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Passive Asset Allocation Modeling

| September 15, 2015
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Asset Allocation

Question: What is the single best investment strategy for the events of tomorrow? See end the end of the article for the answer.

This is an excerpt form the book "Investment Strategies that Work" (2015) - by Brett Machtig & Josh Gronholz

There are many models for passive asset management, and we’ll explore the effectiveness of these strategies. Although these are some of the brightest minds of this century, as you will find out, these experts do not agree. We found that it was nearly impossible to get five people to agree on pizza ingredients, let alone the single best passive asset model for all investors in all markets for all times. We will consider the effectiveness of simple passive modeling, risk reduction modeling, endowment  modeling, alpha-driven modeling and economic “doomsday” investment modeling. The two most common simple passive models are “Age Equals Income” and the “60 Percent Stock / 40 Percent Bond”  portfolio models.


  1. Simple Models

Age Equals Fixed Income Portfolio – The first simple passive model sets the percentage you invest in fixed-income securities equal to your age. This strategy is based on the concept that when you are young, you can take more risk because you have a longer time horizon. Then as you age, you should take less risk. Paul Samuelson (2009), first American to win the Nobel Prize in Economics, is credited with the introduction of this investment strategy. This approach is used by many firms, financial advisors, and pensions including Ric Edelman, Charles Schwab, Fidelity, AARP, and Vanguard. Source: See their respective websites

Many 401(k)s use default investments that match the fixed income fund percentages to your age based on the year you plan on retiring. These plans use retirement “target date” funds, where the “target date” is equal to your estimated retirement date.

Although target-term fund managers roughly use the fixed income equals age strategy, managers do not agree on how the target date fund should be constructed. For instance, “Target-date funds designed for those retiring in 2010 fell by as much as 41.3 percent in 2008. Typically, the target-date adviser buys a mix of stock and bond funds. But every firm had a different interpretation of how it should be asset allocated. Thus, funds with the same target date could have 20 percent in stocks while another could have 40 percent. That can explain much of the difference in performance between funds with the same target date.”


Here is how the model should work. See Exhibit 1:

If you are 55, you have 55 percent of your assets in fixed income securities. Fixed Income securities can include U.S. Treasuries, corporate bonds, international bonds and high-yield bond funds, the rest is in US and international equities.

A year later, you reduce equities by one percent and increase fixed income by one percent.

The positive side of this strategy is it is very simple and straightforward to implement.

On the negative perspective, many more factors play into a person’s risk profile than just his or her age such as job uncertainty, the future perspective of the economy, and the size and diversification of other assets.

Another negative factor to this strategy is it assumes fixed income securities will have less risk and will not often correlate (moves in the same direction) to equities. Both factors proved to be false in 2008. While this has been true that a 60 percent stock and 40 percent bond mix has reduced portfolio risk as interest rates have declined from 1981 to 2014, we don’t expect it to be necessarily true as interest rates rise from our historic 2015 low rates.

The Moderate 60 Percent Stock / 40 Percent Bond Portfolio – Another very commonly used simple passive model is the Moderate 60 Percent Stock / 40 Percent Bond Portfolio. 1973-2012, Inflation 4.3%  Source:


  1. Risk Reduction Modeling

Risk Reduction Modeling sets out as its primary objective to reduce downside risk of an investor’s portfolio while earning modest returns. For the best passive models that illustrate this concept, we will look at Harry Browne, Bridgewater & Associates, and Ray Dalio portfolio models. These models traded similarly over this specific timeframe, but could differ depending on the stock exposure of the portfolio in bad times.

Harry Browne’s Permanent Portfolio – Harry Browne outlines “17 simple rules for financial safety” and provides detailed commentary on their explanation and implementation in the book, Fail-Safe Investing, also known as the permanent portfolio. According to Browne this type of portfolio has the goal of assuring “that you are financially safe, no matter what the future brings” including economic prosperity, inflation, recession or deflation. This is because some portion of the portfolio will perform favorably during each of those economic cycles.

