And here is the table:

Here are the Lazy Portfolio Smackdown results for 2011. Note: these numbers are preliminary because mutual fund dividends have not yet been reported. So those lazy portfolios that hold mutual funds that pay dividends in mid to late December will probably end up about 1% higher than these numbers.

Incredibly, the Harry Browne Permanent Portfolio wins again. It beat all other non-permanent portfolios by at least 5.5%! Have a look at the chart:

Click on the image to get a larger, more readable graphic.

To see the components of each Lazy Portfolio, visit the Professional Lazy Portfolios page.

Look how steadily the Harry Browne Permanent Portfolio (HBPP) gained during 2011. Especially when compared to the rest. Look at the wild ride they would have put you through from April until September. Tough to stomach that!

And for those of you who love a more tabular look:

Breaking down the HBPP, here are how the individual components performed for 2011:

  WOW, who would have thought that long-term treasuries would go up 34%? And look at gold, up almost 10%, which also marks its 11th consecutive year of gains. Holy bullion Batman! Even cash money did you better than your bank account, up 1.4% in short-term Treasuries.

Thank you Harry Browne!

How about the losers? Well, the silly Dilbert portfolio, all stocks, dropped almost 10%. Scott Adams recommended this (google it), but it is pretty dumb. Not much less dumb is the portfolio I put out a few years ago, also all stocks, that sought to mimic the IFA Portfolio 100, their riskiest plan. So in a year when risky stocks did poorly, portfolios that invested in all risky stocks stunk.

How about something more reasonable? Good old Rick Ferri, the guy who says his “best investment in gold was his wedding ring” how did he do for you in 2011? Here is his portfolio (prior to December dividend reporting)

He puts 40% into a broad bond index, thinks REITs are cool, and adds some international equities for spice. The portfolio gained you less than if you had put the whole thing into SHY, the short-term treasuries fund. (But dividends for December are still coming) That’s pretty stinky. And as you can see from the chart, you got a pretty wild ride in 2011 to boot. And he makes money doing this?

Which non-Permanent Portfolio did best in 2011? That would be the Scott Burns Couch Potato Portfolio, up 5.9%. (And remember that December dividends aren’t yet included in this result.)

Two funds: stocks and TIPS. Stocks flat-lined. TIPS made you some money. And the ride wasn’t too wild, especially when compared to the others. But HBPP was better in both performance and risk.

I don’t want to wrap up this year-end review without mentioning the poor performance of PFPFX, the Permanent Portfolio Fund. With HBPP up 11.5%, you’d expect that the mutual fund loosely based upon his philosophy would be close to that, but you’d be wrong. PRPFX was up only 2.2% (including December dividends) for 2011. Why? Because it deviates from HBPP in risky ways including Silver, Swiss Francs, and growth stocks. And of course it has a 0.77% expense ratio for its management fees. That is disappointing. But THEY got $118 million, based upon having $15.4 billion invested. I’m not liking this.

Gee whiz, I wish I could create a mutual fund that invested in VTI, 30-year Treasuries, IAU, and short-term Treasuries. I’d pay something like 0.08% and would charge you people 0.20%. Let’s see, with $15 billion dollars under management, I’d take in $18 million each year. Easy money!

And for your tabular view:

The innovations in the Bitcoin realm are coming quickly. And since I last looked, they now discourage mining bitcoins on your own. And also since I looked, there are now physical Bitcoins! I just read an article asking whether they might be considered illegal.  These things look great and help push their acceptance forward.

So I finally installed the Bitcoin app and have a Bitcoin address for you to send me some:

1NTsbjZH4HnqeQKK5dpFzfjJvGjr61N1ps

Not to bribe you or anything, but I figure if I can get a couple of coins from my (diminishing) audience, I would be encouraged enough to do another MMM show.

1-mo: -5.2%

2-mo: -8.3%

YTD: -5.2%

Since 12/31/09: 5.4%

click for full-size ugly graphology

Let’s look at 1 and 2 month returns just for fun, ok? First, returns for September 2011:

Next, returns for August and September 2011 combined:

Ouch Rick Ferri! I think it was this time last year when I went to the Bogleheads convention and Rick Ferri laughed at the idea of owning gold. Who’s laughing now, Ricki? Difference between bottom and top is almost 22%. That’s shocking.

And of course, full Year-To-Date returns for 2011 through September:

Wow, only two Lazy Portfolios are positive this year. Guess who???

It is striking that the PRPFX mutual fund is off so significantly from the pure Harry Browne ETF version. It is probably due to the fact that PRPFX holds some silver, which got killed, and foreign currencies, which were down against the dollar. 

Harry Browne, thank you.

One thing that is particularly striking is that PRPFX took a much sharper dip so far in September than the pure Harry Browne 4xETF portfolios.  I suspect this is partly due to the fact that PRPFX owns some silver (down very sharply) and also some foreign currencies (down due to rising dollar).

Me still likey the Permanent Portfolio, even though what was once up about 12% for 2011 is now up (only) 6.5%.

Biggest Losers on the chart (caution, not rebalanced) were Dilbert (-1.9%) and Vanguard Windsor (-1.5%), and MMM Do It Yourself Funds (-0.7%). Glad I got out of that idea.

