In a previous posting , I calculated the 12 month rolling returns for all IFA portfolios.

That posting is in error (that I do not believe was my fault). I have corrected it. It turns out that Feb 1, 2008 thru Jan 31, 2009 was not the worst 12-month rolling period, but it did come close.

I’ll be watching to see what happens at the end of this month.

Here is the corrected chart.

[Update: Corrected the image. Note that the Bogle portfolio is corrected in the Google Spreadsheet - to some extent.]

I have copied Simba’s Backtest Portfolio spreadsheet from the Bogleheads forum into a Google Spreadsheet that you can use to back test a portfolio of Vanguard mutual funds and compare their performance from 1972 – 2008 to the IFA Index Portfolios. Combine the funds any way you like and compare them against IFA’s twenty portfolios. I included the "returns" for gold there for your convenience.

This graph from that spreadsheet shows the plots of a few others including the Coffeehouse portfolio, Harry Browne’s Permanent Portfolio, Scott Burns’ Four Square portfolio, and a couple of others along with IFA’s portfolios (they follow a nice line). Unfortunately, Google spreadsheets doesn’t do labeling very well on the data points. I would have liked each point to be colored and have a legend identifying those colors. Anyway, remember you want to be at a point at the top left on this graph. The line that is formed is called "The Efficient Frontier" beyond which it is difficult if not impossible to achieve. The strong correlation between returns and risk is evident.  However, it is easy to be bottom right!

If you want to play with the spreadsheet yourself, feel free to bring it up. You’ll need a Google account. Leave the years to be 1972 – 2008 in order for the comparisons to be valid. Here’s the link:

https://spreadsheets.google.com/ccc?key=pOjc3ot10vgs0eml-DJZKcw&newcopy

But wait, there’s more!

IFA is now allowing you to submit your past financial statements to them so that they can compare you’re portfolio’s performance against their index portfolios. Go their web site at ifa.com to learn more. Here are some comparisons they have already performed.

I just remembered a web site that was a Tool many many shows ago. This tool will help you benchmark your portfolio or to test out a new portfolio. It will allow you to compare it against another benchmark and it will calculate returns, standard deviations, and also Sharpe ratios.

The web site is http://www.icarra.com

Get over there and create an account and try it out. They have really made some nice improvements since I last used it.

At the end of October 2008 we experienced the worst 12-month rolling period for stocks in 50 years. Then at the end of November we outdid that.  Now at the end of January 2009 we have a new low for a 12-month rolling period in many indexes and portfolios. We came close to the worst rolling 12 months again, but did not pass it.

The following table is taken from ifa.com, combining the returns for 11 months from 1 Feb 08 through 31 Dec 08 and the 1 month return for Jan 09.

Here is the corrected table.

Previous table, wrong:

Source: http://www.ifa.com/portfolios/PortReturnCalc/index.aspx and http://www.ifa.com/portfolios/

I see that Andrew Horowitz over at the Disciplined Investor has taken a look at our Lazy Portfolio Smackdown and thinks that it is idiotic. He says, "How can anyone, even in the best of times, believe that simply throwing money into a few funds and forgetting about them is prudent?" Perhaps even more telling is his lead statement, "Lazy Portfolios has to be one of the most ridiculous investment strategies that has ever been invented."

So let me outline a few points that need to be understood in order to discuss this rationally.

The Lazy Portfolio Smackdown was set up to compare the return vs. risk characteristics within index investing. We did not compare index investing vs. other strategies. However, in 2006 we did run a comparison against a stock-picking strategy. We compared Jim Cramer’s buy buy buy stocks against two lazy portfolios, one with ETFs and one called the IFA Index Portfolio 100 . The lazy portfolios gained over 20% that year and the stock-picking portfolio was -0.2%. But that’s just me, not a scientific study. Let’s move on.

