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 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.

Mostly Voices [0:52]

Expect the unexpected. It's a relatively small place.

Mostly Uncle Frank [0:57]

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. I don't think I'd like another job. What we do have is a little free library of updated and unconflicted information for do-it-yourself investors.

Mostly Voices [1:25]

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

Mostly Uncle Frank [1:29]

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 Voices [1:50]

But now onward, episode 269.

Mostly Uncle Frank [1:54]

Today on Risk Parity Radio, we're just gonna do what we do best here, which is tackle some emails, some more from our patrons and some others.

Mostly Voices [2:06]

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

Mostly Uncle Frank [2:11]

First off, first off, I have an email from Drew. And this one is about... Gold, Mr. Bond.

Mostly Mary [2:19]

And Drew writes... I'd love to hear your thoughts about this new article by Larry Swedroe, ironically written just after funds like GLD hit all-time highs. Drew.

Mostly Voices [2:31]

Do you expect me to talk? No, Mr.

Mostly Uncle Frank [2:38]

Bond, I expect you to die! Well, before we get to this article that you've excited too, which is very interesting, I think, in a couple of different ways. Mostly from a analytical perspective as to how to read something like this. But before we get to that, I just want to thank you for being one of our patrons on Patreon.

Mostly Voices [2:57]

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

Mostly Uncle Frank [3:04]

Drew got to go to the front of the line for getting his email answered. and all of that money we collect there from the patrons is given to the Father McKenna Center, which is the charity for this podcast. And you can learn about that and becoming a patron at the support page at www.riskparityradio.com. But now getting to this article that you've cited to by Larry Swedroe. Yes. Now Larry Swedroe is somebody that is a professional and does a lot of good work, particularly about factor investing. And he also does believe in trying to maximize diversification of portfolios. But it's interesting, and I don't know why he seems to have this issue, but he just does not like gold and he's always looking for something else to use. And we'll talk about those something else's, which he mentions at the end of the article and compare those to gold, because I think That's where the punch line of this all ends up. Funny how, how am I funny?

Mostly Voices [4:07]

But this article does remind me of my legal career that if

Mostly Uncle Frank [4:10]

