rise to the cream of the crop when back-testing. 

A portfolio that adds gold (or other commodities) and bonds is very likely to have lower volatility, but there is a very good chance that bonds especially will not perform over at least the next decade as they have over the past 30 or 40 years.  Gold is anyone's guess.  As with most arguments that I've see the answer can lie somewhere in the middle.  My take on this is that I'm fine with 100% stocks now (in the accumulation phase) but when we retire we might want to have a certain amount of money set aside so that if the market goes down for a while we don't have to pull from stocks at that time.  Most people I think allocate this to cash.  If we instead allocated this portion to lower correlated assets (though also likely lower returns as well) it might be better than keeping such a large amount in cash.  Just a thought I had to how we might handle the volatility in retirement. 

I've seen several comments in this thread similar to the bolded passage.  "Based on current conditions, asset X seems set to underperform for the foreseeable future."  You could have said the same thing about bonds in '70s when interest rates were rising.  And bonds did indeed tank for a while.  But then interest rates started falling, and bonds had good performance for 30+ years.  No one can accurately predict all the round trips that various assets are going to make over the next 4 decades.  That's why you practice asset allocation instead of just picking what you think is set to outperform in the near term.

[Monkey Uncle]

Much of the discussion in this thread focuses on the apparent fact that the GB is the result of data mining, therefore it can't be expected to outperform in the future as it has in the past.  There have been various attempts to substitute other assets to prove this point, but it seems that those substitutions have been cherry-picked to make the GB look bad.  If we substitute in the closest appropriate index for each data-mined asset, that should remove the data mining effect without being biased toward a particular point of view.

Let's divide the stock allocation among US, international, and all of the available market caps.  So that 40% of the portfolio becomes 8% each in LCB, MCB, SCB, ID, and EM.  Why not just use the TSM and TI?  Because those are cap weighted, and thus biased heavily toward large caps.

The 40% in treasuries all goes in TBM.  No issues with cap weighting in that index.

The 20% gold allocation goes in commodities instead.

Using Tyler's calculators, this portfolio produced a 40-yr SWR of about 5.2%.  Lower than the GB's 5.9%, but still considerably better than the 3.9% produced by TSM, the 4% produced by 60/40, and the 4.4% produced by a typical 3-fund portfolio (equal parts TSM, TI, and TBM).

Long term CAGR was 5.7%, slightly lower than GB's 5.8%.  It was more volatile than the GB, with a worst down year of -23.4% (vs. -8.8 for GB) and longest drawdown of 4 yrs (vs. 2).  Interestingly, the worst year was about the same as the 60/40 and 3-fund portfolios, but the longest drawdown for 60/40 and 3-fund was much longer (10 yrs for both).  TSM was the most volatile of all with a -37% worst year and 13 yr draw down.

So it appears that data mining contributed some to the GB's attractive return/volatility profile.  But the more generic diversified portfolio was still less volatile and produced a higher withdrawal rate than 100% TSM, 3 fund, or 60/40.

So in my mind, the GB does have some data mining artifacts that aren't likely to be repeated, but there is something to the diversification effect.  Sure, no one knows for sure whether that effect will be repeated going forward, but given that it occurred using broad indexes in place of cherry-picked assets indicates that something was going on besides data mining.

[dandypandys]

This is why it's so hard to stay the course. There's always a hook. For someone new to investing, as I suspect many people on this forum are, you might not have seen how these stories typically play out:

-------------------------------------
"Investing is risky, you have Inflation, Deflation, Prosperity, and Recession, and you never know which one is coming next. Therefore you should dedicate portions of your portfolio to each of these phases, by buying X, Y, Z, and V."
-------------------------------------

That's a great story. The trouble comes when choosing your X, Y, Z, and V. I've been reading about portfolios like this for years, and they always have one thing in common, they backtest well. Very well. Is this a coincidence? Could it be that only the portfolios which perform very well in backtesting, also have an interesting story behind them? Or is it possible that almost every portfolio has a market-beating story......it just has to beat the market first before you pay any attention to it.

It is easy to fall victim to the Survivorship Bias.  After any process that leaves behind survivors, the non-survivors are often destroyed or muted or removed from your view. If failures becomes invisible, then naturally you will pay more attention to successes. Not only do you fail to recognize that what is missing might have held important information, you fail to recognize that there is missing information at all. Here are some possible options for each phase you may have missed:

Prosperity:

• Total US Stock Market
• Large Cap Value
• Large Cap Growth
• Large Cap Blend
• Mid Cap Value
• Mid Cap Growth
• Mid Cap Blend
• Small Cap Value
• Small Cap Growth
• Small Cap Blend
• Micro Cap
• Total International Stock Market
• Emerging Market
• Pacific Market
• Europe Market
• International Value
• International Small
• S&P 500
• Dividend Appreciation
• High Dividend
• Value Index
• Growth Index
• FTSE Social Index
• Extended Market

Inflation:

• Short Term Tips
• Long Term Tips
• Gold?
• REITS?
• Silver?
• Coal?
• Platinum?
• Diamonds?
• Oil?
• Natural Gas?
• Coffee?
• Sugar?
• Copper?
• Wheat?
• Cotton?