He asks, "what is the point of standard deviation in this table?" Yes, it is shown over one year here. The context is that we are comparing the volatility of an investment vs. the return it generates. After all, risk is the source of returns. Why use standard deviation? It helps us compares apples to apples. It is a good way to compare the performance of a 100% equity allocation against a 60/40 equity/bond allocation, for example. The 100% equity is expected to have a higher risk than the 60/40 split. But what if both portfolios had the same return? Obviously the 60/40 would have been a better choice. Said another way, there must be something wrong with the composition of the all equity portfolio.

But I do caution that looking at portfolios over just a one year period is not sufficient. We really need to look at much longer time frames to statistically capture the correlation of return to risk. But this is also the escape hatch of active managers. If they are lucky one year, they tout their "out performance" as proof they know something. Why do we never hear from the "under-performers?" Very few of active managers have long term records of performance. And of those that do, fewer still have outperformed the market. In fact, I don’t know of any who have. Remember Bill Miller of the Legg Mason Value Trust fund (LMVTX) who was the only manager to outperform the S&P 500 for 15 consecutive years? Have a look at a chart of LMVTX for 2008. His long-term returns are completely wiped out.

Let me answer another way. The standard deviation is used to calculate the Sharpe Ratio of the portfolio. The simplest definition of this ratio is that it measures "top-leftedness" of a portfolio when plotted on a chart of return vs. risk. As return goes higher on the y axis and risk gets larger going right on the x axis we want our portfolio to be top left as far as possible. High returns at low risk is the ideal.

Here is a return vs. risk chart of some of the Lazy portfolios in 2008:

Source: Foliodex.com (when it works) You can see a pretty tight correlation between risk and return.

Remember that risk also measures the potential losses in a portfolio as well as the potential gains. The higher the risk, the higher the potential magnitude of both losses and gains. Sure the Lazy Portfolios had large losses in 2008. But compared to what? Freddie Mac? GE? AIG? GOOG? Or how about these gems from one of Andrew’s posts at the beginning of 2008. He says, "It is a good time to look for deep value…" while cautioning not to chase yield.

I skipped some of the banks in his "screen" just to save time. What would these stock picks look like plotted on the chart above? Pretty much bottom right. Some would be completely off the chart both bottom and right.

But let’s say you were an absolute genius and picked the five best of these and invested your portfolio there. With 20% in each of LEG, PFE, EQR, PGN, WIN I calculate a 2008 return of -14.9% with a risk of 23%. Looking that up on the chart, it would indeed have been better than most. So, what are the chances you would have been a genius and picked the absolute five best? And when should you sell? You have to be right twice, remember? What if, instead, you picked a couple of the worst stocks?

I mentioned that risk is the source of returns above. But keep in mind that there are various types of risk: unsystematic and systematic are two. Systematic risk refers to the risks of the entire market as opposed to the unsystematic risks specific to one stock. Unsystematic risk is not rewarded. Investing in the stock of a single company adds only risk but not return. Better to invest in a market portfolio which minimizes the unsystematic risk of any one particular company. Take a look at this reward vs. risk chart over a period of 20 years. It compares a market-based approach vs. picking individual stocks. Remember that you want to be top-left. Sure, MSFT had higher returns, but would you have been able to put your entire net worth in that one stock and ride its volatility? Even the entire Dow Jones underperformed portfolios 50 thru 100.

What portfolio of stocks can you pick that go further top left than in that chart? And at what effort? If being lazy yields such great reward vs. risk characteristics, why waste time, energy, bid/ask spreads, commissions, tax consequences, and other expenses doing anything else?

Why would someone be so antagonistic towards lazy portfolios when it can be shown they have the best return to risk ratio over the long term? Let’s look at the economic incentives of holding different positions on investing. If someone wants to make money in the investing business, would they try to come up with a unique angle and give their clients the impression they know something that everyone else does not? Or would they follow a scientific approach that most everyone else already knows? Most try the former, thinking it appeals to clients who are seeking answers.

