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 [0:18]

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 Risk Parity Radio. If you are new here and wonder what we are talking about, you may wish to go back and listen to some of the foundational episodes for this program. And those are episodes 1-3-5-7-8. and nine. One of our listeners, Karen, has also reviewed the entire catalog and has additional recommendations as foundational episodes. Ain't nothing wrong with that. And Karen's recommendations are episodes 12, 14, 16, 19, 21, 56, and 82, in addition to the first five that I mentioned. Now, I realize women named Karen get a bad rap these days, but I assure you that all of our listeners are intelligent, thoughtful, and savvy. Yes! And don't forget that the host of this program is named after a hot dog. That's not an improvement.

Mostly Voices [1:41]

Lighten up, Francis.

Mostly Uncle Frank [1:45]

But now onward to episode 168. Today on Risk Parity Radio, we are going to finish off our emails from March finally, and get into a few from April. But before we get to that, first a note of celebration is in order. This podcast crossed one quarter million downloads last week. Inconceivable. And I have each and every one of you to thank for that. I'm grateful for the audience that we have and the interest you have shown. As the technologist Kevin Kelly says, what you're trying to do when you create a podcast or a blog or anything is get to a thousand true fans. And we seem to have at least a thousand downloads every week of the new podcast.

Mostly Voices [2:44]

So I have to say I'm probably pretty close to that. Yes! And that makes me feel pretty good. So bold strategy, Cotton, let's see if it pays off for him.

Mostly Uncle Frank [2:56]

To celebrate, I will play you a little clip from one of my guilty pleasures, the Numberphile YouTube channel, which is run by some English mathematicians. And anyway, there's a nice old gentleman named Johnny Ball Talking about the basis for the Risk Parity Radio logo that I thought was very apropos for the occasion. Au contraire.

Mostly Voices [3:21]

So what I've got is five dots here, which I've already mapped out to make a pentagon. And inside the pentagon, I'm gonna form a pentagram. And the pentagram was used by the Pythagorean cult in southern Italy, the followers of Pythagoras. and they felt it was magic, just magic. And in a way, I agree with them. Wonderful thing about the pentagon is all these lines are divided by golden ratio. There's two things you can measure. You can measure that distance there, short distance to the side, or the long distance across there. Divide that into there, you always get the golden ratio. But even when you split it up again, divide that into that golden ratio, and it's just absolutely beautiful.

Mostly Uncle Frank [4:03]

And now moving on, I'd like to talk to you about what's going on over at Risk Parity Chronicles. You may recall from episodes 153 and 160 that one of our listeners, Mark, had created a useful backtester shortcut tool to use with Portfolio Visualizer and Portfolio Charts via a Google spreadsheet. And Justin over at Risk Parity Chronicles has put this up, founded a home on his website, and also created a nice tutorial video explaining what it is and how to use it. The best, Jerry, the best. And I invite you all to check it out. I will link to that in the show notes. But it is most excellent. The numbers all go to 11. And I thank Mark, Karen, and Justin for their contributions to making that happen. Justin's also got an interesting post there about which asset classes seem to do the best in inflationary times. You had only one job. They may not be the ones you think. You should check that out too. I'll also link to that in the show notes. And now getting to what we seem to do best around here. Here I go once again with the email. And... First off. First off, we have an email from Doran. And Doran writes...

Mostly Mary [5:33]

Hi Uncle Frank, Millennial here. Thanks to you, I've learned that 90% of your return is based on your macro asset allocation. I noticed on your risk parity portfolios you don't simply use VTI or an equivalent for the entirety of your stock portion. Why? What should one start to consider once they've made it to $100,000 in VTI for an accumulation portfolio? Thanks for all you do. P.S. Please tell your listeners to stop apologizing for themselves when they submit questions. There's nothing to apologize for. We're all learning.