I was feeling a little left out earlier this year… on my portfolio returns that is. But now I am feeling pretty good. Not that feelings should have anything to do with it! Table as of 10 August 2011.

The individual components of the Permanent Portfolios are as follows:

VTI +2.0% – Total Stock Market

TLT -3.1% – Long Term Bonds

IAU -6.4% – Gold

SHY  +0.1% – T-bills

—-

VBR +0.6% – Small Cap Value

VWO -3.4% – Emerging Markets

And for reference, here the components of all of the Lazy Portfolios we track here.

I forgot that his comparison page only goes back to 1985 and that I was the one who modified the page to go back to 1972. Guess I’ve got some work to do.

Have fun.

The fund expense ratios (according to morningstar.com except GTU* ) are as follows:

GLD: 0.40%

IAU: 0.25%

GTU: 0.38%*

SGOL: 0.39%

DGL: .75%

UBG: 0.30%

Cumulative Monthly Performance of Select Lazy Portfolios for 2010 (Click for big view. Data from Yahoo! Finance adjusted quotes from 12/31/09 through 12/31/10 except IFA from IFA.com and after max 0.9% advisor fee.)

The IFA 100 portfolio consists of 100% stocks and is designed to be IFA’s riskiest portfolio while the PRPFX is roughly 25% stocks and is designed to be lowest risk for return. Pretty interesting that they are the two highest returning portfolios for 2010. And they reached their peaks taking wildly different paths. The IFA 100 was erratic while the PRPFX was smooth and steady. The HBPP and PBPP were even steadier but with slightly lower returns than PRPFX.

In a fairer comparison of IFA portfolios to permanent portfolios, the IFA 50 had a 13.0% gain. The long term risk of IFA 50 is closer than IFA 100 to that of HBPP.

One of the surprises of 2010 was the relatively poor performance of the Larry Swedroe Minimum Fat Tails portfolio. Its long term risk-adjusted results for the last 30 years were quite good when compared to the HBPP. But not so in 2010. Digging into it shows that 70% of the portfolio is in TIPS or short term Treasuries. They were up 6.1% and 2.3%, respectively. The other 30% of the portfolio is 15% small cap value and 15% emerging market. They helped to bring the whole portfolio up to a 8% return for the year. I have often heard people say that investing in TIPS is protection against inflation. I think I’d rather have gold (up 29.3%) serving as intended in its inflation-protection role.

The purist Harry Browne Permanent Portfolio (ETF version) which invests one quarter in each stocks, bonds, cash, and gold had these respective gains: VTI 17.4%, TLT 9.0%, SHY 2.3%, and GLD 29.3% for a total return of 14.5%.

My variation of Harry Browne’s portfolio was up 15.8% because of a slightly riskier stock position. Instead of putting a quarter in VTI (up 17.4%), I place an eighth in small cap value (VBR up 25.1%) and an eighth in emerging markets (VWO up 19.5%) for a combined stocks gain of 22.3%.

And in a final note, I am finally fully invested in my own portfolio, with some minor variations due to legacy investments (like that amazing SCCO). So with my large cash holding through most of the year, my portfolio gained 11.3% in 2010. Considering that I am counting on an average 6% gain, I dun purty good.

Good luck in 2011. See you right here again in 365 days.

[Returns computed using Yahoo! Finance adjusted historical quotes from 12/31/09 through 12/31/10 except IFA from IFA.com and after 0.9% max advisor fee.]

Click for larger graphic.

Data calculated using Yahoo! Finance historical adjusted quotes, except for IFA from IFA.com and using 11/29/10 data. There may be errors in the calculations, invest at your own risk.

Use this link to subscribe in iTunes (copy and past it into iTunes using the Advanced -> Subscribe to Podcast… menu:

http://www.crawlingroad.com/podcasts/podcasts.xml

Recently, I have been computing the Max Drawdown of the many Lazy Portfolios. I modified Simba’s spreadsheet to include monthly returns data instead of just yearly data because a portfolio could suffer drawdown within the year and recover before the end of the year, thus masking the fact that a larger drawdown occurred.

The following chart shows the Annualized Returns vs. Monthly Max Drawdown for several Lazy Portfolios from the beginning of 2001 through the end of 2009. (I am in the process of renumbering the Lazy Portfolios, so this post does not correlate with previous posts. See the Appendix for portfolio names.)

Figure 1: Annualized Return vs. Monthly Max Drawdown 2001 – 2009. Click it for a larger chart. See the full legend below.

This next figure is the more traditional chart showing Annualized Returns vs Annualized Standard Deviation in percent.

Figure 2: Annualized Return vs Annualized Standard Deviation 2001 – 2009. Click it for a larger chart. See the full legend below.

The ideal location of a portfolio’s plot point would be at the top left of either chart.

I was really surprised that these two charts looked so similar. Most of the Lazy Portfolios are in the same relative location on both charts. There are some small variations for select plots, but overall the chart looks the same. The biggest part of my surprise is that the Max Drawdown chart used monthly data and the Standard Deviation chart used only end of year data. Specifically, the Max Drawdown chart used 83 sample points while the Standard Deviation chart used only 9. The similarity of the charts gives me confidence that using Standard Deviation as a measure of risk is appropriate for evaluating the relative performance vs. risk of the Lazy Portfolios.

