Mostly Voices [0:00]

A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines. If a man does not keep pace with his companions, perhaps it is because he hears a different drummer.

Mostly Mary [0:18]

A different drummer. And now, coming to you from dead center on your dial, welcome to Risk Parity Radio, where we explore alternatives and asset allocations for the do-it-yourself investor. Broadcasting to you now from the comfort of his easy chair, here is your host, Frank Vasquez. Thank you, Mary, and welcome to episode 111 of Risk Parity Radio.

Mostly Uncle Frank [0:44]

Today on Risk Parity Radio, we are going to do what we do best here.

Mostly Voices [0:48]

You need somebody watching your back at all times. Which is... Here I go once again with the email.

Mostly Uncle Frank [0:56]

and our first email of the day, first off, comes from Keith and Keith writes, Uncle Frank, your podcast has completely changed the way I think about investing. Fat, drunk, and stupid is no way to go through life, son. Thank you for introducing me to the benefits of reduced volatility in a properly Diversified portfolio. I love your work and appreciate the effort you put into it. One of the things that you have taught me is that a The risk adjusted return rate is the most important feature of a retirement style portfolio because it allows for a higher withdrawal rate. The sharp ratio expresses this idea by taking the portfolio return and dividing by the standard deviation of the return. A higher sharp ratio means that your portfolio can support a higher withdrawal rate, but it also tells you something about how much leverage the portfolio can handle without risking going bust. I've been reading about a calculation called the Kelly Criterion that is similar to the Sharpe Ratio, except that it uses the square of the standard deviation in the denominator, and he links to an article. This article provides some quantitative advice on how much leverage is too much. Have you thought about how withdrawal rates and leverage are closely related because they are both dependent on the return to risk ratio? One of the things I've been thinking about is how you might take an unlevered portfolio and calculate a maximum SWR for it and also calculate a maximum leverage ratio. The portfolio can probably support taking either the max withdrawal rate or using the max leverage, but I suspect that you can't do both. Any thoughts on how you might balance the two in a rational way? Seems relevant to your model portfolios because some of them have an aggressive withdrawal rate and a bit of leverage. Signed Keith. All right, this is a most excellent email that touches on some things near and dear to my heart. Yeah, baby, yeah! The first is the Kelly Criterion. And the history of this is interesting. If you read that article, you'll get some of it. It was invented by a guy named Kelly, but he didn't do a whole lot with it. This is back in the 1950s. The people that really worked with it were Claude Shannon and Ed Thorp. Now, if you want more on Ed Thorp, I commend to you to read his autobiography, which is called A Man for All Markets. that he published in the past few years. This is the person that first figured out how to count cards at a blackjack table. And they also devised ways of beating roulette by timing and having a small computer in their shoe. So he went on after that to trade a lot of options and make a lot of money in the financial markets using various and sundry techniques. He essentially invented the Black-Scholes model of pricing options before Black and Scholes came out with it so that he had the advantage of trading with it as a secret formula before anybody else knew about it. So anyway, the Kelly Criterion is primarily used by gamblers and people who trade options and futures because what it is determining is how big of a bet you can make an optimal size for your bet, which usually ends up being like one or two percent of your entire gambling pile. You have a gambling problem. Or options trading pile. Well, you have a gambling problem.

Mostly Voices [4:25]

Because the idea is even if you have a successful system,

Mostly Uncle Frank [4:29]

