30/60/10 vs HBPP

[push3r]

I was reading a forum post at bogleheads which is a discussion thread for a blog post at bogleheads blog with regards to the HBPP. http://www.bogleheads.org/forum/viewtop ... 38272  Someone by the alias of "Desert" suggested that a portfolio of 30% stocks / 60% intermediate bonds (say, 10 years) / 10% gold would beat the HBPP in all categories: return (very close), drawdown, volatility, and sharpe ratio. 

So, I pulled up a website to back test and used http://www.peaktotrough.com/hbpp.cgi.  Check it out. It's true that this 30/60/10 is very close to the HBPP. Starting from 1972 to present.

What do you think?

Quoting "Desert":
Yes, the 25/75 portfolio looks excellent for the risk averse investor. The treasuries do a better job than corporates during really steep equity declines, presumably because of the "flight to safety" behavior. A similar portfolio that might appeal to both PP shoppers as well as 25/75 investors is the following mix: Bump up the equity percentage to 30% in an effort to capture a bit more ERP. To counter the increased equity volatility, lengthen the maturity of the treasuries from 5 years to 10 years. And finally throw in 10% gold. This 30/60/10 portfolio did even better than the 25/75% mix (and better than the PP), and it also allows the investor to hold enough gold to provide a significant insurance benefit in the event of serious left tail events.

And yes, the 30/60/10 outperformed (higher return, lower volatility) than a 30/70 mix. The uncorrelated gold does a good job of smoothing out the ride, even with a mere 10% allocation. It's an extremely low-cost portfolio as well. The treasuries can be purchased through vanguard, so there is no expense ratio for the 60% allocation. VTI (or VT, if international allocation is desired) can provide the equity allocation at low cost. And gold can be held via GLD or in physical form.

[dualstow]

Desert's here, too, so I guess he'll chime in.

[barrett]

Push,

I am posting more than usual today because my back is keeping me from moving around much. So, it's just possible the quality of my advice could be off but here's what I think...

That strikes me as a good asset mix but I don't like that there is no cash in there. Cash is often referred to the "most under appreciated aspect of the PP" or some variation thereof. If you are young and accumulating fairly quickly, you might not have to worry about the cash as much because you can just keep adding to lagging assets. Generally though we think of cash as "dry powder" that allows us to take advantage of market dips and buy assets when they are cheap.

Alas when stocks went south in 2008, I didn't have any cash readily accessible. At least I didn't panic sell but it would have been great to have been in a position to pick up some cheap equities. Most people in the PP at that time just sold LTTs and bought stocks as part of a regular rebalancing back to the 25% bands.

In short, without a cash allocation, you would definitely have to sell something (maybe at an inopportune time) when it comes time to rebalance.

[I Shrugged]

Cash is what I wonder about.  To me it is just undeployed investment money.  I am keeping my 25%, but for what purpose?  I don't need it to keep me calm.  And it's yielding nothing.  Of course I recall when cash earned double digits or close. It seems like if your PP becomes big enough, there should be a ceiling on the dollar amount to keep in cash.  I confess to keeping most of my "cash" in Vanguard short term bond funds, though.  Roughly, I'm probably as close to the 30-60-10 AA as I am to the 4x25 right now.  I'm like 34-50-16, with the 50 mixed between long and short term bonds and funds.

I have to think some more about this. 

[barrett]

Shrugged,

As you probably know, a lot of people hate the 25% cash position and try to fudge it. I have a lot of my "deep" cash in savings bonds that are yielding 4% or better. I don't have enough real cash (short-term treasuries) to be able to rebalance quickly and without tax consequences (the savings bonds are in taxable). But I am working on building that up some. It's cheating on the pure HBPP concept but we all have to be able to live with our investments.

The pure 4 X 25 balance is what I am to be at when I retire. But that is easy to say now. If short-term rates are still at zero I'll fudge somehow probably. I like your ceiling idea. And I guess "big" is relative. Hmm.

[Pointedstick]

This 60-30-10 portfolio seems to make a lot of sense when 1) you don't need the cash cushion for withdrawals or anything else and 2) cash yields are in the toilet.

[rickb]

30/60/10 is basically a slightly out of balance 4x25 PP.  The cash and long term treasuries in the PP are more or less equivalent to intermediate bonds when considered together.  So, the PP is 25/50/25 when considering the same assets as the 30/60/10.  Slightly more stocks, and less gold - but really not that different.

[KevinW]

Well, way back in 2013, a 4x25 PP with cash did better than a 3x33 with no cash...

[push3r]

How would one rebalance the 30/60/10 portfolio? 

[I Shrugged]

Looking back at Craig and Jim's book, I see they said if your PP gets big enough, consider keeping one year's expenses in cash and the rest in short term treasuries.

[AdamA]

30/60/10 is basically a slightly out of balance 4x25 PP.  The cash and long term treasuries in the PP are more or less equivalent to intermediate bonds when considered together.  So, the PP is 25/50/25 when considering the same assets as the 30/60/10.  Slightly more stocks, and less gold - but really not that different.

I agree.  I think either one would work fine.  Whichever you choose, though, you have to stick to it.

If you waffle, you'll probably lose.  I like the 25% bc it's psychologically the easiest for me.  All assets get equal treatment. 

[buddtholomew]

I don't recall having this much freedom to adjust the 25% allocation to gold. I would be careful reducing your allocation because of recent poor performance. The PP selects the most volatile assets for a reason. Dampening volatility with additional cash is the recommended approach. With that said, a 30/60/10 allocation is suitable for a conservative investor who has a distaste for gold and no need for cash.

[jason]

How does re-balancing work?  Also, this would be much more inefficient from a tax perspective, given that the interest on Treasuries is taxed as ordinary income.

[Kevin K.]

I've been mulling over this post for awhile. I don't want to overempathasize porfolio backtesting, but I certainly was impressed by how superior Desert's 60/30/10 allocation was to the PP when I ran the numbers on Peak to Trough.

As a frugal early retiree living off of assets I don't see the lack of cash in this allocation as a huge problem. Certainly one could keep a year's living expenses in high-yielding cash and treat it as part of the bond allocation withou skewing the results much at all, or just use a low-cost intermeditate term Treasury ETF for part of the 60% and sell a chunk when needed.

The other thing that made me think again about this was reading William Bernstein's very recent booklet, "Skating Where the Puck Was: The Correlation Game in a Flat World." I was familiar with his previous positive comments about the PP, so this section towards the end of the essay came as a bit of a surprise:

Still, the Harry Browne portfolio looks too good to be true. What’s wrong with this picture? Several things. For starters, gold was not easily investible during the first decade of this period; in fact, it was downright illegal to sown the stuff from 1933 to 1974. Start the analysis in 1980, for example, and you were a full percent better off leaving it out of the portfolio entirely (i.e. owning one third stocks, bonds and bills). Put another way, you can go off the gold standard and open up its ownership only once. It seem highly unlikely that gold will return several percent more than inflation in the coming decades; almost by definition, zero percent above inflation seems more like it.

Next, compare the difficulty of purchasing and storing gold in, say, 1975 with the ease of buying a gold ETF today. (You’re aware, of course, that GLD is, as of this writing, one of the world’s largest ETFs.). If you’ve read this far, you realize that ease of purchase is a warning signal that the asset class in question’s correlations with other risky assets has risen.

Likewise, the less than 2% gap that separated stock, bonds, and gold for 1964-2011 does not manke any sense, and for much the same reason: The period, particularly its last half, saw a historic bull market in both bonds and gold, a pairing of events not likely to recur any time soon. Assume the same 4% inflation rate for the next several decades, and the returns of stocks look like thy will fall slightly from 9.58% to around 7% (4% inflation plus 2% dividends plus 1% dividend growth), the returns of gold from 8.15% to 4%, the returns of long bonds from 7.77% to the current yield of 2.8%, and bills from 5.33% to God only knows what, but likely close to the assumed inflation rate of 4%. Average together all 4 of these numbers and you get an expected return of...4.5%/0.5% nominal/real. You’ll gain some return from rebalancing, but lose most of that to investment expenses. There will be tears.

So why I’ll admit that the Harry Browne portfolio still has a lot to recommend it, I’m not sanguine about its current popularity, which rests on the salutary recent performance of its two most unorthodox risky components, gold and long bonds. Both investment history and human psychology suggest that when these two asset classes turn sour, as they will one day, Harry Browne adherents will abandon the approach in droves, as suggested by fund flows in and out of the Harry Browne-inspired Permanent Portfolio (PRPFX) over the past few decades.

