Tyler9000 wrote:The orange dots represent the typical spectrum between a 100% TSM portfolio on the left and a 100% TBM portfolio on the right.
It's interesting to see the recommended boglehead-ish portfolio is almost the lower boundary. If I'm reading it right, it also seems to dispel the notion that one can over-diversify to the point of diminishing returns.
Dragline wrote:I am envisioning that the best way to "play" this would be to take a lower average return/drawdown and leverage it by a factor somewhere between 1 (meaning no leverage) and 2. Then you have a competitive hedge fund.
I'm not sure what you mean. (sorry if I'm being slow)
jennypenny wrote:
It's interesting to see the recommended boglehead-ish portfolio is almost the lower boundary. If I'm reading it right, it also seems to dispel the notion that one can over-diversify to the point of diminishing returns.
Once you account for the drag of rebalancing costs (fees and taxes) there probably is a limit where too much diversification is a net negative. And if I'm right about the upper-left cluster, tilting a TSM fund towards any other stock class (or classes) in an all-stock portfolio is almost guaranteed to add risk even if it does boost returns. But you're absolutely correct that there's a lot more space in the truly diverse "body" than most people realize.
Compare a portfolio with a projected 7% return and a 10% max drawdown with one that has a 9% return with a 30% max drawdown.
By using a little leverage on the former portfolio-- borrowing and investing, in the ratio of 9/7, you should end up with something that yields around 9% yet only has a 9/7 * 10% = 12.85% drawdown.
These are back of the envelope numbers, so don't quote me on them but you get the idea.
Tyler9000 wrote:I also suspect that the "head" at the top left represents the preponderance of all-stock portfolios. I'm looking into that.
Related suggestion: make it possible for someone to color specific data points within the cloud based on their composition? E.g. Let's say that a person wants to see where all the portfolios that include Small-Cap Value, REIT, and Gold are - there are probably a couple dozen...those portfolios that have those assets (but may have others as well) would show up a different color to see if they cluster together. This would probably be more useful when the user identifies 3 or 4 assets to reduce the possibilities (but might also help you with the top left "head" question above), but that also makes it perfect for someone who had a base portfolio that they already like, and are looking for the best single asset to add to boost returns/reduce downside - if there is a tight cluster, it might not be worth it; if there is a very loose clustering, then it is worth it.
black_son_of_gray wrote:This would probably be more useful when the user identifies 3 or 4 assets to reduce the possibilities (but might also help you with the top left "head" question above), but that also makes it perfect for someone who had a base portfolio that they already like, and are looking for the best single asset to add to boost returns/reduce downside.
Adding the scatter plot directly to the tool presents some technical challenges I'll have to work through. My more immediate goal is to add your "force include" option that will let people be specific about what assets they know they like. That's a great idea.
Yeah, maybe its too ambitious, but it would be really cool if you could put in four or five "forced" assets and have it spit out the allocations (percentages) that would get you to the furthest upper right of the graph.
black_son_of_gray wrote:This would probably be more useful when the user identifies 3 or 4 assets to reduce the possibilities (but might also help you with the top left "head" question above), but that also makes it perfect for someone who had a base portfolio that they already like, and are looking for the best single asset to add to boost returns/reduce downside.
Just wanted to let you know I've added a "Require" option to the Portfolio Finder. It's a great feature -- thanks for the suggestion.
jennypenny wrote:
"identifies the historically least painful options"
Could you define "least painful"? (sorry if I missed it somewhere)
In this context, pain is measured by the worst-case annual return of the last 44 years. So the "least painful" option had the minimum worst annual loss for your desired average return.
Dragline wrote:This is really outstanding work/analysis. Looking at that scatterplot above, one of the things that jumps out at me -- besides it looking like a face down human with no limbs -- is the general curvature of the shape, which shows that trying to goose returns just a few percentage points really increases the possibility of serious drawdowns.
