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. A different drummer.

Mostly Mary [0:19]

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.

Mostly Uncle Frank [0:38]

Thank you, Mary, and welcome to episode 113 of Risk Parity Radio. Today on Risk Parity Radio, we will begin to try to be able to finish off the emails for July.

Mostly Voices [0:56]

Well, I'm not sure we will, but without further ado, Here I go once again with the email.

Mostly Uncle Frank [1:01]

First off, and first off we have an email from Greg. And Greg writes, Message, hi Frank, I heard about you through your guest appearance on the Choose FI podcast and have been listening ever since. Thanks. Thanks for the education you provide about risk parity investing. I stumbled across something on Twitter called The Weird Portfolio by a guy who calls himself the Value Stock Geek. It is a risk parity style portfolio and I thought it might be interesting. Have you seen this and what do you think of it? Link with the portfolio allocation at the bottom of the page and I will link to this article on Medium. Portfolio composition he says is 20% VBR, 20% VSS, 10% VnQ, 10% VnQi, 20% S-G-O-L and 20% V-G-L-T. Thanks, Greg. Well, I did take a look at that article. It's a very long article, but a very good description of his pathway to a risk parity style portfolio. And I thought it was particularly instructive because he talks about a lot of different asset classes. their history, how they fit in, how they don't, other research, other things. But it's good to see that other people are reaching the same kinds of conclusions on their own and are talking about it. So I will link to that in the show notes. I think it's a interesting read if you have the time. Now, as for this particular portfolio, yes, it is definitely a risk parity style portfolio and looks a lot like the Golden Butterfly Portfolio we talk about, it just has more stocks in it and does not have short-term treasury bonds in it. So in theory, it's going to have more returns and more risk in it. But in order to do something interesting with it, I went ahead and did a portfolio visualizer analysis of it and compared this weird portfolio to a golden butterfly portfolio and to a golden ratio portfolio all in one go, which you can do there. You can do three portfolios at once. And I will link to that in the show notes. But briefly, so I went and did this on the asset class calculator there because that allows you to go further back in time and has more data. So for this weird portfolio, we are looking at a portfolio that is 20% US small cap value, 20% international small cap, 20% long-term treasuries, 20% REITs, and 20% gold. And then for the golden butterfly, if you recall, that is 20% US stock market, 20% small cap value, 20% long-term treasury, 20% short-term treasury, and 20% gold. And then the other sample portfolio we compared with it, this is a golden ratio. And that one we have 21% small cap value, 21% large cap growth. So that's 42% of those stocks, 26% in long-term treasuries, 16% in gold, 10% in REITs, and we did 6% in short-term treasuries in this version. And so you can just take a look at the portfolio returns. and where you see this, and this is an analysis that goes back to 1995. So it's a decent amount of data, although not as much as you'd like, but just looking at the compounded annual growth rates, the weird portfolio falls right in between the golden butterfly and golden ratio for this period. It has a compounded annual growth rate since 1995 of 9.47% compared to 8.58% for the Golden Butterfly and 9.98% for the Golden Ratio. It does have a higher standard deviation, which I expect is due to that international funds that it's got or international stocks that it's got in there. And it has a larger maximum drawdown in this period, which is probably its worst Characteristic here. So in the, since 1995, the weird portfolio has a maximum drawdown of 33.18% compared to the golden butterfly at 16.64% on the golden ratio at 24%, which yields sharp ratios showing this weird portfolio is less than the other two. The sharp ratio for the weird portfolio is 0.71 compared to 0.86 for the golden butterfly and 0.89 for the golden ratio. Similarly with the Sortino ratio, that drawdown hurts the weird portfolio giving it a Sortino ratio of 1.06 compared to Golden Butterfly of 1.35 and Golden Ratio of 1.37 for this period. Now I think this weird portfolio probably performs better if you go back further because international stocks did have better performances back in the 70s and part of the 80s and into the 90s. But they also did well in the 2000s compared to US stocks. So if you want to take more look at that, I take a look at that article because it refers a lot to portfolio charts and the calculations done there back