(There are arguments for each one of these.)

Deflation:

• Long Term Bond Index
• Long Term Treasuries
• Long Term Government Bonds
• Long Term Corporate Bonds
• Long Term Municipal Bonds

Recession:

• Money Market
• Short Term Bond index
• Short Term Treasuries
• Short Term Tips
• Ultra Short Term Bonds
• CDs
• Savings accounts

Now for the fun part. No matter which combination of these (including those I didn't mention) ends up winning, there will be an enticing story behind it all, explaining why there must be a fundamental reason behind such success! We finally got an answer to why Gold fits in the "Inflation" bucket, despite the data showing it clearly does not track inflation, and the answer is "it's complicated". We're told that Gold and Small Cap Value aren't necessary components, yet without these components the portfolio under-performs the average.

What if I read some similar articles, and choose this portfolio in 1972, based on the same "fundamentals" here? These are reasonable choices, and from the perspective of the 1972 investor, make perfect sense. Growth has been beating Value for almost a decade, showed no signs of slowing up, and every article you could find was singing the praises of Growth.


Had it gone well, we'd be seeing articles about The Growth Butterfly, not The Golden Butterfly. Instead I'm broke at 70 years old, cursing some article I read over 30 years ago.


Indeed, these hooks can seem promising, even exciting. But they clearly fall flat here. If you choose such a portfolio, acknowledge that it's based purely on backtesting, as the story simply doesn't check out. And if choosing a portfolio based purely on backtesting doesn't start ringing red alarm bells in your head...you really shouldn't be investing in a portfolio like this at all.

My advice to any newbies in this thread, don’t fall into the trap. You buy the market not because it backtested well during a specific phase, and will make you rich in the process. You buy the Total Stock Market Index, simply because you want to capture the market. You want a percentage ownership of all available companies across the globe. You want your share of the world's collective profits/production. Again, indexing beat or matched half of all invested dollars in the past, I do not expect mathematical laws to change, so I expect it to beat or match half of all invested dollars in the future.

You don’t buy the Total Bond Market Index because it was less volatile in the past, but because bonds are a written contract, where you are paid periodic interest payments, and in the end you get your full investment back. In most cases (70% of VBTLX) the contract is guaranteed by the government. This makes it a relatively safe place to put your money.

These aren't stories based on how it performed in the past. You won't get confused about why these options are included in the portfolio at all, when the story doesn't seem to follow reality, only to get an "it's too complicated so I'll just tell you inflation" answer from the expert. It's a simple definition of what these components are.

Sol put it perfectly in another thread:
-------------------------------------
People don't choose indexing because it backtests well against an index.  They choose indexing because they want to get market returns, good or bad, without taking on any additional risk by trying to beat the system.  I choose indexing because I'm prepared to play the game straight and accept average returns the same as everyone else is getting, at the lowest cost to me.  I'm not trying to win at anyone else's expense.
-------------------------------------

As did Brooklynguy:
-------------------------------------
If you use backtesting alone, you have proven nothing more than the fact that the strategy has worked in the past.  It is textbook survivorship bias to draw a conclusion solely from backtesting, because you are ignoring the infinite number of conceivable and backtestable strategies that failed to work in the past.  If you backtest enough strategies, you are bound to find one that worked through random chance alone.
-------------------------------------

My advice to any newbies would be to steer clear. Survivorship bias is the single greatest fallacy in investing, and it’s better to find out now, than after 16 years of under-performance. I will reiterate this for the newbies of the thread looking for a "consensus". I don't think newbies can responsibly handle the information on Tyler's site. Once you consider yourself an expert, have read a few books, and have watched your own portfolio in the market for a few years to know how you'll react, come back and see what you think.

You must remind yourself that when you start to pick apart winners and losers, successes and failures, the living and dead, that by paying attention to one side of that equation you are always neglecting the other. If you are thinking about opening a restaurant because there are so many successful restaurants in your hometown, you are ignoring the fact that only successful restaurants survive to become examples. Maybe on average 90 percent of restaurants in your city fail in the first year. You can’t see all those failures because when they fail they also disappear from view.

As Nassim Taleb writes in his book The Black Swan, “The cemetery of failed restaurants is very silent.” Of course the few that don’t fail in that deadly of an environment are wildly successful because only the very best and the very lucky can survive. All you are left with are super successes, and looking at them day after day you might think it’s a great business to get into when you are actually seeing evidence that you should avoid it.

This post above made a lot of sense to me. Thanks Interest Compound.
I have been following this thread very carefully and have read the huge 3-fund portfolio thread by Tayler Larimore over on Bogleheads forum. 3 fund is what i have chosen for my 403b - or as close as i can get, but i also have 20k of physical gold and silver that i have held on to since 2008-11. Reading this thread, i have gone back and forth on the value of keeping it and having that further diversification to my 3-fund or selling it finally paying off my condo in full. Many of you have said do the sell. I didn't blindly ignore the advice- as I did sell half of the original 40 and dump it into my 5.9% condo loan but still hesitating on selling the final 20k- pretty much because of this thread and going back and forth with the arguments.

