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 [0:37]

Thank you, Mary, and welcome to episode 133 of Risk Parity Radio. Today on Risk Parity Radio, we're going to have another all email extravaganza with some very interesting ones to answer here. But before that, I'd like to give a shout out to our latest patron on Patreon. Who is Justin? Who joins our small, happy little band of people who support the show with a few bucks here and there, which all goes to charity.

Mostly Voices [1:12]

We few, we happy few, we band of brothers.

Mostly Uncle Frank [1:16]

And as your prize, if you do that, you get to have your email go to the front of the list. Cool. Which we will demonstrate. very shortly.

Mostly Voices [1:27]

But without further ado, I'm intrigued by this, how you say, emails.

Mostly Uncle Frank [1:32]

And first off, first off, surprise, surprise, we have an email from Justin. Surprise, surprise, surprise.

Mostly Mary [1:43]

And Justin writes, hi Frank, just became a Patreon supporter of yours. Glad to help you and the Father McKenna Center continue your great work on both counts. Not really a question, but a recommendation to give the November 22nd episode of Animal Spirits a listen, as it features two brothers who started an ETF along risk parity principles. For the first 10 to 15 minutes, they go through the ETF they started, HOM, and I'm thinking to myself, this is classic risk parity. And then, towards the latter half of the interview, they make the direct reference. In my opinion, The thing about investing in Lowes and Home Depot seems a little gimmicky, but it does seem promising for an investor who wants a quick and easy ETF based on risk parity principles. Also, the ETF reminds me of the investing approach one of your kids, or maybe just your one kid, was or is following to save for an intermediate term goal of buying a house. It might be nice to take it through Stein's 10 part framework on your show, or at least throw in your two cents on the concept. Anyway, keep up the good work, Justin. Well, that's very interesting.

Mostly Uncle Frank [2:47]

I did go listen to that podcast and look at the website Life Goal Investments, which I will link to in the show notes. And it says right on their page, Our portfolios start with risk parity at their foundation. It's not always clear which part of the economic cycle tomorrow will bring, and therefore we believe our clients should remain strategically invested in assets that can perform across different parts of the economic cycle. Each of our portfolios will maintain a strategic exposure to stocks, bonds, commoditiescrypto, inflation-linked securities, but will also have the latitude to tactically adjust when the market presents opportunities. With risk parity as the foundation of our strategic allocation, we use a risk premia overlay to determine our asset class and security selection. So they are using risk parity portfolios, risk parity style portfolios for intermediate goals. It is kind of gimmicky, if you will, because they have, for instance, yeah, the Lowes and Home Depot to save for the house. They have some travel related stocks in the fund that invest for saving for a vacation and so on and so forth. They've got five funds there. But imitation is the sincerest form of flattery, I suppose, since I've been recommending this to my children for some time now that they use a risk parity style portfolio to save for those intermediate goals, including a house. I think the Golden Ratio is a good sample portfolio for that purpose or something that looks like that. The Golden Butterfly is also a good sample portfolio to use for that purpose.

Mostly Voices [4:26]

Yes.

Mostly Uncle Frank [4:30]

What I also find is interesting though is that these commercially prepared risk parity style portfolios invariably seem to underperform what we can do ourselves as do-it-yourself investors. And I think part of the problem in addition to the fees that are applied is oftentimes the purveyors of these products just make them too complicated. So they violate the simplicity principle. And then the other thing they do is violate the Holy Grail principle in that they don't really analyze the correlations very closely of the things they put in these portfolios. So there's lots and lots of stuff if you look in one of these commercially prepared portfolios, but it's not always as uncorrelated or with the low correlations that you would really want it to have and include some things that really don't belong in there. This one has some corporate bonds and other things like that, for instance. Forget about it.