However, in terms of human understandability, I like Max Drawdown better because one can immediately apply the number to their own situation. It is simply a matter of multiplying one’s portfolio value by the Max Drawdown percentage. For example, for a peak portfolio value of $100,000 invested in the PBPP, the Max Drawdown during the period was about $15,000. That number is understandable. It also is easy to compare the Max Drawdown of PBPP to the Max Drawdown of the Rick Ferri Core Four portfolio, for example, which dropped about $45,000.

The problem with Max Drawdown is that computing it requires many more sample points to get the actual value. I had previously computed Max Drawdown using only year-end values. When I did that, the Max Drawdown of the PBPP was only 0.5% compared to about 15% for using month-end values. It turns out that the PBPP dropped about 15% in 2008 but recovered most of it before the end of the year. Even so,  Obviously we would need daily values to get the true maximum number.  Even so, a chart of Max Drawdown using only year-end values showed the same relationship between the Lazy Portfolio plot points.

Max Drawdown is an easier risk number to comprehend than standard deviation. But it is more difficult to compute. And the relationship between the portfolios’ risk remains largely the same.

Appendix

The following table lists the legend key for each plotted Lazy Portfolio along with its full name.

Here is the spreadsheet of each portfolio’s holdings. Click to make it readable. Someday I will update this web site to show the contents of each of these Lazy Portfolios in HTML format.

Data is from Yahoo! Finance historical adjusted returns. Actual data used where possible. Data prior to inception for VBR used VISVX, VWO used VEIEX, TLT used VUSTX, GLD used gold, SHY used VFISX. The data and the resulting analysis may contain errors. Invest at your own risk.

And here is the video:

Today (Thursday, 14 October) was basically Jack Bogle Day. Sure, we heard some about how the Bogleheads got started and we even took the time to go around the meeting room and have every person in attendance tell something about themselves. In addition to Jack Bogle, also in attendance are some authors of investing books you may know: Bill Bernstein, Bill Schultheis, Rick Ferri, and the authors of the various Bogleheads books.

But immediately after the introductions, Jack showed up a little early. Don’t think me presumptuous for using his nickname, that is what he prefers. He spoke with some prepared remarks for about an hour or so and then took questions for another hour or so. We had lunch, then he and Bill Bernstein answered some more questions. He then gave each of us a copy of his new book “Don’t Count On It!” Subtitled Reflections on Investment Illusions, Capitalism, “Mutual” Funds, indexing, Entrepreneurship, idealism, and Heroes. Then we stood in line to have Jack sign his name and we spoke with all of the other authors present.

Here are some representative notes and quotes I took from Jack’s talk.

“Mutual fund companies are run for the benefit of the managers and not the benefit of investors.” Except, of course, one mutual fund company…

“Last year Fidelity managers made $2.6B and Vanguard managers made $0.” [Correction: he said Fidelity's earnings were $2.6B]

He showed a chart of how Vanguard’s average expense ratio keeps dropping. But noted that now with the size of assets under management, one basis point equals $140M. So it would be easy to say, “Let’s spend $140M on something, they’ll never know.” So Jack recommends they think in terms of dollars and not in terms of basis points.

He said, “Keeping expenses low is a simple, moronically simple, yet it is an idea that nobody thought of.”

He said that in 2010,  ETF’s share of the index market matches the index fund share. ETF share of index assets is 51.9%

On the topic of holding assets for the long term, he said, “One firm holds its assets for an average of 11 seconds. I don’t know how you feel about that, but that’s not long term investing.”

“There is no place to hide these days. Never seen anything like it. Assuming we don’t have a big disaster, which is a big assumption to me, we will see 2.5% real returns on equities in future (after inflation and expenses).”

“Gold was a terrible investment over 100 years. Rank speculations. I am almost tempted to buy gold but I won’t. 1 or 2 or even 5% to play with is OK.”

“I am a little worried about the risks that are still out there. US Financials is a mess. Pensions are bankrupt. Don’t see how they will get 8%. Wall St. Values are in tatters. America has lost ability to govern itself. I find a lot of resonance when I speak about values. I find young people are seeking something nobler. I am hoping to make a tiny difference in values. To get a financial system that works for all of you and not Wall St.”

“Rebalance? Data says don’t bother. Maybe if you need a 50/50 portfolio and it gets to 60/30 then rebalance if you need to.”

“The power of money in Washington is disgusting.”

“I think about what is going on with Emerging Market funds. They are among the largest ETFs. The Data said 33% of all EM holdings were in ETFs. Makes me worried because ETF owners are traders. Suppose something happens to Brazil and traders decide to get out. Could be a big… Still, in the long run that should not matter. If EM is held up by Mutual fund demand, when they go it could cause trouble. Vanguard should be careful when getting into these funds.”

Finally, Bill Schultheis, the author of The Coffeehouse Investor, stood up and asked a question of Jack and Bill Bernstein. It was about the disaster of 401K plans for the average citizen. How they don’t understand how to invest their own money. And would Jack and Bill recommend a more managed approach. Bill answered first and said, “The less autonomity the better. Don’t let people run their own funds. I want a big maternalistic approach.” Jack basically agreed and listed a few points about 401(k) plans: “1. You’re going to borrow money from it 2. You will take it out. 3 you don’t have to contribute to it 4. The investor has no guidance . With the average 401k being $54,000, have a great retirement.” Jack prefers the idea of a privatized personal retirement plan like former President George W. Bush initially suggested.