Mostly Uncle Frank [6:04]

All right, first what you are talking about is called the macro allocation principle that we first discussed back in episode number seven as one of our three main principles. And it comes from chapters 18 and 19 of the Book of Jack, which is Common Sense Investing by Jack Bogle. Top drawer, really top drawer. Now just to clarify what this is and what it isn't for everyone, what was being looked at there was a series of studies going back to the 1980s in which portfolios were being compared and all these portfolios were professionally constructed portfolios by asset managers who are trying to do the best for their clients or institutions. And the conclusion drawn from it, that it was really the macro allocations, meaning the stock, bond, and other divisions of the portfolio that were the main drivers of how it performed. And so that all portfolios with the same basic macro allocations tended to perform, I think he says over 94% the same most of the time. And the main conclusion he was focusing on in that book was that it didn't make a whole lot of sense to be paying lots of people to be stock picking when you could just set up macro allocations with index funds and get the same or better results without paying the exorbitant fees to pay stock pickers to go stock picking and bond picking. But this also applies in a broader sense to portfolios that are constructed of index funds. Most index funds are well diversified over hundreds or thousands of stocks, and therefore most collections of index funds, whether you have one, three, five or seven or however many you have there in your portfolio, are going to be well diversified stock portfolios. So if you're talking about an accumulation portfolio that is a hundred percent stocks, it is not a very good use of your time to spend a lot of time fund picking. It makes more sense just to pick a few funds and stick with them and whether you are just going with the simple path to wealth solution of under 100% Vti or a Merriman 4 fund or any number of other well-trodden 100% stock portfolios. You can expect that they're all going to perform about 90% the same and that you are not going to know which is the best combination in advance. But whatever combination you do choose, you want to stick with that combination and not be jumping in and out of funds because That is actually how amateur investors tend to underperform even the funds that they hold themselves is by jumping in and out of them depending on which one performed best last.

Mostly Voices [9:15]

You can't handle the gambling problem. And that's just a bad process.

Mostly Uncle Frank [9:20]

Now getting to your question, why would you just not continue on with this one fund portfolio as a stock portion of a risk parity style portfolio? It's because you can do better in terms of diversification. Recall that the purpose of holding one of these kind of portfolios has a lot to do with your decumulation phase or living off this portfolio, in which case what you're trying to actually maximize is not the returns, but the safe withdrawal rate. And that is a combination of both the returns and the overall volatility of the portfolio and especially what are the maximum drawdowns likely to be both in depth and in length of time. And so by better diversifying the stock portion of a risk parity style portfolio, you can improve those characteristics and then ultimately improve your projected safe withdrawal rate. What you should recognize about a total stock market fund like VTI is that it is not balanced across all kinds of stocks. Because of its construction, in particular its cap-weighting, that it holds much more of the largest companies, it is naturally tilted towards what you would call large-cap growth stocks, the biggest companies that are growing the fastest.

Mostly Voices [11:09]

And so it is not naturally Diversified as much as you would like in a more broadly Diversified portfolio and the easiest way to fix that or at least partially fix it mostly fix it is to add small cap value to your risk parity style portfolio I'm telling you fellas you're gonna want that cowbell and whether you do that somewhere along the way of

Mostly Uncle Frank [11:13]

your accumulation journey or you do it later when you are constructing your retirement style portfolio is up to you, although it's a bit easier if you do it somewhere along the way due to the tax consequences of having to sell lots of a large cap growth or VTI portfolio to buy other components that you may want to have. And you might just stop there as we have with some of our sample portfolios. You look in the Golden Butterfly, the stock portion is just total stock market and small cap value. You could have a similar holdings in the Golden Ratio and Risk Parity Ultimate portfolio with other things added to it. But those two things make a good base. And finally, as for listeners apologizing for themselves when they submit questions, I don't think they're necessarily apologizing, at least not all the time. I think they're just trying to be polite.

Mostly Voices [12:15]

Young America, yes sir. Which is a practice that Mary recommends. Mary, Mary, why you buggin'?