Mostly Voices [5:24]

So I think it will be interesting actually to do some comparisons

Mostly Uncle Frank [5:28]

in the future. And what we will do at year end is do a comparison with RPAR in particular, because it's been around long enough. With these new ones that you find, we'll wait until they've been around for a year and then do some comparisons with our sample portfolios to see the do-it-yourselfers against the professionals, if you will. Yeah, baby, yeah. In that line, I'll also link to this in the show notes. I did a comparison between AQR IX, which is one of these commercially prepared risk parity style portfolios from AQR investing, which is very complicated to our golden ratio and golden butterfly since October 2010, when AQR IX came into existence. And you'll see from the portfolio visualizer analysis that AQR IX has a compounded annual growth of 6.51% compared to the golden ratio is 10.26% or the golden butterfly 7. 55% over that 11-year period and sharp ratios of 0.7 for AQRIX versus 1.2 for golden ratio and 0.99 for the golden butterfly. So I think honestly we can do better than the professionals with our simple constructions. as long as we adhere to that Holy Grail principle and really focus on whether our choices are correlated or uncorrelated and then putting them in in proportions to give us that much lower volatility overall. But it sounds like you've helped me line up a nice show for January. Groovy, baby! And thank you for that email.

Mostly Mary [7:18]

And second off, Second off, we have an email from David, and David writes：hi Frank, awesome podcast. Are you still doing one-on-one consulting?

Mostly Uncle Frank [7:24]

And the answer is, why yes I am.

Mostly Voices [7:27]

Sitting out there waiting to give you their money.

Mostly Uncle Frank [7:31]

I don't like to advertise it too much because I don't really want that many clients. So I end up with a couple a month and that seems to be sufficient for my needs. or my interest in retirement, if you will. But if you are interested, send me an email to frank@riskparityradio.com and we can set that up. It is $300 an hour for a two hour minimum, just so you know. This is for financial coaching. It's a technical term for it. I will sit down with you and review all of your particulars, take a look at your plans, and make some suggestions. and we'll have a couple of Zoom calls, which are usually pretty fun. And I should say one thing that that endeavor has allowed me to appreciate is the sophistication of this audience. Most of you have been do-it-yourselfers for some time and have been very good investors for some time and are just looking for that little added extra. You see, most most blokes are gonna be playing at 10.

Mostly Voices [8:35]

You're on 10 here, all the way up, all the way up, all the way up. Where can you go from there? Where? I don't know. Nowhere, exactly. What we do is if we need that extra push over the cliff, you know what we do? Put it up to 11. Exactly. Which I hope to be able to provide.

Mostly Uncle Frank [8:52]

And thank you for that email. Reminds me I probably should mention this every once in a while, every few months.

Mostly Voices [9:00]

We had the tools, we had the talent.

Mostly Uncle Frank [9:03]

And our next email is from Paul, and Paul writes, Thanks for the great show. Well, Paul, thank you for being a great audience. We have over a thousand loyal listeners to this podcast now, and I get extremely interesting, well thought out emails to discuss on it, which makes it so much better overall. These go to 11. Because you raise questions that I haven't always thought about. or considered in depth. So it increases my knowledge while hopefully increasing yours as well. We use the buddy system. No more flying solo. And thank you for that email. And our next email comes from Ted and Ted writes. Hi, Frank. I was in your breakout session at the economy conference in Cincinnati.

Mostly Mary [9:48]

I really enjoyed your presentation and the discussions. Also, it was great to put a face to the voice I hear on the podcast. I have an Executive Compensation Program 457(b) Top Hat plan that will begin a monthly payout in January. It is designed to be fully paid out over seven years. I have the ability to choose the investment allocation mix, but the monthly payout by plan designation is proportionally taken from all of the investments. With the above information, what allocation mix would you recommend? Thanks much for your thoughts. I feel a risk parity approach makes sense, but the short seven-year payout window overlaid on our current higher than normal inflationary environment and the payout taken proportionally from all the investments has me second and third guessing myself. Thanks so much, Ted.

Mostly Uncle Frank [10:39]

Well, a top hat plan, you say. Top drawer.

Mostly Voices [10:43]

Really top drawer.

Mostly Uncle Frank [10:47]

I was just down at the club discussing this with my friend Thurston. He was telling me about his dreams.