I asked Jack about his thoughts on the future of the US Dollar and the Federal debt and how that would affect the investor. Would we see hyperinflation? He answered that currency speculation is not something to get into. That we would want the dollar to fall relative to China. That China owns a large amount of our bonds and they may fall in value if interest rates rise. He repeated that he should probably buy some gold for insurance (against the US Dollar) but that he is just “too busy” to do it.

It has been great being here at the Bogleheads 9 reunion. Everyone is nice to talk with and with such a small gathering, we have lots of time to talk to everyone.

It looks like Harry Browne was really onto something with his recommendation of owning 25% in stocks.

(click for larger graphic)

If you cannot read this, it says that the permanent portfolios are up about 20% since January 2008 and just about everything else is still negative.

And here is the table of returns through September 2010:

Data on IFA portfolios is courtesy of ifa.com. All other portfolio returns are calculated using Yahoo! Finance historical returns and may not include dividends paid in the most recent month.

Watch “Proper Benchmarking and Alpha” for a lesson on measuring risk against a complete set of important factors. These videos are based upon IFA’s Quote of the Week Issue #82.

Part 1:

Part 2:

Most all of the other portfolios are stock-centric and while they may own some bonds, they are usually a mixed bond portfolio instead of purely long-term (20- to 30-year) US Treasuries. None of the other own gold.

Here are the individual component YTD results of the Paul Boyer Permanent Portfolio:

• Small Cap (VBR): -0.7%
• Emerging Market (VWO): -0.5%
• 20+ Treasury Bonds (TLT): 23.6%
• Gold (GLD): 13.8%
• Cash (SHY): 2.3%

It is amazing to note that Cash in the form of short term treasuries (SHY) outperformed all but 7 of the 25 lazy portfolios! And who would have thought that long term bonds would be up 23.6% after only 8 months? Not me. And that is why one invests in a Permanent Portfolio: No one can predict the future. So invest in all four economic possibilities: prosperity, inflation, deflation, and recession.

Have you shifted into a Permanent Portfolio yet?

Here are the returns of the individual components of the lazy portfolios:

*Note that these results use Yahoo! Finance adjusted historical returns with the exception of IFA portfolios results from IFA.com that include IFA’s fee.

Permanent Portfolio performance during the very volatile month of May

This May was the worst May since 1940.  The Dow and VTI (total stock market) both had losses of -7.9%.  Volatility has returned to the market!  When the market is volatile, the wisdom of investing in the Permanent Portfolio becomes apparent.  The Harry Browne Permanent Portfolio always has the same four assets: total stock market (VTI), gold (GLD), long term Treasury bonds (TLT) and short term Treasury bonds (SHY).  These assets are rebalanced each year.

Let’s see how the Permanent Portfolios performed on a weekly basis for the very volatile month of May.

Date                Stocks            Gold           Long Bonds     Short Bonds      PermPort
—               VTI               GLD                 TLT                  SHY

May   3 –   7          -7.0%               2.5%              4.1%                  0.3%                     0.0%
May 10 – 14           3.0%               1.8%             -0.7%                  0.1%                     1.0%
May 17 – 21          -4.5%              -4.3%              3.7%                 0.1%                    -1.2%
May 24 – 28           0.7%               3.2%             -2.0%                  0.0%                     0.5%

Total for May       -7.9%               3.1%              5.1%                  0.5%                     0.2%

2010 to May          -0.1%             10.8%              8.9%                  1.4%                     5.5%

The week-by-week returns show that the Permanent Portfolio is much less volatile than the VTI.  The volatility is amazingly low because the VTI and TLT (and GLD) move in opposite directions — they are negatively correlated.  The first week of May provides a good example of the negative correlation of the assets:  the VTI was down -7.0% while GLD was up 2.5%, TLT was up 4.1% and SHY was up 0.3%.  This resulted in a 0.0% change for the Permanent Portfolio.  The returns for each of the other three weeks further demonstrate the negative correlations of the assets.

The final returns for the month of May show that if you had been invested in the Permanent Portfolio you would have been ahead by 0.2% instead of being behind by -7.9% for a VTI investment.  A Permanent Portfolio investor would not think that this May was the worst May since 1940.

The last line in the table shows the year-to-date returns for each of the assets.  The advantage of the Permanent Portfolios over the VTI (total stock market) is obvious.

The main problem with the Permanent Portfolio is that it is just too boring for most investors!

Below is a Return vs. Risk Chart for these portfolios from 1985 through 2009 (Note: this chart does not include returns through the end of May 2010). The ideal portfolio would be high return at low risk and thus appear at the top left of the chart. [Chart data is computed using Simba's spreadsheet from the Bogleheads.org forum with the exception of IFA portfolios from ifa.com.]

See how there is almost an invisible boundary line from lower left to upper right? That is the “Efficient Frontier” and shows that returns are correlated with risk over the long term. It is nearly impossible to construct a portfolio that will be above that efficient frontier. So the only question you need to answer is, how much risk are you willing to accept. That is, can you tolerate the downturns in the market in the short term?

