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Did Your ‘Diversified Portfolio’ Protect You in 2008?

Back when I was an impressionable college student I was shown an asset allocation rubric. The rubric was a list of asset classes with a recommended percent of funds to be invested in each asset type. The result would be a diversified portfolio.

It was my first exposure to asset allocation and it made a lot of sense.

The allocation I was presented was very similar what I have listed below and I’ll call it “Portfolio 1”.

Asset Allocation Portfolio 1

The problem with this portfolio is that is dropped over 55% in the 2008 financial crisis.

Without any bonds (or gold) this portfolio was subject to a massive drawdown.

Since January of 2007 to January of 2017 this portfolio has a compound annual growth rate (CAGR) of just 5.58%.

Plus the correlation with US stocks is .98.

In fact an investor would have been better off just buying the Vanguard Total Stock Market Index (VTSMX) and calling it a day. The “Just Buy VTSMX” strategy would have had a 7.25% CAGR with a lower maximum drawdown of around 50%.

Asset Allocation: Portfolio 2 (Add Bonds)

To be fair, the allocation actually calls for a 40% allocation to short term bonds. Adding 40% bonds would have limited the maximum drawdown to a much more manageable 33.72% with a CAGR of 4.77%.

Correlation of this portfolio is still .98.

HIGMW Asset Allocation

But enduring a 33% drawdown for a a 4.77% return doesn’t seem stellar to me. So I’m been experimenting with different asset allocations using

The HIGMW Asset Allocation I’ve developed would have a maximum drawdown of 28.77% with a CAGR of 7.38%. Correlation with US stocks drops below the 90s down to .87, still high, but at least lower.

Now the actual investments in my allocation are listed below. I had to swap out some funds in order to get a sense of how this allocation would have performed in 2008.

However, many of the funds I like did not exist in 2008.

Yes, this allocation is 30% bonds. And yes, I think US stocks and bonds are in a bubble. And yes indeed I Don’t Own US Treasuries. But 20% of my allocation to bonds are outside the US and the other 10% are in a fund managed by Bill Gross mainly consisting of corporate bonds and only 6% in government bonds.

So my 30% allocation to these bond funds in no way contradicts my views on US debt.

I also allocated 20% to gold and 10% to real estate. I think if inflation does pick up (even more) these hard assets will add some resilience to the portfolio.

Small cap value stocks have outperformed over the last 45 year so I’m overweight small cap value. 10% is allocated to international small cap value stocks and 10% to small cap value stocks in the US. The 20% allocation to the First Trust Dorsey Wright Dynamic Focus 5 ETF is an interesting ETF in that it is somewhat trend following. Combine these three funds and 40% of this allocation is to stocks.

Gold doesn’t pay a dividend or yield. But until the central banks around the world stop acting like crazy people gold will remain a large part of my portfolio.

I don’t think I can be convinced that governments can continue to borrow, print and spend money without consequences.

Five Reasons Why You Can Own Too Much Gold

Five Reasons Why You Can Own Too Much Gold

I previously wrote an article, “I Own Too Much Gold” and I’ve gotten several replies on twitter such as, “Impossible” and “No Such Thing”.

I strongly suspect (although I can’t prove it) these folks didn’t read the article. But in case they did and still aren’t convinced here are five reasons why you don’t want to own too much gold as a percentage of your asset allocation:

Reason 1: Lack of Tax Benefits

In the US, gains on physical gold are taxed as ordinary income, which could be a lot higher for you than the capital gains rate.

Even if you were an uber-gold bull and thought it was going to $100,000 per ounce would you really want to pay all your taxes on those gains as ordinary income?

Why not invest in some gold mining stocks (which would certainly go up as well if gold skyrocketed) and pay the capital gains tax rate? Why not hold some of those gold mining stocks in a Roth IRA so you pay zero capital gains taxes?

Reason 2: Diversification

too much gold
Sometimes less is more

It’s important to be diversified in non-correlated assets. If I owned no gold, it would be important to own some, as gold tends to be less correlated with stocks and bonds. However, for the same reasons why you don’t want to be all in one asset class, you don’t want have too much of your assets tied up in gold.

If all you own is gold you don’t own any silver! Some speculate that silver will go up in value even higher than gold. If that’s the case you’ll want to diversity your precious metal holdings into the gray metal as well.

Reason 3: Liquidity

If you’re like most people, you need to buy food, clothing, energy, and the staples of living. You want to have some money in a more liquid format so you can pay for these things. If all your money was in gold, how are you going to pay your taxes or buy food?

Reason 4: No Cash Flow

If you invest in a business or a rental property or a dividend paying stock, there is cash-flow. If you own shares of a company, that company has employees trying to grow the business and increase shareholder value. Gold doesn’t do anything of those things. This is okay, gold doesn’t need to do those things (which come with their own set of risks), but if all your money is in gold then you are by definition missing out on opportunities to invest in cash-flow producing assets.

Reason 5: Charity

Wealth is a good servant but a terrible master. Ultimately you can’t take your gold with you and one of the great perks of having extra money (or wealth) is giving it away to those in need!

Do you want to gift your gold to a charity and have them have to deal with selling it?

