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 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 [1:13]

But whomever you are, you are welcome here.

Mostly Voices [1:28]

But now onward to episode 249.

Mostly Uncle Frank [1:32]

Today on Risk Parity Radio we will try to clear out some more of our backlog of emails. I found a few more from January, believe it or not. And so without further ado, here I go once again with the email.

Mostly Voices [1:47]

And first off, we have an

Mostly Uncle Frank [1:51]

email from Wesley. His name was Wesley, but she never called him that.

Mostly Mary [2:03]

Isn't that a wonderful beginning? Yeah, it's really good. And Wesley writes, Happy New Year, Frank and Mary. Can I get your thoughts on using muni bonds in replacement of U.S. Treasuries in a taxable brokerage account? Suppose I wanted to use a golden butterfly portfolio for retirement. But most of my savings were in a taxable account and I were in a high marginal tax bracket. Would using a long-term muni bond fund and a short-term muni bond fund offer the same diversification benefits? Thank you for all you do, Wes.

Mostly Voices [2:36]

Nothing gave Buttercup as much pleasure as ordering Wesley around. Fine, boy. Polish my horse's saddle. What's I see my face shining in it by morning. As you wish. Well, the short answer to your question is partially inconceivable.

Mostly Uncle Frank [2:55]

But let's go through a few of the particulars. First, municipal bond funds are always going to yield a lower rate than similar bonds that are not municipal bonds, and that's because they have these tax advantages. But what that also tells you is that they are most directed at people in the very highest ordinary income tax rates for their taxable accounts, those 30% plus rates, which means they tend to be discounted as if you are in the highest tax bracket for the most part, which means if you're not in the highest tax bracket, then choosing municipal bonds over Similar bonds that are not municipal bonds is usually not the best choice for you. This is very highly dependent on which tax bracket you're in. And of course, holding municipal bonds in tax protected accounts, retirement accounts generally makes no sense at all.

Mostly Voices [3:56]

Are you stupid or something?

Mostly Uncle Frank [3:59]

Because the primary reason you were holding them is for their tax benefits. Now getting to diversification, there is a big difference here between your short bonds and your long bonds. Because when you are talking about short-term bonds, you are basically talking about something that you are holding for stability and has essentially a zero correlation with whatever else is in your portfolio. And so you can hold a variety of instruments to fulfill that need. They could be short-term municipal bonds, they could be money markets, they could be savings accounts, they could be I bonds. They could be MIGAs. Anything that is of short duration and tends to be stable is on the table for that and it can be changed as you go through time. And I should have mentioned short-term bond funds as one of those other short-term instruments. So whether you might use a short-term municipal bond in a taxable account depends on your tax rate and then just comparing it to whatever else you have available at the time. And you can switch in and out of these things as times change or your tax rate changes. So if you are getting the best after-tax income out of a short-term municipal bond as compared to some other short-term instrument, then yeah, you should choose that. And it won't matter for the purpose of the portfolio because we're talking about short-term instruments here. And they all tend to behave the same in terms of how they contribute to an overall portfolio. Now, long-term bonds are different because the purpose of long-duration bonds is not for the income primarily, unless you are holding some kind of extended bond ladder. The purpose of long-term bonds is diversification and in particular diversification from stock funds. And so on that metric, long-term treasury bonds are going to be more diversified over long periods of time. from your stock funds and probably other things in your portfolio than municipal bonds will be. And I can link to a little correlation analysis in the show notes so you can see that typically a long-term bond fund has a negative correlation over long periods of time with the stock market and a municipal bond fund has a slightly positive correlation to stock funds. Now, assuming you have multiple account types, both retirement and non-retirement accounts, This would probably end up just being an asset location exercise where you'd probably be putting most of your long-term bonds into retirement accounts, whereas your short-term bonds or municipal bonds, if you're using those, can go in your taxable because you're probably using them anyway to live on, at least in part. And so that is the general approach I would take to this topic. As you wish was all he ever said. Farm boy, fill these with water. Please. As you wish. And thank you for your email. Hold it, hold it.

Mostly Voices [7:08]

What is this? Are you trying to trick me? Where's the sports? Do you think anybody wants a roundhouse kick to the face while I'm wearing these bad boys? Bower your sensei. Bower your sensei. Second off. Second off, we have an email from a Mark.