The book calls this type of investment portfolio, a “permanent portfolio” and advocates that it be re-balanced once per year so that the 25 percent allocation is maintained annually for each asset class. A mutual fund based upon his earlier book,Inflation-Proofing Your Investments written in 1981, is Permanent Portfolio (PRPFX) and has a ten-year return of 6.93 percent  since its inception in 1982 and its 2008 loss was -6.5 percent. Source:, * 1973-2012, Inflation 4.3%  Source:

Bridgewater Associates’ Risk Parity Portfolio – The Risk Parity methodology appears to be a refinement of Harry Browne’s strategy. Here are two white papers by Bridgewater that introduce the concepts of risk parity:

  • “Engineering Targeted Returns and Risks“ – Bridgewater
  • “The Biggest Mistake In Investing” – Bridgewater

Bridgewater Associates, LP one of the world’s largest hedge funds. “Risk Parity” was pioneered by Paul Podolsky, Ryan Johnson, and Owen Jennings based on interviews with personnel who created the Risk Parity strategy.

Many pension funds have used a version of the “Risk Parity” portfolio. The portfolio has the following allocations in Exhibit 2. The strategy spreads the risks on various economic cycles:

  • Investors could set up “Risk Parity” portfolios, assuming that you do not know what the future is going to hold.
  • The “Risk Parity” portfolios should cover two scenarios: growth and inflation, each in either a “rising” or “falling” condition.
  • How stocks and bonds perform in the growth and inflation scenarios: When growth is slower-than-expected, stocks go down. When inflation is higher-than-expected, bonds go down.  When inflation is lower-than-expected, bonds go up.
  • So the “risk parity” portfolio should consist of four different collections. As a result, your entire portfolio balances risk. This works because, at some point, there’s a ruinous asset class, which will destroy returns and wealth. Worse, you do not know which one of the four cycles will hurt your portfolio next.  Source:

Although the Risk Parity Portfolio has done well in a declining interest rate environment, it does not perform as well in both the low and rising interest rate environments.

Ray Dalio’s All-Weather Portfolio – In 1975, Ray Dalio founded the Westport, Connecticut-based Bridgewater Associates which became the largest hedge fund in the world, as of 2014, with over $160 billion in assets under management. Source: Assets as of as of October 2014

In 2007, Ray Dalio predicted the global financial crisis, and in 2008 published an essay,“How the Economic Machine Works; A Template for Understanding What is Happening Now” which explained his model for the economic crisis.(1) He self-published a 123-page volume called Principles(2), in 2011, which outlined his logic and personal philosophy for investments and corporate management based on a lifetime of observation, analysis, and practical application through his hedge fund.


In 2014, Tony Robbins interviewed Ray Dalio and asked him his ideal asset allocation. Dalio said the key is to balance risk in all seasons since nobody knows when the next season will begin. The fundamental idea is that the future is impossible to predict. The future will fall into four basic economic scenarios: rising growth, falling growth, rising inflation, and falling inflation. Different types of assets do well in each of these scenarios.   Sources:  Wikipedia,  1)  (2 ),1973-2013, Inflation 4.3%  Source:

As mentioned earlier, although these risk reduction models have done well in a declining interest rate environment, they may not do as well in the current low-interest rate or in a rising interest rate environment.


  1. Passive Alpha-Driven Modeling

Alpha-Driven Modeling is intended to create more return than its index. Unfortunately, they do it at a cost of higher drawdown risk exposures. Here are some top passive alpha-driven portfolio models.

Andrew Tobias’s The Only Investment Guide You’ll Ever Need Portfolio – Andrew Tobias is the author of The Only Investment Guide You’ll Ever Need, which for more than thirty years has been a favorite finance guide, earning the allegiance of more than a million readers across the United States. * 1973-2012, Inflation 4.3%  Source:   

Rob Arnott’s the Fundamental Index: A Better Way to Invest Portfolio – Robert D. Arnott is an American entrepreneur, investor, editor and writer who focuses on articles about quantitative investing. He edited the CFA Institute’s Financial Analysts Journal and has edited three books on equity management and tactical asset allocation, including The Fundamental Index: A Better Way to Invest. Mr. Arnott’s suggested asset allocation is simply the following: 25 percent stocks, 25 percent bonds, 25 percent commodities, and 25 percent real estate as well as a more detailed allocation. Source:

The allocation then looks like this: 25% Stocks: 8.34% U.S., 8.33% International Developed Markets, 8.33% Emerging Markets; 25% Bonds: 8.34% U.S., 8.33% International Developed Markets, 8.33% Emerging Markets; 25% Commodities; and25% Real Estate: 12.5% U.S., 12.5% International Markets.  1973-2012, Inflation 4.3%  Source:

William Bernstein’s The Intelligent Asset Allocator Portfolio – The Intelligent Asset Allocator, by William Bernstein is a proponent of the equity or index allocation school of thought. He believes that all investment selection strategies should be focused on allocating between asset classes, rather than selecting individual stocks and bonds. He also does not believe in the timing of their sales. * 1973-2012, Inflation 4.3%  Source:  

This group generated the greatest gains but also had the largest drawdowns in bad years.


  1. Endowment Modeling

Some of the brightest investment minds manage college endowments. Here are some examples of passively managed assets. These funds are managed for long-term and that these models are simplified.

Mebane Faber and Eric Richardson’s Ivy Portfolio – The Ivy Portfolio by Mebane T. Faber and Eric W. Richardson manages quantitative strategies at Cambria  Investment Management, including equity and global tactical asset allocation portfolios. Their book, The Ivy Portfolio shows step-by-step how to track and mimic the investment strategies of the highly successful Harvard and Yale endowments. Using the endowment Policy Portfolios as a guide, the authors illustrate how an investor can develop a strategic asset allocation using an ETF-based investment approach. ETF is the acronym for Exchange Traded Fund which is defined in Appendix III.

Dave Swensen’s Asset Allocation Portfolio, Yale Foundation Asset Manager –David F. Swensen has been the Chief Investment Officer at Yale University since 1985. He is responsible  for managing and investing Yale University’s endowment assets and investment funds, which totaled $23.9 billion in 2014. Swensen earned an average annual return of 11.8 percent on his investments over the ten years leading up to 2009. He is notable for inventing “The Yale Model,” which is an application of the modern portfolio theory. Source:* 1973-2012, Inflation 4.3%  Source:   

Mohamed El-Erian’s When Markets Collide Portfolio – Mohamed El-Erian, the former CEO and co-investment chief of the investment management firm PIMCO,  suggested his asset-allocation strategy in his 2008 book, When Markets Collide. He served for two years as president and CEO of the Harvard Management Company and served as a faculty member of the Harvard Business School. He spent 15 years at the International Monetary Fund (IMF) in Washington, D.C., where he served as Deputy Director. El-Erian suggests a diversified portfolio that includes international stocks and bonds which provide global diversification and lower volatility, respectively. Source:

In addition, El-Erian also suggests holding real estate and commodities to provide an inflation hedge. Lastly, he suggests an exposure to opportunities (spin-offs, IPOs, and “thematic tilts”) in an effort to seek timely opportunities to boost returns., 1973-2012, Inflation 4.3%  Source:

Over time, these endowment funds have done well but since their holding period is effectively infinite, they can more easily ride the market ups and downs.


  1. “Doomsday” Portfolio Modeling

Every year there are books that predict the end of times. Can you remember 2000 when there was a concern of a worldwide meltdown? Or the many books that predict an upcoming financial collapse?

Here are two that see the end of financial times ahead and how their passive investments have worked.

Peter Schiff’s Crash Proof: How to Profit from the Coming Economic CollapsePortfolio – Peter Schiff has written several books including Crash Proof: How to Profit From the Coming Economic Collapse, February 2007. Looking at Schiff’s earlier predictions that gold could reach as high as $5,000 a troy ounce from a dollar perspective, he says it’s time to “pay the piper,” and said that the “greenback will almost surely collapse during Obama’s second term, as a whole lot of bad economic policy comes to a head.” Source:

James Rickards, the author of Currency Wars and The Death of Money, agrees with Schiff. In 2010, one of those threats was Congress using taxpayers money to buy the people’s endearment. James Rickards’ outlook is even gloomier than Schiff’s.

He recommends buying gold, silver coins, farmland, and fine art. Rickards’ strategy is not covered in this book, but if it were covered, it would be much like Schiff’s. 1973-2013, Inflation 4.3%  Source:


So How Have These Models Performed Relative to One Another?

