Desert Portfolio Question

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Jeffreyalan
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Desert Portfolio Question

Post by Jeffreyalan » Fri Jan 04, 2019 8:02 am

I have a question for the group. I decided about a year ago to run a Desert Portfolio (60% 10 year Treasury, 30% TSM, 10% Gold) for my savings instead of the traditional 4x PP. It just about broke even last year which is what you would expect given the market

A backtest of this portfolio from 2008 shows a return of 5.71% vs 5.15% for the PP with lower volatility and a 2% lower max drawdown.

I know the lower gold percentage makes the portfolio a bit risker in the case of financial cataclysm. But otherwise, what are the risks of this portfolio that I might be missing? My wife recently got laid off from her job and she is receiving a large severance package. I am thinking of putting all of our savings into the Desert Portfolio and then only drawing from it in the case of emergency. So I am trying to figure out of there are any risks to this portfolio that I am not seeing.
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Re: Desert Portfolio Question

Post by DragonJoey3 » Fri Jan 04, 2019 2:38 pm

Well the obvious risk is rising interest rates, but really the portfolio isn't that far off from the PP. Instead of a Bond-Barbell (25% 30-year, and 25% 1-year) you replace it with 60% mid-range bond (10-year). That puts you slightly overweight on bonds compared to the PP, which means that as interest rates shoot up you are more likely to see higher losses than the PP.

Really the portfolios aren't that different, but that's the only major point of difference.
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Kbg
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Re: Desert Portfolio Question

Post by Kbg » Fri Jan 04, 2019 5:21 pm

Agree with DJ3.

Go to portfoliovizualizer and and put in each portfolio and then do the years below instead of the full history.

1972-1986

1986-1999

1999-2012

2012-2018

Gold always adds some volatility, the periods above are cherry picked but you will quickly see gold helps or hurts depending on the time frame. For whatever bond allocation you go with a 55 STT to a 45 LTT percent split will give you pretty much identical results regardless compared to an ITT bullet. The "big" risk is something similar to the 70s where inflation is going through the roof. In any event, mess around with PV using the above time periods. It will give you a good feel for how the assets interact. One thing you may want to do is run all the five year periods from 1972 to 2018 and take notes. 10% gold in a portfolio gets you most of what it can provide in terms of diversification.

Here are the two ports side by side going back to 1978.

https://www.portfoliovisualizer.com/bac ... 0&Gold2=25
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Kbg
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Re: Desert Portfolio Question

Post by Kbg » Fri Jan 04, 2019 5:34 pm

OBTW 65ITT/25Stk/10gold is the historical efficient frontier for these assets using PV's data...which is the theoretical most bang for the least bounce portfolio.

Unfortunately you have to reverse engineer a barbell because the calculation to arrive at the efficient frontier will always put in a ton of low vol thereby killing returns. I did that and if we assume the above (or the desert 60%) is our bond allocation but you wanted to be more PP like you would multiply the bond allocation by .55 which using the desert would result in a 33 STT/27LTT bond mix...so I now introduce to all the Desert PP

33 STT/27 LTT/30 Stk/10 Gold :)

8.70% CAGR -10.39% MaxDD 0.64 Sharpe since 1978 which beats the PP on all metrics (but not hugely so)

Personally I've moved more toward the risk parity (desert) type portfolio as it is the same basic concept as a PP to profit in all environments, but the fact is the assets don't behave the same in terms of response (positive or negative). In terms of the Desert PP I like it because you have designated cash allocation which you can more easily integrate into daily real life.

To be sure and by way of full disclosure/caveat it is important to understand that behind risk parity is the assumption the future will be like the past. A saving grace thought is that we know HB backtested to come up with the PP...
Last edited by Kbg on Fri Jan 04, 2019 9:56 pm, edited 1 time in total.
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Re: Desert Portfolio Question

Post by Jeffreyalan » Fri Jan 04, 2019 7:42 pm

Would most feel comfortable keeping 100% of your savings in the Desert Portfolio? Is it safe enough from major losses and wild swings? In the year I have been invested in it, it has been fairly docile.
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Re: Desert Portfolio Question

Post by Kbg » Fri Jan 04, 2019 10:40 pm

Jeffreyalan wrote:
Fri Jan 04, 2019 7:42 pm
Would most feel comfortable keeping 100% of your savings in the Desert Portfolio? Is it safe enough from major losses and wild swings? In the year I have been invested in it, it has been fairly docile.
Assuming you use intermediate treasury bills for the 60% bonds you are not going to lose that money in nominal terms. Now of course this assumes the US govt remains solvent but there is a reason why the rest of the world believes US debt as the gold standard and basis for measuring all other forms of debt. The best rule of thumb for bonds is your rate of return is the coupon rate of the bond...and that is the case if held to maturity. Your biggest concern/worry is a loss in real terms (e.g. inflation). If we look at the 70s the bond portion of the Desert got crushed, but stocks and bonds were enough to provide a real rate of return. The 70s was the best decade ever for the PP and it returned a CAGR of 15% compared to Desert's. Nominally the worst drawdown ever was 10%.

