The "Balanced" (60/40?) Investor: Topic for Discussion & Analysis | New Thread

Linton

JohnWinder said:

Nice discussion. A couple of issues came up for me.

Linton said:

On specific objectives:

1) Short term expenditure:
2) Medium term expenditure:
3) Long term comfort blanket, the objective being to ensure that investors don't lose sleep during a crash with the danger that they convince themselves to sell out.   I am with Malthuisian here.  This is mainly a problem for relatively inexperienced investors who could well look at their equity investments separately.  A good answer would seem to be to use multi-asset funds at an appropriate risk level as one would naturally look at the fund as a whole.  If one doesnt have the knowledge to do a job properly it is best to pay a professional.
4) Income:

Without suggesting there's anything wrong with thinking along those lines, it's only about retirement investing. The thread, until that point, was about accumulation and retirement investing. Only 3) seems to have broad relevance, and it well describes a '60/40' type approach with which one chooses two types of assets: equities for growth, and a very low risk bond/cash component, in a balance to suit your nerves (or your advisor's nerves if they're helping you). It doesn't need to be any more complicated than that, although it can be by: borrowing to buy the equities, thus enhancing any positive returns; substituting for some gold or other commodities; including direct real estate if diversification is possible, or putting the assets into mental buckets if it aids thinking.

It is about retirement investing, but then retirement investing is where 60/40 is most often quoted and most relevent.  

If you are young with retirement far in the future with a steady income that exceeds your basic needs what rational reason would you have for only investing 60% of your investable wealth?  Surely with say 30 years to go before you need the money anything below 100% equity is sub-optimal and purely for psychological purposes.  And you may as well just invest in a global tracker since in those early days your final wealth is far more dependent on your contributions than your investment returns.

Linton said:

Why would you want to reduce volatility whilst allowing reasonable gains? 

Indeed you might want to reduce volatility because 'volatility drag' can reduce overall returns if they're measured by the somewhat misleading 'average returns per year' measure. An asset that halves in value after the first year, then doubles in the second year has an average return of (100-50)/2, but has gone nowhere. Whereas an asset which increases 25% in the first, and then 25% in the second year is a horse of a different colour.

https://resourcereit.com/insight/volatility-drag-investment-returns/

 I do not believe that anyone with an understanding of basic statistics (never mind higher mathematics) would write the reference you provide.  It is at the same level as the "proofs" that 1=2.

But firstly if you want to combine consecutive returns you use the geometric mean, not the arithmetic mean.  So 100% and -50% over 1 year is equivalent to mutiplying by 2 and 0.5 which combined give sqrt(2X0.5)=1, ie a 0% change, over 2 years.  Using the arithmetic mean is meaningless (pun intended).

Secondly the paper you quote is mathematical fundamentally flawed - "volatility drag", at least in the form described does not exist. The paper assumes that returns follow a simple Gaussian distribution with +x% being equally likely as -x%.  This simply is not true except for very small %s.  It would be nice to give a mathematical proof but unfortunately MSE does not provide mathematical typesetting.  So a "reductio ad absurdum" proof will have to suffice.....

If the assumption were true you would expect that 100% rises and 100% falls would occur with equal likelihood.  Clearly they don't. Therefore the assumption is incorrect.

A mathematically justifiable model is to use a Gaussian distribution based on log(1+%return/100) so a 50% fall is as likely as a 100% rise.  Such a model would show that volatility about a fixed value does not result in a long term change, which is what one would expect.

firestone

since hitting semi retirement a couple of years back i have moved out of 100% equity and tried to trim to about 60% or 70% equity across 2 accounts as after talking to my wife  it feels like the time to trim back a bit  but not sticking to any hard or fast rules.So my pension is now 60/40 with the equity being sustainable Global and the bond funds being ethical/sustainable as well
The joint account with my wife which is meant to be hands off was consolidated down to a 50/50 split with her choice being her original Baillie Gifford managed which we added to and me picking GCT for the rest
Then with  my almost 100% equity (finding it hard to change the habit) i have 90% equity with about 30% passive 60% active plus 10% convertible bonds etf which some may say is not really safe bonds  (the bonds have grown a bit and i may trim but letting run for now)

JohnWinder

Linton said:

 I do not believe that anyone with an understanding of basic statistics (never mind higher mathematics) would write the reference you provide.  It is at the same level as the "proofs" that 1=2.
But firstly if you want to combine consecutive returns you use the geometric mean, not the arithmetic mean.  So 100% and -50% over 1 year is equivalent to mutiplying by 2 and 0.5 which combined give sqrt(2X0.5)=1, ie a 0% change, over 2 years.  Using the arithmetic mean is meaningless (pun intended).