Currently my 403b is as close to a 3 portfolio as possible with:

14% Standard Stable Asset Fund II
4% Vanguard Long-Term Treasury Admiral
67% Vanguard Total Stock Mkt Idx Adm
14% Vanguard Dvlp Mrkts Indx Admrl
1% Vanguard Emerging Mkts Stock Idx Adm

future contributions: 80/20   -( as a 41 year old perhaps a little high on stocks not sure yet)
20% Standard Stable Asset Fund II
60% VTSAX
15% VTMGX
5% VEMAX

Then that 20k gold and silver-  what to do - what to do.

[phwadsworth]

This thread is great, thank you, loving the discussion and learning tons!

[Interest Compound]

Much of the discussion in this thread focuses on the apparent fact that the GB is the result of data mining, therefore it can't be expected to outperform in the future as it has in the past.  There have been various attempts to substitute other assets to prove this point, but it seems that those substitutions have been cherry-picked to make the GB look bad.  If we substitute in the closest appropriate index for each data-mined asset, that should remove the data mining effect without being biased toward a particular point of view.

Let's divide the stock allocation among US, international, and all of the available market caps.  So that 40% of the portfolio becomes 8% each in LCB, MCB, SCB, ID, and EM.  Why not just use the TSM and TI?  Because those are cap weighted, and thus biased heavily toward large caps.

The 40% in treasuries all goes in TBM.  No issues with cap weighting in that index.

The 20% gold allocation goes in commodities instead.

Using Tyler's calculators, this portfolio produced a 40-yr SWR of about 5.2%.  Lower than the GB's 5.9%, but still considerably better than the 3.9% produced by TSM, the 4% produced by 60/40, and the 4.4% produced by a typical 3-fund portfolio (equal parts TSM, TI, and TBM).

Long term CAGR was 5.7%, slightly lower than GB's 5.8%.  It was more volatile than the GB, with a worst down year of -23.4% (vs. -8.8 for GB) and longest drawdown of 4 yrs (vs. 2).  Interestingly, the worst year was about the same as the 60/40 and 3-fund portfolios, but the longest drawdown for 60/40 and 3-fund was much longer (10 yrs for both).  TSM was the most volatile of all with a -37% worst year and 13 yr draw down.

So it appears that data mining contributed some to the GB's attractive return/volatility profile.  But the more generic diversified portfolio was still less volatile and produced a higher withdrawal rate than 100% TSM, 3 fund, or 60/40.

So in my mind, the GB does have some data mining artifacts that aren't likely to be repeated, but there is something to the diversification effect.  Sure, no one knows for sure whether that effect will be repeated going forward, but given that it occurred using broad indexes in place of cherry-picked assets indicates that something was going on besides data mining.

Pure Story 1:

Prosperity = US Stock Market
Inflation = TIPS
Deflation = Long Term Treasuries
Recession = Short Term Treasuries

Pure Story 2:

Prosperity = US Stock Market
Prosperity x2 = International Stock Market
Inflation = TIPS
Deflation = Long Term Treasuries
Recession = Short Term Treasuries

I fail to see how these portfolios were "cherry-picked to make the GB look bad". Tyler specifically said options like Total International also work. If your issue is with putting TIPS, the one and only asset guaranteed to track inflation, in the Inflation box, I don't think that's a very strong argument :)

Now The Growth Butterfly (Pure Story 3) was definitely cherry-picked to make GB look bad:

Prosperity = Large Cap Growth
Prosperity x2 = Large Cap Growth
Inflation = TIPS
Deflation = Long Term Treasuries
Recession = Short Term Treasuries

Only to highlight how the portfolio is reliant on picking tomorrow's outperformer. Choose wrong, and you're in trouble.

[Interest Compound]

5.9% condo loan

If there were an asset guaranteeing a 5.9% return, with no volatility, would you put your money there, or in Gold/Silver?

If there were an asset guaranteeing a 5.9% return, with no volatility, would you put your money there, or in Bonds?

To me it's an easy answer. Pay off the loan :)

[Tyler]

Tyler specifically said options like Total International also work. If your issue is with putting TIPS, the one and only asset guaranteed to track inflation, in the Inflation box, I don't think that's a very strong argument :)

For the record, I said that one can replace some assets like SCV with things like total international and get similar (but not identical) results.  I also offered portfolios that use things like REITs and commodities instead of gold.  I did not say that all assets can be interchanged with whatever sounds sorta similar to you with no consequences, and I encourage people to explore those consequences by testing their assumptions using my tools and other resources before proceeding.  Many assets are more complicated than what you see on the surface. 

For example, TIPS funds are not guaranteed to track inflation.  If they did, they'd always have a positive real return.  They don't.



Just like gold is affected by more than just inflation, TIPS are too.  They are bonds and their value responds inversely to interest rates.  TIPS will track inflation very well provided one holds them all the way to maturity and ignores the price changes along the way.  TIPS index funds, however, do not hold the individual bonds all the way to maturity.  They sell them early to maintain the target average maturity of the fund, and when they do the value of the bond will have changed and the fund may make or lose money.  If you want TIPS to perfectly track inflation you need to buy them directly and never sell any to rebalance.  Otherwise, you're really just adding a slightly boosted version of intermediate bonds.



Basically, if you want to add TIPS to the Golden Butterfly the more appropriate slot is the long term treasuries, not gold.  Try it out in the calculators and you'll see what I mean. This is also how the Swensen and Swedroe portfolios use TIPS -- it's part of the bond allocation. 

[Tyler]

5.9% condo loan

If there were an asset guaranteeing a 5.9% return, with no volatility, would you put your money there, or in Gold/Silver?

If there were an asset guaranteeing a 5.9% return, with no volatility, would you put your money there, or in Bonds?

To me it's an easy answer. Pay off the loan :)

+1!

[Interest Compound]

Basically, if you want to add TIPS to the Golden Butterfly the more appropriate slot is the long term treasuries, not gold.

Is it your position that gold protects against inflation better than a TIPS fund?

I did not say that all assets can be interchanged with whatever sounds sorta similar to you with no consequences.

That's the crux of my argument. This is exactly what I intended to highlight. While the choices might seem similar, if you choose the wrong one there will be big consequences. The success of the Golden Butterfly is reliant on picking tomorrow's outperformer.

[Tyler]

Is it your position that gold tracks inflation better than a TIPS fund?

No.  I simply pointed out that your statement that TIPS are "guaranteed to track inflation" is factually incorrect and that there is a far more important factor in the price movement that is shared by all other bond funds.  Just because TIPS and gold are both sensitive to inflation does not mean they are interchangeable, and casually substituting TIPS for gold without recognizing the difference between a bond and a commodity is not a reasonable comparison.
 

That's the crux of my argument. This is exactly what I intended to highlight. While the choices might seem similar, if you choose the wrong one there will be big consequences. The success of the Golden Butterfly is reliant on picking tomorrow's outperformer.

The idea behind the Golden Butterfly is exactly the opposite -- to not attempt to guess tomorrow's outperformer and to intelligently diversify so that you're prepared for any outcome.  In Taleb's terms: "By accepting the natural fluctuations in the economy and seeking out investments that benefit from them, it is possible to construct a more antifragile portfolio."  The assets for this type of strategy are not arbitrarily chosen by backtesting with no wisdom nor by dogma with no evidence.  But don't take my word for it.  If one takes the time to read the books behind the Permanent portfolio, Swensen portfolio, and Ivy portfolio they can explore the concept in depth from multiple perspectives.

Even if you find my personal arguments unconvincing, there are many other people way more knowledgeable than me who suggest a variety of good asset allocations beyond just buying the whole market and hoping things work out for the best.  You've actually quoted many of them in this thread (Bernstein, Malkiel, Taleb, etc), so I assume you value their ideas.  Rather than tearing down the portfolios that do not resonate with you, seek out the ones that do. 

Now if you simply reject modern portfolio theory and believe all of those people writing books on asset allocation are wrong, that's fine.  But at that point the objection is really more fundamental than the specifics of the Golden Butterfly, and I suggest we start a new thread for that. 

[Monkey Uncle]

Much of the discussion in this thread focuses on the apparent fact that the GB is the result of data mining, therefore it can't be expected to outperform in the future as it has in the past.  There have been various attempts to substitute other assets to prove this point, but it seems that those substitutions have been cherry-picked to make the GB look bad.  If we substitute in the closest appropriate index for each data-mined asset, that should remove the data mining effect without being biased toward a particular point of view.

Let's divide the stock allocation among US, international, and all of the available market caps.  So that 40% of the portfolio becomes 8% each in LCB, MCB, SCB, ID, and EM.  Why not just use the TSM and TI?  Because those are cap weighted, and thus biased heavily toward large caps.

The 40% in treasuries all goes in TBM.  No issues with cap weighting in that index.

The 20% gold allocation goes in commodities instead.

Using Tyler's calculators, this portfolio produced a 40-yr SWR of about 5.2%.  Lower than the GB's 5.9%, but still considerably better than the 3.9% produced by TSM, the 4% produced by 60/40, and the 4.4% produced by a typical 3-fund portfolio (equal parts TSM, TI, and TBM).

Long term CAGR was 5.7%, slightly lower than GB's 5.8%.  It was more volatile than the GB, with a worst down year of -23.4% (vs. -8.8 for GB) and longest drawdown of 4 yrs (vs. 2).  Interestingly, the worst year was about the same as the 60/40 and 3-fund portfolios, but the longest drawdown for 60/40 and 3-fund was much longer (10 yrs for both).  TSM was the most volatile of all with a -37% worst year and 13 yr draw down.

So it appears that data mining contributed some to the GB's attractive return/volatility profile.  But the more generic diversified portfolio was still less volatile and produced a higher withdrawal rate than 100% TSM, 3 fund, or 60/40.

So in my mind, the GB does have some data mining artifacts that aren't likely to be repeated, but there is something to the diversification effect.  Sure, no one knows for sure whether that effect will be repeated going forward, but given that it occurred using broad indexes in place of cherry-picked assets indicates that something was going on besides data mining.

