POLL: How did you overcome the fear of tracking error?

General Discussion on the Permanent Portfolio Strategy

Moderator: Global Moderator

Henryinroad
Junior Member
Junior Member
Posts: 17
Joined: Thu Aug 06, 2020 10:46 pm

POLL: How did you overcome the fear of tracking error?

Post by Henryinroad » Fri Aug 14, 2020 3:21 am

Long story short, I just established a portfolio strictly following the allocation of PP. 25% eggs put into each asset basket.

Problem is, when I did that, what freaked me out was the recent overvalued price level of TLT and SPY. This just makes me very hesitant to keep going and ignore the market noise.

So, if you were me, how would you handle the situation?
1) Try to use option for hedging against the downside of TLT and SPY
2) Lower the bet in TLT and SPY
3) Stay focus and determined, respect the theory behind PP

REALLY hope to get some advice from you guys. Thank you very much.
User avatar
Hal
Executive Member
Executive Member
Posts: 1349
Joined: Tue May 03, 2011 1:50 am

Re: POLL: How did you overcome the fear of tracking error?

Post by Hal » Fri Aug 14, 2020 5:12 am

Option 4 :D

Listen to his radio show archives and note where he says that overvalued assets can become even more overvalued.
https://www.youtube.com/channel/UCzu55W ... QIQ/videos
Aussie GoldSmithPP - 25% PMGOLD, 75% VDCO
Henryinroad
Junior Member
Junior Member
Posts: 17
Joined: Thu Aug 06, 2020 10:46 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by Henryinroad » Fri Aug 14, 2020 7:23 am

Hal wrote:
Fri Aug 14, 2020 5:12 am
Option 4 :D

Listen to his radio show archives and note where he says that overvalued assets can become even more overvalued.
https://www.youtube.com/channel/UCzu55W ... QIQ/videos
Note he didnt foresee/ experience negative interest rate when he made those comment about how overvalued assets can become even more overvalued.
User avatar
Kriegsspiel
Executive Member
Executive Member
Posts: 4052
Joined: Sun Sep 16, 2012 5:28 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by Kriegsspiel » Fri Aug 14, 2020 7:51 am

Henryinroad wrote:
Fri Aug 14, 2020 3:21 am
Long story short, I just established a portfolio strictly following the allocation of PP. 25% eggs put into each asset basket.

Problem is, when I did that, what freaked me out was the recent overvalued price level of TLT and SPY. This just makes me very hesitant to keep going and ignore the market noise.

So, if you were me, how would you handle the situation?
1) Try to use option for hedging against the downside of TLT and SPY
I think options are interesting, they're one of those things I'm planning on getting into. That said, I like the PP for its simplicity. If you want to use options, give yourself some capital and do it outside of the PP instead of trying to fit it in. Keep the PP simple and mechanical and you can forego any mental stress you usually get from having to figure out how to invest.
2) Lower the bet in TLT and SPY
I'd keep it as normal and do any tilting as a VP play.
3) Stay focus and determined, respect the theory behind PP
It seems like you're getting into a white-knuckle mindset when the PP is pretty damn chill. You're a good candidate for the whole PP + VP philosophy. Buy some options or stocks as a VP and do your stressing over them, if you'd like to. Think of it like little experiments you're doing with little downside but big upside, like Taleb's barbell strategy.

Lastly, if you nerd out over on Tyler's site, you'll see that the PP does have some down years, but it gets back on an even keel pretty quick.
You there, Ephialtes. May you live forever.
User avatar
buddtholomew
Executive Member
Executive Member
Posts: 2464
Joined: Fri May 21, 2010 4:16 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by buddtholomew » Fri Aug 14, 2020 8:16 am

What’s surprising to me is you believe Gold is undervalued or at fair value. Gold is the highest performer in the PP YTD.
Henryinroad
Junior Member
Junior Member
Posts: 17
Joined: Thu Aug 06, 2020 10:46 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by Henryinroad » Fri Aug 14, 2020 8:23 am

Kriegsspiel wrote:
Fri Aug 14, 2020 7:51 am
Henryinroad wrote:
Fri Aug 14, 2020 3:21 am
Long story short, I just established a portfolio strictly following the allocation of PP. 25% eggs put into each asset basket.