Mostly Mary [7:30]

And Mark writes, Heads up. I came across a new tool that you may want to let your listeners know about. Etfrc.com I especially like the fund overlap tool, which tells you how many duplicate holdings there are between two ETFs. I haven't seen this anywhere else and it is very useful. I also like the factor scorecard which in my personal opinion is more useful than the Morningstar style boxes. I am still digging in and learning about the capabilities but I will be adding this to my toolbox alongside portfolio charts, portfolio visualizer, etc. When it rains it pours. I ran across another awesome new tool We can thank Rob Berger this time for pointing out this one. It's projectionlab.com, a pretty amazing financial projection tool written by a 30 year old kid. Unlike etfrc.com, I am now a paid subscriber of this one and gladly so. Also, Kyle, the tool author, is super responsive on the Discord channel to questions and feature requests, and not just questions from Rob Berger, but from me as well. I want to hold you every morning and love you every night, Kyle. I promise you nothing but love and happiness. There are so many great features of the tool that I don't want to try listing them here, but I will point out just one. The tax analytics in the plan view are super helpful when planning Roth conversions in the out years to optimize taxes.

Mostly Voices [9:06]

I swear by the moon and the stars and the sky. I'll be there, Cal.

Mostly Uncle Frank [9:14]

Well, yes, Mark, these are two more recent entries into retirement planning tools or financial projection tools, and I will link to both of them in the show notes. They are interesting and fun to use, although I don't think I would pay to use either one of them. But I'm funny like that. What do you mean funny? Funny how? I think these are most useful for people who haven't thought very deeply about what they're doing here and to make sure that they've captured all of the different parameters that go into this kind of planning. But I do also think there is some danger here in becoming over-reliant or dependent on these tools because they are kind of these attractive black boxes that spit out answers to you. So in that regard, they can provide a false sense of security. Danger, Will Robinson. Danger. Because what you really need to understand is what are the inputs that go into these calculations and how changing those inputs changes your potential outcomes. Because in reality, the future is so uncertain that the best we can do at any point in time, particularly as we're talking a decade or more out, is to come up with a range or ballpark that we are likely to be in based on our decisions today. and to think that we can get much more granular or specific ends up being kind of a false perception as these kind of calculations that are often spit out of these things that give you a percentage chance of success. That actually does not make much sense in a world of uncertainty because you cannot calculate probabilities to that rate of success. All you really need to know is that range of likelihoods or that ballpark because you will make adjustments along the way to your expenses or other things. I'll tell you, whenever I use one of these tools, the first thing I want to know is, well, what are the assumptions and inputs that go into them? Because if they're not good assumptions or inputs and then they are compounded through the use of the tool, you can get a lot of garbage out of these things. I'm much more comfortable looking at setups that are less specific but more comprehensive. And that factor in better the issue of liquidity, which I think is something that is often lacking from these kinds of tools. So the first things I'm thinking about when I'm thinking about financial planning are First, what are the annual expenses we're talking about, and then how much of those annual expenses are accounted for through some form of annual income, whether it comes directly from working pensions, rental properties, business interests, royalties, or whatever. If you just know that, then you know what your net expenses or net uncovered expenses are that need to be covered by your portfolio investments. Or your ability to generate additional income as the case may be. That's the fact, Jack. That's the fact, Jack. So then what you are hopefully looking at is a liquid pile of assets to be invested however you choose, out of which you are taking enough to cover the residual expenses that we're talking about. And here's where the idea of liquidity really comes in. Because liquid assets are easy. You can always just sell a little piece of them. and be on your way and use that for expenses. With illiquid assets, you can't count on selling a piece of them. And so they need to be modeled in a couple of different ways. One way of modeling them is to keep them in that expense calculation you already did. So if you have a rental property and it's generating some kind of net income, you can either look at it as an illiquid asset that could be on the block to be sold. or just an income generator, in which case you're treating it akin to a pension or other source of annual income. But if you have an illiquid asset that is not generating income, it typically does not belong in your big asset pool to cover annual expenses. It belongs in a separate category, which is illiquid and non-income generating, which is the worst category of assets you can hold if you're trying to live on something. and it may even have carrying costs. Like if you're just holding raw land that is not generating an income, you may have to pay taxes and insurance and other things on it. So it may actually be a net expense for you on an annual basis and only an asset on a long-term basis. And so that's generally how I'll divide up the three asset pools, assets that are currently income generating. and are likely to continue to generate net income. Assets that are completely liquid and available to cover expenses, like investment accounts. And then this other category of assets that are illiquid and non-income generating that I really don't want to have more of than I have to. Not going to do it. Wouldn't be prudent at this juncture. And then knowing that, you can see how you can convert one thing into another category. or it may fall into another category. So, for example, you have an income generating property, but you lose your tenants or the building burns down or something happens to it and it no longer is generating income. Then it's going to go into that third category of illiquid, non-income generating assets. You may decide at that point just to sell the thing and then it becomes a liquid asset and it goes into the category of liquid assets. that are available to cover expenses. At some point in your financial life, you may take some of those liquid assets and convert them into an annuity stream, a pension stream, in which case they get to move over to that first category of something that you account for by its income. Surely you can't be serious. I am serious. And don't call me Shirley. Now, to me, putting all these things on simple spreadsheets is a better planning tool than some of these fancy things where you input everything into because it allows you to see better where your levers are, either reducing expenses, increasing income, changing your portfolio structure, or doing something with these illiquid assets that you may have lying around. Because when I have things laid out that way, I can look at it and see not only that things are fine, but why they are fine, and if they're not fine, how to make adjustments for it. Whereas if you have one of these black box financial calculators, it's often unclear if there is a problem as to what the problem is and the best way to approach remedying it.

