Why I Chose Patience over Re-balancing

Many financial advisors recommend re-balancing your portfolioA group of financial instruments. no less often than annually to ensure the asset allocation is consistent with your risk tolerancePersonal preference indicating how much risk you are willing to take to achieve a higher return., as illustrated in this post from Schwab. In the past, I haven’t been one to re-balance my portfolioA group of financial instruments., so I spent some time thinking about why I haven’t followed this common advice. Up until recently, almost all of my invested assetsThe value of things the company owns and amounts it is owed have been equities, equity-based mutual funds or exchange-traded funds (ETFs). As such, I didn’t need to do any re-balancing across asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More.

In this post, I’ll explain re-balancing, its specific purpose and examples of its benefits and drawbacks. I’ll also explain my strategy (which may or may not be right for you).

What is Re-balancing?

Re-balancing is the process of buying and selling securities in your portfolioA group of financial instruments. to meet certain targets. In the case of asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More, the primary purpose of re-balancing is to maintain your target riskThe possibility that something bad will happen./reward balance.

Some people have targets that define their desired allocation across asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More. One common rule of thumb is that the portion of your portfolioA group of financial instruments. that should be in bonds is equal to your age with the rest in stocks. In my case, that would mean roughly 60% of my portfolioA group of financial instruments. in bonds and 40% in stocks. The goal of this rule of thumb is to decrease the volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results. of your investment returns as you get older and closer to that age at which you need to draw down your assetsThe value of things the company owns and amounts it is owed in retirement.

How Does Re-balancing Work?

The process of re-balancing is fairly simple. Periodically, such as once or twice a year, you compare the market value of your investments with your targets. If there is a significant difference between how much you own in an asset classA group of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors a... More and your target percentage, you sell the portion of your investments that is above the target and reinvest the proceeds in something different.

Let’s say your target is 75% stocks and 25% bonds. You start the year with $10,000 of investments – $7,500 in stocks and $2,500 in bonds. If stocks go up by 10% and bonds go up by 5%, your year-end balances will be $8,250 in stocks and $2,625 in bonds, for a total of $10,875. Your targets though are $8,156 of stocks (75% of $10,875) and $2,719 of bonds. To put your portfolioA group of financial instruments. back in balance, you would need to sell $94 (= $8,250 – $8,156) of stocks and buy $94 of bonds.

You can avoid selling any assetsThe value of things the company owns and amounts it is owed if you have money to add to your investments at the end of the year. Continuing the example, let’s say you have another $500 available to invest at the end of the year. That brings your total available for investment to $11,375 (= $10,875 of investments plus $500 cash). Your targets would be $8,531 (= 75% of $10,875) for stocks and $2,843 for bonds. In this case, you would buy $281 of stocks and $219 of bonds to meet your targets, eliminating the need to sell any of your assetsThe value of things the company owns and amounts it is owed.

What Does Asset Allocation Do?

The chart below compares the average annual returns and riskThe possibility that something bad will happen. profiles of several sample portfolios with different mixes between stocks and bonds. In the middle four portfolios, the first number is the percentage of the portfolioA group of financial instruments. invested in stocks and the second number is the percentage in bonds.

Average Returns

In this chart, the average annual return is represented by the blue dash. When the blue dash is higher on the chart, it means that the returns on the portfolioA group of financial instruments. were higher, on average, over the historical time period.

Volatility

The green boxes correspond to the ranges between the 25^th percentileThe value below which a stated percent of observations fall. For example, 25% of the observations fall below the value corresponding to the 25thpercentile. and the 75^th percentileThe value below which a stated percent of observations fall. For example, 25% of the observations fall below the value corresponding to the 25thpercentile.. The whiskers (lines sticking out of the boxes) correspond to the ranges from the 5^th percentileThe value below which a stated percent of observations fall. For example, 25% of the observations fall below the value corresponding to the 25thpercentile. to the 95^th percentileThe value below which a stated percent of observations fall. For example, 25% of the observations fall below the value corresponding to the 25thpercentile.. When the box is tall and/or the whiskers are long, there is a lot of volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results.. In this case, it means that the annual return on the portfolioA group of financial instruments. varied a lot from one year to the next. At the opposite end of the spectrum, when the box and whiskers are all short, the range of returns observed historically was more consistent.