Some confusion perhaps. I thought you earlier wrote that some people might want to reduce volatility, when you wrote:

'Different reasons for wanting to do this will lead to different ways of doing it.  For example a young long term investor may want this because they are afraid of losing all their money.  An experienced retired investor may want to protect future income in the short and medium term.'

And agreeing with you, I suggested another reason, namely that volatility reduces the compound average growth rate but this does not show up with arithmetic means of returns. But sorry if the maths was clumsy.

Arithmetic means can be misleading, as I tried to show with 100% and -50% over two years. I didn't want to complicate it by suggesting that a compound average growth rate is a much better measure of annual returns, but it is because if you tell me that my investment grew by 5%/yr (CAGR) I know that in the second year I also got 5% growth on the growth of the first year, and so on subsequently. It's not too hard to picture for people with an understanding of compounding.

Linton

JohnWinder said:

Linton said:

 I do not believe that anyone with an understanding of basic statistics (never mind higher mathematics) would write the reference you provide.  It is at the same level as the "proofs" that 1=2.
But firstly if you want to combine consecutive returns you use the geometric mean, not the arithmetic mean.  So 100% and -50% over 1 year is equivalent to mutiplying by 2 and 0.5 which combined give sqrt(2X0.5)=1, ie a 0% change, over 2 years.  Using the arithmetic mean is meaningless (pun intended).

Some confusion perhaps. I thought you earlier wrote that some people might want to reduce volatility, when you wrote:

'Different reasons for wanting to do this will lead to different ways of doing it.  For example a young long term investor may want this because they are afraid of losing all their money.  An experienced retired investor may want to protect future income in the short and medium term.'

And agreeing with you, I suggested another reason, namely that volatility reduces the compound average growth rate but this does not show up with arithmetic means of returns. But sorry if the maths was clumsy.

Arithmetic means can be misleading, as I tried to show with 100% and -50% over two years. I didn't want to complicate it by suggesting that a compound average growth rate is a much better measure of annual returns, but it is because if you tell me that my investment grew by 5%/yr (CAGR) I know that in the second year I also got 5% growth on the growth of the first year, and so on subsequently. It's not too hard to picture for people with an understanding of compounding.

You do not quote the whole post.  Lets make it clearer. I do not believe that volatility reduces the average growth rate. Your cited article certainly does not prove it because the maths is wrong.  If you can cite something authoritative that does prove it I may change my mind.

tigerspill

It doesn't matter.

People picked up 60/40's in the past despite having a range of investing desires - ultimately they were using the bonds as a hedge against the equity element. That's probably not as appropriate as it was given where the world is now, and the llikelihood of inflation being greater than deflation I would guess.

I agree that there's different investigating strategies on offer - a 100% equity portfolio wiith some decent defensives might be better than cash. Likewise a multi-asset fund may better. I'm not saying everyone should have an equity/cash portfolio, but that people who currently have, or are thinking about buying, a traditional 60/40 equity/bond fund based on what it *used* to offer may find that an equity/cash portfolio will actually perform more in line with historic 60/40 returns than a 60/40 will going forward.

Could you elaborate on what you mean by defensive options other than cash or bonds?
I am going through my asset allocation strategy at the minute and in particular trying to work out what I need for defensive other than cash.

ivormonee

dunstonh said:

Traditionally, this has been the domain of the "60/40" investor

In the UK, Balanced referred to 40-85% equity.    It was felt that the name was too vague in what it meant and that some people would invest above their risk profile without realising.  So, they dropped the Balanced name and went for the description.

 What benchmark(s), if any, do you use?

I tend to use the closest VLS fund personally.     Sector average is not a good benchmark given its wide variation.

