It Works

This is the average return for the S&P 500 over the past 20 years and its SOR. It includes 5 down years including the dot com bust, the 2008 recession and 2018. I adjusted the returns by using the % risk of a less risky portfolio namely a 60/40 portfolio. A 60/40 portfolio would expect to be 59% as risky as a 100% S&P portfolio, so I adjusted the returns such that the 1998 28.58% return became an expected 17% in the 60/40 and then generated a SOR for the 20 years risk adjusted. I also took the tangent portfolio which is a 16/84 portfolio and risk adjusted that list of returns. I then generated what each portfolio would return if you started with 1M total and subtracted 4.5%/ yr in both the static 60/40 and low risk/high risk portfolios. This portfolio has a bad early SOR of 3 years in years 3,4,and 5, the dot com bust years. Over 20 years the 1M portfolio delivered 945K total return into my bank account.

I then generated 2 portfolios one with $135K (3 years WR) and generated returns for 20 years in a 16/84 portfolio (low risk). In down years I subtracted the 4.5% WR from the low risk account, and subtracted nothing from the high risk account. In up years I subtracted the 4.5% from the high risk account. The high risk 60/40 account started with 865,000 and the low risk 135,000 for the same 1M start. I extracted the same $945,000 from each account over 20 years. At the end starting with 1M the 60/40 account had generated a total 1,772,226. The dynamic low/high account generated 1,793,801 or an additional 21,500. The low risk account flamed out in 2008. It provided funding for the entire dot com bust plus some for the 2008 recession before all the money was exhausted. The improved rate of return is small but positive and it’s effectively free money generated by the improved non correlated diversity and the efficiency of the tangent portfolio. Note these low/high risk portfolios both reside on the efficient frontier. If you were to compare to a BH3 for example you would generate more free money in the low/high portfolio. It’s not harder than re-balancing a 60/40 to apply the trading rules. It does exactly the opposite of what the “bucket method” does to a portfolio. I might fool with this a little more to see how a higher risk portfolio say 80/20 or 90/10 performs against a low/high with a similar high risk portion.

4 Replies to “It Works”

  1. Fascinating stuff – the dual efficient frontier portfolios provide an impressive synergy. Been looking at my portfolio as a whole for so long using Personal Capital it’s hard to mentally segregate the high/low portfolio even though it shouldn’t be.

    Keep it coming,


    1. If I put out a book it will have far more to consider than this. My experience is FIRE literature is woefully lacking in terns of what needs to be considered in planning for retirement and how to effectively achieve those goals and in some cases the narrative is down right wrong.

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