Markowitz Portfolios with Graham Bands in the Accumulation Phase

Abstract

In this article, the authors consider historical real returns of tax-exempt portfolios consisting of equities and short-term bonds over 90 different 30-year time periods from 1900 to 2018, in which fixed real contributions were made to the portfolios annually. Two main types of portfolios are considered. The first is a “Markowitz portfolio” in which the investor annually contributed evenly between equities and bonds and never rebalanced the portfolio. The second is a “Markowitz portfolio with Graham bands,” in which the investor annually contributed evenly between equities and bonds but rebalanced the portfolio to an overall 50/50 allocation whenever the equity or the bond portion of the portfolio exceeded 75% of the overall portfolio value. The authors also consider analogous results when short-term bonds were replaced by less-liquid guaranteed income instruments, such as TIAA Traditional, providing higher yields. These results are intended to provide useful historical data to assist investors in the accumulation phase and their advisors in asset allocation decisions.

TOPICS: Portfolio theory, portfolio construction, equity portfolio management

Key Findings

• • Historically, investors in a thirty-year accumulation phase have done well by contributing half of their investments in an index fund modeling the S&P 500 and the other half in short-term government securities; never rebalancing. In this article, such a portfolio is called a “Markowitz portfolio.”

• • Investors in a thirty-year accumulation phase have also historically done well by contributing half of their investments to an S&P index fund and the other half to short-term government securities; rebalancing the portfolio back to a 50/50 allocation whenever either the equity or the bond portion of the portfolio exceeded 75% of the overall value. Such an investment strategy is consistent with one advocated by Benjamin Graham. However, such rebalancing has had a historical tendency to provide portfolio returns lower than that of the Markowitz portfolio indicated above.

• • Since 1900, investors implementing either of the above two strategies, when contributing annually a constant real value to their portfolios, never had in the accumulation phase the bond portion exceed 75% of the overall portfolio value. Hence, investors sympathetic to either of the above allocations might wish to consider placing the bond portion of their portfolios into less-liquid instruments typically providing a higher yield. Historically, such investment modification has provided improved returns.