Portfolio Update – September 2021 – Why The 60/40 Portfolio Is Not Balanced

When it comes to the All Seasons Portfolio strategy, or any other risk parity strategy for that matter, one of the fundamental ingredients is how to allocate the capital between assets in the portfolio based on risk rather than capital.

Why this is important, or even why bother doing it at all, is a question I get quite often. I think therefore it is time to have a closer look at risk parity portfolio allocation principles. Here I mean the reason for why the allocation to the assets is based on their risk (volatility) rather than equal weight based on capital.

In this article, for a comprehensible description, we will be examining a simple two-asset portfolio to illustrate the importance of weighting assets based on risk rather than capital. For this example, I will be using a 60/40 Portfolio consisting of 60% stocks and 40% bonds, as this is popularly (and erroneously) considered as a “balanced portfolio”, and as this is a portfolio allocation strategy among both retail and institutional investors.

Continue ReadingPortfolio Update – September 2021 – Why The 60/40 Portfolio Is Not Balanced

Portfolio Update – August 2021 – Retail Investors’ Irrational Expectations of Risk Parity

What I have observed from discussions with retail investors who are not yet aware of the benefits of risk parity, is that there is a great misunderstand of the goals of risk parity, and incorrect expectations of what such strategies should provide.

When explaining what risk parity is, being a strategy that pieces together risk premiums and returns from a wider array of asset classes, but where the timing of the earned positive returns from each asset are spread out in such a fashion that during all economic regimes, some of the assets will see negative returns, but the positive returns of other assets will offset losses and provide your portfolio with an overall profit.

This means that through proper diversification, on a portfolio level you cancel out much of the volatility inherit in each of the individual asset classes, so that you get a much smoother ride with lower portfolio volatility, but can still expect equity-like returns over time. You should expect rolling hills and valleys rather than mountains and canyons.

But as I have alluded to in recent posts, even though the All Seasons Portfolio strategy and other similar strategies (Golden Butterfly, etc. for example) are rationally the best fit for most investors, during times when the stock market outperforms, it becomes difficult to see your neighbor get richer on the stock market while your safe portfolio lags.

This kind of underperformance fatigue sets you up for a great risk if you abandon the safe strategy for a high-risk strategy when the market crash (the one that you were protected against) occurs.

Continue ReadingPortfolio Update – August 2021 – Retail Investors’ Irrational Expectations of Risk Parity

Why Volatility Trend Tracking Matters And How To Optimize Your Portfolio Based On Inverse Volatility

As an investor who has adopted a risk parity mindset, and perhaps have implemented a portfolio following risk parity principles, such as the All Seasons Portfolio, I am sure you at least have a fundamental understanding of the importance of volatility.

In several articles, I have discussed why it is vital for retail investors in particular to decrease portfolio volatility, and using another term, to decrease portfolio risk. Otherwise, we risk not achieving our financial goals, if we would encounter bigger drawdowns than we can afford, or that we allocate too much capital to a single asset class such as stocks when such assets face a period of lagging returns.

So, if the question is "How can I reduce portfolio volatility", the answer is Risk Parity. Using these types of strategies and investing in several asset classes and allocating capital based on the asset classes' relative risk, you can significantly decrease the overall volatility of your portfolio, while still earning the risk premiums of each asset.

To facilitate management of risk of the different assets in a portfolio, and to implement a bottom-up risk parity approach for my stock exposure through an Inverse Volatility strategy, I have developed a Volatility Analyzer tool that also includes an Inverse Volatility Portfolio Optimizer. I first and foremost developed this for my own needs, which I will describe further below, but have found that it may be a useful resource also for you.

In this article, we expand on why tracking volatility is important and how it is easier to forecast than returns, as well as explain how my developed tool works.

Continue ReadingWhy Volatility Trend Tracking Matters And How To Optimize Your Portfolio Based On Inverse Volatility

Portfolio Update – July 2021 – The Two Most Important Risks For Retail Investors And How To Avoid Them

With the recent strong positive trend in stocks and risk assets since April 2020, I have been thinking quite a bit about a couple risks that face retail investors and which have become more and more relevant now that I get a bit of vertigo from the S&P 500.

