Gyroscopic Investing

In one of Bogle's later books (can't remember which one), he mentioned that he was coming to think that his default advice for young people might just be
50% total stock market
50% total bond market
forever, regardless of age.  I think he's basically right except that you need some kind of hedge against currency devaluation in there.

Just before I settled on the PP I was gravitating toward
50% total world stock
50% intermediate Treasury index
which comes from Bogle's 50/50 suggestion, but: the stock is globalized for geographic and currency diversification; and corporate bonds are eliminated in keeping with academic modern portfolio theory findings that bond credit risk is not compensated fully.

Given that the world stock market is roughly 1/2 US stock market and 1/2 "stuff denominated in another currency," and that 50% IT Treasuries resemble 25% LT Treas. and 25% T-bills, this portfolio becomes the PP if you squint hard enough.

It's still my "backup" that I'd use if I ever had an account that couldn't contribute to a true PP, or would suggest to someone that refused to use the PP for some reason.

KevinW wrote: I think he's basically right except that you need some kind of hedge against currency devaluation in there.

There's that whole problem of rising inflation to hyper-inflation. Maybe it never happens in our lifetime but maybe it does. It will only take one time to wipe out all the bond holders and cash hoarders.

50% stocks and 50% LTTs has a pretty good track record except in the 70s and this last decade when compared to inflation. Few losing years and low volitility but without gold (or maybe some foreign bonds) you really are putting your faith in the U.S. central bankers to keep the inflation genie bottled up. International stocks wouldn't be enough since their economies would probably get disrupted if the dollar printing went really crazy. Still.....if people refuse to buy gold this is a really simple plan to implement.

I also think that this is an "okay" allocation.  I have money in a 529 but can't figure out how to build a PP with it.  I went with this 50% TSM \ 50% TBM approach instead.

It's not the PP but it'll work.

I stated that this was a good solution for most investors on the Boglehead's forum and was called an idiot. Good to see the NY Times is also written by idiots.

Indices wrote: I stated that this was a good solution for most investors on the Boglehead's forum and was called an idiot.

That's surprising!  Why were you called an idiot?  I'd have thought that the Bogleheads would think this a conservative but effective approach.

Lone Wolf wrote:

Indices wrote: I stated that this was a good solution for most investors on the Boglehead's forum and was called an idiot.

That's surprising!  Why were you called an idiot?  I'd have thought that the Bogleheads would think this a conservative but effective approach.

No they believe young people should be full up with risk and equities and gradually go to bonds.

Lone Wolf wrote: I also think that this is an "okay" allocation.  I have money in a 529 but can't figure out how to build a PP with it.  I went with this 50% TSM \ 50% TBM approach instead.

It's not the PP but it'll work.

I think that this a reasonable next-best approach, especially if you buy some gold coins. 

I also think the "bond" portion of way too many portfolios tends to be 1) too short in duration (even when they ARE long duration, they're callable so it's pointless), and 2) too risky (mortgages, munis, corporates, foreign, etc).

I think the fact that the 50% bond portion is longer in duration and 100% treasury makes this a pretty solid portfolio.

Besides, if you're trying to get someone into the PP, and you tell them the 4x25 assets, it can sound crazy, but if you tell them "50% stocks, 50% treasury bond ladder... oh, and make sure you have a 6-month cash-cushion and some gold coins in a safe" you could basically have a PP for this person without them even realizing it.  Maybe we should be presenting the PP in that context to our friends, not starting the whole thing off trying to explain why you want 50% of your portfolio in 30-year bonds yielding less than 3% and a shiny yellow metal.... oh and another 25% in bills .01%.

There is a strategy problem I'm trying to think through.

If you think you are behind in where you think you should be on your investments given your age and objectives, should you increase the risk in your portfolio and hope for a lucky roll of the dice, or should you radically decrease the risk in your portfolio and try to hang on to what you have?

Maybe this just comes down to preference or personality, but it seems like there should be a game theory solution.

cowboyhat wrote: There is a strategy problem I'm trying to think through.

If you think you are behind in where you think you should be on your investments given your age and objectives, should you increase the risk in your portfolio and hope for a lucky roll of the dice, or should you radically decrease the risk in your portfolio and try to hang on to what you have?

Maybe this just comes down to preference or personality, but it seems like there should be a game theory solution.

I've found that many people that earn less can make better planning decisions than someone taking big bets and has a huge loss. I also believe the more conservative investment approaches probably have better long term results because people are less likely to go in and out of the markets which kills performance.

Portfolio optimizations often leave out the human emotion problem. It's not something that can be modeled. I suspect that a portfolio like the Permanent Portfolio with very low volatility and possibly lower returns than a much riskier heavier stock portfolio is probably going to win. Simply because most people will never stick with the heavy stock portfolio. They are probably going to experience a punishing loss with the strategy eventually and bail out. The optimal gains they think they will get will not be realized.

