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Vanguard S&P 500 ETF (VOO): Survival/Withdrawal Portfolio Update


A lifebuoy with banknotes lie on a blue background, the concept of assistance and security in finance

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Investment Thesis And Background

We started providing regular updates of our survival/withdrawal portfolio (“SWP”) in our free blog articles and to our members, since we launched our marketplace service on Feb 1, 2022. You can see the first update on the SWP and many of its details in this free blog article here.

It has been a very turbulent time so far. The overall equity market lost about 13.6% since Feb 1, while our SWP has lost 8.3%, outperforming the market in relative terms by about 5.3%. Later you will also see that our SWP not only outperformed the overall equity market in cumulative total return but also during each and every month. Do not overlook such outperformance, even if it is relative terms. The math of compounding is asymmetric, so a 10% loss hurts you more than a 10% gain helps you. Avoid. Especially if you actually withdraw, avoiding withdrawals at large losses is crucial in the long run.

Since our marketplace launch in Feb 2022, some readers have asked about our portfolio strategies and the market conditions have changed dramatically. Hence, we think it is a good idea to provide an update to our portfolio here and elaborate on our thoughts going forward. The main takeaway is that we see it is a good time to deploy cash now (that is, of course, after you’ve put aside enough cash to ensure your short-term survival needs already). The main reason is that our exposure index (“EI”), defined as equity yield plus bond yields, is now at a very attractive level of 4.11% now, compared to the historically low level of less than 3% in Feb 2022. And next, you will see how you can approximate the EI yourself using the Vanguard S&P 500 ETF (VOO) information, and how you can use VOO as a cornerstone fund to construct such as SWP for yourself.

Recap Of SWP

Here is a brief summary of the main ideas to facilitate the rest of the update. Interested readers can go to our free blog article for more details.

It is a variation of Ray Dalio’s All-Weather Portfolio (“AWP”) – a variation that made it more conservative to suit my goals and needs. It is a variation that we have been applying for more than 15 years to manage our short-term portfolio – a portfolio that we use to provide liquidity and meet our short-term needs. The portfolio consists of:

  • About 10% cash or cash equivalent. The level of cash is dynamically adjusted based on the valuation of VOO and bond rates. It can (and did) go to 0% when the market is undervalued like during the 2020 pandemic turmoil. The details of the adjustment method and updated allocation will be elaborated on later in this article.
  • About 10% of gold
  • About 15% of intermediate-term bonds
  • About 20% long term bonds
  • And the remaining are invested in stocks with an overall market fund such as VOO as the main holding.
  • The exact allocation of each asset class is adjusted dynamically (partly because the cash allocation is adjusted dynamically) as to be elaborated below.

Update Of Macroeconomics Parameters

Our cash position adjustment is based on the EI, exposure index, as aforementioned. The EI is defined as the summation of equity market yield (can be approximated by VOO dividend yield) and treasury bond yield (taken as 10-year treasury bond rates here). Hope the basic concept is intuitive enough. The EI represents the opportunity cost of having cash. High EI indicates high cash opportunity cost and vice versa.

Now let’s look at some specific numbers for EI. The chart below displays the summation of VOO and 10-year Treasury yields over the last decade as an approximation for EI. The summation started at a peak value near 6% in 2010 – a golden time to deploy cash as much as we can afford. Then it has been in a steady decline with the secular bull market for both equity and bonds. The EI bottomed below 3% in later 2021 and earlier 2022 (about when we launched our marketplace service). And we have been repeatedly cautioning our readers and members during those times to move toward maximum cash holding and enter a hunker-down mode.

Now, the market dynamics have changed again. The EI has reached 4.11% now with the surges in treasury rates and recent equity market corrections. To put it under perspective, the EI has reached or neared the 5% level only three times during the past decade as you can see below. And each time is during a period when stocks, bonds, or both are at attractive valuation levels. And now is getting close to such a time, and our plan is to (and has been) deploy cash dynamically based on the EI, as elaborated in the next section.

