Portfolio Diversification Needs To Make Sense

Brett Arends had a head scratcher of an article about a "crazy retirement portfolio" that has beaten the market for 50 years. The portfolio itself equal weights seven asset classes as follows.

 

The ETFs in the image are the ones Brett suggested as proxies for each asset class. Where it is several asset classes, equal weighted and rebalanced once per year, it seems similar to The Permanent Portfolio that equal weights stocks, long bonds, gold and cash. Portfoliovisualizer won't go back 50 years but here are the last ten years of the portfolio compared to 100% SPY and 100% Vanguard Balanced Index Fund (VBAIX) which is a proxy for a 60/40 portfolio.

 

The blue line, the portfolio, has not kept up anywhere near the red line (SPY) or the yellow line (VBAIX) which kind of makes sense. Where equities are the thing that goes up the most, most of the time a portfolio allocated 43% to equities (REITs only look like equities on the way down) is unlikely to keep up with 100% equities or 60% equities. That doesn't make Brett's portfolio bad on its face although a slightly higher standard deviation than 60/40 with a much lower CAGR isn't so hot. 

Let's compare Brett's portfolio to the Permanent Portfolio as designed by Harry Browne and the mutual fund that goes by the same name.

 

Brett's portfolio does well in this comparison but here it is heavier in equities than the other two, even if just a little more than PRPFX. 

This is ground we've covered many times. The last ten years could be an aberration but Brett's portfolio seems unlikely to keep up with more standard asset allocation benchmarks and certainly not the stock market. It wildly outperformed both SPY and VBAIX in 2022 which makes sense, less equity exposure and less fixed income exposure even though REITs got crushed. 

An idea like Brett's portfolio seems valid enough to me. Someone who's a little ahead of the game might be better off with a portfolio that has less volatility but gives a good chance of staying ahead of inflation over a longer period. In my opinion, the mix of the seven funds as Brett presented them will achieve the effect but is not the best way to do so. Reduced exposure to interest rate risk makes sense to me, I think 14% in REITs is way too much, same for gold in my opinion. 

Exploring different ways to manage volatility in a portfolio is kind of a hobby around here but when you go down this road it is crucial to take the time to learn what a given portfolio won't do and whether you can live with that. If you need to keep up with equities somewhat, then you don't want to build a portfolio that looks like the one Brett featured in his article.