Catching a Golden Butterfly

Catching a Golden Butterfly

Portfolio Talk

One of the most common mental hurdles to overcome when researching asset allocation is the siren call of maximum returns.   Nobody likes the feeling of leaving potential money on the table.  Combine that with a bit of accurate but out-of-context historical data, misinterpretation of assumptions, and “common knowledge” that glosses over the details, and you naturally see a strong bias towards the stock market in most investment circles.  Raise your hand if you’ve heard these before:

The stock market has the highest returns over the long run.

Higher risk, higher reward.

The implied conclusions are that diluting your portfolio with non-stocks must also dilute the return, and that the accompanying stock volatility is the unavoidable price to pay for better long-term returns.

Both are simply inaccurate.

Modern portfolio theory has opened the gates for simple but sophisticated portfolio concepts that defy conventional investing wisdom, and the Portfolios section here contains several good portfolios that matched or surpassed the total stock market in long-term real CAGR with fewer stocks and lower volatility.  For curious optimizers like myself, that begs the question – what might a portfolio look like that matched the superior historical returns of the Total Stock Market but the volatility of the lowest standard deviation portfolios?  That seems like the best of both worlds.  Is it even possible?

After a bit of tinkering, the short story is “yes”.  Based on the appealing symmetry, I call one such portfolio the Golden Butterfly.  One wing with two segments is made of stocks, the other is made of bonds, and the stabilizing head is gold.

Golden Butterfly

Asset Allocation

  • 20% Large Cap Blend
  • 20% Small Cap Value
  • 20% Long Term Treasuries
  • 20% Short Term Treasuries
  • 20% Gold

The Golden Butterfly is essentially a modified Permanent Portfolio with one additional asset class that incorporates some of the characteristics of a few other notable lazy portfolios.  The PP already features a bond barbell with long term and short term treasuries, so the stock equivalent of equal parts large and small cap from the Bernstein portfolio is a natural fit.  With a nod to Larry Swedroe for the small cap value preference, the resulting stock allocation has good diversification with two non-overlapping stock funds and a bit more small cap punch overall.  Finally, with the preference for equal weighting of the various assets that I’m admittedly fond of, the resulting asset allocation is remarkably simple and balanced.

So how do the returns look?  Let’s compare the Pixel charts of the Total Stock Market and the Golden Butterfly side by side:


The Golden Butterfly had a nearly identical long-term real CAGR but with 60% less volatility, a single worst year of only -11%, and a longest drawdown of only two years!  Importantly, the lost decades of the 70’s and 00’s are completely absent and the chart is a soothing sea of blue.  Looking at it from another angle, the 7.8% standard deviation was only 0.8% shy of the famously stable Permanent Portfolio but with notably higher returns.

For retirees, you’re in for a pleasant surprise and a nice lesson in the effect of volatility on withdrawal rates.


Not only was the Golden Butterfly great for accumulation over all timeframes, but it was also vastly superior in retirement with 40-year Safe and Perpetual withdrawal rates nearly 2%(!) higher than the stock market equivalent.  Note that the best Perpetual WR for the stock market portfolio was actually lower than the worst one for the Golden Butterfly.  Mathematically, the low volatility not only improves the long-term withdrawal rates but also extends the effect to shorter terms.  While you needed to add 3.6% every year to a stock portfolio to maintain inflation-adjusted principal in the worst rolling 10-year period, the Golden Butterfly sustained the principal even over that shorter duration with a pretty reasonable 3.6% withdrawal rate.  A happy retiree would have slept quite soundly and never questioned their choice of investments even while their friends were looking for other investment options or a new job to stop the bleeding.

The effects of intelligent diversification in asset allocation are pretty astounding and in my opinion don’t get nearly the amount of discussion they deserve.  By neglecting to explore the ways that portfolio construction can not only boost returns but also reduce volatility and enhance overall investing satisfaction, too many people sell themselves short.  Hopefully the Golden Butterfly example will help open a few eyes to the possibilities out there, and perhaps inspire others to similarly experiment with new ideas of their own.  Investigate it in more detail for yourself, compare it to other options, and even play with the numbers using the calculators.  Why settle for a single stock fund when there just might be better options with the same benefits and fewer downsides?

Golden Butterfly SD vs CAGR

UPDATE: For more information, check out my post on the theory behind the Golden Butterfly.  You may also notice that the portfolio section recommends a total stock market fund instead of large cap blend. I changed several portfolios from LCB to TSM to make them easier to translate between countries, but practically speaking the results should be very similar and either fund type is just fine.