The future return keeps getting lower, as the market goes higher


Jeff Bezos has a saying, “Your margin is my opportunity.”  He has found ways to eat the businesses of others by providing the same goods and services at a lower cost.  Now, that makes Amazon more productive and others less productive.  The same is true of other internet-related businesses like Google, Netflix, etc.

And, there is a slight net benefit to the economy from the creative destruction.  Old capital gets recycled.  Malls that are no longer so useful serve lower-margin businesses for locals, become homes to mega-churches, other area-intensive human gatherings, or get destroyed, and the valuable land so near many people gets put to alternative uses that are better than the mall, but not as profitable as the mall prior to the internet.

Laborers get released to other work as well.  They may get paid less than they did previously, but the system as a whole is more productive, profits rise, even as wages don’t rise so much.  A decent part of that goes to the pensions of oldsters — after all, who owns most of the stock?  Indirectly, pension plans and accounts own most of it.  As I have sometimes joked, when there are layoffs because institutional investors representing pension plans  are forcing companies to merge, or become more efficient in other ways, it is that the parents are laying off their children, because there are cheaper helpers that do just as well, and the added profits will aid their deservedly lush retirement, with little inheritance for their children.

It is a joke, though seriously intended.  Why I am mentioning it now, is that a hidden assumption of my S&P 500 estimation model is that the return on assets in the economy as a whole is assumed to be constant.  Some will say, “That can’t be true.  Look at all of the new productive businesses that have been created! The return on assets must be increasing.”  For every bit of improvement in the new businesses, some of the old businesses are destroyed.  There is some net gain, but the amount of gain is not that large in aggregate, and these changes have been happening for a long time.  Technological progress creates and destroys.

As such, I don’t think we are in a “New Era.”  Or maybe we are always in a “New Era.”  Either way, the assumption of a constant return on assets over time doesn’t strike me as wrong, though it might seem that way for a decade or two, low or high.

As it is today, the S&P 500 is priced to deliver returns of 3.24%/year not adjusted for inflation over the next ten years.  At 12/31/2017, that figure was 3.48%, as in the graph above.

We are at the 95th percentile of valuations.  Can we go higher?  Yes.  Is it likely?  Yes, but it is not likely to stick.  Someday the S&P 500 will go below 2000.  I don’t know when, but it will.  There are enough imbalances in the world — too many liabilities relative to productivity, that crises will come.  Debt creates its own crises, because people rely on those payments in the short-run, unlike stocks.

There are many saying that “there is no alternative” to owning stocks in this environment — the TINA argument.  I think that they are wrong.  What if I told you that the best you can hope for from stocks over the next 10 years is 4.07%/year, not adjusted for inflation?  Does 1.24%/year over the 10-year Treasury note really give you compensation for the additional risk?  I think not, therefore bonds, low as they may be, are an alternative.

The top line there is a 4.07%/year return, not adjusted for inflation

If you are happy holding onto stocks, knowing that the best scenario from past history would be slightly over 3400 on the S&P 500 in 2028, then why not buy a bond index fund like AGG or LQD that could virtually guarantee something near that outcome?

Is there risk of deflation?  Yes there is.  Indebted economies are very susceptible to deflation risk, because wealthy people with political influence will always prefer an economy that muddles, to higher taxes on them, inflation, or worst of all an internal default.

That is why I am saying don’t assume that the market will go a lot higher.  Indeed, we could hit levels over 4000 on the S&P if we go as nuts as we did in 1999-2000.  But the supposedly impotent Fed of that era raised short-term rates enough to crater the market.  They are in the process of doing that now.  If they follow their “dot plot” to mid-2019 the yield curve will invert.  Something will blow up, the market will retreat, and the next loosening cycle will start, complete with more QE.

Thus I am here to tell you, there is an alternative to stocks.  At present, a broad market index portfolio of bonds will likely outperform the stock market over the next ten years, and with lower risk.  Are you ready to make the switch, or at least, raise your percentage of safe assets?


Fewer laws protect you now. In some ways, the laws are more virtual than real, and only apply to real situations, and not virtual ones.

Let me explain.

Though checks make up an increasingly smaller fraction of transaction volume in the US, they are still a lot higher here than in Europe.  As such, federal and many state legislators have not caught up with the effects of a hybrid system, where they attempt to regulate electronic banking transactions under the same rules as paper checks.

Many people like making mobile deposits, rather than going into the bank, or snail-mailing the deposits in.  But what happens if a check gets mobile-deposited to two banks?  Or, since many banks don’t actively check mobile deposits closely, what if someone repeatedly deposits a check to his bank, while altering the check number?

The latter scenario happened to me, and I am out a considerable amount of money because I was not following my accounts closely.