Mostly Voices [16:12]

Ah, say legare, they will take the high road and I will take the low road and I will be in Scotland for them.

Mostly Uncle Frank [16:23]

Because often the solution has to do with converting those illiquid, non-income producing assets into either liquid assets that can be invested or at least income producing assets.

Mostly Voices [16:38]

Where you putting the artillery? There.

Mostly Uncle Frank [16:42]

Uh-. Here. The most common one of those is downsizing a house. Or turning it into a rental property. I am the Impaler and I say, yeah. And so while I will use some of those calculators occasionally, at least the free ones, it's more for entertainment purposes and to see whether I'm on track according to the calculator, and I really don't use it for planning purposes. The plans are ruined! Because I'd prefer to apply my own assumptions to these different categories of assets depending on what class they are in. The emperor makes the decisions around here. It will go. But like everything in personal finance, I do see these things getting better over time and getting cheaper. And so there's no reason not to play around with them. And I will link to those in the show notes. And thank you for your email. Everything that has transpired has nothing to do with my design.

Mostly Voices [17:50]

Last off, we have an email

Mostly Uncle Frank [17:54]

from a different Mark. And a different Mark writes...

Mostly Mary [17:59]

Hi Frank, I recently discovered your podcast and am really enjoying the deep discussions of asset allocations.

Mostly Voices [18:07]

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

Mostly Mary [18:14]

I am firmly in the accumulation phase, so not necessarily incorporating a risk parity style portfolio, but I wanted to get your perspective on a couple of questions. One, I'd prefer to have an asset allocation of 50% large cap growth, 50% small cap value. Unfortunately, I'm limited by the fund options in my 401 which currently makes up about two-thirds of my retirement savings. What's the best approach for trying to hit my preferred asset allocation when I don't have the funds I need in my 401? There are good funds available, especially low-cost fidelity funds, S&P 500, total US mid-cap, and total US small cap. So I can model a total US portfolio there, but I don't have a specific small cap value fund or large cap growth. I'm thinking I either set up my 401k like the total stock market with three Fidelity funds or just use the Fidelity S&P 500 alone to basically stand in as my large cap growth. Then in my and my wife's Roth IRAs, we can buy as much small cap value as possible, which would get us to about 66% large cap and 33% small cap value. I'm telling you, fellas, you're gonna want that cowbell. Is there a better way to try to hit your desired asset allocation when the funds available are limited? Two, what's the purpose of preferred shares in a risk parity portfolio? I probably should go back and listen to the early explanation episode, but I feel unclear on how it helps. Are funds like SCHD or VTV a good stand-in? or is PFF the best option, despite its higher expense ratio? Could high-yield bond funds take PFF's place? Thank you for taking the time to respond, and thanks for all you do to educate do-it-yourself investors. I love your work, Mark.

Mostly Uncle Frank [20:15]

All right, looking at your first question about different fund choices in your 401k and elsewhere. I think that a S&P 500 and a large cap growth fund and a total market fund are all going to give you about the same performance over time and which one is going to be better over any given period is just a coin flip. So if you want to just use that S&P 500 fund in your 401k and then make other adjustments outside the 401k in your IRAs or taxable accounts, to me that makes a lot of sense. Fortunately, this does not need to be very exacting in your accumulation phase in particular, because what will typically happen is as you max out these 401 s and IRAs, then you're going to spill over into ordinary brokerage accounts and be able to invest in whatever you want in those. And that may happen a little later, but you can catch up on the allocations at that point in time. I would be a little wary of Funds that are just completely small cap that include small cap growth in them. Because in terms of which is more important, the size factor or the value growth factor, generally the value growth factor tends to be more important for diversification purposes. So if you have to choose, I would focus more on that than on the size factor. But I should reemphasize again, the main point of this and where you're getting the most bang for your buck is by using 100% equity funds that are internally diversified like all the ones we're talking about and that are low cost. That really gets you 80 to 85% the way there and then adding in the small cap value just tweaks it up a bit. These go to 11. Where this really starts to matter is when you get to your decumulation phase and then rebalancing and having different assets that perform differently in different environments makes a lot more difference.

Mostly Voices [22:14]

That is the straight stuff, O' Funkmaster.

