The Gold Conundrum And The Thing About Portfolios

After my piece on gold silver ratio was published, one of my acquaintances read it and asked me this question: is gold (or commodities in general) really necessary for The Bedokian Portfolio?

As usual, my response is: it depends.

Elaborating on my answer, I shall use the Portfolio Visualizer (seems obvious that this place is becoming my go-to site) to carry out a simple back test, with three versions of the US Bedokian Portfolio and benchmarked to the Vanguard 500 Index Investor, representing the US equity market.

• Bedokian Portfolio 1 (Portfolio 1): The balanced Bedokian Portfolio; 35% equities, 35% REITs, 20% bonds, 5% commodities (gold) and 5% cash.

• Bedokian Portfolio 2 (Portfolio 2): We shift the 5% component from gold to equities, hence 40% equities, 35% REITs, 20% bonds and 5% cash.

• Bedokian Portfolio 3 (Portfolio 3): We shift the 5% component from gold to REITs, hence 35% equities, 40% REITs, 20% bonds and 5% cash.

The period covered is from 1994 to 2018, as 1994 is the earliest year that REITs data is available on the Portfolio Visualizer site.

Fig. 1a – Portfolio returns, table view, 1994-2018. Inflation is not factored in.

Fig. 1b - Portfolio returns, graphical view, 1994-2018. Inflation is not factored in.

From Figures 1a and 1b, in terms of returns, the balanced Bedokian Portfolio lost out to the other two alternatives, which in turn trail badly against an all-equities portfolio. Risk-return (Sharpe and Sortino ratios) and volatility wise (standard deviation), the balanced portfolio had a slight edge over the rest.

So can we say do not add gold? Not so fast.

What if we use the period between 2001 and 2010? This decade covered the aftermath of the dot-com bust, the subsequent super bull, the Global Financial Crisis (GFC) and the follow-up recovery.

Fig. 2a – Portfolio returns, table view, 2001-2010. Inflation is not factored in.

Fig. 2b - Portfolio returns, graphical view, 2001-2010. Inflation is not factored in.

Interestingly, the balanced Bedokian Portfolio gave the most returns, yet still scored well in risk-return and lower volatility than the rest.

By now you may be wondering: these numbers are just hindsight statistical play, and I could just find a favourable period to prove my point. Yes, in a way that is correct, but what if in real life there was really a person who had a 10-year investment plan starting from Jan 2001; the gold allocation would had given additional returns (and lower volatility and better risk-return ratio) if he/she decided to withdraw all at Dec 2010 as compared to the rest. 

In my ebook I had stated that commodities are a form of insurance against market volatility¹. Though in the examples of Figures 2a and 2b, the difference of protection was not much, but at least it proved its insurance role.

Now The Thing About Portfolios…

Bringing in a related point, in my opinion there is no best strategic asset allocation-based investment portfolio around (and yes The Bedokian Portfolio is no exception). Each one of them has its own strengths, weaknesses, best and worst performance at different points in time and differing duration. So in summary, there could be one portfolio that is good at some moments, but not all of the time.

Yet I would like to emphasize that having a diversified portfolio of various asset classes still trumps a one-asset-class-only portfolio, especially in managing returns and risks at the same time.

And I shall end off with this disclaimer: past performance is not an indication of future results.

1 – The Bedokian Portfolio, p37

Assumptions on Portfolio Visualizer Data

Asset class representations used in the data: Equities = U.S. Stock Market; Bonds = Total U.S. Bond Market; REITs = REIT, Commodities = Gold; Cash = 1-month Treasury Bills. All dividends are reinvested and transaction costs (e.g. commissions) are not included.

Results

To see the results (Figures 1a and 1b) in its entirety for the 1994-2018 period in Portfolio Visualizer, click here.

To see the results (Figures 2a and 2b) in its entirety for the 2001-2010 period in Portfolio Visualizer, click here.

References

Standard Deviation – https://www.investopedia.com/terms/s/standarddeviation.asp

Sharpe Ratio – https://www.investopedia.com/terms/s/sharperatio.asp

Sortino Ratio – https://www.investopedia.com/terms/s/sortinoratio.asp

What Star Wars Can Teach Us About Investing

Today is Star Wars Day.

