Risk vs Reward

A place to talk about speculative investing ideas for the optional Variable Portfolio

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Hal
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Risk vs Reward

Post by Hal » Mon Nov 23, 2020 4:16 am

Was listening to some of BelangP's talks today and it had me wondering about risk vs reward. BelangP uses 35% Gold/65% US shares.
Have a look at the portfolio visualizer graph below. The PP has half the draw down, but half the final balance.

What criteria do you use for sacrificing gain vs loss? Would you invest in something that just preserved the capital but had no gain?

Edit: Couple of extra charts for Corto. Note I am not endorsing either approach, just interested in the reasoning ;)
Attachments
35% Gold 65% Shares.png
35% Gold 65% Shares.png (132.75 KiB) Viewed 1319 times
PP.png
PP.png (109.35 KiB) Viewed 1319 times
Blue is PP & Red 35%Gold 65% US shares.png
Blue is PP & Red 35%Gold 65% US shares.png (151.43 KiB) Viewed 1349 times
Last edited by Hal on Mon Nov 23, 2020 9:07 am, edited 1 time in total.
Aussie GoldSmithPP - 25% PMGOLD, 75% VDCO
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Cortopassi
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Re: Risk vs Reward

Post by Cortopassi » Mon Nov 23, 2020 8:09 am

So much depends on the start date, and this chart I assume also does one lump sum at the start, with no rebalacing along the way. These kind of charts maybe don't really reflect reality?
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Re: Risk vs Reward

Post by pmward » Mon Nov 23, 2020 8:17 am

Yeah this is something that I have thought long and hard on, and ultimately why I broke away from static allocations like the PP and moved to a quant based approach on the majority of my funds (I still hold a static 20% gold allocation because I couldn't find a tactical strategy to use gold that I liked the results of, and I'm just generally a gold bull over the next decade or so).

My current quant strategy unlevered backtested to the early 90's (as far back as is possible to test it) has ~18% CAGR and a 25% max drawdown. I started moving my funds over to this before the corona crash. Seeing how it handled all the volatility this year convinced me to make it the core of my portfolio. I also recently went through this "risk vs reward" debate on leverage recently. I decided to go the route of using some leverage, which increases CAGR to ~28% (+10% CAGR) at the cost of an extra 5% max drawdown (~30%). I think 2x CAGR to max drawdown increase is worth the cost of leverage, imo. So obviously CAGR and max drawdown are the two most important stats to me. Moreover, the spread in between the two is really telling. In my current portfolio I have a CAGR that is only 2% lower than the max drawdown. This leads to the 3rd metric I care about, which is time to recover. Obviously, my average time to recover is less than a year, and max is about a year and a couple months. Obviously, one cannot hang their hat on the future being equal to the past. So I have built in assumptions that a larger max drawdown is likely ahead of me, and that CAGR going forward will also be lower than it was in the past. But even still when I look at all of the metrics combined, is the cost of risk worth the potential reward for me, my goals, and where I am at in life? That answer is a resounding yes. So this maybe helps to explain how I personally look at the tradeoff of risk vs reward.

Now specifically to your example there, is doubling max drawdown worth 1.5% CAGR? I would say no. You would likely wind up in a better spot levering the PP up to 10.6% return vs just increasing equities and eliminating your deflation protection. You still wind up with "double" the final balance over the course of the years sampled, but your max drawdown would be much less, and the spread between CAGR and both average and max drawdown would also be much tighter (which translate directly into a quicker time to recover).

Lastly, one thing everyone has to consider is personality. What I am doing isn't for everyone, just like a PP isn't for everyone, and your 65/35 you presented isn't for everyone. I picked a portfolio in the end that fits me as a trader/investor. Someone who cares about "value" should not invest in a "momentum" strategy, and someone who cares about "momentum" shouldn't invest in a "value" strategy (at least when "value" does not have "momentum"). Someone that wants their portfolio to be easy and/or wants as few trades as possible shouldn't pick an active strategy. Someone that is allergic to gold probably shouldn't invest in a PP. Someone that values growth of capital more than preservation of capital shouldn't invest in a PP. Someone that values preservation of capital above growth of capital shouldn't be "all in VTSAX". I could go on and on. There are n number of ways to intelligently invest your capital. If you pick one that suits your personality, you're going to enjoy the ride. If you pick one that does not fit your personality, you're going to hate it. So these things are highly personal and highly individual.
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Re: Risk vs Reward

Post by Kbg » Tue Nov 24, 2020 5:38 pm

pmward,

Care to share?
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Re: Risk vs Reward

Post by pmward » Wed Nov 25, 2020 10:31 am

Kbg wrote:
Tue Nov 24, 2020 5:38 pm
pmward,

Care to share?
I'll PM you.
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