  • My soon-to-be former bank would not reimburse the losses, citing the account agreement, even though they facilitated the thefts by not checking the drafts against my account.
  • The same was true of the bank of the fraudster, which accepted the same altered check again and again.
  • The state of Maryland would not prosecute fraud charges against the person, because the crime was not committed inside a bank branch, and they could not conclusively prove that the perpetrator did the crime, even though all of the money went to his account.  And,that is even though the perpetrator admitted it to me, and I have it in writing.
  • Thus, I have an informal agreement with the perp to pay me back or face a tort claim.  His situation is not strong, and you can’t squeeze blood from a stone.  I could force him into bankruptcy, but what good would that for me?  I’m not vengeful.

So what is the best defense?  Check your transactional accounts weekly if not daily.  On that level, the banks will take the losses, if you identify them fast enough.

I began doing that recently, and found someone using one of my credit cards to pay his phone bill.  I have since reversed most of those charges.  GIven that many vendors try to induce you into payment plans that auto-renew, it is wise for that reason to do so, that you would cancel services that you no longer use.

So what can I say?  I could have not written this up, but I am not perfect in my personal money management… better that others learn from my mistakes.  Until the state and Federal governments get their acts together, you are your own best defender.  Check your transactional accounts frequently.  The money you save will be your own.

Photo Credit: Steve Rotman || Markets are not magic; government economic stimulus is useless with debt so high

Weird begets weird

I said in an earlier piece on this topic:

I use [the phrase] during periods in the markets where normal relationships seem to hold no longer. It is usually a sign that something greater is happening that is ill-understood.  In the financial crisis, what was not understood was that multiple areas of the financial economy were simultaneously overleveraged.

So what’s weird now?

  • Most major government running deficits, and racking up huge debts, adding to overall liability promises from entitlements.
  • Most central banks creating credit in a closed loop that benefits the governments, but few others directly.
  • Banks mostly in decent shape, but nonfinancial corporations borrowing too much.
  • Students and middle-to-lower classes borrowing too much (autos, credit cards)
  • Interest rates and goods and services price inflation stay low in the face of this.
  • Low volatility (until now)
  • Much speculative activity in cryptocurrencies (large percentage on a low base) and risk assets like stocks (smaller percentage on a big base)
  • Low credit spreads

No one should be surprised by the current market action.  It wasn’t an “if,” but a “when.”  I’m not saying that this is going to spiral out of control, but everyone should understand that The Little Market that Could was a weird situation.  Markets are not supposed to go up so steadily, which means something weird was fueling the move.

Lack of volatility gives way to a surfeit of volatility eventually.  It’s like macroeconomic volatility “calmed” by loose monetary and fiscal policy.  It allows people to take too many bad chances, bid up assets, build up leverage, and then “BAM!” — possibility of debt deflation because there is not enough cash flow to service the incurred debts.

Now, we’re not back in 2007-9.  This is different, and likely to be more mild.  The banks are in decent shape.  The dominoes are NOT set up for a major disaster.  Risky asset prices are too high, yes.  There is significant speculation in areas Where Money Goes to Die.  So long as the banking/debt complex is not threatened, the worst you get is something like the deflation of the dot-com bubble, and at present, I don’t see what it threatened by that aside from cryptocurrencies and the short volatility trade.  Growth stocks may get whacked — they certainly deserve it from a valuation standpoint, but that would merely be a normal bear market, not a cousin of the Great Depression, like 2007-9.

Could this be “the pause that refreshes?”  Yes, after enough pain is delivered to the weak hands that have been chasing the market in search of easy profits quickly.  The lure of free money brings out the worst in many.

You have to wonder when margin debt is high — short-term investors chasing the market, and Warren Buffett, Seth Klarman, and other valuation-sensitive investors with long horizons sitting on piles of cash.  That’s the grand asset-liability mismatch.  Long-term investors sitting on cash, and short-term investors fully invested if not leveraged… a recipe for trouble.  Have you considered these concepts:

  • Preservation of capital
  • Dry powder
  • Not finding opportunities
  • Momentum gives way to negative arbitrages.
  • Greater fool theory — “hey, who has slack capital to buy what I own if I need liquidity?”

Going back to where money goes to die, from the less mentioned portion on the short volatility trade:

Again, this is one where people are very used to selling every spike in volatility.  It has been a winning strategy so far.  Remember that when enough people do that, the system changes, and it means in a real crisis, volatility will go higher than ever before, and stay higher longer.  The markets abhor free riders, and disasters tend to occur in such a way that the most dumb money gets gored.

Again, when the big volatility spike hits, remember, I warned you.  Also, for those playing long on volatility and buying protection on credit default — this has been a long credit cycle, and may go longer.  Do you have enough wherewithal to survive a longer bull phase?

