Tuesday, January 6, 2009

Lazy Portfolios (2): Risk Analysis

In the previous post, we compared the total 10 year return of the lazy portfolios and found that the Ultimate Buy&Hold Portfolio was the winner. However, the portfolios are not created equal, since the allocation of the bond funds and stock funds are not the same in these portfolios. How much risk we would have to take in order to achieve the total return in each of these portfolios?

Historical return suggests that stocks always out-perform bonds in the long run. General assumption is that the more stocks in a portfolio, the higher return, and also the higher risk involved. So what is the bond and stock allocation in each of the portfolio and how the asset allocation corresponds to the total return in 10 years?

The table below lists the total return, bond and stock allocation of the Lazy Portfolios.

(1) The first group of the portfolios (Ultimate Buy & Hold, Coffee House and Dr. Bernstein's Smart Money) contains 40% bond funds and 60% stock funds, the highest bond allocation (40%) in the group. They can be considered to be the safest in the Lazy Portfolios.
(2) The next group of portfolios (Margaritaville, Yale unconventional, Aronson Family Portfolio) contains ~ 70% stock funds and 30% bond funds. This group can be considered the 2nd safest portfolios.
(3) Dr. Bernstein's No Brainer portfolio contains 75% stock funds. This is a relatively aggressive portfolio.
(4) The second grader's Starter Portfolio contains 90% stock funds. It can be considered as a very aggressive portfolio.
(5) The last one is the Vanguard S&P500 Index which contains 100% stock, used as comparison.

In contrast to our general belief that more stocks, higher return, the first group of portfolio with 60% stock and 40% bond performed the best during the period studied (1998-2008). As you can see from the graph below, it looks like that the total return is inversely related to the stock allocation in these portfolios. The higher the stock allocation, the lower the total return, with the S&P500 Index performed the worst.

The first group of Lazy portfolios with 40% bond/60% Stock allocation (Ultimate Buy & Hold, Coffee House and Dr. Bernstein's Smart Money) gave the best return during the 10 year (1998-2008) studied. In this case, the higher the stock allocation, the lower total return. The Ultimate Buy&Hold portfolio gave the best return with a relatively safe asset allocation (40% bond, 60% stock), the best choice with controlled risk in the group.

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