What % of your portfolio are active vs passive funds?

bowlhead99

aroominyork wrote: »

If you were 25 years from accessing your funds why 40% bonds? Why not 100% equities and ride out the bumps?

A portfolio of uncorrelated assets with diversification, periodically rebalanced, can give you a return with appreciably better volatility but much closer to the higher returning asset than one might have expected from the reduction in variance of returns.

Yes, we know more reward may require more risk, but nobody wants to 'pay' more than they need to, in terms of risk taken on, to get the return with which they'd be comfortable.

There will be some sort of mix that represents an 'optimum' rather than simply taking more and more risk and volatility for the chance of higher returns. A bit like if you are upgrading your PC to a faster processor or buying nice wine or jewellery, at some point you will unscientifically think 'ok this is the sweet spot, there's no point paying 100% more for something that's only 5% faster /tastier / prettier, even if you recognise that you would prefer that better one if it were possible with money literally no object.

You could Google 'efficient frontier'; here's an example from the first page of links which has some theory and a couple of charts -
https://corporatefinanceinstitute.com/resources/knowledge/finance/capital-allocation-line-cal-and-optimal-portfolio/

The efficient frontier for an asset mix does depend on the relative return of the assets and their correlations. The problem is when working out how to position our portfolio allocation we don't know what the risk and return and correlation will be, and can only judge on historic data. The last two or three decades of equity returns vs bond returns does not actually tell you the next few, which could be quite different - equity up bonds down and vice versa might be expected, but what if both went up and down together due to some unusual macro factors...

bostonerimus

aroominyork wrote: »

If you were 25 years from accessing your funds why 40% bonds? Why not 100% equities and ride out the bumps?

60/40 was on a nice place on the efficient frontier, a nice balance of risk and return, close to the inflection point. Luckily I also caught the bond bull market. Now that I’m retired I’m near to 80/20 because I can afford to take the risk. I’ve stopped rebalancing assuming that equity returns will be greater than the bonds and I’ll have a rising equity allocation. My goal is to maximize the value of what I leave to my heirs. They aren’t relying on that money, and neither am I, so I’m ok taking the risk.

MaxiRobriguez

bowlhead99 wrote: »

A portfolio of uncorrelated assets with diversification, periodically rebalanced, can give you a return with appreciably better volatility but much closer to the higher returning asset than one might have expected from the reduction in variance of returns.

Yes, we know more reward may require more risk, but nobody wants to 'pay' more than they need to, in terms of risk taken on, to get the return with which they'd be comfortable.

There will be some sort of mix that represents an 'optimum' rather than simply taking more and more risk and volatility for the chance of higher returns. A bit like if you are upgrading your PC to a faster processor or buying nice wine or jewellery, at some point you will unscientifically think 'ok this is the sweet spot, there's no point paying 100% more for something that's only 5% faster /tastier / prettier, even if you recognise that you would prefer that better one if it were possible with money literally no object.

You could Google 'efficient frontier'; here's an example from the first page of links which has some theory and a couple of charts -
https://corporatefinanceinstitute.com/resources/knowledge/finance/capital-allocation-line-cal-and-optimal-portfolio/

The efficient frontier for an asset mix does depend on the relative return of the assets and their correlations. The problem is when working out how to position our portfolio allocation we don't know what the risk and return and correlation will be, and can only judge on historic data. The last two or three decades of equity returns vs bond returns does not actually tell you the next few, which could be quite different - equity up bonds down and vice versa might be expected, but what if both went up and down together due to some unusual macro factors...

I don't understand why anyone bats an eyelid to volatility if they know their investing horizon is 25 years, they want growth not protection and the investor is confident they will continue to be a buyer and not a seller of assets. Volatility is simply not a risk that needs to be managed at that point and if anything, pandering to it weighs on potential returns.

The equity/bond split made sense when bonds were very profitable. They're not anymore. Multi-decade investors therefore should be looking elsewhere.

bostonerimus

MaxiRobriguez wrote: »

I don't understand why anyone bats an eyelid to volatility if they know their investing horizon is 25 years, they want growth not protection and the investor is confident they will continue to be a buyer and not a seller of assets. Volatility is simply not a risk that needs to be managed at that point and if anything, pandering to it weighs on potential returns.

The equity/bond split made sense when bonds were very profitable. They're not anymore. Multi-decade investors therefore should be looking elsewhere.