Comparison of Portfolios

I have arranged the portfolios so that the one with the most volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results. – 100% in the S&P 500 – is on the left and the one with the least volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results. – 100% in bonds as measured by the Fidelity Investment Grade BondA form of debt issued by government entities and corporations. Fund (FBNDX) – is on the right. You can see how adding bonds to the S&P 500 reduces volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results. as the height of the boxes and whiskers gets smaller as you move from left to right. At the same time, the average annual returns decrease as bonds are added to the portfolioA group of financial instruments.. Over the time period studied (1980 to 2019), the S&P 500 had an average annual return of 8.7% while the BondA form of debt issued by government entities and corporations. Fund had an average annual return of 7.2%. By comparison, returns on investment grade bonds are currently generally less than 4%.

Another Perspective

Because stocks and bonds are not 100% correlated, the volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results. (spread between tops and bottoms of boxes and whiskers) of owning a combination of both is less than the volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results. of owning just the riskier asset – stocks. As I was preparing the chart above, I noticed, though, that the bottom whisker for the 100% bonds portfolioA group of financial instruments. goes lower than the bottom whisker for the 80% bonds portfolioA group of financial instruments..

Specifically, there were more negative returns in the historical data (i.e., more years in which you would have lost money in a single year) if you owned just bonds than if you owned the portfolioA group of financial instruments. with 80% bonds and 20% stocks. The 80% bondA form of debt issued by government entities and corporations. portfolioA group of financial instruments. had a negative return only 7.5% of the time while the 100% bonds portfolioA group of financial instruments. had a negative return 10% of the time! As more bonds are added to each portfolioA group of financial instruments., the blue bar/average moves down. This downward shift actually moves the whole box and the whiskers down.

This relationship can be seen in the chart below.

The dots correspond to the portfolios in the previous chart with labels indicating the percentages of stocks in the portfolios. The horizontal or x-axis on this chart represents the average annual return. Values to the right correspond to higher average annual returns (which is good). The vertical or y-axis represents the percentage of years with a negative return. Values that are higher on the chart correspond to portfolios with more years with negative returns (which is bad).

Optimal Portfolios

“Optimal” portfolios are those that are to the right (higher return) and/or lower (fewer years with negative returns). Any time a point is further to the right and at the same level or lower than another one, that portfolioA group of financial instruments. better meets your objectives if probabilityA percentage or the equivalent fraction that falls between 0% and 100% (i.e., between 0 and 1) that represents the ratio of the number of times that the outcome meets some criteria to the number of po... More of having a negative return is your riskThe possibility that something bad will happen. metric.

More Stocks Can Be Less Risky

I have circled two pairs of dots. The ones in the lower left corner are the two I’ve mentioned above. The 20% stocks (80% bonds) point is lower than and to the right of the 0% stocks (100% bonds) point. As you’ll recall, the average return on the 20% stocks portfolioA group of financial instruments. is higher than the average return on the all-bond portfolioA group of financial instruments. so the dot is to the right (better). The percentage of the time that the annual return was less than zero was smaller for the 20% stocks portfolioA group of financial instruments. so the dot is lower (also better).

There is a somewhat similar relationship between the 60% and 80% stocks portfolios (circled in green in the upper right). The 80% stocks point is at the same level and to the right of the 60% stocks point. As such, if average annual return and probabilityA percentage or the equivalent fraction that falls between 0% and 100% (i.e., between 0 and 1) that represents the ratio of the number of times that the outcome meets some criteria to the number of po... More of a negative return are important metrics to you, moving from 80% to 60% stocks or 20% to 0% stocks would put you in a worse position as you would have less return for the same riskThe possibility that something bad will happen..

Re-balancing Can’t Be Done Blindly

Setting a target asset allocation, such as 80% stocks and 20% bonds, allows you to target a riskThe possibility that something bad will happen./reward mix that meets with your financial goals. As I indicated, the purpose of re-balancing is to ensure that your portfolioA group of financial instruments. is consistent with your goals. However, it is important that you considering the then-current economic environment when re-balancing.

Interest Rates

For example, interestA charge for borrowing money, most often based on a percentage of the amount owed. rates are lower than they were at any point in the historical period used in the analysis above. Over the next several years, interestA charge for borrowing money, most often based on a percentage of the amount owed. rates are unlikely to decrease much further, but could stay flat or increase. If interestA charge for borrowing money, most often based on a percentage of the amount owed. rates stay flat, the returns on bondA form of debt issued by government entities and corporations. funds will tend to approach the average couponThe interest payment on a loan. rate of bonds which is in the 1% to 3% range depending on the quality and time to maturity of the bonds held. This range is much lower than the average annual return of 7.2% in the illustrations above.