For this post, I will pull out nine famous quotes from the science fiction movie franchise and relate them to our real-life investment experiences.

#1: “Do or do not. There is no try.”

Yoda uttered this line while training the protagonist Luke Skywalker in The Empire Strikes Back. 

The key gist here is commitment. When learning about investing, or conducting your fundamental analysis, have determination and focus while carrying out the tasks. Do not do things half-heartedly.

#2: “You must unlearn what you have learned.”

Again from Yoda while teaching Luke in the same movie. 

It is refreshing to re-read some of the investment basics that we had gone through. Who knows, putting on that newbie hat again might spark some other points of view that we may have overlooked back then. Also, after a period of investing, most of us are quite into our own style and methodology, but it is good that if we could look at other alternatives and try to incorporate some of their pluses to ours to make it better.

#3: “Fear is the path to the Dark Side.”

And again, from Yoda, but this time from The Phantom Menace, while speaking to Anakin Skywalker.

Fear is one of the powerful emotions felt by humans, as it is the instinct to trigger the “fight or flight” response. While this is useful in physically dangerous situations, in the world of investing, this is a big no-no. The important thing is to stay calm and take stock of what is going on, before deciding on your next move. Engulfed by fear, and chances are your portfolio will go to the dark side, of losses.

#4: “Great, kid. Don’t get cocky.”

Han Solo told this to Luke in A New Hope, after the latter had shot down an enemy spacecraft.

It is common for new investors to feel euphoric and confident after getting their first positive returns. However, if this “high” continues, overconfidence will set in, and this could be detrimental in subsequent investment analysis and decisions. Be happy, yes, but everyday is not a Sunday, so stay focused and resume your everyday routine.

#5: “Now, be brave and don’t look back.”

This was said to Anakin by his mother, Shmi Skywalker, just before the former left home to train to be a Jedi, in The Phantom Menace.

It is natural that we do look back at our decisions and wonder if they are good or bad. Whatever it is, it was over and we have to make do with it. Lamenting on past investment decisions, such as ‘I should have sold it at a higher price’ or ‘I was following this counter but did not go in. Now it went up above my valuation’, is not healthy. Leave this baggage behind and focus on the present.

#6: “Who is the more foolish? The fool, or the fool who follows him?”

Obi-Wan Kenobi quipped this in A New Hope.

This is akin to herd mentality, or some might say “jumping on the bandwagon” or “fear of missing out”. Be it an asset class, a sector, a region/country or even an individual share/bond, there are times when it becomes hot, everybody will want to have a piece of it. Sometimes it is better to take a breather and find out what is it all about before making that jump. To quote another phrase from a song: “Wise men say only fools rush in”.

#7: “Stay on target.”

A pilot muttered this while flying towards the attack target in A New Hope.

There are aims and objectives when starting off an investment portfolio, such as to have an $X amount of portfolio generating Y% of yield when I reach age Z. Investing is a long journey, at least 10 years in my definition, so please do not stray from your course unless absolutely necessary.

#8: “Difficult to see. Always in motion is the future.”

And we are finally back to Yoda, who said this to Luke in The Empire Strikes Back.

As I have always mentioned countless times, we really do not know what the future holds. We may have past and present data (i.e. the Force in our context), but these provide at most a guesstimate. In my opinion a guesstimate is still better (and more prepared) than a wild stab in the dark wearing a blindfold.

#9: “The greatest teacher, failure is.”

This last one is from Yoda (who is full of sensible quotes if you know by now) to Luke in the latest Star Wars movie The Last Jedi.

Failure is one of the biggest bugbears one could face in life, but it is also a good lesson to learn from. Pick up the pieces, learn from them and move on. Do not let just a few bad experiences put you totally off from investing. Strength is not from winning all the time, but also from climbing up when you are down.

Unfortunately, there is no lesson to be shared from the most famous quote of all: “No, I am your father”.

May the Fourth be with you.