What is the optimal ratio of equities to bonds for an investment that requires a 5% annual drawdown?

Ray_Singh-Blue

When the father of modern portfolio theory, Harry Markowitz, was asked how he would invest among stocks and bonds, he replied that to minimize future regret, he would split his contributions 50/50 between bonds and equities.

I think it is hard to improve on the simplicity of this.

Albermarle

Ray_Singh-Blue said:

When the father of modern portfolio theory, Harry Markowitz, was asked how he would invest among stocks and bonds, he replied that to minimize future regret, he would split his contributions 50/50 between bonds and equities.

I think it is hard to improve on the simplicity of this.

Although in the current poor environment for bonds, then maybe it is too simple . Something along the lines of 60% equities; 20% bonds and 20 % other ( cash, gold, property etc ) would probably be a better bet .

Ray_Singh-Blue

I kind of agree, but once you make it more complicated, you make it more complicated, and where do you stop?

Your "better bet" is a little like my actual portfolio: 52% shares, 40% cash, 8% gold.

 https://forums.moneysavingexpert.com/discussion/5176363/take-a-peek-at-my-hand/p

I wish I had been 50:50 stocks bonds instead, with hindsight.

Interest rates are rising and the prices of issued bonds are therefore falling, I'm thinking of starting a bond journey soon.

Frequentlyhere

Ray_Singh-Blue said:

I wish I had been 50:50 stocks bonds instead, with hindsight.

Interest rates are rising and the prices of issued bonds are therefore falling, I'm thinking of starting a bond journey soon.

I'm also intending to move into bonds and have been using cash to date, but I'm curious as to why you regret going with what you did, Ray?

Even on a total return basis (coupons included), a typical bond fund like VGOV is back to prices seen in 2016, and that's before we account for the ravages of inflation. With cash it has at least been possible to earn 1-2%  in 1 year fixes in that time period. Meanwhile, gold has done very well.

My regret personally has been not having a higher equity allocation, easy to say with hindsight.

My intention now is to move to something like 60% equity, 20% bonds, 10% cash, 10% gold.  

masonic

Frequentlyhere said:

Ray_Singh-Blue said:

I wish I had been 50:50 stocks bonds instead, with hindsight.

Interest rates are rising and the prices of issued bonds are therefore falling, I'm thinking of starting a bond journey soon.

I'm also intending to move into bonds and have been using cash to date, but I'm curious as to why you regret going with what you did, Ray?

Even on a total return basis (coupons included), a typical bond fund like VGOV is back to prices seen in 2016, and that's before we account for the ravages of inflation. With cash it has at least been possible to earn 1-2%  in 1 year fixes in that time period. Meanwhile, gold has done very well.

My regret personally has been not having a higher equity allocation, easy to say with hindsight.

My intention now is to move to something like 60% equity, 20% bonds, 10% cash, 10% gold.  

I don't think anyone could have predicted to what extent, and for how long, the rise in gilt prices would continue. The returns, for negligible risk, were stellar. On the flip side, yields have been floored. It is only in the last couple of years that the tune has changed. The unwinding of this highly unusual situation is now well underway. Historically, returns from bonds have beaten long term inflation by about a percentage point. We're still a long way from that, but as bonds fall in price, their yield increases. Even with a yield somewhat lower than consumer cash savings accounts, their negative correlation with equities makes them of greater value for diversification. A "typical" bond fund like VGOV will hold some quite long-dated gilts, which are most sensitive to increasing interest rates, so there is considerable risk at the moment as interest rate expectations are increasing month by month. A return to normal interest rates of ~5% is not out of the question, but so far markets are anticipating just half of that.

CheekyMikey

I I have always had a couple of global bond funds in my pf, worth about 20% of my pf. They’ve never offered any more than a few percent growth at best. Have just completely sold out of one and reinvested into the fund equivalents of CGT and PAT. I’ve also just taken a large cash pension lump sum which I’m keeping in cash deposits, currently in two Chase accounts with a view to moving most into fixed rate once I see what comes available in the next month….hoping for 1 year @2.25% and 2 year @ 2.7% soon.

masonic

CheekyMikey said:

I I have always had a couple of global bond funds in my pf, worth about 20% of my pf. They’ve never offered any more than a few percent growth at best. Have just completely sold out of one and reinvested into the fund equivalents of CGT and PAT. I’ve also just taken a large cash pension lump sum which I’m keeping in cash deposits, currently in two Chase accounts with a view to moving most into fixed rate once I see what comes available in the next month….hoping for 1 year @2.25% and 2 year @ 2.7% soon.

If you look under the hood of CGT and PAT, you'll find they are around 40% equities. If you plot an efficient frontier chart, you'll find that ~20% equities is lower risk than 0% equities, and that 40% equities is higher return and of comparable risk to 0% equities. This is based on long term data and will vary depending on the period of time analysed. If the 40% equities are selected with a capital preservation mandate, then it may be equivalent in risk to a lower percentage of an equities index. The bond component of both funds is largely inflation linked, and relatively short duration. As a consequence, these trusts look well placed as defensive building blocks for an investment portfolio at the present time.

tebbins

The particular equities in CGT and PAT, though including a variety of global trackers in various weights, are focused on real estate and arguably shouldn't be counted towards the equity allocation of a portfolio.

CheekyMikey

tebbins said:

The particular equities in CGT and PAT, though including a variety of global trackers in various weights, are focused on real estate and arguably shouldn't be counted towards the equity allocation of a portfolio.

That’s why I thought they’d be a good addition to my pf instead of bonds…not only do they offer a good chance of a high level of stability with decent returns for only a slight increase in risk, they also don’t have much duplication with my existing equity holdings other than Alphabet, Microsoft and Visa within PAT. I have more cash holdings now too to dilute that extra risk, which I think has made my overall pf a bit more defensive for a few years whilst I see how things pan out. As ever, time will tell…

aroominyork

tebbins said:

The particular equities in CGT and PAT, though including a variety of global trackers in various weights, are focused on real estate and arguably shouldn't be counted towards the equity allocation of a portfolio.

That's debatable and I'm not sure the fund managers would agree. The CGT factsheet has an asset class of 'funds/equities' which includes the property holdings.