To all, I wish you well in investing.  Just remember that new asset classes that have never been through a “failure cycle” tend to produce the greatest amounts of panic when they finally fail.  And, all asset classes eventually go through failure.

So as volatility has spiked, perhaps the free money has proven to be the bait of a mousetrap.  Do you have the flexibility to buy in at better levels?  Should you even touch it if it is like a knockout option?

There are no free lunches.  Get used to that idea.  If a trade looks riskless, beware, the risk may only be building up, and not be nonexistent.

Thus when markets are “weird” and too bullish or bearish, look for the reasons that may be unduly sustaining the situation.  Where is debt building up?  Are there unusual derivative positions building up?  What sort of parties are chasing prices?  Who is resisting the trend?

And, when markets are falling hard, remember that they go down double-speed.  If it’s a lot faster than that, the market is more likely to bounce.  (That might be the case now.)  Slower, and it might keep going.  Fast moves tend to mean-revert, slow moves tend to persist.  Real bear markets have duration and humiliate, making weak holders conclude that will never touch stocks again.

And once they have sold, the panic will end, and growth will begin again when everyone is scared.

That’s the perversity of markets.  They are far more volatile than the economy as a whole, and in the end don’t deliver any more than the economy as a whole, but sucker people into thinking the markets are magical money machines, until what is weird (too good) becomes weird (too bad).

Don’t let this situation be “too bad” for you.  If you are looking at the current situation, and think that you have too much in risk assets for the long-term, sell some down.  Preserving capital is not imprudent, even if the market bounces.

In that vein, my final point is this: size your position in risk assets to the level where you can live with it under bad conditions, and be happy with it under good conditions.  Then when markets get weird, you can smile and bear it.  The most important thing is to stay in the game, not giving in to panic or greed when things get “weird.”

Another quarter goes by, the market rises further, and the the 10-year forward return falls again.  Here are the last eight values: 6.10%, 6.74%, 6.30%, 6.01%, 5.02%, 4.79%, and 4.30%, 3.99%.  At the end of September 2017, the figure would have been 4.49%, but the rally since the end of the quarter shaves future returns down to 3.99%.

At the end of June the figure was 4.58%.  Subtract 29 basis points for the total return, and add back 12 basis points for mean reversion, and that would leave us at 4.41%.  The result for September month-end was 4.49%, so the re-estimation of the model added 8 basis points to 10-year forward returns.

Let me explain the adjustment calculations.  In-between quarterly readings, price movements shave future returns the same as a ten-year zero coupon bond.  Thus, a +2.9% move in the total return shaves roughly 29 basis points off future returns. (Dividing by 10 is close enough for government work, but I use a geometric calculation.)

The mean-reversion calculation is a little more complex.  I use a 10-year horizon because that is the horizon the fits the data best.  It is also the one I used before I tested it.  Accidents happen.  Though I haven’t talked about it before, this model could be used to provide shorter-run estimates of the market as well — but the error bounds around the shorter estimates would be big enough to make the model useless. It is enough to remember that when a market is at high valuations that corrections can’t be predicted as to time of occurrence, but when the retreat happens, it will be calamitous, and not orderly.

Beyond 10-years, though, the model has no opinion.  It is as if it says, past mean returns will occur.  So, if we have an expectation of a 4.58% returns, we have one 4.58%/yr quarter drop of at the end of the quarter, and a 9.5% quarter added on at the end of the 10-year period. That changes the quarterly average return up by 4.92%/40, or 12.3 basis points.  That is the mean reversion effect.

Going Forward

Thus, expected inflation-unadjusted returns on the S&P 500 are roughly 3.99% over the next ten years.  That’s not a lot of compensation for risk versus investment-grade bonds.  We are at the 94th percentile of valuations.

Now could we go higher?  Sure, the momentum is with us, and the volatility trade reinforces the rise for now.  Bitcoin is an example that shows that there is too much excess cash sloshing around to push up the prices of assets generally, and especially those with no intrinsic value, like Bitcoin and other cryptocurrencies.

Beyond that, there are not a lot of glaring factors pushing speculation, leaving aside futile government efforts to stimulate an already over-leveraged economy.  It’s not as if consumer or producer behavior is perfectly clean, but the US Government is the most profligate actor of all.

And so I say, keep the rally hats on.  I will be looking to hedge around an S&P 500 level of 2900 at present.  I will be watching the FOMC, as they may try to invert the yield curve again, and crash things.  They never learn… far better to stop and wait than make things happen too fast.  But they are omnipotent fools.  Maybe Powell will show some non-economist intelligence and wait once the yield curve gets to a small positive slope.

