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 [0:21]

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 [0:36]

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, and 9. 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 177 of Risk Parity Radio. Today on Risk Parity Radio, we're just going to do what we do best here and try to catch up on a few of these emails, at least get to the middle of May. And so without further ado, here I go once again with the email. First off, and our first email comes from Andrew. Now, this email only came in a day or two ago. But it goes to the front of the line because Andrew is one of our Patreon patrons.

Mostly Voices [2:26]

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

Mostly Uncle Frank [2:32]

Which means he has gone to our support page on our website, www.riskparityradio.com, and elected to make a monthly donation to the charity that we support on this podcast. We don't have any sponsors, we just have a charity. And it is the Father McKenna Center, which serves hungry and homeless people in Washington, DC. And there is also a link on the support page, so you can check that out. Full disclosure, I am a board member of the Father McKenna Center, and will be taking over the role of treasurer this year. I do want to thank all of our patrons and to remind you, to please note that if you send me an email, because I can't keep track of all of you now. Forget about it! And I shouldn't have said front of the line for Andrew, I should say front of the queue so he understands what I'm talking about, since he is a native of the British Isles, although he lives elsewhere incognito these days. What a strange person. But anyway, Andrew writes. Thanks, Frank and Mary, for this great show.

Mostly Mary [3:48]

Do you think the rise of passive investing will end up negatively impacting the efficiency of the market? There seems to be a reasonable case that for something approaching an efficient market, you need people who are taking a position and passive index tracking funds are not in that position taking business. I believe passive funds now account for about 20% of the market and seem to be growing year on year. I am not sure if the nuclear age follows the steel age, and I can already hear you playing the we don't know sound bite. You don't know. I don't know.

Mostly Voices [4:20]

Nobody knows.

Mostly Mary [4:24]

But I wonder whether we are seeing the impact of index investing with an overall increase in asset valuations. I ask this question not to be overly speculative, but more in the spirit of taking a long-term view.

Mostly Uncle Frank [4:35]

Will active and passive funds keep themselves in check like foxes and rabbits? I think we need them to, right? As without active speculation, is there a market for it and an index to track? Well, I suppose before getting to the meat of your question, I'd just like to think about a walk down memory lane of markets that markets, in fact, have never been that efficient when you think about it. They were run by open outcry and on paper, and it sounded kind of like this. And it used to be that you couldn't even trade something without having a spread of at least 18 of a dollar. 12.5 cents. So in the past 30 years, markets have become a lot more efficient just on the way they operate. And the players have changed too. Now a great majority of the trading is actually done by computers running algorithms, which can have its own issues, as we first saw in 1987, but seems to be relatively under control these days. But now just thinking about index funds and their role in the markets, The markets are still dominated by institutions, and these include pensions, insurance companies, hedge funds, investment banks, all of whom are trying to beat the market or to hedge some liability that they have. And this has led to more funds in the market than actual shares to hold in the market, believe it or not. And a lot of those are managed, but a lot of them are also various kinds of index funds focused on various sectors of the markets. And those tend to rise and wane with popularity over time as you see people trading in and out of various things. And we may be seeing an example of that right now where the large growth stocks that have dominated the markets for the last decade have really taken it on the chin in the past six months here or so. Well, meanwhile, old line industrial companies, energy companies, insurance companies have all done fine and people are talking more and more about moving their money into those sorts of things. So I don't really think that the fact there are a lot of index funds that hold a lot of these things really changes the overall trading in the market, which is more dictated to me by the technology than by whether they're index funds or not. So it's not really something I worry about too much. But on the other hand, if you're holding one of these risk parity style portfolios, only a small portion of your overall portfolio is going to be held in some kind of traditional large cap growth or total market fund that is cap weighted. So it's probably less of a concern for you. And I'll just link to an article written by Ben Carlson in the show notes about this same issue. And he writes in the conclusion of this article, which he talks about this issue, he says, It is silly to assume index funds are going to draw active managers away from markets. There is just too much money at stake for that to ever happen in a meaningful way.

Mostly Voices [8:02]

See, I made Lewis a bet here. Lewis bet me that we couldn't both get rich and put y'all in the Paul house at the same time. He didn't think we could do it. I won. I lost.

Mostly Uncle Frank [8:13]

One dollar. And I tend to agree with that. As long as we have lots of large institutions hiring lots of large fund managers to go in and try to make money on the corners of the markets, I don't think we're going to have any problem from the efficiency perspective. So if and when we have crashes, they are Not likely to be any different than the crashes we have had in the past based on whether there is passive indexing going on in some portion of the market. That's not how it works. That's not how any of this works.

Mostly Mary [8:46]

And thank you for that email and your support.

Mostly Uncle Frank [8:51]

Yes. Second off. Second off, we have an email from visitor number 4691. This came in through the website and I should just make a note that if you want to make sure I get your email, send it to the email address frank@riskparityradio.com I do get, I believe, all of the messages sent through the website, but sometimes they seem to get lost and I need to go back and recover them.

Mostly Mary [9:29]

But Visitor4691 writes：I have been listening to your show and just have one thing I don't quite get. It is all the lazy portfolios out there. How come nobody recommends holding gold and long-term treasury, except for Ray, of course? All the mainstream advisors don't recommend it. Would you have an explanation? Do they not know your portfolios have been more efficient in the past? What gives? Well, what gives here are basic human behaviors that are to be expected.

Mostly Uncle Frank [9:57]

and are reflected in the opening lines of this podcast that a foolish consistency is the hobgoblin of little minds. But first, I would be remiss if I did not note that your suppositions contain two straw men and one logical fallacy. He didn't fall? Inconceivable. The two straw men are first that there are not lists of lazy portfolios that include Risk parity style portfolios in them. And I'll just give you a couple of examples of that. You can go to the portfolio charts, list of common portfolios. You can go to optimize portfolios, list of portfolios. And I'll link to that in the show notes, but that's neither here nor there. And the second straw man would be that only Ray Dalio has written about this. In fact, there are reams of materials written about this. some of which are cited in our first few episodes, particularly episodes three and five, I believe. But I'm also going to link to a page on Risk Parity Chronicles, which is a site founded by one of our listeners, Justin, where he lists reams of papers and other resources about risk parity style investing. So to say that it's only been the subject of Limited popularity, exposure, or analysis would be an error. It's a straw man. That's not true. Forget about it. All right, now the logical fallacy here is called an argumentum ad populum or arguing that something is right and good because it is popular, i.e. because it's on somebody's list somewhere or is well known. Therefore, it is the best or a good idea. And that is really fallacious in this context because the right portfolio for you does not have anything to do with the popularity of any given portfolio and whether it's on somebody's list or not. It's going to depend entirely on the situation and the goals of the investor and not on the popularity of the portfolio. But now let's talk about the more interesting aspect of your question, which is the human behavioral aspect. And this appears to be true in just about any field of reference. And what I'm going to refer you to is called Plank's Principle, formulated by the physicist Max Plank. I should say Plank. Count the money. Demoneet.

Mostly Voices [12:37]

Monet, say it.

Mostly Uncle Frank [12:40]

Monet, Monet, Monet, Monet, Monet. MoneT. Perfect, don't forget. Give it to me again, MoneT. MoneT. Very good. And it was referring specifically to science, but it also tends to apply to just about any field generally. And what he said was, science progresses one funeral at a time. At least that's the shorthand version of referring to what he wrote here. which he wrote in 1950. But let me give you the longer version. I'll link to this in the show notes. Max Planck said, A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die and a new generation grows up that is familiar with it. An important scientific innovation rarely makes its way by gradually winning over and converting its opponents. It rarely happens that Saul becomes Paul. What does happen is that its opponents gradually die out and that the growing generation is familiarized with the ideas from the beginning, another instance of the fact that the future lies with the youth.

Mostly Voices [13:47]

Young America, yes sir.

Mostly Uncle Frank [13:51]

Now, a century before Max Planck wrote that, Ralph Waldo Emerson wrote a more generalized version of it in his essay Self-Reliance. Which you hear at the beginning of this podcast every day, or every time you listen to it. Real wrath of God type stuff. That part of it begins a foolish consistency is the hobgoblin of little minds, adored by little statesmen, philosophers, and divines. Then it goes on to say, with consistency, a great soul has simply nothing to do. Surely you can't be serious. I am serious. And don't call me Shirley. All right, well, how does that apply to what we're talking about here? which is the evolution of portfolio construction. It applies because people and industries are reluctant to admit they were mistaken or wrong in the past when presented with new information. And so somebody that has written a book 20 years ago or has a newsletter or has always adopted some kind of investing is unlikely to change that view even when confronted with new information. And it's a human failing. We don't want to admit we're wrong. Wrong! Or that there are better ideas that have been presented to us.

Mostly Voices [15:12]

I really don't like it, and I'm not gonna go.

Mostly Uncle Frank [15:17]

And what Emerson was saying about that is that consistency is not really a virtue. People treat it like a virtue. At least I was consistent. Well, That may be great when you're talking about interpersonal relationships. It's not so great when you're just talking about intellectual thought processes. It ends up becoming a crutch instead of a virtue and an excuse for not changing your mind.

Mostly Voices [15:40]

I want you to be nice until it's time to not be nice.

Mostly Uncle Frank [15:50]

And there are also financial and reputational interests at stake. Many parts of the financial services industry have built their business models on certain kinds of thinking.

Mostly Voices [16:02]

They're sitting out there waiting to give you their money or you're gonna take it.

Mostly Uncle Frank [16:05]

Certain ways of constructing portfolios, a lot of them involving complex instruments and expensive managers and other kinds of approaches. And if they were to admit that that was not optimal for a lot of people, they're basically shooting themselves in the foot as far as their business is concerned. Third prize is you're fired. For people who have written books or newsletters or hold themselves out as pundits or gurus, the reputational motivation for not having to admit you were wrong is extremely strong and extremely difficult to overcome. You can't handle the truth. But you do see people change occasionally. And I always view that as a sign that somebody is genuine and somebody you want to listen to a little closer. Now, one of those people is Paul Merriman, who recently on a podcast, he was talking about his evolution from recommending a complex 10 fund portfolio to now spending more time recommending simpler portfolios with two to four funds in them.

Mostly Voices [17:19]

I'm telling you fellas, you're gonna want that cowbell.

Mostly Uncle Frank [17:23]

And the reason he changed his mind is because when he interviewed Jack Bogle and sat down with him, Jack said, you, do great work. These are great portfolios, but I don't think most do-it-yourself investors are going to be able to manage them properly. And that's something simpler might be better. and he's worked with a few guys, and I just heard him on a podcast recently saying that the kinds of things they're coming up with now using tools like Portfolio Visualizer and analyzing the data involving many fewer funds are just as good or better than the older, more complicated portfolio that he used to recommend. And I give him credit and applaud him for recognizing that and making the change there. Another good example of this is what Bill Bengen has been saying, if you've been listening to his interviews for the past year and a half or so. And what he has said is that the kind of portfolio that he was analyzing back in 1994, which was just an S&P 500 fund and an intermediate treasury bond fund, was not that well diversified in that if you have a better diversified portfolio, you are going to have a better or higher projected safe withdrawal rate. And he's in the process of writing another book on that, saying that where he used to say 4.1% was the historical safe withdrawal rate, if you diversify that portfolio better, it's probably gonna be more like 4.7% based on what he's doing. That is the straight stuff, O' Funk Master. But why can he say that now that he couldn't say that then? He can say that now because he's got more and better data to use for these kinds of analyses. Now, I realize some people do not want to acknowledge that there is more and better data today and ways of analyzing it than there were in the past, leading you to different conclusions about portfolio construction than you may have had in the past. But I do feel like that's why it's important for us to think about having principles of portfolio construction and we use the simplicity principle, the macro allocation principle, and the holy grail principle as the real basis for thinking about this topic, as opposed to thinking about individual funds or a limited set of asset classes. But I think where this is really going is reflected in a recent book about the perfect portfolio written by Andrew Lowe, and we talked about this in episode 165. And anyway, he interviewed all kinds of eminent finance people, some who had won Nobel prizes going back to Harry Markowitz himself, and determined that there is one thing that they all agreed upon. Don't ever take sides with anyone against the family again. Which is that the holy grail of investing is diversification not only within asset classes, but across asset classes. Bow to your sensei. Bow to your sensei. And I should note that that is how these ideas typically trickle through ever since the 1950s or 60s. They start in an academic context. They filter through next to hedge fund managers and professionals. who are seeking an edge in the industry. But they don't get down to retail investors for really decades. And there is an impetus by the financial services industry not to bring new ideas in that might be more efficient and might lower their commissions and fees.

Mostly Voices [21:04]

Because we're adding a little something to this month's sales contest. As you all know, first prize is a Cadillac Eldorado.

Mostly Uncle Frank [21:11]

But the advantage that we have today as do-it-yourself investors is that we have access to all of this stuff that we never could have had access even 10 years ago. We can read the papers, we can use the tools, we can access lots of different asset classes through low-cost ETFs.

Mostly Voices [21:28]

We had the tools, we had the talent.

Mostly Uncle Frank [21:32]

But the fact that some people are not there, don't want to go there, and may never get to those ideas is normal. And it's not something I worry about or get upset about.

Mostly Voices [21:44]

Expect the unexpected.

Mostly Uncle Frank [21:47]

Simply because we can choose what we want to do for ourselves and if and when we find better ideas we can apply them immediately without waiting for someone else's approval, somebody's lazy portfolio list or anything else. We are not required to be consistent with what others have done and are free to be self-reliant and do as we see fit and as Emerson recommended, and I do too.

Mostly Voices [22:14]

It's 106 miles to Chicago. We got a full tank of gas, half a pack of cigarettes, it's dark, and we're wearing sunglasses. Hit it.

Mostly Uncle Frank [22:29]

And thank you for that email.

Mostly Mary [22:35]

Third off, we have an email from Nate, and Nate writes, Hi Frank, I have something close to a golden butterfly portfolio. Recently, I sold the long-term treasury portion, TLT, to harvest the loss. As an alternative, I bought ZROZ, but only with 66% of the position and left 33% in cash since ZROZ acts as a 1.5 times lever versus TLT. Now that the 30 days are up, I was planning to sell the ZROZ and buy back into TLT with the ZROZ proceeds, plus the 33% cash originally set aside. However, I'm looking at the cash and it's tempting to instead stick with ZROZ and use the cash for something else. Are there any strong reasons why I should convert the ZROZ and cash back to TLT instead? Thanks, Nate.

Mostly Uncle Frank [23:27]

Well, Nate, that's a good practical question, but I think many people holding these portfolios do face. Just in case anybody's wondering what Nate is doing, he sold part of his long-term treasury position, which was invested in TLT, which is the most popular fund for that position, and bought a fund that invests in even longer-term versions of treasury bonds called ZROZ in a proportion that matches in terms of volatility and returns. I mean, I can only really tell you from my personal experience that ZROZ does seem to perform as advertised in relation to TLT. So I would expect that it will continue to be about 1.5 times as volatile and have 1.5 times the return characteristics as TLT. But I can't guarantee that in the future. You can't handle the crystal ball. I do end up holding a lot of varieties of these types of things for this very reason, because the other reason you may want to hold on to ZROZ instead is to have a long-term capital gain or loss to deal with in a year, as opposed to fiddling around with it now and generating a short-term capital loss or gain. If you do put that cash to work, you will be essentially increasing the risk profile and hopefully the reward profile of the portfolio. And what I'm saying there is if you were to leave it in cash, that portion of your portfolio with the cash and the ZROZ should perform the same purpose and have the same effect in your portfolio as the TLT did, depending on your rebalancing rules. But if you put it into something else, then you are taking on whatever risk reward profile that you put that cash into as a new addition to your portfolio. So it's going to change the profile of the portfolio by some incremental amount. Crystal Ball can help you. It can guide you. Obviously it would be simpler just to go back to TLT, but I do recognize that there are tax issues going on here and that is often a reason to deviate from simplicity into something that's ultimately more efficient.

Mostly Mary [25:47]

I think I've improved on your methods a bit too. And thank you for that email.

Mostly Voices [25:51]

Last off.

Mostly Uncle Frank [25:55]

Last off, we have an email from my contact info. Again. Oh, I didn't know you were doing one. And my contact info writes. Frank, hope you are well.

Mostly Mary [26:07]

Thank you for tolerating and replying to my emails. Elated that you dealt with direct indexing. Innovation is a positive, and most new financial products may have some marginal benefit in the economic sense of the word. Direct indexing thus may be a useful tool, but the expression is fundamentally problematic as it is neither direct nor indexing. Specifically, it entails a more concentrated portfolio and an intermediary. Sorry for the rant. Thank you.

Mostly Voices [26:37]

You are correct, sir. Yes. Well, my contact info. I'm glad you appreciated the discussion.

Mostly Uncle Frank [26:46]

I believe you are referring to what we talked about in episode 174. I think a lot of these innovations often are used as marketing gimmicks to generate fees for providers in the financial services industry. Am I right or am I right or am I right? It's not that there's anything wrong with them or that they're not useful in their own right. It's just that that's not a reason to pay somebody more money to do one of these things. These days you could do direct indexing yourself if you wanted to. You can also do tax loss harvesting pretty easily if you want to. That's another gimmick that is ladled on as an added benefit for many of these robo-advisors and other advisors saying, oh, we can do this tax loss harvesting for you. Anybody want to see second prize? Second prize is a set of steak knives. You know, it's worth something, but it's not worth paying an AUM fee for. It just really isn't. A my straw reaches across the room and starts to drink your milkshake. And I'll link to an article from the White Coat Investor in the show notes about tax loss harvesting in particular. Dr. Dali is always pretty good about identifying and shooting down the latest and greatest marketing schemes from the financial services industry.

Mostly Voices [28:19]

Dead is dead. You have more chance of reanimating this scalpel than you have amending a broken nervous system.

Mostly Uncle Frank [28:26]

And I enjoy that very much. And thank you for that email. But now I see our signal is beginning to fade. We will pick up again this weekend with our weekly portfolio reviews of the seven sample portfolios you can find at www.riskparityradio.com and continue to hack away at the emails. I believe I just got another one from a patron. We will also review our monthly distributions for those portfolios. If you have comments or questions for me, please send them to frank@riskparityradio.com That email is frank@riskparityradio.com or go to the website www.riskparityradio.com and put your message into the contact form and I'll get it that way eventually. That's a very good system. If you haven't had a chance to do it, please go to your favorite podcast provider and like, subscribe, give me a review, some stars. That would be great. Mkay. Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio. Signing off.

Mostly Mary [29:37]

I have people skills. I am good at dealing with people. Can't you understand it? What the hell is wrong with you people? 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.