to 1970. But I think what this shows you is that this is a very flexible strategy. You can get there in more than one way. I hope people stop calling it weird because it's not that weird and hopefully people will be thinking this is normal in the future. But I was very happy to take a look at that. That was a very interesting suggestion. Groovy, baby. Thank you for that email. Second off, And second off, we have an email from David. And David writes, Tom, yes, he's calling me Uncle Tom now. My son's name is Tom, but I'm still Frank. Anyway, he says, you, systematic review of risk parity investing with actual examples is unique and valuable. I also enjoy your rants. If possible, it may be interesting to analyze Vanguard lifecycle target risk portfolios relative to your risk parity portfolios. Thank you for your work. It is enlightening and should be more widely considered amongst financial professionals. Well, thank you for that email, David. So I went ahead and did that. I pulled off the Life Strategy Fund that is called Moderate Growth. which is a 60/40 kind of portfolio from Vanguard that is comparable to the Golden Ratio or Golden Butterfly in terms of risk reward. It's designed for the same sorts of things. Anyway, if you look at what it's comprised of right now, it's 37% total stock market, 28% total bond market, 24% total international stock market, and then 11% total international bond market. And so what did we find when we ran this in a comparison analysis at Portfolio Visualizer? Well, I won't bury the lead. We find that this portfolio is vastly inferior to our sample portfolios. And the reason for that, I can tell you, is because it's just not as well diversified. A lot of the bonds in this portfolio are going to be corporate bonds. And so they're going to be positively correlated with the stock market. It is also true that most international bonds are positively correlated with the US stock market. That has a lot to do with the strength or weakness in the dollar. The weakness in the dollar affects both bonds from outside the US and US stocks. I should say when the dollar is stronger, both of those tend to go down, which yields their positive correlation. But anyway, let's take a look at this analysis. I will be linking to it in the show notes as well. And so what do we see here? This goes back to January 1994. We're using the asset allocation calculator there. And so the portfolio allocations for the Vanguard Life Strategy Fund are 37% in the US stock market, 28% in the global ex-US stock market, 24% in the total US bond market, and 11% in global bonds. Again, we use two of our sample portfolios that should be comparable to this in terms of risk reward. And so we're looking at the Golden Butterfly. That's the one that's 20% US stock market, 20% US small cap value, 20% long-term treasuries, 20% short-term treasuries. and 20% gold. And then we're also looking at the golden ratio here. And that one is 21% US small cap value, 21% US large cap growth, 26% long-term treasuries, 16% gold, 10% REITs, and we did 6% in short-term treasuries in this variation. And so looking at the portfolio returns since 1994, We see that the Vanguard Life Strategy Fund had a compounded annual growth rate of 7.74% compared to the Golden Butterfly at 8.18% and the Golden Ratio at 9.51%. So it's inferior on those metrics. It looks even worse when you look at the drawdowns. The worst year for the Life Strategy Fund was minus 25% compared to the Golden Butterfly at only minus 7% in the Golden Ratio and only minus 11%, so two or three times as bad in the worst year. The maximum drawdown for the Life Strategy Fund was minus 37% compared to minus 16.6 for the Golden Butterfly and minus 24 for the Golden Ratio, which leads you to sharp ratios for this period for the comparison purposes. Vanguard Life Strategy is down there at 0.57% compared to Golden Butterfly at 0.81, and golden ratio at 0.84, Sortino ratios, similarly because of those awful drawdowns the life strategies got, it's at 0.82 for the Sortino ratio compared to 1.26 for the golden butterfly and 1.28 for the golden ratio. And so this is just a good example of why we do what we do here and why we have a holy grail principle in that we focus on diversification and correlations. Yes. In addition to using basic low cost funds. Now, the Life Strategy Fund is what I would consider a typical portfolio from the 1990s. It is a late 20th century invention and it was very good for its time. The idea of just getting some low cost index funds, putting them together in a 60/40 combination. and going with that. That made sense then. But we know better now. And we ought to do better now. We're in the 21st century. We're 20 years on from this. And you would think that 20 years later we might have learned a thing or two.

