Back in December of 2017, I outlined specifics of my retirement portfolio (RP) (see here). I talked about asset distribution in my active 401K plan and my Rollover IRA plan.

For my 401K plan, I chose a simple portfolio strategy based on the concept of Permanent Portfolio, whereas for my Rollover IRA plan, I chose a well-diversified 7Twelve  Portfolio. My retirement funds were distributed across 28 different funds covering a wide spectrum of asset classes.

The thinking back then was,

1. Equity markets are frothy; therefore play safe with Permanent Portfolio  (PP)
2. Extreme-diversification across all available asset-classes through 7Twelve Portfolio

Permanent Portfolio (PP) allocates 25 % of assets to Gold. In my construction of PP, I avoided any investment in Gold assets. Warren Buffet’s disdain for Gold, in particular, his philosophy on purchase of productive assets as a route to investing success was quite influential to my thinking on Gold.

Not a lot has changed since my last report on RP. Markets are still on a tear and low interest non-inflationary environment still persists. Given this fact, probably it probably seems  prudent for me to continue to follow the recipe I outlined for my RP.

However, recently I came across an excellent website on portfolio allocation, https://portfoliocharts.com/ (thanks to Mr Money Mustache Forum).

In particular, I was intrigued by the so called Golden Butterfly portfolio, (GB), the homegrown portfolio by Tyler, the creator of portfoliocharts.com. Tyler has written an extensive blog article, titled, Catching a Golden Butterfly, explaining his thinking behind GB.

Glossing over the numbers for GB, I learned that over a very long time horizon (almost 50 years), GB has produced relatively high returns (6.2 % annualized vs 5.9 % for the 7Twelve Portfolio) while maintaining low volatility (8 % vs 9.8 % std-deviation for 7Twelve).

I  learned that portfoliocharts.com offers an elegant framework to back-test asset allocation strategies and visualize the results, going all the way back to 1970 and that the website maintains a list of popular portfolio recommendations by professionals. Furthermore, the website offers an opportunity for individuals to construct their own portfolio with different mix of asset allocation.

Indeed, quite a comprehensive and useful resource for every-day investors such as myself and I was onto it in no time.

In table below, I have compiled the performance (annualized returns and volatility, as measured using std. deviation and the ulcer index) for all portfolios listed on the portfoliocharts.com website.

In addition, I have included my homegrown, AppliedValue (AV) Portfolio, that I constructed using the “Build a portfolio” tool provided on the website.

The charts below, provide a visual schema of the returns for the portfolios as a function of the underlying portfolio volatility.

In general, the volatility/returns point for majority of the portfolios fall on a straight regression line, with increasing returns producing a corresponding increase in portfolio volatility. The two portfolio’s that can be considered outliers (especially, if observed through the lens of the Ulcer index), are the GB Portfolio (shown in red) and the AV Portfolio (shown in green).

The AV portfolio is my construct based on the following observations

1. Presence of Gold followed by the presence of small scale value (SCV) fund in any given Portfolio, seems to dampen the volatility of the Portfolio much more so than the returns. For example, the average Ulcer index for portfolios with Gold fund is 4.4 % as opposed to 8.7 % for portfolios without Gold. For portfolios that do not contain either Gold or SCV fund in their portfolio mix, the Ulcer index jumps to 9.6 %.
2. Over the past decade, since the financial crisis, US markets have been on tear. In particular, since the start of 2013, the S&P index has more than doubled where as emerging market equities have dropped to negative returns.
3. REITs have exhibited historically low correlation with equities and are considered to be good long term inflation hedge. Further more, some what counter intuitively, in a rising interest rate environment, REITs have outperformed S&P500.

Based on these changes and starting from GB, I set out to set my home grown AV portfolio. Below is the comparison of asset distribution for the GB and the AV portfolio. For reference I also include the TSM portfolio.

The following changes with respect to GB,

1. Adding REIT and Emerging markets fund and
2. Removing Short Term Bond fund

has allowed me to boost the average returns (7.7 %) that are comparable to those obtained with TSM (7.6 % annualized returns), while still maintaining significantly lower volatility (11.8 %) relative to TSM (17 % ).

Before concluding, I want to note the following:

1. All the numbers presented above are derived from Portfoliocharts.com
2. More details on the methodology and the underlying assumptions are available at here
3. The list of data sources are available here

The top 3, among all the assumptions listed on the website, are in my opinion very important for any investor who may want to mimic the portfolio construction for their personal accounts, hence I am reproducing these here

1. All returns are taken as a snapshot on December 31st.
2. Returns include reinvested dividends.
3. Portfolios are re-balanced annually.

I want to conclude by again drawing comparison to my  RP construct, which is based on the 7Twelve portfolio.

Looking at a 20 year time period, (Jan 1999 to Dec 2018), which probably is a reasonable time frame to consider over the working-career of an average retail investor, according to portfoliocharts.com, 7Twelve portfolio returns are 4.16 % vs. 3.91 % for the TSM portfolio.

The numbers available from Israelsen’s website, www.7twelveportfolio.com for the same 20-year period are, 6.87 % average annualized returns for the 7Twelve portfolio, relative to 5.51 % for the Vanguard S&P 500 index fund.

While there are subtle differences in the way Tyler constructed the 7Tweleve portfolio (see his notes here), the significant differential in the numbers available on Israelsen’s website vs those available on portfoliocharts.com , as far as I can tell, stem from the fact that Tyler is reporting real-annualized returns (returns after adjusting for inflation).

Regardless, the directional trend is clear. Over a twenty-year period, the average returns for 7Twelve portfolio has been better than those of the total stock market.

For the same 20 year period, GB average annualized returns are 5.01 % and those for the AV portfolio are 6.65 %. AV seems to outperform the TSM, 7Twelve as well as the GB portfolio quite handsomely.

$1000 invested in a AV portfolio would over the period of 20 years would grow as follows

These findings have prompted me to revisit my RP, and I anticipate making some changes to align my portfolio towards AV in the near future.