If interestA charge for borrowing money, most often based on a percentage of the amount owed. rates go up, the market price of bonds will go down, lowering returns even further. As such, the risk-reward characteristics of bonds change over time. I would characterize them as having lower returns and higher riskThe possibility that something bad will happen. (the one-sided riskThe possibility that something bad will happen. that prices will go down as interestA charge for borrowing money, most often based on a percentage of the amount owed. rates go up) now than over the past 40 years.

Stock Prices

Similarly, the S&P 500 is currently close to or at its highest level ever in a period of significant economic and political uncertainty. While I don’t have a strong opinion on the likely average annual returns on the S&P 500 in the next few years, I think it is likely to be more volatile in both directions than it has in the recent past.

If you re-balance your portfolioA group of financial instruments., you will want to form your own opinions about the average returns and volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results. of the asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More in which you invest. With these opinions, you can decide whether the asset allocation you’ve held historically will still provide you with the riskThe possibility that something bad will happen./reward profile you are seeking.

Re-balancing and Income Taxes

Another consideration when you are deciding whether and how often to re-balance your portfolioA group of financial instruments. is income taxes. Every time you sell a security in a taxable account, you pay income taxes on any capital gains. If you lose money on a security, the loss can offset other capital gains. On the other hand, if you own the securities in a tax-free (Roth or TFSAA type of Defined Contribution Plan available in Canada. Contributions are made with after-tax dollars, but no taxes are paid on any changes in the market value of the investments in the account or wh... More) or tax-deferred (traditional or RRSPA type of Defined Contribution Plan available in Canada. No taxes are paid on the contributions or any changes in the market value of the investments in the account until the money is withdrawn. That ... More) account, re-balancing has no impact on your taxes.

Re-balancing Example

Let’s look at an example of the taxable account situation. If you targeted a portfolioA group of financial instruments. of 60% stocks (in an S&P 500 index fundA type of exchanged-traded fund (ETF) or mutual fund that invests in such a way that the returns on the fund are identical or very close to a market index. For example, an S&P 500 index fund wou... More) and 40% bonds (in FBNDX) from 1980 through 2019, you would have made the transactions shown in the chart below.

In this chart, the bars represent the amount of the transaction as a percentage of the amount of stocks held at the beginning of the year. A bar that goes above zero indicates that you would have bought stocks in that year. A bar that goes below zero indicates that you would have sold stocks in the year. The proceeds from every sale would have been used to purchase the bondA form of debt issued by government entities and corporations. fund. Similarly, the money used to purchase stocks would come from a corresponding sale of the bondA form of debt issued by government entities and corporations. fund.

In every year, you either sell some of the stock index fundA type of exchanged-traded fund (ETF) or mutual fund that invests in such a way that the returns on the fund are identical or very close to a market index. For example, an S&P 500 index fund wou... More or the bondA form of debt issued by government entities and corporations. fund. The difference between the price at which you sell a security and the price at which you buy it is called a capital gain. You pay income taxes on the amount of capital gains when they are positive. In the US, many people pay a Federal tax rate of 15% on capital gains in addition to any state income taxes. The Canadian tax rate on capital gains is of about the same order of magnitude.

Reduction in Return from Income Taxes

Income taxes, assuming a 15% tax rate, would have reduced your annual average return from 8.4% to 8.1% over the 1980-2019 time period. Put in dollar terms, you would have had just under $250,000 at the end of 2019 if you started with $10,000 in 1980 and used this asset allocation strategy if you didn’t have to pay income taxes. By comparison, you would have had about $220,000 if you had to pay income taxes on the capital gains, or 12% less.

As you consider whether re-balancing is an important component of your financial plan, you’ll want to make sure you understand the impact of any income taxes on your investments returns.

Why Only Equities?

You may have been wondering why I was invested almost solely in equities for all of my working life and not in a combination of asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More, such as stocks and bonds. My philosophy was that I preferred to use time to provide a diversificationThe reduction in volatility created by combining two or more processes (such as the prices of financial instruments) that do not have 100% correlation. benefit rather than an array of asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More. By keeping my invested assetsThe value of things the company owns and amounts it is owed in stocks, I was able to take advantage of the higher expected returns from stocks as compared to bonds.

The chart below helps to illustrate this perspective.

It compares the volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results. of the annual return on a portfolioA group of financial instruments. of 100% stocks over a one-year time period with the same portfolioA group of financial instruments. over five years and with a portfolioA group of financial instruments. of 60% stocks and 40% bonds over one year.

