The Value Stock Geek Asset Allocation

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The Appeal of Lazy Portfolios

I love following the market and picking stocks. I love the challenge of it, and I find it fun. This blog tracks my efforts in this arena. I think a reasonably concentrated value portfolio of 20-30 cheap stocks with good balance sheets in diverse but out-of-favor industries ought to outperform the market significantly over time. However, it’s not for the meek, as the last few years of my results have demonstrated. You need to stomach higher volatility than the market and endure long periods where you look like an idiot by underperforming the market. I have no problem with any of this, including looking like an idiot.

With that said, I’m also a big fan of “lazy” portfolios and think that’s the optimal approach for most people. What’s a lazy portfolio? You diversify across a bunch of asset classes that will deliver returns in different economic environments. You buy and hold it and don’t try to time the market. You avoid making the big, macro bets that I love to think about but often get wrong like: (1) Will we endure another 1929-32 episode? (2) Will the dollar increase over the next 10 years or go down? (3) Are US stocks over or undervalued? (4) Will the rest of the world outperform? (5) Will we endure an inflationary episode like the 1970s?

I don’t know the answers to these questions, but neither can any of the financial gurus who claim they can.

I love speculating about future events, but I’m also conscious of the fact that my guess is as good as anyone else’s. Macro calls and market timing are hard.

Another way to generate alpha is stock picking. I’m trying hard on this front, but I’ve also bought enough value traps to appreciate the intense difficulty of security selection.

Predicting the future is hard. Hell, it’s hard enough to figure out what is happening in the present. Here is a funny post from 2008. Intrade, a betting market, had the odds of a recession at 45% on April 17th, 2008. We were already in a recession at that point, but there was still a debate about it! I recall similar discussions during the early 2000s. There was a serious debate in 2001 about whether we were going to have a recession while we were already in one. This is an excellent article about the difficulty of predicting the future. Experts, in all fields, even when equipped with classified information, can’t predict the future.

As investors, we face the challenge that the “experts” are useless. Few economists can predict what is going to happen. Few fund managers do, either. Meanwhile, we end up paying vast sums of our hard earned dollars to experts for advice that isn’t useful.

This begs the question: what should I do with my savings when the future is unpredictable, and experts know nothing? It’s a question fraught with emotion because making money is hard. It’s not a game. I worked my tail off for the money I have, and I don’t want to squander it. I’m sure you’re likely in the same boat.

I think that the best approach is a diversified portfolio of low-fee ETFs and/or mutual funds that should deliver a consistent return in most economic environments. Low fees and diversification are the answer. I prefer ETF’s because they are more tax efficient than mutual funds. With that said, mutual funds make it easier to reinvest dividends. Mutual funds, especially balanced funds, make it a lot easier to set it and forget it. People are also more tempted to trade ETF’s. It’s a controversial topic, but I am squarely in the ETF camp.

A diversified portfolio of low-fee ETF’s and mutual funds means one thing: a lazy portfolio. A mix of asset classes that only need to be rebalanced once in a while.

I wrote about a great lazy portfolio created by the superinvestor and maestro of asset allocation himself: David Swensen. You can read my post about it here. Swensen’s recommendations are solid, and my 401(k) selections are pretty close to what he recommends.

For a great menu of different lazy portfolios, check out the Portfolio Charts blog. The author maintains a great list of different lazy portfolios to choose from, depending on your views on asset allocation and the ability to stick with an approach.

Here are some popular approaches (all returns are in real, inflation-adjusted returns):

1. The classic 60/40. If you want to keep it basic, this is the approach. 60% US Stocks, 40% US bonds. A 5.8% average rate of return, 34% max drawdown. 12 years is the longest period that the portfolio remained in the red. It’s a decent approach.

Basic things are often derided, but let’s face it: like chocolate cake, Starbucks, the Beatles, or pepperoni pizza – something becomes basic because there is something inherently awesome about it. You can also implement this in a single Vanguard mutual fund, set it up to reinvest dividends and interest, and forget about it. They can do the rebalancing for you, and you don’t even have to look at it.

Vanguard has a variety of Lifestrategy balanced funds for a low fee which adopts this approach. They’re balanced with a mix of stocks and bonds, and all of the work is done for you. The 60/40 fund is a the Lifestrategy moderate growth fund.

