Structural Dynamic Allocation using Modified HBPP

[LittleD]

I'm new to the forum but have been a lurker for a couple of years now.  I have been using the HBPP for sometime with
minor modifications.  I also follow Mebane Faber and his fine research work and thought I would post this research project from Gestaltu on a variation of the Harry Brown methodology.  I know they do evaluate many more asset classes than used in the standard HBPP but their research using risk parity allocation and momemtum seems valid from an intuitive review.  I would be interested in what the experts on this board think of their research and if their strategy might help some of the "nervous hands" out there stay the course with Harry's philosophies.



http://gestaltu.com/2013/10/dynamic-ass ... olios.html

[craigr]

I would be interested in what the experts on this board think of their research and if their strategy might help some of the "nervous hands" out there stay the course with Harry's philosophies.

IMO. The absolutely biggest threat to an investment portfolio is the investor running it. The psychology of investing is tricky and can lead people to make all sorts of bad decisions. I feel that those bad decisions are greatly amplified when you introduce things like:

1) A very complicated investment portfolio.
2) Any kind of market timing.
3) Frequent rebalancing requirements.

Complicated investment portfolios require a lot of monitoring. But humans are really bad at looking at their investments frequently and losses/gains can trick you into making decisions that are bad long-term. For instance, losses in an asset become more painful the more you see them. So if you are looking at things daily or even weekly you run the risk of getting really on edge and making a knee jerk reaction like dumping an asset entirely. Likewise for gains you run the risk of wanting to pile into supposedly easy riches and really crank your risk of a large loss up considerably.

Then there is the market timing aspect that can also roll into rebalancing. Basically every time you introduce a situation where you are buying/selling an asset based on some kind of signal or some kind of tight rebalancing band you have an opportunity to second-guess your decision. Not only do you have the first part to buy/sell an asset. But you get to do it *again* when you buy/sell into another asset with the proceeds.

The thing is rebalancing sounds so easy to do on a spreadsheet and backtest. But in reality, most humans are really horrible at doing rebalancing in real life and lose the nerve or second-guess the decision constantly. They are also open to influence from external sources that could be offering really bad advice (stock gurus, latest hot tip, what is going on in the news that day, etc.). So all things considered, it's best for a portfolio to rebalance less frequently than more frequently.

So while I understand the theory behind more complicated strategies in terms of balanced risk, maybe better returns, etc. The reality to me is that most investors should just stick to something simpler because they are less likely to tamper with things. As a result, they will stay fully invested and have a better chance of obtaining maximum gains available to all market participants.

The above also doesn't account for the actual operational costs of a portfolio that contains many different funds and requires more frequent trading (higher fees, commissions, taxes, etc.). My experience has always been that a portfolio that is expensive to operate will under perform a simple portfolio that keeps costs as low as possible.

So my advice is, and has been for years, to keep investing as simple as possible. That's why I personally stick to the four basic asset classes and don't do anything tricky. Simplicity is a core investment principle for me and is really important for long-term success.

[LittleD]

What you write is true in most cases but still, even with simple portfolios, individuals will still try the oldest market timimg method I've heard of...The ICSIA method (I can't stand it anymore).  You could well be right that that methodology could be too complicated for many to implement.  The things I thought were interesting were the number of classes found appropriate; The small amount of allocation to each slice of the pie; That much uncorrelation could make it more of a smooth ride into the future. 

As if you say, money always flows from the overvalued asset into another asset class, this portfolio might just capture most of the flows of capital?  Costs of rebalancing can always be a big deterrent, but with this many slices of a total pie, you might just be able to stand pat for long periods of time.  If you can fill the slices with low cost ETF's, it might not be all that much trouble to at least explore it.

Always value your comments, Craig...

[craigr]

What you write is true in most cases but still, even with simple portfolios, individuals will still try the oldest market timimg method I've heard of...The ICSIA method (I can't stand it anymore).  You could well be right that that methodology could be too complicated for many to implement.  The things I thought were interesting were the number of classes found appropriate; The small amount of allocation to each slice of the pie; That much uncorrelation could make it more of a smooth ride into the future.

Yes I agree it could smooth things out as you may have sub-assets that don't go down as much as a major one.

Then again, you could find those smaller specialty assets could collapse even harder in a particular wedge of the portfolio and that amplifies losses.

For instance in 2008 people that held lots of mining stocks got creamed even though the gold bullion wedge showed a slight gain. So there was a miscalculation in how the assets would perform. Same thing happened for commodities vs. gold. Many people thought gold and commodities were interchangeable, but when the banking system was in serious crisis the commodity funds took a serious beating where gold didn't.