Pure Story 1:

Prosperity = US Stock Market
Inflation = TIPS
Deflation = Long Term Treasuries
Recession = Short Term Treasuries

Pure Story 2:

Prosperity = US Stock Market
Prosperity x2 = International Stock Market
Inflation = TIPS
Deflation = Long Term Treasuries
Recession = Short Term Treasuries

I fail to see how these portfolios were "cherry-picked to make the GB look bad". Tyler specifically said options like Total International also work. If your issue is with putting TIPS, the one and only asset guaranteed to track inflation, in the Inflation box, I don't think that's a very strong argument :)

Now The Growth Butterfly (Pure Story 3) was definitely cherry-picked to make GB look bad:

Prosperity = Large Cap Growth
Prosperity x2 = Large Cap Growth
Inflation = TIPS
Deflation = Long Term Treasuries
Recession = Short Term Treasuries

Only to highlight how the portfolio is reliant on picking tomorrow's outperformer. Choose wrong, and you're in trouble.

You totally ignored the point of my post.  How do you explain the fact that a non-data-mined, non-cherry-picked, diversified portfolio of broad indexes beat the pants off of the total stock market, 60/40, and 3-fund portfolios?

[Interest Compound]

Is it your position that gold tracks inflation better than a TIPS fund?

No.  I simply pointed out that your previous statement that TIPS are "guaranteed to track inflation" is factually incorrect.  Both gold and TIPS can be used for inflation protection in different types of portfolios.  But neither solely track inflation, and they are not interchangeable in every portfolio.  There are good reasons the PP and GB do not use TIPS instead of gold, and it has nothing to do with backtesting. 
 

That's the crux of my argument. This is exactly what I intended to highlight. While the choices might seem similar, if you choose the wrong one there will be big consequences. The success of the Golden Butterfly is reliant on picking tomorrow's outperformer.

The idea behind the Golden Butterfly is exactly the opposite -- to not attempt to guess tomorrow's performer and to intelligently diversify so that you're prepared for any outcome.  In Taleb's terms: "By accepting the natural fluctuations in the economy and seeking out investments that benefit from them, it is possible to construct a more antifragile portfolio." 

The assets are not arbitrarily chosen by backtesting nor by dogma with no evidence.  If one actually reads the books behind things like the Permanent portfolio, Swensen portfolio, and Ivy portfolio they'll understand this and avoid common pitfalls like casually substituting TIPS for gold in a portfolio that already holds 40% bonds. 

Some people avoid poor decisions by educating themselves on the topic.  Others do so by deferring to the wisdom of people they trust.  Even if you don't trust the Golden Butterfly in the slightest, there are many other people way smarter and more knowledgeable than me who suggest a variety of good asset allocations beyond just buying the whole market and hoping things work out for the best.  Rather than tearing down the ones that do not resonate with you, seek out the ones that do.

TIPS are guaranteed to track inflation. A TIPS fund will approach this guarantee as we get closer to the average effective maturity date of the fund. This is exactly what we see in the charts in my last post. Tangent aside, you don't seem to be claiming that Gold protects against Inflation better than TIPS, so let's not get off track.

We seem to be going in circles now. Yes, the story is great. Just as great as all the other similar stories which were all amazing outperformers in their day (more so than the Golden Butterfly for their time period), only to move back down to Average (red box) as time went on.



I'll continue tearing it down, along with any other portfolio which misleads financial newbies into believing they've found the Holy Grail, only to end up losing everything. They don't see it for what it is. They don't see that it's a competition. Tell someone they can beat Michael Jordan in a game of basketball, and they will laugh in your face...but give them a sales pitch for "one weird trick" to beat the market, and people will line up to give you money.

For the newbies in the thread, it's important to understand this next point.  When someone claims you can beat the market (matching average returns, with 1/5th the volatility) over the long term, they're saying you can beat over half of all money invested in the market this year, then again next year, and again the year after that...for as long as they live.  All by using a published, widely known strategy, that the other market participants (the people they claim to be beating) are aware of.  This is essentially the claim:

---------------------------------------------
"<Insert Strategy Here> beat over half of all invested dollars in the past.  While this information is public, I do not expect the losers to adopt my published strategy, or change to a better strategy, so I expect it to continue beating over half of all invested dollars in the future."
---------------------------------------------

This isn't just someone saying, "I can beat Lebron James in a 1 on 1 basketball game, you can too!"

It's,

---------------------------------------------
"I can beat Lebron James in a 1 on 1 basketball game, every single year, and he knows exactly what I'm going to do each time, and he doesn't copy my strategy or figure out a way to beat me, so I expect I will continue beating him in the future, you can too!"
---------------------------------------------

Compared to:

---------------------------------------------
"Indexing beat or matched half of all invested dollars in the past, I do not expect mathematical laws to change, so I expect it to beat or match half of all invested dollars in the future."
---------------------------------------------

While Tyler is very careful to state the future is unknowable, financial newbies just can't responsibly handle this information. They don't understand the risks. They hear him say, "The idea behind the Golden Butterfly is exactly the opposite -- to not attempt to guess tomorrow's performer", but they don't realize the story is irrelevant. It's not the story that got them excited about the Golden Butterfly. It's the results. The backtested results. The possibility of matching the performance of 100% stocks, but with 1/5th the volatility. This success, is very much reliant on picking tomorrow's outperformer.