Mostly Uncle Frank [12:24]

But that her husband does not always follow.

Mostly Voices [12:27]

Mary, Mary, I need your huggin'. And thank you for that email.

Mostly Uncle Frank [12:38]

Second off, we have an email from George, who also has as part of his email, boom daddy. Looks like daddy's bringing home the barbecue. And George, aka boom daddy, writes, howdy, love your podcast.

Mostly Mary [12:58]

I am into episode 57 and a little over three weeks. I've been binge listening. Question about dividends generated by holdings in your portfolios. Do you automatically reinvest all generated dividends, or do you allow those dividends to go to your cash bucket and then determine where to reinvest or if dividend generator was the up holding for the month, then you use that for the cash distribution. Just trying to understand the exact mechanical process you are following. Thanks and keep up the great work. I'm recommending your site and podcast to everyone I know who has an interest in these topics, and is able to understand the concepts. Blessings, George. Alright, the answer to this question has mostly to do with convenience and efficiency.

Mostly Uncle Frank [13:44]

First, if you are in a drawdown scenario and you are living off your portfolio, then you do not want to reinvest your dividends automatically because that just creates an additional transaction. What you want to be doing is taking that money first, as the money you're going to live on, and then to the extent you need more for a distribution, then you sell something. And then if it turns out you have a lot of cash or too much cash for whatever reason at rebalancing time, then you would reinvest it at that point in time. But you really want to minimize the transactions, particularly in taxable accounts, both because you don't want to generate taxes and because it makes your record keeping very messy the more transactions you have. And that gets us to another couple of general considerations. If you were talking about an IRA or a 401k, it really doesn't matter whether you reinvest or not because those transactions are not going to generate taxable events and you have less need to keep track of them. But when you are talking about a taxable account, every time you buy shares it creates a new and separate tax lot for that investment. And so lots and lots of small transactions can create lots and lots of headaches. Am I right or am I right or am I right?

Mostly Voices [15:06]

Right, right, right.

Mostly Uncle Frank [15:09]

So for me, I think it's better management in a taxable account not to reinvest dividends, even if you're not spending them right away, because you may be paying taxes with them or you may wish to reinvest them in something else in the portfolio. And that also goes to one of the alternate use cases for these risk parity style portfolios, which is to use them for intermediate term accumulations, say for the down payment on a house or something else like that that's going to take you a number of years, but you wouldn't call it a long term investment. You can use one of these portfolios for anything that's, say, three years to ten years. as an accumulation vehicle. In those cases, as you are accumulating, you are adding to the asset that is performing the worst as you put more money into the account. So that is also a reason not to reinvest the dividend so you can do that sort of rebalancing as you go because you are again trying to minimize the number of transactions you have going on there. Now, all of this being said, this is not generally a critical decision in the way you manage your portfolio. And that's because generally the amount of cash you're talking about relative to the size of the portfolio is going to be pretty modest unless you had the unfortunate experience of investing in mutual funds that pay massive unpredictable dividends in December like some of Vanguard's did. last December, but I would just try to stay away from those kind of funds to begin with. And thank you for that email, George. You are truly a gentleman.

Mostly Voices [16:57]

Really top drawer.

Mostly Uncle Frank [17:01]

Next off, we have an email from Eddie J. Hey, Johnson. Oh, you listen has to call me Johnson.

Mostly Voices [17:08]

My name is Raymond J. Johnson Jr. Now you can call me Ray. Or you can call me Jay, or you can call me RJ, or you can call me RJ Jay, or you can call me RJ Jay Jr. But you doesn't have to call me Johnson.

