Easing into the PP over time

[MiniB]

I've read several posts where people dont like owning too much gold, or bonds are in a bubble, or for whatever reason want to ease into the PP.  The reactions are always, all or nothing, because if you dont follow the PP, you wont get the protection from screwing with the allocations.

What if I setup my PP now in my 20s as such:

10% Gold
10% Cash
10% LT Bonds
70% Stocks

In theory, I currently have a 40% PP and a 60% Variable Portfolio that is 100% stocks.

Then as I age, every year, I increase the PP by 1% each.

So in 1 year I will be 11% gold, 11% cash, 11% LT Bonds, 67% Stocks.

I do this for 15 years and hit 25/25/25/25

Theoretically Stocks have the highest performance of all 4 assets, and with enough time, it should pay off.  With gradual reduction in stocks, even if I am wrong and Stocks have 15 years of bearish performance, I didnt lose too much money.

I borrowed this concept from the traditional Age in Bonds theory where you increase bond allocation 1% each year you age to gradually get less aggressive.  Since Full PP is the least aggressive possible, then gradually increasing to full PP is like increasing bonds in a traditional portfolio.

[Brad243480]

I would say that as long as you can stick to this approach, it is vastly better than many other types of investing.  But it is certainly no PP.  You write:

"Theoretically Stocks have the highest performance of all 4 assets, and with enough time, it should pay off."

But that is a crucial element of the PP, i.e. that we don't know what the best performing asset will be.  If you are so sure that stocks will have the best performance over your investment horizon, I see no reason not to put 100% of your portfolio in them.  

In my opinion, a 70/10/10/10 portfolio would be better than most Bogleheads portfolios simply because it has some gold allocation.  But it makes an attempt to predict the future, through overweighting a particular asset class that you are GUESSING will perform a certain way because of past performance.  Not as bad as stock picking, certainly, but still a form of fortune telling, as Harry would say.  Not to mention that such an allocation would almost surely have higher drawdowns and make it more difficult to stick to, which is as important as any aspect of the PP.

[rickb]

Rather than treat this as a single total portfolio and rebalance each year as you suggest, I think a better idea would be to explicitly treat this as two portfolios - a 4x25 PP that starts with 40% and an all stock VP with 60% - and then transfer money from the 60% stock portfolio (one-way) into the PP.  To do this in 15 years, you'd take 1/15th of the 60% stock the first year and put it in the PP and then rebalance the PP if needed.  The next year take 1/14th of the remaining all stock VP and put it in the PP (and rebalance if needed), and so on.  By doing this you're basically betting stocks will do better than the PP over the next 15 years.  If this is what you think, fine, but realize this is a VP bet.  The advantage of treating it as two portfolios is if stocks get killed, you won't be taking money out of the PP to shore up the VP. 

[MiniB]

"Theoretically Stocks have the highest performance of all 4 assets, and with enough time, it should pay off."

But that is a crucial element of the PP, i.e. that we don't know what the best performing asset will be.  

Brad,

I think it's a given that stocks MUST have the best performance over time.  here is why:

1) Gold must have a 0% performance in the long run because technically everything is measured against gold.  1 ounce of gold bought the same thing 100 years ago that it would buy today and that it will buy in 100 years.

2) Bonds must have a lower performance over stocks over the long run because bonds are safer.  If bonds start doing "Better" than stocks in the long term then bond rates must drop to compensate for the reduced risk.  Then from that point on, bonds will do worse than stocks due to the lower rates.  And averaging it all together, bonds MUST do worse than stocks in a long enough time horizon.

3) Cash has to do worse than bonds otherwise no one would loan money at long rates.  Long bonds must have a risk premium associated to drive up returns over cash, over the long term.

Since stocks are the riskiest, they must do better in the long term.  If 100 years passes and stocks underperform cash, then no one will ever invest in stocks again, unless they demand a higher ROI from the investments.

In my understanding, by definition, stocks MUST be the best performing class in the long term, however my investment horizon does not meet the criteria of long term.  20 or 40 years isnt "long term."  Long term is 100s of years.
My bet with overweighting stocks, at least early, is that the longer I have market exposure to stocks, the greater chance that the risk premium will be realized in owning stocks.

[Brad243480]

You make a few good points, and you also recognize the ridiculousness of Siegel's 200-year study in "Stocks for the Long Run."  That is true about gold having a long-term return of zero, but, as you point out, stocks can have a negative return over 20-40 years (as can any asset class).

I think overall you make some great points and I also agree with rickB that you should treat the stock-only allocation as your VP, and the 40% allocation as your PP.  Don't mix the two, not even psychologically.  One last point, which I made earlier:  You seem to have a cool head about investing, but most people don't and let emotions get in the way of their decisions.  So many people would have a difficult time sticking to a stock-heavy AA like this, and then would bail out at the worst time and get back in at an even worse time.  That is why the PP is so great, becaus it forces you to buy things that are out of favor and sell things that are so in favor.  Automatically...without even thinking about it.