Mostly Voices [12:59]

Am I right or am I right or am I right? Right, right, right. And we have.

Mostly Uncle Frank [13:03]

And we have the tools. We have the talent. We have the tools. We have the talent. And so now we can construct better portfolios. than these typical life strategy kind of funds that you still see as popular.

Mostly Voices [13:20]

Forget about it. And thank you for that email.

Mostly Uncle Frank [13:24]

And now going to a much longer email. This one's from Chris D. Let me just read it first and then we'll have at it. He says, hi Frank, I'm a big fan of Risk Parity Radio and found it by way of Choose FI. I've binged through most of your episodes, but have yet to find my specific scenario discussed. If you've already covered this topic, could you point me in the right episode? Here is the scenario and questions. How does one minimize the tax exposure of a risk parity portfolio that wholly exists in a taxable account? My wife and I have sold our house and have about $500,000 in cash that we'd like to park in a taxable account. We are thinking of a risk parity style allocation and will continue to contribute to this account, then plan to liquidate it in five to seven years to purchase another house stepping out of home ownership for a bit. The full amount of funds will be inside a taxable account. We are in the 30% tax bracket and will remain there in the future, but plan to retire in about seven to ten years from now. We have been eyeing the Golden Ratio sample portfolio but are nervous of the tax implications that gold and REITs have when we would go to cash out. We have all the usual tax advantage retirement and taxable accounts and are a pretty normal profile for professionals working and saving for full careers. We like the idea of keeping this money separate from our retirement portfolio as it is intended for the specific purpose of purchasing a house. Alright, he's got Five questions.

Mostly Voices [15:03]

Yeah, baby, yeah!

Mostly Uncle Frank [15:07]

Question numero uno：Is a risk parity portfolio strategy such as the Golden Ratio in a taxable account the right strategy to preserve and grow a cash windfall over a short horizon such as this? And the answer is yes with some caveats. Keep in mind that preserving and growing a portfolio are two conflicting things. So you are looking as a balance between preserving and growing the portfolio. And this will be more dictated by two things：when you plan on using the money and then how much of it do you have to use all at once and how hard of a stop date is that. In your case, it's also going to depend on your retirement plans and when you're pulling the plug on that and your other income at that point in time. But I think we'll get to that as we go through the rest of these. Question numero dos, are there options to minimize the tax impact of gold and REITs? They reduce their amounts or swap them out for something else, yet still have the reduced volatility of a risk parity style portfolio. And the answer is yes, but first, before we get to that, let's consider how much the taxes are going to be on this. Because if you're talking about a portfolio like the golden ratio, only 10% of it is in REITs. So $500,000, only $50,000 of that is in REITs. It's going to pay, say, 5% a year on that, which is 2,500 bucks, and then you're going to pay tax on that. So that is not going to be a huge tax bill even at your marginal rate. With respect to gold.

Mostly Voices [17:01]

That's gold, Jerry, gold.

Mostly Uncle Frank [17:04]

