THE THEORY
According the The Intelligent Investor By Benjamin Graham, the Investor should have a substantial bond component to counteract the dips in the volatile stock component. He should seek to have anywhere from 25% - 75% of his money in the bond component - preferentially a 50/50 split. His method suggested that you rebalance on some long-term frequency (quarterly, annually, etc.) so as to keep the balance. In doing so the theory goes that you would have money to re-invest during the dips in the market and thus come out ahead of the person who would solely invest in stocks.
THE DATA
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65 Years of S&P 500 Data.
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65 Years of S&P 500 Avg Dividend.
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65 Years of US Treasury Yields on Long Term Bonds.
THE MODEL
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The model will Dollar-Cost Average into the market with some split going into the a general bond fund.
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The amount to Dollar-Cost Average is not a fixed number. Its basically a calculated amount based on inflation and lower-middle class salary investing 15% into his 401K. (All this is to say think about $100 per month in 1954 and ~$700 per month now).
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The split between the stock and bond components is initially user determined. Excel will go on to solve for the best overall return.
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Dividends, whether from the stock market or the bond component, are paid out annually and are re-invested.
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The Bond Coupon Rate is user determined -- Unfortunately the math was too complicated for a spreadsheet without running simulations iteratively to use actual treasury data.
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Re-balancing is done in either one or two methods(More methods to come!!)
(1) Re-balancing on a predetermined frequency.
(2) Re-balancing reactively to market conditions. Specifically, in this model it would be to dips in the market. So only rebalance when the market tumbles.
THE RESULTS - Prefatory Comments
As we all know the general market goes up readily year over year. Over this 65 year period to present, it has gone up 7.6% year over year. The bond component is steady given its user inputted, but in general it has decreased. The real money in these situations has been selling bonds and not waiting for them to mature. There is no easy way to track the market price for individual bonds across the years, so I will have to have an update at a later time providing additional info.
THE RESULTS - Actually this time...
So plain and simple, it proved to be a fruitless endeavor to have a bond component whatsoever. No matter which method of rebalancing chosen, it was better to have 100% of your money in the general market. (In-fact the reactive method of rebalancing your portfolio worked out worse than doing it on a schedule) The returns realized were far more than the market average given the dividend re-investment OVERALL RETURN ~44,000% :: COMPOUNDED RATE ~6% Year over Year (Some of you may be confused a little as to how you can have the market go up 7.6% year over Year on average and still do better than the market at a 6% Year over Year return with dividends, and thats because the trailing end of the model is not reflective of the averages and will both skew and distort the information. Additionally, the money recently invested will show a 0% return in the immediate; money really needs to be in the market for a while for it to be entirely reflective.)
One might be asking at this time, ok well these numbers entirely depend on the coupon rate selected for bonds, and I would totally agree. Thats why I over-estimated the bond coupon rate at 7% or more, and still it was optimal to put 100% into stocks.
For more information. Excel would change both the balance as well as the frequency in the first model and it always landed on 100% stock component as being the most optimal. In the second model it would optimize the balance as well as how much the market had to drop before rebalancing. Similarly, 100% was the most optimal. What was determined from graphing the data was that unless one had foresight into coming crashes it was only optimal to keep all of your money in the market. A future analysis will have to be done to determine about how much foresight would be needed. To elaborate further, if you could sense a market recession coming on it would be beneficial to skew your balance (something Graham recommends if possible) and this model didnt show that. This is obvious but difficult to put into practice for fear of losing out.
Graham advised this for a few reasons that were not elaborated, in his day the index funds available to us today were not available and his advice wasnt as simple as... rain or shine you are to rebalance... as mentioned in the last paragraph, you were to use an understanding of the market to determine what ratio of stocks to bonds you should have and not keep it a set ratio.
FINAL COMMENTS If you are to invest in bonds, do so not as a consistent strategy or reactively. It should be done as a hedge against future crashes if you are to make money from it. Another analysis will soon look at foresight hedging your portfolio and then returning post-crash to a predominate stock based portfolio. Also, a 100% index fund into the S&P 500 proves to work out just fine and shouldnt be looked down upon as a great way to make money for your retirement.
Submitted February 08, 2020 at 07:15PM by BigCastIronSkillet https://ift.tt/2H6kYZZ