Who can tell?   Well, let’s see how this grand experiment goes as Baby Boomers arrive at the stock market too late to save for retirement, but just in time to put in the top of the equity market.  Though I am waiting until S&P 2900 to hedge, I am still carrying 19% cash in my equity portfolios, so I am bearish here except in the short-run.

PS — think of it this way: it should not have gone this high, therefore it could go higher still…


Dear Readers, this is another one of my occasional experiments, so please be measured in your comments.  The following was written as a ten-year retrospective article in 2042.


It was indeed an ugly surprise to many when the payments from Social Security in February 2032 did not come.  Indeed, the phones in Congress rang off the hook, and the scroll rate on incoming emails broke all records.  But as with most things in DC in the 21st century, there was no stomach to deal with the problem, as gridlock continued to make Congress a internally hostile but essentially passive institution.

Part of that gridlock stemmed from earlier Congressional reforms that looked good at the time, but reduced the power of parties to discipline members who would not go along with the leadership.  Part also stemmed from changes in media, which were developing in the 1980s because the media was increasingly out of sync with the views of average Americans, but came to full fruition after the internet became the dominant channel for news flow, allowing people to tune out voices unpleasant to them.  Gerrymandering certainly did not help, as virtually all House seats were noncompetitive.  Finally, the size of the debt, and large continuing deficits limited the ability of the government to do anything.  The Fed was already letting inflation run at rates higher than intermediate interest rates, so they were out of play as well.

Despite occasional warnings in the media that began five years earlier after the Chief Actuary of the Social Security Administration suggested in his 2027 year-end report that this was likely to happen in 4-6 years, most media and people tuned it out because it was impossible in their eyes, and face it, actuaries are deadly dull people.  Only a few bloggers kept up a drumbeat on the topic, but they were ignored as Johnny One-Note Disasterniks.

Shortly thereafter, the obligatory hearings began in Congress, and the new Chief Actuary of the Social Security Administration was first on the list to testify.  First he explained that when the Social Security was developed, this safeguard was added in case the income and assets of the trust were inadequate to make the next payment, that payment would be skipped.  He added that by law, skipped payments would not be made up later.  After all, Social Security is an earned right, but mainly a statutory right and not a constitutional right.  Then he commented that without changes, a payment would likely be skipped in 2033 and 2034, two skips each in 2035 and 2036, and by 2037 three skips would be the “new normal” until demographics normalized, but that would likely take a generation to achieve, as childbearing was out of favor.

There were many other people who testified that day from AARP, its relatively new but strong foe AAWP (w -> Working), and various conservative and liberal think tanks, but no one said anything valuable that the Chief Actuary didn’t already say: without changes to benefits or taxes (contributions, haha), payment skipping would become regular.  It was a darkly amusing sidelight that members of the House of Representatives managed to trot out every “urban myth” about Social Security as true during their hearings, including the bogus idea that everyone has their contributions stored in the own little accounts.

The eventual compromise was not a pretty one:

  • Cost-of-living adjustments were ended.
  • Benefits were means-tested.
  • Late retirement adjustment factors were decreased.
  • All the games where benefits could be maximized were eliminated.
  • Immigration restrictions were loosened for well-off immigrants.
  • The normal retirement age was raised to 72, and
  • “Contributions” would now be assessed on income of all types, with no upper limit.  That said, the rate did not rise.

That ended the payment skipping, though it is possible that a skip could happen in the future.  As it is, much of the current political climate is marked by intergenerational conflict, with Social Security viewed derisively as an old-age welfare plan.  A visitor to the grave of FDR did not find him doing 2000 RPM, but did note the skunk cabbage that someone helpfully planted there.  As it was, quiet euthanasia, some voluntary, some not, took place among the elderly Baby Boomers, tired of being labelled sponges on society, or picked off by annoyed caretakers.

It should be noted that as benefits were cut in real terms, friends and families of the some elderly and disabled helped out, but many elderly people led lives of poverty.  Perhaps if they had expected this, they would have prepared, but they trusted the malleable promises of the US Government.

The open question at present is whether it was wise for society to promote collective security schemes.  As it is, with seven states in pseudo-bankruptcy, many municipalities in similar straits if not real bankruptcy, and many countries suffering with worse demographic problems than the US, the problems of these arrangements are apparent:

  • Breaking the link between childbearing and support in old age discouraged childbearing.
  • Every succeeding generation of participants got a worse deal than those that came before.
  • Politicians learned to prioritize the present over the future, and use monies that should have been put to some productive future use into the benefit of those who would consume currently.
  • Complexity encouraged gaming of the system, whether it was maxing benefits, or faking disability.
  • Retirement ages that were too low made the burden too heavy to the workers supporting retirees.

Future articles in this retrospective series will touch on some of the other problems we have recently faced, as many involuntary collective security measures have hit troubled times, and the unintended effects of too much debt, both governmental and private are still with us.

