The Markets are Mad – Time for a Fundamental Strategy change

I have been on a simple path to wealth. But with the markets going mad, I’ve done the biggest revision of my investment philosophy in 10 years (when I decided to get one). I’ve decided on a broadly diversified asset class mix, with divergent correlations to do well in all conditions, this will be actively rebalanced with new deposits.

“Tony, by having a fifty-fifty portfolio, you really have more like a ninety-five percent risk in stocks”

Ray Dalio in Money Master the Game

For a while, the surest path to Financial Independence was property, then it was (is?) to just buy the market with broad-based passive index funds. It changes over time, the fundamentals stay the same (otherwise they aren’t fundamentals), but the instruments and options available change.

I’ve been following the simple path to wealth, buying VTI (55%) and VEU (45%) monthly for the last 8 months. Trusting the market – at least over the long run. But watching GamesStop Corp, Tesla and Bitcoin over the last 1-6 months. I am not convinced the market has a clue.

People who have never made a personal investment in their lives, the first question they seem to ask, is where can I buy Tesla and Bitcoin? – When I’m seeing it on TV, all I see is hype and a bubble, yes there could be fundamental value there, but I don’t know what proportion is hype and what is value.

My first VTI and VEU purchases in May 2020 are up 37%. Even with Dollar Cost Averaging (DCA) my eToro portfolio is up a staggering 17%-20%. Yes, I got lucky in that a lot of this was a recovery from a massive dip (do I need to avoid the next one? What if I was on the other side?). But the 1-year return on VTI is 17% and VEU is 11% – this after a mini-correction and during a pandemic – this really doesn’t make sense to me.

What is going on?

  • Do I think the market is over-valued? – Yes.
  • Do I think there will be a correction? – Probably.
  • Do I think that the market might still continue to grow and I shouldn’t miss out? – Also, probably.
  • Do I know there will be a crash? – Yes.
  • Do I know when there will be a crash? – Not a clue.
  • Do I think it’s going to volatile and bumpy ride? – Absolutely.

It’s tricky to balance between staying the course (chopping and changing will result in failure) and avoiding being trapped into cognitive dissonance. New thoughts emerge and ideas can be improved upon. They become better and are not necessarily opposing. VHS became DVDs which became Streaming. The fundamentals stay the same.

My default strategy has been buy the market. VTI and VEU to be precise. Then myself, Barclays and Investec also own two properties together, which I am the minority partner in both. I am excluding these properties as they are not really part of this strategy and more a result of the buying vs. renting where the maths made sense. It has meant that I’m probably lighter on REITs than I perhaps would be otherwise.

So far, I have been buying market-weighted index funds which means that I am arguably ascribing to Momentum investing – it goes up, so I buy more, as it will continue to go up. The counter philosophy is Value investing – sell high, buy low.

Over this last weekend, I have revisited the fundamentals and married those into the options currently available.

Why it is important

“In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”

Attributed to Benjamin Graham

The problem is that life is perhaps a short run. Especially on a FIRE journey. Academically, the Value investing argument makes sense. This is offset by the efficient market hypothesis – all known facts [on average] are priced in – so there is no value without insider information.

With a 4 year targeted Financial Independence time horizon, I can’t just ignore volatility, like I can in my pension, which has a 30-year horizon. I also know that asset allocation and rebalancing can reduce risk and at times even enhance return.

I did some sensitivity analysis on my financial forecast model. Only really focusing on the impact of stocks.

  • Currently, I am 37% FI and 44% lean FI
  • I typically use 7-8% after inflation return (I had to use something) – which projects me reaching 98% of my FIRE number (Lean FI 117%)
  • Assuming 0% return – This drops to  92%.

Then I looked at the drivers:

  • 1.48X of the growth is determined by my high savings rate (89%)
  • 0.18X of the increase is determined by the return (11%)

But if the market drops 20%:

  • Assuming all in cash (0%) – 92% of FI
  • Stocks (7-8%) – 74% of FI

So the key needle mover is savings rate and my risk sits in two areas, losing my job and asset allocation.

The last decade has seen two drops of 50%. It may not happen, or it may happen and recover, but it’s just not worth the risk to me. I’ve argued that I’m all-in on stocks because I’m in the Wealth accumulation phase. But maybe I’m not.

Going back to fundamentals

Reverting back to my principles or fundamentals, there are really only 4 things you can do:

  • Start early
  • Diversify – I have been doing this across stocks, but not asset classes.
  • Reduce fees and taxes – I do this as much as makes sense.
  • Rebalance – sell high, buy low – I haven’t been doing this.

A smart mate of mine messaged me the below which got me thinking that we are in a unique time, where we cannot rely on past strategies alone –

“Low-interest rates in the US are driving up a few main asset classes from what I’ve seen.

1) cost of education, 2) cost of equities (shares), 3) cost of housing …

These asset classes are not included in the CPI but have massive long-lasting adverse effects in the economy which are not measured in the short/ medium term as a result of future depressed disposable consumer income (be It a graduate who has massive debt, a house owner who has paid off a bigger home loan, or people who invested in shares getting lower returns as they paid such a high price for them currently ). So if you ask me… Inflation is getting “exported” to the future”

In other words inflation may be dead, but reborn in a different way.

I knew I needed to start thinking differently, so I sought counsel from people smarter than me.

Some thoughts from people smarter than me

The below is mostly extracted from Money Master the Game. Where Tony Robbins had access to people whose thoughts are usually reserved for people with $100m+ NAV.

