How safe is the stock market?

[DcifrThs]

ahnuld and evan,

can you guys makea thread a sticky if i respost the leveraged portfolio above?

i think it really is about as good as you can get as far as long term risk adjusted excess returns and is easy enough that anybody on this board can do it.

it beats the hell out of any other portfolio i've seen posted on this board and if you know anywhere from nothing to everything about investing it makes sense for you to have a large portion of your passive money allocated to it.

i will be using this allocation and will advise my friends and family accordingly. let me know if i can repost it as a separate post w/ a title like "Close to optimal passive portfolio"

thanks,
Barron

[DcifrThs]

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Barron, it's pretty easy to upload an excel spreadsheet into Google docs and then publish that, but I'm sure you knew that. Also, there is no easy way to show formulas that I'm aware of.

Quick question, what do you assume about margin rates here? I've never really considered going on margin (in spite of the strong theoretical case) and part of that is b/c margin rates can be kind of high. For example, looking at eTrade margin rates they start at 9.74% (<50k) and fall to 6.74% (>1m). As I'm not a millionaire, these margin rates don't look super enticing to me!

Any specific thoughts on leveraging here? I know margin accounts are not the only way to lever, and if your personal margin rate is 9.74% it almost certainly can't be the best way. [img]/images/graemlins/grin.gif[/img]

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no assumption on margin b/c no actual margin is used:

Dynamic S&P 500 fund

instead you pay minimal (relatively speaking) expense ratios.

also, i didn't know about the google docs, but can you see my formulas that way? if not then that isn't a huge deal b/c the important assumptions are the correlation/sharpe ratios etc.

i'll try to do that now (never used google docs)

Barron

EDIT:here is the link to my published spreadsheet. i still think it would be useful to see my pretty spreadsheet w/ the formulas so if somebody could tell me how to host it or whatever that'd be nice:

Portfolio Analysis Normal vs. Leveraged

further, this is UUUUUGGGGGLLLLLy relative to mine on my desktop. the places you should concentrate your energy are the "Risk", "Expected Sharpe Ratio" rows as well as the correlation cells. i took a most of the corerlations (that i manually keyed in) from historical analyses and from logical application of expected future correlations.

hope this helps.

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i was playing around with some mean/variance optimization w/ solver and came up with a few alternative allocations based on some scenarios.

one HUUUUGE problem with all these #s (and all portfolio #s in general not calculated w/ simulations) is that correlations and volatiltiies are unstable. rolling correlations move a TON as to rolling volatilities.

overall though these portfolios are very good and you can adjust them based on your needs/desires.

Scenario Tests: Dynamic S&P Dynamic OTC Ultra Intl Govt. L-Bond Adv CCF EMD Fund U.S. TIPs Fund Return Risk SR
Original Values 10.00% 7.00% 5.00% 8.00% 25.00% 20.00% 25.00% 4.33% 9.21% 0.47
Max return w/ SR >=.45 10.66% 8.90% 17.97% 0.00% 22.29% 16.75% 23.44% 5.04% 11.20% 0.45
Max SR unconditional return/risk 8.02% 0.00% 9.13% 15.13% 11.14% 17.88% 38.70% 3.81% 7.75% 0.49
Max Return SR>=.43 10.71% 12.77% 21.32% 0.00% 27.69% 14.31% 13.19% 5.45% 12.67% 0.43

sorry it looks a little ugly but you can go to the linked spreadsheet above on the bottom of the page for a clearer table.

best i can do is a 5.45% excess return with a 12.67% risk. this is assuming the lowest acceptable sharpe ratio is .43.

the lower the sharpe ratio requirement, the more the portfolio seems to allocate to the dynamic OTC fund and .43 gives a well balanced portfolio in risk space and a very nice excess return (i.e. in total return space this works out to be 8% or something like that with very minimal risk relatively speaking)

Barron

[pig4bill]

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The whole point of fixed income, since the return absolutely sucks, is return OF principal, not return ON principal.

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No, the main point of having bonds in your portfolio is the low or negative correlation w/ stocks (aka diversification).

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Are you serious? What the hell then, just buy a box full of baseball cards.

If I'm going to invest (which I don't) I want some return. I don't want to sink money in something just because it's "not stocks". Besides, there are over 7,000 different stock. Since I've been trading in the 70's I've never seen them all move together.

[DcifrThs]

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The whole point of fixed income, since the return absolutely sucks, is return OF principal, not return ON principal.

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No, the main point of having bonds in your portfolio is the low or negative correlation w/ stocks (aka diversification).

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Are you serious? What the hell then, just buy a box full of baseball cards.

If I'm going to invest (which I don't) I want some return. I don't want to sink money in something just because it's "not stocks". Besides, there are over 7,000 different stock. Since I've been trading in the 70's I've never seen them all move together.

