In Search Of The Perfect Portfolio: 6-Month Update No ratings yet.

This past February, based on a review of some investing wisdom from John C. Bogle and Peter L. Bernstein, I offered Seeking Alpha readers my take on the perfect portfolio for the next 10 years.

In combination, the two linked articles, one on my personal blog and one right here on Seeking Alpha, offer a thorough grounding in the argumentation offered by Mr. Bernstein in favor of a portfolio comprised of 60% stocks and 40% bonds, followed by a slight modification of such in line with a more recent recommendation by no less than John C. Bogle that, given the present environment, a 50/50 allocation may be even more prudent.

What did I suggest as the ‘perfect portfolio?’ Here is how I summarized it in my Seeking Alpha article:

Without further ado, then, here is my “base” allocation for the next 10 years.

  • 30% U.S. Stocks
  • 20% Global ex-US Stocks
  • 50% Long-Term U.S. Treasuries

In summary, we are talking about a 50/50 allocation in stocks vs. bonds, with the stock allocation being broken down 60/40 between U.S. stocks and foreign stocks.

Well, a full 6 months have now gone by since that initial article was published and, my goodness, a lot has happened in the world, some of it perhaps very much expected, other parts perhaps not so much. How has the information I presented held up so far? I was curious to find out, and perhaps you may be as well. So, what do you say? Shall we take a look together?

Running Backtests in Portfolio Visualizer

To perform this analysis, I ran a series of backtests in Portfolio Visualizer (hereafter PV). Here are the parameters I used for all backtests:

  • In each case, the backtest covers the current year, from January to the end of August. Technically, this goes back just a little further than the writing of my initial article in February. However, I wanted to keep it simple, not attempting to use any month-over-month comparisons and coming up with faulty data, perhaps by my own error. Nevertheless, I believe the results are a fair representation, and helpful in the big picture.
  • I started the portfolio with an initial balance of $10,000.
  • In each case, the comparisons reflect both inclusion and reinvestment of all dividends.
  • In general, I go with annual rebalancing in my PV backtests. In this case, however, since the time frame was shorter than that, I went with the next closest thing, quarterly rebalancing.

Breakdown By Component

First, I will start with the breakdown by component. How did I pick my components? I did so based on the three follow-up articles I wrote suggesting specific ETFs with which to implement the ‘perfect portfolio.’

In my follow-up article featuring suggested ETFs for U.S. stocks, I offered 3 options. Ultimately, I suggested that readers desiring to pick a “standard” option (S&P 500 or U.S. Total Market) use either the iShares Core S&P 500 ETF (IVV) or the Vanguard Total Stock Market ETF (VTI). However, I also offered up an intriguing 3rd option, the Invesco S&P 500 Equal Weight ETF (RSP), for at least some consideration.

When I ran the results, IVV was the winner, with a final balance of $11,889 in a version of the ‘perfect portfolio’ with that option selected. At $11,881, VTI came in $8 behind. So, for purposes of the rest of this article, I purposely picked the worst of the two to include in my for comparison. As a side note, RSP, my 3rd option, turned out to be the ‘worst’ of the bunch, bringing in the overall portfolio at $11,834, As can be seen, however, at least for this short period you would have done just fine with any of the 3 choices.

For the foreign portion of the comparison, I went with the Vanguard Total International Stock ETF (VXUS), my clear first choice of suggested ETFs for foreign stocks. As a teaser, I did offer several alternatives to VXUS in that article, including options for investors interested in precisely controlling their allocation between developed and emerging markets. There’s some good stuff in there, be sure to have a look if this intrigues you.

Finally, for the bond portion, I didn’t mess around. I went full TLT (sorry, couldn’t resist) with my proposed 50% allocation to the iShares 20+ Year Treasury Bond ETF (TLT). In my article, I did hedge my bets a little bit, offering alternative options for investors scared stiff by the longer-duration of TLT. More on that later when I ‘fess up concerning my personal portfolio.

