A Yield-Based Asset Ratio to Boost Minimum Investment Returns

Using A Yield-Based Asset Ratio to Boost Minimum Investment Returns

by Arthur Copeland Eschenlauer (March, 2024)

A fixed stock-to-bond ratio has some disadvantages (regarding risk-of-loss, minimum gain, and reward-for-risk-of-loss-taken) that are seldom discussed, but which I discuss formally on SSRN:

"A Yield-Based Asset Ratio to Boost Minimum Investment Returns"

Minimum investment returns are of primary importance to funding retirement expenses from a portfolio of volatile assets. Prolonged periods of low yields have at times had severe effects on minimum 20-year returns. Is there a strategy that can mitigate weak medium-term returns more effectively than fixed-percentage stock allocations?

Benjamin Graham allowed for fluctuation in the proportion of a portfolio invested in common stock. Considering his "Margin of Safety" principle for stock purchases and its complement for stock sales, one might adjust the stock percentage of the portfolio based on both the earnings yield of stock and the current yield of bonds, facilitating capital appreciation by avoiding trading until the present yield of the purchased security is substantially greater than that of the sold security. Precautions may be required when stock prices exceed historically sustainable levels.

A simple formula implementing such a "Yield-Based Asset Ratio" hypothetically would have had a minimum real compound annual growth rate (CAGR) of 1.92% for 20-year intervals since 1911 when allocating between 10-year US Treasury bonds and the S&P 500 index, considerably higher than would have been observed for 6%, 60%, and 85% stock allocations (CAGR -2.33%, -0.41%, and 0.09%, respectively). Results suggest that a fixed-percentage stock allocation may not offer the best protection of returns and principal for interval lengths of 11 or more years. Volatile assets pose undue risk to their principal value over the short term.

Note well that this formula applies only to assets that are held as long-term investments; short-term investments (whose principal must fund expenditures that are only a few years away) are more advisably allocated to low-volatility assets (ultra-short term bonds, money market funds, CDs, TIPS, etc.). One ought to take the least risk with whatever they cannot afford to lose!

This link leads to an (experimental, "use at your own risk") calculator for percent stock in a portfolio, based on relative yields of bonds and stocks (consistent with Benjamin Graham's "Margin of Safety" principle, particularly considering the relationship of bond and stock yields when evaluating the risk of investing in stock).

Disclaimer

I am not a financial advisor. Do not construe this material as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product; it has been provided for general informational purposes only. Please treat this material with commensurate skepticism, bearing in mind that investment involves risk-of-loss and that future results cannot be predicted. Please seek advice specific to your situation from a competent financial professional. "May you invest with your head, not over it."

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"Prior Art"

This page formerly had the links for theory that I developed that did not take bond yield into consideration. Because, in my view, it is more consistent with Benjamin Graham's "Margin of Safety" principle to consider bond yield, I moved those links to: