How to answer this question?

fishdrzig · Post by **fishdrzig** » Sat Apr 18, 2015 7:26 am

I had a discussion last night with a friend of mine about the HB PP 4x25. He does think this portfolio is a good one but his answers to my inquiries were if you have 15 years left to invest before retirement - why would you not increase the equity % and just convert your entire portfolio over to the HB PP at retirement? Couldn't really come up with an answer to satisfy him. Any thoughts?
Thanks

buddtholomew · Post by **buddtholomew** » Sat Apr 18, 2015 9:10 am

There is no guarantee that equities will outperform gold or treasuries over that time frame.

Pointedstick · Post by **Pointedstick** » Sat Apr 18, 2015 9:41 am

buddtholomew wrote: There is no guarantee that equities will outperform gold or treasuries over that time frame.

Not much of a better way to put it than that.

And to graphically illustrate this point, here's a depiction of stock real returns over various timeframes. As you can see, there have absolutely been periods of time when 15 year real returns were zero or negative.

[img width=700]http://cdn.mymoneyblog.com/wordpress/wp ... stmont.gif[/img]

ochotona · Post by **ochotona** » Sat Apr 18, 2015 10:13 am

Amazing chart.

rickb · Post by **rickb** » Sat Apr 18, 2015 10:33 am

ochotona wrote: Amazing chart.

There's a thread about it, with versions for the PP as well - http://gyroscopicinvesting.com/forum/pe ... c-graphic/

Tyler · Post by **Tyler** » Sat Apr 18, 2015 3:34 pm

buddtholomew wrote: There is no guarantee that equities will outperform gold or treasuries over that time frame.

+1

Another problem with riding stocks and flipping the switch on your portfolio at retirement 15 years out is that negative stock returns in year 14 run a very high risk of pushing out your retirement date. Someone planning to retire in 2008 and sell 75% of their stocks would have been quite depressed.

If your friend is depending on a taxable account, there's also the tax consequences of selling so much at once. Does handing over a large portion of his taxable portfolio to the government the day he retires affect his retirement budget?

Especially in retirement, it's important to be invested in a portfolio you believe in for the long haul. The best day to start investing that way is today. At the very least, I'd recommend phasing in the long-term plan over 5 or more years leading up to retirement to limit the timing and tax consequences above.

sophie · Post by **sophie** » Sat Apr 18, 2015 5:57 pm

+1 Tyler!

To add to what you just said: you are more likely to suddenly need to access your savings during bad economic times. That's when you're more likely to lose your job, for example. Just ask all those people who had to dip into their 401K's in 2000 and 2009 when they got laid off or had to finance a margin investment gone sour, after they thought they were on track to an early retirement when the stock market was running gangbusters.

barrett · Post by **barrett** » Sun Apr 19, 2015 2:21 pm

fishdrzig wrote: I had a discussion last night with a friend of mine about the HB PP 4x25. He does think this portfolio is a good one but his answers to my inquiries were if you have 15 years left to invest before retirement - why would you not increase the equity % and just convert your entire portfolio over to the HB PP at retirement? Couldn't really come up with an answer to satisfy him. Any thoughts?
Thanks

Yeah, one thought is that something like a 40/20/20/20 portfolio with the 40% being in stocks is still probably a great asset mix in the long run. It will be more volatile than a 4X25 PP, but if that 40% in stocks also makes one comfortable with large gold, LTT and cash allocations, then it's a good option. We shouldn't be too strident about the 4X25 allocation.

Sequence of returns (what Tyler and Sophie were essentially getting at) in a stock-heavy portfolio would be a real concern for me at any point within ten years of retirement.

madbean · Post by **madbean** » Sun Apr 19, 2015 4:18 pm

barrett wrote: Yeah, one thought is that something like a 40/20/20/20 portfolio with the 40% being in stocks is still probably a great asset mix in the long run. It will be more volatile than a 4X25 PP, but if that 40% in stocks also makes one comfortable with large gold, LTT and cash allocations, then it's a good option. We shouldn't be too strident about the 4X25 allocation.

The thing about 25/25/25/25 is that it is completely agnostic about the future.

40/20/20/20 may very well be a great asset max in the long run. Maybe not. I think Keynes was right about the one long term prediction we can count on for sure. We'll all be dead.

ochotona · Post by **ochotona** » Sun Apr 19, 2015 7:00 pm

madbean wrote: The thing about 25/25/25/25 is that it is completely agnostic about the future.

Why do people keep saying this? Yes, any fixed percentage allocation plan is agnostic about the future. But any fixed percentage choice is in some way biased, or a wilda** guess, or based on past irrelevant information or something. I think people get misled about the symmetry of the original PP allocation. Symmetry doesn't mean anything. It's just coincidence, or a deliberate simplification; it's not magic.

barrett · Post by **barrett** » Sun Apr 19, 2015 7:03 pm

madbean wrote:
barrett wrote: Yeah, one thought is that something like a 40/20/20/20 portfolio with the 40% being in stocks is still probably a great asset mix in the long run. It will be more volatile than a 4X25 PP, but if that 40% in stocks also makes one comfortable with large gold, LTT and cash allocations, then it's a good option. We shouldn't be too strident about the 4X25 allocation.
The thing about 25/25/25/25 is that it is completely agnostic about the future.

Understood and that is how I am invested. I guess the point I was trying to make is this... fishdrzig has a friend who likes the asset mix of the PP but just has an issue with the proportions. His friend is inquiring about a tilt toward prosperity that I don't think ruins the whole PP concept. It certainly changes it but that 40/20/20/20 is not a bad portfolio, IMO.

Any of us who have tried to talk about the PP to friends or family members usually never even get to the point where someone says, "Hmm, that doesn't sound bad, but...". Once you mention a significant allocation to gold or cash, they just shut down. The discussion never even gets to long term bonds.

The stock data that PS resurrected shows how risky it is to hold only stocks. Taking out 60% of the stocks and divvying it up between gold, cash and LTTs certainly brings the volatility WAY down.

barrett · Post by **barrett** » Sun Apr 19, 2015 7:09 pm

I see that ochotona just posted. I can't remember ocho's exact allocation from past posts but it's not a strict 4X25. Does that mean it's bad or wrong? I don't think so. Anything that has some balance and is not based purely on hope for a specific outcome certainly is better than going all stocks, all gold, cash under the mattress, etc.

ochotona · Post by **ochotona** » Sun Apr 19, 2015 7:45 pm

I backtested using PeakToTrough from the date when gold peaked in 1980 until the present... I wanted to see what happened with two gold bear markets and one gold bull market. Of course we also know we had a fantastic twenty-year stock market run 1980-2000. I also wanted to see how much you could pare down cash before the portfolio started getting too volatile for my tastes.

Turns out, below 20% cash, the portfolio starts to lose the characteristic smoothness of the classic PP. If I trim gold to 15%, the CAGR goes up, and more importantly, the Sharpe Ratio goes up (improved risk-adjusted returns). Of course... will it work for decades to come? Who knows? Who knows if 25% x 4 will work for decades to come?

15% gold, 33% stock, 32% 30 yr Treas, 20% 3 yr Treas in lieu of cash, 15/35 rebalancing bands, date: 1-1-1980 to 4-17-2015

CAGR 9.11%
Sharpe Ratio 0.61
# drawdowns > 10% = 6
Max DD 17.21% (1980-01-21 - 1980-03-27) yup... due to the gold... so this is a really bad sequence of returns case, where you gut-punch your portfolio right at the start
annualized standard deviation 6.9%

Classic 4 x 25 PP:

CAGR 8.42%
Sharpe Ratio 0.52
# drawdowns > 10% = 5
Max DD 18.78% (1980-01-21 - 1980-03-27) Worse than my tweaked portfolio, because of more gold
annualized standard deviation 6.8%

For one more drawdown event, and a tiny bit more std dev, I will take the better CAGR and the better Sharpe Ratio and the lower Max drawdown. Better than even trade for me.

And my tweak is still better even if you start 1-1-1975, a 40+ year test, with two gold bull and two gold bear markets. The Sharpe Ratio increases to 0.63, the CAGR to 9.55%.

This guy @technigal on Twitter hates it when I mention this allocation. It's like throwing Holy Water on a vampire.

Post by **dualstow** » Sun Apr 19, 2015 9:20 pm

madbean wrote: The thing about 25/25/25/25 is that it is completely agnostic about the future.

ochotona wrote: Why do people keep saying this? Yes, any fixed percentage allocation plan is agnostic about the future.
...

I don't know. 90-100% in any one asset sounds pretty religious/kool-aidy in comparison, not agnostic.

rickb · Post by **rickb** » Sun Apr 19, 2015 11:29 pm

ochotona wrote: I backtested using PeakToTrough from the date when gold peaked in 1980 until the present... I wanted to see what happened with two gold bear markets and one gold bull market. Of course we also know we had a fantastic twenty-year stock market run 1980-2000. I also wanted to see how much you could pare down cash before the portfolio started getting too volatile for my tastes.

Turns out, below 20% cash, the portfolio starts to lose the characteristic smoothness of the classic PP. If I trim gold to 15%, the CAGR goes up, and more importantly, the Sharpe Ratio goes up (improved risk-adjusted returns). Of course... will it work for decades to come? Who knows? Who knows if 25% x 4 will work for decades to come?

15% gold, 33% stock, 32% 30 yr Treas, 20% 3 yr Treas in lieu of cash, 15/35 rebalancing bands, date: 1-1-1980 to 4-17-2015

CAGR 9.11%
Sharpe Ratio 0.61
# drawdowns > 10% = 6
Max DD 17.21% (1980-01-21 - 1980-03-27) yup... due to the gold... so this is a really bad sequence of returns case, where you gut-punch your portfolio right at the start
annualized standard deviation 6.9%

Classic 4 x 25 PP:

CAGR 8.42%
Sharpe Ratio 0.52
# drawdowns > 10% = 5
Max DD 18.78% (1980-01-21 - 1980-03-27) Worse than my tweaked portfolio, because of more gold
annualized standard deviation 6.8%

For one more drawdown event, and a tiny bit more std dev, I will take the better CAGR and the better Sharpe Ratio and the lower Max drawdown. Better than even trade for me.

And my tweak is still better even if you start 1-1-1975, a 40+ year test, with two gold bull and two gold bear markets. The Sharpe Ratio increases to 0.63, the CAGR to 9.55%.

This guy @technigal on Twitter hates it when I mention this allocation. It's like throwing Holy Water on a vampire.

The question is what does "agnostic" mean? I think you're hitting on the same point as MG in the "risk adjusted" thread , http://gyroscopicinvesting.com/forum/pe ... s%27-heel/ - i.e. are you agnostic because the portions of your portfolio allocated to each potential outcome are the same (4x25 PP), or because the risk contribution of each portion is the same?

As I see it, the problem with the equal risk approach is that risk varies over time. If I ask MG what my allocation should be he can't answer unless I tell him a start and end date over which he'll compute risk. My guess is Browne completely understood this and his 4x25 answer is a "close enough" answer based on the premise that we can't predict what will happen in the future (in which case, we're not trying to optimize any historical sequence).

Is 4x25 optimal over the last 40 years? Hell no. Did Browne know this? Hell yes.

But what's optimal over the last 40 years is the wrong question. The right question is what is pretty likely to be close to be optimal over the next 40 years, including as possibilities (which no Monte Carlo simulations do) that the US dollar collapses (because the US government collapses). Adding this possibility means no backtesting over any time period, except one where the prevailing government collapses, is relevant.

If you reduce your gold holding (or hold it in some paper form rather than gold you can hold in your hand) because your number crunching says that this creates a better expected CAGR, that's fine. But what probability have you assigned "total US dollar collapse" in your CAGR computation? Browne's 4x25 answer includes this scenario. With 4x25 you certainly don't come out losing nothing - but you don't lose everything either. The question is how much do you want to be left with in this scenario? Browne's answer is 25%. If the number crunching says 15% produces the optimal CAGR are you happy with ending up with 15% in this particular scenario? Is the CAGR difference between preserving 15% of your assets vs. 25% of your assets in a SHTF scenario worthwhile? Serious gold bugs put 100% of their assets in gold. In the SHTF scenario they win. But if the world doesn't end tomorrow (or the next day or the next) they lose. My guess is Browne understood this, and 25% was his compromise answer.

Pfanni · Post by **Pfanni** » Mon Apr 20, 2015 1:40 am

There are a lot of US citizens posting here. As a European I am always fascinated by their love for the stock market.
Look at Japan - twenty year bear market in stocks. Can't that happen in the US?
If long-term investing in the stock market would make one rich, there would be a lot of rich people. But there aren't.

I told this to my insurance/retirement-dealer, how can you count on 7% CAGR when the economy barely grows 2% (in real terms) for years now (this being Europe)?. Doesn't make sense to me.
Then came the '08/'09 crash and I looked like a genius. Allianz insurance stopped offering the deal I got (investing my pension money in the stock market, capping my gains at 4% monthly but 0% loss for money invested more than 1 year, so no drawdown basically).
Guess what, '08/'09 blew up their risk models. Stupid insurance salespersons. 7% CAGR, stock returns always great, only game in town, dream on.. that's what brought me to Harry Browne & PP. The agnostic side of it. Doing something different with my money than most other people but without completely subscribing to the gold (tinfoil hats) brigade.

bedraggled · Post by **bedraggled** » Mon Apr 20, 2015 5:39 am

What does the Sharpe ratio mean, please?

Thanks.

ochotona · Post by **ochotona** » Mon Apr 20, 2015 6:42 am

Wikipedia - "In finance, the Sharpe ratio (also known as the Sharpe index, the Sharpe measure, and the reward-to-variability ratio) is a way to examine the performance of an investment by adjusting for its risk. The ratio measures the excess return (or risk premium) per unit of deviation in an investment asset or a trading strategy, typically referred to as risk (and is a deviation risk measure), named after William F. Sharpe.[1] To this day, the Sharpe Ratio is still found as a prime metric for any alternative investment.[2]"

So for two investments with the same return, pick the one with higher Sharpe. Or, if you get more returns and more Sharpe, even better. If more returns and same Sharpe, the investment has more return only because it is riskier. If less returns and same Sharpe, bad choice.