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they may not all move together, but they have an extremely high correlation.

i've now posted the best portfolio i can construct and it can't hurt to go over it. it wouldn't be possible without bonds and commodities in addition to treasury inflation protected securities as well as emerging market debt funds.

just because you've never invested in bonds, doesn't mean nobody should. further, i bet your portfolio has had significantly larger historical volatility than what many investors would want. and i bet it swung viciously during various recessions/market turbulance/economic volatility.

Barron

[spider]

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Are you serious? What the hell then, just buy a box full of baseball cards.

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Yeah, I've been totally sincere/serious in this thread. I probably am not explaining things well, but I'm just espousing basic portfolio theory, sometimes loosely referred to as simple diversification. If I could explain it any better than I have, I would. But I probably can't so just read up on portfolio theory if you care. In particular, the stuff about covariance/correlation among the various assets in your portfolio.

With all due respect, a lot of folks think this is just "don't put all your eggs in one basket", and that is part of it, but there's also more to it than that.

[spider]

Hey Barron, thanks for posting this stuff, it is interesting and I wish I knew enough to give some good comments.

But one thing I would add is that I think you'll want to be very careful with assumptions about how this thing is levered. If the levering is done via the funds themselves (i.e. RYTTX) I think it makes it a little harder to understand how the portfolio generates its return. Anyway, just a comment, not a criticism.

[spider]

Another comment/questions about leverage: your spreadsheet assumption is that your leveraged (dynamic) S&P fund is identical to an ordinary S&P fund except both the risk and return are exactly doubled. But... there must be some cost for leverage, right?

[DcifrThs]

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Hey Barron, thanks for posting this stuff, it is interesting and I wish I knew enough to give some good comments.

But one thing I would add is that I think you'll want to be very careful with assumptions about how this thing is levered. If the levering is done via the funds themselves (i.e. RYTTX) I think it makes it a little harder to understand how the portfolio generates its return. Anyway, just a comment, not a criticism.

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the 2x target is obtained through futures, options, the physical security, and swaps.

i know it is dependable b/c of the list of massive purchasers of this fund. this is how the best get leverage (my old employer uses this i just found out so that makes me extremely confident in its validity).

i've never posted specific tickers before b/c i've never been confident in the makeup of them. now that i've done my due diligence i'm comfortable with the allocation and am happy with how it looks and tests.

Barron

[spider]

But what about the 4.75 front load & 1.68 expense ratio for RYTTX? Could that in part be representing the cost of leverage either directly or indirectly via higher transactions costs associated w/ options, swaps, etc? And for comparison, obv you can take some non-levered fund like SPY which has no load and a .08 expense ratio.

So nothing against RYTTX or anything, it just seems to me like there has to be some measurable cost for levering, right?

Maybe I am off base here and don't understand things, but could you or anyone else give me an example two simple investments which each cost the exact same amount, yet one will be an exact multiple of the other in terms of return?

[DcifrThs]

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But what about the 4.75 front load & 1.68 expense ratio for RYTTX? Could that in part be representing the cost of leverage either directly or indirectly via higher transactions costs associated w/ options, swaps, etc? And for comparison, obv you can take some non-levered fund like SPY which has no load and a .08 expense ratio.

So nothing against RYTTX or anything, it just seems to me like there has to be some measurable cost for levering, right?

Maybe I am off base here and don't understand things, but could you or anyone else give me an example two simple investments which each cost the exact same amount, yet one will be an exact multiple of the other in terms of return?

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you're askin good questions.

the front load is a time fee that you pay whereas the expense ratio is paid yearly.

many many funds chrage both of these. etfs get around the front load and tend to have lower expense ratios, but there are still fees associated with investing.

any mutual fund has at least an expense ratio and i'd venture to guess most have front load fees.

one thing i'm not sure of is if you pay the front load any time you put new money into the fund. it makes a difference but stillworth it since you are paying for a service that in no way shape or form can 99.999999999999999% fo the population do (especiallyw ith the leverage).

so you're pyaing for leverage (where you'd be paying ETF fees or mutual funds) in exchange for a ridiculouly large improvement in your sharpe ratio.

the real question would be "how much is that difference portfolio efficiency worth?" if it is more than the cost of the leverage to attain it, then clearly you should do it. in this case, the cost of leverage pales in comparison to the gains in portfolio efficiency.

i'm going to make a thread about this sometime this week and just go step by step through why the portfolio works and why there isn't a person who is passively invested in the markets to allocate at least some if not a substantial amount of their capital to it.

and those return #s look low, but they are excess return #s so don't include the 'risk free rate' that you get in addition to it (probably like 3% or so).

anyways, i hope this helps.

one think you can also do by the way, is to increase the equity allocation of this portfolio (OTC & dynamic S&P & int'l ultra) early on and sacrifice sharpe ratio for absolute returns since you have a long time to invest and gradually shift into this portfolio as you age by allocating more to TIPS and CCFs as you get closer to retirement.

Barron