Ironically, many financial advisors put people in a 60/40 allocation and charge 1% for this allocation. Vanguard will do it for you for .13%.

2. The All Seasons Portfolio. This is the portfolio created by Ray Dalio and promoted by Tony Robbins in his book, Money: Master the Game. A 5.3% average rate of return, 16% max drawdown, and 10 years in the red. The portfolio is 30% US stocks, 40% long term bonds, 15% intermediate bonds, 7.5% commodities, and 7.5% gold. This portfolio is for people who watched 2008 and said to themselves: never again. This approach appeals to the risk-averse who never want to endure another episode like 2008 but still want to invest and grow their savings.

There are a lot of assumptions built into this approach. Much of the return for the portfolio since 1981 is an epic, multi-decade reduction in interest rates. This buoyed the profits in long-term bonds, which have delivered equity-like returns over the last 40 years with low volatility. (Bonds prices and interest rates are inversely related – when bond yields go down, bond prices go up. We’ve been in this environment since the ’80s. It probably won’t last forever.)

Interest rates won’t decline indefinitely. They typically rise during inflationary periods like the 1960s and 1970s. When inflation comes back, a fundamental assumption of the All-Weather allocation is that the gold and commodities will deliver a high rate of return when the long-term bond allocation takes a beating. This is what happened in the 1970s, but I don’t know if this will happen again. Then again, Ray Dalio is a lot smarter than I am with a multi-billion dollar net worth to back it up.

3. The Boglehead’s Three-Fund Portfolio. This is the approach embraced by Bogleheads with three simple index funds. Bogleheads.org is a fantastic discussion forum with a rich array of useful information for DIY investors. It’s 40% US stocks, 20% international stocks, and 40% bonds. It delivers a 5.7% rate of return, with a 32% max drawdown, and a 10-year money-losing period. It’s a sensible approach. You’re zeroing in on the three major asset classes and getting the market return on all of them for a low fee.

4. 100% US Stocks. Straightforward and simple, but not easy. This is the approach embraced by the FIRE community. This is also close to Warren Buffet’s recommended asset allocation (90% stocks, 10% bonds).

This approach will likely work over the long run, but it’s not easy to stick with. I don’t think the people who embrace this approach are fully conscious of the risks embedded in it. Since 1970, US stocks have earned a 7.6% rate of return (hooray!) but had a 49% max drawdown (ouch), and 13 years of money-losing (double ouch). The max drawdown is from 2008. The 13 year stretch of real losses begins in the 1970s, a decade of fantastic rock (Pink Floyd, Zeppelin) and terrible investment returns, which set the stage for two decades of supercharged performances in the 1980s and 1990s. Two decades of interest rates falling from 20% to 5% do wonders for financial assets.

The Portfolio Charts website takes the returns back to 1970. Bringing things back further, US stock-only investors suffered an 80% drawdown during the depression. US stocks occasionally have a lost decade, like the 2000s, when US stocks had two crushing 50% drawdowns and delivered a real return of -1.21%. Staying long-only US market cap weighted stocks also ignores the valuation of the market. If US stocks ever enter a truly insane bubble like Japan in the 1980s (this isn’t happening now – Japan’s CAPE ratio went up to 100 in 1989, and the US is at 28 now), you could go decades without a return.

This also assumes that US stocks will always be capital friendly and that the US economy will provide the best returns. This was certainly the case in the 20th century. It has been the case this decade. It wasn’t the case in the 2000s. It may not be the case for the rest of the 21st century. As an American, I certainly hope that US stocks maintain their strength, but hope is not an investment program.

5. The Pinwheel Portfolio. This was designed by the author of the Portfolio Charts site and is one of the best approaches on there. 15% US stocks, 10% small cap value (yes!), 15% international, 10% emerging markets, 15% intermediate bonds, 10% cash, 15% REITs, 10% gold. This is broad diversification, and it works. A 6.7% rate of return, only a 26% max drawdown, and only 5 years of money-losing in the portfolio.

These 5 portfolios are just a small little sampling of the menu of lazy portfolios that are available. You can check out the full menu of low-cost, lazy, DIY asset allocations options here at the Portfolio Charts blog.