if your bets are too large, you can still go broke in a spade of bad luck, if you will. So the Kelly Criterion answers this question as to how big your max bet ought to be on any particular thing. Now you do need to know the exact probabilities in order to calculate it, but so that becomes a problem. You can do that more or less in gambling situations often, but you can't really do it with respect to markets, at least not on a short time frame. But anyway, So it does go into these issues regarding standard deviations and how far away and what the risk of ruin or risk of loss is for a given situation. So it is related to the Sharpe ratio. It's probably more related to what is called the Sortino ratio, which is like the Sharpe ratio, but it really focuses on the drawdowns of a portfolio and not the upside. It basically looks at the part of the analysis that only deals with the drawdowns and that's the Sortino ratio. So that's another one to look at. Now your observation is correct that these things are closely related and they are both dependent on the return to risk ratio in terms of how much leverage could you take in a portfolio and also what is the maximum drawdown. They all derive from both Returns and volatility in the portfolio. Now, what ends up being the critical factor is the maximum drawdowns both in depth and in length. If you know what that is, you can get a good idea as to whether a portfolio could withstand an amount of leverage. Because if you know the maximum drawdown has been, say, 20% and you doubled the size of the portfolio by adding 100% leverage, the maximum drawdown of that portfolio is going to be 40%. It's just that simple as far as that calculation is concerned. In terms of modeling this, the easiest thing to do is to simply go over 100% with the tools we commonly use. So you can go to portfolio charts and you're not limited to putting in a portfolio that adds up to 100%. So if you putting in a leveraged portfolio, you can make it go over 100% and run the analysis that way. And you'll see some kinds of extraordinary results. Some of these leveraged portfolios do have perpetual withdrawal rates of over 8%. You can do the same thing at Portfolio Visualizer for a portfolio comprised of individual securities. by adding in a cash portion that is negative. So you put in cash X as the ticker symbol and then you put in, say, minus 50 if the rest of your portfolio adds up to 150. So the whole thing ends up to be 100 at the bottom. And then you could run that analysis and check that out for a leveraged situation. And what you will find is that If you have a very well diversified portfolio, you can add some leverage to it, and then you will either have greater returns or a better safe withdrawal rate or some combination thereof with some limitations on it, depending on how well it is diversified. And we have done those sorts of things in our experimental portfolios, the accelerated permanent portfolio, the aggressive 5050, and the new leverage golden ratio, which you might want to take a look at. If you look at that article you posted, it has a very interesting portfolio it was fooling around with, which was a portfolio that was comprised of 50% SPLV, which is a low volatility fund that matches S&P performance or is designed to match S&P performance paired with 50% in TLT, the long-term Treasury Bond Fund. And they were applying leverage to that to show how you could get the same kind of risk that you might have in a total stock market portfolio, but have better returns. And that is the idea behind the experimental portfolios that we're fooling around with and why we are applying a much higher withdrawal rate to those to test them live to show that they can withstand those kinds of withdrawal rates. Now, that's not to say I'm recommending you do any of that, because a lot of this is relatively new, particularly when we're talking about some of these leveraged funds. But this is an option, and you have correctly identified the mathematical observations necessary to get to that. So I very much appreciate you bringing this to our attention.

Mostly Voices [9:34]

Prove me, baby.

Mostly Uncle Frank [9:38]

and thank you for that email. Second off, we have an email from Jeffrey and Jeffrey writes, hello, I've been running a risk parity portfolio for a few years now. Mine is 40% US stock ETFs, which are VOO and VXF, 15% gold ETF using BAR, 15% Cash in government bills, 15% long-term treasuries, ZROZ, 12.5% IVOL ETF, and 2.5% VXF ETF. I think you probably meant VXX for that, but I'm not sure because you already had VXF in the stock part of that. But anyway, continuing on. Given the current macro environment, Low interest rates, stretched stock valuations, closed print. What is your confidence that a risk parity portfolio such as mine or the Golden Butterfly will exceed a return of, say, 4% in the next five years? It seems there are so many headwinds facing many of the components. Obviously, nobody knows the future, but I wondered how confident you are that these portfolios will return at least 3% to 4% annually going forward. Thanks and love your podcast, Jeffrey. Well now Jeffrey it sounds like we're talking about crystal balls. We're gonna have a visit from Sonia here.

Mostly Voices [11:06]

My name's Sonia. I'm going to be showing you the crystal ball and how to use it or how I use it. As you can see I've got several here. A really big one here which is huge.