It would be interesting, at least to me, if you were to turn this on its side (flip the x and y axes) so it looks like a human falling backward and see if you can fit a curve to the data. It obvious forms a power-law/exponential function.
I am envisioning that the best way to "play" this would be to take a lower average return/drawdown and leverage it by a factor somewhere between 1 (meaning no leverage) and 2. Then you have a competitive hedge fund.
So I grabbed some data (input 1-10 on CAGR and took the average of the first 10 outputs) and ran it through Wolfram Alpha on an exponential fit and came up with this:
Basically, once you start getting over about 7% CAGR, the risk/potential drawndown kind of goes nuclear. You are better off staying down around 5-6% CAGR for the most part.
Dragline wrote:
So I grabbed some data (input 1-10 on CAGR and took the average of the first 10 outputs) and ran it through Wolfram Alpha on an exponential fit and came up with this:
Basically, once you start getting over about 7% CAGR, the risk/potential drawndown kind of goes nuclear. You are better off staying down around 5-6% CAGR for the most part.
Nice work! Yeah, that sounds about right.
Another fun fact: there's not a single portfolio above a 7.8% return that doesn't include some combination of small cap value, emerging markets, and international small. So if you prefer more traditional assets, the 7% range is also a practical cap.
BTW, it looks like I was right about the cluster in the top left.
The red zone is all of the portfolios holding nothing but US stocks. The blue expands that to all stocks including international and REITs. The green cluster in the bottom right shows the portfolios with all bonds and cash. The real action is in the gray area with truly diverse portfolios. Each black dot represents a lazy portfolio on the site.
If you wanted to play the trading game, that analysis suggests there is potential in shooting for a higher CAGR and using trailing stop losses to avoid the worst. Possibly shifting gains into the low volatility passive side?
jennypenny wrote:I've lost HOURS playing with all of the tools on your site, Tyler! It's worse than falling down the youtube rabbit hole LOL.
Before I started the site it was just me playing with spreadsheets for hours. At least now I have some fellow addicts to talk to.
George the original one wrote:If you wanted to play the trading game, that analysis suggests there is potential in shooting for a higher CAGR and using trailing stop losses to avoid the worst. Possibly shifting gains into the low volatility passive side?
The trick with stop losses is knowing when to get back in. Minimizing losses is nice, but if you also miss the gains you're not necessarily better off.
Blown away Tyler. Makes me really look forward to some productive years of RE. Nice work, I've taken to linking to your website in many a /r/financialindependence thread.
Wouldn't it be fun to draw a shape around the section of dots on your "All Possible Combinations" graph and get back what those portfolios were and some numbers? Likewise to see where your chosen portfolio ends up being placed (in this graph or any other of the graphs you have showcased).
So that's where all of the Reddit traffic is coming from! Thanks for spreading the word.
Those are really cool ideas. Maybe I can break the "All Possible Combinations" chart into blocks and isolate the predominant assets for each block or something like that. I do enjoy locating my own portfolio ideas on the chart -- I just need to find a way to get that particular tool down to a manageable file size.
That least painful portfolio is interesting! It keeps pulling up permanent-portfolio type allocations with some tilts towards higher-risk/anomalies that have performed better historically (e.g. Small Cap Value, Emerging Markets) - but still it's basically there.
Yep! The bones of the Permanent Portfolio are very strong. IMHO, it's a great foundation for any portfolio.
BTW -- I also just updated the Portfoilo Finder to calculate returns from a start-date-independent perspective. The results are even more interesting than before.
If anything, the Permanent-Portfolio-like options are even more prominent. Check it out.
Was following the discussion on GB portfolio at MMM. Gave me the idea of a Portfoilo Finder (the original one) animation: start with the earliest year you are comfortable which has enough back data and run a Monte Carlo, graph it and point out some interesting portfolios, move to the next year and watch how the highlighted points move, repeat.
I don't think this adds a ton more value since the new tool was introduced, but would be very visual indeed.