OK, so with no further ado, here we go. In the graphic below, Portfolio 1 is VTI, our U.S. domestic stock component, Portfolio 2 is VXUS, representing foreign stocks, and Portfolio 3 is TLT, long-term U.S. treasuries.

Source: Portfolio Visualizer By-Component Backtest

In summary, had you placed your entire $10,000 ‘bet’ on VTI, you would have been sitting with $11,784 today, $10,871 had you gone all in on VXUS, and, shock of shocks, $12,300 had you fully committed to TLT. Along the way, you would have experienced maximum drawdowns of between roughly 2%-6.5%.

From that, you can quickly gather that 2019 has been a somewhat unusual year, so far, in that all 3 asset classes have actually done quite well. U.S. stocks, up 17.84% YTD, foreign stocks turning in a respectable 8.71%, and then, perhaps the biggest surprise of all, long-duration U.S. treasuries! If you had told me we would be sitting on 23.00% gains, even though I wrote the article recommending them, I myself would not have believed you.

Maybe I can just conclude this section by featuring a tweet from @RitholtzWealth for your perusal.

Enough said.

The ‘Perfect Portfolio’ Takes On The S&P 500

I hope you found that by-component breakdown of interest. But, now we get to the real deal. Putting it all together, how did the portfolio fare as a whole?

To answer that question, I decided to put it up against the S&P 500, using the venerable SPDR S&P 500 ETF Trust (SPY) as my proxy. Let’s take a look. First of all, here is the PV graphic displaying the portfolio. As can be seen, Portfolio 1 is a simple 100% allocation to SPY, Portfolio 2 is the 30/20/50 allocation proposed in the ‘perfect portfolio.’

Portfolio Construction - SPY vs. Perfect PortfolioSource: Portfolio Visualizer Total Portfolio Backtest

Next, the results. Take a minute to click on the graphic to enlarge it, which should offer you a chance to clearly view the results. Take a minute to digest, and then I’ll offer just a few comments.

Perfect Portfolio vs. SPY (S&P 500 Average)Source: Portfolio Visualizer Total Portfolio Backtest (Previously Linked)

As mentioned in the previous section, all 3 components of the portfolio did well. What caught me by surprise is the fact that the results, in terms of the final portfolio value, were almost identical! The blue line and the red line ended up in basically the same place.

But that’s also where things diverged. The ‘perfect portfolio’ got there with much less volatility and risk. Check out the comparative standard deviations; 16.05% vs. 6.53%. Sharpe and Sortino ratios? Off the charts. And the data point that truly floored me? Zero, that’s right, zero max drawdown!

The last data point that I want to feature is the U.S. market correlation. For SPY, of course, it is 1.00, a perfect correlation. You ride one thing, for better or worse. For this period, that correlation came out to .38 for the ‘perfect portfolio.’ Put in a different way, with the ‘perfect portfolio,’ you never ‘hitch your entire future prospects to one wagon.’

Before we leave this section, one last comment. Admittedly, this is one very short slice of time. I don’t anticipate for one minute that results this spectacular will be the norm the longer we track this together. However, for the sake of transparency, my current plan is to do that every 6 months; hopefully, not enough to irritate and bore everyone but just to touch base.

A Few Thoughts On Why This Matters – And The Future

Why is all of the above so important to ponder as you plan your investment portfolio? Let me not answer that question myself, but rather feature two short excerpts from that Bernstein and Bogle article I wrote that started this whole journey.

First, my own summary of information gleaned from Bernstein:

Because the simple fact is; no one knows the future with 100% certainty. Bernstein argues that “the constant lesson of history is the dominant role played by surprise.” Because of this, unexpected events defy the forecasts of even the keenest investors. And it is this steady stream of surprises that contributes to the volatility of stocks, particularly in the short run.

As Bernstein observes, “you can make a killing in one year and give it all back and more in another.”

