Let’s look at what 5 important thought leaders had to say about constructing a portfolio for the long-term (10+ years); and how their portfolio models are expected to perform over the next 10 years, based on asset returns, volatility and correlations according to JP Morgan Asset Management and Research Affiliates.

Here’s the spoiler:

- Ray Dalio’s “All Weather” portfolio has the best risk adjusted expected return
- David Swensen’s “Reference” portfolio has the highest expected return
- John Bogle’s traditional “60/40 Balanced” model using global stocks is a contender
- Harry Browne’s “Permanent” portfolio isn’t a contender
- Warren Buffet’s “Estate Plan” portfolio has the highest potential, but the worst risk adjusted return
- For all portfolios, the expected returns are significantly below returns of the last several years.

Here are mug shots of the 5 thought leaders.

(click images to enlarge)

Their portfolio models in our approach, would be for the Broad Core sleeve. More income intensive securities would go into the Income Core sleeve of the portfolio. And, when, as and if it makes sense to make some tactical bets, we can add narrowly focused assets we believe will do particularly well in the Tactical Opportunity sleeve of the portfolio. This discussion is only about portfolio models for the Broad Core sleeve.

**David Swensen**is the long-time CIO of the Yale endowment. He is acknowledged as one of the best at that job, if not the best. In 2005, he translated his 2000 book for institutional portfolio managers (“Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment”) to one suitable for individual investors. In that book (“Unconventional Success: A Fundamental Approach to Personal Investment”), he described a “reference portfolio” for the long-term. He made it clear that adjustments are needed to fit the specific needs, goals, limitations and psychology of each investor; but that the reference portfolio is a good place to begin the thinking process about a suitable portfolio. In his reference portfolio he stresses the functions which must be provided (capital growth, inflation protection, deflation protection, and protection in times of crisis). He specified assets for the portfolio and how much of each function each asset provides.

**Ray Dalio**is the founder and CEO of Bridgewater Associates, one of the oldest and largest private funds (about 40 years old and about $160 billion in assets). He wrote about his All Weather strategy in a white paper in January 2012. His fund has been very successful with the core All Weather portfolio model, and around which they make certain other tactical investments. Their core portfolio is equally weighted to deal with 4 scenarios (rising corporate profits, falling corporate profits, rising interest rates, and falling interest rates). Then within each of those 4 segments of the All Weather portfolio, he specified suitable asset categories, which are then equal weighted for volatility (“risk parity”).

**Harry Browne**(deceased) was an investment advisor and author, who in his 1999 book “Fail Safe Investing” was focused on limiting losses in a portfolio that would be profitable in any market, which he posited was best accomplished with equal amounts invested in stocks, long-term Treasuries, T-Bills and Gold. That was dubbed a “permanent” portfolio.

**John Bogle**is the founder and former CEO of Vanguard. He virtually created the index mutual fund industry, launching the first ever index fund (dubbed “Bogle’s Folly”) on December 31, 1975, to track the S&P 500 index. He is a firm believer that no amount of effort can predict the future of markets, and that active management is not competitive with index funds over long periods. He recommends simply owning a broad index stock fund, such as one based on the S&P 500, and a broad bond index fund, such as one based on the aggregate US bond market. He is an advocate of a 60% stocks, 40% bonds allocation.

**Warren Buffet**is the CEO of Berkshire Hathaway, which has made him one of the richest people in the world. He is a fierce critic of the expense drag created by actively managed funds and their trading costs due to high turnover. He believes that low cost index funds are the only way to go, and that a domestic focus is at least good enough, if not best. In his 2013 letter to Berkshire Hathaway shareholders he gave investment advise which he felt was good enough for most investors by revealing his instructions to his estate trustee: “… instructions I’ve laid out in my will … cash will be delivered to a trustee for my wife’s benefit … My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”

Using the 10-year forecasts for asset returns, volatilities and correlations published by JP Morgan Asset Management (optimistic) and by Research Affiliates (less optimistic), let’s see how the recommended portfolios from those 5 thought leaders would be expected to perform in the future.

It is important to know that any single value projection of portfolio return is not a good idea. Because assets go up and down in price over time, it is more reasonable to think of future returns in terms of a probability range of return; with the most likely return near the middle of the distribution, and the increasingly less likely, but still possible returns spread out above and below the middle. That is how our first image is presented. The probability distribution is developed through Monte Carlo simulation.