Mostly Uncle Frank [22:18]

And at that point, you'll probably be leaving jobs and be able to roll 401ks into IRAs and put it in whatever you want. So I think you're doing fine with whatever you choose there. Young America, yes sir. And I wouldn't sweat it too much. Now moving to question two, what's the purpose of preferred shares in a risk parity portfolio? Well, preferred shares are definitely not something everyone needs in their portfolio. And I put them in the sample portfolios just for illustrative purposes more than anything else, because I want people to understand that they're available and what they might do with them. Preferred shares are similar to municipal bonds in the respect that they are very good for people in high tax brackets. in taxable accounts. And the reason that is so is because the dividend payouts from preferred shares funds are mostly qualified dividends, so they get taxed at the lower long-term capital gains tax rate and not at the higher ordinary income rate that ordinary dividends and other interest payments would get taxed at. But they are stock funds and so they do have a lot of similar characteristics two stocks that tend to be about half as volatile overall, do not have much capital appreciation, but do pay most of their returns in the form of these dividends. And you can use them as kind of stock bond hybrids. And so you'll note in the sample portfolios we do not use them that much. We do not have any allocation to them in the first three portfolios. We have a small allocation to them in the Risk Parity Ultimate, but only because I wanted to include everything. in that kind of kitchen sink portfolio, and then they're really used as ballast in those two levered portfolios. So really just to dampen down the volatility of the rest of the portfolio. I don't think they make that much sense for most people unless you're in a high tax rate in a taxable account. However, I will say that they are a superior vehicle if your methodology for investing were to be one of these people that wants to live just on dividends, which is a sub-optimal strategy. But if you were going to do that, if that was your plan, you'd be much better off using preferred shares funds like PFF than you would be in using dividend funds simply because the preferred shares funds are going to be paying more dividends at a steadier rate and they are qualified dividends for the most part. So if you fancy yourself a dividend investor or an income investor, which I don't, Forget about it. You should be looking at those because they're probably better than what you're holding, at least in the taxable side of your account. Now comparing that to funds like SCHD or VTV, this does go to why you're holding these particular things. If you were looking for something that was a large cap value fund to go as part of the stock portion of your overall portfolio, you would be looking at something like VTV or SCHD. Those are both large cap value funds when you analyze them on a factor basis, which is the way you should be analyzing these funds, not on whether they pay dividends or not, or what country they're from.

Mostly Voices [25:40]

Fat, drunk, and stupid is no way to go through life, son.

Mostly Uncle Frank [25:44]

So those would be better choices than PFF if you were looking for that kind of diversification in the stock portion of your portfolio. Where PFF would be better is if you were just looking for income out of this. Because it's going to be paying more income and better quality income than those two things. I would not look at them as comparable investments because the preferred shares fund is just more bond like than the other two. You are correct that PFF is also similar to high yield bond funds in a way. You are correct, sir, yes. High yield bond funds are generally actually worse they tend to be more volatile than a preferred shares fund, and they pay ordinary income as far as the income that comes out of them. So high yield bond funds are really one of those things that actually do not belong in most people's portfolios, at least most individual investors portfolios. Because if you're looking for diversification, you need to own a different kind of bond, like a treasury bond. High yield bond funds are the most highly correlated with stocks. And if you're looking for income, then you're better off getting it in the form of qualified dividends from a preferred shares fund and not from a high yield bond fund. And it's for that same reason that a preferred shares fund like PFF is also going to be a better choice than something that is using a buy right strategy options over a stock holding covered calls, that sort of thing. And again, it goes to this income issue that if you are looking for income, you want it to be taxed at the lowest rates available and not the highest rates available. Think McFly, think! And preferred shares funds tend to remain fairly stable over long periods of time, whereas buy right covered call funds tend to decay over time. For more information on preferred shares funds, I would go all the way back to episode number nine. 'Cause that's what we talked about there. I'm glad you're enjoying the show and thank you for your email. And now as an extra added bonus we have a comment from Alexei.

Mostly Voices [28:02]

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. And the dude writes.

Mostly Mary [28:14]

Love today's pod. More Newman drops, please, and thank you, AZ.

Mostly Uncle Frank [28:18]

The dude is, of course, referring to episode 238, where we rolled out the Newman clips from Seinfeld.

Mostly Voices [28:26]

Hello, Jay. May I come in? What do you want?

Mostly Uncle Frank [28:30]

Unfortunately, I can accommodate that request. No. No. No.

Mostly Voices [28:38]

I have a receipt for a rental car with your signature, including a report of some damage to the rear seat. It seems as if the springs were so compressed that they completely collapsed the right side. No man. No man.

Mostly Uncle Frank [28:50]

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. Hello, Jerry.

Mostly Voices [29:39]

Good night, Jerry. Good night, Newman.

Mostly Mary [29:47]

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.