The Permanent Portfolio, on which The Golden Butterfly is based, was created in 1982, and it's a great example of the consequences when you don't pick tomorrow's outperformer. From 1972 to 1982 The Permanent Portfolio looked even better on the charts than The Golden Butterfly does today! But had you gone all-in back then, you would've underperformed even 100% bonds:



The scary part? It didn't move that far on the graph. If you look at The Permanent Portfolio now, it doesn't look so bad...because the backtesting includes the data from before it was created! Does no one else see a problem with this?? Of course the portfolio is going to backtest well before it was created, that's why it was created!



And Tyler, don't underestimate yourself. :) All those other big names came up with their outperforming portfolios the same way you did. You're just as smart as them. You could write a "Golden Butterfly" book right now, earn millions from all the same financial newbies who bought all those other books, then watch as they proceed to underperform.

[Interest Compound]

Let's divide the stock allocation among US, international, and all of the available market caps.  So that 40% of the portfolio becomes 8% each in LCB, MCB, SCB, ID, and EM.  Why not just use the TSM and TI?  Because those are cap weighted, and thus biased heavily toward large caps.

The 40% in treasuries all goes in TBM.  No issues with cap weighting in that index.

The 20% gold allocation goes in commodities instead.

Sorry, I only debate one market-beating portfolio at a time. And even then, only when it seems to be misleading financial newbies. Make a new thread, and maybe I'll jump in with my thoughts once I'm done here. :)

[steveo]

So it appears that data mining contributed some to the GB's attractive return/volatility profile.  But the more generic diversified portfolio was still less volatile and produced a higher withdrawal rate than 100% TSM, 3 fund, or 60/40.

So in my mind, the GB does have some data mining artifacts that aren't likely to be repeated, but there is something to the diversification effect.  Sure, no one knows for sure whether that effect will be repeated going forward, but given that it occurred using broad indexes in place of cherry-picked assets indicates that something was going on besides data mining.

This to me is the sort of information that analysis on portfolios like "The Golden Butterfly" should be utilised for. A diversified asset allocation does have certain advantages. Having some commodities in your portfolio gives you an asset that can go on long bull runs and it should be uncorrelated to stocks.

[Interest Compound]

So it appears that data mining contributed some to the GB's attractive return/volatility profile.  But the more generic diversified portfolio was still less volatile and produced a higher withdrawal rate than 100% TSM, 3 fund, or 60/40.

So in my mind, the GB does have some data mining artifacts that aren't likely to be repeated, but there is something to the diversification effect.  Sure, no one knows for sure whether that effect will be repeated going forward, but given that it occurred using broad indexes in place of cherry-picked assets indicates that something was going on besides data mining.

This to me is the sort of information that analysis on portfolios like "The Golden Butterfly" should be utilised for. A diversified asset allocation does have certain advantages. Having some commodities in your portfolio gives you an asset that can go on long bull runs and it should be uncorrelated to stocks.

Until you realize that a large portion, probably about half, of those portfolios underperform. If you only look at the winners, you fail to realize there's any missing information at all.

[steveo]

The idea behind the Golden Butterfly is exactly the opposite -- to not attempt to guess tomorrow's outperformer and to intelligently diversify so that you're prepared for any outcome.

In my opinion this is exactly what modern asset allocation is about. I just think dropping the tilts makes portfolio's much more about intelligently diversifying. So just use broad indexes. Ideally all world stock market (I personally think domestic is required because of currency risk), all commodities, all bonds and a REIT (dependent on how much your house is worth if you own it). I wonder how a 25% each portfolio would go. Assuming that stocks will tend to outperform all other asset classes then make stocks 50% and split amongst the other asset classes.

I should add that this approach is very similar to a 3 fund portfolio. You could just make it a 4 fund portfolio by adding some commodities and then choose your weightings.

[steveo]

So it appears that data mining contributed some to the GB's attractive return/volatility profile.  But the more generic diversified portfolio was still less volatile and produced a higher withdrawal rate than 100% TSM, 3 fund, or 60/40.

So in my mind, the GB does have some data mining artifacts that aren't likely to be repeated, but there is something to the diversification effect.  Sure, no one knows for sure whether that effect will be repeated going forward, but given that it occurred using broad indexes in place of cherry-picked assets indicates that something was going on besides data mining.

This to me is the sort of information that analysis on portfolios like "The Golden Butterfly" should be utilised for. A diversified asset allocation does have certain advantages. Having some commodities in your portfolio gives you an asset that can go on long bull runs and it should be uncorrelated to stocks.

Until you realize that a large portion, probably about half, of those portfolios underperform. If you only look at the winners, you fail to realize there's any missing information at all.

I think though underperforming is a subjective concept because it is about the return to volatility trade off. The point in my opinion is to have a diversified portfolio across different asset classes and not tilt within those asset classes.

I definitely think that half the portfolios will underperform and that is why you don't tilt and you choose the asset allocation that works for you. It could still be 100% stocks for instance. In that case you are just stating that you are okay with significant volatility because over the long term you expect stocks to outperform. It could be 100% bonds. It could be 25% between each asset class. Something like 25% international stocks, 25% domestic, 25% bonds & 25% commodities would probably work pretty well. You can cut it though anyway you like.

