Softpanorama (slightly skeptical) Open Source Software Educational Society

May the source be with you, but remember the KISS principle ;-)

Conclusions

1. Introduction
2. Popular 401K investors delusions
3. Fashionable mutual funds mix
4. Follow the leader
5. Naive siegelism
6. "Financial alchemist" strategy
7. "All money in bonds" or "Depression might start tomorrow" strategy.
8. "Gold always shines bright"  and "Commodities rulez" strategies
9. Lifecycle strategies
10. Economic cycle based market timing
11. Combination of lifetime strategies with market timing.
12. Conclusions
13. Webliography
14. Old News

After reading tons of articles and several dozen of books on the subject as well as spending  many hours on simulations I became convinced that:

• There is no magic bullet and generally you should expect to get back only those money that you managed to save beating only inflation. Positive returns after inflation for 401K portfolios are not that easy to achieve. Wall Street and fund managers need to live and live well and that translates into lower returns for ordinary investor. There is no free lunch and huge profits of brokers are profits taken from investors. There is no other source.

• There is no relevant statistically significant facts which can demonstrate that portfolios based on simple  lifestrategy-based stock-bonds allocation (age based or other simple implementation of "life strategy" possibly using a fund with a given target date of retirement or even 50/50 strategy) are worse that static multi-component portfolios that are prevalent today...
   

• In case of static mixes you should be careful with rebalancing: blind rebalancing (for example calendar based) can dramatically worsen returns essentially converting them from winning into losing strategies. A recent research study advocates “opportunistic rebalancing” of portfolios to enhance returns. See In Favor of 'Opportunistic Rebalancing' - Seeking Alpha

  • Specifically, Gobind Daryanani’s paper, “Opportunistic Rebalancing: A New Paradigm for Wealth Managers” published in the January 2008 Journal of Financial Planning, concludes that a 20-per-cent threshold monitored every second week is the optimal rebalancing strategy. If the target allocation for equities is, say, 60%, no adjustments are made until equities fall outside the threshold band of 48% to 72%. This does not happen often but when it does the biweekly monitoring of the portfolio is sure to catch it and lead to action. The end result is rebalancing that is infrequent but best in terms of capturing buy-low-and-sell-high opportunities, and thus augmenting returns.

    According to Daryanani’s testing of rebalancing strategies on U.S. financial assets over the 1992-to-2004 period, “opportunistic rebalancing” outperformed the widely used five-per-cent threshold band (monitored annually or quarterly) by 0.25 to 0.30 basis points a year. The margin is trimmed after factoring in costs, taxes, and adjusting for volatility, but still positive.

    Note that Daryanani does not adjust asset allocations back to their exact target but to the closest boundary in the tolerance band, defined as equal to 50% of the threshold band. Thus, in the example above if equities climbed past the 72% level, they would be cut back not to 60% but to 66% (effectively, the midpoint between the target and threshold band).
     

• Any mixed index funds based stocks/bonds portfolio with shared of stocks and bonds close to 50% are statistically competitive with all stocks portfolio and usually has better returns then all bonds portfolios. Even if they are not necessary better  they are simpler, carry less risk that all stock portfolios and can even save you some fund expenses: after a certain threshold the more mutual funds you own the less is your total return.  Over diversification is a self-defeating strategy.  You should have some general understanding of the direction of economics and chose funds that corresponds this understanding (investing with crowd). It usually does not pay to be a contrarian...
   

• For the past ten years returns of all S&P500 in case of cost averaging are approximately equivalent to 6.5% bonds.  That makes it on par with the return of high yield bonds.
   

• Life strategy portfolios are as good or better as static binary stock bond mixes and carry less risks as you age while providing comparable or better returns.

Last modified: February 27, 2008