Mostly Uncle Frank [17:24]

And Eddie Jay writes, Dear Frank, in episode 160,

Mostly Mary [17:29]

you indulged us with an answer to the question of what might be an ideal generic two-fund portfolio to optimize risk and reward. Your suggestion was 80% NTSX and 20% Gold, which gives you that nice 3 to 2 stock bond ratio, not too far from 1.5 to 1.6 times sweet spot for leverage, and sufficient gold to diversify those two asset classes. I was wondering why you didn't suggest more NTSX and a levered gold fund, for example, 10% of a two times gold fund. In any case, just last month, our friends at WisdomTree released a new levered multi-asset ETF called GDE, which gives you 1.8 times of 50/50 S&P 500 in gold. There was some excitement about this fund on the leveraged ETF community on Reddit, LETF. Although by itself it has an undesirably high amount of gold, you can get some very nice exposures by combining it with another leveraged fund like NTSX. For example, using some very rough math, a portfolio of 70% NTSX and 30% GDE should get you exposures of about 83% S&P 500 42% Treasuries and 27% gold, or about 1.5 times the 5527-18. I was wondering what you think about this idea for a basic two-fund portfolio, once there is some reasonable amount of performance data and minimum AUM in GDE to rely on. Thanks.

Mostly Uncle Frank [19:01]

Well, we did talk about this new fund GDE in the last episode, episode 167. I think it's interesting, but I would wait and watch it for a few years to see if it performs as advertised. Getting to your main questions, honestly, when I constructed that 2-Fund portfolio back in episode 160, I did not give it a whole lot of thought. And the reason I didn't is because I view this kind of question as one of those if you were on a desert island, which two books would you bring with you? Or which two foods would you like? if you could only have two foods. And that's because fortunately for us, in reality, we do not live on desert islands and that we can have many more funds than two. Ahoy there, matey. And so it seems to me that using that as an artificial restriction is not a very useful method of deciding what to invest in overall. and my preference is to have funds that only invest in one thing because they're much easier to combine and then also to manage in terms of rebalancing and other things going forward. So in any of these constructions, for example, I would want to have some small cap value It doesn't work for me. I gotta have more cowbell. I gotta have more cowbell. Or REITs or utilities or some other diversified stock components besides the usual S&P 500 that is put into these composite funds. I'd also like to have more control over the kinds of bonds, in particular the durations of the bonds and the proportions of the durations of the bonds. in the portfolio, and that's much easier to do when you're talking about individual funds that are focused on specific bonds and specific durations. Now, all that being said, if you're going to construct a two-fund portfolio using some of these composite funds, the one you propose, 70% NTSX and 30% GDE, seems to me could work pretty well for a Simple to fund levered risk parity style portfolio.

Mostly Voices [21:32]

That is the straight stuff, O'Funkmaster. So I would not say don't do it.

Mostly Uncle Frank [21:40]

I would say you don't have to do it because you have other options available. I think with most of these portfolios you're going to end up with somewhere between five and ten funds, which is still quite manageable. But these desert island questions are kind of fun to think about sometimes.

Mostly Voices [21:59]

Life on the open seas. Land ahoy.

Mostly Uncle Frank [22:05]

And so thank you for that email. Yo ho ho. Last off. Last off. We have an email from Alexi.

Mostly Voices [22:19]

So that's what you call me, you know, that or his dudeness or duder or, you know, Bruce Dickinson. If you're not into the whole brevity thing.

Mostly Mary [22:28]

And the dude writes. Here's a kind of fun revisit of the Golden Ratio portfolio using the short-term Treasury real estate and a touch of leverage to create space for long volatility and trend. 20% TLT, 20% GLDM, 20% VIoV, 20% DBMF, 7% UPRO, 2% VIXM, 1% VIXY, 10% EUO, RIP CROC, sad face, AZ.