Photo Credit: Christopher || Maintaining a marriage is simple… if you do it right…


There are at least eight reasons why taking a simple approach to investing is a wise thing to do.

  1. Understandable
  2. Explainable
  3. Reduced “Too smart for you own good risk”
  4. Clearer risk management
  5. Less trading
  6. Taxes are likely easier
  7. Not Trendy
  8. Cheap


You have to understand your investments, even if it’s just at the highest overview level.  If you don’t have that level of understanding, then at some point you will be tempted to change your investments during a period of market duress, and it will likely be a mistake.  Panic never pays.  How to avoid panic?  Knowledge reduces panic.  Whatever the strategy is, follow it in good times and bad.  Understand how bad things can get before you start an investment program.  Make changes if needed when things are calm, not in the midst of terror.


You should be able to explain your investment strategy at a basic level, enough that you can convey it to a friend of equal intelligence.  Only then will you know that you truly understand it.  Also, in trying to explain it you will discover whether your investments are truly simple or not.  Does your friend get it, even if he may not want to imitate what you are doing?

Take an index card and write out the strategy in outline form.  Would you feel confident talking for one minute about it from the outline?

Reduced “Too smart for your own good risk”

If you have simple investments, you will tend not to get unexpected surprises.  One reason the rating agencies did so badly in the last crisis was that they were forced to rate stuff for which they did not have good models.  The complexity level was too high, but the regulators required ratings for assets held by banks and insurers, and so the rating agencies did it, earning money for it, but also at significant reputational risk.

Why did the investment banks get into trouble during the financial crisis?  They didn’t keep things simple.  They held a wide variety of complex, illiquid investments on their balance sheets, financed with short-term lending.  When there was doubt about the value of those assets, their lenders refused to roll over their debts, and so they foundered, and most died, or were forced into mergers.

I try to keep things simple.  Stocks that possess a margin of safety and high quality bonds are good investments.  Stocks have enough risk, and high quality bonds are one of the few assets that truly diversify, along with cash.  That makes sense from a structural standpoint, because fixed claims on future cash are different than participating in current profits, and the change in expectations for future profits.

Clearer risk management

When assets are relatively simple, risk management gets simple as well.  Assets should succeed for the reasons that you thought they would in advance of purchase.  Risk assets should primarily generate capital gains over a full market cycle.  fixed Income assets help provide a floor, and limit downside, so long as inflation remains in check.

With simple asset allocations, you don’t tend to get negative surprises.  Does an income portfolio fall apart when the stock market does?  It probably was not high quality enough.  Does you asset allocation give large negative surprises close to retirement?  Maybe there were too many risk assets in the portfolio after a long bull run.

Cash and commodities (in small amounts) can help as well.  Those don’t have yield, and don’t typically provide capital gains, but they would help if inflation returned.

Less trading

Simplicity in asset allocation means you can sleep at night.  You’ve already determined how much you are willing to lose over the bear portion of a market cycle, so you aren’t looking to complicate your life through trying to time the market.  Few people have the disposition to sell near near top, and few have the disposition to buy near near the bottom.  Almost no one can do both.  (I’m better at bottoms…)

Pick a day of the year — maybe use your half-birthday (as some of my kids would say — it is six months after your birthday).  Look at your portfolio, and adjust back to target percentages, if you need to do that.  Then put the portfolio away.  If you have set your asset allocation conservatively, you won’t feel the need to make radical changes, and over time, your assets should grow at a reasonable rate.  Remember, the more conservative asset allocation that you can live with permanently is far better than the less conservative one that you will panic over at the wrong time.

Taxes are likely easier

Not that many people have taxable accounts, though half the assets that I manage are taxable, but if you don’t trade a lot, taxes from your accounts are relatively easy.  Unrealized capital gains compound untaxed over time, and there is the option to donate appreciated stock if you want to get a write-off and eliminate taxes at the same time.

Not Trendy

You won’t get caught in fads that eventually blow up if you keep things simple.  You may be pleasantly surprised that you buy low more frequently than your trendy neighbors.  Remember, people always brag about their wins, but they never tell you about the losses, particularly the worst ones.  Those who don’t lose much, and take moderate risks typically win in the end.


Simple investment strategies tend to have lower management fees, and fewer “soft” costs because they don’t trade as much.  That can be a help over the long run.

That’s all for this piece.  For most investors, simplicity pays off — it is that simple.


Just a note before I begin. My piece called “Where Money Goes to Die” was an abnormal piece for me, and it received abnormal attention.  The responses came in many languages aside from English, including Spanish, Turkish and Russian.  It was interesting to note the level of distortion of my positions among those writing articles.  That was less true of writing responses here.