Mostly Uncle Frank [11:23]

So how do we approach these issues and not deal with the crystal ball problem? The crystal ball problem is this. It goes to a cognitive bias that Kahneman and Tversky identified, which is called the possibility effect, which means that you hear stories about the possibility of something happening and you tend to over-weight that depending on how vivid the story is and how often you hear it. You can't handle the crystal ball. It has nothing to do with the actual probability of something happening. which is why it's a cognitive bias. To get around that, we must consult an expert in this. If you can find a book called Risk Savvy by a German guy named Gerd Gigerenzer with the Max Planck Institute, he talks about this cognitive problem and that the best way to deal with it is to focus on base rates. What is the base rate of this thing happening or what is the base rate of it have happening in the past? Because that's your best estimate. Not what your stories are. It's what, well, did this happen in the past? And how often did it happen? And how often did it not happen? Got to invert. Charlie Munger says, Invert, Invert, Always Invert. So how much, how often did this not happen in the past is a more relevant question then how often has it happened in the past? So you can calculate a base rate for this. And the way you do it is you go to portfolio charts and you look at what is called the heat map, which is all these little boxes in a big graph that goes back to 1970 showing how these a portfolio, say the Golden Butterfly, performed over a series of years and how the average return functioned during that series of years. I went ahead and looked at this. That heat map is based on what's called the real compounded annual growth rate. So it does not account for inflation. I'm sorry, it accounts for inflation. You would need to add inflation to get the nominal rate. And so if you look at it, it showed that in 10 out of 47 years, the five year average real growth rate for the Golden Butterfly portfolio was less than 4%. I think it was always at least 3%. So they're really talking about 10 of these instances after five years where the average growth rate was between three and 4%. That's 21.3% out of the 47 incidences for this, calculating this base rate. Now, what does that tell you about the Nominal rate, the actual headline rate on the returns of this thing, what it tells you is that it had a 100% success rate over the past 50 years, 100% success rate. So if you're looking at a nominal 4% withdrawal rate, just looking at your portfolio and taking 4% out of it starting now, that's a 100% success rate for that. So, Based on that, and I base my predictions on base rates, I don't base them on stories that people tell on TV.

Mostly Voices [14:41]

Forget about it.

Mostly Uncle Frank [14:44]

I would say that I would be 80% confident that the Golden Butterfly portfolio is going to have at least a 4% withdrawal rate after inflation, including inflation. So it's gonna be at least six, five to 7% over the next five years. And I have 100% confidence, or I should say 99.9% confidence, that it will have a nominal rate of at least 4% for the next five years. So I would be happy to bet a large amount of money against anyone. Just email me. Like, we could bet $20,000 on this. I'm serious. Because the crystal ball method of predicting this is frankly stupid and I'd be happy to prove that to anyone and put my own money on it. So if you want to bet say $20,000 that the nominal average growth rate for the Golden Butterfly portfolio over the next five years will exceed 4%, I'd be happy to take that bet. Well, you have a gambling problem. As for the headwinds facing these portfolios. The problem with talking about headwinds is they don't all come at the same time. It is extremely rare to have lightning in a snowstorm. I know it happens occasionally, but it's extremely rare and doesn't happen for very long. Similarly, we're unlikely to have 40 days of hail. We are unlikely to have the sun shining and rain occurring at the same time for any Real length of time. And that is essentially what you are talking about with these headwinds. Because the purpose of putting these different things in your portfolio is when one of those headwinds comes, you have something in your portfolio that's going to perform well during that headwind. And what you're betting on is you're not going to see all the headwinds come together at the same time in some kind of apocalypse. As for your particular portfolio, the thing I would be most concerned about is that it's too conservative, that it has too much cash in it. you have 15% in bills, which is a large cash portion, particularly when you pair that up with 12.5% in iVOL. So that's 27.5% in things that are essentially dragging on your portfolio and not likely to contribute a lot to its long-term success. So while that may be great for surviving for a few years, it's probably not going to be good for the next 20 years or 30 years. And so I would think about that issue with respect to this kind of portfolio. I don't think you need both a big pile of cash and a big pile of Eyewall. Instead of the Eyewall, which is presumably there for inflation issues, you might consider things that do well in inflationary environments such as Small cap value stocks, which would include things like banks and insurance companies. You might consider some kinds of REITs. You might consider some kinds of commodity funds. All of those things are likely to do better than IVOL in an inflationary environment. They just will. And you can see that from the reflation that we had starting last November for the next six months, comparing what IVOL did to some of the things I just suggested, you'll see there's no contest if that's what you're really worried about. But for more on IVOL, you can go back to episodes 70 and 72 where we analyzed it in great detail. And thank you for this email. I'm always pleased to be able to talk about base rates and cognitive biases induced by vivid crystal balls.