Looking at a shorter term, here is a chart showing just the previous ten years from 2000 through 2009.

I like the boost to returns the Paul Boyer Permanent Portfolio got during prosperity and it didn’t hurt too much during recession either.

And to see if you can indeed stomach a bad short term, here is a chart with just the previous three years:

How about a chart of just the recent heyday of stocks from 2003 thru 2006:

Looking at past charts is fun, but should not be the only data you use to make investment decisions. I like the Permanent Portfolio concept because it is so simple, has low fees, and covers the four economic cycles of prosperity, inflation, deflation, and recession. It has been shown to be the lowest in risk among the lazy portfolios while not sacrificing returns. They are the only portfolios to include gold.

Here are the components of each of the portfolios*:

*Note that these results use Yahoo! Finance adjusted historical returns with the exception of IFA portfolios results from IFA.com that include IFA’s fee.

Would you be interested in an all-weather portfolio that, despite hardly ever changing its composition, performs creditably in almost all market environments?

Hulbert characterizes the Permanent Portfolio this way:

Browne’s idea was to invest in a basket of asset classes, each one of which has a low correlation with the others. As a result, when any one of the asset classes is performing poorly, there is a good chance that the others will at least be holding their own — if not actually appreciating in value.

He describes Harry Browne’s Permanent Portfolio as an antidote to volatility. He then gives some past performance of the PRPFX fund which somewhat implements Harry Browne’s concept:

This fund over the last 15 years (through Apr. 30) has produced an 8.2% annualized return, which is remarkable given that stocks, gold and bonds did not, individually, do as well: The Wilshire 5000 index gained 7.9% over the same period, the Shearson Lehman Treasury Index produced a 6.3% annualized return, and gold bullion rose at a 7.7% annualized pace.

I might suggest that while the result of the four asset classes is low correlation, that is not the way Harry Browne explained the reasoning. Instead, the portfolio is designed to have one component that does well in each of four different economic circumstances: prosperity (stocks), inflation (gold), deflation (LT Bonds), and recession (cash). Harry said that while you can expect one of the assets to go down, the one that goes up more than makes up for the loser. For example, while one asset may go down 30% or 40%, the winning asset can go up 200% or 300%, more than making up for the loss.

I think the best thing about the portfolio is this: No one can predict the future so we might as well invest in all possibilities.

Thru yesterday’s market turmoil, the components have done the following:

VTI +2.8% (Stocks)

TLT +9.2% (Bonds)

SHY +1.3% (Cash)

GLD +10.4% (Gold)

And the total portfolio, assuming 25% in each at the start of 2010 is…

+5.9%

How’s that compare with YOUR portfolio?

And here’s the book you need to read:

First, the original portfolio:

Stocks: VTSMX (Total US Stock Market)
Bonds: VUSTX (Long-term Bond)
Cash: VMPXX (Money Market)
Gold (Kitco 1972-2004, GLD 2004-2009)

yielded the following return vs. risk:

P1 (HBPP):

Compound Annual Growth Rate (CAGR): 9.1%
Standard Deviation (Risk): 8.02%
Sharpe Ratio: 0.46

Next, substitute 2-Year Short Term Treasuries (VFISX) instead of Money Market:

P2 (P1 with 2-yr T-Bills):

CAGR: 9.5%
Standard Deviation (Risk): 8.17%
Sharpe Ratio: 0.50

Alternatively, how about for the “Prosperity” component, i.e., Stocks, we substitute  half US Small-Cap Value and half Emerging Markets for the US Total Stock Market:

P3 (P1 with 12.5% VISVX and 12.5% VEIEX):

CAGR: 10.8%
Standard Deviation (Risk): 8.57%
Sharpe Ratio: 0.64

And finally, combine P2 and P3 to have 2-yr T-Bills, US Small Cap Value, and Emerging Market:

P4 (P2 with 12.5% VISVX and 12.5% VEIEX):

CAGR: 11.3%
Standard Deviation (Risk): 8.65%
Sharpe Ratio: 0.68

And just for comparison I ran “Solver” on Simba’s spreadsheet to find the least risky portfolio that yielded 11.3% of that time span. It came up with the following mix:

VISVX (US Small Cap Value): 13.43%
VEIEX (Emerging Market): 14.30%
PCRIX (Commodities): 5.19%
VFITX (5-Yr T-Bills): 49.31%
VFISX (2-Yr T-Bills): 7.88%
Gold: 9.88%

Which resulted in:

P5 (Solver optimized portfolio):

CAGR: 11.3%
Standard Deviation (Risk): 7.25%
Sharpe Ratio: 0.80

And here is a chart with them all plotted, CAGR vs. Standard Deviaion (Risk):

I’ve played with lots of combinations of back-tested portfolios through many different time periods and one thing is common: substituting VISVX and VEIEX for VTSMX resulted in higher returns and a higher Sharpe Ratio. And short term T-Bills for cash also added nicely.

Note that I only show the Solver optimized portfolio (P5) for reference. I believe it strays too far from the Permanent Portfolio strategy to be safe going forward.