My main point is this: if something either has no value or can’t be valued, it can’t be an investment.  Speculations that have strong upward price momentum, like penny stocks during a promotion, are dangerous to speculate in.  Howard Marks, Jamie Dimon and Ray Dalio seem to agree with that.  That’s all.

Now for Q&A:

Greetings and salutations.  🙂

Hope all is well with you and the family!

Just have what I believe is a quick question. I already know [my husband’s] answer to this (Vanguard index funds – it his default answer to all things investment), but this is for my Mom, so it is important that she get it right (no wiggle room for losing money in an unstable market), hence my asking you. My Mom inherited money and doesn’t know what to do with it. a quarter of it was already in index funds/mutual funds and she kept it there. The rest came from the sale of real estate in the form of a check. That is the part that she doesn’t know what she should do with. She wanted to stick it in a CD until she saw how low the interest rates are. She works intermittently (handyman kind of work – it is demand-dependent), but doesn’t have any money saved in a retirement account or anything like that, so she needs this money get her though the rest of her life (she is almost 60). What would you recommend? What would you tell [name of my wife] to do if she were in this position? BTW, it is approx $ZZZ, if that makes a difference. Any advice you can give would be very much appreciated!

Vanguard funds are almost always a good choice.  The question here is which Vanguard funds?  To answer that, we have to think about asset allocation.  My thoughts on asset allocation is that it is a marriage of two concepts:

  • When will you need to spend the money? and
  • Where is there the opportunity for good returns?

Your mom is the same age as my wife.  A major difference between the two of them is that your mom doesn’t have a lot of investable assets, and my wife does.  We have to be more careful with your mom.  If your mom is only going to draw on these assets in retirement, say at age 67, and will draw them down over the rest of her life, say until age 87, then the horizon she is investing over is long, and should have stocks and longer-term bonds for investments.

But there is a problem here.  Drawing on an earlier article of mine, investors today face a big problem:

The biggest problem for investors is low future returns.  Bonds have low rates of returns, and equities have high valuations.  You’ll see more about equity valuations in my next post.

This is a real problem for those wanting to fund retirements.  Stocks are priced to return around 4%/year over the next ten years, and investment-grade longer bonds are around 3%.  There are some pockets of better opportunity and so I suggest the following:

  • Invest more in foreign and emerging market stocks.  The rest of the world is cheaper than the US.  Particularly in an era where the US is trying to decouple from the rest of the world, foreign stocks may provide better returns than US stocks for a while.
  • Invest your US stocks in a traditional “value” style.  Admittedly, this is not popular now, as value has underperformed for a record eight years versus growth investing.  The value/growth cycle will turn, as it did back in 2000, and it will give your mom better returns over the next ten years.
  • Split your bond allocation into two components: long US high-quality bonds (Treasuries and Investment Grade corporates), and very short bonds or a money market fund.  The long bonds are there as a deflation hedge, and the short bonds are there for liquidity.  If the market falls precipitously, the liquidity is there for future investments.

I would split the investments 25%, 35%, 20%, 20% in the order that I listed them, or something near that.  Try to sell your mom on the idea of setting the asset allocation, and not sweating the short-term results.  Revisit the strategy every three years or so, and rebalance annually.  If assets are needed prematurely, liquidate the assets that have done relatively well, and are above their target weights.

I know you love your mom, but the amount of assets isn’t that big.  It will be a help to her, but it ultimately will be a supplement to Social Security for her.  Her children, including you and your dear husband may ultimately prove to be a greater help for her than the assets, especially if the markets don’t do well.  The asset allocation I gave you is a balance of offense and defense in an otherwise poor environment.  The above advice also mirrors what I am doing for my own assets, and the assets of my clients, though I am not using Vanguard.


This will be a short post, though I want to toss this question out to readers: what investment strategies do you know of that are simple, and work on average over the long-term?

Here are four (together with posts of mine on the topic):

1) Indexing

Index Investing is not Inherently Socialistic

Why Indexes are Capitalization-Weighted

Why do Value Investors Like to Index?

On Bond Investing, ETFs, Indexes, and the Current Market Environment

2) Buy-and-Hold

Buy-and-Hold Can’t Die

Buy-and-Hold Can’t Die, Redux

Buy and Hold Will Return — 2/15/2009 (what a time to write this)

Patience and a Little Courage

Risk vs Return — The Dirty Secret

3) The Permanent Portfolio

The Permanent Portfolio

Can the “Permanent Portfolio” Work Today?

Permanent Asset Allocation

4) Bond Ladders

On Bond Ladders

I chose these because they are simple.  Average people without a lot of training could do them.  There are other things that work, but aren’t necessarily simple, like value investing, momentum investing, low volatility investing, and a few other things that I will think of after I hit the “Publish” button.