Searching for my own approach

Outside of the blog, I have a separate asset allocation. My 401(k) is reasonably diversified between multiple asset classes. Most people would say I’m underweight the US equity market with only a 25% allocation to the Russell 3k (because I think US market cap weighted indexes are expensive, poised for low returns over the next decade, but I still want an allocation to it because I might be wrong). The rest is divided up among a bunch of asset classes: the US bond market, TIPS, REITs, high yield bonds, emerging markets, international developed. It’s a smorgasbord of what’s available. I wish my 401(k) had some value-oriented options, but I have to diversify among the asset classes available to me.

I also have separate brokerage accounts in which I buy and hold ETF’s. For these accounts, nearly all of my equity exposure is value-oriented, and I own some diversifiers. Over the years, it’s turned into a real soup of many different ETF’s. I’ve wanted to simplify these accounts for a long time into four or five ETF’s, but have been searching for the right balance. I also want to stick to a passive, diversified, approach and have been searching for the right path.

With this passive allocation, I wanted to accomplish many goals:

  1. Small Cap Value Allocation. I want to fully embrace small-cap value stocks. There is a reason that these factors (small stocks, cheap stocks) outperform. I don’t believe that they outperform because they are riskier, which is the argument of the academics. I think they outperform because small-cap stocks are more likely to be mispriced. Cheap stocks are also expected to be mispriced. Small cap value investors earn higher and more consistent returns over the long run because they are systematically buying compressed multiples and sell after those multiples go higher. It’s possible that both factors (small cap and value) have been degraded, but I don’t think this is the case, and I believe they are likely to outperform over the long term. It is a sensible approach that makes logical sense to me. Because multiples are always changing for individual stocks, I believe this approach also provides a more consistent return than the market. During bull markets, small-cap value underperforms, but it has never had a lost decade like market cap weighted US equities. With that said, small-cap value often draws down with the broader market when we encounter economic trouble and doesn’t provide any protection in a 2008 style event.
  2. Insurance against large, rapid, drawdowns. Speaking of horrific drawdowns, I want insurance during a market episode like 1929-32, 1973-74, or 2008. I don’t want to endure an event where I lose more than 50% of my money, which is going to happen to my equity allocation every once in a while. I’m not Stanley Druckenmiller or Ray Dalio.
  3. Inflation insurance. I want protection if inflation erodes the American economy and hammers all asset classes, as it did in the 1970s.
  4. No lost decades. I want asset classes that deliver a consistent return. I don’t want something that provides returns sporadically and is prone to lost decades like market cap weighted US stocks. There are fabulous decades for US stocks like the 1990s and 2010s, and then decades where US stocks are dead money, like the 1970s and 2000s. I don’t want to lose money for over 10 years.
  5. Small cap value international exposure. I don’t want to have home country bias and want some exposure to foreign equities. With that said, I also don’t want to invest heavily in a bunch of mega-cap European banks with trashy balance sheets. I don’t want to buy market cap weighted Japanese stocks at a CAPE ratio of 100 at a moment like 1989. I don’t want to buy the BRICs in 2007 at crazy CAPE ratios and expectations. I think the best way to avoid bubbles is to gear the foreign allocation towards small cap value. Like US small-cap value, international small-cap value should systematically avoid the bubbles and deliver a relatively consistent rate of return compared to their large-cap market cap weighted index brethren.