Mostly Voices [10:54]

Well, you haven't got the knack of being idly rich, you see. You should do like me, just snooze and dream. Dream and snooze. The pleasures are unlimited. Yes, you take my dreams, like the one that you just interrupted. It was marvelous.

Mostly Uncle Frank [11:12]

I was foreclosing the mortgage on a lifelong friend, and I was creating a poverty pocket right in the heart of Beverly Hills. But enough of those fun and games. Alright, for those of you who don't know what this is, it is part of the section 457 of the tax code, which allows companies to create executive compensation packages, which Ted has described, and they have various features and payouts. And yes, the IRS itself does refer to this as a top hat plan. I will link to the IRS website in the show notes where you can read about them to your heart's content if you wish. Don't be saucy with me, Bernaise. But as to your question, it is an interesting question with this seven-year payout, because essentially you're getting the money out and being forced to pay taxes on it as it comes out. And I have a couple of different thoughts here. My first big thought is that it depends on what you're doing with the money. if your idea was that you were going to be spending this money as income as it came out, then you would probably want it in safer investments, cash, bonds, those sorts of things, and then take more risk in other parts of your portfolio with the idea that this is essentially this big pile of cash that you're just getting out and spending down. But if we were to look at this in a vacuum as if this was your only asset, I realize that that's not realistic. But in those circumstances, then the fact that there is a tax event in the middle of it wouldn't change the overall allocation in your portfolio. So what you would be doing is putting in whatever allocation you wanted for long term and then taking the tax bite as it came out and putting it back in the same kind of portfolio that it was in. And I think those are the two ends of your risk spectrum or your decision making spectrum from going from considering this money as immediate short term money or considering it as the longest term money as in money you're going to live off essentially forever, in which case you would put it into that risk parity style or other retirement style portfolio now and then as it comes out, reallocate it to the same kind of portfolio as you go. I think you're going to have more flexibility though, because you have a whole bunch of other assets, I'm assuming. From a cash management perspective, it's probably easier just to take the money out, pay the taxes, and live on that money as part of the money you are living on in early retirement. I have a similar situation where we're getting a return of capital. Really top drawer. In connection from my retirement and we're simply just using that as current expense money. But it's always a pleasure to hobnob with the top hat crowd. Now there's only one use for money and that's to make more money. But Mr. Howell, I want to spend it to make people happy. Well, that's a very noble sentiment, very warm and generous, but stupid. That's not an improvement. And it was a pleasure to be able to go to that economy conference and have that breakout session. with a lot of you who are interested in this material. The best, Jerry, the best. Hopefully there'll be more of that in the future. And thank you for that email. And now, last off. Last off, we have an email from MyContactInfo14. At least that's the only name I have here. Forget about it.

Mostly Mary [14:56]

And my contact info writes：Frank, I enjoyed your recent podcast on forecasting. Perhaps all professionals should be required to disclose track records before making public prognostications. One of the reasons I think your podcast is one of the best is your willingness to openly discuss your model portfolios weekly. Thank you again for your efforts. Not sure if you want to go down the rabbit hole of whether or not markets are efficient, But based on my experience, it is useful to look at how markets correlate with themselves over various time periods. For example, how SPX correlates with itself lagged by a certain period. I have found that this simple exercise shows that forecasting is problematic. All right.

Mostly Uncle Frank [15:39]

Yes, I purposely created those model portfolios so I would have something to discuss weekly and to also show in real time how these things work because I think we end up with too much theory and not enough practical knowledge in this area. So to have something we can look at and talk about, I think is very helpful. Sorry I wasn't able to discuss them this past weekend. Geez. I was off in Chicago enjoying my retirement with some friends, some of whom I've been friends with for over 50 years, believe it or not. But as to your question, you have just peeked into a rabbit hole that could suck you in and down for quite a while. We got a scary one for you this week.

