Does Geometric Balancing have the potential to become extreme? Does it ever call for a portfolio that’s unjustified, or way outside conventional thought? Sometimes the portfolio will be “wrong”, and when it is should you fear the consequences?
I’ve spend hours thinking about this, and came to an interesting conclusion. I think of the question this way: Will the strategy ever rebalance into a portfolio that is not already logically employed by millions of investors today? Let’s start with the most aggressive portfolio.
Portfolio of 100% Stocks
For the base strategy, this is as aggressive as it gets. Fully loaded up on what is typically the riskiest asset in the portfolio. It’s rare for the portfolio to go here, but it does happen. It’s much more common to see a 90-10 type split (see June ’19), which is still pretty aggressive, and free of most diversification.
This portfolio does very well in bull markets.
The thing is though, 100% investing in the S&P 500 is a common investment strategy. It’s employed and recommended by lots and lots of people. Including one of the greatest investors of all time.
Warren Buffet said his recommended default portfolio would invest 90% in the S&P 500 and 10% in short term bonds. If one of the greatest investors ever thinks that an “average person who is not an expert on stocks” should invest in a 90/10 portfolio, is there anything radical about a strategy that leans heavily in stocks? It’s just mimicking what millions of other investors have as their base.
The 60/40 Portfolio
The default position for many investors is 60% stock and 40% bonds. Interestingly, geometric balancing averages 50% stocks, 35% bonds, 10% gold, 5% cash. If you ratio only on stocks and bonds that equates to 59% stocks and 41% bonds.
Strange coincidence?
But even beyond 60/40, when you look at a bond/stock mix, you can find support for many different levels.
- 80/20 generally maximized long term returns.
- 60/40 roughly maximized risk adjusted returns.
- Some use 70/30 to find a middle ground.
- Jack Bogle used a 50/50 split in his own portfolio.
I’m about 50 percent stocks and 50 percent bonds and I spend half my time worrying about why I have so much in stocks and the other half worrying about why I have so little in stocks. A 50-50 stock/bond allocation is fine, probably if you’re younger a little more aggressive
Jack Bogle.
He goes on to discuss how legendary investor Benjamin Graham also used a 50/50 portfolio.
So you can see there is strong justification for a wide variety of stock to bond ratios. Millions of investors all over the world use stocks and bond portfolios all through this range.
What About Gold?
You may be thinking, yes but you mix gold into that most of the time. Does that make the strategy extreme?
Well it is less common I would agree, but it’s not extreme. Another one of the greatest investors ever, Ray Dalio founded of the largest and most successful investment funds in the world. Mr. Dalio believes you should hold a small amount of gold in your portfolio. He recommends around 10%, and one of his flagship products is believed to hold about that amount. Others have also recommended a small amount of gold.
Even mainstream market pundit Jim Cramer has recommended including some gold in your portfolio. Including some gold in a portfolio is practically conventional at this point.
The Permanent Portfolio
Another time tested strategy is the permanent portfolio. Created by Harry Brown, the permanent portfolio holds equal parts stocks, bonds, gold and cash (sound familiar). Some people eliminate the cash and just hold equal parts stocks, bonds and gold, 33% of each.
The Permanent Portfolio has been on a tear lately, and its popularity seems to be growing with many realizing it does a great job controlling drawdowns while still providing a reasonable return. So when you see my portfolio dive down towards equal weights between the assets, it’s mirroring the permanent portfolio.
Once again, lots of wisdom found in the construction of the permanent portfolio.
What About Going Big On Bonds?
Back to Ray Dalio. Almost 30 years ago he created a portfolio designed to work in any investing climate. Mr. Dalio’s “All Weather” portfolio has performed wonderfully over the past 25 years.
The all weather portfolio is built around the concept of “risk parity”. Very simply, it tries to equalize “risk” in the portfolio among all asset classes.1 There’s lots of math involved, but luckily for us he summarized its composition for the world. In an interview with Tony Robbins, he divulged a portfolio he called the “All Season Portfolio“.
- 40% Long Government Bonds
- 15% Intermediate Government Bonds
- 7.5% Gold
- 7.5% Commodities
- 30% Stocks
This is the portfolio he said he would pass down to his family for their use through time.
Simplified down this becomes:
- 55% Bonds
- 15% Gold/Commodities
- 30% Stocks
Ray Dalio uses and recommends a bond heavy portfolio. So even when Geometric Balancing moves into a large bond position, it’s still emulating one of the most famous strategies in investing.
Is There a Bad Portfolio?
So take a step back and look at each one of these portfolios. Each one is different. Each one has performed well historically. Each one has different strengths and weaknesses. And Geometric Balancing will mimic each one at different times, effectively “trying” 2 to own the portfolio with the correct strength for that market.
Geometric Balancing is a mix of some of the greatest portfolios ever developed and recommended by some of the greatest investors ever. But instead of mixing them simultaneously, it mixes them through time.
Once I grasped that someone brilliant had already recommend holding the same portfolio my strategy was calling for, I ceased being concerned about “unconventional portfolios”. Each of the portfolios is conventional. Each of the portfolio’s work.
What isn’t conventional, and what makes Geometric Balancing so powerful, is how the strategy calibrates between:
- A Buffet portfolio
- And a Bogle Portfolio
- And a Browne Portfolio
- And a Dalio Portfolio.
automatically depending on the current market environment.
How else can you invest dynamically with 4 of the wisest investors ever?
1-Slightly less simplified: It aims to produce the tangency portfolio discussed here, but does so with specific assumptions about the returns in the the portfolio in relation to risk. This still underplays the intellectual framework behind the construction of the all weather fund which is probably worth its own post someday.
2- This isn’t a conscious “trying”. The math of geometrically maximizing returns, and then respecting errors and other criteria moves the portfolio on its own.
Thanks for the blog and for laying all of this out so thoughtfully! I am still trying to figure out the math for three risky assets and looking forward to solving the puzzle!
Bridgewater (and others) recently put out research on why long-term treasuries might not be as useful in portfolios as they have historically been given how low yields are. Little room left for treasuries to increase when equities drop. (https://www.bridgewater.com/grappling-with-the-new-reality-of-zero-bond-yields-virtually-everywhere). They recommend a combination of gold and TIPS as a better equity hedge in an MP3 world where governments use ‘helicopter money’ to combat economic weakness (as they cannot lower interest rates any further).
Curious if you have thought much about this. Specifically TIPS. I think your system would naturally under-weight treasuries as their correlation to equities increased, and you already have gold in there. But finding an asset to replace 30 year treasuries would be very helpful if they no longer play the diversification role that they historically have.
Hi CCM, I’m curious if you’ve ever made progress on the math of balancing three risky assets – I’m about to start on that project myself. You can email me if you’d like to work together. patrick (at) patrickdfarley (dot) com
This article, while interesting, is totally out of date. Treasuries no longer make sense.
Check out the website portfoliocharts.com for comparisons of the different portfolios. I found it very interesting.