I talked about P4 on MMM-175: The Perfect Portfolio. While I am not yet invested in it, it is the one I am targeting. I do not expect a CAGR of 11.3% for the next 37 years, but if I can get 6% I will be very happy.

Oh, and don’t miss THE END-ing!

• Name: iPad (Ding!)
• Size: 9.7″ (Ding! I said 10″)
• Form Factor: Basically a large iPod Touch (Ding!)
• Home Button? (Ding!)
• Aluminum back? (Ding!)
• Buttons and holes: headphone (Ding), microphone (Ding), volume (Ding), mute (Ding), sleep (Ding)
• USB port? (Bzzzt!) Only has Apple dock. But that serves to connect to your computer. And it does have adapters for cameras.
• Orientation: (Ding! Both portrait and landscape)
• WiFi (Ding)
• Internet connectivity: (Ding? 3G is optional. Nice surprise that it is easy to get 250MB/mo for $14.95)
• Won’t have a phone (Ding!)
• Software: (“It will be like an iPhone with some iWork apps available for download” DING! DING!) It actually runs iPhone apps like I expected.
• Books: (“They will probably start selling books through iTunes.” DING! DING!)
• GPS and big maps (DING!)
• Cameras: (BZZZZZT!) Not three, not two, not even one camera. Maybe version 2?
• Cost? I said $899 dropping to $699. I assumed it would have a 3G card installed. Their price for 3G? $629 to $829. Plus you want to buy the keyboard, case, and adapters. So I give myself a DING! for the price as well.

So I think I got most everything right. Big misses on cameras and USB port. Bottom line is that the iPad is pretty much exactly what I pictured it to be in my mind. I will own one (or more).

I have a small window of time before the official announcement is made before which I can make my own predictions, wish lists, and observations about the new miracle device. Apple is expected to announce it on January 27th at a media event. I guess there is not enough time for them to get all my wish list items incorporated into the thing, but at least they will have my wish list for their 2nd generation of it by 2011.

First, my preferred name for the thing is the Apple iPad. I like the way it rhymes with iPod and it is alliterative with iPhone as well. iSlate is my 2nd choice just because it sounds cool. iBook would be my 3rd choice as it would fit into the MacBook line nicely, but iBook places too much emphasis on this thing being just an eReader and not enough on the other things I want it to do. Read on. iTablet? Sounds like something Dell would call it.

Form factor. The iPad will have the 10” screen everyone is expecting and will basically be a “Honey I Blew Up the iPhone” looking thing. A home button at the bottom and that’s all you see physically. Aluminum back, buttons and holes along the edges. Nice places to put your fingers as you hold it in portrait or landscape orientation.

Buttons and holes will include those found on the iPhone: Headphone/microphone jack, volume buttons, mute switch, sleep button. But it will also include USB. The BIG question is will it include a power hole or a iPod dock hole? You see, it makes a difference in deciding if the iPad will SYNC with a computer or will BE a computer. Will your iTunes library still be on your MacBook and you have to sync it with the iPad, or will the iPad have enough storage to hold all your music by itself? My guess: it will BE a computer and can run iTunes on its own. It could still share music with your MacBook with that family sharing  route and it could share photos and files and so forth. So my money is on it having a nice magnetic power adapter with all kinds of neat accessories we can buy like a car charger and external battery. PLEASE let me use the same magnetic adapter as my MacBook. My guess: they won’t! (They make TONS of money on those things!) And make some kind of adapter that lets me plug it into all my various iPod connectors in the car and external speakers.

The USB adapter will allow commonly needed connections like cameras, flips, and, wait for it… iPhones! And yes, i want to be able to charge my iPhone from the battery of my iPad. You won’t need USB for the external keyboard and mouse because those will connect via BlueTooth. And while you are typing and mousing on your iPad, you will need it to somehow stand up, won’t you? So I’m wondering if this thing will have some sort of picture-frame-like stand on its back that lets you sit it on a desk or table either in portrait or landscape orientation.

I keep harping on orientation. For me this is key to the iPad: being able to read books and long pdfs on it in portrait mode. Already it is more useful than a MacBook for that reason alone. I find reading books in landscape to be too small a window into the text. I don’t know how many others are like me, but the first thing I do on a new computer is move all of those dock or taskbar things from the bottom of the screen over to the left side. That gives me a little more reading room on my MacBook. And I try to trim menu bars and status bars away as well. With the iPad in portrait mode I will be in reading heaven even on a smaller 10” screen.

How will this thing get on the Internet is a key question. Of course it will have Wi-Fi. But will it be on the 3G and EDGE networks as well? Will I have to buy more service from ATT Wireless? Will it tether through my iPhone? Will the iPad BE a phone? My hopes are that it will BE a phone that uses the same phone number as my iPhone, that I can talk on either one, that I can switch between one and the other during a call, that I can surf the net on the iPad while talking on the iPhone, that it can let me make and receive calls with my BlueTooth headset, and that it can act perfectly well as a desktop speakerphone. Not too much to ask, right? If iPhone was the “Jesus Phone” then what would this iPad be, the “GOD” phone?