Mostly Uncle Frank [23:06]

All right, just to clue everybody in as to what Alexei's trying to do here, as he is one of our power users. As this goes back to episodes 53, 55, and 57, In episodes 53 and 55, we first began discussing something called the Dragon Portfolio, which is a creature created by Artemis Capital in Austin, Texas. Now we know that the basic building blocks of most risk parity style portfolios are stock components, treasury bond components, and a gold component. But we also know that's not all that's out there. Really? And two other components that seem to be useful that are incorporated into this Dragon Portfolio are a component that covers volatility or volatility funds and another component that covers managed futures or trend following futures contracts. And you can go back and check out the links about the Dragon Portfolio and the analysis done there, but they found that these Two additional components have improved the diversification and performance of these sorts of portfolios over time. Now, the problem that we have as do-it-yourself investors is that there are not very good options in terms of selecting ETFs to cover things like volatility and managed futures. So it's one of those things that we continue to poke around at and wonder about and think about. as what are the best solutions for those sorts of things. And Alexei's been doing a lot of work looking at different sorts of options for those components. So what he's plopped in here for the volatility component of this is a little bit of VIXM and a little bit of VIXY, which are both straight volatility funds that we've experimented with before. They are indeed very uncorrelated with the stock market and just about anything else, but the problem with them is they tend to have a negative return in most years, and they function more like insurance than a true component that's adding value to a portfolio. Now, Alexei's also added to this a fund called EUO, which I have not analyzed. But that fund is short euros. We're talking about a currency here. And funds like that do tend to perform like these volatility funds and do tend to be negatively correlated with the stock market. He also mentions CROC, Croc, which we talked about back in episode 146. The problem with Croc is that it's going away. It did not have traction on the markets and so the fund itself is being retired and will no longer be available as of something like May 10th. That one was short the Australian dollar. But you can go back to episode 146 where we talked about that. The same considerations may or may not apply to EWO. I do not know yet. I have not analyzed it. The other fund that he's got here in the mix is called DBMF. which we discussed in detail in episodes 55 and 57. Now this is a fund called the DBI Managed Futures Strategy Fund, which tracks and recreates the trading activities of a number of hedge funds that it monitors. Now it's only been around for a few years and over most of its history it generated positive returns. They weren't very exciting and the fund did not do too much. But we do see that in the recent environment that this fund has done quite well and is up about 20% year to date. And so it is looking more and more like that this kind of fund or this fund may be the answer to this question as to how could we as do-it-yourself investors easily incorporate a managed futures or trend following strategy into a risk parity style portfolio. One thing that's really nice about this particular fund is it has almost zero correlation to anything else. And so it really is a great diversifier. And if it's going to perform in a very positive fashion in the kind of challenging environment we've had for both stocks and bonds over the past few months, that adds to its value considerably. So I think this is a good learning experience for all of us. Are you stupid or something? And I'm very grateful to have listeners like Alexei who go and do their own experiments and then share them. And what I did do is create an asset correlation matrix, which is what you always want to do when looking at a portfolio and put all these things in it. I'll link to that in the show notes and you can see what the performance of each of these components has been like and its correlation to the other items in the portfolio.

Mostly Voices [28:23]

We use the buddy system. No more flying solo.

Mostly Uncle Frank [28:26]

And I think as we go forward and see how a lot of these newer funds perform, particularly as we go through complete market cycles, we'll get a much better idea as to which ones are the most useful to be using in our portfolios in the future.

Mostly Voices [28:44]

Okay, everybody, everybody chill.

Mostly Uncle Frank [28:47]

And then it will be nice to have a few more arrows to stick in our diversified quivers.

Mostly Voices [28:56]

What we do is if we need that extra push over the cliff, you know what we do? Put it up to 11. Exactly.

Mostly Uncle Frank [29:00]

And thank you for that email. Take it easy, dude. Oh, yeah. I know that you will. But now I see our signal is beginning to fade. We'll pick up again this weekend. with our weekly portfolio reviews of the seven sample portfolios you can find at www.riskparityradio.com and probably tackle a few more emails here. 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 message into the contact form there And I'll get it 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, a review. That would be great. Okay. Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio signing off.

Mostly Voices [30:05]

I don't know any more mathematics that goes with this at all, other than the thing is beautiful. And it links nature to geometry. And I love them both. Cheers.

Mostly Mary [30:16]

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.