Mostly Voices [16:28]

Let me describe some of the things and ideas that

Mostly Uncle Frank [16:31]

come up in this rabbit hole. First of all, this question of whether or not markets are efficient or not is the wrong question. I think this is a Schrodinger's cat kind of issue. It could be alive or it could be dead. The markets could be efficient or they could be not. The correct question is when are the markets efficient and when are they not? And that may be an unanswerable question because markets tend to have unstable equilibria. Most of economic models and financial models are based on the idea of a static model. And so you can determine what the equilibrium is and it doesn't move. In the real world, the equilibria are moving around all the time. So they're not static. That's why markets seem to behave one way for some period of time and then all of a sudden do something completely different. Dogs and cats living together, mass hysteria.

Mostly Voices [17:29]

Underlying this is a fundamental idea from nature about the

Mostly Uncle Frank [17:33]

mathematics of nature. And the mathematics of nature are fractal mathematics. This is a area of math that was invented by a guy named Benoit Mandelbrot, who was probably one of the most important thinkers of the latter half of the 20th century. And he came up with a type of mathematics that happens to describe many, many things in nature, including the heights of trees, the weather, earthquakes, the distribution of wealth, and it also accurately describes financial markets, which he noticed first by seeing a chart of cotton prices in the early 1960s. He had a unique ability to take equations and convert them into shapes in his mind or see shapes and convert them into equations. I'm not aware of anybody else in the world that he's ever been able to do that. Anyway, so he passed away in 2015, but before that he wrote a book called the Misbehavior of Markets. It was published around 2007. And Nassim Taleb called this the deepest and most realistic finance book ever published.

Mostly Voices [18:44]

Real wrath of God type stuff.

Mostly Uncle Frank [18:48]

And so if you are interested in how markets work, I suggest you read that book. What you realize from this kind of mathematics is that you can take very simple formulas or flow charts like the way ants decide what to do or a simple recursive formula like Mandelbrot came up with and create things that are of infinite complexity like markets. And that is why if you look at the Risk Parity logo, that little red thing that looks like a Buddha In the middle, the top middle, is in fact a representation of what is called the Mandelbrot set. It is a function that's actually been turned on its side to look like the Buddha that has infinite complexity based on a simple formula. And I will link to a graphical representation of that from YouTube in the show notes so you can look at its infinite complexity. So let's talk a little bit more about what it means to have unstable equilibria in a system. One of the best models of this that you can visualize is having a pile of sand or a pile of rice where you are dropping one grain of sand or rice onto the pile at random intervals. And what you will have or see is the pile growing and growing and then at a certain point it will reach an unstable equilibria, and the next grain of sand or grain of rice will cause an avalanche in the pile. And it is impossible to predict which one of those grains will cause the avalanche, which is the fundamental problem of trying to predict financial markets. That sure, that grain of sand, whatever it was, caused an avalanche in the past, but it might not cause an avalanche in the future. It probably won't. It'll probably be a different kind of a grain of sand, a different kind of event that causes the avalanche, and there is no way to predict which one of those grains is going to cause the next avalanche in the markets. What turns out to be true in these kind of models, though, or systems, these complex adaptive systems is the technical term for them, is that often they have emergent properties. They're things that are generally true about them in the aggregate that you cannot predict in these specific. So in the case of the stock market, it is generally true that the stock market tends to go up over long periods of time. And the longer the period of time, the better kind of accuracy you can have over predicting the likely outcome. Another example of an emergent property would be mortality tables that insurance companies use. As we know, it's impossible to predict when each of us is going to die and how we're going to die and when that's going to occur. These are seemingly random events. However, in the aggregate, it is very possible and easy to predict aggregate mortality. And so that is why you can have insurance policies And insurance companies can predict overall how many people are going to die, but they can't predict which ones are going to die. That also tells you why you're better off with an index fund than with individual stocks, because it's very difficult to predict the long-term success or failure of individual companies, but it's relatively easy to predict the long-term success of all of them as an aggregate. and you would describe that as an emergent property of this kind of complex adaptive system. What else seems to be true in these kind of systems is that you are better off using simple rules of thumb to navigate your way through them than to try to optimize. Because as soon as you're trying to optimize, you're actually trying to pick which of those grains of sand or rice is going to cause the next avalanche. And this does lead us to the simplicity principle that we follow around here, that it's much better to have a simpler portfolio with simpler rules. And that kind of portfolio is more likely to give you predictable, reliable outcomes, which is why having portfolios that change their asset allocations a lot or jumping in and out of the market based on various rules or conditions are less likely to succeed in the future than they were in the past. It's also why our very simple sample risk parity style portfolios are likely to do better than these complicated things that we see that are commercially available. Now a couple more books of suggested reading material in this area. Pick up a book by Michael Mauboussin who is a Columbia Business School professor. It's called More Than youn Know：Finding Financial Wisdom in Unconventional Places, which talks about observing this fractal model in various places in nature and then bringing that back and realizing that financial markets perform the same way. Another good book to read is Risk Savvy by Gerd Gigerenzer. who is a doctor and a professor at the Max Planck Institute in Germany. And the thesis of that book is that when we are looking at these complex adaptive systems that have a lot of unpredictability in them because they're based on this fractal mathematical models, it is better to use simple rules of thumb to deal with that uncertainty than to try to optimize based on forecasting. It also gets to another central theme we deal with here indirectly, which is that your best prediction in these kind of environments is often just the base rate. And the base rate is an average over a very long period of time. So in the case of the stock market, the average real compounded annual growth rate is about 8% that's after inflation, that's what real means for about the past hundred years. So that by itself is a better prediction of what's going to happen in the future than any crystal ball that anybody can roll out. A really big one here, which is huge.