So it could be by adding more asset classes you make the risk analysis much harder and the interaction between the assets very hard to predict.

As if you say, money always flows from the overvalued asset into another asset class, this portfolio might just capture most of the flows of capital?  Costs of rebalancing can always be a big deterrent, but with this many slices of a total pie, you might just be able to stand pat for long periods of time.  If you can fill the slices with low cost ETF's, it might not be all that much trouble to at least explore it.

Always value your comments, Craig...

In general I always fall back to simple is better than complex. Whether it's investing, designing a product, etc. My gut feeling is that a portfolio with 10+ asset classes will just be too hard to manage and introduce a lot of unforeseen consequences if the markets do something really screwy. So my first reaction is to always avoid making things overly complex.

But with that said, there is nothing wrong with adding some of these assets to a variable portfolio if one wanted to do so. For instance, people have made good arguments for more international exposure or even real estate exposure bringing the total asset classes in the portfolio from four to six. I don't have a strong argument against this if they know the risks involved. My only comment really is to be sure emotionally it's something you can handle as an investor. Over time I've just found for myself and others that keeping things very simple is a significant tactical advantage for investing. It's an advantage because it really eliminates a ton of behavioral finance gotchas that are lurking inside of complicated portfolios.

I truly and honestly feel that the more opportunities an investor has to tinker with their portfolio, the worse it is likely to perform long-term. But that's just my experience and everyone needs to approach the situation in a way that's best for them.

[LittleD]

Yes I agree it could smooth things out as you may have sub-assets that don't go down as much as a major one.

Then again, you could find those smaller specialty assets could collapse even harder in a particular wedge of the portfolio and that amplifies losses.

For instance in 2008 people that held lots of mining stocks got creamed even though the gold bullion wedge showed a slight gain. So there was a miscalculation in how the assets would perform. Same thing happened for commodities vs. gold. Many people thought gold and commodities were interchangeable, but when the banking system was in serious crisis the commodity funds took a serious beating where gold didn't.

So it could be by adding more asset classes you make the risk analysis much harder and the interaction between the assets very hard to predict.

You make a good case as always and I have no quibble.  Reading this board for the last few years as well as Bogleheads, Mebane Faber & Paul Merriman, I get a sense that even with really easy portfolios and rebalancing rules (refered as market timing by some) there are still lots of people really more risk averse than they admit.  Most likely those people who just can't stand to lose a single percent would be better off getting a financial advisor to manage their portfolio under the rules that they could live with.  That way the portfolio could be managed for risk mechanically without them even looking at it.  We all know that market timing in any form is just downside portfolio insurance and any insurance has a cost associated with controlling that risk.  There is no free lunch and you give up some asset return for that risk mitigation whatever technique you use.  I would never invest in a risky asset class such as "gold mining stocks" without a hedge to mitigate risk (Sell Stop). 

I do appreciate your comments and teaching, Craig.
Have an awesome day!

[modeljc]

I would be interested in what the experts on this board think of their research and if their strategy might help some of the "nervous hands" out there stay the course with Harry's philosophies.

IMO. The absolutely biggest threat to an investment portfolio is the investor running it. The psychology of investing is tricky and can lead people to make all sorts of bad decisions.

I agree.  But a real problem for most of us is chasing performance.  It is so hard to stick to a plan.  Look at the result of buying gold at the bottom in 1982 and holding it for 19 years until the year of 2000.  The return is -2.0%. 

Most of us will have a hard time with 25% allocation in Gold.  We are force to sell good performing assets to re balance into an asset class that return -2.0% for 19 years!

Human nature just will not let most of us stick to a losing plan for years and years.

So while a simple allocation probably wins it just is not going to work for most of us.

I am a fan of the PP and am not going to change as I am 76 years old.

I like the idea of smaller asset percentages.  Yes more expensive and harder to manage.

I don't think you need 10 asset classes but something along the lines of the SAXO Bank global may be the ticket.  Craig posted a link and I think it is worth following for several years.  Here is the link again:

http://www.tradingfloor.com/posts/globa ... 1436493309

The short Introductory video is a good starting point.

[KevinW]

Reading this board for the last few years as well as Bogleheads, Mebane Faber & Paul Merriman, I get a sense that even with really easy portfolios and rebalancing rules (refered as market timing by some) there are still lots of people really more risk averse than they admit.