Mostly Voices [18:39]

Now you can also use the ball to connect to the spirit world. The crystal ball is a conscious energy.

Mostly Uncle Frank [18:44]

All right, our next email comes from Brendan and Brendan writes, hi Frank, I'm powering through your RPR podcasts and thoroughly enjoying. They really resonate. I have several questions if you don't mind. Apologies if you've already covered. Still working my way through the episodes. How does a longer drawdown affect risk parity? Say a 50-year timeline as opposed to the benchmark 30-year. I haven't heard you discuss fees, one of the few dimensions you can control for investing. How does that weigh in? The sample RPR portfolios seem to hold a higher expense ratio as compared to broad-based index funds, and the Delta certainly adds up over 30 to 50 years. Is there risk parity interoperability with with bucket methodology zero to five year, five to 10 year, greater than 10 year. How would you handle the unknown of drawdown start? Could be zero years away, could be 10 years away, thanks. Okay yeah we have addressed some of these but I'm happy to address them again in one place here. So in terms of looking at the timeline there is a safe withdrawal rate which is tied to a year, usually 30 year time frames, but you can tie safe withdrawal rate to less than that or more than that. If you look at the safe withdrawal charts on portfolio charts, you'll see a graph that goes from zero years out to 40 or 50 years. But the other rate you want to look at is called the perpetual withdrawal rate, and that is the forever rate. Because the perpetual withdrawal rate is the rate that you could take out and not diminish the amount that's in the portfolio at the end of the term adjusting for inflation. So over time, the safe withdrawal rate and the perpetual withdrawal rate will converge. If you look at those portfolio charts things, you'll see that. But also look at what's called the PWR. So if you're worried about more time, just use the perpetual withdrawal rate is the answer to that question. Yes. Now, as to fees, I think you need to think about the order of magnitude we're talking about here. The fees, when we're talking about portfolios, whether they have 0.05 or 0.15, that is not a very meaningful distinction between funds. The meaningful distinction comes when you're talking about over 1% of a fund, which is 10 or 20 times the fees. that are attached to a simple index fund portfolio. These fees are accounted for in the simulations that we run both at Portfolio Visualizer and for Portfolio Charts. So they are accounted for there. In many respects, the rebalancing of these funds outweighs the fees that you're talking about. You're getting more benefit from being able to rebalance things that are uncorrelated or negatively correlated than you are from any increase in fees. And also in that order of magnitude discussion, you need to think about the fact that the largest proportion of these portfolios is still going to be in low fee index funds. So the fact that you have 10% of a portfolio with a higher fee attached to it is not really going to have any material effect on the overall performance over time. And so the alternative are just fixating on fees and only picking the lowest fee funds regardless of diversification really violates what we would call the Holy Grail principle, which is to find uncorrelated assets. Now you want to get the ones with the lowest fees available, but that should not be the primary concern. That should be a secondary concern. You might say the same thing people say about taxes. Don't let the tax tail wave the investment dog and you don't want the fee tail to wave the portfolio dog as well. As for the timing of a drawdown, yes, that's also taken into account in these analyses. They are run over time with many different parameters. And so when you see the Monte Carlo situation, you'll see everything from the worst case scenario to the best case scenario. plotted along these graphs, I suggest looking at portfolio charts as the easiest way to visualize some of these things. In practice, what you're really concerned about is an early drawdown in your portfolio. That's the big risk, that sequence of return risk people talk about, that you're going to have an early drawdown in your portfolio. You don't care as much if your portfolio has doubled in the past 10 years and then it suffers a 20 or 20 or 30% drawdown because you haven't been taking out that much money out of it anyway. But that's where also looking at the max drawdown, historical drawdown for a portfolio, both in depth and in length is important. And there is a drawdown chart at Portfolio Charts, which illustrates that for any portfolio that you analyze there. So if you look at one of our risk parity style portfolios, you'll see maximum drawdowns of typically less than 20% that go on for a maximum of three or four years. If you compare that to a standard 60/40 portfolio or some standard mix of stocks and bonds, you are looking at usually drawdowns there of 30% or more that last for up to 13 years. So which would you rather have? You don't get to have perfection, but you do get to have choices. Would you rather have a portfolio with a max drawdown of less than 20% that goes on for three or four years, would you be able to survive that if the drawdown came on year one? Or would you rather have a standard portfolio that has a drawdown of up to 13 years, which is what happened to many portfolios in 1999? I think the answer is clear, but you will be answering this for yourself, depending on what you choose.

