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 Risk Parity Radio. If you have just stumbled in here, you will find that this podcast is kind of like a dive bar of personal finance and do-it-yourself investing. Expect the unexpected. It's a relatively small place. It's just me and Mary in here. And we only have a few mismatched bar stools and some easy chairs. We have no sponsors, we have no guests, and we have no expansion plans.

Mostly Voices [1:10]

I don't think I'd like another job.

Mostly Uncle Frank [1:14]

What we do have is a little free library of updated and unconflicted information for do-it-yourself investors.

Mostly Voices [1:23]

Now who's up for a trip to the library tomorrow?

Mostly Uncle Frank [1:27]

There are basically two kinds of people that like to hang out in this little dive bar.

Mostly Voices [1:34]

You see in this world there's two kinds of people my friend.

Mostly Uncle Frank [1:37]

The smaller group are those who actually think the host is funny regardless of the content of the podcast. Funny how? How am I funny? These include friends and family, and a number of people named Abby. Abby someone. Abby who? Abby normal. Abby normal. The larger group includes a number of highly successful do-it-yourself investors, many of whom have accumulated multimillion dollar portfolios over a period of years. The best Jerry, the best. And they are here to share information and to gather information to help them continue managing their portfolios as they go forward, particularly as they get to their distribution or decumulation phases of their financial life.

Mostly Voices [2:39]

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 [2:43]

But whomever you are, you are welcome here.

Mostly Voices [2:47]

I have a feeling we're not in Kansas anymore.

Mostly Uncle Frank [2:55]

So please enjoy our mostly cold beer served in cans and our coffee served in old chipped and cracked mugs, along with what our little free library has to offer.

Mostly Mary [3:14]

But now onward to episode 206.

Mostly Uncle Frank [3:18]

Today on Risk Parity Radio, we'll just get back to what we do best here.

Mostly Voices [3:26]

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

Mostly Uncle Frank [3:31]

And first off, we have an email from my contact info.

Mostly Voices [3:36]

Oh, I didn't know you were doing one.

Mostly Mary [3:40]

Oh sure, I think I've improved on your methods a bit too. And my contact info writes.

Mostly Uncle Frank [3:45]

Frank, hope you're well.

Mostly Mary [3:49]

I cannot recall if you have mentioned the below book. It covers many of the statistical concepts you frequently discuss, and I thought it may make sense to highlight given that the ideas apply broadly, not just to investing. Thank you. The book is the Success Equation, Untangling Skill and Luck in Business, Sports, and Investing by Michael J. Mauboussin.

Mostly Uncle Frank [4:10]

Well, yes, that's a very interesting book, the Success Equation. I view it as a follow on to Melvyn's earlier book called More Than youn Know, which was about the application of fractal mathematics and power laws to various natural phenomena, including markets and other things. and I will link to a little review in the show notes so people can just get a short summary of what this book is about. But basically it's about looking at different domains and considering the importance of luck or skill in each domain. And a lot of it is done using sports because there's lots of data involved in sports, but it also applies to a lot of investing in business. And just so everybody knows, Michael Mauboussin is a professor at the Columbia Graduate School of Business, and so knows a lot about these topics. But let me just read a short part of this review so we're clear on what we're talking about. The review says, the Luck vs. Skill Continuum ranges from all luck, EG roulette, to all skill, EG running marathons. Between these extremes, hockey has a large luck component, whereas basketball primarily involves skill. The analysis of this topic draws heavily on athletics because of the vast and detailed records generated by sports and the many practical lessons that can be extracted from them. Recognizing where an activity lies in the luck versus skill continuum can shape strategy, hone skills, help in dealing with uncertainty, and improve performance in numerous ways. that are relevant to investing. Sample size is the key to understanding luck versus skill. Investors should, one, consider the sample size. If an activity is controlled mainly by luck, a small sample will not do. Two, understand history, which helps in skill-based activities more than in luck-based activities. And three, categorize events by simple slash complex payoff. versus narrow/extreme outcome. The complex/extreme combination resembles the black swans highlighted in Nassim Taleb's work. Mobassir notes that most financial blowups have resulted from naively applying statistical methods in a world of black swans. Well, I think that point one made in that article that in domains that are ruled by luck, Having a very large sample size or a very large part of data is very important for do-it-yourself investors. Because one of the most common errors that amateur investors make is by looking at recent performance of various funds or asset classes and trying to project that forward. And by recent, I mean less than 10 years. Because statistically, a lot of that outperformance is likely to be due to luck. and if something is due to luck, then it's likely to revert to some kind of a mean or blow up in the worst case. So to counteract that, we want to be looking at as much data as we have available, and hopefully in the context of investing, it's at least 20 to 25 years worth of data. And also considering that a broad asset class, such as small cap value or large cap growth, is more likely to perform consistently over time than some narrowly focused sector or group of stocks, which may merely be having its day in the sun for one particular reason or another. It will help as every day it will brighten all the way it will keep on the sunny side of life. Thinking about this topic from a larger life perspective, one of the podcasts I like to listen to over the years has been Masters in Business, which is Barry Ritholtz's podcast. And he's just interviewed many, many great investors, the Warren Buffetts and the Charlie Munger's of the world, Jack Bogle and many others. And if you go back and listen to some of those early interviews in particular, One theme that comes out of this is when he asks them sort of the secret of their success, they basically say, well, you have to work hard and be smart about it, but if you're going to have really outside success, you're also going to need some luck. And to me, oftentimes the difference between moderate or good success and super success in a given field is due to being in the right place at the right time. or taking advantage of the right opportunity at the right time. And if you think about it in the case of somebody like Warren Buffett, one of the main secrets of his success is just living so long, because something like 98% of his wealth was accumulated after age 60. And so if he hadn't lived into his 90s, he may not have been so famous as one of the best investors of all time. And given his diet, that was certainly more due to luck than to skill. You can't handle the gambling problem. And for my most obscure reference on this topic, I commend to you a episode of the Twilight Zone called, Of Late I Think of Cliffordville. You unlock this door with the key of imagination. Beyond it is another dimension, a dimension of sound, a dimension of sight, A dimension of mind. And I will link to a little summary of that in the show notes that you can find on YouTube. But in that episode, a highly successful businessman near the end of his life thinks to himself, Wouldn't it be great if I could take all my skills and knowledge and just go back in time and how much better I would have done and how much quicker I would have become wealthy at that time? And so he makes a deal with the devil and that happens to him. And when he gets back in time, he goes and buys this property with these oil rights that he knows are going to become very lucrative in the future because he had done it before. But what he doesn't realize that the technology that was available at that time was not sufficient to develop that property. in terms of its oil rights. And so he goes bankrupt, ends up selling the property, and then when you go back into the future, he is the janitor of the building, and the former janitor of the building, whom he sold the property to in the alternative timeline, became the wealthy businessman. Now, of course, that's just drama, and there's some unrealism in it. And I'm not just talking about the time travel. But it is certainly true that if you have an idea, but it's not the right idea for the right time or place, it may not go anywhere. And that's just bad luck. But on the flip side of that coin, if you do have the outright idea at the right time in the right place, you'd have to attribute some of the success there to having good luck. Anyway, just something to ponder. While we relax in our easy chairs.

Mostly Voices [11:52]

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.

Mostly Uncle Frank [12:03]

And thank you for that email. Second off. Second off, we have an email from Wesley.

Mostly Voices [12:11]

Phone boy, polish my horse's saddle. I want to see my face shining in it by morning. As you wish.

Mostly Uncle Frank [12:20]

And Wesley writes, hi Frank, first, I can't thank you enough for your content.

Mostly Mary [12:24]

You are talking about the nonsensical ravings of

Mostly Voices [12:28]

a lunatic mind.

Mostly Mary [12:32]

You've made me reexamine everything I thought I knew about DIY investing, and I have learned so much from you and the resources you suggest.

Mostly Voices [12:39]

Forget about it.

Mostly Mary [12:43]

I wanted to see if you could expand on your recent conversation on accumulation portfolios from episode 198. I have 15 to 20 years before I would be tapping retirement accounts and am currently 100% US small cap value. I accept that the ride would be bumpy and know there's a chance it would underperform the total market, but I'm hoping the combined small and value factors will give me the excess premium history says it should. These go to 11. My questions, is it unreasonable to go all small cap value during accumulation? Does the macro allocation principle you often reference apply to a small cap value fund? Also, I imagine it would be prudent to transition to a risk parity portfolio a few years before retirement. But I found it interesting when I put 100% US small cap value in the PortfolioCharts.com analyzer that the safe and perpetual withdrawal rates are higher than many of the parity portfolios. So, would it be unreasonable to be 100% small cap value for life? In case it wasn't obvious, I love me some cowbell. Thanks for all you do, WC from SC.

