Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, May 18, 2015. You can also find the re-balance calendar for 2014 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

The Balanced Stock and Long Term Treasury Bond Portfolios

In this newsletter, we continue to explore the role of long term Treasury bonds in portfolio construction. In the previous newsletter April 27, 2015: Long Term Treasury Bond Behavior, we looked at the T-Bond behavior. From that, we see that T-Bond can be extremely volatile. Furthermore, it is worth to bring up the chart shown in that newsletter here again: 


The key findings from the above chart are that T-Bond reached post Great Depression low in 1940 and started to rise in 1949 till 1981. Current situation is similar to either 1940 or 1949, depending on whether one thinks we are already at a rising rate environment or the current sub zero rate environment will last another 5-8 years (or less). Between 1940 and 1949, the interest rate has been kept steady. However, one should keep in mind that this period encompasses the World War II period and it is somewhat unusual in that sense. 

We will focus on these two periods (1940-1981 and 1949-1981) and look at how a balance portfolio behaves. 

Stock and Long Term Bond Balance Portfolios

It has been pointed out that 20%-30% stocks and 80%-70% bonds composition represents the ‘optimal’ portfolio composition that has the lowest volatility (or standard deviation). Technically, if one tries to optimize a portfolio by setting the optimal objective as lowest standard deviation, one would derive these types of portfolios (or ‘efficient frontier’ with respect to the lowest standard deviation). 

It is important to remember that an all bond portfolio is NOT the ‘safest’. So, even if you are in retirement or ultra conservative, you should have some exposure to stocks. 

Now let’s take a look at how several of these balance portfolios have fared for the past 80 so years. In addition to 20% stocks and 80% T-Bond portfolio, we also look at 50%/50% composition. Furthermore, we also look at the ‘combo’ portfolio that is the average of 20/80 and 50/50, or 35/65 portfolio. 

Some stats: 

  20/80 50/50 35/65
number of negative years 13 18 15
biggest one year loss -10.80% -23.20% -17.01%
biggest one year loss (since 1940) -6.16% -11.96% -7.80%
annualized return (since 1928) 6.28% 7.88% 7.13%

But if we look at their 5 year rolling returns: 


If we exclude years before 1941, all 3 portfolios have no negative 5 year rolling return. However, we should note that in 1941, both 50/50 and 35/65 had -7.4% and -5.78% annualized returns for its past 5 years, a pretty bad performance (i.e. every year, on average, a negative 5 or 7% return)!

Naturally, we are interested in how these portfolios performed during the long rising rate periods. 

Rising rate periods

Since we are aware that for the last 30 plus years, bonds have been in a super bull cycle (i.e. a secular declining rate period). The annualized returns in the above table are somewhat skewed. The following table shows the portfolio performance in the two overlapped rising rate periods (from 1940-1981 or from 1949-1981):

  20/80 AR 50/50 AR 35/65 AR
From 1940-1981 4.53% 6.96% 5.77%
From 1949-1981 4.81% 7.44% 6.17%
From 1940-2014 6.28% 7.88% 7.13%

What we can draw from the table: 

  • We prefer higher rising environment than a long period of low interest rate environment. From  from 1940 to 1949 , interest rate was kept low but steady. This has hurt returns as since 1949, even though interest rates had risen dramatically, the returns were higher than that in 1940-1981, indicating the returns in 1940-1949 had a negative impact on the overall returns. 
  • In a rising rate environment, we prefer more exposure to stocks as 50/50 had better returns than 35/65 that was better than 20/80. In fact, this should be more so than in a normal environment: in a rising rate environment, 50/50 had more than 2.6% annual return than 20/80 while in the overall 1940-2014 period, the difference is 1.6%. This is also intuitive: bonds tend to be more troublesome in a rising rate period. 
  • Similarly, rising rate hurts the portfolios’ performance: the returns from 1940-1981 and 1949-1981 are all lower than those from 1940-2014.  This again shows a possible difficult period ahead, just like what Bill Gross’ moaned about (see A sense of ending). 

Put succinctly, a strategic portfolio should be slightly tilted to more stock exposure in a rising environment (but be extremely careful not to over exposed as stocks are actually more volatile and can incur much larger loss). However, in general, we are now entering a period of low returns everywhere (bonds and stocks). Thus, more exposure to active (tactical) allocation might be warranted. 

The balanced static portfolios

We use both VFINX (Vanguard 500 Index Investor) (representing S&P 500) and VUSTX (Vanguard Long-Term Treasury Inv) to construct live static portfolios that are rebalanced annually. Here are the portfolio performance data: 

Portfolio Performance Comparison (as of 5/1/2015):

Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR 10Yr Sharpe
50 Stocks 50 Long Treasury Bonds 1.1% 13.4% 11.1% 12.2% 8.7% 0.9
35 Stocks 65 Long Treasury Bonds 0.6% 13.1% 9.3% 11.3% 8.4% 0.96
20 Stocks 80 Long Treasury Bonds -0.0% 12.9% 7.3% 10.3% 7.8% 0.78

Year by year performance >>

Notice that 35/65 portfolio has the best 10 year Sharpe. In fact, for the past 25 plus years since 1989, it has had the best Sharpe ratio. Also, 35/65 has not had a single negative year since 2001. However, as what we discussed above, as a mega new trend (i.e. rising rate) is developing, we are increasingly more skeptical on using the past performance to extrapolate anything onward. 

Market Overview

Long term bonds had a very bad week, so did the REITs. In fact, both long term bonds and REITs are showing trend scores that are close to negative. However, stocks (other than REITs) are in reasonably strong up trend. We have been in such a fragile recovery period for a long time while stocks have risen relentlessly. For now, the best way is to follow the trends. 

For more detailed asset trend scores, please refer to 360° Market Overview.

We would like to remind our readers that markets are more precarious now than other times in the last 5 years. It is a good time and imperative to adjust to a risk level you are comfortable with right now.  However, recognizing our deficiency to predict the markets, we will stay on course. 

We again copy our position statements (from previous newsletters): 

Our position has not changed: We still maintain our cautious attitude to the recent stock market strength. Again, we have not seen any meaningful or substantial structural change in the U.S., European and emerging market economies. However, we will let markets sort this out and will try to take advantage over its irrational behavior if it is possible. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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