Mostly Voices [24:51]

Stand, it's God. What? It's gone. It's all gone. What's all gone? The money in your account. It didn't do too well. It's gone.

Mostly Uncle Frank [25:01]

As for the bucket methodology, I think that's just a confusing way of looking at the same thing from a different angle. It's like looking at a staircase from the side where you see the stair steps or looking at it from the front where everything just looks like a bunch of levels. You can look at your portfolio either one of those ways. It doesn't change what the portfolio is. The problem with bucket strategies that I see is they overcomplicate the situation because basically they're trying to put a band-aid on a portfolio that doesn't work right. If you had a portfolio that worked right, that was going to sustain the lower sequence of return risks, like a risk parity style portfolio, then you wouldn't need to be putting band-aids of buckets on this thing. In fact, many of these portfolios already have the equivalent of a bucket, short-term bucket, if you will, built into them. So, for instance, the Golden Butterfly portfolio is 20% short-term treasury bonds. That's a short-term bucket, if you want to call it that. The Golden Ratio has 6% in that. That's just in cash. You could also call that a bucket if you wanted to call it a bucket. But I don't think calling it a bucket really makes it any different. I think you should be analyzing your portfolio from the holistic perspective, just looking at the whole thing. If you have a bucket strategy, then you need a whole another set of rules to add onto the top of it. When do you refill the buckets? Do you ever refill the buckets? Do you need to refill the buckets after the first five years? After the first three years? How are you going to predict that? But I will tell you where bucket strategies make the most sense. They make the most sense with relation to your expenses. not to your portfolio construction. Because if you know your expenses are going to be higher in a certain period, then yes, you would want to make adjustments to deal with that issue. But that is an individualized issue for your personal situation. It really does not have anything to do with portfolio construction per se. And that also applies to situations where you know you're going to be getting, say, a pension at a certain date, or you're going to be taking Social Security at a certain date and you're counting on that. You might also make allowances or changes based on that personal situation. But again, that's expense related to your personal situation, not portfolio construction related. But thank you for that email. And our next email comes from Kelly and Kelly writes message. Hi, thanks so much for the work you're doing. I'm up to number 70 so far. Found your podcast researching QYLD. I'm a member of Money for the Rest of Us and have listened to every podcast. David Stein has example portfolios too. Here's my issue. I did okay investing until COVID and then I sold most of my stocks. I'm retiring in seven months at 62. Me and my wife's combined net worth is approximately 1 million. It might be enough, therefore I'm being overly anxious and conservative. I've been trying to create a workable portfolio that I can sleep with for years now, still struggling with the fear when with implementation. I've been working for over 40 years and averaging 80 hours a week and making lifestyle sacrifices to reach this point. I thought writing this message might be therapeutic. So thanks for listening. Your podcasts and resources have given me renewed motivation to create and implement a plan. Blessings to you and your family, Kelly. Well, thank you for that very nice email. I hope writing it was therapeutic and I hope I can give you some advice here that will be helpful. Well, I should say it's not advice, it's infotainment. Obey the disclaimers at the end of this podcast. So, I think there's just, I guess, a couple of things that I'm thinking about to help you out here. First, I would focus mostly on your expense side of things. That is what you can really control the most. So think about how you're living now and how that might change your housing situation, your medical insurance situation, the other things that you want to be doing in retirement. Also for you, I think Social Security is going to be a big part of your income and when you take that is going to be an issue when you and your wife take that. There are strategies for that. I am not an expert in that. I need to look it up myself. But I know that there are different strategies for having one spouse take it early and then maybe suspend it and then the other one takes it later. And a lot of it depends on what your Contributions have been over over your life and then how that translates into your benefit amount. You'll need to look that up at ssa.gov, the Social Security Administration has all that information. And they do actually have some calculators there for you that might be useful for that. In terms of the portfolio, I think the one thing you need to keep in mind is that you're only 62. My father's 92. And so you could be living a very long time. I hope you do. And so if you're going to live a very long time, then you have to have things that will perform and continue to grow over a long period of time. And that's really why your portfolio does have