[sophie]

It's not a bad way to manage a near-PP in a limited retirement fund, if you can supplement with the gold portion outside of your retirement plan or use a brokerage window if you're lucky enough to have one.

Note also that it's not too dissimilar to one of MediumTex's favorite super-simple investing recommendations:  the Wellesley fund supplemented with 10% gold.

I agree with AdamA and others who are reluctant to mess with the HBPP - you can prove lots of things with backtesting that won't necessarily pan out going forward.  And that's one of the problems with backtesting:  if you tinkered with the PP once, who says you won't tinker with it again, and again.  Whereas with backtesting you assume no tinkering for 20+ years - highly unlikely!  Sticking with a strategy that you won't second guess constantly is probably more important than slightly increasing returns.

That said...I have wondered about the wisdom of holding 25% gold, and whether the PP's returns were significantly juiced by the never-to-be-repeated 1972-74 gold bonanza.  Reducing to 30/30/30/10 is an idea I would like to ruminate about some more.  Not sure I want to give up on the barbell strategy though...having cash has a LOT of advantages.

[rickb]

That said...I have wondered about the wisdom of holding 25% gold, and whether the PP's returns were significantly juiced by the never-to-be-repeated 1972-74 gold bonanza.  Reducing to 30/30/30/10 is an idea I would like to ruminate about some more.  Not sure I want to give up on the barbell strategy though...having cash has a LOT of advantages.

Hmmm.  There are lots of portfolios that will do fine in relatively normal times.  The question is how extreme are the abnormals that a portfolio can withstand.

How about 90% drop in the stock market?  BTW, this is what happened between 1929 and 1933.

How about 75% drop in the price of gold?  Again, it happened between 1980 and 1999.

How about long term interest rates spiking up to 15%?  Guess what?  It happened in 1981.

How about hyperinflation (inflation of 50%/month)?  Yup.  Happened (pre WWII Germany, Argentina, Zimbabwe, etc etc etc).

How about currency collapse?  Too many examples to cite, i.e. pretty much every single currency ever used in the history of the world, except those currently in use.

How about government collapse?  Again, too many examples to cite, i.e. every single government in the history of the world, except the ones currently in existence.

The point is that some of these don't go so well without a significant allocation to gold.  If you want to dismiss these as "not going to happen", then fine.  But understand there are scenarios where you will lose everything except the gold you can hold in your hands.  And these scenarios have definitely happened in the past.  And they'll definitely happen in the future.  Will they happen to the US in your lifetime?  Who knows. 

Paraphrasing Dirty Harry: But being these are scenarios that will blow away everything you own except gold, you've gotta ask yourself one question: "Do I feel lucky?" Well, do ya, punk?

The point is not to keep up with the Joneses.  The point is to have a portfolio that more or less keeps up in normal times, but will preserve your accumulated wealth even if the Joneses are absolutely crushed.

[stuper1]

The point is not to keep up with the Joneses.  The point is to have a portfolio that more or less keeps up in normal times, but will preserve your accumulated wealth even if the Joneses are absolutely crushed.

Very well said.  You really captured the point of holding 25% gold right there.

[l82start]

Paraphrasing Dirty Harry: But being these are scenarios that will blow away everything you own except gold, you've gotta ask yourself one question: "Do I feel lucky?" Well, do ya, punk?

i like this!...  that is a signature worthy quote... 


the post, in its entirety, would be a good addition to any boglehead gold bashing thread as well..

[Kevin K.]

Much as I love the Dirty Harry quote - and got into the PP in good part because of its "bunker in the event of Armageddon" design, I think there are plenty of counterarguments worth making here - most of them already made by Mr. Bernstein.

It's "permanent" designation notwithstanding, the PP allocation was and is a product of brilliant thinking in response to circumstances of Mr. Browne's time. Obviously it was designed to withstand any kind of event that had happened in the past or that he could foresee happening, but that doesn't mean he wouldn't have changed the allocation (as he did, significantly, even during his lifetime) had he foreseen systematic manipulation of the gold market, the effects of gold ETFs, and the kind of worldwide correlation of all asset classes that's been made possible by the internet and high-speed trading.