  6. No gold or commodities. I do not want to invest in commodities or gold. Yes, commodities and gold did great in the 1970s. Yes, “fiat”, blah blah blah. I agree with Warren Buffett’s perspective. Gold sits there in a vault and produces no cash flow. It is an entirely speculative endeavor because the return is wholly based on the resale value. I want to avoid purely speculative assets like art, collectibles, and cryptocurrencies. Not interested. There are other ways to manage the risk of inflation, which is what gold is really for. There aren’t any long term tailwinds to increase the price of gold over the long run. It did well in the 1970s, but then gave back all of those gains in the 1980s and 1990s. It had another great run from 2000 through 2012, which has since dissipated. Here are a couple charts: (1) gold in the 1980s and 1990s, (2) Gold in the 1970s. Gold was an excellent tool to weather the inflation of the 1970s, but it’s volatile, unpredictable, with no long-term prospects for appreciation.golds80s90s.PNGgold1970s
  7. Low fee, rules-based, approaches. I want the strategy to be low cost, systematic, with a passively constructed portfolio. I don’t want to pay high fees for my allocation. I don’t want a fund that charges me more than 25 bps. I also want approaches that are systematic and aren’t going to be impacted because the fund manager is going through a divorce.
  8. No large-cap market cap weighted equity indexes. I want to get away from market-cap weighted indexes. Over the long run, I don’t believe market cap weighting is the optimal approach for equity investing. Market cap weighted indexes wind up investing heavily at cyclical peaks in the most overvalued stocks. Market cap weighted indexes buy more of the stocks that are going up, which I believe is the worst way to invest. At cyclical peaks, you wind up holding the most overvalued names of the moment. You wind up with massive allocations to technology stocks in 2000 and massive allocations to financial stocks in 2007.
    A good example is Japan. Japanese stocks still haven’t returned to their 1989 highs. However, if you veered away from market cap weighting, there was still money to be made in Japanese stocks. While market cap weighting in Japan has been dead money since Zack Morris ruled Bayside High, an approach like the magic formula generated an 18% return. Ditto for US stocks in the 1970s and the 2000s. The indexes were crushed, but equally weighted and value approaches still delivered a profit. It’s these periods that provide the “value premium.” The value premium doesn’t happen reliably, year after year. It has delivered over these long periods when the large-cap indexes are working off previous excesses. Equal weighting and strategies like small-cap value still delivered returns in these environments, while the broader market was crushed. The broader market was crushed because the index was heavily invested in the biggest, hyped up names. Avoiding market cap weighting looks stupid during bull markets because all of the biggest stocks are going up. As for me, I have no problem looking stupid and underperforming in bull markets for a more consistent return. The benefits are only apparent when large-cap bubble stocks implode, like Japan in the late ’80s the US in the early 2000s, the BRICs in 2008, or the Nifty Fifty in the early ’70s.
  9. Insurance that doesn’t lose money over the long run. I don’t want assets that lose money over the long term or are dead money for long stretches of time, like gold. This is why my “insurance” can’t be in the form of managed futures or other egghead-created fancy strategies, which often come with an equally fancy fee. An approach like going long volatility futures is unacceptable for me. This strategy is likely going to lose money over the long run. The returns are concentrated with black swan events. I don’t want to lose money for 10 years, so I get a 50% pop if another 2008 happens.
  10. No leverage, no concentration. I don’t want to use leverage or concentration. As Charlie Munger likes to say: “All I want to know is where I’m going to die so I’ll never go there.” Well, where do most financial strategies go to die? What causes nearly all of the great financial blow ups? It’s almost always excessive concentration, leverage, or both. The guys who do this are fooling themselves. They should ask themselves this question: are you smarter than the managers of long-term capital management?

