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 [0:36]

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 1-3-5-7-8. 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 181. Today on Risk Parity Radio, we are going to finish off the emails from May. So we'll only be a couple of weeks behind.

Mostly Voices [2:03]

And without further ado, here I go once again with the email.

Mostly Uncle Frank [2:10]

And first off, we have an email from Brian. And Brian writes, Frank, hi.

Mostly Mary [2:17]

I wonder if you could comment on rebalance bands versus annual rebalancing. It seems that rebalance bands are a bit trickier for the DIY investor to track. However, the delta in outcome is significant. Here are two backtests of a Golden Butterfly portfolio. One is the Golden Butterfly with a 3.75 annual distribution, using rebalance bands. It has a $134,000 final balance. Another is a golden butterfly with a 3.75 annual distribution using annual rebalancing. It has a $125,000 final balance.

Mostly Uncle Frank [2:59]

Thanks for the good work, B. Well, Brian, rebalancing is an interesting topic. Because I don't know whether there's ever been any real definitive research about it. I will link to an article in the show notes from Michael Kitces, where they talked about basic rebalancing of kind of a standard stock bond portfolio. And they looked at both calendar rebalancing and rebalancing on bands. That was weird, wild stuff. And what they determined, at least with that kind of portfolio, is that rebalancing more than once a year on a calendar basis really didn't add anything to performance. And that as for rebalancing bands, about 20% relative seemed to be the optimal rebalancing band in what they were looking at. So just for clarification, 20% relative would be if you had something that was supposed to have a 25% allocation, and then it sank to a 20% allocation. That would be 20% relative because 10% of 25 is 2.5 and 20% of 25 is 5%. The other way of doing it, either in conjunction with what you're doing with your relative, is called absolute. And so going from 25 to 20 in that circumstance would be a 5% absolute deviation for a rebalancing band. Now it's my belief that the optimal rebalancing bands are going to vary by portfolio, and that's why it's hard to do any definitive research on this. And it also does matter whether you are accumulating in this portfolio or decumulating in this portfolio or just leaving it alone. So what you've done here is pretty interesting, and I'll link to it in the show notes. Just for the audience's edification, what Brian has done here is taken a golden butterfly portfolio with data going back to 1978 with a 3. 75 annual distribution coming out of it and then used rebalancing bands in one scenario. And he put in 5% absolute and 25% relative as the conditions that would trigger rebalancing. So you'd have to have both of those be true for a rebalancing to occur. And what he found with these two back tests was that the one on the rebalancing bands he selected had a better performance overall than the one with annual rebalancing. Surely you can't be serious. I am serious and don't call me Shirley. Now I went ahead and did another scenario where I did a 10% absolute deviation and a 40% relative deviation, and that scenario performed even better than the two that you have. The best, Jerry, the best. The problem with all of this, however, is that it is going to be also dependent on your particular data set. That is the straight stuff, O Funkmaster. So if you were trying to figure out what's the best rebalancing plan for a particular portfolio subjected to a particular withdrawal rate. The best procedure for that is probably going to be to segment your data so that you take five or 10 year chunks of it, optimize for that five or 10 year chunk, and then compare it with other data in different five or 10 year chunks from your entire data set, which is the way people commonly attempt to do this.

Mostly Voices [6:49]

Groovy, baby. Now it ends up being a lot of work. I don't think I'd like another job.

Mostly Uncle Frank [6:57]

And the results are never conclusive because they are always dependent on the overall data set. My personal belief is that another factor in this analysis is going to be the volatility of the components of the portfolio and that a portfolio that's composed of more volatile components, say leveraged funds or something else, is going to benefit from wider bands, which makes sense when you think about it. Really? The other question or variable here is how exactly you go about implementing this. Now using that data from Portfolio Visualizer, depending on how you set it, if it's annual, it's actually only checking once per year in that data set. If it's monthly, it's checking once per month at the end of the month. to see whether the rebalancing conditions have been met if you're using rebalancing bands. Now in real life you could set this for any period you wanted. You could be checking it every day, you could be checking it more than one time a day, or every week, or every month, or every quarter, and how often you check that is going to change the performance of the overall portfolio in some ways. In the sample portfolios that we have that use rebalancing bands, I've adopted the once a month checking to see whether the conditions have been met and we just do that on the 15th of the month. If you're going to do it monthly, I would pick more of a random date than the end of the month because oftentimes there is price action at the end of months, quarters, or years that is based on speculation and immediately reverses in the next couple days after that. So overall you can see that having rebalancing bands is probably a better concept than rebalancing on a calendar basis. But there's a lot of devils in the details as to how you pick them and how you implement them for a given portfolio.

Mostly Mary [9:04]

Now you can also use the ball to connect to the spirit world.

Mostly Uncle Frank [9:08]

And just to throw another monkey wrench in the works, In theory, you could also do both, that you always rebalance on a calendar and then you do additional rebalancing based on bands if certain conditions occur at other times during the year. But I can't tell you if that would be better or worse either, We don't know.

Mostly Voices [9:35]

The other real-world consideration you always have to take into account is taxes

Mostly Uncle Frank [9:40]

and making sure most or all of these transactions only trigger long-term capital gains if they trigger capital gains at all. Because you wouldn't want to have a lot of rebalancing in a taxable account that generates a lot of ordinary income.

Mostly Voices [9:55]

Not going to do it. Wouldn't be prudent at this juncture.

Mostly Uncle Frank [9:59]

But it's an interesting topic and we're going to talk a little bit more about it next. And thank you for that email. Second off. Second off we have two emails from Grant.

Mostly Voices [10:15]

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

Mostly Uncle Frank [10:18]

And since they are both about the same thing we will just read them one after another.

Mostly Voices [10:23]

Mary Mary why you buggin? and then talk about them.

Mostly Uncle Frank [10:32]

So Grant writes, Uncle Frank,

Mostly Mary [10:36]

while Portfolio Visualizer is a great website for backtesting portfolios, it may be limited in its ability to backtest rebalancing of levered portfolios, which often require rebalancing several times per month. I use a fully levered version of the Golden Butterfly portfolio without the short-term treasury component with 25% of UPRO, TMF, TNA, and UGL. You have a gambling problem. The link below shows the Portfolio Visualizer backtest with a 20% relative deviation rebalancing band. The Rebalancing tab and the results shows that rebalancing only happens at the end of each month. rather on the day that the relative deviation is triggered. In September of 2011, by the time TNA was rebalanced at the end of the month, it already had a 56% relative deviation, well above the 20% trigger. Is there a way to have a better backtest of levered portfolios with day-to-day triggered rebalancing? Is Portfolio Visualizer limited to monthly data only? I want to turn it up to 11.

Mostly Voices [11:50]

If we need that extra push over the cliff, you know what we do? Put it up to 11. 11, exactly.

Mostly Mary [11:58]

Your Upro Pony Rider from Waco, Grant. Uncle Frank, I was not happy with my search for a back testing tool that included day-by-day data from my levered portfolio. So, I built my own crude back testing tool in Excel. I pulled the daily adjusted close data from Yahoo Finance for UPRO, TMF, TNA, and UGL going back to June of 2009. The tool will return the ending balance and number of rebalancing triggers for a specific relative deviation rebalancing band percentage. I tested relative deviation percentages for this fully levered portfolio from 0% to 80%.

Mostly Voices [12:42]

Now witness the firepower of this fully armed and operational battle station!

Mostly Mary [12:50]

The results are fascinating. Here is a summary of my findings. One, at 0%, the portfolio rebalances every day for 3,254 days, turning $10,000 into $171,000. we will use this value as a point of reference. Between 1 and 15% relative deviation, the portfolio rebalances several times per month, and the ending portfolio value stays in a tight range of around $170,000 and begins to fall as the percentage increases. These values are much higher than what Portfolio Visualizer reports, which is around $138,000 as it only calculates on a monthly basis at the end of each three months. The relative deviation range between 15% and 35% returns a lower ending portfolio value between $135,000 to $155,000, well below the performance of daily rebalancing. Portfolio visualizer data starts to sync up in this range as the rebalancing nears once per month. Four, the relative deviation range between 50 and 60% actually returns the best results, ranging from $180,000 to $220,000. Rebalancing this happens once to three times per year, but on very specific dates, typically after a large move in one of the assets. Five, above a 60% relative deviation, there is a steep falloff in the overall return of the portfolio, falling from $200,000 to around $125,000. This leads me to several conclusions. Very low percentage ranges lead to a tight predictable range, but would be very tedious and tax inefficient. Moderate rebalancing ranges do not allow this levered portfolio the room to run and rebalances just as one asset is starting to grow. Ranges over 60% miss several peaks for each asset and never rebalance. But the sweet spot for my specific fully levered portfolio is around 50%, which captures the majority of optimum rebalancing events after large moves of each asset. I will include a link to a Google Doc of my spreadsheet if anyone wants to play with it. Happy trails, Grant.

Mostly Uncle Frank [15:24]

Who cares about the clouds if we're together? Just sing a song and bring the sunny weather. Well, Grant, I'd have to say that you are one of my most maniacal listeners with these leveraged funds, but I'm always interested to see what you're doing with them.

Mostly Voices [15:45]

Well, you have a gambling problem.

Mostly Uncle Frank [15:52]

I will link to your sample levered portfolio backtest from your first email and the Google Doc spreadsheet from your second email. although it looks like you are going to have to give people access to the Google spreadsheet if they ask you for it so they can actually take a look at it. Now this touches on some of the issues we were just talking about in the last email. And yes, it's true that the Portfolio Visualizer site uses monthly and annual data. which may not be enough if you are considering trading more often than that or have leveraged funds. One thing you should do is I noticed that you had done your analysis from the first email based on the annual data and you want to change that setting to month to month at the top. And if you do that, you'll find that your sample portfolio actually has a better performance if it's being looked at every month for rebalancing purposes as opposed to being looked at every year for rebalancing purposes. Now, I'm not aware of any free sites like Portfolio Visualizer that have daily data that is attached to a whole bunch of analysis tools. But obviously you've found a little bit of a way around that.

Mostly Voices [17:14]

Yes.

Mostly Uncle Frank [17:19]

And there is data from places like Yahoo Finance that you can download and put into Excel spreadsheets if you are so inclined and adventurous. You can't handle the gambling problem. And I think your findings are interesting. They kind of confirm my suspicions about more volatile components in a portfolio. And since these are three times more volatile than sort of your standard stock funds, and if those stock funds, as found by Michael Kitces and others, seem to work well on a 20% rebalancing band, it's not surprising to me that a three times levered fund is going to be working best on a 50 to 60% rebalancing band for relative deviation. So your findings tend to confirm my suspicions and also reinforce the idea that the best rebalancing bands are likely to be different for every portfolio depending on how it is being used and what specifically is inside of it. As a practical matter, you will have to always come up with something that is reasonable to implement and won't cause you too many tax headaches. And fewer transactions is definitely better when it comes to taxes.

Mostly Voices [18:36]

Am I right or am I right or am I right? Right, right, right. But thank you for your email and your work here. Nothing you have ever experienced can prepare you for the unbridled carnage you're about to witness.

Mostly Uncle Frank [18:51]

Hopefully others will check it out and get something out of it too. Fear, that's the other guy's problem.

Mostly Voices [18:56]

Last off.

Mostly Uncle Frank [19:00]

Last off, we have an email from my contact info. I didn't know you were doing one.

Mostly Mary [19:08]

Oh sure, I think I've improved on your methods a bit too. And my contact info writes. Frank, given your background as a lawyer, wondering if you care to comment on the fiduciary impact of the ownership structure of Vanguard. Just finished the Bogle Effect and the unique ownership of Vanguard as presented in the book is compelling. Do you think from a longer term perspective The significance of the ownership structure is large enough to justify transfer of most, if not all, assets to Vanguard? Or do you think the ongoing competitive pressure from Vanguard will keep expenses at other firms reasonable? Below is from Vanguard.

Mostly Uncle Frank [19:50]

Well, I will link to this in the show notes, but my answer is that I am kind of skeptical about this idea that Vanguard is this wonderful good actor that will be a good actor for all times. You need somebody watching your back at all times. I think these are all ultimately businesses that tend to change over time, tend to offer different products depending on the demand they see out there and their belief as to what they can make off of them. If you think about Vanguard Fidelity and Schwab and their histories, Vanguard was really set up to be the low-cost leader, but also a mutual fund company with the idea that you would come to Vanguard, use all of their funds, but not use anything else. You can check out any time you like, but you can never leave. That idea has become a bit obsolete in the days of no fee trading. and the efficiency of ETFs. And you can see that by the fact that Vanguard has had to move and create a lot of ETFs in the past five to ten years just to keep up with the marketplace. And there's a question now as to whether Vanguard is losing its way because it's doing private equity kind of stuff, trying to get into smart beta types of things, and then the scandal it just had in the past year with one of its target date funds. So I don't see today's Vanguard as intrinsically better or worse than other names out there. Now talking about these other names, if you think of Fidelity's history, Fidelity's history was to have the best managed funds in the business. And so they were one of the hottest things on the planet back in, say, the 1990s. But were kind of overtaken then by the index fund revolution and had to adapt. So now their model seems to be more of a low-cost leader. And their objective seems to be to get people in the door, get them to set up accounts, make it easy for people to do that, and then use that as a springboard to sell particular services to particular people. So when you open up accounts at Fidelity, don't get surprised. When people from Fidelity start contacting you because they see what you've got in your portfolio can guess as to whether you're in retirement close to retirement and might be interested in some kind of management services. And then they will try to sell you something.

Mostly Voices [22:31]

A, B, C, A always B, B, C closing, always be closing, always be closing, For us do-it-yourself investors, the best answer is generally thanks, but no thanks.

Mostly Uncle Frank [22:51]

Now, Schwab has an even different pedigree that goes back to the 1970s with the idea of being the lowest cost broker on the planet, and they only really got into the fun side of things later. These days, I understand that most of their profits are actually generated by the float, or essentially all of the cash that people have sitting in accounts at Schwab, which they can then use for leverage other investments and other things, because they don't pay a lot of interest on that cash, if any at all. They have gotten in trouble very recently for the way they've structured and marketed their life strategy funds. The SEC just issued them a large fine because the way those funds were constructed, they said, there was going to be no fees on them and no costs. But in fact, what they did is just had a large pile of cash sitting in those funds, which effectively allowed them to make money off of them. And so the SEC determined that that was faulty advertising or marketing, as there is a cost to a fund if you put money in there and a bunch of it is just sitting there in cash as opposed to being invested. and I'll think see if I can link to an article about that in the show notes. But it just happened in the past week here or so. I drink your milkshake. All of this is to tell you simply that all of these brokerages have a lot of useful features for do-it-yourself investors these days. But there's also a lot of stuff there that is not useful, helpful or cost effective for you. Forget about it.

Mostly Voices [24:30]

And while Vanguard may be different in its ownership

Mostly Uncle Frank [24:35]

structure, I'm not sure that is ultimately that different in the way that it's presenting itself these days to us do-it-yourself investors. No contrare. Don't be saucy with me, Bernaise. So I would just use the one that's most useful to you or that you feel most comfortable with for whatever reasons and be willing to shift if one becomes substantially better than another in the future, which could happen. It happened once. I do think they are all kind of converging on this model of offering low cost, no fee trading and easy access for do-it-yourself investors with the idea that once you are in the door, then you are available to be marketed to. Do you have life insurance, Phil?

Mostly Voices [25:26]

Because if you do, you could always use a little more, right? I mean, who couldn't? With other funds and services and other things.

Mostly Uncle Frank [25:34]

Get them to sign on the line which is dotted. Which to me actually seems perfectly reasonable because nobody's twisting your arm or forcing you to buy anything in particular from them. Just be mindful of what they are doing. Because as do-it-yourself investors, I think we are much better buying kind of more raw ingredients and constructing our portfolios from them. And I'm talking about a small cap value fund, a large cap growth fund, an intermediate treasury bond fund, or something that is just basically one thing as opposed to buying composite things that are to be managed in a certain way. Like these target date funds or life strategy funds or other kinds of composite funds. Because those actually tend to make self-management more difficult than actually helping you reach your goals. And they are more of marketing fodder than anything else.

Mostly Voices [26:30]

Forget about it. At least in my view. Bow to your sensei. Bow to your sensei.

Mostly Uncle Frank [26:37]

And thank you for that email. But now I see our signal is beginning to fade. We'll pick up this weekend with our weekly portfolio reviews of the seven sample portfolios you can find at www.riskparityradio.com on the portfolios page. And we'll probably get into some of June's emails. 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 and I'll get it that way. If you haven't had a chance to do it, please go to your podcast provider and like, subscribe, give me some stars, a review. That would be great. Mmmkay? Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio.

Mostly Voices [27:35]

Signing off. Happy trails to you, till we meet again.

Mostly Mary [27:53]

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.