But my guess of what will actually happen is more limited. I think for this first release it will have Wi-Fi and 3G and EDGE DATA networking only. You will have to add some sort of appendage to your ATT Wireless iPhone plan to get remote internet on the thing. No calls, talking is for iPhones and that is the way we say it will be, says Apple. Maybe in a later release they can figure out if it makes sense to add a phone or not. Perhaps too many people will end up using the data plan to make Skype calls and they will come around.

What about software? Is the iPad a small MacBook or a big iPhone? Wow, this is a tougher one to call. I can make a good case for both. You want to be able to run iWork on the thing, right? But yet Apple wants you to buy 10 billion apps for the thing too. So like a flash it hits me: it runs MacOS but with an iPhone mode so you can do BOTH. But the iPhone OS is all about limiting what you can do. Will Apple want to limit what you can do in the iPad? If so, it will be more like an iPhone with some iWork apps available for download. Actually in that case they will probably throw in some iWork apps for free but you gotta buy all the other cool stuff.

How will you use this thing if you already have a MacBook and an iPhone like I do? You will have your iPhone in your pocket, your MacBook on your desk, and your iPad in your hands. On the couch, in a seat, or in bed. This is the “media comes to me” device. Read a book? Sure, the iPhone already has the Kindle app from Amazon so you can buy thousands of books for $9.99 and start reading. Knowing Apple, they will probably start selling books through the iTunes store. Don’t wanna miss a market, right? But I better be able to get pdfs onto this thing easily and freely or it goes in the trash.

You will also of course watch movies, listen to music, surf the net, and make blog postings. Standard fare. It is the book reading thing that makes the iPad so special. And of course it will be the first successful touch screen computer from Apple. The iPhone set the stage, but now we will have pinch and zoom super-sized. We’ll be using our arms more to see those details from the satellite view. Ah yes, GPS. Big maps finally. Would this thing be appropriate on the dashboard? Not unless it has a camera that can show what is in FRONT of the car! And speaking of cameras, it needs at least two: One on back like normal on the iPhone for taking vids of others and one on front for taking vid of you. Maybe one on the side just to be sly. And I’d really love it if the one on the front is actually UNDER the center of the screen, invisible to us but fully able to see us nonetheless. That way on video calls people will be looking AT YOU instead of somewhere off into space.

Finally, the dreaded question: How much will they want for this thing? Remember when the Jesus Phone first came out how much they charged? Same deal here, waayy more than what we want to pay. They will really put it to those early-adopter guys, hahaha! I expect that early price to be $899. Gasp! With netbooks retailing for $399! Yep, but it will drop after a few months to $699 and everybody will be like, “Whew, now I can afford one at last.”

So prepare for the iPad invasion. Prepare for the weeping, shaking bodies to behold not the iTablet being brought down from the mountain but the iPad being unveiled on Steve’s stage. I can’t wait.

To start, I selected a widely-followed portfolio of stocks and bonds. The Fund Advice Vanguard Moderate portfolio has the following composition:

(Fund Advice recently split their recommended 12% of VDMIX into 6% VDMIX and 6% VFSVX, the All-World ex-US Small Cap index.)

The Fund Advice portfolio placed 32% in fixed-income and 68% in equities. For the period 1972 through 2009, the portfolio achieved a compound annual growth rate (CAGR) of 10.95% with a standard deviation (risk) of 11.6%. This works out to a Sharpe ratio of 0.51.

Let’s now see what would have happened if instead of 100%, we placed 75% of our investment in the Fund Advice portfolio and the remaining 25% in gold. We would have achieved a CAGR of 11.09%, a risk of 10.08%, and a Sharpe ratio of 0.58. So gold did add to the returns for the period while reducing the risk. How could that be since gold itself was very risky over the period? Gold by itself returned only 8.62% while being a whopping 26.88% risky.

How about instead of investing the 25% in risky gold, we had placed the 25% in safe but similarly rewarding Treasury Money Market fund? The Vanguard VMPXX by itself for 1972 through 2009 had a CAGR of 5.66% with a risk of only 3.03%. The resulting combination with the Fund Advice portfolio shows a CAGR of 9.75%, a risk of 8.77%, and a Sharpe ratio of 0.5.

The return vs. risk of the three portfolio mixes and the individual components gold and money market (MM) are shown in the following graph.

So against our intuition, investing in risky gold actually reduced risk in the overall portfolio while adding to the returns. It even beat a comparable portfolio that invested in money markets. This is the power of Modern Portfolio Theory in action showing that while some assets zig, others zag to combine in wonderful ways.

Sources: Vanguard.com, Simba’s spreadsheet (with 2009 data added), Bogelheads.org, FundAdvice.com.

Here is the model portfolio composition which is based on the IFA Index Portfolio 25 (source). We will call this the Vanguard 25 portfolio:

I am going to use the time period from 1999 through 2009 for the analysis. Crunching the numbers in Simba’s spreadsheet (Revised with 2009 data added. More info about the spreadsheet at the Bogleheads forum.) I come up with a compound annual growth rate (CAGR) of 5.6% with a average annualized standard deviation (risk) of 7.1%. This works out to a Sharpe ratio of 0.41 for the time span.

