After yesterday's look at an article on supposedly failed diversification from the NYT I found another one from Reuters. The Reuters post was very similar to the NYT article.
One thing that I did not mention is that 2008 (and for however long it lasts beyond 2008) has been the year that is the outlier for everything. It has been the outcome that would be the least probable scenario in any sort of financial planning process.
With that sentiment I am not commenting on whether it should have happened, whose fault it is, the fixes gone bad, what I think will happen next or anything else just the simple idea that down 40%, 30-40% below the 200 DMA for broad market indexes, the implosion in oil, the possibility that the fixed income market is worse off than equities, that commodities have also imploded and anything I am forgetting have created a cocktail of 100 year floods in every asset class (including the bizarre rally in treasuries; TYX as at 3.11!).
2008 was the year no asset allocation model would ever realistically account for. The odds that a diversified portfolio that took no defensive action would stand up to this onslaught were close to nil.
Some of my recent posts have explored ways to possibly construct a different type of portfolio that would mean a different type of market participation and a different type of result. The reason anyone would consider this is if they simply find they cannot stomach normal stock market behavior. However the assumption that the capital markets and the sorts of inter-assets relationships that have existed for decades are now permanently defunct is a bad bet.
This is a disruption of normal market function, without getting into how long it might last for now, that is what it is. I still think normal stock market participation, with some sort of defensive strategy, is the best way to go. I can envision a scenario where a lot of people one way or another give up on stocks, then maybe we end up having a decent cyclical bull market and many of the folks who gave come back in just in time for the next cyclical bear.
The explorations of different portfolio methods is interesting and can be a learning tool as I think it stretches out the mind a little bit but above all I would urge (repeat theme here) keeping it simple with a normal-ish portfolio. Defensive action in the manner I've described before is simple. There is no need to even worry about magnitude--indeed I was wrong about the bear market's magnitude (down 50% twice in one decade? really?) but that has not mattered.
To reiterate a point made many times over, it doesn't matter if every fund or stock you have is down 40%, what matters is not being fully invested in a bunch of funds and stocks that are down 40%.
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27 comments:
...nothing new here today. What you are describing is a balanced approached to asset allocation. Yawn.
..but sensible advice. Yawn again. The KISS method rules.
I'm hoping for an ETF that tracks the 200 dma.
Hussman is espousing similar "planned" logical approach to investing. It maybe boring and get some people yawning, but I just kind of love the returns :)
I did find that Hussman is just plane wrong and uninformed about one thing. He said "...not because the market is diabolical and secretly wishes to frustrate the greatest number of investors..."
He has no idea what he is talking about. The market is clearly and undeniably diabolically trying to frustrate the greatest number of investors :)
First, thanks for your comments. Granted that the balanced effect hasn't helped YET. The point is that we don't know where growth will occur going forward, and being balanced will put us at risk in those areas, just after all correlations have gone to 1. Still, applying some sell discipline, like Mabane Faber discusses, seems reasonable.
Here I am, the guy you all know and love as the down 11% guy.
First, I must say that I have been reading Roger for many years since I found his writing on The Street.
Second, I continue to follow him because he's not just another CNBC pundit. In fact, CNBC would improve their grade by a wide margin if Roger were a regular guest.
Third, he's honest and he cares.
All that said, I disagree that this is just a disruption of normal market function. THIS TIME IS DIFFERENT. Much more than the last twenty times people asked, "is this different"? We have the makings of a perfect storm. So far we've been hit with a few rogue waves.
The sky could be falling. On top of the usual indicators that everyone is following is the muni bond market. They're getting slammed. Some are down over 30% and I'm talking the A-AAA rated bonds. Our state government problems are another shoe that's going to drop.
When I started buying muni's about 15 years ago I told my broker of my very conservative investment style. He told me not to worry because we're only buying insured bonds and for any of them to fail THE ENTIRE MUNICIPAL MARKET IN THIS COUNTRY would have to be in a state that we haven't seen since the great depression.
GUESS WHAT? We're almost there!
The states need money to balance their budgets. They're going to have to cut services and raise taxes. That's RAISE TAXES!