Kshartle wrote:

KevinW wrote: I think he's basically right except that you need some kind of hedge against currency devaluation in there.

There's that whole problem of rising inflation to hyper-inflation. Maybe it never happens in our lifetime but maybe it does. It will only take one time to wipe out all the bond holders and cash hoarders.

50% stocks and 50% LTTs has a pretty good track record except in the 70s and this last decade when compared to inflation. Few losing years and low volitility but without gold (or maybe some foreign bonds) you really are putting your faith in the U.S. central bankers to keep the inflation genie bottled up. International stocks wouldn't be enough since their economies would probably get disrupted if the dollar printing went really crazy. Still.....if people refuse to buy gold this is a really simple plan to implement.

I concur.  A 50/50 split is probably a massive improvement on the sort of portfolios that 70-80% of the sheeple use.  But inflation is its Achilles heel.  Throw in 10% gold and put 20% of your stock holdings (10% of total portfolio) in VEU for currency diversification and I think that would go a long ways towards mitigating inflation risk.  It's not the HB PP but I think it would work. And volatility levels should be low enough to avoid the kind of losses that make people freak out and bail from the markets, usually at the worst possible time as Craig noted. 

The HB PP can be a hard sell for people who are not yet ready to question the wisdom of all the talking head idiots on CNBC.  But I keep telling friends and family that asset class diversification needs to be more then just bonds and stocks.  Even a mere 10% gold allocation can really help cut your losses if the brown stinky stuff hits the rotating blades.  I tell them to think of it as the financial equivalent to catastrophic health insurance.  Sometimes really really bad things happen, and they don't always make appointments.

In abstract, there is nothing wrong with 50/50 per se.  But the article describes this allocation as conservative, and some Boglehead posters believe it represents the middle ground (what is fairer than 50/50?).  But such an allocation is still dominated by the performance of its equities.  That is, it is not 50/50—in effect.  Of course, the maturity of the fixed income matters greatly (if one were using T-Bill vs. 30-year Treasuries).  But still.

Here is an article that discusses the theoretical power of equities vs. bonds .  Even if we disagree on statements made in the article, in general, 50/50, isn't.

"Size matters — the stock “eggs”? are about nine times as big as the bond “eggs.”? ...in terms of variance, stocks are nine times riskier than bonds."

http://www.panagora.com/assets/PanAgora ... cation.pdf

craigr wrote:

cowboyhat wrote: There is a strategy problem I'm trying to think through.

If you think you are behind in where you think you should be on your investments given your age and objectives, should you increase the risk in your portfolio and hope for a lucky roll of the dice, or should you radically decrease the risk in your portfolio and try to hang on to what you have?

Maybe this just comes down to preference or personality, but it seems like there should be a game theory solution.

I've found that many people that earn less can make better planning decisions than someone taking big bets and has a huge loss. I also believe the more conservative investment approaches probably have better long term results because people are less likely to go in and out of the markets which kills performance.

Portfolio optimizations often leave out the human emotion problem. It's not something that can be modeled. I suspect that a portfolio like the Permanent Portfolio with very low volatility and possibly lower returns than a much riskier heavier stock portfolio is probably going to win. Simply because most people will never stick with the heavy stock portfolio. They are probably going to experience a punishing loss with the strategy eventually and bail out. The optimal gains they think they will get will not be realized.

That is an excellent point. An optimal mathematical strategy is not useful if it requires psychologically impossible behavior.

A risk parity HBPP portfolio would be approximately:

Stocks 2.38%
LT Bonds 11.55%
Gold 3.41%
ST Bonds 82.66%
1.08% Real CAGR (1928+)

Without the ST Bonds, it would be:

Stocks 13.71%
LT Bonds 66.61%
Gold 19.68%
3.25% Real CAGR (1928+)

MG

Roy wrote: In abstract, there is nothing wrong with 50/50 per se.  But the article describes this allocation as conservative, and some Boglehead posters believe it represents the middle ground (what is fairer than 50/50?).  But such an allocation is still dominated by the performance of its equities.  That is, it is not 50/50—in effect.  Of course, the maturity of the fixed income matters greatly (if one were using T-Bill vs. 30-year Treasuries).  But still.

Here is an article that discusses the theoretical power of equities vs. bonds .  Even if we disagree on statements made in the article, in general, 50/50, isn't.

