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Dear ProFolio

Dear ProFolio,

I’m trying to build a portfolio that will generate a zero real rate of return that will buy me the same amount of goods today as it would 30 years from now. I have 25% in gold, 25% in a 5yr CD ladder, 25% in Global Bonds, 5% in Long/Short Fund, 5% in short term TIPS, and 5% each in Swiss, Singapore, Norwegian currencies. Would you recommend anything different?


Your goal is to match inflation with minimal volatility. Lets make a simplified model of your portfolio to see what your current expectation should be for return and volatility is and see if adjustments can be made to lower the volatility for the desired return.

The 5-yr CD ladder consists of 1-yr, 2-yr, 3-yr, 4-yr and 5-yr CDs. After each year, a new 5-yr CD is purchased. 5-yr CD rates are similar to 5-yr treasury yields. In our model we will use 5-yr treasuries.

We will use Barclays Global Aggregate for the global bond holding.

Long/short funds can offer some exposure to equities with potentially lower volatility. The downside of long/short funds is that the have higher expense ratios (averaging 1.8%) than typical index funds (<0.25%). There is not a good model of long/short fund. For the model we will assume the long/short fund captures 75% of the markets positive and negative returns. Since this is only a 5% holding in the portfolio it shouldn't impact things too much if we are a little off.

The 5 year TIPS data only goes back to 2003. Luckily, 5 year TIPS correlate very well with 5 year treasuries (0.84). We can use the 5 year treasuries as the model for our TIPS holding.

Being long foreign currencies is essentially being short the dollar. Individual currencies are volatile, for example, over the last 45 years the Swiss Franc has fallen from 3.88 to 0.98. The Singapore dollar has risen from 0.48 in 1982 to 0.74. The Norwegian Krone has fallen from 0.15 in 1989 to around 0.12. For this simplified model we will short the US Dollar Index with the foreign currency. This should give us an inflation hedge from a falling US dollar.

Here are the model portfolio holdings along with annualized return data and volatility from 12/31/96 through 10/31/17.

From 12/31/96 through 10/31/17 this portfolio had an annualized return of 4.73% with an annualized volatility of 5.85%. Over this period inflation averaged 2.12%.

Note that gold has the highest volatility. By putting some of the gold holding into 90-day T-Bills you can lower volatility and still meet your goal of meeting or exceeding inflation.

Additionally, assuming the portfolio follows a normal distribution, once the annualized volatility is below the annualized return the probability of the portfolio losing value in any given year is below 16% or less than one year out of every 6 years.

My first recommendation is to lower your gold holding until the expected volatility falls below the expected return. Therefore make your gold holding around 10% with 15% put into 90-day T-Bills.

The next recommendation to lower overall volatility would be to lower your foreign currency exposure. I understand the desire to create a hedge with some exposure to foreign currency, but I would keep any hedge below 10% of my portfolio, your current foreign currency hedge is 15%.



The information presented here is the opinion of the author and may quickly become outdated and is subject to change without notice. All material presented in this article are compiled from sources believed to be reliable, however accuracy cannot be guaranteed. No person should make an investment decision in reliance on the information presented here.

The information presented here is distributed for education purposes only and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or participate in any particular trading strategy.

Performance data showing past performance results is no guarantee of future returns.

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