I could go on about the muni bond insurer debacle and such but I think I've made my point.
This time is different than maybe two times in history.
Re: 07:15
Ask any guy that's been married 6-8 times and they will all tell you it was the three little words that got them in trouble. No, not "I Love You", but rather "this one's different".
How bad things are depends on your vantage point. After 6 plus decades, in my view other periods have been worse. Your being down 11% is good and shows great wisdom. However, if you stay where you are, you will likely be left in the dust. Roger's commentaries are really quite sound-IMHO of course.
"Ask any guy that's been married 6-8 times and they will all tell you it was the three little words that got them in trouble. No, not "I Love You", but rather "this one's different".
LOL...I think "any guy" might need
to be the one to change.
CNBC announced:
All guests in 2009 must wear
white t-shirts listing all
their PERSONNAL investments.
(attempt at humor)
Regular readers know me. I'm only down 11% because I'm a chicken, not because I'm wise.
Has diversification really failed?
If the S%P 500 is down 39% and you're only down 25% due to diversification, that means diversification is working (at least to me). Perhaps a lot of people have a hangover from the late 90s; while they don't think stocks always go up, maybe they think they aren't supposed to suffer huge losses.
I remember the risk questionaire from, what is it, IFA.com? There are specific questions on how much of a 1 year loss you're willing to take.
The principle of compounding is familiar to everyone in building wealth but it is just as destructive on the way down as it is constructive on the way up:
Down 25% requires a 33+% gain to break even; quite feasible.
Down 40% requires twice that (66.6% gain) to break even; takes more work and risk or time.
Down 50% requires that you double your entire stake, 100% gain, just to break even; the risk and/or time factor could now become a major impediment to reaching financial goals.
Shorter version: Regardless of wealth-building strategy it is a good idea to develop a regime that helps you avoid big losses.
What if there was a passive asset allocation designed 3 decades ago that with a historical CAGR of 11+% and a YTD return of -4.84% this year. Would anyone be interested in this?
For some reason I haven't been able to get anyone to comment on this idea when I post about it... Not complaining just scratching my head... I started doing backtests at assetplay.net and morningstar when my endowment style portfolio caught on fire a few months ago, and it looks very solid. 25% small value, 25% long gov't, 25% cash, 25% gold.
I am not against doing the best job possible to increase the reward/risk possible of the equity portion of my portfolio including diverse equity positions and defensive selling. But I have definitely been convinced to shift by target allocation for the future.
Greg Mankiw has a great graph that puts 2008 in perspective
http://gregmankiw.blogspot.com/2008/12/life-in-left-tail.html
OG
Isn't it 'cue'? :)
To offer a little more personal evidence about the definition of 'failure', I started a paper fundadvice.com ultimate buy and hold over at marketocracy. I did this probably at the worst time (the beginning of this year). So have a look at it here if you want. It pretty much agrees with the link that Stephen posted. The UBH is down about 25% this year. The chart really shows the stability vs. the major averages.
To me, this is the first step in proving the concept in real time. I'll give it another few years and see how it handles the up side of the cycle.
Supposedly this strategy will outperform not necessarily because it runs hotter on the way up, but it doesn't lose as much on the way down. A fact that many would probably find comfort in right now. It also seems to have proven that this time around.
I enjoy looking at portfolios; I track that and others here and you can see how it has done since 2001. I'll probably get earlier data filled in by the end of the year.
Matthew--Very interesting allocation. Personally, I have a really hard time with just 4-5 buckets, regardless of what the numbers prove. Same with with Mebane Faber's allocation. I don't know why; maybe the actual $$$ pooled in this manner just look too concentrated on my brokerage statement. Silly, if you look at the historical correlations.
Matthew: using Morningstar data, your YTD is -7%.
If I use Vanguard SC value, Vanguard prime money market, Vanguard Long term treasury and GLD, returns are:
2008 ytd: -7%
2007: 9.6
2006: 11.9
2005: 8.4
VFINX returns in for those periods are, startig in 2005: 4.8%, 15.6%, 5.4, and -39%.