Problem is, when I did that, what freaked me out was the recent overvalued price level of TLT and SPY. This just makes me very hesitant to keep going and ignore the market noise.

So, if you were me, how would you handle the situation?
1) Try to use option for hedging against the downside of TLT and SPY
I think options are interesting, they're one of those things I'm planning on getting into. That said, I like the PP for its simplicity. If you want to use options, give yourself some capital and do it outside of the PP instead of trying to fit it in. Keep the PP simple and mechanical and you can forego any mental stress you usually get from having to figure out how to invest.
2) Lower the bet in TLT and SPY
I'd keep it as normal and do any tilting as a VP play.
3) Stay focus and determined, respect the theory behind PP
It seems like you're getting into a white-knuckle mindset when the PP is pretty damn chill. You're a good candidate for the whole PP + VP philosophy. Buy some options or stocks as a VP and do your stressing over them, if you'd like to. Think of it like little experiments you're doing with little downside but big upside, like Taleb's barbell strategy.

Lastly, if you nerd out over on Tyler's site, you'll see that the PP does have some down years, but it gets back on an even keel pretty quick.
Thanks for many good ideas, VP is sth I hvnt thought before, gonna work on that
Henryinroad
Junior Member
Junior Member
Posts: 17
Joined: Thu Aug 06, 2020 10:46 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by Henryinroad » Fri Aug 14, 2020 8:27 am

buddtholomew wrote:
Fri Aug 14, 2020 8:16 am
What’s surprising to me is you believe Gold is undervalued or at fair value. Gold is the highest performer in the PP YTD.
It seems that whether an asset class, like GOLD, is
"undervalued or at fair value" or not ,
is not dependent on its past performance.

It's more relevant to the economy at this moment.

Looks at the dollar index, inflation rate, economy growth, interest rate.
User avatar
drumminj
Executive Member
Executive Member
Posts: 319
Joined: Wed Jul 22, 2015 9:16 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by drumminj » Fri Aug 14, 2020 8:28 am

Henryinroad wrote:
Fri Aug 14, 2020 3:21 am
Problem is, when I did that, what freaked me out was the recent overvalued price level of TLT and SPY. This just makes me very hesitant to keep going and ignore the market noise.
How do you know what's overvalued and what's not? Are you smarter than the broad market?

If you think you know better than the market, than the PP probably isn't the right fit for you. Part of sitting well with the PP is accepting you don't know what's going to happen, hence being equally invested in the possible outcomes/economic scenarios.
User avatar
sophie
Executive Member
Executive Member
Posts: 1959
Joined: Mon Apr 23, 2012 7:15 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by sophie » Fri Aug 14, 2020 8:52 am

Every year (except this one I think) there's a poll asking which asset is predicted to do best in the coming year.

Almost every year the consensus prediction has been proven wrong. I think this year most people would have picked stocks as the best performing asset, and....wrong again!

Henry, I think the Harry B. quote you were looking for is "no asset is so high that it can't go higher". In other words what looks "high" to us still doesn't say anything about future performance.

So I guess the answer to "how do I overcome fear of tracking error" is to avoid checking the portfolio too often and just put yourself in the mindset that your investments are on autopilot and don't need you to pet them or whatever it is you do during a check. And when a rebalance is indicated, deal with it mechanically and just do it without letting your emotions get in the way.
User avatar
Smith1776
Executive Member
Executive Member
Posts: 3505
Joined: Fri Apr 21, 2017 6:01 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by Smith1776 » Fri Aug 14, 2020 4:49 pm

I've come to the conclusion that I must be kind of an odd duck when it comes to tracking error regret. I've literally never felt such regret. It's not like I just have some iron clad will that allows me to resist it. I have legit just never felt it.
🛞 The All-Terrain Portfolio 🛞
User avatar
Mark Leavy
Executive Member
Executive Member
Posts: 1950
Joined: Thu Mar 01, 2012 10:20 pm
Location: US Citizen, Permanent Traveler

Re: POLL: How did you overcome the fear of tracking error?