"Size matters — the stock “eggs”? are about nine times as big as the bond “eggs.”? ...in terms of variance, stocks are nine times riskier than bonds."

http://www.panagora.com/assets/PanAgora ... cation.pdf

MachineGhost wrote: A risk parity HBPP portfolio would be approximately:

Stocks 2.38%
LT Bonds 11.55%
Gold 3.41%
ST Bonds 82.66%
1.08% Real CAGR (1928+)

Without the ST Bonds, it would be:

Stocks 13.71%
LT Bonds 66.61%
Gold 19.68%
3.25% Real CAGR (1928+)

MG

Roy wrote: In abstract, there is nothing wrong with 50/50 per se.  But the article describes this allocation as conservative, and some Boglehead posters believe it represents the middle ground (what is fairer than 50/50?).  But such an allocation is still dominated by the performance of its equities.  That is, it is not 50/50—in effect.  Of course, the maturity of the fixed income matters greatly (if one were using T-Bill vs. 30-year Treasuries).  But still.

Here is an article that discusses the theoretical power of equities vs. bonds .  Even if we disagree on statements made in the article, in general, 50/50, isn't.

"Size matters — the stock “eggs”? are about nine times as big as the bond “eggs.”? ...in terms of variance, stocks are nine times riskier than bonds."

http://www.panagora.com/assets/PanAgora ... cation.pdf

I think the PP is just fine, as is.  My point is simply that 50 stocks / 50 bonds (especially ordinary maturities) still represents a portfolio whose returns will be dominated by the equities.

Clive have you looked at the asset mix in the CPI etf that machine ghost mentioned? It has lots of STT, some Yen, some gold, some LTT and some Russel 2000.

I took a look at the methodology.  It seems to be based on ranking ETF/ETN correlations to CPI while checking for asset class overlap, rebalancing monthly, reconstituting annually.  Its an interesting approach but the layer of fees is going to kill the relatively small real return.  The PP should outperform.

MG

stone wrote: Clive have you looked at the asset mix in the CPI etf that machine ghost mentioned? It has lots of STT, some Yen, some gold, some LTT and some Russel 2000.

Came across an article at the Financial Advisor website about Harry Markowitz's portfolio allocation....50/50....so wanted to pass this along:

http://www.fa-mag.com/component/content ... sting.html

This thread's of particular interest to me as I fall in that category of being in a situation where I'm interested in the PP, but it's not feasible to implement the 4x25 allocation. 

I've long held to the 3 fund model (often called the Margaritaville portfolio) as I don't quite trust having everything in one currency.  I wish I could at least buy into a big basket of foreign currencies or ST/intermediate debts in other currencies as a gold stand in, but barring that I suppose equity in non US interests is the next best thing. 

But I am wondering if I should even bother.  You aren't getting the performance of the PP either way so does it even really matter?  Is the third fund just complicating things?

Realize I'm not in the least bit concerned what the historical return has been on any portfolio, that number is interesting but meaningless to me as I have to deal with the now and plan for the future.  I'm more concerned with a design to cover major contingencies like currency devaluation (which I believe will happen all my life, in different parts of the world, at different times).

Good article.  Markowitz' seminal work was not on asset classes, it was on individual stocks.  To use the mean variance optimization framework at the asset class level extends his thesis beyond its domain.  One would need enough history to approach stability at the asset class level.  At 51.6 years each flipping between fixed and floating exchange rates, I would say 100 years is bare minimum which is hardly common data lengths in portfolio optimization software. Even then I still doubt that every possible economic scenario has already occured in the past.  Stagflation was not thought to be possible before it occured in the 1970's so no "optimal" portfolio could possibly have modeled that influence from the historical data beforehand.

"1/n" like the PP may not be as "optimal" as "1/historical risk" but I prefer tactical allocation for reducing risk rather than strategic allocation.  But for someone that doesn't "believe" in that, it might behoove them to look at "1/historical risk".  The last time I did such an analysis, it was approximately: 50% LT bonds, 23% Stocks, 17% Gold, 10% ST bonds.

MG

Bonafede wrote: Came across an article at the Financial Advisor website about Harry Markowitz's portfolio allocation....50/50....so wanted to pass this along:

http://www.fa-mag.com/component/content ... sting.html

Gold coins.

MG

shoestring wrote: This thread's of particular interest to me as I fall in that category of being in a situation where I'm interested in the PP, but it's not feasible to implement the 4x25 allocation. 

I've long held to the 3 fund model (often called the Margaritaville portfolio) as I don't quite trust having everything in one currency.  I wish I could at least buy into a big basket of foreign currencies or ST/intermediate debts in other currencies as a gold stand in, but barring that I suppose equity in non US interests is the next best thing. 

But I am wondering if I should even bother.  You aren't getting the performance of the PP either way so does it even really matter?  Is the third fund just complicating things?