For each portfolio, the return probability distribution is represented by a box with whiskers. The line in the middle of the box is the 50^{th} percentile return, which is equal to or near the mean expected return. Half of the probable returns expected to be higher than the 50^{th} percentile, and half lower than that value. The entire box encompasses the middle 80% of probable returns (from the 10^{th} to the 90^{th} percentile). The whiskers extend out above and below the box so that the entire box and whiskers encompass 98% of probable returns (only 1% are expected to be higher, and only 1% are expected to be lower). Because of shocks and crises, the lower 1% could be a lot lower. For that, we present what could be thought of as a worst case (at least a very bad case) year, when the return is 3.5 standard deviations below the expected mean return.

This chart is the main one we used to decide our spoiler alert at the beginning of this letter.

The green colored boxes and whiskers are based on the more optimistic JP Morgan assumptions. The yellow colored boxes and whiskers are based on the less optimistic Research Affiliates assumptions.

Note, that only the deeper green and deeper yellow colored boxes and whiskers have their 1^{st} percentile above zero. If the bottom whisker is above zero, it means that the forecasts expects a 99% chance that at the end of 10-years, your portfolio will be worth more than at the beginning.

The portfolio models with the bottom whisker above zero when using JP Morgan assumptions are the Swensen Reference, Dalio All Weather, and Bogle 60/40 with global stocks. The models with 99% chance of a positive 10-year outcome when using the Research Affiliates assumptions are only the Dalio All Weather portfolio, and the Simple 2 Asset Risk Parity model (which uses the S&P 500 and intermediate-term Treasuries in a ratio that expects the same risk from each asset).

The lighter colored boxes and whiskers have varying probabilities less than 99% that the portfolio will grow in value over 10 years. In fact, the simplified Dalio All Weather portfolio (published by Tony Robbins, based on his discussions with Dalio), has about a 10% chance after 10 years of being worth less than the starting value. The Warren Buffet “estate plan” portfolio has by far and away the higher upside potential (because it is 90% stocks), but also something near a 10% chance of a cumulative negative return.

The best “worst case” year is with the Dalio All Weather portfolio with both the JP Morgan and Research Affiliates assumptions, but it has an unsatisfying most likely return below 5%. The highest most likely return is the Swensen Reference portfolio, which has a 99% chance of a positive 10-year return under JP Morgan assumptions, but has a small chance of a negative 10-year cumulative return with assumptions from Research Affiliates.

The Bogle 60/40 with global stocks fares well under JP Morgan assumptions, but has a small chance of a negative 10-year return under Research Affiliates assumptions.

The Swensen portfolio and the Bogle portfolio have the highest current yield, which is somewhat of a hedge against the downside, at 2.35% and 2.36% respectively — essentially the same yield.

Overall, for the more risk averse folks who can tolerate returns below 5%, the Dalio All Weather portfolio is attractive. For those who require return of 5% or more, with limited risk of a 10-year negative return; the Swensen mode is attractive. The Bogle 60/40 with global stocks is a close runner-up to the Swensen model, but not quite as attractive based on the two sets of assumptions we used.

The 90% stocks approach from Buffet is just fine if you very young and have more than 10-years for “time in the market” to work for you; or, you are wealthy enough to start, and would continue to be wealthy enough with no retirement lifestyle change even if you had a cumulative 5% annualized 10-year negative return. Otherwise, 90% in stocks may be a bit to aggressive for most investors over 50 to 55 years old, particularly at this time in the market cycle.

Here is a different way to look at the same data. These next two tables are color coded to show 10-year annualized returns:

- greater than 7% in dark green
- from 5% to 7% in light green
- below 5%, but positive in light pink
- negative returns in dark pink.

**With JP Morgan Assumptions:**

**With Research Affiliates Assumptions:**** **

And here is yet one more way to use color coding to gain perspective on the relative merits and demerits of the portfolio models. All of the returns taken together are coded red, yellow or green on a sliding scale from lowest in red to highest in green.

**With JP Morgan Assumptions:**

**With Research Affiliates Assumptions:**

Now for the grand reveal. What is inside each of these portfolios? Focus on the category, not just the proxy ETF. We did the projection without any specific security in mind. The securities we show here as proxies are not the only ones that fit into those models, but they are representative of those that do.

The ETFs used to label the allocation in this next table are simply short-hand to identify the asset classes from the table above. The numbers are all percentages.

I’d to ask each of you to think about these projections for these model portfolios as general approaches, and tell me which appeal most and least to you as they relate to your Broad Core sleeve (as distinct from the Income Core sleeve and Tactical Opportunity sleeve of your portfolio) to see if we are still on the right track for your personal situation and needs.

Looking forward to our discussion.

[symbols identified in this article: SPY, VXUS, VWO, VGIT, TIP, VNQ, GLD, DBC, VGLT, BND]