I don't like the idea of picking the GB or the PP because of the tilts but the concept behind a diversified set of assets working together I think is solid.

[wienerdog]

The Permanent Portfolio, on which The Golden Butterfly is based, was created in 1982, and it's a great example of the consequences when you don't pick tomorrow's outperformer. From 1972 to 1982 The Permanent Portfolio looked even better on the charts than The Golden Butterfly does today! But had you gone all-in back then, you would've underperformed even 100% bonds:

What are you using for bonds?  I show it does better than 100% bonds from 82 to 15.

[Interest Compound]

So it appears that data mining contributed some to the GB's attractive return/volatility profile.  But the more generic diversified portfolio was still less volatile and produced a higher withdrawal rate than 100% TSM, 3 fund, or 60/40.

So in my mind, the GB does have some data mining artifacts that aren't likely to be repeated, but there is something to the diversification effect.  Sure, no one knows for sure whether that effect will be repeated going forward, but given that it occurred using broad indexes in place of cherry-picked assets indicates that something was going on besides data mining.

This to me is the sort of information that analysis on portfolios like "The Golden Butterfly" should be utilised for. A diversified asset allocation does have certain advantages. Having some commodities in your portfolio gives you an asset that can go on long bull runs and it should be uncorrelated to stocks.

Until you realize that a large portion, probably about half, of those portfolios underperform. If you only look at the winners, you fail to realize there's any missing information at all.

I think though underperforming is a subjective concept because it is about the return to volatility trade off. The point in my opinion is to have a diversified portfolio across different asset classes and not tilt within those asset classes.

I definitely think that half the portfolios will underperform and that is why you don't tilt and you choose the asset allocation that works for you. It could still be 100% stocks for instance. In that case you are just stating that you are okay with significant volatility because over the long term you expect stocks to outperform. It could be 100% bonds. It could be 25% between each asset class. Something like 25% international stocks, 25% domestic, 25% bonds & 25% commodities would probably work pretty well. You can cut it though anyway you like.

I don't like the idea of picking the GB or the PP because of the tilts but the concept behind a diversified set of assets working together I think is solid.

Agreed. The concepts are definitely solid. If you don't go into it thinking you're going to get all of the return, without any of the risk, you'll probably be fine.

That said, I'd love to participate in a new thread analyzing commodities. Ibbotson published some research in 2006 suggesting a commodities allocation could improve a portfolio and it quickly became a sort of fad. Oddly enough, right after the research was published, commodities developed a high correlation with stocks and ceased to be a good diversifier. Funny how things like that happen.

Before:



After:



And this is before looking at their high expense ratio (0.50% - 0.75%) and high annual turnover (75% - 125%).

[Interest Compound]

The Permanent Portfolio, on which The Golden Butterfly is based, was created in 1982, and it's a great example of the consequences when you don't pick tomorrow's outperformer. From 1972 to 1982 The Permanent Portfolio looked even better on the charts than The Golden Butterfly does today! But had you gone all-in back then, you would've underperformed even 100% bonds:

What are you using for bonds?  I show it does better than 100% bonds from 82 to 15.

[Radagast]

There actually is a little bit of theory behind this, which is volatility and correlation to the US stock market, and it looks a little something like this:



For as long as one correlation is negative and the other is close to zero the future is likely to be similar to the past for these three assets. There is nothing magic here.

[wienerdog]

I thought Browne only used US treasury bills for his cash portion?

[steveo]

Agreed. The concepts are definitely solid. If you don't go into it thinking you're going to get all of the return, without any of the risk, you'll probably be fine.

I agree, This is my concern with following these portfolios blindly. I think all they offer are example portfolios and then you go out and choose your own portfolio. You shouldn't though be thinking my portfolio is special and I'll beat the market. You could but it's unlikely. It's the same issue I have with picking individual stocks. It's going to come down to luck and why take that risk on.

That said, I'd love to participate in a new thread analyzing commodities. Ibbotson published some research in 2006 suggesting a commodities allocation could improve a portfolio and it quickly became a sort of fad. Oddly enough, right after the research was published, commodities developed a high correlation with stocks and ceased to be a good diversifier. Funny how things like that happen.

....
And this is before looking at their high expense ratio (0.50% - 0.75%) and high annual turnover (75% - 125%).

I'd like to see something on commodities because I'd like to have some but when I look at ETF's that offer this they return basically nothing and have a high expense ratio. I've said previously if I had a lot of money - i.e. a low WR than I would consider purchasing some commodities but I don't have a low WR now and I don't intend to retire on a low WR.

[Interest Compound]

I thought Browne only used US treasury bills for his cash portion?

In the book, "The Permanent Portfolio: Harry Browne's Long-Term Investment Strategy", he says:



Then continues to show these returns for that asset in 1981:



https://books.google.com/books?id=AQK6HbG7LtUC&pg=PT113&source=gbs_selected_pages&cad=3#v=onepage&q&f=false

This matches perfectly with the Cash/MoneyMarket asset in PortfolioVisualizer for 1981:

[wienerdog]

Your pictures or whatever you posted didn't work.  Not sure what you were linking to in the google book as a cartoon came up but if you go to the chapter 8 on Cash. 