It's interesting, but not impressive at this point 'cause Gold has gone insane the last few years.
I'm not sure how to get annualized returns for gold pre-GLD.
Stephen,
This is good stuff. Is there a way we can get some sort of notification when you update data?
Sure; I could just post a comment here or something.
I update it every January - OR when I add portfolios or test new ideas.
This year we've had the big market losses and the fact that I've figured out to calculate annualized gains. so it has been updated several times.
Hi Stephen, thanks for posting your analysis. Harry Browne is the original designer of that allocation I posted about. I believe he would contend that gold ( and other hard assets), have a strong economic relationship to assets such as cash and equities. This means that it is not coincidence that gold went up during the inflationary expansion caused by over-leveraging of global financial markets.
It is also not a coincidence that when things started to stray toward deflation gold went down and long US bonds went up. This is how Browne said the permanent portfolio was supposed to work.
Anyway, something interesting to chew on...
One could make the argument that it IS coincidence - 'cause that's when gold ETFs because available and let every Tom, Dick, and Harry easily buy gold that bloggers were telling them to buy.
The Journal of Financial Planners had an article a few years ago showing that the long term returns of commodities was essentially zero - which was part of the reason they help balance your portfolios in bad times for equities. So it would be interesting to see what the long term returns of the other 3 pieces of the portfolio would be while just putting the gold portion at a 0% return each year.
But then again perhaps GLD came out because the price of gold had started to move already ;)
I think you probably meant to ask for gold return =inflation% instead of =0% but here are the numbers you asked for since its easier for me. I got this from assetplay.net data which goes from 1972-2007:
Small Cap Value - 34%
Long Term Government Bonds - 33%
2 Year ST Treasury - 33%
Portfolio Stats:
Average Return 10.99%
CAGR 10.62%
Standard Dev 9.1%
Correlation TSM 0.65
Correlation EAFE 0.28
Max Annual DD (8.9)
That site doesn't have gold data, but using broad commodities as a proxy:
Small Cap Value - 25%
Commodities - 25%
Long Term Government Bonds - 25%
2 Year ST Treasury - 25%
Portfolio Stats
Average Return 11.49%
CAGR 11.27%
Standard Dev 7.04%
Correlation TSM 0.51
Correlation EAFE 0.19
Max Annual DD (2.9)
DAng. The article is in May 2007 but I can't find it on the website.
Ok, not to keep yapping. Last post.
A quick google search for the name you mentioned comes up with this. Turns out it's a take on the permanent portfolio mutual fund.
It does specify "stocks" and not "small value stocks." I'll have to mess around with numbers to see if it makes a difference to use sc value vs. S&P 500. I'd probably compare gold vs. a precious metals or precious metals/mining ETF.
Now that I have a source, I'll probably add this to my list. It's an interesting concept; thanks.
I used Browne's approach in the 80's but it didn't work well in practice as originally laid out. Browne's model relied upon very strong volatility in the active components so, for example, "stocks" were typically represented by warrants or very high beta equities, "bonds" were typically represented by treasury strips or other long duration instruments.
One of the problems as folks have noticed is that asset classes have a tendency to become more correlated in a crisis so the assumption that you could reliably predict one would zig when another zagged didn't pan out when you needed it most.
I still use the original framework as a conceptual tool for my core strategic portfolio but, like the Permanent Portfolio fund Browne and a colleague started, do not follow the original model (AFAIK Browne was never active in the actual management of that fund).
Very interesting Stephen. At a quick glance I like the simplicity and average annual return of the Motley Fool's "ETF Portfolio". Thanks for your post.
Mad Max
Browne not only encouraged a Permanent Portfolio, he also encouraged a Speculative Portfolio to hopefully juice returns. In a perfect world, with rebalancing, the Permanent Portfolio could well result in an absolute return of nil. Mr.Browne alluded to this in later years.
T
The permanent portfolio allocation worked fine in this market. It is the only allocation that has true diversification in my opinion. Stocks are down 30+% but the Long Term bonds it holds are up 25% and climbing. For such a simple allocation it sure does work. You can download all his radio shows discussing the strategy from here:
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