Financially reviewed by Patrick Flood, CFA.
The Golden Butterfly Portfolio is a medium-risk portfolio similar to Ray Dalio’s All Weather Portfolio. Here we’ll look at its components and the best ETF’s to use in its construction.
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Contents
What is the Golden Butterfly Portfolio?
The Golden Butterfly Portfolio is essentially a modified version of the Permanent Portfolio. It was designed by Tyler of PortfolioCharts.com. Its asset allocation looks like this:
- 20% Total US Stock Market
- 20% US Small Cap Value
- 20% Long-Term Treasury Bonds
- 20% Short-Term Treasury Bonds
- 20% Gold
Tyler maintains that the Golden Butterfly Portfolio “goes against conventional investing wisdom.” I wouldn’t really go that far. We know that Small Cap Value has historically paid a risk premium and gets us exposure to the Size and Value factors, small- and mid-caps have beaten large-caps historically, short-term treasury bonds are a cash equivalent, and long-term treasury bonds offer the greatest degree of negative correlation to stocks (and are thus a very good hedge/insurance for a stock crash).
The only real point of contention in my opinion is the heavy allocation to gold. I’m personally not a big fan of gold. It has a nonnegative correlation to stocks, albeit low/small, is much more volatile than bonds, is not a value-producing asset (it has a real expected return of zero), and has not been a reliable inflation hedge historically.
Your excitement – or lack thereof – over gold also depends on your view of monetary policy. I’m personally of the mind that monetary policy in the United States is fundamentally different post-Volcker (1982), in that we now know which levers to pull and which levers not to pull in order to avoid a hyperinflationary environment like we saw in the late 1970’s, when bonds suffered and gold did well.
I would argue that in a long-term investment portfolio with an investment horizon of 20+ years, holding gold only creates an opportunity cost where you could have held something else in its place. That said, I’ll concede that it may offer a short-term diversification benefit and the metal does seem to reliably hedge against currency devaluation, making for safer withdrawal rates in retirement, so adopting the Golden Butterfly Portfolio may very well be a prudent move at or near retirement, or for a risk-averse investor who wants to cover all bases for all environments to minimize volatility and risk.
Golden Butterfly Portfolio vs. Permanent Portfolio
The premise of the Permanent Portfolio is to utilize assets that perform well in four economic conditions: expansion (stocks), recession (cash or short-term bonds), inflation (gold; debatable), and deflation (long-term treasury bonds). The Golden Butterfly Portfolio simply takes those same assets and specifically adds Small Cap Value, a move that I’m a fan of. This invariably makes it comparatively more “aggressive” than the Permanent Portfolio, but we’re still talking about a relatively low-volatility, all-seasons portfolio.
In taking up a larger stock position, we’re also tilting toward an expansionary economic environment. I’m okay with this; the economy grows more than it declines. Your adoption thereof may depend on your economic outlook.
Here’s some backtesting comparing the two:
As we’d expect, going back to 1978, we see a greater CAGR and Sharpe for the Golden Butterfly, with slightly more volatility.
Golden Butterfly Portfolio vs. All Weather Portfolio
Compared to Ray Dalio’s All Weather Portfolio, we’re talking about more gold, more stocks, and less treasuries. Like the All Weather, the Golden Butterfly Portfolio is designed to “weather” any storm by utilizing diversification.
As mentioned, the Golden Butterfly Portfolio tilts toward economic expansion. Dalio chooses to be a little more market-agnostic with the All Weather Portfolio, admitting that we don’t know what the future will hold.
With data for the Commodities sector only going back to 2007, here’s what the comparison looks like through the end of 2019:
Results have been very close for that time period. The AW still wins out on risk-adjusted return (Sharpe) due to its lower volatility.
Let’s explore an alternative. If you’re like me, you might replace Commodities in the All Weather Portfolio with Utilities (I delved into this here). Making that change, we can get data going back to 1999, and the results are pretty different:
The All Weather beats the Golden Butterfly Portfolio on every metric – higher CAGR and Sharpe (risk-adjusted return), smaller drawdown, and significantly less volatility. Keep in mind those last two are usually the entire point of investing in an asset allocation such as these.
When we stop to think about these results, it makes sense. The Golden Butterfly Portfolio’s unusually large allocation to gold drives up its volatility and hurts its returns over the long run.
Golden Butterfly Portfolio ETF’s for M1 Finance
M1 Finance is a great choice of broker for U.S. investors to implement the Golden Butterfly Portfolio because it makes regular rebalancing seamless and easy, and it has zero transaction fees. I wrote a comprehensive review of M1 Finance here. Investors outside the U.S. can use eToro.
Utilizing mostly low-cost Vanguard funds, we can construct the Golden Butterfly Portfolio pie with the following ETF’s:
- VTI – 20%
- VBR – 20%
- VGLT – 20%
- VGSH – 20%
- IAU – 20%
You can add this pie to your portfolio on M1 Finance by clicking this link and then clicking “Add to Portfolio.” Investors outside the U.S. can find the ETFs above on eToro.