Second, a direct quote from none other than Jack Bogle himself, when discussing multiple current events with a young man interested in investing:

You don’t know, and I don’t know, what’s going to happen in any of them, the market doesn’t know, nobody knows . . . so what you want to think about is how much risk you can afford. (Italics mine)

To put it bluntly, as you turn on CNBC (or other favorite information source) tomorrow, and listen to first one pundit explain why the market will rocket between now and the end of the year, only to be quickly followed by another predicting a sharp decline, please hear these words of, not ETF Monkey, but Bernstein and Bogle, ringing in your ears.

Having said that, just a couple of thoughts.

First, as featured previously, TLT has had a tremendous run-up of late. From all I can see at this point, there is perhaps now even a greater chance than when I wrote my initial article that this could continue. The evidence seems to suggest that in fact the world economy is slowing and there could be continued downward pressure on interest rates.

Still, you want to stay balanced, and never get greedy. In my own case, I recently lightened up slightly on TLT along with one other ETF, simply because they were getting a little overweight in my portfolio. Now, that’s my personal situation, not necessarily indicative of yours.

Second, what about the question of U.S. vs. foreign stocks? I had another reader tweet me recently and share that he was “adding to [his] international fund through FZILX.” Basically, the Fidelity ZERO International Index Fund (MUTF:FZILX) can be considered a proxy for VXUS, my ETF of choice for this asset class.

Again, while no one knows the future, something for consideration. Here are the equity characteristics of VTI, my proxy for U.S. stocks, from its Vanguard webpage.

VTI Equity CharacteristicsSource: Vanguard VTI Website

Next, the same screen for VXUS, my proxy for foreign stocks.

VXUS Equity CharacteristicsSource: Vanguard VXUS Website

In both cases, have a look at the area featured in yellow. Next, perhaps have a look at the respective earnings growth rates, just two lines below the shaded area in each case. So, while foreign stocks may be considered to carry a little more risk than U.S. stocks, you are being rewarded for taking that risk by a much ‘cheaper’ purchase.

Further, as featured in this 6-month review, foreign stocks have, if anything, slightly underperformed. Nothing fundamental has changed that changes the basic story. So my personal inclination is to leave my allocation solid here, if anything, adding to it as my dividends feed me cash to invest.

I’m going to stop there. This article is already closing in on 2,000 words, plenty long. I also have some amazingly astute readers, and I am hoping some will elect to share their observations in the comments section.

Final Closing Thoughts – Including on Gold

While not directly referenced in, or officially part of, the ‘perfect portfolio,’ allow me to touch briefly on another topic. In the process of putting these articles together, one of my readers also encouraged me to take a close look at gold. To that point in time, I had never included an allocation to gold in my portfolio.

If asked why, I would likely have featured Warren Buffett’s view of gold, as evidenced by the following quote:

[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again, and pay people to stand around guarding it. It has no utility.

However, I kept an open mind, and did a fair amount of reading on the topic. Out of that came a total of 5 articles on gold, two on my personal site and three here for Seeking Alpha. For convenience, here’s a link to the last of the five articles, from my personal site, which you might say starts from the conclusion, revealing the 3 ETFs I ultimately settled on for my own portfolio, and offering links to all the other articles along the way. You can read as little or much as you care to.

Long story short, I have benefited during this 6-month period from that decision as well. I’ve heard the expression “It’s better to be lucky than good,” and perhaps I have been that. However, I also believe that, with these combined learnings, my portfolio is perhaps better diversified than it has ever been.

Is that important, at this point in time? Tell you what, I’ll stop here and let Ray Dalio answer that question.

Thanks for reading! As always, until next time, I wish you…

Happy (and safe) investing!

Disclosure: I am/we are long VTI, TLT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes, and to consult with their personal tax or financial advisors as to its applicability to their circumstances. Investing involves risk, including the loss of principal.

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