We really don't have enough history with many of these asset classes for backtesting to be all that useful. I mean of course gold has 5000 years+ of history but IMHO what's relevant for U.S. investors is the history since 1975, which is very brief. The paper gold market changes everything, the ability to manipulate the price as happened in 2013 is fairly unprecedented, and the powers of governments (with ours at the top of the list) to confiscate should they choose to do so are also unprecedented. I still believe gold is a vital asset to hold, but I think 25% deserves questioning. I also think the fact that the 60:30:10 allocation did in fact perform better than the PP during the market crises that have happened in our lifetimes deserves to be taken into account.

The rest of Bernstein's essay (it's short - an easy hour read) is also worthwhile, in part because given what has happened with the financial markets during his investing career he's recommending keeping a signficant portion of one's assets outsides the markets altogether. I think he and Harry Browne would have gotten along just fine despite Bernstein's recent comments on the PP.

[Kevin K.]

Before committing to the PP I, like any number of other folks here, had a complex, slice-and-dice portfolio; watching all of its purportedly non-correlated assets tank in unison during the 2008 crash was a major wake-up call. I still follow the returns of that kind of portfolio, and also appreciate the market insignts of one of the smartest DFA-oriented advisors I've come across.

Here's a link to a worthwhile article from earlier this year on market performance from 2000-2013 that does a brilliant job of contrasting the ongoing Wall Street hype/narrative about what's going on with what has actually happened. His comments about gold will be of particular interest to some:

http://www.evansonasset.com/index.cfm?Page=161

[sophie]

Thank you Kevin K!  A refreshing article indeed.

Not into making any decisions at the moment but I'm really enjoying this thread and would like to hear from some more people!

Couple issues with gold that's been on my mind lately...one is that the paper gold phenomenon is truly new and untested waters, and makes me increasingly nervous.  Entrusting your money to GLD and the like seems diametrically opposed to the role that gold is supposed to play in the PP, like keeping money outside the financial system, and insurance against doomsday scenarios.  If I'm going to keep my 25% in gold, then my next goal is going to be to devote new PP savings to buying physical gold and replacing most of the paper gold in retirement accounts with other investments.  That would leave me with primarily cash and gold in taxable, which is perhaps just fine.

The other is that physical gold is worth relatively much more than stocks and bonds stashed in a tax-deferred account.  That's because with the physical gold, you only need to pay the collectibles tax on the gains when you sell.  With the retirement account, you need to pay full ordinary income rates on the entire amount on withdrawal.  So that 25% gold stash, if you have most of it in physical, is effectively weighted even more than 25% unless you're the rare individual whose savings are in Roth or taxable accounts.

[buddtholomew]

I too plan to purchase physical gold in taxable as it allows one to TLH ETF losses and restore the 25% allocation.

I am one to cut losses and run. Perhaps this is the prudent thing to do, but isn't this exactly the behavioral mistake we strive to avoid. We are always able to convince ourselves that a losing position will continue to fall. This time I am sticking to the re-balancing bands and making a purchase when required.

I may feel this way because of my VP allocation to equities. This almost feels like a repeat of 2013.

One thing that I never really appreciated before holding gold was how a decline has diminishing effects on the total $ lost. Hopefully gold bottoms when I do rebalance :-)

[Thomas Hoog]

There are several assetallocations better (CAGR) compared to 4x25 %. Out of my head, rang 300 out of 10.000. The best one (round figures) was (1972 -2012) 50 % Gold & 50 % Stocks. (1982 - 2012) was 100 % Bonds.
So basically you have to choose one you feel happy with depending on your personality, life etc. And then stick to it, that is the hard part.
Back in 2012, I have made 3 allocations which were all slightly better than the 4x25% and put them as a guideline depending on age. (in fact your investment horizon). It is stiill on my website (just a amateur website).
http://www.verstandig-beleggen.nl/index.php?paginaid=9

[HB Reader]

I think many of the comparisons here that span the 1960s to early 1980s are a little unrealistic as they don’t comport with the reality that was faced by most small investors during that period.  Few individual investors would have been able to cost-effectively benefit from the returns in “intermediate term”? bonds and stock indexes that appear so simple and evident in today’s statistical tables, especially if they were required to make frequent purchases, sales, and rebalancings.

For background:  I began buying savings bonds and coins in small amounts (usually under $25) when I was thirteen in 1965.  I began reading HB’s books in 1974 and making “serious”? periodic investments (starting at about $75 a month) when I was just out of graduate school in 1979.  I began buying PRPFX, supplemented with gold coins, stock mutual funds, and Treasuries, for a (slightly unbalanced) PP in late 1983.  I later ditched PRPFX altogether and went to a straight 4x25 HBPP in the early 2000s.  From the mid 1980s to now, I’ve also had a VP (with a fairly conventional allocation) for about a third to a half of our investments.

