Barbell/Black Swan investing?

[Architect]

Hi,
I know most here follow MPT approach, but does anybody follow a barbell strategy? Taleb (The Black Swan) and Richelson (Bonds, The Unbeaten Path ...) recommend this approach. The idea is that you put 85%-90% of your portfolio into buy/hold vanilla govt. bonds, and then speculate the rest looking for positive black swans.

I did a variation of this this last two years which worked great for this latest black swan, and am trying to decide whether it's time to go back to a MPT approach or continue this for some time.

 

[dex]

How do you find the items to speculate upon?

 

[james22]

I likey Swedroe's version: 70% TIPS, 5% CCF, 25% IS/I/EM SV.

 

[Architect]

dex,
Good question. I'm not dedicated enough for venture capital. For me that portion would be plain stock investing, stock picking, sector picking ...

 

[FUEGO]

So Architect, care to share what you were invested in, and why, and what your rate of return was? Maybe teach us a lesson?

To note, I generally follow the MPT method. I have considered dumping a small portion into some black swan bets via derivatives (or maybe a 3x leveraged ETF). I had a few ideas that would have worked out well over the last year or so. Specifically, buying far out of money puts on USO (oil) back in Sept 08. That would have returned ~1300% as of today. Also, going very short on the Shanghai Composite index (or similar China index) back when it was over 5000 (it is at 2000 today) - probably a few hundred percent return or more depending on how I would have implemented it.

Just a few shoulda-coulda-woulda's. It seems easy to spot a bubble, just hard to figure out how long it will inflate before popping. As the old saying goes, the market can stay irrational just a bit longer than you can stay solvent.

 

[Gone4Good]

Hi,
I know most here follow MPT approach, but does anybody follow a barbell strategy? Taleb (The Black Swan) and Richelson (Bonds, The Unbeaten Path ...) recommend this approach. The idea is that you put 85%-90% of your portfolio into buy/hold vanilla govt. bonds, and then speculate the rest looking for positive black swans.

I haven't read "The Black Swan" so I may be talking out of school here, but the idea sounds a lot like speculating on significantly out of the money calls and lottery tickets. My guess is the most likely result of this approach over the long run is you'll end up with a 10-15% smaller portfolio invested entirely in government bonds.

Timing the "black swans" is nearly impossible. Folks have been warning about the risks of too much consumer debt for a couple of decades now. Plenty of people have been wiped out betting against the US consumer over the years. If you were lucky enough to get the timing exactly right, you could have made a killing. But nearly no one did, and most people who tried were way too early.

An old axiom among traders is apropos I think, "The market can stay irrational longer than you can stay solvent." (edit: Ditto what Fuego said.)

 

[Nords]

I know most here follow MPT approach, but does anybody follow a barbell strategy? Taleb (The Black Swan) and Richelson (Bonds, The Unbeaten Path ...) recommend this approach. The idea is that you put 85%-90% of your portfolio into buy/hold vanilla govt. bonds, and then speculate the rest looking for positive black swans.

Our "barbell" is our govt pensions & rental real estate on one side with our high-equity ER portfolio and an interest in angel investing on the other side.

I haven't read "The Black Swan" so I may be talking out of school here, but the idea sounds a lot like speculating on significantly out of the money calls and lottery tickets. My guess is the most likely result of this approach over the long run is you'll end up with a 10-15% smaller portfolio invested entirely in government bonds.

Funny how our library request list suddenly spiked up to 33 for that book. So it'll be a while before I get my hands on it again.

But Taleb isn't setting FIRECalc at an 80% success rate and hoping that past is prologue. IIRC he's making sure that Treasuries* will cover his expenses and then he's hedging inflation (or hoping to) with options. So while your conclusions are correct, he's reaching his life expectancy with "enough" assets while sleeping soundly at night. He's also not paying financial advisors or annuity salesmen to hold his hand.

Speaking of the efficient market hypothesis, I wonder if a "black swan" fad will shrink the options spreads that are part of this strategy and squeeze out whatever profits they were yielding.

*Groucho Marx during an interview:
Reporter: "What are you invested in?"
Marx: "Treasuries."
Reporter: "You can't live off the income from Treasuries!"
Marx: "You can if you buy enough of them..."

 

[NW-Bound]

I read Taleb's books, and saw his barbell strategy.

After the crash of 2000-2003, I independently thought of something similar. I only wanted a nice steady 10-12% return (before inflation) in the long run, like stocks, but with the downside limited.

So, I told myself that I could put all my money in safe places, then take the 4-5% interest from that to buy options. Done right, I could triple that money or more, and get my modest 10-12% return on the total portfolio. Done wrong, I only lose to inflation that year.

However, execution is everything, and I needed to learn. So, I put aside 0.5% of my portfolio to buy call options of depressed companies from time to time. I bought calls not puts because I have been a bull.

Since 2001, I was about even in that little play money. This year, I lost all of it. Now, I still have most of my money invested the traditional way, and perhaps would do better if I watched those options more closely. I don't know.

Not to detract from what else in his books, but Taleb's advice is like telling people to drop school and to become a Grand Slam tennis player. Perhaps he could do it, but I couldn't. Remember that Taleb's full-time job was derivative trading.

 

[Architect]

So Architect, care to share what you were invested in, and why, and what your rate of return was? Maybe teach us a lesson?

I put it all into 30Y treasury bonds. Ultra safe assets, with a long duration risk tilt I guess, speculating that interest rates would decline. It might seem like a very risky bet (what everybody was saying at the time), but some basic research validated the soundness of the approach. That is, the deflating credit bubble wasn't too hard to predict two years ago.

Timing these things is hard though, so I erred on the early side and meanwhile just collected my 5% coupon. Total return maybe 50%.

...Yrs to go
Maybe I got lucky, but seeing crack houses sell for $500k, it did seem likely that the house of cards was finally going to collapse. I couldn't find anything that would save things this time.

Not to detract from what else in his books, but Taleb's advice is like telling people to drop school and to become a Grand Slam tennis player. Perhaps he could do it, but I couldn't. Remember that Taleb's full-time job was derivative trading.

I think an important part to realize you have enough assets to pay for your milk in the safe portion. The point is that you can't blow up (trader speak). The bonds always pay your salary, while the speculation gives you growth.

I'm seriously considering it, as I now have enough assets to live off of while keeping them in bonds.

 

[NW-Bound]

I'm seriously considering it, as I now have enough assets to live off of while keeping them in bonds.

Then, it may work for you. I don't have enough, and still need to get 8-10% before inflation (in the long run) to live on.

 

[Architect]

Thanks. I've got about $1M liquid, am still planning on working (young one at home and like what I do), and am thinking of starting my own business at some point. I still have to buy a house again, but renting is paying off now as prices continue to decline.

The general message seems to be buy-buy-buy stocks. Buy now because the market is going up. Buy now because they're cheap. I've done fine by being very conservative with just a few well researched bets. Buy and hold hasn't worked too well, for me. Plus I sleep better.

Then, it may work for you. I don't have enough, and still need to get 10% before inflation (in the long run) to live on.

 

[NW-Bound]

Well, I have more than that, plus my 2 houses. I may not be the tightwad I thought I have been.

And talk about blowing up, I don't consider my 30% drop from last year high a "blow up". Another 30%, then I will get concerned.

 

[FUEGO]

I put it all into 30Y treasury bonds. Ultra safe assets, with a long duration risk tilt I guess, speculating that interest rates would decline. It might seem like a very risky bet (what everybody was saying at the time), but some basic research validated the soundness of the approach. That is, the deflating credit bubble wasn't too hard to predict two years ago.

Timing these things is hard though, so I erred on the early side and meanwhile just collected my 5% coupon. Total return maybe 50%.

Timing these things is hard indeed. Have you figured out when you will get back into equities (if ever)? That could be exceedingly difficult.

I'm just trying to decipher your investment history. It seems like you had a zero return from 1995 till 2005 (per your past statements) and then you had a 50% return since 2005. Just based on that info, it looks like you have had an average annualized return of around 2.9% per annum. Just wanted to point out that being invested in the S&P 500 since 1995 would have produced average annual returns of around 6.5% per annum. Timing these things is hard indeed.

 

[Architect]

I'm really undecided about stocks. I'm guessing that I'll feel more comfortable sometime next year, maybe spring to summer. I think this recovery will take about a decade, but that's the best I have.