The blue bars on the first and second bars (100% stocks for one year and five years, respectively) are at the same level, meaning they had the same average annual return. Both the box and whiskers on the second bar are much more compact than the first bar, indicating that the annual returns fell in a much narrow range when considered on a five-year basis rather than a one-year basis.

Cost-Benefit Comparison

Comparison of the first and third bars highlights the cost and benefits of diversifying across asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More. The box and whiskers on the 60/40 portfolioA group of financial instruments. are both shorter than the 100% stock portfolioA group of financial instruments.. That is, there was less variation from year-to-year in the annual return for the 60/40 portfolioA group of financial instruments. than the 100% stock portfolioA group of financial instruments.. However, the average return (blue line) on the 60/40 portfolioA group of financial instruments. is a bit lower because the 60/40 portfolioA group of financial instruments. had an average annual return that was less than the 100% stock portfolioA group of financial instruments..

My Focus

The comparison on which I focused in selecting my investment strategy is the one between the second and third bars. That is, I compared the volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results. and average returns of a 100% stock portfolioA group of financial instruments. over five years with the volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results. and average returns of a 60/40 portfolioA group of financial instruments. over one year. As can be seen, there has been less volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results. in annual stock returns when considered in five-year time periods. Yet, the average return on stocks is higher than the average return on the blended portfolioA group of financial instruments.. Because I didn’t anticipate that I would need to draw down my investment portfolioA group of financial instruments., I was willing to look at riskThe possibility that something bad will happen. over longer time periods and tolerate the year-to-year fluctuations in stock prices in order to expect higher investment returns.

Your time horizon until you might need the money in your investment portfolioA group of financial instruments. and your willingness to wait out the ups and downs of the stock market are important considerations as you decide whether this strategy or a more traditional blended portfolioA group of financial instruments. is a better fit for you.

July 21, 2020September 18, 2020

Why I Don’t Hold the All Seasons Portfolio

The All Seasons PortfolioA group of financial instruments. reports amazing statistics about its returns. I’d never heard of the All Seasons PortfolioA group of financial instruments., so had to check it out. As I’ll discuss in more detail, it is an asset allocation strategy with more than 50% of the portfolioA group of financial instruments. allocated to US government bonds. In this current environment of low interestA charge for borrowing money, most often based on a percentage of the amount owed. rates, one of my followers asked my opinion of the portfolioA group of financial instruments. as an investment strategy for the near future. The answer is, as is almost always the case, it depends. However, after studying the portfolioA group of financial instruments. and relevant data, I won’t be aligning my portfolioA group of financial instruments. with the All Seasons PortfolioA group of financial instruments..

In this post, I’ll define the All Season PortfolioA group of financial instruments., talk about when each of the components of the portfolioA group of financial instruments. is expected to perform well and provide a wide variety of statistics regarding its historical performance. I’ll also talk about the need to re-balance assetsThe value of things the company owns and amounts it is owed to stay aligned with the portfolioA group of financial instruments. and the impact of income taxes on your investment returns. I’ll close with how I’ve changed my portfolioA group of financial instruments. based on this analysis.

All Seasons Portfolio

Ray Dalio is an extremely successful hedge fund manager. If you have more than $5 billion in investable assetsThe value of things the company owns and amounts it is owed, he might consider accepting you as a client. His fund is famous for the All Weather investment strategy. According to Tony Robbins, in his book MONEY Master the Game, the annual returns on the All Weather portfolioA group of financial instruments. exceed 21%![1]

Composition of Portfolio

In an interview with Robbins, Dalio described a much simpler version of the All Weather portfolioA group of financial instruments. for the rest of us. This asset allocation is called the All Seasons portfolioA group of financial instruments.. The allocation in the All Season portfolioA group of financial instruments.[2] is:

40% in Long-Term US Bonds (20+ years), using the iShares Barclays 20+ Year Treasury BondA bond issued by the US government with a fixed interest rate and a maturity of more than 10 years. fund (ticker symbol TLT)
15% in Intermediate US Bonds (7-10 years), using the iShares Barclays 7-10 Year Treasury BondA bond issued by the US government with a fixed interest rate and a maturity of more than 10 years. fund (ticker symbol IEF)
5% in Gold, using the SPDR Gold Trust (ticker symbol GLD)
5% in CommoditiesBasic goods often used as inputs to the production of other goods or services. The primary categories in which commodities fall are metals, energy, livestock and agricultural products., using the PowerShares DB Commodity Index Tracking fund (ticker symbol DBC)
30% in the S&P 500

This allocation is illustrated in the pie chart below.