Post by Mark Leavy » Fri Aug 14, 2020 4:55 pm

Smith1776 wrote:
Fri Aug 14, 2020 4:49 pm
I've come to the conclusion that I must be kind of an odd duck when it comes to tracking error regret. I've literally never felt such regret. It's not like I just have some iron clad will that allows me to resist it. I have legit just never felt it.
Heartily agree.
Once you've completely internalized what your allocation is supposed to do, it feels great to watch it do it. I get a thrill out of both the ups and downs. I love watching the movements match the theory.
User avatar
Tortoise
Executive Member
Executive Member
Posts: 2751
Joined: Sat Nov 06, 2010 2:35 am

Re: POLL: How did you overcome the fear of tracking error?

Post by Tortoise » Fri Aug 14, 2020 5:48 pm

The very term “tracking error” never made much sense to me.

If your priority is to track a certain index, then invest in a corresponding index fund.

Otherwise, why even talk about “tracking error”? You’ve chosen to track something else.
User avatar
mathjak107
Executive Member
Executive Member
Posts: 4456
Joined: Fri Jun 19, 2015 2:54 am
Location: bayside queens ny
Contact:

Re: POLL: How did you overcome the fear of tracking error?

Post by mathjak107 » Fri Aug 14, 2020 5:51 pm

Tortoise wrote:
Fri Aug 14, 2020 5:48 pm
The very term “tracking error” never made much sense to me.

If your priority is to track a certain index, then invest in a corresponding index fund.

Otherwise, why even talk about “tracking error”? You’ve chosen to track something else.
I agree ...the term is irrelevant when you are not tracking the same thing
User avatar
buddtholomew
Executive Member
Executive Member
Posts: 2464
Joined: Fri May 21, 2010 4:16 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by buddtholomew » Fri Aug 14, 2020 5:57 pm

I think it’s tracking error with respect to “the market”. I should have just put it in the SP500 like everyone else instead of this weird PP concept. I’m under-performing my peers...

Tracking error can also mean your S&P500 ETF is supposed to match the S&P500 after expenses but it under-performs or over-performs annually by 1%,2%...

The PP is not the S&P so your benchmark is different. Same as if someone held international stocks.
Kevin K.
Executive Member
Executive Member
Posts: 516
Joined: Mon Apr 26, 2010 2:37 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by Kevin K. » Fri Aug 14, 2020 7:58 pm

It's "tracking error regret" not "fear of tracking error." And if you look at Tyler's recent posts in the "commentary" section of Portfolio Charts about portfolios that have done best during recessions and market crises, as well as those that offer the smoothest ride and highest safe and perpetual withdrawal rates, all of them have substantial tracking error relative to the U.S. stock and bond market and classic portfolios like 60:40 or Three Fund as well as more complicated slice-and-dice, value-and-small tilted, internationally-diversified approaches as typified by the Merriman Ultimate.

In your original post about switching from the All Weather to the PP over on Bogleheads you said: "I'm a novice who is seeking a way to produce 7-8% annualized return safely with the least volatility and drawdown risk." That was my dream as well when I left the corporate world prematurely and I implemented a more complex version of this "conservative" MPT portfolio that has been through DFA's backtesting system and *couldn't* lose more than 8% during a market crisis:

https://portfoliocharts.com/portfolio/s ... portfolio/

Back in the real world, my even more diversified version of that portfolio with less than 40% equities was down 23% during late 2008. I'd have been much better off in Vanguard Wellesley, which lost only 12.5% that year and more than recovered in '09.

The PITA with the PP is not just tracking error but owning two assets (gold and LTT's) that mainstream investing sites like Bogleheads think are respectively stupid choices at any time (gold) and an insanely stupid choice at the present time (LTT's) along with a soupçon of plain vanilla stocks and a boatload of cash returning nothing.

In any case, I think you ought to cut your annual return expectations in half to 3-4% and then get clear about whether it's volatility or drawdowns that really bother you. The PP is volatile by design. You could go 100% Wellesley, or 60-70% ITT's and the rest TSM and most likely get the more realistic returns I mentioned without having to own any weird volatile assets but if your bigger concern is robustness during crises and you can live with the tracking error I still haven't found a better "bunker" than the PP.
Last edited by Kevin K. on Fri Aug 14, 2020 11:55 pm, edited 2 times in total.
Henryinroad
Junior Member
Junior Member
Posts: 17
Joined: Thu Aug 06, 2020 10:46 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by Henryinroad » Fri Aug 14, 2020 9:59 pm

Kevin K. wrote:
Fri Aug 14, 2020 7:58 pm
It's "tracking error regret" not "fear of tracking error." And if you look at Tyler's recent posts in the "commentary" section of Portfolio Charts about portfolios that have done best during recessions and market crises, as well as those that offer the smoothest ride and highest safe and perpetual withdrawal rates, all of them have substantial tracking error relative to the U.S. stock and bond market and classic portfolios like 60:40 or Three Fund as well as more complicated slice-and-dice, value-and-small tilted, internationally-diversified approaches as typified by the Merriman Ultimate.

In your original post about switching from the All Weather to the PP over on Bogleheads you said: "I'm a novice who is seeking a way to produce 7-8% annualized return safely with the least volatility and drawdown risk." That was my dream as well when I left the corporate world prematurely and I implemented a more complex version of this "conservative" MPT portfolio that has been through DFA's backtesting system and *couldn't* lost more than 8% during a market crisis:

https://portfoliocharts.com/portfolio/s ... portfolio/

Back in the real world, my even more diversified version of that portfolio with less than 40% equities was down 23% during late 2008. I'd have been much better off in Vanguard Wellesley, which lost only 12.5% that year and more than recovered in '09.

The PITA with the PP is not just tracking error but owning two assets (gold and LTT's) that mainstream investing sites like Bogleheads think are respectively stupid choices at any time (gold) and an insanely stupid choice at the present time (LTT's) along with a soupçon of plain vanilla stocks and a boatload of cash returning nothing.

In any case, I think you ought to cut your annual return expectations in half to 3-4% and then get clear about whether it's volatility or drawdowns that really bother you. The PP is volatile by design. You could go 100% Wellesley, or 60-70% ITT's and the rest TSM and most likely get the more realistic returns I mentioned without having to own any weird volatile assets but if your bigger concern is robustness during crises and you can live with the tracking error I still haven't found a better "bunker" than the PP.
Thanks for your encouragement. My risk appetite is similar to yours. Heartily agree with most of your points.

To rephrase my struggle: do u think GOLD + TIP + CASH would be better "bunkers" than TLT

My major concern is more related to the "death" of TLT. That the TLT would lose its stablization function.

The problem is, what happened in the past wont necessarily happen in future. The backtesting result you and I see on the computer screen does not take sth in account: negative interest rate

The model of PP is invented by Harry Browne, but he seemed also not able to foresee today's extremetly distorted environment, the level of interest rate, and the potential blow to nominal bond.

What's your opinion after reading this:
https://www.bridgewater.com/grappling-w ... everywhere

Much appreciated for any thought, thanks again
User avatar
Tyler
Executive Member
Executive Member
Posts: 2066
Joined: Sat Nov 12, 2011 3:23 pm
Contact:

Re: POLL: How did you overcome the fear of tracking error?

Post by Tyler » Fri Aug 14, 2020 10:27 pm

Henryinroad wrote:
Fri Aug 14, 2020 9:59 pm
The problem is, what happened in the past wont necessarily happen in future. The backtesting result you and I see on the computer screen does not take sth in account: negative interest rate
That's only partially true. If you look at real rates rather than nominal rates, the low rates today are not that unusual and negative real rates have been much deeper in the past than they are now.


Image


In fact negative real rates are one of the situations where gold tends to shine. So I'd argue that the PP is better prepared for this situation than almost any traditional portfolio of stocks and bonds.