As compared to the PP it is clear the Desert and the PP alternate outperforming each other and sometimes for quite a while. Over very long periods of time, most all of these portfolios end up in the same place. The optimal portfolios are usually defined as best sharpe or best geometric returns. The former usually has around 65% bonds with the rest in stocks while the latter is usually in the area of 80 stocks/20 bonds.

In short, if history is any guide you are in the area of max sharpe. With 60% in intermediate term treasuries you should be about as safe as you can be while still earning a decent return.
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Re: Desert Portfolio Question

Post by Jeffreyalan » Sat Jan 05, 2019 9:11 am

I am using ETFs for the portfolio:

60% IEF (iShares 7-10 Treasury)
10% IAU (iShares Gold)
15% MGC (Vanguard Large Cap)
15% SLY (SPDR Small Cap)

I use M1 Finance as my broker. They are perfect to run such a portfolio. I can deposit $500 there and they will buy $500 in the exact percentages I specified with no trading fees. Same with selling.

So my intention is to keep all of my funds in that portfolio and then on the 1st of every month, pull out only enough for my budgeted expenses for the entire month. That keeps my money working for me all of the time, makes me stick to a fixed budget and everything goes well...unless the portfolio tanks of course! Then I will have wished I had just kept it in the bank!
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Re: Desert Portfolio Question

Post by ochotona » Sat Jan 05, 2019 9:22 am

For Desert I would mix IEI and IEF ETFs in order to arrive at a 5 year intermediate average duration.

IEF 7-10 to me seems to be longer than what is meant by "intermediate". Yes, these things are not strictly defined.
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Re: Desert Portfolio Question

Post by Jeffreyalan » Sat Jan 05, 2019 9:43 am

ochotona wrote:
Sat Jan 05, 2019 9:22 am
For Desert I would mix IEI and IEF ETFs in order to arrive at a 5 year intermediate average duration.

IEF 7-10 to me seems to be longer than what is meant by "intermediate". Yes, these things are not strictly defined.
I thought that the Desert Portfolio specifically called for 10 year Treasuries as opposed to intermediates which could be anywhere from 5-7 years generally. Although even IEF is technically an 8 year duration. To get to 10 years exactly using ETFs you would need to mix TLH and IEF. I settled on IEF just to simplify things a bit. Adding in TLH and bumping the duration from 8 to 10 adds very little for the trouble.
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Re: Desert Portfolio Question

Post by Jeffreyalan » Sat Jan 05, 2019 10:04 am

I think what I am struggling with are the "risk" factors. Now that we are a one-income family, we can less afford to take financial hits. But we also need to make our money grow as much as possible. That is the dilemma. Should I just put our money in the local bank money market account, earn 2.35% and call it a day? Or should I place the funds in the Desert Portfolio and theoretically earn more than that but also put our funds at market or ETF/Counterparty risk?
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ochotona
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Re: Desert Portfolio Question

Post by ochotona » Sat Jan 05, 2019 10:18 am

Jeffreyalan wrote:
Sat Jan 05, 2019 9:43 am
ochotona wrote:
Sat Jan 05, 2019 9:22 am
For Desert I would mix IEI and IEF ETFs in order to arrive at a 5 year intermediate average duration.

IEF 7-10 to me seems to be longer than what is meant by "intermediate". Yes, these things are not strictly defined.
I thought that the Desert Portfolio specifically called for 10 year Treasuries as opposed to intermediates which could be anywhere from 5-7 years generally. Although even IEF is technically an 8 year duration. To get to 10 years exactly using ETFs you would need to mix TLH and IEF. I settled on IEF just to simplify things a bit. Adding in TLH and bumping the duration from 8 to 10 adds very little for the trouble.
Tyler, what duration did you intend?
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ochotona
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Re: Desert Portfolio Question

Post by ochotona » Sat Jan 05, 2019 10:23 am

Jeffreyalan wrote:
Sat Jan 05, 2019 10:04 am
I think what I am struggling with are the "risk" factors. Now that we are a one-income family, we can less afford to take financial hits. But we also need to make our money grow as much as possible. That is the dilemma. Should I just put our money in the local bank money market account, earn 2.35% and call it a day? Or should I place the funds in the Desert Portfolio and theoretically earn more than that but also put our funds at market or ETF/Counterparty risk?
Jeffrey, the only way to answer that is to ask what is the time when you think you're going to spend this money, and for most people there are multiple periods when the money will be used... house, car, college, retirement, etc.

If you have something coming up in the next 10 years, I would not put money into Desert. Look at the Long Term returns chart at
https://portfoliocharts.com/portfolio/desert-portfolio/

You could have dead money for a decade.

Good lord, where do you get 2.35% at a local bank money market? Marcus online pays 2.05%, Ally online is 2.0%.
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