Some recollections and observations:

The quote from Bernstein (for whom I have great respect and whose books I have read) isn’t correct about gold not being investible during the 1960s and early 1970s.  Ownership of gold bullion was illegal.  But it was perfectly legal and very easy to purchase slightly older gold coins (like British Sovereigns and certain U.S. gold coins) with low numismatic premiums over their bullion value.  Bank safe deposit boxes to store them in were also cheap – often free with a checking account.  In fairness to Bernstein, few U.S. investors (probably lulled by the isolated bliss of the post-WWII U.S. stock market and the stability of the U.S. dollar) bothered to investigate or take advantage of this simple investment alternative.

In 1967 I bought British Sovereigns at the coin and stamp desk of a major department store (Wannamakers) in Philadelphia for less than a 10% premium over gold value.  It was like buying a pair of shoes.  In 1974 I bought and sold Mexican 50 peso pieces at two of several precious metals brokers specializing in silver bullion and gold coins in Dallas at about a 5% premium over gold value.

Until the early 1980s, stocks, bonds and T-bills, especially in small amounts, were almost equally as expensive and difficult to buy and sell (everything considered) as gold.  Discount brokers, money market funds, and index funds did not appear until the late 1970s/early 1980s.  The brokerage industry enjoyed artificially high SEC-fixed commission rates until deregulation in 1975 (which took an additional several years to have an impact).  Before that purchasing stocks or bonds in relatively small amounts, whether individually or in baskets of some type, involved high minimums and large commissions for most investors.  There were some open end mutual funds around, but virtually all were actively managed and had high (probably 2%, on average) yearly expense fees and high up-front loads.

Buying Treasuries directly, either through a regional Federal Reserve Bank or over the counter in Washington, involved filling out a long written form and showing up in person with cash (usually $10,000 or more), or delivering or mailing in a certified casheirs check in advance of an auction.  You had to arrange and accept delivery of a registered certificate (just like a stock) or a bearer bond.  Savings bonds could be purchased at any commercial bank or through payroll deduction, but until the program was overhauled in 1982, they were very different (and extremely uncompetitive) investments compared to what you know today.  It literally required an act of Congress for rates to be raised or lowered.

The point of all this is not to favor any particular asset class.  It is to point out that most lop-sided asset allocations assume more exactitude informed by current conditions than is warranted by past real world experience.

Also, while I haven’t run simulations on every optimized allocation, I suspect most result in more real world rebalancings than a simple and robust 4x25% allocation where most transactions involve adding to or subtracting from a substantial cash balance.  They also tend to cherry-picked time frames.  Just as you can arbitrarily choose 1974, 1980, or 2011 as starting points to deflate the case for buying gold, you can arbitrarily choose 1973, 2000, or perhaps today to deflate the case for buying equities.

I recognize that limited choices (as you have in most 401k accounts) make sticking to a PP allocation difficult.  That was probably the biggest single obstacle I faced (apart from the psychological tug to buy more stocks during the late 1990s) during my accumulation years.  But there is usually some way to accomplish it, or at least come close.  In my experience, also keeping some money in a VP actually made hewing to a PP with my safe money a little easier.

Also, Berstein’s implication that the PP has gained a great amount of “current popularity”? (not to pick on him – I really did like his book) in recent years that is subject to the transitory whims of fickle investors chasing performance strikes me as a little strange.  In my experience, very few investors have even heard of or considered anything like the PP.  I believe the number of investors strategically investing equal amounts in gold, bonds, cash, and stocks as part of a conscious strategy is infinitesimally small compared to those using more conventional approaches.

[rickb]

I think many of the comparisons here that span the 1960s to early 1980s are a little unrealistic as they don’t comport with the reality that was faced by most small investors during that period. 

...

This is a seriously excellent post.  Thanks for taking the time to describe the historical reality.  Investing today is a completely different animal than investing was 30 or 40 years ago.  Many comparisons use synthetic returns based on investments that simply weren't available.  Vanguard's S&P 500 index fund, the first generally available index fund, was founded in 1976 (!).  Before then, if you wanted to match an index you had to do it yourself (good luck, with a portfolio of anything less than $5M).