That's going to be more like 15% of the portfolio. So that's going to be more like $75,000 of this portfolio or slightly more. Now it is really almost impossible to predict the price of gold in the near future in this time frame. What we know very long term is that it keeps up with inflation. But that it could be substantially higher or substantially lower at the end of this cycle. If it just keeps up with inflation, which is very low these days, averaging 2 or 3%, then you are talking about, you know, 10 to 15% gains in this, which is going to be maybe 7 to $10,000. and when you sold it, if you sold all of it at once, yes, you would have to pay the taxes on that. That's going to be a few thousand dollars, but this is not unlike the REITs earning income over time, so you're not paying on it all the time. You'd be only paying that one time when you liquidated it, if you liquidated it, and we'll be talking about that. The other issue you should really think about here is why you have that gold in there. The reason you have that gold in there is you are afraid that the stocks are not going to perform very well or the bonds are not going to perform very well during this period. It's there for diversification. So if things go as well as you could imagine, we have similar environments to say the past decade, your gold may not do very much at all. In fact, it may go down in value while your other things are going up, in which case you'll be selling it at a loss. over this short period of time, there will end up being some things in your portfolio that are sellable at a loss, in which case you would be realizing tax losses, not tax gains on this sort of thing. You really hope that gold is one of those things because that implies that the other assets are probably doing quite well. Now, substitutions you might make. For the REITs, you might also try utilities, a fund like VPU or XLU. We did do an analysis of utilities, and that was back in episode 27. And the reason REITs and utilities are usable for this is because while they are part of the stock market, they are a very small sliver of the overall stock market, and they have they happen to be the very least correlated in terms of sectors with the overall stock market. So that's an option. The reason that's more helpful than REITs is because utilities are more likely to pay qualified dividends, which qualify you for long-term capital gains tax treatment of the dividends paid on those. The other option you might consider for that is preferred shares, which also pay mostly qualified dividends. Now that's a slightly more conservative holding than REITs or utilities, so it's going to pay the dividends, but probably not going to have much capital appreciation. And it may even have capital depreciation, but that may also be helpful for you. And if you are looking for those, you can go all the way back to episode nine. Now for gold. I love gold. The only real substitute that would have a different tax treatment, I would think, unless you're getting into trading futures contracts, would be GDX. GDX is an ETF comprised of gold miners, mostly the very largest ones like Barrick Gold. Now GDX is correlated with gold, but it's not exactly the same. It's slightly more correlated with the stock market than gold is, so it doesn't have quite as much diversification. It's also more volatile than gold, about one and a half times, and can sometimes perform in very strange ways. But that would give you another stock fund, which would be taxable like other stock funds. And so that might be something you want to look into, but I think if you do start Fiddling around with that and doing analyses, you'll find that that portfolio tends to underperform portfolios with just straight gold in them, at least in most time frames.

Mostly Voices [21:44]

You are correct, sir. Yes.

Mostly Uncle Frank [21:53]

So while you can consider those alternatives, I think you should also look and see what your tax bill is likely to be. I don't think it's going to be that extraordinary given the relatively low allocations these have in the overall portfolio. All right, question numero trace. Is there a drawdown strategy that could be used to reduce the tax implications as we approach out target date for the cash need? Well, the best one I can think of is this and it's circumstantial to your circumstances. If you are planning to retire in seven to 10 years, I assume your income outside of your assets is going to go down substantially. And if that happens, it's going to put you in lower and lower capital gains brackets. If you're in the 20% now, I couldn't really tell. That's the highest one if you're making over $500,000 a year. But once you get under that, then you get into the 15% long-term capital gains tax bracket. I don't think you're going to be down in the 0% because you'd have to income under $100,000 for a couple essentially. But that would put you in a lower bracket for making these transactions. Now the way you could swing that is this. You say you need $500,000 in cash that you've got from selling this house. Now that doesn't mean you need to use that whole $500,000 to buy the new house. You could put a smaller down payment on the new house, keep this portfolio riding for a while until your tax brackets drop and then do any machination sales or what have you and put more into the house at that point in time if you like. I think this probably makes a lot of sense in your circumstance given your tax issues and how low mortgage rates are now. And that's something you wouldn't need to decide until you got somewhere down the road. But to me, that is the best option for managing taxes at that point in time. You're just going to have several different moving blocks, and you can move them in certain ways that will help reduce your tax liability. All right, question numero quattro, why not just dump the full amount into a risk parity ETF such as RPAR and avoid the need to manage and rebalance the portfolio? Well, the answer is you could do that, but you might not like it. The RPAR portfolio has a lot of tips in it. And so that is probably going to drag it down over time. We analyzed that ETF back in episode 31, if you want to take a look at it. If you like the way that portfolio is constructed, yeah, you can go right ahead and use that. But if you don't, then you're going to have to manage your portfolio. The good news is this is not going to require a whole lot of management. The way you manage it is very simple. You have to rebalance it once a year, but if you're putting more money into it as you go, you can just keep buying what's low. And that's all the managing you need to do of it. It really is not going to require you much time or effort once you have your allocation set. All right, question numero Cinco. If this were you, how would you preserve a windfall so you can use the funds in five to seven years from now. Bow to your sensei. Bow to your sensei.