Showing the portfolios side-by-side illustrates the “ride” of each one.  Here is the Compound Annual Growth Rate and downside risk of each allocation in Exhibit 21.

From a risk-return standpoint, Ray Dalio and risk parity (both came from the same source using slightly different interpretations of the research) by far performed the best in his passive asset allocation modeling, adjusted for risk. In addition, Bernstein offered the highest return, but that came with a significantly greater loss exposure in down markets. Many of these investment professionals like Mohamed El-Erian have since changed their models over time, and their changes are not reflected in the calculations above. Understanding these allocations can help you in coming up with a method for how your 401(k)’s assets should be allocated. They can also help with the asset allocations within your variable annuity contracts.


What Have You Done For Me Lately?

How have these portfolios performed over the last decade? Exhibit 4 shows the performance of the passive and all-equity models over the last five years (Blue Bars) and how each did in 2008 (Red Bars).

The best five-year performer was CAG’s Diversified All-Equity portfolio with an 18.8% average annual gain, but the returns come with losses in 2008 exceeding 40%. Ray Dalio again did very well with a 9.3% five-year return with no drawdown at all in 2008.

The worst risk-adjusted performers were Ken Fisher and Peter Schiff with a 7.7 percent and -4.8 percent return respectively while having a 2008 reductions of -43.0 percent and -30.5 percent respectively. Ken Fisher and Peter Schiff’s ten-year returns were a mere 4.7 percent and -1.1 percent respectively. Most of Ken Fisher’s investments have been in U.S. stocks with ten to fifteen percent in international or global stocks. The Rob Arnott Portfolio also did not do well with a five-year return of 4.0% and a -30.3% drawdown in 2008.

As you can see, finding the right all-equity or passive model is important. However, is determining the right asset allocation for all economic times asking the right question? Is it worth earning ten percent, if it means losing 40 percent in a down market?

Albert Einstein spent his entire life trying to come up with one theory that explained the whole universe. Since his passing, many refinements have been made and still there has been no exact formula that can explain the universe in its entirety. The search for the “one investment allocation” that will work in all scenarios is much like the search for the Holy Grail or the one theory that will describe the universe. The question you have to ask yourself: “Is the goal a unifying asset allocation theory? Or is the goal higher returns while lowering the downside risks?” We believe a better question is: How should you invest for different economic times? In our blogs we will explore both all equity and active management modeling.


Answer to the Question:

What is the single best investment strategy for the events of tomorrow? There is no right answer, except in retrospect. Each model has its ideal environment. Alpha models do the best in good times, risk parity models do better in declining interest environments, and doomsday models do best, well, in times of a real doomsday scenario. In other blogs, we cover the factors to consider in making that choice as well as how these models compare to active asset modeling and all equity models. To get our 100-page report, entitled Investment Strategies that Work for more answers call 952-831-8243.


by: Brett Machtig, & Josh Gronholz

     # # #

We Can Help.

If you want a review of your situation, we will do it for free. The Capital Advisory Group Advisory Services is an asset manager that helps guide wealth accumulation and management. Our team helps executives, retirees, and business owners with financial planning, asset management, tax guidance, risk mitigation, and estate planning. We help clients create wealth by analyzing income, cash flow and taxes with the goal of each becoming great savers. We scrutinize what can derail the plan. Finally, we help clients grow into investors with realistic expectations, giving them strategies to help reduce the impact of market downturns and helping them create plans to assist in meeting their future income and asset objectives.

As a Registered Investment Advisory (RIA) firm, we are held to the highest standard of financial service firms.  We are held to the “fiduciary” standard of care. The Center for Fiduciary Studies states that: “Advisors held to the fiduciary standard must employ reasonable care to avoid misleading clients and must provide full and fair disclosure of all material facts to your clients and prospective clients.”(1)

According to the SEC, “advisors held to the fiduciary standard have a fundamental obligation to act in the best interests of the clients and to provide investment advice in the clients’ best interests. Under the fiduciary standard, advisors owe clients undivided loyalty and utmost good faith.”(2)

We take our fiduciary standard very seriously at The Capital Advisory Group Advisory Services.  We search for ways to better our clients’ current and future financial situation.  We want the best for you and your family.

The Capital Advisory Group Advisory Services uses independent research to identify low-cost investment options, as high fees have an adverse impact on returns. We analyze fees and fund performance using programs like Fi360 to select better investment options and doing side-by-side peer comparisons improve results.(3) 


Our Approach

Our goal is to help avoid you expensive financial lessons and become your “Personalized Chief Financial Officer.” The philosophy we have is to take our three decades of client and personal financial experiences and apply workable solutions to help you better manage your financial needs. We are an independent group with no proprietary investment products or sales quotas.

We are a fee-for-service advisor.  We have found that just commission-based asset management can be an obstacle that may not always work in your best interests.

Our approach rewards us over time, where we have to earn our relationships every day. Our fees vary depending on portfolio size, type of assets, and asset management style. Because our fee-based compensation increases only if portfolios grow, our interests are aligned with yours. We focus on financial objectives and your future growth.


Our Investment Process

Before we develop a personal investment strategy, we take a hard look at where you are currently. We assess investment goals, available resources, desired rate of return, and risk tolerance. Our research allows us to customize a plan to help fit your individual needs and develop your unique “Investment Policy.”  Once the blueprint is in place, advisors provide personalized investment advice. We allocate assets in a way that is intended to enable you to obtain an expected return for a specific level of risk. We believe that asset allocation is responsible for more than 90 percent of the variations in investment portfolio performance – so choosing the right asset allocation for you is our top priority. Each of our models is actively managed and back-tested to help manage risk.

Along the way, we monitor your progress including client statements and reports that summarize investment activity and compare your current portfolio results to your goals. We make periodic adjustments to re-balance your portfolio, adjusting our strategies to fit your individual needs. Through-out, we maintain constant vigilance over market awareness with our investment committee. Thank you, and please give us your feedback. We can be reached at 952-831-8243.


About the Authors:

Brett Machtig has authored several books and is the founding partner of The Capital Advisory Group, a private asset management and retirement planning services firm located in Bloomington, MN. Their firm manages more than $400 million in assets for 83 institutions and about 850 families as of December 31, 2014. He has been helping affluent investors execute financial strategies, meet income objectives and realize life visions for more than 30 years. Approachable, genuine and down-to-earth, Brett holds himself to a high standard of accountability and seeks to achieve positive financial results on behalf of each client. In this article, Brett shares the effectiveness of each strategy and how to improve it. 

Josh Gronholzgraduated Summa Cum Laude from the University of Minnesota’s Carlson School of Management and is a Registered Asssitant. He has worked in asset modeling with The Capital Advisory Group Advisory Services and has spent the bulk of his career modeling various investment scenarios and assisting individuals along their way to financial success and personal wealth.

We can be reached at or; 952-831-8243 or[email protected] or [email protected].


(1) of 8/2014
(2) as of 8/2014
(3), as of 8/2014, Results not guaranteed.

The information contained does not constitute an offer to buy or sell securities and is provided for illustrative purposes only. The information comes from reliable sources, but no guarantees or warranties are given or implied to its accuracy or validity. The strategies listed do not necessarily reflect those of its publisher, MGI Publications or its authors. Information obtained from publicly available sources listed herein and footnoted where applicable. Securities offered through United Planners Financial Services of America, a Limited Partnership, 480-991-0225 member FINRA/SIPC, 7333 E Doubletree Ranch Rd, Scottsdale, AZ 85258. Advisory Services offered through The Capital Advisory Group, LLC 5270 W. 84th Street, Suite 310, Bloomington, MN 55437, 952-831-8243, an independent registered investment advisor, not affiliated with United Planners Financial Services of America. ADV, Part 2A as of 3/26/2015, available upon request. Many investments are offered by prospectus. You should consider the investment objective, risks, and charges and expenses carefully before investing. Your financial advisor can provide a prospectus, which you should read carefully before investing. An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a money market fund. Diversification does not guarantee a profit or protect against loss. Please consult your attorney or qualified tax advisor regarding your situation. Asset allocation and rebalancing do not guarantee investment returns and do not eliminate the risk of loss.

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