+1

I have also been participating in investing forums for some years, and have read thousands of pages of investing literature, and have come to the same conclusion. Most everyone is more risk-adverse than they or mainstream advisers will admit. In the terms of Boglehead "need, willingness, and ability" to take risk, it seems like most people should be at 0-30% stocks. WAY lower than 70/30 or "age in bonds." Holding a volatile portfolio requires a combination of self-assuredness, confidence the status quo mixed capitalist system, and a bit of recklessness; that combination certainly exists, but is rare.  The default advice should be something like the PP or a 20/80 index portfolio, not the usual stock-heavy portfolios that very few people can actually follow through on.

[craigr]

IMO. Most investors with a stock heavy portfolio will under perform an investor with less stock exposure over time. The primary reason for this is volatility in the portfolio will cause the stock heavy investor to bail out and get caught in market timing traps that kill performance. 

My core view on retirement savings is to try to grow it at a reasonable rate but don't expose it to large losses. If you want to swing for the fences, take the risk in your career and not your life savings. Meaning try starting a business, going for better promotions, etc. If you have excess savings you can afford to lose, then buy some more stock exposure if you can stomach it.

Also I think there is a ton to learn from the extreme retirement folks. Not that I think living in a 200sq. ft. room is a good living. But rather the importance of spending wisely is really under-rated. One of the most important lessons I think from that realm is how expensive it is to re-earn a dollar that is spent (might cost $1.50 to re-earn that $1 after taxes, expenses, etc.). So not spending needlessly is very important. It's much easier to save $1 than to invest a $1 and hope to turn it into $1.50 quickly.

[LittleD]

Craig, you make fine salient points and I agree with many.  I just know from reading posts of many boards that when the markets are even down 2% people start getting nervous and trying to find an easy exit.  I suspect many of these folks should just bite the bullitt and put their money in an SPIA and just get the monthly check.  Investing in any asset class even bonds & treasuries have some risk.  My only thought with submitting this research article for the members review and comment was to validate that the 10 asset classes were properly described and slotted in such a portfolio.  I am much like you in that I don't care to take risk I can't identify or quantify to some degree.  I gravitated to the HBPP because after listening to Harry and your wisdom, I felt that even 25% equities could be to much risk in a portfolio.  I beginning to feel that if I can consistantly beat an all weather bond portfolio, it might be enough.  This 10 class portfolio at least would not be catastrophic if one class were to go belly up. 

Thanks for the welcome and I will continue to monitor the comments.

[KevinW]

Yeah. Or, everyday investors should use a fund-of-funds so that the rebalancing happens automatically and there is no opportunity to screw it up.

[LittleD]

Yeah. Or, everyday investors should use a fund-of-funds so that the rebalancing happens automatically and there is no opportunity to screw it up.

Well said...  It seems sad that so many are behind the 8 ball trying to save up enough for retirement that they keep making the same errors with portfolio management.  It's so hard to stay the course when 1 asset class goes down 30% like Gold and they sell out after it's gone down.  It appears to me that "Buying High and Selling Low" is a character flaw that most investors have to overcome if they ever expect to reach their goals.  I do agree with you that in many cases, investors should search their thoughts and finally decide to let an unbiased 3rd party manage their savings.

[WhiteDesert]

I agree 100%.  Rather than the "standard" 60/40 portfolio, I think the default should be 20/80 (or the PP).  And I'm becoming convinced that it's probably better for many investors not to rebalance into equities during market declines.  In other words, I think rebalancing out of equities to maintain the target risk profile makes sense, but rebalancing into equities in the event of a prolonged Japan-style decline in the market would be very destructive.  I think the quick rebound from the 2008 decline has built a bit of a false sense of security.

Responding to the highlighted portion above (bolding and underlining mine):
So you're advocating only rebalancing into said declining asset after it hits some inflection point and essentially isn't declining anymore? It will interesting to see how effectively we determine that gold has turned that corner.

[Latterly]

I'm new to the forum but have been a lurker for a couple of years now.  I have been using the HBPP for sometime with
minor modifications.  I also follow Mebane Faber and his fine research work and thought I would post this research project from Gestaltu...  I would be interested in what the experts on this board think of their research and if their strategy might help some of the "nervous hands" out there stay the course with Harry's philosophies.

http://gestaltu.com/2013/10/dynamic-ass ... olios.html

Another long-time lurker here, with a pure HBPP. That article reminded me of this Dilbert strip: http://dilbert.com/strips/comic/1997-03-06/. Articles like that have one primary purpose, and it's not educational ;-).

I recently had the opportunity to advise an investment-averse family member, and concluded that the Vanguard LifeStrategy Income fund (which is 20/80, automatically rebalanced) would be better for her than a PP because it would allow her to make one simple investment decision, with no further action required--not even yearly rebalancing. Returns would likely be lower and volatility higher than a PP, but in the long run it would do better than the portfolio constructed by her professional financial advisor.