If one were to make commissions from trading stocks, would that person advocate trading or not trading? If one were to make a fee from assets under management, would that person ask you to invest with them or would they say you can do it yourself? Sure, some people don’t want to do it themselves. In that case they need an advisor that can assess their risk capacity and place their investments in a portfolio of index funds.

If one were to write a book on investing, would they try to come up with unique strategies to outperform the market or would they simply tell people to invest in the market? You know there have been studies of active managers showing that the odds of them beating the market over the long term are about 1 in 38, the same odds of picking one number on a roulette wheel? But of course your manager is the one that beats the market, right? Hey, maybe he actually did beat the market last year. Everyone floods into his fund or firm. Like Bill Miller’s or Bernie Madoff’s. It is what happens next that sickens.

When one takes a rational look at Lazy Portfolios, one can hardly call them "idiotic." Unless of course one is in the business of making money trading stocks on behalf of others.

I have updated the Lazy Portfolio Smackdown page to show the preliminary results for 2008. Note that after a few weeks the results will be updated once again after Yahoo! gets their dividend data included in the historical quotes for each fund. I do not think that the dividend data will alter the results though.

The game started one year ago. I asked people to create a buy and hold portfolio of index funds or ETFs that would exhibit the best return-to-risk ratio in 2008. This would be measured by “top-leftedness” on a plot of Return on the Y axis and Standard Deviation on the X axis. For positive returns, the Sharpe Ratio accomplishes this nicely. But when all returns are negative, the Sharpe Ratio gets screwy (a technical term) and I had to reset 0%  to be at -50% to make it work. Even when all returns are negative, we still want to be top left on the chart.

Winners were to be selected from each of three risk bands: 0% to 8%, 8% to 16%, and then 16%+. Funny how the game worked out. Last year was a RISKY year. Only one person had a portfolio with a Standard Deviation of less than 8%. Congratulations Cosmo, you had a STDEV of 3.5% and a return of 5.1% with your portfolio holding a single fund: the Vanguard Short-Term Bond Index (VBISX). You are the winner of Index Funds: The 12-Step Program for Active Investors by Mark Hebner. And if you actually had your net worth invested in that portfolio, you had a great 2008.

Next up, the medium risk band. As it turned out, nobody had a positive return here, as you can see in the following chart. Which one is top left? The one who lost the least amount is Ariel with a return of -12.6% and a STDEV of 8.2%. Ariel also put the entire net worth in one fund: Vanguard Wellesley Income Adm (VWIAX). Congratulations Ariel, you too are the winner of Index Funds: The 12-Step Program for Active Investors by Mark Hebner. 

Finally the guys who took great risk. This one is a littly silly because here you can gamble on something extremely risky and come out the winner if your number comes up. I should have limited it to something reasonable like 25% or something. Nonetheless, the winner is mudfud who invested in one fund: the China Bear 2X Fund (which was closed on November 14th by the way). Now who in their right mind would really put 100% of their portfolio in this fund? That wasn’t the idea behind this game. Still, if you could handle a risk of 56.1%!!!! OUCH!!! then you got a return of 42.4% for your gamble. Congratulations mudfud, you too are the winner of Index Funds: The 12-Step Program for Active Investors by Mark Hebner.

You can see all of the other entries at the Lazy Portfolio Smackdown page and you can see the portfolios of the so-called “Professionals” — those who make a living recommending portfolios to folks like us.

I’ll be talking more about the results on the Mad Money Machine podcast. Please load it into your iTunes or visit MadMoneyMachine.com to listen on your computer.

Take a deep breath.

Pull the covers up over your head.

Don’t look. 

Well… how about just a little peek?

After ten months of this relentless bear market nonsense, the leader of the professional lazy portfolios has a return of -10.3%. That’s the Harry Browne Permanant Portfolio which bests the rest by at least 10% so far this miserable year. The secret to its “success?” It’s 25% each in Total US Stock Market, 20-year bonds, treasuries, and gold.  The average of the 27 “professional” lazy portfolios is -28.5%.