Asset classes that fit my goals

I decided on five asset classes that accomplish all of these goals.

For the return data, I used Simba’s backtesting spreadsheet at the Bogleheads forum.

US Small Cap Value

US small cap value is the best performing asset class of all time. It delivers a consistent, high rate of return. It doesn’t have lost decades and only underperforms during bull markets.

Since 1927, it has delivered a 12.05% nominal rate of return and a real return of 8.84%. This compares to a return of 9.69% for the US stock market. In terms of maximum drawdowns, the worst moment for both asset classes was the Great Depression. Small cap value lost 76.02%, and US stocks lost 67.71%. During the 2008 financial crisis, small-cap value lost 36.86% compared to 37.04% for the US stock market. During the 1973-74 moment, small-cap value lost 43.81%, and the broad market lost 40.38%.

Basically, small-cap value goes down as much as the broader market during panics. If the strategy were riskier, wouldn’t it go down significantly more than the market?

While small-cap value delivers high returns, small-cap value doesn’t provide downside protection during panics, as noted above.

Small cap value underperforms during bull markets, but it still does alright. If the US economy is doing well, this asset class will deliver a return. It then provides a consistent return, because multiples are always changing in every market, and the strategy systematically takes advantage of it. This provides high, consistent returns over the long run.

In my value-biased mind, I also think small-cap value is less risky than buying US market cap weighted stocks at a CAPE ratio of 28.

My preferred vehicle for this asset class is Vanguard’s small-cap ETF, VBR, which has an expense ratio of only .12%.

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International Small Cap Stocks

I prefer to tilt towards international small-cap value, but I can’t find a cost-effective solution in an ETF for this. For this reason, I think international small-cap without the value component is the way to go. The current valuation metrics on international small caps are usually pretty cheap, anyway. I wish an ETF existed for international small-cap value, specifically, but it doesn’t exist yet.

The allocation also helps me avoid a home country bias in my equity exposure. International stocks are also a good allocation due to currency movements. A strong dollar is typically associated with bull markets. Meanwhile, a weak dollar is often associated with weakness in US stocks. Fortunately, international stocks benefit from a weaker dollar, thus providing an excellent ying to the yang of US stocks. This was most apparent in the 1990s, a terrible decade for international stocks due primarily to a strong US dollar. Meanwhile, international stocks outperformed in the 2000s, because the dollar was weakening.

Like US small cap value, international small-caps also provide a more consistent return than international stocks as a whole.

In terms of drawdowns, this is the riskiest asset class in the portfolio. International small-cap suffered a 50.36% drawdown in 2008 compared to a 44.1% drawdown for international stocks as a whole in 2008. International stocks have sucked compared to US stocks for the past decade, but I don’t think this will last forever. Mean reversion is a force of nature and the current market environment won’t last forever.

My preferred international small-cap ETF is Vanguard’s international small-cap ETF, VSS. The expense ratio is .12%.

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REITs

US REITs are another class that provides a consistent return. I suspect that REITs produce a more consistent return because much of the return comes from the dividend yield, which will continually be paid while market-cap weighted US equities will sway between Mr. Market’s bouts of extreme euphoria and fear.

Meanwhile, US REITs also provide excellent insurance against inflation. As much as the end-the-Fed gold bugs would like the current regime to end, I don’t think they will ever get their wish. Inflation is here to stay. In an inflationary environment, real estate should increase with the inflation rate as the replacement costs of the real estate expand. This was proven true during the inflation of the 1970s, when REITs significantly outperformed the rest of the market.

Like small-cap value, REITs will decline when the economy falters. Real estate was ground zero of the mid-2000s bubble and, and naturally, REITs suffered a serious drawdown of 50.36%.

Also, like small-cap value, REITs deliver a more consistent return than market cap weighted US stocks. I think this is due primarily to the high dividend yields of REITs. Like small-cap value, REITs also underperform during bull markets. As compensation for this, it still delivers a consistent return when large-cap stocks go through their occasional lost decade.

There are long-term concerns with REITs, such as the decline of commercial retail. However, that’s a small slice of the pie, and it’s not going away completely. I also don’t see how we can ever go without real estate like apartments and storage lockers.

My preferred REIT ETF is Vanguard’s real estate ETF, VNQ. It has an expense ratio of .12%. The dividend yield is currently 4.05%.

reitsusstocks

Long Term US Bonds

Long term US bonds are in the portfolio for three reasons: they provide positive long-term returns, they aren’t going to default, and they are excellent insurance when Mr. Market panics. When the world looks like it is ending, investors flock to long term US bonds. The Fed is also usually cutting interest rates during panics, which improves the returns of this asset class.

Since 1980, long-term bonds have been in an extraordinary bull market, delivering a 10.74% nominal return and a 6.51% real return with a maximum drawdown of only 8.66%. Since the ’80s, they have delivered equity returns without the equity risk. I think this amazing performance is unlikely to continue into the future. This performance occurred because of a multi-decade reduction in interest rates from an extraordinarily high level. (Of course, that’s likely what Japanese investors thought in the late 1990s, who then witnessed interest rates drop even further. Remember what I said about how predicting the future is hard?)

The worst period for long-term US bonds was the 1970s when rising interest rates and inflation saw them deliver a real return of -3.37% over that decade, even though they still delivered a nominal return of 4.18%.