Mostly Uncle Frank [13:57]

Ah yes, the cowbell known as small cap value.

Mostly Voices [14:02]

I got a fever, and the only prescription is more cowbell.

Mostly Uncle Frank [14:10]

But let's go at your specific questions.

Mostly Voices [14:17]

First one, is it unreasonable to go all small cap value during accumulation? Fellas, it was sounding great, but I could have used a little more cowbell.

Mostly Uncle Frank [14:25]

And the answer is probably not, but it would be very difficult for most people to do that. And the reason for that is this. Small cap value has a large tracking error with the rest of the market, which means it can tend to underperform or overperform the broader market by a substantial amount for often decades at a time.

Mostly Voices [14:50]

Am I right or am I right or am I right?

Mostly Uncle Frank [14:53]

So in order to gain the true advantage it might provide, you have to be committed to holding it for 30 or 40 years. Most people holding that for a decade or more, like we've seen from 2010 to 2020, and watching it underperform, would not be able to continue doing it. Before we're done here, y'all be wearing gold-plated diapers. That being said, it probably should occupy a much larger space in your accumulation portfolio than is commonly recognized. There's an interesting recent podcast and interview of Paul Merriman on the Earn and Invest podcast, which I think I can link to in the show notes. And he was asked point blank, you know, what is the best simple portfolio for some accumulator to hold? And his answer was half S&P 500 and half small cap value. Okay, everybody, everybody chill. and his recent research has shown that that kind of portfolio compared with other 3-4-10 fund portfolios will never be the top performer or bottom performer in any given year, but it will accumulate steadily and outperform most other kinds of portfolios. Now, I tend to like large cap growth and small cap value a little better only because they're slightly more diversified, but any of an S&P 500 fund, a total market fund, or a large cap growth fund are going to be very similar in their performance and very similar in their relationship to a small cap value fund. So the short answer to your question is yes, yes, but you need to be willing to have underperformance periods of up to a decade or more. and still hold on to that small cap value holding.

Mostly Voices [16:51]

You need somebody watching your back at all times.

Mostly Uncle Frank [16:54]

Now your second question, does the macro allocation principle you often reference apply to a small cap value fund? And the answer to that is, no, not exactly. The macro allocation principle applies when you are looking at types of investments that are just different. Stocks are different than bonds, are different from something like gold, are different from something like managed futures. Those are broad asset classes that are differentiated in a number of different ways and usually have low or negative correlations. A small cap value fund is going to have a high correlation to other stock funds because it's a sub asset class of a broader total asset class. which is the total stock market, and I'm including international stocks too, the global stock market, if you will. What the idea of investing in small cap value is or comes from is the Fama-French research into factor investing. It's three factor model, it's five factor model. That's where it fits in. But those models are all dealing with 100% equity portfolios or the portion of a larger portfolio that is the equity part of the portfolio. And so if you take a portfolio that's just 100% small cap value and let it run for say a decade, and then you compare that to a bunch of other 100% equity portfolios that are reasonably well diversified, maybe one's a total stock market, maybe one's got some international in it, maybe one's got some small cap value and some other things in it, You're going to find that all of those portfolios are going to perform about 90% plus the same because they're all 100% equity portfolios and none of them is highly concentrated in just a few stocks or sectors. And that's really what the macro allocation principle is getting at in terms of the stock portion of your portfolio. That spending lots and lots of time just monkeying around with that is probably not a good use of your time. You'd probably be better off picking a few diversified funds and then leaving it alone after that. Because what's actually going to be more important about the overall performance of the portfolio, including things like drawdowns, is going to be what else is in the portfolio and what the percentages of those things are besides the stock portion of your portfolio. Most people spend far too much time jiggering around with stock funds and not considering what else is in there and how that can be positioned and allocated to better diversify the portfolio and make it perform a little better overall, particularly when you're talking about drawing down on a portfolio. That is the straight stuff, O Funk Master. Now, as to your observation about the performance of small small cap value in the portfolio charts database. That is a good example of how just looking at one particular time frame or one particular data set may not give you completely accurate information. Because what you have to recognize from that data set is that small cap value had its greatest outperformance in the period from about 1975 to about 1987. And it was just stupendous every single year. And because that data set starts close to that time period, the small cap value weighted portfolio has a sequence of returns advantage in that particular data set. Never question Bruce Dickinson. And your results are going to look a bit different if you say started your data at 1990 or scrambled up the data a little bit more like you might do in a Monte Carlo simulation. A good way to think about this is to compare a total small cap value portfolio with a portfolio that keeps its stock portion all small cap value for this period we're analyzing and then adds other things into it. And the difference comes largely in the projected drawdowns. So, I ran a few different things there, which you can do yourself, but the small cap value 100% portfolio over that time period had a 6.6% 30-year safe withdrawal rate and a 6.3% perpetual withdrawal rate, but it had a drawdown of 50%. If you were to create a golden ratio portfolio in there and use the stock portion as all small cap values, that would be 42% small cap value, 26% long-term treasuries, 16% gold, 10% REITs, and 6% in short-term bonds. You'd end up with a portfolio with a higher 30-year safe withdrawal rate of 6.8%, slightly lower perpetual withdrawal of 5.9%, but only having a drawdown, a max drawdown of 19%. and a much shorter period. If you run a very simple portfolio that's 50% small cap value, 30% long-term treasuries, and 20% gold in there, you'll get a portfolio that has a 6.9% safe withdrawal rate higher than the 100% small cap value portfolio, a perpetual draw rate of 6. 0%, but a maximum drawdown of only 15% in like three or four years. And so I think the upshot of this is that you probably do not want to have a 100% equity portfolio if you were trying to maximize your withdrawals in retirement. And many people have found that the sweet spot in that seems to be between 50 and 60% in equities. Bill Bengen says it's somewhere between 50 and 55%. He's also used the figures of 40 to 70% that I've commonly quoted. Wade Pfau says it's between 35 and 80% in equities. And I think all of those are good metrics for constructing a retirement portfolio that you're drawing down on. Now, if your goal was to die with the most money, then spend as little as possible and keep it all in equities. I gotta have my cowbell. But that's a different goal. that I have. It doesn't work for me. And then most other people have when they think about it a little bit. I'm telling you fellas. But enough on that and thank you for that email. Last off, we have an email from Adam and Adam writes.