to have a significant amount of equities in it to support that. And what I'm talking about is somewhere between 40 and 60% in stocks is generally what has been recommended for retirement style portfolios. It's what we have in our base portfolios here. And the reason for that is that you do need to have that continuous growth. And the other things in your portfolio just need to support that. They need to provide some possibility of income. They need to provide some diversification so you don't have big drawdowns. But that's really, you know, sort of where we're going here. So if you can just keep that in mind, I need to have 40 to 60% in stocks because I'm going to live a long time. That's kind of the baseline of where you start here. And you can see that also as an illustration with the sample portfolios. I mean, if you look at that most conservative portfolio we have there, the All Seasons, that's only 30% stocks. And while it's doing well enough to support the drawdowns that we're applying to it, you know, it's not doing that well with just a few more stocks in it, the next portfolios, the Golden Butterfly, Golden Ratio, and Risk Parity Ultimate are doing much better. And the main reason they're doing much better is they just have a slightly bigger allocation to the stock market. So I mean, I hope that helps. I hope that is therapeutic and soothing in some respects to you. Just one more observation here. I would be really careful about things like QYLD. That is kind of a fad investment these days. And we talked about it in episode 89 that these are these covered call funds that pay a lot of income. But when you look at their total returns, they actually underperformed the stock market. And I can tell you these were popular once upon a time in the early to mid 2000s before the 2008 crash. They worked just fine while things were going fine, but when the stock market crashed and then recovered very quickly, they don't recover the way the stock market recovers often because of the way they're structured with the options and whether the new versions that are out now, including QYLD and some of the other ones, are going to perform well over time and not decay which is usually what they do, is really an open question. So I would be wary of things like that. I would be wary of anything that somebody presents to you saying, look at this newfangled thing or look at this complicated thing. It's going to solve all your problems. Because really the chances are it's really not going to solve all your problems. What's going to solve your problems is a basic well-diversified portfolio and that's the best you can do. It's the best anybody can do. And if you do want to listen to that analysis of QYLD, it's back in episode 89. I didn't look like you hadn't gotten up to that one so far, but give it a listen and you'll get more on that. And thank you for that email. Our next email comes from Evan and Evan writes, Hi Frank, my wife and I have learned so much from your show in a short amount of time. Really appreciate you putting out all this quality content for free and explaining in excellent detail about risk parity style portfolios, which has been difficult for me to find much more info about elsewhere. We've listened to at least a dozen or so of your episodes so far. I'm listening to episode 105 right now and one of the emails you're answering towards the end mentioned they couldn't find popular gold ETFs like GLDM on Vanguard. This is incorrect, as I just bought GLDM on Vanguard yesterday. The catch is I had to transition my Vanguard mutual fund account to a Vanguard brokerage account first. This gave me access to the wide world of ETFs, whereas before I only had access to a more limited selection of mutual funds. It's a free process and you can do it through the website, but it can take a couple days for it to go through. The dichotomy between the accounts is a bit confusing, is a bit of a confusing aspect of Vanguard, but they definitely have GLDM and I think they have other popular gold ETFs too. Just wanted you to let you know that in case it saves one of your listeners the hassle of moving away from Vanguard unnecessarily. Later, Sensei! Evan. Bow to your Sensei! Bow to your Sensei! Well, thank you very much for that. I did references, I think, in an earlier episode, but it should be referenced again. I think this is an issue with, with Vanguard in terms of just complication and ease of use. I don't have a Vanguard account, so I very much appreciate it when people tell me how things work over there. I do think that Vanguard is right now a bit behind on the customer service aspect of things and, and some of the capabilities of Fidelity and Schwab. But, you know, hopefully they'll catch up. I think they, they will catch up. they'll just have to. I think that no fee trading and being able to trade ETFs and fractional shares of ETFs is really kind of the new normal and the new standard that all of these brokerages ought to be able to live up to. I would not leave Vanguard if I'm already there, particularly if I had a bunch of mutual funds, but it's very good to know that you can do anything you need to do there. Thanks again. That was weird, wild stuff. And we have time for one more email today. Last off. This one comes from Paul, and Paul writes, hi, Frank. Love your podcast. It's so educational and funny.