That said, most people don’t need to work on investing.  They need to work on cash management, and I have written a small fleet of articles there.  Managing cash is simple, but it takes self-control, and that is what most people lack in their financial lives.

But for those that have gotten their cash under control, with a full buffer fund, the above strategies will help, and they aren’t hard.

Final note: I realize valuations are high now, so buy-and-hold is not as attractive as at other times.  I realize that interest rates are low, so bond ladders aren’t so great, seemingly.  Indexing may be overused.  Most of the elements of the Permanent Portfolio look unappealing.

But what’s the alternative, and simple enough for average people to do?  My answer is simple.  If they can buy and hold, these strategies will pay off over time, and far better than those that panic when things get bad.  There are few regularities in the markets more reliable than this.


This is a small thing, and so this will be a small post.

Learn to set your expectations right.

When you buying something and see a price like $19, $19.95, or $19.99, think $20.

When you are buying a car, and see prices like $19,000, $19,900, $19,990, or $19,999, think $20,000.  The same thing applies to homes, and be sure you have a strong estimate of all of the extra taxes and fees that will get thrown into the price.

People tend to look at the front number(s) and get mesmerized.  Learn to round it up as a buyer.  We tend to get too quick in our judgments, and be too optimistic when we buy, so round prices up — especially true if you are on a budget, and you are keeping a running total of costs.

Now, if you think this doesn’t happen in institutional pricing, it happens there as well.  I remember cases where I was trying to sell bonds, and I could not get a deal done, I would ask my sales coverage, “Why? How is the other side pricing the bond?”  If it was a dollar price like $100, I would make a note of it, and if the market fell for general reasons under that price, I would make an offer a little under the price, say $99.95.  Frequently, I would sell the bonds for my client, even if the yield spread had worsened in relative terms, and the bonds were less attractive to a more rational buyer.  The same applied to other means of pricing bonds, and applied the opposite way if I was trying to buy bonds.  You would be surprised how many were looking for a shiny price like $105, and after a general rally deals would get done at $105.01.

Buffett has sometimes had a phrase, “Your price, my terms.”  If there are other facets to the deal than merely price, try giving the other guy his price in a prominent way, with other terms that favor what you want to achieve.

You would think that people would be more rational, but they are often not, and you and I aren’t much better.  That is why I encourage you to think conservatively in your economic decisions to avoid undue optimism.

PS — remember that this happens with institutional investors in setting target prices as well — they like the glossy round numbers.


I will admit, when I first read about the Permanent Portfolio in the late-80s, I was somewhat skeptical, but not totally dismissive.  Here is the classic Permanent Portfolio, equal proportions of:

  • S&P 500 stocks
  • The longest Treasury Bonds
  • Spot Gold
  • Money market funds

Think about Inflation, how do these assets do?

  • S&P 500 stocks – mediocre to pretty good
  • The longest Treasury Bonds – craters
  • Spot Gold – soars
  • Money market funds – keeps value, earns income

Think about Deflation, how do these assets do?

  • S&P 500 stocks – pretty poor to pretty good
  • The longest Treasury Bonds – soars
  • Spot Gold – craters
  • Money market funds – makes a modest amount, loses nothing

Long bonds and gold are volatile, but they are definitely negatively correlated in the long run.  The Permanent Portfolio concept attempts to balance the effects of inflation and deflation, and capture returns from the overshooting that these four asset classes do.

What did I do?

I got the returns data from 12/31/69 to 9/30/2011 on gold, T-bonds, T-bills, and stocks.  I created a hypothetical portfolio that started with 25% in each, rebalancing to 25% in each whenever an asset got to be more than 27.5% or less than 22.5% of the portfolio.  This was the only rebalancing strategy that I tested.  I did not do multiple tests and pick the best one, because that would induce more hindsight bias, where I torture the data to make it confess what I want.

I used a 10% band around 25% ( 22.5%-27.5%) figuring that it would rebalance the portfolio with moderate frequency.  Over the 566 months of the study, it rebalanced 102 times.  At the top of this article is a graphical summary of the results.

The smooth-ish gold line in the middle is the Permanent Portfolio.  Frankly, I was surprised at how well it did.  It did so well, that I decided to ask, what if we drop out the T-bills in order to leverage the idea.  It improves the returns by 1%, but kicks up the 12-month drawdown by 7%.  Probably not a good tradeoff, but pretty amazing that it beats stocks with lower than bond drawdowns.  That’s the light brown line.

ResultsS&P TRBond TRT-bill TRGold TRPP TRPP TR levered
Annualized Return10.40%8.38%4.77%7.82%8.80%9.93%
Max 12-mo drawdown-43.32%-22.66%0.02%-35.07%-7.65%-14.75%


Now the above calculations assume no fees.  If you decide to implement it using SPY, TLT, SHY and GLD, (or something similar) there will be some modest level of fees, and commission costs.