Mostly Voices [25:24]

Well, I suppose there's a couple of ways I can think of doing this.

Mostly Uncle Frank [25:28]

The simplest way would be to take a substantial portion of it and just go instead of parking it in a complicated portfolio, just put it in some kind of short-term bond fund or a municipal bond fund if you're comfortable with that. And that might be a good idea for money that has a hard date that you need to spend it on because it's that hard date that's really the problem here. The other suggestion I have for you is to create a situation where you have a more flexible date. One of those ways is by thinking about I don't need to put all this down in the house at once. I can just put a portion of it down on the house at once. Another way is by maybe extending out the time that you're renting until you actually retiring and then you're in a lower tax bracket, you can take care of it there. Another way is this, take this money and put it at interactive brokers. Why do I say put it at interactive brokers? Because you can open a margin account there that you can borrow money out of it at 1%. So if you get to the point in time and you think the tax bills are going to be too bad if you're selling a whole bunch of stuff. You can simply borrow some of the money out on margin at 1%, use that, take a tax deduction for that, and then space out your sales of the rest of the portfolio over some period of time. And since I haven't encountered interactive brokers, that's probably what I would be thinking about how to manage this in terms of the sequence of need for the money and the source of money at a particular time. That's also a reason why I would not think of this as a separate fund entirely. I would combine it or combine the thought of it with other assets that you hold, assuming you have other taxable assets, because there may be some solution there that I'm not aware of that would make your situation more flexible. The more flexible your time horizon is, for using all the money or part of the money, the easier this is going to be to manage from a tax perspective. Another idea that I've thought about is take some of the portion that's to be invested in bonds and instead of putting it in something like TLT or VGTLT, put it in TMF, the Leveraged Fund, and then take some of what you would have put in that. You only need one third of that to match the same Put the rest of that in a short-term bond fund or some thing that has low volatility on its own. Because there's a high likelihood that if the stock market does well, that TMF fund will actually record large capital losses. They won't be as large as the capital gains of the stock market, but there'll be capital losses in there, which you could then harvest, which will be convenient. As you manage this thing, that will be something you want to think about on a year-to-year basis. Is there something in my portfolio that has gone down in value such that I can tax loss harvest it? And the way you do that here is you simply sell it and then buy something that is similar but not the same. And there are all kinds of different ETFs out now that it's fairly easy to find in any of these categories something that is similar but not the same and use that as a mechanism for tax loss harvesting. Now there's one other thing you could do, take a very small portion of this and put it in volatility funds. Those are also likely to generate capital losses. I'm basically telling you buy some insurance that's likely to lose money and that will save you on your taxes and give you something else to tax laws harvest. Now it is going to drag down your portfolio a little bit. So I think I'd be careful with those things because I don't trust them very much. If you're familiar with options, you could also just buy straight VIX call options and watch those decay over time and you'll lose some money there, which you can then tax laws harvest. And the rest of his email says, Thank you for reading my email and for sharing all the knowledge with us. It's really amazing you take the time to do so. Chris D. from Portland, Oregon. Okay, just some final comments. My first final comment is that the taxation of this kind of portfolio is really no different from the taxation of any kind of financial asset portfolio you might be holding. I mean, the worst things you could hold would be like junk bonds and things like that, or things that pay high dividends, those call option ETFs, those would be horrible for your taxes. So you'd want to avoid those. But when you're thinking about this portfolio versus some other alternative, you do need to think in your mind, what would that other alternative be? Because that's what you're comparing against. You're not comparing this alternative with no taxes at all unless you were to just hold it in cash or put it in some kind of municipal bond. I think it ultimately does come down to how flexible you are on the other end as to when you need to use this money and how much of it you need to use and whether you can extend that period to a period where your income is much lower. That is ultimately the silver bullet for dealing with taxable accounts. Don't mess with them until your income is lower, which is why that interactive broker margin account option might be of some interest to you. You need somebody watching your back at all times. But thank you for that lengthy email. It does raise some interesting issues we've talked about in some respects in the answers to other emails, but it's good to talk about them again because I'm sure they apply to many others. And our next email comes from Ricky and Ricky writes, hi Frank, love the podcast and also the sound bites. Ricky don't lose that number.