There's a significant probability that a volatile portfolio..ie 100% equities...will produce poorer returns than a more diversified portfolio. Its the accumulation equivalent of the retirement spending sequence of returns issue in that big losses early on can compound dow the years. Maximising potential return should not be the goal, you should be looking to maximise the probability that you will end up with enough return to be successful.

aroominyork

bostonerimus wrote: »

There's a significant probability that a volatile portfolio..ie 100% equities...will produce poorer returns than a more diversified portfolio. Its the accumulation equivalent of the retirement spending sequence of returns issue in that big losses early on can compound dow the years. Maximising potential return should not be the goal, you should be looking to maximise the probability that you will end up with enough return to be successful.

So if, on a 25 year horizon, Portfolio A provides a 98% chance that you will end up with enough returns to be successful, while Portfolio B provides a 99% chance, you would choose Portfolio B even if you are likely to have significantly less funds at term?

MaxiRobriguez

bostonerimus wrote: »

There's a significant probability that a volatile portfolio..ie 100% equities...will produce poorer returns than a more diversified portfolio. Its the accumulation equivalent of the retirement spending sequence of returns issue in that big losses early on can compound dow the years. Maximising potential return should not be the goal, you should be looking to maximise the probability that you will end up with enough return to be successful.

If you can prove a strategy will produce poorer returns over the long term then that's an acceptable consideration.

What I was trying to suggest was far too many people with a long term horizon fret about 20% swings in the past 12 months. It's irrelevant because they're not liquidating for decades. If it's a 20% down swing and a 25% upswing compared to an alternative portfolio which is doing 6% down and 10% up then the volatile portfolio is better if all other things are equal.

If anything, the volatility is better for the long term investor who can add weight to the position on the dips if they have spare change.

coyrls

MaxiRobriguez wrote: »

If you can prove a strategy will produce poorer returns over the long term then that's an acceptable consideration.

What I was trying to suggest was far too many people with a long term horizon fret about 20% swings in the past 12 months. It's irrelevant because they're not liquidating for decades. If it's a 20% down swing and a 25% upswing compared to an alternative portfolio which is doing 6% down and 10% up then the volatile portfolio is better if all other things are equal.

If anything, the volatility is better for the long term investor who can add weight to the position on the dips if they have spare change.

Your example is wrong. A 20% swing down followed by 25% swing up would leave you back where you started. A 6% down followed by a 10% up would leave you 3.4% better off. So you would be better off with the less volatile portfolio in your example.

bostonerimus

MaxiRobriguez wrote: »

If you can prove a strategy will produce poorer returns over the long term then that's an acceptable consideration.

What I was trying to suggest was far too many people with a long term horizon fret about 20% swings in the past 12 months. It's irrelevant because they're not liquidating for decades. If it's a 20% down swing and a 25% upswing compared to an alternative portfolio which is doing 6% down and 10% up then the volatile portfolio is better if all other things are equal.

If anything, the volatility is better for the long term investor who can add weight to the position on the dips if they have spare change.

It’s not a matter of proof, it’s difficult to prove anything when we are dealing with the future. All you can do is look at the past and try to model potential future returns based on historical data. That will produce a number of potential outcomes with various probabilities. Balancing the distribution of returns against their probabilities is the key and that will be influenced by personal circumstances. So if someone is paying into a good DB pension then a very high equity allocation in their other investments might be appropriate, but if all you have is a DC pension you might want to be a bit more cautious. In a bull market 100% equities looks great, but it doesn’t take much of a downturn to make people wicsh of the stability of some fixed income

MaxiRobriguez

coyrls wrote: »

Your example is wrong. A 20% swing down followed by 25% swing up would leave you back where you started. A 6% down followed by a 10% up would leave you 3.4% better off. So you would be better off with the less volatile portfolio in your example.

Yes it is isn't it. Well done me. Sigh.

But the original point still stands in that investors with a very long term horizon should ignore short term volatility when it comes to choosing investments. Selections should be based on growth potential.

Linton

aroominyork wrote: »

So if, on a 25 year horizon, Portfolio A provides a 98% chance that you will end up with enough returns to be successful, while Portfolio B provides a 99% chance, you would choose Portfolio B even if you are likely to have significantly less funds at term?

Differentiating between 98% and 99% is a bit meaningless, as the difference is well with error bounds and both are sufficiently close to 100% as you are likely to get. Expand the difference to something meaningful and the answer for any rational investor should be to achieve the objective at minimum risk.



In my case being retired the objective is to achieve a particular income for the rest of my life. I choose to put nearly 30% of my money into a wealth preservation portfolio that I intend to match inflation with a low chance of returning significantly more or significantly less. Increasing my income beyond the objective would not increase my happiness because I would have nothing worthwhile to spend it on. Failing to meet the objectve would cause major unhappiness. So decreasing the Wealth Preservation % to provide a higher return would be irrational even if it meant ending up with a larger estate on death.