What's a Butterfly Portfolio? Graham Stephan Has the Answer

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  • Graham Stephan recently recommended the golden butterfly portfolio as a more resilient way to invest.
  • This portfolio invests in stocks, bonds, and gold, allowing it to avoid significant losses in any economic scenario.
  • Although it reduces volatility, the golden butterfly has much lower long-term returns than stock-heavy portfolios.

If you're tired of market volatility, the golden butterfly portfolio could be the answer.

For most investors, 2022 wasn't a great year. The stock market had its worst performance since the Global Financial Crisis, with the S&P 500 dropping by 19.4% and the NASDAQ by 33.1%. Even if you know the best strategy is to weather the storm and wait for the market to rebound, it's never fun to see your brokerage account take a hit.

Ups and downs are normally just seen as a fact of life for investors. When there's a bear market, your investments lose money, at least temporarily. But there is a way to significantly cut down on volatility with your portfolio.

It's called the golden butterfly portfolio, which is designed to be resilient to all types of economic cycles. Investor Graham Stephan shared this portfolio in his newsletter, and he recommends it for those looking for more stability. While it works for that, it also has a drawback you should know about.

How the golden butterfly portfolio works

The golden butterfly portfolio involves dividing your investments equally into five market segments. Here's how to split up your investments according to Portfolio Charts (the version Stephan shared had some slight differences, but this is the original):

  1. 20% U.S. total stock market
  2. 20% small cap value stocks
  3. 20% long-term Treasuries
  4. 20% short-term Treasuries
  5. 20% gold

This is much different than typical investment portfolios, which often have a 90:10 or 80:20 split of stocks to bonds. The golden butterfly puts much more in bonds and also invests in gold, which many investors avoid entirely.

Why is this portfolio more resilient to volatility? Stephan explains that there are only four types of economic scenarios a portfolio needs to withstand:

  1. Rising prices (inflation)
  2. Falling prices (deflation)
  3. Market growth (bull market)
  4. Market decline (bear market)

The type of asset that performs best depends on the economic scenario. In bull markets, it's stocks. When there's high inflation, it's commodities, which is why this portfolio has 20% gold. During bear markets and deflation, bonds provide stable returns.

Because the golden butterfly covers all the bases, it can handle any economic environment. It won't always be in the green, but it's highly unlikely that it will lose big.

Should you use the golden butterfly portfolio?

Historically, the golden butterfly portfolio does what it's advertised to do and keeps you from taking any huge losses. But there's one big catch: It significantly trails stock-heavy portfolios in bull markets.

That's the tradeoff for a more stable portfolio. When the market is doing well and stock-heavy portfolios are making 25% to 30%, your golden butterfly portfolio may make less than half that.

Over long periods of time, the golden butterfly portfolio doesn't perform as well as portfolios that have more money in stocks. The table below compares the results three portfolios would have delivered from 1992 to 2022. For each one, the hypothetical investor started with $500, and then invested $500 per month. The three portfolios invest their money as follows:

  1. Golden butterfly
  2. 90:10 in the U.S. stock market and long-term Treasuries
  3. Vanguard 500 Index Investor (an S&P 500 index fund)

Here's how each portfolio performed.

Portfolio Final balance Time-weighted return Best year Worst year
Golden butterfly $843,441 7.64% 21.86% (12.82%)
90:10 stocks to bonds $1,176,171 9.30% 35.22% (31.08%)
Vanguard 500 Index Investor $1,229,423 9.46% 37.45% (37.02%)
Data source: portfoliovisualizer.com, author's calculations.

The stock-heavy portfolios are much more volatile, losing over 30% in their worst years compared to under 13% for the golden butterfly. But they also get much higher returns during their good years. And when you compare the final balances, it's not even close. The S&P 500 fund may be more volatile, but it ends up with nearly $400,000 more. The 90:10 portfolio also performs very well.

It's understandable why you'd want to reduce volatility in your portfolio, especially after a year like 2022. But it's unwise to sacrifice long-term growth for short-term stability. If you're a young adult investing for retirement, most or all of your money should be in stocks. As you get closer to retirement, you can adjust your asset allocation so you're not as vulnerable to bear markets. You could try the golden butterfly at that point, or you could just put anywhere from about 20% to 40% of your portfolio in bonds.

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