Ah, but the leader of the individual entries? How about a positive 41.8%! Of course that’s our non-diversified, anti-china gambler mudfud with his china bear fund. The other winner is Mr. UltraShort himself, Tex Williams, with 80% of his portfolio in ultrashort ETF bets. Most everybody else is playing the game to go long the market for a long time, and is savagely to the down side where they are suppose to be. hahaha. The average of the individual entries is -28.0%

A reminder of what this game is all about for those of you who are new here. At the beginning of 2008, I asked people to design a portfolio of index funds or ETFs that will exhibit the highest Sharpe Ratio by the end of the year. (I didn’t put it in exactly those terms at the time, but now I realize that’s what I meant.) Winners in three risk bands (less than 8%, 8% to 16%, and 16% plus) get a free copy of Index Funds: The 12-Step Program for Active Investors by Mark Hebner. I’m hoping Foliodex.com will be working in early 2009 to help me compute the Sharpe Ratios. Otherwise, I have a handy spreadsheet ready.

I have updated the Lazy Portfolio Smackdown page for results through the end of April. Realize that not all dividends may be included yet. We’ll get things worked out at year end. Things have really changed since last month. Remember when mudfud ruled? Now guess where [he] ranks? Dead last. Also look at the professional lazy portfolios. Harry Browne was in the lead last month. Now old faithful Scott Burns Six Ways from Sunday is on top once again. Wow, what a portfolio.  I’ve added in my Mr. Sharpe portfolio. I designed this portfolio based upon the Sharpe Ratio of funds I included along with strong performance. I got the idea from the Six Ways from Sunday portfolio. Looks like a [non-diversified] winner.

I have updated the Lazy Portfolio Smackdown page to show the March results for both the game entries and the professional lazy portfolios. I’ve moved the composition breakouts for the Professional Lazy Portfolios and the Game Entries to two new pages to help make the results page more readable.

A reader at Diehards.org/forum asked me to add Harry Brown’s Permanent Portfolio to the professional entries. His portfolio is made up of 25% each of the Vanguard Total US Stock Market (VTI), iShares Lehman 20 yr Treasuries (TLT), Cash or short-term Treasuries (I used ticker symbol VFISX), and Gold (GLD). The portfolio is up 1.58% YTD.

You can see graphs of the all of the portfolio results for several different time periods by going to Foliodex.com. One group is for the Lazy Portfolio Smackdown Game Entries and another group holds the Professional Lazy Portfolios, although it is polluted with more portfolios than I am currently tracking.

Total return leaders YTD for the Professionals is Harry Browne (up 1.6%) and Scott Burns Five Fold (down 0.8%).

Total return leaders for the game entries are mudfud, with his 2X China Bear fund, up 25.5% and Tex Williams with his UltraShort funds up 14.6%.

Note that the leading YTD return portfolios are not the kind of buy-and-hold portfolios that are most frequently recommended by the sages at the Bogleheads Forum.

It seems to me that if someone is in the accumulation phase of their long term investing career that these times where stock prices are significantly off of their highs may make it more appealing to continue to add to their portfolios.

The Columbia Journalism Review has an article entitled Mad Money, Bad Blood in which they follow up on last summer’s story from Barron’s about Jim Cramer’s stock picking performance on Mad Money. The article focuses mainly on the disagreements between Barron’s and CNBC.

But the article’s author concludes that the Barron’s piece is sound. And I particularly agree with the author on this point, something that I have been saying also:

First, and foremost, CNBC is wrong to air a show that is centered on stock picking without tracking its own performance or even keeping a record, using whatever criteria it chooses, of the stocks it picks.

Either that or come out and say, "Do not trade on these recommendations."

Too bad the Barron’s article didn’t use the research we conducted here at the Mad Money Machine in both 2006 and 2007 that showed experimentally that following Jim Cramer’s stock picks lagged the markets.