Realize I'm not in the least bit concerned what the historical return has been on any portfolio, that number is interesting but meaningless to me as I have to deal with the now and plan for the future.  I'm more concerned with a design to cover major contingencies like currency devaluation (which I believe will happen all my life, in different parts of the world, at different times).

"Balanced portfolios

Figure 4 presents the drawdown on an illustrative balanced  portfolio  of  50%  equities  and  50% bonds. The drawdown is plotted for both the USA (in  blue,  upper  panel)  and  UK  (in  red,  lower panel).  Individually,  equities  and  bonds  have  on several  occasions  lost  more  than  70%  in  real terms.  But  since  1900,  this  50:50  blend  has never  (USA)  or  virtually  never  (UK)  suffered  a decline of over 50%. Furthermore, the duration of drawdowns  is  briefer  for  the  blend  portfolio  than for the supposedly low-risk fixed income asset.

Measured  in  local  currency  adjusted  for  inflation,  the  long-term  annualized  real  return  on  US equities was 6.3% (6.1% in the UK, from 1930). Meanwhile,  US  government  bonds  had  a  real return of 1.8% (2.1% in the UK, from 1930). The 50:50   blend   portfolio   returned   an   annualized 4.5% in the US (4.4% in the UK, from 1930).

While  a  50:50  equity/bond  blend  has  had  a lower expected return than an all-equity portfolio, it has also had a lower volatility. Since 1900, the standard deviation of real equity returns has been 20.3% in the USA and 20.0% in the UK, as compared to bonds which has a standard deviation of 10.2% in the USA and 13.7% in the UK. For the blend portfolio, the standard deviation was attractively low: 11.7% in the US and 14.4% in the UK.

There  is  nothing  special  about  a  50:50  asset mix   and,   in   reality,   investors   should   diversify across  more  assets  than  just  local  stocks  and bonds. However, this example serves to highlight the risk-reducing potential of a balanced portfolio of bonds and stocks.

Bonds as a diversifier

Why  is  the  downside  risk  of  the  blended  stock/ bond portfolio lower? There are two reasons. First, bonds  are  less  volatile  than  equities. The  country profiles  (page  31  onwards)  show  that  in  all  22 Yearbook markets, bonds have had a lower standard  deviation  (averaging  12.5%  across  our  19 countries) than equities (which average 23.4%).

Second,  bonds  are  imperfectly  correlated  with stocks.  Figure  5  plots  the  correlation  between stock  and  bond  returns  computed  in  real  terms over a rolling window of 60 months. The correlations  are  shown  for  both  the  USA  and  UK.  The stock-bond correlations as at end-2010 are negative:  for  the  USA  a  correlation  of  –0.14,  and  for the UK –0.03.

In  contrast  to  recent  experience,  the  stock-bond correlation has been positive, although fairly low,  over  the  very  long  term.  In  the  USA,  using real  returns  over  the  period  1900–2010,  it  averaged  +0.19  with  a  range  of  –0.38  (in  January 1960)  to  +0.67  (in  October  1924).  In  the  UK, using  real  returns  over  the  period  1930–2010,  it averaged  +0.31  with  a  range  of  –0.31  (in  May 2007) to +0.74 (in December 1939).

When  inflation  accelerated  and  subsided,  from the  1970s  to  the  1990s,  changes  in  inflation expectations  drove  both  stock  and  bond  markets in  tandem.  Stock-bond  correlations  were  briefly negative around the 1929 Crash and for a longer period in the late 1950s and early 1960s. But, in the  turmoil  of  the  2000s,  when  bonds became  a desirable  safe-haven  asset,  the  correlation  became strongly negative in both countries."

Source: Credit Suisse Global Investment Yearbook 2010

Clive wrote: My data models indicate that the PP might provide a 2.6% longer term average real reward, whilst for 50-50 stock/bonds its 4.7%

If an investor has $1m, desires a $20K yearly income and deposits 15 years worth of income ($300K) into an inflation linked investment with the intent to draw down that to zero over the next 15 years, then in order to replenish that $300K amount they'd need to invest

600K in a PP
300K in a Stock/Bond 50/50

i.e. approximating

1.02615 = 1.5
1.04715 = 2.0

On this measure one investor might initially allocate 300K to inflation bonds (for income withdrawals), 600K to PP (for growth) and 100K to wherever else they deem to be appropriate; the other allocates 300K to inflation bonds (income), 300K to Stock/Bond 50/50 (growth) and 400K to wherever else they deem appropriate.

The indications are that both investors might initially level to a similar 150K in stocks, 150K in bonds to similar overall effect.

Clive,
Is the stock portion of your 50/50 model all US shares or is it mixed US and international?

Clive
Thanks for that.