"Because the stability of cash is so important, the Permanent Portfolio holds its cash in ultra-safe U.S. Treasury (T-Bills) with maturity of 12 months or less.  The reasons why T-Bills are preferred over the other options will be discussed in the chapter"

Switch to short term treasuries and see if your 100% bond statement holds true.

The Permanent Portfolio looked even better on the charts than The Golden Butterfly does today! But had you gone all-in back then, you would've underperformed even 100% bonds:

Not defending the PP as it is way too conservative for me but it seems like you're using the wrong data to prove your point.  Maybe it was an honest mistake?  I don't think I have seen anywhere that uses a money market or cash for the cash position.  IE (SPY, TLT, IAU, SHY)

[Interest Compound]

Your pictures or whatever you posted didn't work.  Not sure what you were linking to in the google book as a cartoon came up but if you go to the chapter 8 on Cash. 

"Because the stability of cash is so important, the Permanent Portfolio holds its cash in ultra-safe U.S. Treasury (T-Bills) with maturity of 12 months or less.  The reasons why T-Bills are preferred over the other options will be discussed in the chapter"

Switch to short term treasuries and see if your 100% bond statement holds true.

The Permanent Portfolio looked even better on the charts than The Golden Butterfly does today! But had you gone all-in back then, you would've underperformed even 100% bonds:

Not defending the PP as it is way too conservative for me but it seems like you're using the wrong data to prove your point.  Maybe it was an honest mistake?  I don't think I have seen anywhere that uses a money market or cash for the cash position.  IE (SPY, TLT, IAU, SHY)

I've uploaded the post for you here as an attachment. 1982 matches as well, 10.5%. The data is accurate.

[Radagast]

Portfolio visualizer defaults to that option, and it is not really wrong. I think that short term treasuries are 2 years or something for portfolio visualizer, which is recommended only with caution. I believe a treasury-only money market is recommended for the PP.

[wienerdog]

I thought the rule was to have 1 year of expenses in Tbills for harsh market down turns and rest in short term which normally is 1 to 3 years?  Could be wrong but seems like an awfully large amount to hold in a moneyy market or cash.

[arebelspy]

I don't really buy the LeBron comparison, but this was really powerful, to me:

The Permanent Portfolio, on which The Golden Butterfly is based, was created in 1982, and it's a great example of the consequences when you don't pick tomorrow's outperformer. From 1972 to 1982 The Permanent Portfolio looked even better on the charts than The Golden Butterfly does today! But had you gone all-in back then, you would've underperformed even 100% bonds:



The scary part? It didn't move that far on the graph. If you look at The Permanent Portfolio now, it doesn't look so bad...because the backtesting includes the data from before it was created! Does no one else see a problem with this?? Of course the portfolio is going to backtest well before it was created, that's why it was created!

That's 32 years of underperformance, since it was created, if you ignore the backtesting data used to create it?

That's a fairly long timeframe, to me, on the length of many people's retirement, even if they ER in their 40s.

(Less volatile, yes, but not less volatile than bonds, which it also lost to--and the 40/60 max drawdown isn't that high anyways.)

Data like this is cooler, to me, than stilted comparisons to LeBron or admonishments about newbies.

If the GB behaves similarly, because of a similar story, we end up with the situation described earlier in this thread: stable, low returns.  Good if you're paranoid of the market, not so good if you want your money to last a long time.

But if you're expecting a higher WR due to having a GB/PP portfolio, and those assets DON'T outperform (as the PP assets didn't, over the last 32 years), you're in trouble.

I can definitely see someone ERing on 5%+ WR due to seeing the "safe WR" graphs on Tyler's site, despite disclaimers.

[Tyler]

That's 32 years of underperformance, since it was created, if you ignore the backtesting data used to create it?

That's a fairly long timeframe, to me, on the length of many people's retirement, even if they ER in their 40s.

Well, another way to look at it is that the period starting in 1982 is the single most favorable start year for stocks and bonds.  The PP line actually sets more reasonable expectations than the others and is far more consistent over other timeframes.  "Underperforming" in this example doesn't mean it wasn't an excellent choice in terms of overall risk adjusted returns. 

The issue of how one can identify a good portfolio ahead of time among all of the uncertainty and competing information is an interesting topic, and to limit it to debating this one portfolio does not do it justice.  I've started a new thread on that and hope everyone contributes. 

[AdrianC]

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.

Take the last 30 years:

Total Stock Market  7.31
Small Cap Value  7.76
Long Term Treasury  5.52
Short Term Treasury  2.32
Gold  0.94
Permanent Portfolio  4.66
Golden Butterfly  5.51
No Gold  6.33

Those are compound annual growth rates. It doesn't look like the lower volatility of the PP and GB improved CAGR tremendously.

[AdrianC]

[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.

I just finished Swenson's book (Unconventional Success) and thought it was worth the time. You can skip about half of it where he's just railing on Wall Street. The explanation of the core asset classes and how they work together is very good.

I did notice that he never mentions gold... ;-)