Economic Indicators

The portfolio’s name, All Seasons, refers not to the four seasons of the calendar year but to four indicators of the economic cycle. These four indicators are:

Higher than expected growth (often measured using gross domestic product or GDP)
Lower than expected growth
Higher than expected inflation (often measured using the consumer price index or CPI)
Lower than expected inflation

I note that there is overlap between the first pair of characteristics and the second pair. That is, a period of higher than expected growth can have either higher or lower than expected inflation.

The chart below shows which of the five components of the portfolioA group of financial instruments. are expected to perform well in each part of the economic cycle, according to Robbins.[3]

Growth

Inflation

Rising

Stocks

CommoditiesBasic goods often used as inputs to the production of other goods or services. The primary categories in which commodities fall are metals, energy, livestock and agricultural products.

Gold

CommoditiesBasic goods often used as inputs to the production of other goods or services. The primary categories in which commodities fall are metals, energy, livestock and agricultural products.

Gold

Falling

Treasury Bonds

Stocks

Historical Performance

According to Robbins[4], the All Seasons portfolioA group of financial instruments. had a compounded annual average return of 9.7%, net of fees, from 1984 to 2013. By comparison, I calculate the corresponding value for the S&P 500 to be 8.4%. In addition, the All Seasons portfolioA group of financial instruments. had much lower volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results., with a standard deviationA standard deviation is a (slightly messy) statistical calculation that results in a positive number that measures how much the possible results differ from the average result. For those of you who ... More of 7.6%, as compared to the S&P 500 which had a standard deviationA standard deviation is a (slightly messy) statistical calculation that results in a positive number that measures how much the possible results differ from the average result. For those of you who ... More of 17%. So, at first glance, the All Seasons portfolioA group of financial instruments. seems to be a terrific option – higher return for lower riskThe possibility that something bad will happen..

My Estimate of Returns

There are many challenges to calculating the returns on the All Seasons portfolioA group of financial instruments..[5] I made many assumptions to better understand the returns, so do not consider the statistics I’ve calculated as accurate, but I think they are close enough to be informative.

The chart below shows the annual returns on the S&P 500 and my approximation of the returns on the All Seasons portfolioA group of financial instruments. from 1963 to 2019.

From this graph, it appears that the biggest benefit of the All Seasons portfolioA group of financial instruments. is that the non-S&P 500 asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More diversify away a substantial portion of the significant negative returns on the S&P 500. For example, in the three years in which the S&P 500 had returns worse than -20%, I approximated that the All Seasons portfolioA group of financial instruments. lost an average of only 0.1%!

Returns by Asset Class

I wasn’t able to get a long enough history of Commodity price data, but was able to calculate the average return on the three other asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More during those same years (1974, 2002 & 2008), as shown in the table below.

Asset ClassA group of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors a... More	Average Return in Years when S&P 500 Return was < -20%
S&P 500	-30.5%
7-10 Year US Treasury Bonds	8.0%
20 Year US Treasury Bonds	15.2%
Gold	33.5%

As can be seen, all three asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More had positive returns in those three years, with Gold having the most significant increase.

My Investing Goals

I retired a little over two years ago, so have changed my investing goals to make sure I can meet my cash needs as I don’t have any earned income to cover my expenses. Specifically, now that I’ve switched from the accumulation phase to the spending phase, I have less tolerance for volatilityThe possibility that something will deviate from its expected or average value, including both good and bad results..

Goals While Accumulating

While I was accumulating assetsThe value of things the company owns and amounts it is owed, I wanted my invested asset portfolioA group of financial instruments. to produce returns that were at least as high as the overall market. I use the S&P 500 as my metric for market performance. During that time, I was quite willing to tolerate the ups and downs of the market because I was diversifying my risk over time. As a confirmation of my risk tolerancePersonal preference indicating how much risk you are willing to take to achieve a higher return., I point out that I did not sell any assetsThe value of things the company owns and amounts it is owed during any of the market “crashes.”

My first market crash was October 19, 1987. I can still remember being in the office that day. The internet was not available to the general public, so our news came from TV and radio. One of the senior people in the office had a TV in his office, though I suspect it had just the over-the-air channels as very few people had cable TV then either. He told everyone what was happening in the market. I asked him whether he was going to move his 401(k)A type of Defined Contribution Plan available in the US. There are three types of contributions that can be made to 401(k)s.
• Pre-tax - No taxes are paid on the contributions or any changes in... More money out of the market into a safer fund. His advice was that it was already too late and that I should just hang on for the ride. That was one of the best pieces of investing advice I’ve ever gotten. I didn’t sell during that crash and haven’t sold during any of the crashes since.