From Swensen –
Asset Allocation is key

From Dalio

As I read through the thinking of many of the greats, they had vastly varying strategies, but these three fundamental principles applied consistently.

  • Asset Allocation <- most important decision
  • Do well in all conditions
  • Don’t lose money (this needs to include losing to inflation)

They actually follow from each other, with the correct asset allocation, I can do well in all conditions and I won’t lose (as much) money in worse conditions.

Dalio broke it down like this – the two key variables are prices and economic growth.

RisingHigher than expected economic growthHigher than expected inflation
FallingLower than expected economic growthLower than expected inflation
We need to do well in all conditions

It is effectively an interpretation of the permanent portfolio:

  • Prosperity: stocks
  • Recession: cash (or commonly short term treasuries)
  • Inflation: gold
  • Deflation: long term treasuries

As it stands, I will only do very well in prosperity and have to ride out the other market conditions.

So what now?

The next steps I took were to watch hours of youtube videos (some of which I’ve linked below – not necessarily even the better ones, just some of the good ones) and examine a few portfolios to identify ones with a decent return and a low standard deviation.

This perhaps doesn’t factor in that these are smart people and they have tried to find something simplified and consistent enough to share – in reality, they will have a more complex and dynamic approach.

For example, at the time Dalio suggested a heavy weighting in bonds, but these were a proxy for what could do well, based on more recent videos, I’m sure it would be substituted to a greater balance away from Bonds – given the current conditions.

Three portfolios I specifically took inspiration from:

  • Golden Butterfly – A very counter-intuitive approach, that finds a simplified portfolio 5 fund portfolio, that gives a surprisingly good result historically. The theory.
  • Swensen Portfolio – A broader diversification than a lot of US asset managers.
  • All Seasons – Dalio’s do well in all conditions approach.

My Asset Allocation

As mentioned earlier, I’m not including my two properties. They were from a rent vs. buy decision and are funded by rent, mine and my tenants.

Based on a lot of reflection, I’ve decided to go with a constant rebalancing or active management approach – Not to be confused with active selection. Each month, when I invest, it will be allocated in a way to go towards re-balancing my portfolio. This could mean that I miss out on some big runs, but over time as each builds up, it should mean my monthly allocation lags this. It does systemize – sell high, buy low – leveraging volatility.

Again, inspired by Dalio, I’m looking for diversification and differentiation across countries, currencies and asset classes. I also want to focus on having liquidity – I have too much locked into property and my pension.

I went through multiple iterations of the below and most of this is based on my circumstances and biases, but perhaps sharing it may help. It will change, but I need to start somewhere.

Overall I’ve ended up with 78% stocks, 18% bonds/cash, and 4% Commodities. The difference with the stocks is that I’ve focused more on differentiation within them.

I did some high-level back-testing on Portfolio Charts – Which is far from a perfect indicator, but it is useful. I also had to use proxies and it doesn’t take into account active rebalancing.

PortfolioAverage ReturnStandard DeviationLoss Frequency
All Seasons5.77.925%
Golden Butterfly6.57.918%
Total Stock Market (US)8.31727%
*Not every asset class is included, accurately, it also assumes US citizen.

So, I haven’t found the secret sauce, perfect portfolio. I am comfortable with it though. I’ve managed to reduce the standard deviation, which means I’m not totally off.

How does this look specifically?

The specific assets are a lot more complex than what I have, but it is still manageable, as I’ve created a spreadsheet where I put in what I have, then what I have to invest, it then tells me how to allocate it actively.

8%BNDUS BondsUSBonds
9%BNDXGlobal BondsGlobal – Ex USBonds
36%VEUEx US – World MarketGlobal – Ex USStocks
3%EWYSouth Korea – World ValueKoreaStocks
5%VBRSmall Cap ValueUSStocks
5%VUGUS GrowthUSStocks
5%VTVUS ValueUSStocks

I should note, that I also put 5-7% extra into my access bond to reduce leverage risk and provide liquidity, before the above.

This gives me the below Asset Balance, to emphasize, I recognize that it is still too weighted towards “prosperity”, but I believe there is enough differentiation with the stocks, that I am comfortable with it.

Active rebalancing should enhance returns or at least reduce the downside risk – every month I’ll buy so it trends towards the target. This gives the assets time to fly, without me clipping their wings and I can buy the others when they are “low”. If one triples in value, I’ll just continue to buy the others, while they are relatively cheaper.

Geographically, I have a nice mix. Naturally weighted towards the US.

I have also considered factor investing, specifically – Market, Small Stocks, Value Stocks and Momentum/Growth in my selection. This is a key form of differentiation.

The way forward

I am going to rebalance for the majority of them this week.

For others, I’ll do it over time. Specifically into bonds (excluding my access bond) and the small portion into silver, gold and cryptos – I plan to Dollar Cost Average into those. Starting with silver.

I’ll refine my strategy over time, as I find the right balance of risk, return and complexity.

What does your asset allocation look like? Will you do well in all conditions or are you planning to ride out the madness when needed and HODL?

If I were to simplify it, and I didn’t have my own context, I’d go with a something like:

  • 35-40% Rest of the World -VEU
  • 35-40% US Market – VTI
  • 10-20% Bonds – BND/BNDX
  • 0-5% Gold/Silver/Commodities/Crypto – Gold/DJP
  • 0-5% Small Cap Value – VBR or some other factor

Resources: – I read and watched loads more (40+) and stopped adding them – this is to give you a flavour of them

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