Mostly Mary [23:49]

Hi Frank, first of all, thank you for your brilliant podcast and content. I'd like to ask you about a book you often quote and it seems you like a lot, which is the Little Book of Common Sense Investing from Jack Bogle. Specifically, the chapter 13 where he says basically to buy a blend slash a total bond market fund and forget the rest for your fixed income portion of your portfolio. I don't think you like that approach, so I wonder why I should listen to you and not Bogle. Thoughts? Thank you.

Mostly Voices [24:20]

Bow to your sensei. Bow to your sensei.

Mostly Uncle Frank [24:24]

Well, Adam, I think you're asking the wrong question, and this leads to a bad thought process that I think a lot of amateur investors use. The question you are asking is whether to believe one person or another person when they have differing views. But the question you should be asking as a do-it-yourself investor is what is the best updated information that I have available regardless of where it came from. So you want to evaluate the information more than you want to evaluate the person. So what's the most important thing you should recognize about any finance book that you ever read, any finance book that you've ever read in your entire life? You should open it up to the very first few pages where they show about the publication, look at when it was written, look at when it was written, and then recognize that things may have changed since then. Inconceivable. Personal finance is not some kind of immutable thing like Newtonian physics. It's a rapidly evolving field. that changes greatly over a decade or two. You will find that it is you who are mistaken about a great many things. And so Common Sense Investing is an excellent book, but it was published in 2007 using largely information that was available in the early 2000s. Now at that point in time, most of the literature we have today about risk parity style investing, about diversification, about the opportunities we have with various ETFs didn't exist then. It was not available. You can't handle the truth. And so some of what's in that book happens to be obsolete. Surely you can't be serious. I am serious.

Mostly Voices [26:33]

And don't call me Shirley.

Mostly Uncle Frank [26:36]

The book is 15 years old now. Anything that's over 10 years old in finance, you should think about what part of this is obsolete, because there's certainly something in that book that is probably obsolete, unless it's about pure mathematics. And certainly that recommendation that you should just use a total bond fund and forget about analyzing that any further is an obsolete notion. Forget about it. Because at that point in time, if you were looking for a low-cost bond fund, it was probably just going to be a total bond fund and that was your only choice. These days, if you look at Vanguard funds, you can find all kinds of differentiated bond funds. So even in just Treasuries, Vanguard has a short-term Treasury bond fund in an ETF form. It has an intermediate Treasury bond fund in an ETF form. and it's a long-term Treasury bond fund in an ETF form. Those were all created in the past 10 years, and those creations were not done by accident or by happenstance. They were done because people that do investing and are constructing portfolios want and need better tools for doing that than a total bond fund.