Goals While Retired

Now that I’m retired, I am drawing down my assetsThe value of things the company owns and amounts it is owed. I’ve made two changes to my asset mix to reflect the fact that I now need to spend my assetsThe value of things the company owns and amounts it is owed rather than add to them.

Instead of having a six-month emergency fund in cash, I now have several years of expenses in cash.
I’ve added a few individual corporate bonds (to be clear, not a bondA form of debt issued by government entities and corporations. fund) that mature in 3 to 5 years to my portfolioA group of financial instruments.. When these bonds mature, they will add to my cash balance to cover my expenses in those years.

For the rest of my invested asset portfolioA group of financial instruments., I’ve maintained the same goal – meet or beat the S&P 500.

By having several years of expenses in cash, I know I won’t have to sell any assetsThe value of things the company owns and amounts it is owed during any market turmoil, such as we are experiencing now. As discussed in my post on reacting to the most recent crash, the market has historically recovered in less than five years (excluding the crash of 1929) and has higher than average returns during the recovery phase. As such, I don’t want to have to sell stocks when markets are down.

How I Evaluate the All Seasons Portfolio

As I said, my goal is to earn a return close to or higher than the return on the S&P 500. I would be willing to take a small reduction in return for less riskThe possibility that something bad will happen., but not much given the other aspects of my strategy. Therefore, I will look at the components of the All Seasons portfolioA group of financial instruments. relative to what I can earn if I just invest in the S&P 500.

In particular, I am interested to see how these asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More perform when interestA charge for borrowing money, most often based on a percentage of the amount owed. rates are low, as they currently are.

Bonds

Returns on bonds (unless held to maturity) and bondA form of debt issued by government entities and corporations. funds have the following characteristics:

The total return is equal to the interest rateThe percentage which, when multiplied by the face amount or principal of a financial instrument, such as a bond, savings account or loan, determines the amount of interest that will be paid to or by t... More on the bondA form of debt issued by government entities and corporations. plus the change in market value from changes in interest rateThe percentage which, when multiplied by the face amount or principal of a financial instrument, such as a bond, savings account or loan, determines the amount of interest that will be paid to or by t... More levels.
Returns are higher when interestA charge for borrowing money, most often based on a percentage of the amount owed. rates are high or are going down.
The total return is similar to the interest rateThe percentage which, when multiplied by the face amount or principal of a financial instrument, such as a bond, savings account or loan, determines the amount of interest that will be paid to or by t... More itself when interestA charge for borrowing money, most often based on a percentage of the amount owed. rates stay fairly stable.
Returns are lower when interestA charge for borrowing money, most often based on a percentage of the amount owed. rates are low or are increasing.

Bond Returns vs. Interest Rate Changes

This relationship can be seen in the chart below which compares the change in the 10-year US Treasury bondA bond issued by the US government with a fixed interest rate and a maturity of more than 10 years. interest rateThe percentage which, when multiplied by the face amount or principal of a financial instrument, such as a bond, savings account or loan, determines the amount of interest that will be paid to or by t... More (yield) with the change in the market value of iShares Barclays 7-10 Year Treasury BondA bond issued by the US government with a fixed interest rate and a maturity of more than 10 years. fund (ticker symbol IEF) in each year from 2003 through 2019.

What Can Happen from Here

We are currently in the last situation listed above. InterestA charge for borrowing money, most often based on a percentage of the amount owed. rates are currently quite low by historical standards. The chart below which shows the yield on the 10-year US Treasury bondA bond issued by the US government with a fixed interest rate and a maturity of more than 10 years. from 1962 to 2020. The last point on the chart is the interest rateThe percentage which, when multiplied by the face amount or principal of a financial instrument, such as a bond, savings account or loan, determines the amount of interest that will be paid to or by t... More on July 8, 2020 of 0.65%. It is lower than the interest rateThe percentage which, when multiplied by the face amount or principal of a financial instrument, such as a bond, savings account or loan, determines the amount of interest that will be paid to or by t... More at the end of any year since 1962.

For all intents and purposes, interestA charge for borrowing money, most often based on a percentage of the amount owed. rates can do one of two things from their current levels – stay about the same or go up. If they stay the same, the return on bonds funds will be about the same as the interest rateThe percentage which, when multiplied by the face amount or principal of a financial instrument, such as a bond, savings account or loan, determines the amount of interest that will be paid to or by t... More on the bonds – currently less than 1% for 10-Year US Treasury bonds and less than 1.5% for 30-Year US Treasury bonds. If interestA charge for borrowing money, most often based on a percentage of the amount owed. rates go up, the market value of the bonds will go down and returns will be even lower.