Along that line, one way to overcome the fear of a portfolio is to appreciate the strength of the team over the daily performance of any one player. A well-built portfolio expects the worst and thrives in adversity.
User avatar
mathjak107
Executive Member
Executive Member
Posts: 4456
Joined: Fri Jun 19, 2015 2:54 am
Location: bayside queens ny
Contact:

Re: POLL: How did you overcome the fear of tracking error?

Post by mathjak107 » Sat Aug 15, 2020 2:22 am

the problem is most don't see negative real returns as a problem .. but nominal is a whole other issue .

negative nominal rates act as a tax on bank reserves . it encourages banks to make loans .

we dont have as tight a loan restrictions as japan or Europe . we tend to have much easier loan requirements as well as banks make riskier loans for ventures here .

so negative rates are not needed here and we likely will not see them .

]
User avatar
sophie
Executive Member
Executive Member
Posts: 1959
Joined: Mon Apr 23, 2012 7:15 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by sophie » Sat Aug 15, 2020 8:05 am

Kevin K. wrote:
Fri Aug 14, 2020 7:58 pm
The PITA with the PP is not just tracking error but owning two assets (gold and LTT's) that mainstream investing sites like Bogleheads think are respectively stupid choices at any time (gold) and an insanely stupid choice at the present time (LTT's) along with a soupçon of plain vanilla stocks and a boatload of cash returning nothing.
Well put!

Yes, the issue is not so much "tracking error" as owning an unconventional set of assets that you constantly feel have to be proven worthy. The PP is quite extreme that way, it's not just a small slice of gold added to an otherwise conventional portfolio. 75% of the PP assets are sneered at by conventional investors.

And if the PP has an extended period of underperformance compared to a standard portfolio (e.g. 80/20 or 60/40) then you feel like maybe those guys might be right and you are doing something wrong. You kind of have to get to a point where you really don't care, and keep reminding yourself that the tracking error disappears over long periods of time.
glennds
Executive Member
Executive Member
Posts: 1265
Joined: Mon Jan 28, 2013 11:24 am

Re: POLL: How did you overcome the fear of tracking error?

Post by glennds » Sat Aug 15, 2020 9:22 am

Tyler wrote:
Fri Aug 14, 2020 10:27 pm
Henryinroad wrote:
Fri Aug 14, 2020 9:59 pm
The problem is, what happened in the past wont necessarily happen in future. The backtesting result you and I see on the computer screen does not take sth in account: negative interest rate
That's only partially true. If you look at real rates rather than nominal rates, the low rates today are not that unusual and negative real rates have been much deeper in the past than they are now.


Image


In fact negative real rates are one of the situations where gold tends to shine. So I'd argue that the PP is better prepared for this situation than almost any traditional portfolio of stocks and bonds.

Along that line, one way to overcome the fear of a portfolio is to appreciate the strength of the team over the daily performance of any one player. A well-built portfolio expects the worst and thrives in adversity.
It would be very interesting to see that same chart with a line plotted for inflation. That would isolate the two reasons for negative real rates and illustrate their relationship to each other over time.
pp4me
Executive Member
Executive Member
Posts: 1190
Joined: Wed Apr 29, 2020 4:12 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by pp4me » Sat Aug 15, 2020 11:10 am

Fortunately I never even heard the term "tracking error" until after I had been using the PP for several years so I had no fear to overcome.

Just looked it up and I still don't get it.
What Is a Tracking Error?
Tracking error is the divergence between the price behavior of a position or a portfolio and the price behavior of a benchmark. This is often in the context of a hedge fund, mutual fund or exchange-traded fund (ETF) that did not work as effectively as intended, creating instead an unexpected profit or loss.
What benchmark are they using to track the "error" any way?

Reminds me of my first wife who was always asking why we didn't have a lot of the things other people did even though I probably made a lot more money than they did. My answer was I don't know and I don't care. Their business is theirs and ours is ours.
User avatar
I Shrugged
Executive Member
Executive Member
Posts: 2062
Joined: Tue Dec 18, 2012 6:35 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by I Shrugged » Sat Aug 15, 2020 12:41 pm

I would have a hard time buying in today. Because I'm a chicken.
But over time, I'm in the same camp as Smith and Mark. I no longer pay attention to tracking error. My PP has a beautiful track record to look back on, and it makes me feel good.