So, I've looked at the sector for 40%-85% equity. There seem to be around 460 funds in this category. Some of the worst performers over one year are Jupiter distribution and growth, at -10.73% and Fidelity MoneyBuilder Balanced at -8.1%. On the top end of the sector there is Baillie Gifford Managed at a return of 35.1%. The sector average is 5.7%. So it's interesting to see what you highlighted about the wide variation - now that I've had a look at it I am shocked as to how wide it really is.

The worst performing mixed asset fund in the category has returned 16.43% less than the average; the best performer has returned 29.4% more than the average. Such a huge disparity!

So, in looking for a benchmark, if we were to use the sector average, what we will be making a comparison with is exactly that: the average of all actively manged funds within that category. But we can't compare to the best, nor to the worst, as that too would be meaningless.

If we look at Vanguard LifeStrategy 60, whhich falls somewhere in the middle of the 40%-85% equity category, that has returned 6.2%. So, a little ahead than the average of the active managers. I suppose the good thing about using Vanguard as a proxy index is that it's an easy thing to do and is close to the average of actively managed funds; for the year that I've checked at any rate.

I won't just yet abandon the search for a better and/ or more meaningful method of comparison/ benchmarking and open to seeing what, if any, other ideas emerge on this subject.

Linton

ivormonee said:

dunstonh said:

Traditionally, this has been the domain of the "60/40" investor

In the UK, Balanced referred to 40-85% equity.    It was felt that the name was too vague in what it meant and that some people would invest above their risk profile without realising.  So, they dropped the Balanced name and went for the description.

 What benchmark(s), if any, do you use?

I tend to use the closest VLS fund personally.     Sector average is not a good benchmark given its wide variation.

So, I've looked at the sector for 40%-85% equity. There seem to be around 460 funds in this category. Some of the worst performers over one year are Jupiter distribution and growth, at -10.73% and Fidelity MoneyBuilder Balanced at -8.1%. On the top end of the sector there is Baillie Gifford Managed at a return of 35.1%. The sector average is 5.7%. So it's interesting to see what you highlighted about the wide variation - now that I've had a look at it I am shocked as to how wide it really is.

The worst performing mixed asset fund in the category has returned 16.43% less than the average; the best performer has returned 29.4% more than the average. Such a huge disparity!

So, in looking for a benchmark, if we were to use the sector average, what we will be making a comparison with is exactly that: the average of all actively manged funds within that category. But we can't compare to the best, nor to the worst, as that too would be meaningless.

If we look at Vanguard LifeStrategy 60, whhich falls somewhere in the middle of the 40%-85% equity category, that has returned 6.2%. So, a little ahead than the average of the active managers. I suppose the good thing about using Vanguard as a proxy index is that it's an easy thing to do and is close to the average of actively managed funds; for the year that I've checked at any rate.

I won't just yet abandon the search for a better and/ or more meaningful method of comparison/ benchmarking and open to seeing what, if any, other ideas emerge on this subject.

You need to be very careful when comparing funds in a sector.  They can be very different.  In this case 40%-85% is a wide range.  The 2 funds at the bottom of the 5 year list focus on income more than growth and income shares have performed relatively poorly for many years. Different performance figures are often not a simple matter of "good" funds and "bad" funds.

In any case 1 year's performance, especially in the past unusual year may be quite different to the long term.

You need to look at the details.to determine which fund is most appropriate for your needs.  The idea that you can sensibly choose an active fund by sticking a pin in a sector list is very wide of the mark.

Notepad_Phil

Thrugelmir said:

... Not a comfortable position to be skewed towards equities given the elevated valuation of many companies already, and the fact that there's an entire generation who'll need to sell these investments down to fund their retirement. 
...

Though unless something changes in the pension landscape then aren't there even more in the next generation who'll be busy buying up those investments to provide the funds for their retirement.

Thrugelmir

Notepad_Phil said:

Thrugelmir said:

... Not a comfortable position to be skewed towards equities given the elevated valuation of many companies already, and the fact that there's an entire generation who'll need to sell these investments down to fund their retirement. 
...

Though unless something changes in the pension landscape then aren't there even more in the next generation who'll be busy buying up those investments to provide the funds for their retirement.

Population is set to decline. Post war baby boom is passing in the developed Western world. 

[Deleted User]

It is worth saying that no-one  on the board is truly neutral.

Be wary of posters who adopt an authoritative tone, there's usually a pre-existing position to bolster.