Mostly Voices [27:49]

We had the tools, we had the talent.

Mostly Uncle Frank [27:53]

the other thing you should recognize about Jack Bogle in particular is he had some idiosyncrasies, particularly about ETFs. He didn't like them and didn't want them at Vanguard originally, because he had this paternalistic view that if you made things easy for people to trade, they would trade them, and so you shouldn't trust your own customers to do the right thing with their own money. Not gonna do it.

Mostly Voices [28:21]

Wouldn't be prudent at this juncture.

Mostly Uncle Frank [28:25]

If you want to hear more about this, there is an excellent podcast discussing this very topic, Jack Bogle and ETFs. It's the Rational Reminder podcast, episode 216 that I'll link to in the show notes. And in that podcast, they interview a guy named Gus Souter, who was Vanguard's former CIO and was there for the better part of 20 years from the late 1990s to the 20 teens. And he had these very kinds of discussions with Jack Bogle. And in fact, they launched ETFs at Vanguard when Bogle was on vacation. And he came back and was very upset about it, but couldn't do anything about it at that point. And all this gets us back to some of our meta themes for this podcast. Don't be saucy with me, Bernays. And one of those comes from Bruce Lee, and I will mangle this quote, but he basically says, Take what is useful, discard what is useless, and add something uniquely your own. And that's in terms of absorbing advice from a guru, a book, or anyone else. So let's apply this. What are the useful principles from common sense investing that we should still be applying? in 2022. One of them is that professionals do not outperform indexes. Forget about it. At least not the professionals that ordinary mortals like us have access to. That principle has held true and data shows that in any given year, 80% of professional investors tend to underperform their indexes or benchmarks. That's not an improvement.

Mostly Mary [30:05]

And only 20% outperform, and then that 20%

Mostly Uncle Frank [30:10]

changes every year. So it's not like somebody's in the top 20 for years on end. The second principle you should get out of that book is that minimizing fees in investing is critical. They're waiting to give you their money or you're going to take it.

Mostly Voices [30:33]

And in particularly minimizing the fees you pay to what he called helpers in that book. I drink your milkshake. I drink it up.

Mostly Uncle Frank [30:45]

Because you cannot expect to even perform as well as the market if you are paying 1% or some large fee every year to some financial advisor. It's just not going to work. So avoid high-priced advisors or helpers avoid high priced managed funds, and avoid loads on funds or anything else that is unnecessary for your investing. Tell me, have you ever heard of single premium life? Because I think that really could be the ticket for you. And the third principle, which we talked about earlier in this episode, comes from chapters 18 and 19 of that book, or is a corollary to those chapters, which is the macro allocation principle that we talk about here. that most of the return characteristics and performance of a portfolio are driven by its macro allocations, those stocks, bonds, and other things, and how much you have of each one in relation to the other, and not by creative stock picking or fund picking within those allocations, at least if you're talking about a reasonably diversified portfolio. And that comes from research going all the way back to 1986. and there's been nothing to suggest that any of that is no longer valid. And that gets us back to finally our overriding meta-principle here, which is that a foolish consistency is the hobgoblin of little minds, and that you shouldn't just be consistent for the sake of being consistent. Here that means that you take a book like Common Sense Investing by Jack Bogle and you differentiate in it what still appears to be valid after 15 years, and what does not seem to be valid after 15 years. And you do not say that because one part of this still seems like the best advice, that all of it necessarily is still a best practice, given what we know today and how things have changed. Wrong.

Mostly Voices [32:44]

Wrong. Right. Wrong.

Mostly Uncle Frank [32:47]

We always want to be re-examining what we're thinking about investing as dispassionately as possible while not getting caught up in fads or other spurious ideas. And I would have to say that using a total bond market fund is probably not a best practice for most people in this day and age, and that you should pick the bonds that are going to do what you need them to do for your own purposes.

Mostly Voices [33:13]

You are correct, sir, yes.

Mostly Uncle Frank [33:17]

And for some more on that, you may wish to go back and listen to episodes 14, 16, 64, and 69, which all talk about bonds and bond funds. But now I see our signal is beginning to fade. 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 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 favorite 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. Signing off.

Mostly Mary [34:25]

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.