Mostly Voices [25:32]

Which is why, as we've seen, these fancy models based

Mostly Uncle Frank [25:37]

on PE ratios and other things are wrong. Once again, they are Wrong! They have not worked in the past and there's no reason to think that they will work in the future other than by random chance. Do I feel lucky?

Mostly Voices [25:52]

Do I feel lucky?

Mostly Uncle Frank [25:56]

Now these are all very difficult concepts for people to get their heads around, especially if they are highly educated and trained to believe that if we have enough data then we can use that data and make a prediction of the future, which works in simple environments, but it also falls into what is called Laplace's demon. When you have an environment that is uncertain, what this says, and this was come up by Laplace who thought, if we just have enough data, if we just have enough data, We could predict the future. We could predict all future events. And that's what turns out not to be true, because in an uncertain environment, it's inherently unpredictable. That was weird, wild stuff. Now, if you want to go even further down this rabbit hole, I have a dormant blog called Prospecting Memetic Fractals, which takes this idea and also applies it to ideas of Kahneman and Tversky. Thinking Fast and Slow, and also the ideas of Rene Girard, who founded something called mimetic theory. As I say, it's dormant. I haven't written on it in many years, but I do use it to kind of keep it as a repository for things that I think about and I find are interesting.

Mostly Voices [27:22]

You are talking about the nonsensical ravings of a lunatic mind.

Mostly Uncle Frank [27:26]

And I will link to that in the show notes. Actually, I'll link to the specific page that discusses fractals. than fractal mathematics. But that's probably enough of the nonsensical ravings of my lunatic mind. And I do see that our signal is beginning to fade. We will pick up this weekend with our weekly portfolio reviews. I was sorry I missed them last week with another bond extravaganza in light of the downturn in the stock market that worked out exactly like the textbook says it should.

Mostly Voices [27:59]

Yeah, baby, yeah!

Mostly Uncle Frank [28:02]

If you have comments or questions for me, please send them to frank@riskparityradio.com that email is frank@riskparityradio.com or you can go to the website www.riskparityradio.com and put in your contact information, fill out the form there, and I will 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. Give me some stars, some reviews and all that. That would be great. Mmmkay? Thank you once again for tuning in.

Mostly Voices [28:37]

This is Frank Vasquez with Risk Parity Radio signing off. Now let me finish that dream on a pleasant note. The wholesale arrest of the Supreme Court. Really top drawer.

Mostly Mary [29:00]

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.