Archives for June 19, 2017

Research Affiliates Custom Portfolio Expected Returns Tool

“The editorial content on this page is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are author's alone.”

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Investment advisory firm Research Affiliates has updated their interactive Asset Allocation tool, which now provides estimates of expected returns for more than 130 asset classes and model portfolios. There are two expected return models, “valuation-dependent” and “yield--growth”. In addition, you can input your own custom asset allocation.

My initial reaction is that while the tool got new bells and whistles, it also became more confusing to navigate and harder on the eyes. Here’s a screenshot of their scatter plot showing the expected risk and return for several asset classes under their valuation-dependent model.

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I created a custom portfolio “CustomMMB” using my current portfolio asset allocation and it is charted below on their risk/return map. In a separate window (not shown) you can see how each individual asset class contributes to the total expected return.

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As you can see, my portfolio did not offer the maximum expected return for its risk level. The RA efficient model portfolio that did includes an exotic mix of asset classes, including Emerging Markets bonds (non-local currency), Bank Loans, US Private Equity, European Private Equity, and direct investments into US Commercial Real Estate (not through REITs). Unfortunately, I’m not even sure how to access many of those asset classes.

I appreciate that they freely share their research methodology and results, specifically covering the valuation perspective. US Equities have historically high valuations, but interest rates are also at historically lows. The next 10 years should be interesting…

Another portfolio analysis tool that lets you input your specific asset allocation is PortfolioCharts.com Safe Withdrawal Rate calculator. This Research Affiliates tool says my expected 10-year real return is only 2.4% (equates to a nominal expected return of 4.6%). The PortfolioCharts.com tool says the same personal asset allocation has a historical perpetual withdrawal rate of over 4% over a 40-year timeframe.

PortfolioCharts.com Safe Withdrawal Rate Tool (Updated)

“The editorial content on this page is not provided by any of the companies mentioned, and has not been reviewed, approved or otherwise endorsed by any of these entities. Opinions expressed here are author's alone.”

eggosI just noticed that PortfolioCharts.com has updated their Withdrawal Rate Calculator. It has improved visualizations and as a personal finance geek I even found it fun. You can enter your specific asset allocation slices down to 1% and see customized results.

The Withdrawal Rates calculator shows the safe withdrawal rate for any asset allocation over a variety of retirement durations based on real-life sequence of returns. Those looking to retire early or leave money to heirs can also see the perpetual withdrawal rate that protected the original inflation-adjusted principal.

You can read about the specifics behind these improvements here. You should also read all the assumptions here. For example:

The withdrawal rate is the percentage of the original portfolio value used for one year of retirement expenses. Each year, expenses are adjusted for inflation (not for portfolio size) to maintain constant purchasing power.

Briefly, a “safe” withdrawal rate (orange) allowed a portfolio to go as low as $1 but never hit zero at the end of the timeframe. In other words, the ride could have still gotten quite hairy for a while. A “perpetual” withdrawal rate (green) never ended up less than the initial principal, even adjusted for inflation. The author Tyler recommends the perpetual WR for early retirees or for people who desire to leave an inheritance for heirs.

Here is the specific chart for my current portfolio asset allocation:

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I would be quite happy with being able to confidently withdraw over 4% (+ inflation adjustments) of my portfolio for the next 40 years. The short-term drawdown paths can still be scary though. The usual caveats with using backtested data also apply.

Playing around, I noticed that the simplest way to change things up was by adding a healthy chunk (~20%) of gold instead of stocks. This seemed to significantly improve the perpetual withdrawal rates in the short-term (0 to 15 years). It’s too bad I still don’t have a firm fundamental understanding of gold. If you can’t maintain faith in it when things are scary, then you shouldn’t own it in your portfolio.

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