If you keep some money in local currency it is easier to donate to a good cause. My favorite charitable organization is Children of Hope and Faith they help feed, clothe and educate orphans in Tanzania. I know the founder and board members personally and I know they have very low overhead which means it is efficient and there is more money going to the kids who need it. You can’t get any better than that!

Of Course You Can Own Too Much Gold

I’m a big proponent of having precious metals in one’s portfolio. Please stop saying you can’t own too much gold because you can.

Here are just a few ideas of investments including and apart from gold.

US Value Stocks have Outperformed Since 1972

US Value Stocks have Outperformed Since 1972

Stocks are one of the key ways I grow my wealth.

I like value investing and value stocks. It’s not some aesthetic or subjective reason. As an asset class US value stocks have a history of outperforming other US stock¬†classes.

I like picking individual stocks but I appreciate that is not suitable for everyone. For some folks a passive index asset allocation strategy could be better.

Equally Weighted Large, Mid, and Small Cap Portfolio Performance Since 1972

If one were to have invested $1,000 in the a portfolio consisting of roughly equal allocations of large market capitalization (“Large Cap”) stocks, mid-cap and small cap stocks in January of 1972, it would have grown to $132,330 by January of 2017. The compound annual growth rate¬†(CAGR) of this portfolio was 11.45%. The maximum drawdown around the 2008 financial crisis was 52.70% (stressful).

During this same time, if one were to invest $1,000 in “US Stocks” the CAGR would have been 10.21%, balance on January 2017 would have been $80,008, and the maximum drawdown would have been 50.89%.


What about Growth Stocks?

A portfolio with 1/3 large, 1/3 mid and 1/3 small cap growth stocks would have done even worse than the allocation above. The CAGR since 1972 has been 10%, the maximum drawdown was 58.6% (wow!), and $1,000 would have grown to $73,508.

So growth stocks performed worse.


US Value Stocks have Outperformed

US value stocks have outperformed growth stocks. A portfolio mixed with 1/3 large cap value, 1/3 mid cap value and 1/3 small cap value would have a CAGR of 13.11%.

A $1,000 investment in 1972 would have grown to $258,618. The maximum drawdown would have been slightly higher than straight market cap stocks, at 55.79% (still stressful) but less than the growth stock portfolio.


What it All Means

There are two main takeaways.

  1. Value stocks outperform other stocks classes
  2. A small increase in the CAGR has a large impact if the time horizon is long enough
  3. US value stocks had a lower maximum drawdown than growth stocks
  4. US value stocks have higher maximum drawdown than stocks in general


For more details on this data see the FAQ.

A New Twist on 60/40 Asset Allocation

A New Twist on 60/40 Asset Allocation

What is a 60/40 asset allocation? I’ll take a quote from an article on my favorite online finance wiki, investopedia:

For many years, a large percentage of financial planners and stockbrokers crafted portfolios for their clients that were composed of 60% equities and 40% bonds or other fixed-income offerings. And these portfolios did rather well throughout the 80s and 90s. But a series of bear markets that started in 2000 coupled with historically low interest rates have eroded the popularity of this approach to investing. – “Why a 60/40 Portfolio is No Longer Good Enough

With that in mind, I’ve found a delightful free tool called Portfolio Visualizer that I’ve been using to backtest various asset allocation strategies.

Today I’d like to share a few basic ones to provide some food for thought. Each of these portfolios is modeled for annual rebalancing, meaning assets would be bought and/or sold each year to retain the original allocation percentages.

Portfolio 1: 100% Allocation to US Stocks

Using this tool, you can see that if in 1972 you invested $1,000 in US stocks, it would grow to be worth $78,509 at the end of 2016, representing a compound annual growth rate (CAGR) of 10.18%. You would have had to endure a drawdown of 50.89%, from November of 2007 through February of 2009. During this crisis the portfolio would have gone from $43,886 down to $21,551.

Portfolio 2: 60/40 Asset Allocation of US Stocks and Bonds

Most people don’t have the iron stomach needed to hold onto their stocks while their portfolio drops by 50%.

Enter the 60/40 asset allocation.

A traditional allocation in the investment community is (or has been) 60% stocks 40% bonds (in this case I used Intermediate Term Treasuries). The thought being that if stocks are going up, bonds are going down, but also that if stocks are going down, bonds will go up. If you did this 60/40 allocation starting in 1972, again with $1,000, the 2016 value would be $58,011, the CAGR would be 9.44% and the 2008 drawdown would have been around 28%.

So you give up $20,500 in exchange for some peace of mind.

Portfolio 3: 60/40 Asset Allocation of US Stocks and Gold

I think that US debt has nowhere to go but down. And I’ve never been particularly fond of loaning the government money, through treasuries or otherwise, so I thought: what if one replaced the 40% allocation to bonds with my favorite yellow metal?

With this allocation the $1,000 invested in 1972 would grow to $85,886 by 2016, the CAGR would be 10.40% and the maximum drawdown would have been 30% back in 1980-1982.

So over the 1972-2016 timeframe, a 60/40 asset allocation of US stocks and gold would have performed better than either 100% US stocks or a 60/40 US stock and bond portfolio.

You can always cherrypick allocations in hindsight that will outperform. But I think it is an interesting datapoint in the case for gold.