The appeal of long-term bonds is their protection during panics. From 1929-32, while $10,000 in US stocks turned into $3,229, long-term US bonds turned $10,000 into $11,828. While long-term bonds delivered lackluster performance in the 1970s due to rising interest rates, they still protected investors during the 1973-74 drawdown. $10,000 in long-term bonds turned into $10,580. US stock market investors saw their $10,000 turn into $5,962 in 1973-74. In 2008, US long term bonds turned a $10k investment into $12,252, while US stock investors saw their investment fall to $6,296.

Long term bonds are panic insurance that I don’t have to pay a premium for. Managed futures lose money over the long run, but long term bonds pay me interest and then run up nicely during a market panic.

My preferred vehicle for long term US government bonds is VGLT, for an expense ratio of .07%

TIPs

TIPs, or Treasury inflation-protected securities, are US treasury bonds that increase with the inflation rate. The expectation is that they will not decline much during a panic and limit the drawdown. Unlike long-term bonds, however, TIPs ought to do well during an environment like the 1970s.

TIPs have only been around since the 1990s, and we haven’t had an inflationary environment like the 1970s since then. So, we don’t really have reliable data for how they would have performed during that time. I think it’s a safe assumption that they would have outperformed the rest of the bond market if they existed in the 1970s.

With that said, I like TIPs because they provide this inflation protection and they also serve as a cushion during drawdowns, although they aren’t as robust as long-term treasuries during those episodes.

My preferred vehicle for TIPs is Vanguard’s TIP ETF, VTIP. It has an expense ratio of .06%.

Putting it all together

Putting this all together into a single portfolio is an odd choice. It’s quite strange because there is zero allocation to US market-cap weighted stocks, which are included in the mix for nearly every popular asset allocation. A portfolio without this component is like making marinara sauce without tomatoes. It’s weird. In my mind, weird is good.

Deciding the appropriate weights of these asset classes in a portfolio is a recipe for significant brain damage. I like to keep things simple. I’ll equally weight them, 20% each.

vsgportfolio

How does this portfolio hold up? According to the backtesting spreadsheet, since 1985 it delivers a 9.67% nominal return with a real return of 6.9%. In 2008, it fell by only 19.96%. (The TIPs data is simulated from 1985-1997 and real after 1997.)

The portfolio’s 9.67% return compares to a 9.29% return for a 60/40 portfolio. It also delivers this return with more diversification and no lost decades.

This compares to 10.6% for a 100% US stock allocation, but US stocks suffered a more significant drawdown of 37% in 2008 compared to 19.96% for my portfolio. The portfolio also provides more consistent returns without lost decades. It predictably underperforms during bull markets for US stocks. It provides protection for different economic environments and limits drawdowns, providing for more consistent returns.

Here is how it stacks up by decade since the 1970s by period. My attraction to this approach is the consistency of real, inflation-beating returns and protection during panics. It underperforms 60/40 slightly during bull markets, which I’m fine with. Unlike 60/40, it continues to deliver a return every decade.

Note: because the TIPs data isn’t available, I substituted TIPs for intermediate treasuries in the 1970s and 1980s. The TIPs data is simulated in the 1990s. International small only becomes available in the spreadsheet starting in 1975, so this period is divided up between 1970-75 and 1975-80. This likely means that the returns would have been even better in the 1970s, as intermediate treasuries don’t offer the same inflation protection of TIPs.

consistent

As the results in the spreadsheet may be a bit suspect, I decided to plug this into the helpful tool over at Portfolio Charts to see how the strategy holds up. TIPs don’t exist on the tool, so I substituted it for intermediate-term treasuries.

The results were equally promising using this tool.

Average Returns

Real inflation-adjusted returns are 7.1%, and the portfolio only lost money 18% of the time. The 60/40 portfolio, in contrast, delivers a 5.8% average and loses money 27% of the time. US stocks provide a 7.6% return and lose money 29% of the time.

annual returns

Goals

How does the portfolio help me reach my goals? Let’s say I have $100,000 and contribute $18,500 to the strategy each year. How long will it take me to hit $1,000,000? It would take roughly 14-19 years of savings to accomplish this goal.

myportfolio.PNGThis is similar to a 60/40 approach, but notice how the range of outcomes is much tighter for my portfolio versus the 60/40. That’s because the returns are more consistent.