Mostly Voices [31:45]

From Napoleon Dynamite. Forget about it. The Simpsons. No! Groundhog Day.

Mostly Uncle Frank [31:53]

Tell me, have you ever heard of single premium life? Because I think that really could be the ticket for you. And Ghostbusters. Mass hysteria.

Mostly Voices [32:01]

Real wrath of God type stuff.

Mostly Uncle Frank [32:09]

You don't wanna call nobody Anyway, I am currently 100% equities, but five years before retirement will transition to 60-40, if I want bonds to act as ballast to my equities, I was intrigued by the preference for long-term treasuries as it is the most uncorrelated stocks. However, don't you introduce inflation risk? Would this low correlation have held in something like the 73 to 75 bear market when inflation was running hot? Is there an analysis of where long-term treasuries had the lowest correlation to stocks in different markets? and inflation conditions compared to other types of treasuries. Also, I don't hear much about emerging markets and risk parity portfolios. Is it because it is still too closely correlated to developed international and US equities? I would think this would make a great asset class given it is a sub asset class least correlated to US equities. Finally, I believe it was episode 88 when a listener named Jamie E asked about putting the highest potentially growing assets in Roth versus traditional, and you answer that depends on when you want to use a particular account and not necessarily the highest growing asset. But couldn't you just rebalance assets without tax consequences between Roth and traditional accounts? I think the highest growth assets should be in Roth, and if you want to use the Roth money as part of your financial plans, sell the asset in the Roth, buy it back in the traditional according to your asset allocation. That way the highest growth asset grew as much as it could tax free in Roth, But you buy it back the same asset in traditional and your asset allocation is preserved. Does this make sense? Thanks, Frank. Strong work, man. Signed, Ricky. Ricky don't lose that number.

Mostly Voices [33:52]

It's the only one you'll ever have. Well, thank you for that email. It does have some interesting questions here.

Mostly Uncle Frank [33:58]