Taking the Golden Butterfly Portfolio International
You may have noticed a glaring problem with the Golden Butterfly Portfolio: it only uses US assets; it has no international exposure. Taking the stocks global, the portfolio and subsequent pie then look like this:
- VT (world stock market) – 20%
- VBR (US small cap value) – 10%
- DLS (world ex-us small cap value) – 10%
- VGLT – 20%
- VGSH – 20%
- IAU – 20%
You can add this pie to your portfolio on M1 Finance by clicking this link and then clicking “Add to Portfolio.” Investors outside the U.S. can find the ETFs above on eToro.
Modified Golden Butterfly Portfolio
A “Modified Golden Butterfly Portfolio” emerged on the Bogleheads forum in mid-2017. Of course, anyone can create their own “modified” version of any portfolio. The one proposed combines my above suggestion of diversifying internationally with equities and avoiding gold:
- 20% Total World Stock Market
- 20% Total World Small Cap Value
- 20% Long-Term Bonds
- 20% Short-Term Bonds
- 10% TIPS
- 10% REITs
Using mostly low-cost Vanguard funds, we can construct this Modified Golden Butterfly Portfolio as follows. At the time of writing, since there’s no ETF available for global small cap value, I’m using half U.S. small cap value and half international small-cap value.
- VT – 20%
- VBR – 10%
- DLS – 10%
- VGLT – 20%
- VGSH – 20%
- TIP – 10%
- VNQ – 10%
You can add this pie to your portfolio on M1 Finance by clicking this link and then clicking “Add to Portfolio.” Investors outside the U.S. can find the ETFs above on eToro.
Leveraged Golden Butterfly Portfolio
We can’t construct a leveraged Golden Butterfly Portfolio that matches the base portfolio perfectly because there are no leveraged ETFs available for short-term bonds or small-cap value stocks. However, holding 20% long-term bonds and 20% short-term bonds is roughly the same thing as holding 40% intermediate-term bonds. We can also combine the 2 20% stocks positions to a single 40% position to track the S&P 500.
The next issue is that there are now no 3x gold ETFs available. Using 3x leverage on intermediate-term treasury bonds and 3x leverage on the S&P 500 for stocks, we can roughly match the intended exposure ratio with the following allocations:
36% 3x stocks
36% 3x interm. treasury bonds
28% 2x gold
This leveraged Golden Butterfly Portfolio essentially becomes a variant of Hedgefundie’s Excellent Adventure with a heavy allocation to gold.
Below is a backtest showing how this portfolio would have performed vs. the S&P 500 and a 60/40 portfolio historically:
Notice this portfolio would have achieved much higher returns historically with volatility not too much greater than an S&P 500 index fund, and with smaller drawdowns. This portfolio even achieved a greater risk-adjusted return than a classic 60/40 portfolio.
Remember that using leverage – especially in the form of leveraged ETFs – increases portfolio risk and the potential for greater returns, but also the potential for greater losses. Do your own due diligence and read the fine print on these products.
Using popular leveraged ETFs from ProShares and Direxion, we can construct this leveraged Golden Butterfly Portfolio as follows:
UPRO – 36%
TYD – 36%
UGL – 28%
You can add this pie to your portfolio on M1 Finance by clicking this link and then clicking “Add to Portfolio.”
M1 Finance is actually currently offering a 1-year free trial of M1 Plus (gets you 2% margin, 1% APY and 1% cash back, and access to Smart Transfers) for users who sign up before January 31, 2021, a $30 bonus for new users who fund their account with $1,000 or more during the month of January 2021, and a transfer promotion bonus for up to $3,500 when transferring an existing account from another brokerage, as outlined below:
Disclosures: I am long VTI, VBR, and UPRO.
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Disclaimer: While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.
Curious as to your choice of TIP for your modified GB portfolio, versus VTIP, SCHP, or LTPZ? Does TIP have a longer average maturity then others, providing better protection (within this overall allocation setup)?
Great question. VTIP is short. LTPZ is long. TIP and SCHP are intermediate, so SCHP would be a suitable replacement. I’ll probably make that swap when I have time. LTPZ would likely be a fine choice too if one has a long investing horizon. I may look into which one backtests better and will come back and update you.
Did some backtesting. As we’d probably expect, the one with LTPZ has delivered slightly greater returns, with slightly more volatility. Identical risk-adjusted returns as measured by Sharpe.
Have you ever thought about a leveraged version of the Golden Butterfly portfolio ?
I did some backtest on PV and it looks amazing,both x2 and x3 versions.
Hi Jeremy. I explored a leveraged option above here.
Yeah,my bad I didn’ see that for error
Which one has the best chance to perform with higher sharpe ratio,cagr and lower drawdown and standard deviation,if you had to bet on it:
Hedgefundie or Leveraged Golden Butterfly ?
Tough to say. I’d bet the leveraged Golden Butterfly would have lower volatility and smaller drawdowns but it would probably sacrifice some return with the gold. Hedgefundie would likely have a higher CAGR with more volatility, but long term bonds are also starting to look potentially questionable. I’d imagine the risk-adjusted returns as Sharpe would be extremely close.