EI

Source: author with Seeking Alpha data

Updated Cash Allocation And Allocation Of Other Assets

The next chart shows the SWP allocation we published between Feb 2022 and May 15, 2022. We update and publish our SWP in the mid of each month. As you can see, because the EI was low in Feb 2022 and the opportunity cost of keeping cash was low, we allocated 10.1% of our SWP to cash, close to our ceiling of cash reserve. BTW, our own guideline for cash holding is that it should be able to cover around 6 months of living expenditures when combined with the intermediate bonds and dividends generated by this SWP portfolio.

Fast-forward to May 2022, you can see that:

  • We have decreased cash allocation substantially to 4% only now, again because of the high EI level now.
  • At the same time, you can also see that we’ve adjusted the bond-equity ratio from 70% in Feb to 68.5% now to adapt to the relative valuation changes between equity and bond.
SWP

Source: author

Performance Update

As you can see from the chart below, our SWP has consistently outperformed the market on a monthly and also cumulative basis since Feb 2022. As aforementioned, do not dismiss such outperformance, even if it is only relative outperformance sometimes, especially if you are actively withdrawing. Compounding is intrinsically asymmetric; a 10% loss hurts you more than a 10% gain helps you. And avoiding withdrawing at large losses is more critical to walking away with profits (even though the latter may “feel” better).

SWP ROI

Source: author

The longer-term performance has been detailed in our earlier article here. And only a brief summary is provided here:

  • The next chart shows the backtest results since 1994. The performance of the SWP lags the overall market in general in the long term due to the cash holding. But it fluctuates a lot less and does a much better job preserving my capital, as seen in the next chart. As highlighted by the blue boxes, its standard deviation is about half of that of the overall market, its worst year performance is about 1/3 of the overall market, and finally, the maximum drawdown is about half of the overall market.
  • The preservation capabilities are even more impressive when we look at the historical drawdowns during all the market crises. In the past three decades or so since 1994, there have been 4 major market crises. As highlighted in the orange box, the overall US markets suffered drawdowns of 50%, 44%, 15%, and 5% respectively. In contrast, the conservative portfolio only suffered one double-digit drawdown of 26%. And all the other drawdowns are in the single-digit range, from ~2% to 8%.
SWP

Source: Author, with simulator from Portfolio Visualizer, Silicon Cloud Technologies LLC

SWP drawdowns

Source: Author, with simulator from Portfolio Visualizer, Silicon Cloud Technologies LLC

SWP

Source: Author, with simulator from Portfolio Visualizer, Silicon Cloud Technologies LLC

Final Thoughts And Risks

VOO, with its broad exposure and low fee, can serve as a cornerstone equity fund for a variety of portfolios. This article shows a simple way to use VOO and treasury rates to build a survival/withdraw portfolio (SWP or sleep well portfolio).

The EI has reached 4.11% now with the surges in treasury rates and recent equity market corrections, making it an attractive time to deploy some cash. This might feel counter-intuitive to momentum traders who’d like to move into a hunker-down mode because of the current market volatility. But to put things under perspective, the EI bottomed below 3% in earlier 2022 – and to us, that was the time to move toward maximum cash holding and hunker-down.

And the detailed holdings in our current SWP are shown below. As you can see, we like holding a relatively simple and concentrated portfolio. Our own experience and experiences helping others have repeatedly shown that a few well-understood holdings governed by a few timeless concepts not only deliver better performance but also with LOWER, not higher, risks.

Finally, a few words about the risks and limitations of our approach:

  • The SWP will lag the overall market in the long term due to the cash holding (and also gold, another non-yielding asset). But again, the goal of the SWP is not growth to start with at all. When – and only – our short-term survival is guaranteed, then we can always build a separate portfolio or pursue aggressive growth following a so-called barbell strategy.
  • The simple dividend yield described above has its limitation. And we do not use the EI computed this way ourselves, although the spread presented in the article illustrates the essence of our idea. The dividend yield from the stock market does not always reflect business fundamentals and can be distorted by things like A) tax law, B) political climate, and C) composition of the market index. Dividend yield of “the market” can be biased if the index is dominated by a few mega-caps who do not pay dividends – like what we are experiencing now. In practice, we have an algorithm to correct for the above distortions to compute an adjusted EI.
SWP may 2022

Author



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