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Allocation Formula

DYI:  If you are new to my blog DYI’s Allocation formula for stocks and bonds is based upon the ultra long term return for a fixed portfolio with 50% stocks and 50% bonds [8.3% average annual return since1926].  If valuations were trading at their mean – Shiller PE¹⁰ at 16.85 – stock to bond allocation would be 50%-50%.  As valuations rise stock allocation is reduced and conversely as valuations decline stock allocation is increased.  Over a 30 to 40 year time span the return will end up being very close to the return for a fixed 50%-50% portfolio with far less volatility.

This approach is excellent for the Defensive Investor with some attributes of an Enterprising Investor.  Changing the allocation as valuations change; no attempt is made to out guess market direction [a fool’s game].  The bond portfolio [Enterprising Investor] DYI’s Gold Indicator for allocation between short dated bonds and ultra long term bonds is recommended.  If an investor in more defensive than Enterprising then pick a short term bond fund and simply be done with the bond component. 

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Allocation Formula

5-01-18
Updated Monthly

% Allocation = 100 – [100 x (Current PE10 – Avg. PE10 / 4)  /  (Avg.PE10 x 2 – Avg. PE10 / 2)]

Current PE10.....31.73

Avg. PE10......... 16.85

% Stock Allocation     0% (rounded)
% Bond Allocation 100% (rounded) 

Logic behind this approach:

--As the stock market becomes more expensive, a conservative investor's stock allocation should go down. The rationale recognizes the reduced expected future returns for stocks, and the increasing risk. 

--The formula acknowledges the increased likelihood of the market falling from current levels based on historical valuation levels and regression to the mean, rather than from volatility. Many agree this is the key to value investing.  

Please note there is controversy regarding the divisor (Avg. PE10).  The average since 1881 as reported by Multpl.com is 16.85.  However, Larry Swedroe and others believe that using a revised Shiller P/E mean of 19.6 , the number since 1960 ( a 53-year period), reflects more modern accounting procedures.

DYI adheres to the long view where over time the legacy (prior 1959) values will be absorbed into the average.  Also it can be said with just as much vigor the last 25 years corporate America has been noted for accounting irregularities.  So....If you use the higher or lower number, or average them, you'll be within the guide posts of value.

Please note:  I changed the formula when the Shiller PE10 is trading at it's mean stocks and bonds will be at 50% - with stocks at 50% representing Ben Graham's Defensive investor starting point; only deviating from that norm as valuations rise or fall.

  5-01-18

Updated Monthly

Current Allocation  

Ultra Long Term Bonds

Allocating between short term bonds

 & 

ultra long term bonds

 

Every month DYI will look back to gold prices from five years ago as compared to current prices.  When gold prices are below from five years ago deflationary - dis-inflationary forces are at work. The most common reason (and other reasons) a recession is coming and with it declining interest rates as the demand for money cools off.  

Conversely if gold prices are higher than five years ago inflationary forces are at work.  The most common is a growing economy (and other reasons) which will soon push interest rates higher.

When gold prices decline from five years ago - Buy Long Term Bonds

When gold prices increase from five years ago - Buy Short Dated Bonds 

  

DYI

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DYI