Mostly Voices [36:36]

Funny, you say? Let me understand this, 'cause I don't, you know, maybe it's me, but I'm funny how? I mean, funny like I'm a clown.

Mostly Uncle Frank [36:43]

I amuse you? What do you mean funny? Funny how? How am I funny? Thank you for sharing your knowledge and humor with us all. Well, I'm glad you appreciate my sense of humor. Not everybody does. Wrong. I'm perfectly sane.

Mostly Voices [36:54]

Everyone else, however, is insane and trying to steal my magic bag. That's okay.

Mostly Uncle Frank [36:58]

Posted below is a recent exchange between Big Earn and I regarding risk parity and lowering risk through leverage in a retirement portfolio. I'm currently still in the accumulation phase with 100% equity portfolio, but looking ahead to an early retirement Within the next decade, fingers crossed and smiley face. Only about 12% of my portfolio is in tax deferred tax advantaged accounts and during retirement I'm considering allocating nearly all of that to long term US treasury bonds and or levered bonds, TMF, and using the rest of my portfolio to implement earns max sharp ratio 8120 portfolio detailed below. I live in a state which taxes capital gains as ordinary income so minimizing ongoing taxes from Portfolio rebalancing, Etc. Is another consideration I have while trying to construct an ideal long-term retirement portfolio. I'd love to get your thoughts on earns recommend date recommended 80 slash 120 levered portfolio and how long-term performance compares to your risk parity portfolios. Thank you so much. And there is below an exchange between him and big earn, which I think would be confusing if I tried to read it all. Let's see, what does Earn say here? He's asking about risk parity style portfolios and Earn says, I generally like the risk parity idea. A variant is the approach of determining the max sharp ratio portfolio and then scale up down to the desired risk return profile. I've shown this to work here and it gives a link of lower risk through leverage. I will link to that in the show notes. It can be done easily with just stocks and bonds, by the way. There's not a long enough history to simulate a full-blown RP portfolio with all the other asset classes. I've attempted to simulate the Ray Dalio all-weather portfolio, 15% gold instead of 7.5% gold plus 7.5% commodities. It doesn't work as well historically in a safe withdrawal rate setting. And he's got another link there. It's part of his, oh, that's the gold, gold hedge against sequence of return risk, part 34 that we have linked to before in our gold episode, episode 40, if you wanted to take a look at that. And then there is some further discussion about what types of bonds you might use in one of these things and how to trade option spreads and earn rights. IB lets you trade spreads so you can place a sell order for a near contract and a buy order for the three-month ahead contract all at the same time. The ideal mix is about 60 to 70% 10-year bonds and the remainder in stocks. You can go with longer duration bonds, but they may not be quite as liquid as the 10-year futures. And then, and I may be reading these in the wrong order, no, I think Paul writes the last comment here. He says, Thank you, Karsten. I'm trying to reconcile your ideal mixed recommendation with the following quote from your lower risk through leverage article. And the quote is probably the most elegant way to implement a sample portfolio of about 80 equities on a 120 bonds would be to hold the entire Equity portion in physicals, EG stocks, ETFs, mutual funds, another 18 in bond funds and remaining 102 in bond Futures. The two percent left over in cash is more than enough to cover the margin on the treasury Futures Is that your suggested ideal mix from a risk parity max SWR perspective for a stock slash leverage bond portfolio during retirement? And the answer is from Big Earn, and that would still be my preferred slash recommended mix. How high you want to lever this up is up to you. If 80 slash 120 is too extreme, maybe start with 60 slash 90. All right, this raises a lot of interesting things that we've talked about in part, but not talked about collectively altogether, I don't think. At least not that I can recall. So first talking about leveraged portfolios in general, and the one in particular he's talking about. I did go over to Portfolio Visualizer and run a little analysis of one of these portfolios that is 80% SPY and then I divided the bond portions into 50% IEF, the intermediate treasury bond fund, and 50% TLT, the long-term treasury bond fund to kind of simulate a just a 10-year bond fund. And so that adds up to 180% and then we use the cash X function to go minus 80% to make it equal 100 and you'll see the performance there. But in order to just do a quick comparison of this, I thought, well, we'll just make this a little bit more diversified and take off 20% off those bonds and put it in gold instead. And so I created a second portfolio that has same amount of stocks, 80%, and then instead of the mixed Bonds, I went with 80% in long-term treasury bonds, TLT, and then 20% in gold. And that's also got the same amount of leverage, so we do minus 