These risks are 1) the risk of us not reaching our financial goals by not managing our investment risk properly and 2) abandoning a safer strategy when we see others making more money with high-risk strategies.

I will discuss these risks more in details below and why they matter, and in particular why it is more urgent for retail investors to have understood these risks.

Namely, apart from institutions with more or less infinite investment horizons, we as retail investors are only active on the financial markets for a quite brief moment when you zoom out and consider all the history of investing.

And as we only get one shot at it (no do-overs), it is important that we get it right from the start. It is crucial to avoid making a mess of our investing careers that we cannot repair later.

I hope you find this text useful, and please share your thoughts in the comments or directly by email to nicholas@allseasonsportfolio.eu.

And as usual, the regular update of my All Seasons Portfolio(s) follows right after the month's special topic. July was a quite good month for me, and I have made a slight alteration of my portfolio, switching the TIPS ETF from a global one to one with longer-term US inflation-linked bonds.

But more of that to come. Now, let's have a look at a different way of defining "risk".

Continue ReadingPortfolio Update – July 2021 – The Two Most Important Risks For Retail Investors And How To Avoid Them

Portfolio Update – June 2021 – A study of risk parity portfolios against S&P 500 since 1927

Earlier this week, I received a very good comment to the monthly portfolio update article which I published last month. In that article, I discussed how the stock market seems greatly overvalued based on several widely different indicators, measuring both listed stock’s earnings and assets, as well as market cap in relation to GDP.

Based on the indicators CAPE (Shiller's PE), Q Ratio, and the Buffett Indicator (market cap to GDP), future potential returns of the stock market over the next decade appear limited.

In the light of this, the question arises whether the All Seasons Portfolio would be a better choice, and how it has performed under similar conditions in the past when compared with the S&P 500. The comment reads as quoted here below and this is what I have set out to answer in this month's article.

We can anticipate that future returns of the stock market will be below what we have become used to in recent years based on these metrics, and the fact that returns 1) usually are clustered in a way that good years are followed by further good years and bad years are followed by further bad years, and 2) always regress to the mean (between 7-10% annually) and that the last decade has seen annual returns far above this level.

When acknowledging the current worrying state of the equity markets, it becomes relevant to further understand how the All Seasons Portfolio has performed versus the stock market under similar market conditions.

Instead, it is relevant to compare against 1) long-term performance over several decades, and 2) periods with similar conditions as where we are currently. To me, these are two extremely central questions to clarify, and that I wanted to have answers to as well.

Continue ReadingPortfolio Update – June 2021 – A study of risk parity portfolios against S&P 500 since 1927

Portfolio Update – May 2021 – Indicators of an Overvalued Stock Market and What You Can Do About It

  • Has the stock market reached a permanently high plateau, or can we expect lower return the coming decade?
  • Monthly Update for May 2021 with a fresh set of charts

I hope you are sitting comfortably and have fetched a nice cup of coffee or something more refreshing, because before we get into the monthly development for May 2021 of my portfolio, we have an elaborate analysis of the value of the stock market in front of us.

There has been a couple of things that have been bugging med lately. That is the current high valuation of the stock market regardless of metric used, and the fact that many non-professional investors' inability to understand that an average annual return of 7-8% on the stock market is just an average rather than something you can expect every year to come.

I think that many have been trapped in a recency bias that will catch up with them eventually, unless retail investors choose to diversify from an all-stock portfolio to something more similar to an All Seasons Portfolio.

I will explain why I think so in detail in this article, so let's just dive into it.

I recently bought the book Adaptive Asset Allocation by the team at ReSolve Asset Management. While the main focus of the book was risk parity and a different view thereto than what the more static All Seasons Portfolio strategy offers, there was one part in the background section that really resonated with me, and which I perceive that many investors, and especially non-professional savers, miss.

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