Let's answer the last one first. Yes, that makes a whole lot of sense because you have these Roth account and traditional account. You may be trying to eventually convert that traditional to Roth before you get to RMD time, but you correctly observe that you can easily just make transactions in both of those without any tax consequences. So you could sell one in the Roth and use that money and buy it back in the traditional and that would be great. That would be great. Mmmkay. And it makes a whole lot of sense. Okay, then going backwards again to the second question about emerging markets and risk parity portfolios. Yes, what I see if you look at those emerging market funds, the common ones like EEM, if you look at what's inside those, it's largely Chinese stocks these days, and it's largely stocks that are either in the technology area or the financials area, lots of big banks. And these end up being highly correlated with these international stocks that populate the US stock market. And that seems to be true even if you look at some of these newer funds that have are excluding China, for example, that the largest companies here end up having correlations over 80% with the US stock market. So in terms of diversification, it's not really helping you much. It's sort of like, yeah, you can add some of that, but don't expect it to perform really much different than your fang stocks or anything like that. It doesn't help that there's so much technology and so much financials in those funds now. They think they looked a lot different in eons gone by. But there are certain kinds of funds, a few of them that I found, that have much lower correlations. And what these tend to look at are things that are doing business primarily in the domestic economies of emerging market countries. And there aren't that many you can find. One of them I have found, I've put into the new version of the Risk Parity Ultimate that we re-jiggered in July, and that is a fund called KBA, which is invest in something called A-shares in the Chinese markets. And that includes all of the things that sell stuff, including alcoholic beverages to the Chinese people. That is their domestic market. So that kind of fund has a much lower correlation to US stock funds and even these emerging market funds. And that's really what you're looking for, I think. These have correlations down in like the 0.4 range. Now of course they've been performing poorly recently, but that is what diversification actually means. When your US stocks are going up, there should be a good chance that your foreign stocks are doing something else at the same time. So that when your US stocks are going down, hopefully the foreign stocks may be going up at the same time. Now, I wish we had publicly traded companies that did business in economies like Nigeria or Pakistan or even India, and you're not getting the domestic kind of stocks there for the most part. I'm afraid that a lot of these countries in the developing and growing countries the businesses that do business in those local economies are largely privately held businesses. They're not traded on stock exchanges, which is unfortunate. But that's actually what you're looking for. That would be diversified. That would be focusing in on an economy that is different from the international economy or the US economy. So the idea is still sound. It's just the implementation that is somewhat difficult these days. you will find that small cap value stocks are in fact less correlated than some of these international stock funds to the overall US stock market. And as to your first question about the long term treasuries, yes they are the most uncorrelated with stocks if you go look at them over time. And we've talked about this before, but I will see if I can link to some other episodes in the show notes. But the idea for having long term treasuries is not because you think that they are going to do well in inflationary environments. In fact, they will perform poorly in inflationary environments. And you know that. We all know that going in. What we don't know is whether we're going to have an inflationary environment or a deflationary environment. So the idea of having one of these portfolios is to have things that do well in all of the environments possible. And so if you don't have any long-term treasury bonds in your portfolio, what's going to do well in deflationary environments? that's the risk that you are facing. And that is the bigger risk that you saw manifested in 2000, 2008, 2020, and at various other times in market history, including back in the 1929 to 32 era. So that's the reason you're holding them. It's not an additional risk. It reduces risk overall. Because what are you holding in your portfolio to handle inflation? It's something different. What you should be holding there are things like small cap value stocks, and REITs, and gold, and maybe some commodity funds. All of those things are going to do just fine in those kind of environments. If you look at, say, small cap value stocks from 1975 to 1987, they didn't have a down year. and that was the major inflationary environment of that era. There was a big downturn that was steep and hard in '73 and '74, came back in '75, but after that what was called the Nifty Fifty at the time, the big tech stocks, the Polaroids and the Xeroxes, kind of sucked wind until you got to the 1980s, and it was a small cap value. commodity related things that were off to the races. So the way you deal with inflation is by holding things besides long-term treasuries in your portfolio. You don't say, oh, there's a risk of inflation, therefore I should ignore all of the other risks. Because if you do that, what if your crystal ball is wrong and there is no inflation? A crystal ball can help you. It can guide you. like for the past 20 years. No! Then you'll be stuck and you'll have a 40% drawdown on your portfolio instead of a 20% drawdown on your portfolio. If you want to look at data for this, the easiest way to do it is to go to portfolio charts and put in whatever assets you're interested in in the my portfolio setting. And then you can look at what's called the heat map. And it'll have little boxes for each year going back to the 1970s. And you can see on these little boxes how an asset class or a portfolio performed in particular periods. So the big question with respect to long-term treasuries is not whether you should have them, but how much you should have. You don't need to overdo it since they are more volatile. You don't need as many of those as you would if you were holding intermediate-term treasuries or short-term treasuries. Easiest way to understand that is to look at how those things did back in 2020. If you can just look this up, the long-term treasury bond funds from January to March of 2020 were up 25-30%. Intermediates were up 10 to 15%. Short terms were up five if you're lucky. So if you wanted something that was going to counteract your serious drops in the stock market, you needed the ones that went up the most. You needed the longer duration because that volatility helps you when assets are negatively correlated. If you have both low volatility and low returns, even if that thing is negatively correlated with your stocks, this isn't going to do a whole lot. It's going to sit there like cash. It's going to sit there like the total bond market fund did in that period, January through March of 2020. It basically was flat, like no help there. Forget about it. As do when do treasuries have the lowest correlations? to stocks. They have it during stock market crashes. They have it based on what is called the flight to safety. All over the world people are crowding into US Treasury bonds during a stock market crash in the US stock market. And so they perform exactly how you want them when you need them to do that. Yes! But those were excellent questions and thank you for that email. Now just don't lose that number. I'd use it if you feel better when you get home. Last off. And we have time for one more email today. This one comes from John Michael. John Michael is actually my brother-in-law, but I think this is a different John Michael, unless he's masquerading by somebody else's email. But anyway, John Michael writes, hi Frank, I'm interested in the experimental Risk Parity Lever investing pie you did for Choose FI. I went on Portfolio Visualizer and saw for myself that the asset classes are negatively correlated. I understand that concept, however, I'm not sure why you have a 3x leveraged ETF as opposed to a regular S&P 500 fund. I've been doing some reading on leveraged ETFs and it seems they are primarily used for short-term investments. Love to hear your rationale and I'm a big fan. Thanks, John Michael. Okay, so this actually gets back to the original concept that hedge funds were doing with risk parity portfolios. What they realized is that they could create a much more conservative portfolio that was better balanced in terms of performance, but that it tended to have a relatively low return. very low risk, but also low return. So in order to improve the return, they added leverage to it. Now, this has been much more difficult for do-it-yourself investors to do, but in the past 12 years, since 2009, we do have some more of these leveraged funds. And while they are not designed for long-term holding, at least the past 12 years, when you combine them, particularly UPRO and TMF, you can get a good performance out of that kind of diversified portfolio with severe diversification. But these are experimental. They don't have 30 years of history. In theory, this should work. In practice, it has worked. And you can run these portfolios in Portfolio Visualizer. You can run variations of them in the Asset Class Analyzer as well. I should say the portfolio we're talking about, I'll link to this in the show notes, is similar to the experimental sample portfolios, but it's got 26% in UPRO, 26% in TMF, those are the leveraged stock and bond funds, then as ballasted as 12% in VIOLV, that's a small cap value fund, 12% in VGIT, that is an intermediate treasury bond fund, 12% in a gold fund, GLDM, and 12% in a preferred shares fund, PFF. And so the rest of that acts as a very conservative kind of almost permanent portfolio while the leveraged funds juice this thing up. You have a gambling problem. And in theory, this should give you something. that has the same or less volatility as the stock market but performs much better. There is a reason why I put Experimental on it：because it is an experiment.