[MiniB]

Brad,

Great point about buying out of favor and selling winners.  I already do this in my "speculating" of the last few years.

For example when REITs were down 60% 18 months ago, I shifted half of my entire portfolio into REITs.  About 1 months ago when REITs were up 100% from that point, and when Europe was down 10% YTD from the banking crisis, I shifted all of that money from REITs into Europe.

I'm a firm believer of buying losers and selling winners, with respect to index funds.  My problem with PP is investing heavily in gold and cash when the long term gains of each are 0 on an inflation based level.  I understand that it helps level out volatility and gains can be captured in the short term, but I also think stocks are great.

[craigr]

Browne actually answers a question about this adjusting of the stock allocation in this show:

https://web.archive.org/web/20160324133 ... -02-13.mp3

I agree with him. It would be nice to know ahead of time that some asset (like stocks) are going to do best going forward, but this just isn't known. If you were a Japanese investor in 1989 and held onto the stocks always win mantra and adjusted your allocation over time you'd find that the bet went against you. Their market has been in a slow slide for over two decades and a more diversified investor would have done better.

I personally don't think the idea of adjusting your allocation with age is a very good idea. The plan makes several assumptions about the performance of stocks that are not always true. We already can look at the market history and see a couple decade+ long periods where stocks have languished for instance. These were especially bad times for people following the stock/age adjustment strategy. They were also very bad times for people who retired and thought stock growth alone would drive their portfolio. Then again we have some periods where stocks done spectacularly well. That's the problem. We just don't know what the future is going to do. I think a balanced portfolio has a better chance of weathering whatever may happen and recommend against adjusting allocations with age.

[Bonafede]

I'm a firm believer of buying losers and selling winners, with respect to index funds.  My problem with PP is investing heavily in gold and cash when the long term gains of each are 0 on an inflation based level.  I understand that it helps level out volatility and gains can be captured in the short term, but I also think stocks are great.

MiniB,

I just wanted to let you know that you're not along on the concerns regarding the PP. I've struggled a lot with trying to modify/improve the PP (as CraigR, MedTex, Clive and rest of the forum can attend). I can't tell you how many countless hours I spent wrestling with the PP, trying to blend more or less of one asset class, taking into account age, risk etc.

And where I landed was a point of exhaustion, a portfolio that was too complicated, and most importantly too much time away from my family.

That being said, I landed in a place where I have a distinct PP and then a VP to try and capture some extra return on top of the PP. The exact mix of PP to VP isn't necessarily important, as long as one is comfortable with the risk profile. I love what Clive said in a previous post:

"The 4x25 is a one-size-fits-all type style that carries the risk that it fits nobody perfectly and as such might be dropped for better fitting alternatives.  Better perhaps to get a variant of the PP that fits you snugly.  What those tweaks are however is a personal choice/matter as at the end of the day you're the only one responsible for the choices you make."

With that being said, I still love to learn about finance and econ, but time to live life!

Also, regarding adjusting for age, the PP just doesn't really follow that approach. And I think for the better. My encouragement to you...after having gone through quite a journey myself...simplify and go!

Cheers and best of luck!

b

[PP4me]

I put together a spreadsheet using the annual returns from this website that helps answer your question. The portfolio assumes annual rebalancing back to the original allocation and 39 years of history.

A 70/10/10/10 portfolio as you suggest has a (CAGR) return of 10% with 12.7% volatility.  Its highest return was 30.7% in 1979 and its lowest return was -21.3 in 2008.  It lost money in 10 of 39 years and $10,000 invested in 1972 became $408,757

A 4x25 Permanent portfolio has a (CAGR) return of 9.7% with 8.2% volatility.  Its highest return was 42.1% in 1979 and its lowest return was -3.9 in 1981.  It lost money in 2 of 39 years and $10,000 invested in 1972 became $371,675.

A slightly more aggressive 40/20/20/20 portfolio has a (CAGR) return of 9.9% with 8.7% volatility.  Its highest return was 38.3% in 1979 and its lowest return was -5.8 in 2008.  It lost money in 4 of 39 years and $10,000 invested in 1972 became $399.451.

As you can see, the 70/10/10/10 portfolio loses its stability because it is overweight stock and also loses the benefit of buying low and selling high rebalancing.  It gains more in volatility than it does in return.  The 4x25 portfolio is a thing of beauty because it takes advantage of the equal weights and rebalancing.  In MY OPINION, a more aggressive portfolio that still holds on to most of the balance and the buy low sell high benefit would be a 40/20/20/20 portfolio.  You could consider this an 80% allocation to a permanent portfolio and a 20% variable portfolio. 

I would not ease into a PP because you lose the balance and don't gain much performance based on historical data.  Again past performance is no guarantee of future results.
Good Luck