So, what if instead of having 100% of our total investment in the Vanguard 25 portfolio we placed just 75% of our investment in it and placed the remaining 25% in gold? Running the numbers in Simba’s spreadsheet (Simba uses this source for gold’s annual return.)  I come up with a CAGR of 7.5% with a risk of 6.9% resulting in a Sharpe ratio of 0.70. Call this one Vanguard 25 w/ Gold. The following chart plots these two results. As a reference I also show on the following charts the Harry Browne Permanent Portfolio which is comprised of 25% each of Total Stock Market (VTSMX), Long Term Gov’t Bond (VUSTX), Money Market (VMPXX), and Gold.

Also shown in the chart is the same exercise but instead of placing 25% in gold we substitute a Treasury bill money market fund (VMPXX) for the 25%. The portfolio with money market fund added resulted in a CAGR of 5.0%, risk of 5.3%, and a Sharpe ratio of 0.41. Call it the Vanguard 25 w/ T-Bills. Note that the Sharpe ratio is the same as the original portfolio because in a Sharpe ratio calculation we subtract out the risk-free rate of return of money markets. So adding money markets to a portfolio does not change the ratio of return vs. risk.

The next chart adds the individual return vs. risk of gold and money market for the same time period showing the higher risk with accompanying higher return of gold for the period.

This next chart adds the individual return vs. risk of all of the other components of the Vanguard 25 portfolio for the same time period.

And for the fun of it, I computed the optimal portfolio for the time span based upon the highest Sharpe ratio and as computed by Excel Solver. This tool allows you to specify an attribute you wish to maximize while varying the percentage amounts of the various funds. In this case, we chose to maximize the Sharpe ratio and allow Excel Solver to pick which combination of which funds achieved it. The following table shows the result.

The OPTIMAL portfolio resulted in a CAGR of 5.8%, a risk of 2.6%, and the resulting Sharpe ratio of 1.12. Its addition to the first chart is shown below.

How about continuing to optimize with a high Sharpe ratio yet obtaining greater return? To do that I subtracted some short-term bonds and added some gold leaving the other two components the same. That is, gold at 35% and bonds at 57%. This resulted in a CAGR of 7.6%, risk of 7.7% and Sharpe ratio of 0.99 and can be seen in the following chart.

Therefore, to answer the original question, “Should a portfolio own gold?” it appears that for the period 1999 through 2009 the answer would have been a resounding “yes.” We find that adding gold to the portfolio resulted in higher returns with less risk.

I caution that this process is called data mining and should only serve as input into future portfolio analysis and not serve as the only decision regarding future investments. In subsequent analysis I will not limit the possibilities to just the Vanguard 25 fund set but will open it up to Vanguard funds available since 1972 and/or 1985.

Sources: Vanguard.com, Bogleheads.org, IFA.com, and http://www.finfacts.ie/Private/curency/goldmarketprice.htm

As you can see, the Harry Browne Permanent Portfolio still has the best “top-leftedness” of these select Lazy Portfolios. It had an annualized return of 8% with an annualized standard deviation of 8.8%. That results in a nicely high Sharpe ratio of 0.75, assuming a risk-free rate of return of 1.37% for all 5 years (not likely).

The HBPP’s out-performance is due to the stellar performance of gold through all of these years. I am still not convinced this is the one for all seasons. So I will be performing some analysis of this portfolio for the years that were most favorable to equities and not gold and see how the HBPP would have held up.

Remember that you’d want your portfolio to be at the top left of the chart because their you get the higher return with the lower risk.

So for the three year period from 2007 through 2009 the Harry Browne Permanent Portfolio showed the best return and the least risk of any of the featured lazy portfolios. More analysis to come…

Here are some takeaways from the table:

1. These portfolios have different objectives, different asset class mixtures, and different risk profiles. Simply comparing them on historic returns is not a way to pick one for an investment.
2. Therefore, a better way to view these would be to look at them on a return vs. risk graph where risk is defined as the standard deviation of the portfolio. Then we could see at a glance which portfolio has the more desired “top-leftedness” (meaning it had higher return for its level of risk).
3. Only two of the portfolios invested in gold, the two top performers. Future results may vary.
4. I believe most funds have no load.
5. I changed the Harry Browne Permanent Portfolio cash holding from VFISX to SHY which results in a slightly lower return (about 1% less). I would prefer to hold it in a money market fund, but Yahoo! Finance does not give me historical returns for them.
6. Remember, this table probably has errors!

Have a look at this table:

On day 1, XLF rose 10% so FAS rose 30%. Great, you’re in the money.

But on day 2, XLF dropped back down to its starting price of $10.00, a decline of 9.09%. The bad news is that FAS declined 3X this amount or -27.27%. This takes its share price down to $9.45 instead of the $10 that you might expect.

So whereas XLF is unchanged after 2 days, FAS is down 5.45% after those same two days.

Why? The power of daily compounding instead of cumulative compounding. The leveraged ETFs are structured in a way that they compound on daily percent changes, not cumulative price changes. The day 2 decline of FAS should only be 23.08% to take it back to its original $10.00 per share price. But because it is 3X of XLF’s daily change, instead it declines 27.27%.

Said another way, the leveraged ETFs operate on the daily percent change not on the price of the underlying index.

Definitely not a buy and hold type of ETF! Not even for one day. Traders: set tight stops!

I’ll discuss on show 150.