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Drawdowns

The data doesn’t include the Depression and 1929-32 drawdown. I don’t think this will happen again, but I’m certainly conscious that it can happen again. I can approximate what my portfolio would have done in this environment with a 60% small cap value allocation, a 20% allocation to long-term bonds, and a 20% allocation to intermediate-term bonds. A $10,000 investment in 1929 would have turned into $4,814 by 1932. In real terms, because there was deflation during this period, I would have been left with $6,381. That’s not bad considering the alternatives at the time.

This would have been painful, but not nearly as painful as being 100% US stocks. The 1929-1932 period turned a $10,000 investment into $3,229.

The bonds, in other words, do their job. They would have kept me in the game.

Since 1970, the maximum drawdown is 32% and the most prolonged period that the portfolio is in the red is only 6 years. The maximum drawdown for the 60/40 is similar at 34%, but the portfolio remained in the red for a much longer period, for 12 years.

medraw

6040

Performance from different start dates

The portfolio suffers short drawdowns and provides consistent, high, returns. The longest drawdown occurs during the 1970s. I’m guessing that if TIPs existed in the 1970s, the 6-year drawdown would have been shorter.

performance

cagr

Financial Independence

I am not financially independent, but I would like to become financially independent at some point. I don’t want to retire or quit working, but I’d like the satisfaction of not needing to work.

I currently have about 5 years of expenses saved up between all of my accounts with no debt but my mortgage. I’m really cheap, brown bag my lunch to work every day, make nearly every meal at home, have no kids, and maintain a low cost of living. I buy most of my clothes at Costco and Wal-Mart and spend about $80 a week on groceries. I drive a beaten up Nissan sedan and plan on driving it until it dies. I live in a modest townhouse, and my mortgage payment is cheaper than what rent would be in a suburban one bedroom apartment. I have little interest in travel, and my primary forms of entertainment are affordable: movies, music, books, and hikes in free public parks. I don’t drink. I save roughly 25% of my income. Meanwhile, I am also privileged enough to have an excellent job after slowly grinding my way up the ranks in my company for the last decade.

I wasn’t this frugal originally, but my experiences in my 20’s rattled me. I had significant debt at the time and worried endlessly about losing my job. Living in fear and not having enough cash for an emergency was not for me. I was also rattled by watching my 40-something coworkers deal with the crippling fear of losing their jobs while they had a ton of debt and expenses. I swore to myself that it would never happen to me and went down a path of frugality.

It’s not possible to stick with my asset allocation across all of my accounts (my 401-k only has market cap weighted options, and I’m using stock selection for the account on the blog), but it looks like this portfolio ought to help me reach my goal of financial independence in a reasonable timeframe. 8-16 years, depending on performance.

I’m currently 37, and I’d like to get there by the time I’m 50. With this approach, I should be able to do it.

fi

If I up my game and embrace extreme frugality, saving 50% of my income, I can get there even faster in 5-12 years. I’m not sure if I am ready to go that hardcore, but hey, discipline equals freedom, as Jocko likes to say. Perhaps I should pick up a side hustle and start eating ramen.

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Comparisons

Using the Portfolio Charts tool, I compared my approach to other lazy portfolios. The portfolio designed here has the highest baseline long term return. Meanwhile, it is ranked 6th for the longest drawdown, 10th in terms of the ulcer index, and 3rd in safe withdrawal rate.

Notably, it ranks only 2nd in average return, bested only by the total US stock market. It accomplishes this with significantly less volatility combined with shorter and more shallow drawdowns. In other words, this portfolio almost delivers the index’s long-term return but with substantially less pain and stress.

Overall, it accomplishes my objectives, and I think it does so in a way that other lazy portfolios could not.

Ranking by baseline return (high returns):

portfolios

Ulcer index ranking (low stress):

ulcer

Conclusion

I think this a sensible approach that will help me meet my goals. If you have any criticisms or suggestions to improve upon the portfolio, then I’d love to hear it.

Portfolio Charts and Simba’s sheet are also great tools to test any similar ideas that you might have. Test your own approach. This portfolio certainly isn’t the end-all of asset allocation, just like the available vast menu of lazy portfolios didn’t speak to my needs and goals. You do you.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.