An example of the Talmud portfolio ¶ Harvard Square Reference

Let every man divide his money into three parts, and invest a third in land, a third in business, and a third let him keep in reserve. - The Talmud, Circa 1200 BC – 200 AD

Now we’ll look at the ancient 1/N (where N=3) portfolio mentioned in the main article which is said to have included land, business interests and cash reserves. As a first attempt at modeling this using modern funds, I selected the Vanguard REIT Index (VGSIX) for land, the Vanguard Long Term Treasury mutual fund (VUSTX) for business interests and the Vanguard Short-Term Treasury Fund (VFISX) for cash reserves. It may be surprising that I decided to use a long term treasury fund instead of a stock market index for the business interests. I suspect businesses 1500 years ago were more likely valued in the same manner as small businesses are today – they sell for roughly two to two and a half years income. In other words, they are valued based on a steady stream of income which is based on the owners hard work, not on growth forecasts.

Performance of REIT, treasury and cash portfolio

This portfolio did slightly better than the simple portfolio (of the S&P 500 index and long bonds) over this particular 15 year period, with a better average ROI of 8.1% versus 7.6% with the same maximum draw down: 25%. It would have been tough to invest in this portfolio during the late 1990′s however, as it made little progress while dot com investors were expecting yearly returns in the 30-40% range, but it may surprise many that it did so well with no exposure to the stock market. But, of course, both housing prices and the stock market are tied to the overall economy. The real surprise to me is that a portfolio discussed 1,500 years ago still works.

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Another possible interpretation of cash reserves back in Roman times is precious metals, so I replaced the short-term treasury fund with the Central Fund of Canada Limited (CEF) which is a half gold, half silver closed end fund.

Performance of REIT, treasury and gold portfolio

Now I’m really impressed. The average ROI shoots up to 11.1% due to the performance of precious metals and the housing bubble, although we take a hit on volatility with a draw down of 29% when real estate prices collapsed in 2008.

I also tried replacing the REIT index fund with a S&P500 index fund (VFINX) which produced the following performance graph and slightly better results: an average ROI of 9.6% and a maximum draw down of 23%.

Performance of a S&P500, treasury and gold portfolio

The particular combinations of asset movements that produced 11% and 9.6% returns for these portfolios may be unlikely to repeat, but as examples they illustrate the advantages of increasing the “N” in a 1/N portfolio among uncorrelated assets.

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Next: The Permanent Portfolio

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