Why the all-weather portfolio is a wash-out
By Barry Ritholtz
Washington Post, December 6, 2014
Motivational speaker Anthony Robbins has a new book on investing, “Money: Master the Game.” It is his first book in two decades, and he has been everywhere, flogging it directly onto the best-seller list.
The good news is that the book contains snippets of conversations with some of the world’s greatest investors.
The bad news is that Robbins is not one of them.
When he is quoting the great investors of our generation, the book is good, even compelling. When he is offering his own advice, it is not. A friend wrote of it, “it’s a tough slog of logical fallacies, inappropriate analogies, self-aggrandizement and exclamation points.”
The book recommends a portfolio that is, to be blunt, bad. Investment advice he has made in the past has similarly been less than stellar.
But Robbins is an upbeat, positive kind of guy, and in that spirit, I will try to be as well. Rather than dwell on the negative, let’s take his advice and see if we can make some lemonade.
I’ll explain why his “all-weather portfolio” is destined to underperform. I’ll suggest a specific portfolio that is likely to do better — and with less volatility and smaller drawdowns. And last, I will put my money where my mouth is, and wager that my portfolio can beat his. I will back that bet with $100,000 in cash.
When it comes to investing, there is no such thing as a one-size-fits-all portfolio. Whenever I write about asset allocation, I am aware that each person has unique risk tolerances, financial goals and tax circumstances. The readers of this column span a big age group, all in different places in the arc of their lives. What might be suitable for a 25-year-old with a growing income and a 50-year time horizon is different than what is for someone in his 60s a few years from retirement.
Robbins is a wildly successful guy. He has touched millions of people with his books and public appearances. My beef is not with him, just some of his recommendations.
With that in mind, let’s look at his portfolio:
All-weather portfolio
30 percent stocks
15 percent in seven- to 10-year Treasuries
40 percent in 20- to 25-year Treasuries
7.5 percent in gold
7.5 percent in commodities
The big problem with this is that it looks backward, not ahead. Two of the bigger bull markets of the past decade have been in commodities, including gold, and in bonds. This portfolio is dramatically overweight in both.
The most obvious problem is bonds, which are 55 percent of this portfolio. The past three decades have seen the greatest bond rally in history. The oil embargo and inflation of the 1970s led to then-Fed Chairman Paul Volcker cranking rates all the way up to 20 percent in 1979 and 1980. The fixed-income story of the 35 years since has been the ongoing fall of interest rates from that 20 percent down to almost zero. As rates go down, bonds go up. Hence, this has been a unique period, one that has been especially good to fixed-income portfolios.
Ben Carlson, an investment analyst who writes the Wealth of Common Sense blog, showed that this recent bull market in bonds radically skewed the returns of Robbins’s portfolio by about 400 basis points a year. The period from 1928 to 1983 would have cut the returns of the portfolio almost in half, from 9.7 percent to 5.8 percent.
Adjusting a portfolio to take advantage of what already occurred is called form-fitting. Indeed, there is no reason to believe that the next 30 years will look anything like the past — especially in fixed-income markets. If you have a time machine, you can go back and take advantage of the bond rally. Otherwise, this portfolio is likely to perform poorly over the next 30 years.
A similar rookie mistake is made with commodities. After nearly three decades of little or no progress, gold had a spectacular run from 2001 to 2011. Then it hit a wall, losing more than a third of its value since those 2011 highs.
In real, inflation-adjusted terms, gold is unchanged since the early 1980s — the last peak in gold. However, it’s not only that one 30-year span: Lots of academic studies show commodities are a drag on portfolios. The key finding is that in real, inflation-adjusted terms, commodities add no value or performance to a set of holdings. As Cullen Roche noted, real commodity prices have been in a 130-year bear market. Based on historical commodity returns, the all-weather portfolio spots a smarter portfolio a 15 percent head start.
This sort of error can be attributed to the recency effect: People tend to assume that what just happened will likely to keep happening, even if it is somewhat unusual. Hence, the extrapolation of recent activity to infinity.
The all-weather portfolio is a biased sample, form fitted to have done well over recent decades.
Understanding that, let’s talk about a portfolio that was developed based on the returns of a century of data. It would look something like this:
All Century Portfolio
20 percent total U.S stock market
5 percent U.S. REITs
5 percent U.S. small cap value
15 percent Pacific equities
15 percent European equities
10 percent U.S. TIPs
10 percent U.S. high yield corp bonds
20 percent U.S. total bond market
This is a classic 60/40 portfolio. You can express this portfolio in a variety of ways, with different fund companies offering variations on a theme. I picked a basic, inexpensive set of holdings from Vanguard and Blackrock.
It looks like this:
(VTI) Vanguard Total Stock Market ETF
(VNQ) Vanguard REIT ETF
(VBR) Vanguard Small-Cap Value ETF
(VPACX) Vanguard Pacific Stock Index Fund
(VEURX) Vanguard European Stock Index
(AGG) iShares Barclays Aggregate Bond Fund
(VWEHX) Vanguard High-Yield Corporate Fund
(TIP) iShares TIPS Bond
This is just one example (but a damn fine one). If you happen to like other fund families, you should be able to find most of these holdings or their equivalents.
Again, one size does not fit all. For a younger investor with a longer timeline, I would add a little more equity — a microcap fund and an international small-cap value fund. That would come at the expense of less fixed income.
A more conservative investor might want to have less equity and more bonds; They could combine the Pacific and European holdings into one holding such as iShares MSCI EAFE Index Fund (EFA), and end up with more bonds at the expense of equities.
Investors interested in this sort of asset allocation can access this portfolio numerous ways. You can do it yourself for free. It requires a bit of work and you need to do a rebalancing once or twice a year. But it’s cheap and easy and will do better than 90 percent of what Wall Street has for sale.
The most challenging part of this is you. Your emotions, your lack of discipline, your ability to stick to a tried-and-true methodology and not get distracted by something shinier.
If you are likely to have any of those behavioral issues, you have two options. You can hire an automated software (a/k/a robo-adviser). Check out Betterment, Wealthfront or Liftoff. It will cost you a little something, but it will help protect you from yourself.
The third route is to hire an adviser. That is the costliest option, but it gets you a variety of additional financial, estate and tax planning. It also gets you a real person to talk you off of the ledge when necessary.
Anyone of these approaches should get you a more steady set of returns than whatever craziness your brother-in-law was talking about over Thanksgiving.
Last, the wager. I am willing to bet Tony Robbins that my Century portfolio will significantly outperform his all-weather portfolio over the next 20 years. Toward that I end, I propose that each of us puts $100,000 into our own portfolios. Set it with whatever automatic rebalancing you want — then leave it alone. On Jan. 1, 2035, whichever one is worth more is declared the winner. The loser then donates that original $100,000 investment to the charity of the winner’s choice.
Seems like easy money to me.
~~~
Ritholtz is chairman and chief investment officer of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. On Twitter: @Ritholtz.
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