As such, I don’t believe the returns on bonds or bondA form of debt issued by government entities and corporations. funds in the near termThe time period over which you re-pay the loan will be high enough to be consistent with my investing objectives. I will continue to buy individual corporate bonds that mature in the next few years to ensure that I have cash available to meet my expenses. But, I do not plan to add any bondA form of debt issued by government entities and corporations. funds to the investment portion of my portfolioA group of financial instruments.. If I were younger and the time until I needed to draw down my investments to cover my expenses was longer, I wouldn’t invest in bonds at all in the current environment.

Gold

I am particularly interested in how gold has behaved, as it isn’t something I’ve studied much. For the current environment, I’m interested in how gold behaves when interestA charge for borrowing money, most often based on a percentage of the amount owed. rates are flat or rising. The chart below shows how I defined historical periods as having interestA charge for borrowing money, most often based on a percentage of the amount owed. rates that are either flat or rising.

The line is the same line shown in the 10-Year Treasury Interest RateThe percentage which, when multiplied by the face amount or principal of a financial instrument, such as a bond, savings account or loan, determines the amount of interest that will be paid to or by t... More chart above. I have shaded periods in which interestA charge for borrowing money, most often based on a percentage of the amount owed. rates have been relatively stable in blue. The time periods in which interestA charge for borrowing money, most often based on a percentage of the amount owed. rates have increased are highlighted in green.

The chart below has the same time periods shaded as the previous chart, but the blue line shows the percentage change in the price of gold between 1971 (when the price of gold was no longer set by the US government) and today[6][7].

Looking back to the 1970s, gold prices were generally up quite significantly when interestA charge for borrowing money, most often based on a percentage of the amount owed. rates were either relatively flat and when they increased. While the increases in price were not as large in the period from 2003 to 2006, another time period when interestA charge for borrowing money, most often based on a percentage of the amount owed. rates were flat, as in the 1970s, annual price increases were still generally in the 10% to 30% range, much higher than would be expected on the S&P 500. Only in the most recent flat period are changes in gold prices not as consistently high.

Gold Funds

Buying gold means that you have to find a way to take delivery of it or pay to have it stored. One article about the All Seasons fund suggested investing in SPDR Gold Shares[8] (ticker symbol GLD) which is an exchange-traded fund (ETF) physically backed by gold. I compared the changes in prices of this ETF with the changes in the price of gold. Although they generally track each other, as shown in the chart below, they are not a perfect match. Nonetheless, this ETF appears to be a much easier alternative for investing in gold than buying gold itself.

Commodities

I wasn’t able to get a long history of returns on commoditiesBasic goods often used as inputs to the production of other goods or services. The primary categories in which commodities fall are metals, energy, livestock and agricultural products., but the table I provide earlier from Robbins’ book indicates that they are expected to behave in a manner similar to gold.

Overall Portfolio Evaluation

The chart below summarizes the annual average returns (on a compounded basis) for each of the asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More for which I could approximate returns from 1963 to 2019[9].

Over this time period, it appears that Gold has had returns similar to that of the S&P 500, but the returns on US Treasuries have dragged down my estimate of the returns on the All Seasons portfolioA group of financial instruments..

I am particularly interested in how these asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More perform when interestA charge for borrowing money, most often based on a percentage of the amount owed. rates are either flat or increasing. The chart below illustrates these returns using the same approximations as above.

In average in both rising and flat interest rateThe percentage which, when multiplied by the face amount or principal of a financial instrument, such as a bond, savings account or loan, determines the amount of interest that will be paid to or by t... More environments, gold has historical outperformed the S&P 500. By comparison. both categories of bonds have underperformed and, in fact, have had average returns during those periods of roughly 0%.

Re-Balancing

The performance metrics reported by Robbins and others assume that you maintain the target mix in each asset classA group of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors a... More. To accomplish that, you need re-balance regularly. That is, you need to to sell asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More that have appreciated the most (or depreciated the least) and buy asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More that have not performed as well.

What is Re-Balancing

Let’s look at an example. At the beginning of a year, you invest $10,000 using the All Seasons portfolioA group of financial instruments.. Your portfolioA group of financial instruments. looks like this:

If your one-year returns were similar to those in 2019, your end of year asset allocation (light green) would not be the same as your target (dark green), as shown in the graph below.

To reach the target allocation, you would need to make the following changes.