80% in cash. And you can take a look at those, which I'll link to this in the show notes, but you'll see that the modified version of that I created, and this just goes back to 2004, has a compounded annual growth rate of 15.56%, which is larger than the one with just stocks and bonds in it, which is a compound annual growth rate of 13.96%. Other than that is very similar in terms of best years, worst years, et cetera. The Sharpe ratios are 1.02 and 1.00. Interestingly enough, the Sortino ratio for the second portfolio is 1.68, which is greater than the Sortino ratio for the only stock bond portfolio that is less diversified at 1.65. and what that tells you is that the second portfolio has about the same volatility, particularly on the upside, but doesn't have as much on the downside. That's what Sartino tells you, because it's downside focused. Now, in terms of more diversification and how you might do this yourself using ETFs and other things, we have talked previously about a fund called NTSX. which is like a 60/40 portfolio only it's been levered up so it functions like a 90/60 portfolio. That's 90% S&P 500 and 60% treasury bonds of all shapes and sizes. We talked about that in episodes 59 and 61 where we did an analysis. We also talked about it again in episodes 94 and 96 answering questions. And then we've constructed a seventh sample portfolio using that as the base, and that is the levered golden ratio portfolio discussed in episode 103. So there are lots of ways to skin this cat and to make this more diversified in different ways, and you'll see that in that particular portfolio. There's another fund out there that would be interesting, and we may talk about it at some point, that has this same idea. It's called Swan, S-W-A-N, It's a Black Swan fund. And that one has 90% in Treasury bond futures or Treasury bonds. And then it's got 10% that are in long-term options on the S&P 500. And so that also ends up being this kind of levered portfolio, but it's more that one's more similar, I think, to what big earns constructed there. in that it's got more bonds than stocks in it. So you can see how taking that portfolio works and then how you can improve it by making it more diversified. So I could also see constructing a levered portfolio with a base of swan and then adding gold and some other elements to it to construct a more diversified portfolio that would perform even better. Where I come out on this, yes, I agree with big earn that you have many options here and you have more options here than you used to. because you don't have to trade those options yourself. There are actually funds you can get off the shelf that are reasonable mixes of these futures and treasury bonds, for instance, already, which could make things easier for you and that you don't have to trade the spreads yourself. What this also gets back to is the original idea that hedge funds had for risk parity style portfolios, which was to construct very conservative portfolios and then add leverage to them to increase their returns. So in a sense, we are getting back to those original hedge fund principles. It's just now we actually have a lot more tools as do-it-yourself investors to do this in various ways and to construct things that are relatively easy to manage, but that also have these nice characteristics. in terms of risk reward ratios. We have the tools, we have the talent. Do make sure you also look at the Sortino ratio in addition to the Sharpe ratio when you are considering these because that does have a greater impact on the safe and permanent withdrawal rates. If you go back and look at that simulated analysis, you'll see that the more diversified portfolio I constructed does have higher safe and permanent withdrawal rates than the original stock bond one talked about there. And for more about the discussion of the use of gold in portfolios, listen to the last episode that I just put out a couple days ago, episode 110, as well as episode 40 and episode 12 where we discuss a lot of this in a lot more detail. But thank you for this email. It really shows how a lot of these ideas are beginning to converge and that the future looks very bright for us do-it-yourself investors with many more ways of doing things and many more ways of analyzing what we are doing so that we can get better outcomes overall. Yes. But now I see our signal is beginning to fade. We will pick up this weekend again with our portfolio reviews of the seven sample portfolios that you can find at www.riskparadioradio.com if you have comments or questions for me, and we'll get to some more of those in that next episode too, you can send them to frank@riskparadioradio.com that email is frank@riskparadioradio.com Or you can go to the website www.riskparityradio.com and fill out the contact form and I'll get your message that way. If you haven't had a chance to do it, please go to your favorite podcast provider and like, subscribe, leave me a nice review and all that great stuff and I will be eternally grateful. That would be great. Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio. Signing off.

Mostly Mary [48:32]

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