Gyroscopic Investing

I recently came across this article:

Not So Magical: Popular 60-40 Mix of Stocks and Bonds Is No Panacea

It's an interesting read, although in the last two sentences of that article the author gets lost trying to find the right asset mix.

What I find interesting about the article is that it explains where the 60/40 portfolio came from — the 60/40 portfolio was apparently derived from backtesting its performance from 1926 through 1965. The author then explains that the 60/40 doesn't work properly during times of high inflation, but he doesn't seem to know why.

But, when you think about it, it's pretty clear that the 60/40 portfolio is a Gold Standard era portfolio. It was designed entirely based on Gold Standard era backtesting. And it was mostly implemented after the Gold Standard era ended — and coincidentally during a baby boom investing era which saw terrific gains in the stock market.

The US Dollar has changed so dramatically since the end of the Gold Standard era, but many investors (and many advisors) still cling to Gold Standard era economics, as if nothing has changed. These individuals often cite charts that show returns going back to 1926 without realizing the consequences of doing so. If it weren't for Harry Browne, I'm sure I would be one of those investors.

Gumby wrote: But, when you think about it, it's pretty clear that the 60/40 portfolio is a Gold Standard era portfolio.

Just prior to investing in PP, I had read a bunch of very good asset allocation books by the likes of William Bernstein (great authors) and Rick Ferri, and was about to buy in to a 60/40 type portfolio.  In the back of my mind I was bothered by the inflation risk.  It was then that I found the PP in an article Bernstein wrote and was sold on the PP.

I can't figure out why more of these 60/40 guys don't like the PP. 

Thanks, Clive! Great info. I can see that the Coffee House is a terrific improvement on the 60/40 portfolio. But, I suspect that there are plenty of investors out there who are still using a traditional 60/40 portfolio without realizing the risks in a post-Gold Standard world. My guess is that those investors probably don't realize is that the traditional 60/40 portfolio doesn't protect the investor from spikes in inflation.



Source: http://www.alliancebernstein.com/CmsObj ... ckbook.pdf

The "traditional" 60/40 portfolio was born from the backtesting in the Gold Standard era. When the US was on the Gold Standard, major inflation spikes weren't really a big problem. Now investors need to inflation-proof their investments, but I'm not sure many casual investors are aware of that strategy change.

Clive wrote: For example a Japanese PP if I recall correctly had at least two years with -13% losses since 1972.

Clive--

I'd be curious to know how a Japanese PP did the year following the 13% drop years.  Any idea?

Adam1226 wrote: I'd be curious to know how a Japanese PP did the year following the 13% drop years.  Any idea?

Keep in mind that Japan didn't offer long-term government bonds so it's not possible to construct a "true" Japanese PP.  We can do approximations (such as 50% intermediate treasuries instead of cash\LT bonds) but unfortunately we know less about a Japanese PP than we would like to.

This is a bummer since Japan is an example of a modern-day deflation, yet we've got no LT bonds to use to find out how it would have played out.