My answer would be to dollar cost average into it over a year or three.
ppnewbie
Executive Member
Executive Member
Posts: 850
Joined: Fri May 03, 2019 6:04 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by ppnewbie » Sun Aug 16, 2020 2:19 am

You have an interesting dilemma. The stock market is currently fake. TLT is bloated and could pop if we experience inflation. I would look at Tyler’s work at portfolio charts on start date sensitivity. Try to view the entire portfolio as one entity. IE If TLT collapses - gold and stocks would likely go up. Also Tyler (portfoliocharts.com) has an excellent post on bond convexity.I would recommend reading Craig Rowland’s book on the permanent portfolio. All that said VOO / VTI and TLT make me nervous as well. Love my gold.
User avatar
mathjak107
Executive Member
Executive Member
Posts: 4456
Joined: Fri Jun 19, 2015 2:54 am
Location: bayside queens ny
Contact:

Re: POLL: How did you overcome the fear of tracking error?

Post by mathjak107 » Sun Aug 16, 2020 3:10 am

if tlt gets hit that bad i don't see how equities will do well nor gold ... high rates are kryptonite to the pp in my opinion.

we never have had a bear market in bonds in my investing life time .. for 40 years rates have only trended down except for a speed bump perhaps in a year , only to trend down further
Henryinroad
Junior Member
Junior Member
Posts: 17
Joined: Thu Aug 06, 2020 10:46 pm

Re: POLL: How did you overcome the fear of tracking error?

Post by Henryinroad » Sun Aug 16, 2020 7:50 am

Tyler wrote:
Fri Aug 14, 2020 10:27 pm
Henryinroad wrote:
Fri Aug 14, 2020 9:59 pm
The problem is, what happened in the past wont necessarily happen in future. The backtesting result you and I see on the computer screen does not take sth in account: negative interest rate
That's only partially true. If you look at real rates rather than nominal rates, the low rates today are not that unusual and negative real rates have been much deeper in the past than they are now.


Image


In fact negative real rates are one of the situations where gold tends to shine. So I'd argue that the PP is better prepared for this situation than almost any traditional portfolio of stocks and bonds.

Along that line, one way to overcome the fear of a portfolio is to appreciate the strength of the team over the daily performance of any one player. A well-built portfolio expects the worst and thrives in adversity.
Hi Tyler, want to say I just came across your web many members mentioned and have huge respect to your web that puts everything together, like, in explaining the convexity concept of bond. Its truly nice to have an objective point of view instead of one-sided argument in favor or against TLT.

Though I have one question:
1) For longer duration bonds, once the interest rate is getting lower and negative , their values can appreciate at a much greater pace, and act as a nice protection to the portfolio.

But one concern raised by some investors like Ray Dalio is more about how low the yield could go, here's the extract of the article from https://www.bridgewater.com/grappling-with-the-new-reality-of-zero-bond-yields-virtually-everywhere:

While one can’t say for sure how low yields could go, the obvious limitation is that at a certain level, cash hoarding becomes a more attractive alternative. Given the frictions between the central bank policy rate and the rates facing other borrowers and lenders (we would guess around -1%), policy rates would be unlikely to trigger a move to cash in most countries. Below that point, it becomes less clear. And at least for now, central bankers across the world have expressed growing hesitancy about further use of negative rates as a policy tool, in particular focusing on the potential adverse effects for the banking system, which could weaken the efficacy of such policies.

My confused thought:

If the yield still haven't reached -1% and -1% is the lowest bottom yield can go:
We could still expect to see an asymmetrical potential reward (biased towards the upside) in TLT, and its worth holding some to hedge against risk of further interest reduction.

However, if the yield already reached the -1% and -1% is the lowest bottom yield can go:
It bascially means all potential reward are fully exhausted, and TLT basically couldn't have any asymmetrical potential rewards?

What are your point of view with regard to the lowest limit of the yield?

2) Aside from GOLD, do you think TIPs are good diversifiers we could consider as inflation-hedge assets?
Post Reply