In my 401k I had roughly a zero return 1995-2005. It didn't have a S&P low cost index option until recently, just a bunch of crummy Fido funds. They finally kicked Fido out and it's got Vanguard lifestyle - gee thanks for finally doing that! In 2006 I put it all into a PIMCO bond fund which has returned about 15% in the last two years, so you could say I had 15%/15 years roughly 1% annualized. It only came about because I did something I'm not supposed to though.

The rest of my money came from selling my house, and combining it with everything else (cashed vested stock options (Co stock has since crashed), stock purchase plan, cash, etc.) The bulk coming from a house, which increased in value from the downpayment by 50X, about a 500% return, 33% annualized. Lucky to catch a housing bubble and time it perfectly.

A difficulty I have with generic calculations is how they work in reality, when you consider fees, available options (401k available funds), timing, taxes, and poor investor decisions. That's why running calculators like Firecalc don't give me tremendous confidence yet.

Timing these things is hard indeed. Have you figured out when you will get back into equities (if ever)? That could be exceedingly difficult.

I'm just trying to decipher your investment history. It seems like you had a zero return from 1995 till 2005 (per your past statements) and then you had a 50% return since 2005. Just based on that info, it looks like you have had an average annualized return of around 2.9% per annum. Just wanted to point out that being invested in the S&P 500 since 1995 would have produced average annual returns of around 6.5% per annum. Timing these things is hard indeed.

 

[Architect]

I was originally going to be a classical musician (became an engineer eventually). My motto back then was

"If you can't learn how to live on a million, you aren't trying hard enough!"

Old habits die hard, I've got enough to be happy.

Well, I have more than that, plus my 2 houses. I may not be the tightwad I thought I have been.

And talk about blowing up, I don't consider my 30% drop from last year high a "blow up". Another 30%, then I will get concerned.

 

[NW-Bound]

A difficulty I have with generic calculations is how they work in reality, when you consider fees, available options (401k available funds), timing, taxes, and poor investor decisions. That's why running calculators like Firecalc don't give me tremendous confidence yet.

I've run Firecalc as a rough guide, though I have seen other people taking it more seriously. In fact, my use of Firecalc agrees more with the Firecalc author's intention. "Why measure with a caliper if you are going to cut with an axe?"

That's said, my method is more along unclemick's philosophy. I can become a really cheap bastard if I need to.

"You can live well whether you are rich or poor. When you are poor, it just costs less". Andrew Tobias

Heh heh heh...

 

[NW-Bound]

"If you can't learn how to live on a million, you aren't trying hard enough!"

Old habits die hard, I've got enough to be happy.

When were you thinking that? A million in 1985 dollars?

Still, the lower amount one needs for happiness, the better.

I've been rationing my pleasures, and constantly stay aware of the old say "A luxury once sampled becomes a neccessity".

 

[Architect]

I don't buy the modern idea that 'a million isn't what it used to be'.

When were you thinking that? A million in 1985 dollars?

 

[Nords]

I've been rationing my pleasures, and constantly stay aware of the old say "A luxury once sampled becomes a neccessity".

HFWR must be on a break so I'll say it: "What once were vices now are habits"...

Our teen hates it when I quote the noted 20th-century philosopher David Lee Roth: "I used to have a drug problem, but now I can afford it."

We have a local realtor, now well into his 70s, who once said that he'll never retire because the cost of doing so gets more expensive every year. He doesn't do open houses anymore but he's still advising clients, speaking at conferences, and leading training seminars. In his case, though, it's all about the new (expensive) hobbies & activities that accompany his travel & leisure time.

 

[riskadverse]

For those of you who would like to know more about Black Swan:


Charlie Rose - Nassim Taleb / James Taylor & Yo-Yo Ma

 

[FIRE'd@51]

My guess is the most likely result of this approach over the long run is you'll end up with a 10-15% smaller portfolio invested entirely in government bonds.

This is pretty much the way I see it, as well. If you spend 10-15% of your portfolio on wasting assets (far out-of-the-money options), the most likely result is that they will expire worthless. In addition option premiums are well above average historical levels. Also, you are coupling these bets with lower than historical government rates, a poor strategy IMO.

 

[Nords]

For those of you who would like to know more about Black Swan:

And if you remember what James Taylor used to look like, then you might want to avoid getting this new glimpse of the guy who used to claim that "Hey, Baby, I'm your handyman..."