Gold	Sell $44
CommoditiesBasic goods often used as inputs to the production of other goods or services. The primary categories in which commodities fall are metals, energy, livestock and agricultural products.	Buy $28
Stocks	Sell $451
Medium TermThe time period over which you re-pay the loan Bonds	Buy $399
Long TermThe time period over which you re-pay the loan Bonds	Buy $67

To attain the high returns reported by Robbins, I suspect you need to re-balance the portfolioA group of financial instruments. fairly often. In my calculations, I assumed annual re-balancing on the first of each year. How often you re-balance the portfolioA group of financial instruments. depends on your personal preference, but should generally be more often when the prices of one or more of the asset classesGroups of similar investments or things you can buy with the expectation they will hold their value, generate income and/or increase in value. The three primary asset classes used by many investors ... More is changing rapidly and no less often than annually.

Impact of Income Taxes

It is better to own portfolios you need to re-balance regularly in a tax-free or tax-deferred account. Otherwise, you will need to pay income taxes on the net of your capital gains and capital losses. 401(k)s and IRAs are the most common tax-free and tax-deferred accounts in the US. The Canadian counterparts are TFSAs and RRSPs.

Continuing the example above, you sell $44 of gold and $451 of stocks for a total of $495. Without going into the details of the calculation, your cost basisThe amount you paid for something. for these two sales combined is $387, for a realized capital gain of $108. Many Americans have a 10% tax rate on capital gains which corresponds to $11 on the capital gain of $108. These taxes reduce your total return by 0.1 percentage point. That might not sound like much, but it can add up. If you make a $10,000 investment in this portfolioA group of financial instruments. and taxes reduce your return from 10.0% to 9.9%, you will have $5,000 less after 30 years. That’s half of the amount of your initial investment!

Changes I’ll Make to My Portfolio

The analysis presented in this post has refined my thinking about my portfolioA group of financial instruments. in two ways.

First, I have confirmed my past thinking that I can maintain a substantial cash position, supplemented by some individual bonds held to maturity, as a hedge against the riskThe possibility that something bad will happen. that the stock market will have a significant downturn. Although holding several years of expenses in cash lowers the return on my total assetsThe value of things the company owns and amounts it is owed, I find it a much easier and less risky strategy than introducing bondA form of debt issued by government entities and corporations. funds into my portfolioA group of financial instruments.. That is, although the return on money market funds where I hold my cash is low, it isn’t much lower than the current returns on US treasury or even high-quality corporate bonds. With the significant potential that the market price of bonds will go down, I am more comfortable with my cash position.

Second, I have invested in the SPDR Gold Trust (ticker symbol GLD). I don’t plan to immediately move as much as the 7.5% of my portfolioA group of financial instruments. into gold as suggested by the All Seasons portfolioA group of financial instruments. (15% if I use gold as a substitute for commoditiesBasic goods often used as inputs to the production of other goods or services. The primary categories in which commodities fall are metals, energy, livestock and agricultural products., too). Rather, I plan to initially invest 1% to 2% of my portfolioA group of financial instruments. in gold and add to that position as I gain more comfort and experience investing in it.

Footnotes

[1] Robbins, Tony, MONEY Master the Game, Simon & Schuster Paperbacks, 2014, p. 391-392.

[2] “Robbins’ All-Seasons PortfolioA group of financial instruments..” TuringTrader.com, https://www.turingtrader.com/robbins-all-seasons/. Accessed July 5, 2020.

[3] Robbins, op. cit., p. 390

[4] Robbins, op. cit., p. 395.

[5] There are many components of the calculation of returns, including assumptions regarding frequency of reinvestment and fees and the choice sources of data used to calculate the returns of the components of the portfolioA group of financial instruments.. As such, I am not able to replicate his calculations. In fact, I found another source for returns on the All Seasons portfolioA group of financial instruments. that, in the single year for which details were provided both sources, shows a return that was 3 percentage points higher than reported by Robbins.

[6] “Historical Gold Prices.” CMI Gold & Silver, Inc, https://onlygold.com/gold-prices/historical-gold-prices/, Accessed July 7, 2020.

[7] “Gold Prices.” World Gold Council, https://www.gold.org/goldhub/data/gold-prices, Accessed July 8, 2020

[8] “Bringing the gold market to investors.” State Street Global Advisors, https://www.spdrgoldshares.com/. Accessed July 8, 2020.

[9] As indicated above, the returns I calculated for the All Seasons portfolioA group of financial instruments. are not as high as were calculated by Robbins.