I feel totally OK that I am adequately covered with 15% gold vs 25% gold in the event of SHTF. We so don't know what total currency collapse SHTF would be like, or how likely, that the differences between 25% and 15% are all within the error bars as far as I am concerned.

Yes, MachineGhost's asset allocation based on risk parity is what I seek also. He wrote recently that 20% gold is good.

bedraggled · Post by **bedraggled** » Mon Apr 20, 2015 7:05 am

THanks.

I have more questions. As I digest this with another read later, I will get back.

Exploring variations on the 4x25 PP is interesting.

Cheers

barrett · Post by **barrett** » Mon Apr 20, 2015 8:14 am

Pfanni wrote: There are a lot of US citizens posting here. As a European I am always fascinated by their love for the stock market. Look at Japan - twenty year bear market in stocks. Can't that happen in the US?
If long-term investing in the stock market would make one rich, there would be a lot of rich people. But there aren't.

To give some perspective from this side of the pond, I don't think the love of stocks is really all that widespread here in the US. As discussed in another thread recently, most Americans don't own any stock. Many who did prior to 2008 have never gotten back in. There are tons of financial advisors who tell their clients that they should load up on stocks, but most Americans never even speak with a financial advisor until they are trying to figure out their retirement strategy at age 60 or so. Just my two cents worth but remember that most Americans don't have any savings to even think about investing.

If you spend time on the Bogleheads forum or over at MMM, you would certainly get the impression that stocks are the holy grail of investing over here, but the reality for most people seems to be very different.

Cortopassi · Post by **Cortopassi** » Mon Apr 20, 2015 8:20 am

And Ochotona looks like an oracle right now with gold unable to hold 1200 yet again!

bedraggled · Post by **bedraggled** » Mon Apr 20, 2015 11:50 am

And Harry Dent says gold down to $250. Not dull at all>

Jim Rogers says he would like to buy gold <$1,000, a 50% retracement.

In 20 years, I found standing still is often beneficial.

ochotona · Post by **ochotona** » Mon Apr 20, 2015 11:59 am

Cortopassi wrote: And Ochotona looks like an oracle right now with gold unable to hold 1200 yet again!

No, no, no... I am no oracle. All I know is that in the past 14 years gold has swung between $500 and $2000. My only call is that right now it is someone "in the middle". So I will not be a gold bug nor a gold hater at this time. Call me if it goes below $1000, or back up towards $2000.

Pointedstick · Post by **Pointedstick** » Mon Apr 20, 2015 12:20 pm

ochotona wrote:
Cortopassi wrote: And Ochotona looks like an oracle right now with gold unable to hold 1200 yet again!
No, no, no... I am no oracle. All I know is that in the past 14 years gold has swung between $500 and $2000. My only call is that right now it is someone "in the middle". So I will not be a gold bug nor a gold hater at this time. Call me if it goes below $1000, or back up towards $2000.

Swinging between $500 and $2,000 tells us nothing about what is high and what is low. Why couldn't gold go to $5,000 or fall to $100? Be wary of interpreting historical data points as though they mean something about what the future will look like.

Tyler · Post by **Tyler** » Mon Apr 20, 2015 12:28 pm

Investing is an activity that will drive natural optimizers crazy. With the PP, some run detailed scenarios on different percentages to look for the ideal breakdown that logically must be something other than a simplified 4x25. With Bogleheads, note that many avoid total market funds for the same reason, electing to slice and dice increasingly minute chunks of obscure indexes looking for that extra bit of back-tested alpha. Don't get me started on stock pickers.

The problem with this mindset is that market conditions constantly change, and the ideal allocation today will be different tomorrow. The holy grail perfect portfolio is knowable only looking backward once it's too late to act on. And of course people never account for the drag (from taxes and bad timing influenced by human psychology) that constant portfolio rejiggering has on their overall performance. They might be surprised to find that they would have more money today by sticking with their original "sub-optimal" portfolio than they do after repeatedly churning funds for "measurably" better returns.

Personally, I found that a healthier and more achievable goal was to stop chasing theoretical perfection and instead seek equilibrium where my portfolio is "good enough" in most any situation. That includes pre- and post-retirement. For me that's the 4x25 PP.

My advice is to get your portfolio 80% perfect and just be happy. The cost of chasing that last 20% just isn't worth it, either in personal life satisfaction or possibly even in after-tax returns. Turn that optimizing energy to things you can actually control like reducing your expenses and learning new skills, and you'll likely be a lot wealthier and happier in the longrun.

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