 What Could Go Wrong

Now, what could go wrong with an analysis like this?  The first point is that the history could be unusual, and not be indicative of the future.  What was unusual about the period 1970-2017?

  • Went off the gold standard; individual holding of gold legalized.
  • High level of gold appreciation was historically abnormal.
  • Deregulation of money markets allowed greater volatility in short-term rates.
  • ZIRP crushed money market rates.
  • Federal Reserve micro-management of short-term rates led to undue certainty in the markets over the efficacy of monetary policy – “The Great Moderation.”
  • Volcker era interest rates were abnormal, but necessary to squeeze out inflation.
  • Low long Treasury rates today are abnormal, partially due to fear, and abnormal Fed policy.
  • Thus it would be unusual to see a lot more performance out of long Treasuries. The stellar returns of the past can’t be repeated.
  • Three hard falls in the stock market 1973-4, 2000-2, 2007-9, each with a comeback.
  • By the end of the period, profit margins for stocks were abnormally high, and overvaluations are significant.

But maybe the way to view the abnormalities of the period as being “tests” of the strategy.  If it can survive this many tests, perhaps it can survive the unknown tests of the future.

Other risks, however unlikely, include:

  • Holding gold could be made illegal again.
  • The T-bills and T-bonds have only one creditor, the US Government. Are there scenarios where they might default for political reasons?  I think in most scenarios bondholders get paid, but who can tell?
  • Stock markets can close for protracted periods of time; in principle, public corporations could be made illegal, as they are statutory creations.
  • The US as a society could become less creative & productive, leading to malaise in its markets. Think of how promising Argentina was 100 years ago.

But if risks this severe happen, almost no investment strategy will be any good.  If the US isn’t a desirable place to live, what other area of the world would be?  And how difficult would it be to transfer assets there?


The Permanent Portfolio strategy is about as promising as any that I have seen for preserving the value of assets through a wide number of macroeconomic scenarios.  The volatility is low enough that almost anyone could maintain it.  Finally, it’s pretty simple.  Makes me want to consider what sort of product could be made out of this.


Back to the Present

I delayed on posting this for a while — the original work was done five years ago.  In that time, there has been a decent amount of digital ink spilled on the Permanent Portfolio idea of Harry Browne’s.  I have two pieces written: Permanent Asset Allocation, and Can the “Permanent Portfolio” Work Today?

Part of the recent doubt on the concept has come from three sources:

  • Zero Interest rate policy [ZIRP] since late 2008, (6.8%/yr PP return)
  • The fall in Gold since late 2012 (2.7%/yr PP return), and
  • The fall in T-bonds in since mid-2016 (-4.7% annualized PP return).

Out of 46 calendar years, the strategy makes money in 41 of them, and loses money in 5 with the losses being small: 1.0% (2008), 1.9% (1994), 2.2% (2013), 3.6% (2015), and 4.5% (1981).  I don’t know about what other people think, but there might be a market for a strategy that loses ~2.6% 11% of the time, and makes 9%+ 89% of the time.

Here’s the thing, though — just because it succeeded in the past does not mean it will in the future.  There is a decent theory behind the Permanent Portfolio, but can it survive highly priced bonds and stocks?  My guess is yes.

Scenarios: 1) inflation runs, and the Fed falls behind the curve — cash and gold do well, bonds tank, and stocks muddle.  2) Growth stalls, and so does the Fed: bonds rally, cash and stocks muddle, and gold follows the course of inflation. 3) Growth runs, and the Fed swarms with hawks. Cash does well, and the rest muddle.

It’s hard, almost impossible to make them all do badly at the same time.  They react differently to changes in the macro-economy.


There are a lot of modified permanent portfolio ideas out there, most of which have done worse than the pure strategy.  This permanent portfolio strategy would be relatively pure.  I’m toying with the idea of a lower minimum ($25,000) separate account that would hold four funds and rebalance as stated above, with fees of 0.2% over the ETF fees.  To minimize taxes, high cost tax lots would be sold first.  My question is would there be interest for something like this?  I would be using a better set of ETFs than the ones that I listed above.

I write this, knowing that I was disappointed when I started out with my equity management.  Many indicated interest; few carried through.  Small accounts and a low fee structure do not add up to a scalable model unless two things happen: 1) enough accounts want it, and 2) all reporting services are provided by Interactive Brokers.


Besides, anyone could do the rebalancing strategy.  It’s not rocket science.  There are enough decent ETFs to use.  Would anyone truly want to pay 0.2%/yr on assets to have someone select the funds and do the rebalancing for him?  I wouldn’t.