Mostly Voices [46:44]

Well, you have a gambling problem!

Mostly Uncle Frank [46:48]

I didn't think of these experiments myself. If you go to Optimize Portfolios, the author of that website has a whole bunch of different variations of common portfolios with leveraged funds. and so you can see those there. And I should say if you are looking for the history of acid correlations and risk parity style portfolios, I would go back and listen to episodes 3 and 5 where you will get a lot of that and some interesting links. I will also link to this investing pie for your Perusal, and thank you for that email. But now I see our signal is beginning to fade. I'm not sure I'll be able to do another podcast this weekend. I will be traveling again, but we'll see. Even if I'm unable to do that, I will try to put up the weekly portfolio reviews on the portfolios page for the sample portfolios at www.riskparadioradio. com We're still not through all of July's emails, but hopefully I'll get through them by the end of August. I think I will after next time actually. If you have comments or questions for me, please send them to frank@riskparadioradio.com that email is frank@riskparadioradio.com or you can go to the website www.riskparadioradio.com and put in your message into the contact form there, and I'll get your message that way. If you hadn't had a chance to do it already, I would appreciate it if you would go to your podcast provider and like, subscribe, comment, give it stars, all that nice stuff. That would be great. Thank you once again for tuning in.

Mostly Voices [48:43]

This is Frank Vasquez with Risk Parity Radio. Signing off.

Mostly Mary [48:59]

The Risk Parity Radio Show is hosted by Frank Vasquez. The content provided is for entertainment and informational purposes only and does not constitute financial, investment, tax, or legal advice. Please consult with your own advisors before taking any actions based on any information you have heard here making sure to take into account your own personal circumstances.