How to BEAT The Market!!

I read a recent article on the PoF Facebook site about some stock picker who crushes it at least according to him. I beat the market by living on the “efficient frontier”. Here is an example:

This is 1M invested in a BH3 Vanguard fund portfolio with a WR of 4% over 30 years and normal SORR and historic inflation. The graph uses a log scale on the y axis since it makes running out of money look more dramatic and the graph is inflation adjusted. On the 10% line you are doomed at 23 years and have only 1/4 of your starting portfolio at the 25% line. You are essentially even at 50%. This is a 50/50 scenario half the people do well half do poorly some so poorly they run out of money.

This is a 80/20 US stocks US Bonds Vanguard portfolio made up of the same US funds used in the BH3. The foreign fund is eliminated and that amount is added to US stocks. The 80/20 lives on the efficient frontier. All other parameters the same as above only the asset mix has changed to move the portfolio to a less risky risk return position on the EF plane.

Notice the success rate of the portfolio is 93% in the 80/20 as opposed to 82% in the BH3. Notice ALL lines still have money at 30 years. The 25% in the BH3 had 1/4 of the start amount. In the 80/20 nearly 1/4 is still in the 10% line’s portfolio. And the 50/50 split where “half do worse half do better” is now the 25% line, so in the 80/20 scenario 3 out of 4 do better. Notice the 90% end value of 5.1M in he BH3 and 8.3M in the 80/20. If the BH3 is supposed to represent “the well diversified market”, the 80/20 clearly beats the market and not by a little. On the 50% line you have doubled your money and considerably improved your longevity simply by choosing the the more efficient portfolio. Specifically at the 50% rate of return line the 80/20 effectively has an additional 2.2% of return compounded over 30 years

That’s called beating the market! In my last post I talked about choosing what is essential. Clearly choosing an efficient portfolio is essential. Just as clear by eliminating the Foreign fund, the FOMO turns to the JOMO. The fear of missing out becomes the joy of missing out. This is essentialism and parsimony in practice.

6 Replies to “How to BEAT The Market!!”

  1. Retrospectively it has been better to own US equity/fixed income, perhaps mirroring Vanguard Wellington during accumulation, and then Wellesley during retirement.

    For those of us accumulating now, asset prices are at ahistorical valuations. International stocks may be “cheaper” and this may lead to better returns vs. US stocks in the future.

    We also seem to have entered new grounds in terms of Central Bank manipulation of interest rates and asset prices. I cringe every time my DCA index fund auto invest triggers, because I’m fairly certain I will lose a tremendous amount of value during the upcoming, inevitable correction. I’m heading towards 10% ETF gold but not sure what else to buy now instead of stocks.

    1. Buy bonds. If you think the market is going to crash the rule is buy low sell high. I own GLD but I own it to have something to sell in a downturn since gold soars in a downturn. Corrections come and go. You can manage risk by managing your AA between stocks and bonds which are uncorrelated, and re-balance yearly when the market is up store some of that value in bonds (sell high) when the market crashes buy stocks (buy low)

      The market cycles and is overall up about 80% of the time and down 20% (I consider sideways being an extension of up) so this technique properly times the market automatically without human intervention and limits risk. If a S&P 500 portfolio has 15% risk, a 60/40 stock/bond has about 10% risk. When the crash comes and the S&P goes down 50% the 60/40 goes down about 30%. To get back to zero the S&P has to increase 100% while the 60/40 only 60%. It reaches 60% well before the S&P gets even and if supercharged with the buy low strategy from re-balancing in a down market it really pops. In 2008 the S&P didn’t reach it’s 2007 highs till 2013 while the 60/40 broke through in 2011. That 2 more years of compounding and compounding is how you make dough.

      The other thing I suggest is a second small portfolio (maybe 3 WR) of mostly bonds and a little stocks about 15/85 or 20/80. When the crash comes reduce the SWR by 10% and take money out of the small portfolio leaving the big portfolio alone to grow and re-balance. By doing this you eliminate early SORR risk which is deadly. You don’t have to refill the small if you use it, one use is enough to re-index your portfolio to a better outcome. Here is an article I wrote on this technique.

      International is a dumb move in my opinion. International is STRONGLY correlated with US stocks about 90% and it carries a higher risk. A 90% correlation means when US crashes international crashes and crashes harder because of the larger risk. EM is even worse. In 2008 US went down about 50%, EM went down 70%. EM has yet to return since it’s rate of return is dismal compared to S&P. You get more risk and NO BENEFIT in a crash IMHO. Piling on more and more highly correlated assets does not improve diversity as is clearly demonstrated in this article. If you’re worried about the market and own a BH3 turn it into a a 2 fund US stock US bond portfolio by selling global. If you’re REALLY worried buy more bonds and less stocks when you convert, moving to a 60/40 or 50/50 allocation with a little GLD or something. You will make nearly as much return with a LOT less risk over the BH3

      1. I thought I had a well-diversified portfolio going into 2007. By the end of 2008 every one of my 8-10 “diversified asset classes” were down. The only one that went up were my bonds.
        Since then I have been 40:40:20. Stocks:Bonds:Other. In retrospect 100% S&P 500 would have done better. But that is fine. I have exceeded all of my financial goals and needs and I don’t worry about crashes or dips.

        1. For me I discovered a account aggregator which allowed me to track all of my myriad of accounts. I also discovered modern portfolio theory. The aggregator allowed me to turn my entire portfolio into a single entity and then optimize the entity on the efficient frontier to a single risk and a single return. Those were the essential steps for accumulation and I then just saved as much as I could. My life was otherwise well optimized as well, like right sized house, properly valued cars, college covered for my kids, no other debt etc. Once done by managing the portfolio for best risk/return, the thing pretty much took care of itself.

          Now with Personal Capital available it’s become plug and play to optimize. Many things had to happen in the history of investing. Cheap mutual funds with no load, cheap trading costs, good tax software that tracks things without fail across decades, things like that. I’ve been using some version of the same tax software since 1986 and as time went on the software was acquired and developed but my data never lost compatibility, so things like TLH tracking became much easier.

          I don’t worry either. Once you get old it becomes hard to run yourself out of dough before you run out of breath as long as you tax plan and have end of life scenarios for both you and your wife covered.

  2. For this 2nd smaller safety net portfolio which is heavy in bonds, do you have it in a regular brokerage account? It would not be tax efficient, correct?

    And what are your thoughts on doing municipal bonds (tax free) to avoid this versus the total bond market index fund if it is in a brokerage account?

    1. Right now my second fund is in cash in a high yield, backed up by SS which I can take at any time. When I hit 70 (or 72 if SECURE passes), I’ll have a IRA in an efficient frontier tangent account. I’ll spend down the RMD OR I’ll accelerate distribution if needed due to a market dump. By then I’ll be on SS and so will my wife. So I have the low risk account, but my distribution plan will be a little different because of my proximity to SS. You’ll have to work through the tax consequence based on your expected income vs rate of muni return. If your taxes are large because your income is large, muni’s are a good deal if you can get any return. If your income is small the tax advantages kind of vanish into the noise. You can always change types as the tax picture changes from pre to post.

      I used to own Muni’s when they paid in the 4’s or 5’s and I was making a ton of money and paying a ton of taxes. Now I live on a simple middle class income in the 12% and messing with muni’s is too many moving parts.

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