you're really going to analyze something, you not only have to read what it says on its face, but also look to what it is citing or referring to, because oftentimes that thing that is being cited does not quite say what the author says it says. I don't think it means what you think it means. And we have a couple of those things going on with this particular article here. Inconceivable! Now the title of this article is Misguided Investor Expectations on the Risk and Returns of Gold. And the first part of the article does cite to some article surveying a bunch of quote, households and professional investors about expectations on returns of gold, and that finds that they are really all over the map. And although a lot of people think they know why gold does what it does, nobody is really very good at predicting what gold does and what it's going to do it. And I do agree that the average investor, whether they like gold or not, seems to have a Dunning-Kruger idea about gold. Dunning-Kruger is the effect where people know a little bit and therefore overvalue or think they know more than they actually do. And I think that's true, that people either have an unreasonably negative opinion of it or an unreasonably positive opinion of it and seem to think that they know when it's going to go up in value and why it goes up in value or down in value. And experience tells us that that is just as unpredictable as any other asset class. and maybe even more so. Now the article then goes on to talk about two other articles. One is called the Golden Dilemma by Claude Erb and Campbell Harvey. And then another one is called the Golden Rule of Investing by Pim Van Vliet and Harold Lore. And Schwedro essentially tries to use these articles to downplay or discount the value of having gold in a diversified portfolio. saying that it's only a hedge part of the time and not a perfect hedge. And he quotes selectively from each of those articles. And we'll get to his ultimate conclusions, which I will read. But let's first take a look at these articles that he's citing and see what they really stand for. Now, this first paper, the Golden Dilemma, covers a period of 1975 to 2012 for gold and tries to analyze, you know, what its performance was like. How does that compare with other things? so on and so forth. There's a real problem with that time frame though, and I understand that they probably didn't cherry pick this on purpose. But the fact of the matter is they started this analysis at a high point for gold in 1975 at the beginning. Gold actually fell about 25% in 1975 after having this huge run up from $35 an ounce. in the early 70s. It went up very substantially in the years before that. So in effect, this would be like analyzing the stock market if you started at the end of 1999, when the stock market hit a peak and was about to go down. So it's really an inauspicious or kind of unfair or unusable place to start an analysis from. and because they start there, they end up concluding that gold has a lower yield than both stocks and bonds, which is not the case depending on whether you start in a different year. In most years you would see that gold has a return that is between stocks and bonds essentially. Now you really don't get to the more interesting part of this paper until you get towards the end, section 6.5 on page 40 of this paper is entitled Gold in a Diversified Portfolio. I'll just read this part. There are at least two reasons one might consider gold in a diversified portfolio. First, gold has low correlations with other tradable assets. Exhibit 27 shows five-year rolling correlations of gold and a number of standard global equity and bond market benchmarks. While these correlations vary through time, they are on average low. the recent equity correlations with the MSCI ACWI, MSCI EAFE, and the S&P 500 are about 0.2. The fixed income correlations are somewhat higher. The correlations with Barclays Aggregate and the Merrill Global Government ex-US are about 0.4. Historically, the fixed income correlations have been lower. The message here that on average, Gold has low correlations with equity and fixed income benchmark returns. However, the correlations are unstable. And this is in fact the reason we would hold gold in a diversified portfolio and why Ray Dalio and Bridgewater do it. It's going back to that holy grail principle that you're looking for things with low correlations to combine. Now, the fact that correlations are unstable You can say that about any combination of two assets, unless you're comparing an asset to the dollar that is being priced in dollars. So for example, in 2022, energy stocks were negatively correlated with the rest of the stock market. They were going up while the rest of the stock market was going down. That's usually not true. They're usually positively correlated and highly so. On the other hand, Treasury bonds are usually negatively correlated with the stock market or have a low correlation but were positively correlated in 2022. And in 2022, gold exhibited both positive and negative correlations to the stock market depending on what time of year you were looking at. And then I'll read you the conclusion from page 43 where it says, Investing in gold is potentially a way to maintain purchasing power, the purchasing power of gold rises and falls as the real price of gold rises and falls. Investing in gold entails a bet as to the future real price of gold, whether or not an investor even thinks about the bet. It is a fact that the real price of gold is very high compared to historical standards. Now note this article is analyzing it up to 2012 and is not analyzing the current price or what happened in the past 10 years. It goes on. A number of reasons have been advanced to explain the current real price of gold. Some of these stories argue the real price of gold is too high and others suggest the real price could go even higher. The goal of this paper is to analyze these competing narratives. And I would say that this paper was inconclusive in its conclusions. And it was interesting because gold did go down after this, although not in some predictable way and has gone up and down since then, but is now near again at all time highs. But what we really get from this paper is that gold has a positive return and is uncorrelated with stocks and bonds, which means it's a useful thing for putting in a diversified portfolio. Now let's go on to this next paper, which was actually just written in 2023. The Golden Rule of Investing from Fleet and Lore. Now this one also suffers from the problem of starting at the beginning of 1975 when gold was at a local peak and so it naturally makes the returns look lower than they would if you had picked just about any other starting point. Nevertheless, here's what it concludes. Conclusion. The Golden Rule of Investing is to avoid capital losses. To this end, some conservative investors hold a part of their wealth in gold. Indeed, our empirical study corroborates that a portfolio's loss probability, its expected loss, and downside volatility can be brought down with modest allocations to gold. However, hedging downside risk via gold investing comes at the cost of lower return, conversely including low volatility stocks in the multi-asset portfolio increases its defensiveness considerably, without giving up returns. Notably, the effectiveness of the resulting defensive multi-asset portfolio increases with the investment horizon. While we've intentionally kept the empirical setup concise, it could readily be extended to consider additional asset classes and factors. Notwithstanding perfect safe heavens are difficult to find, but a mix of defensive equities, bonds, and a small allocation to gold can help reduce capital losses. And so this paper, unlike the article that Larry Swedroe wrote, is actually in favor of including modest allocations to gold. And in fact, if you read the rest of the paper, it looks like the same thing that we've concluded here, which is that that modest allocation in most portfolios is about 10 to 15%. What's also interesting about what I just read is it describes why having a more diversified portfolio like this is good for a drawdown portfolio and would have a higher safe withdrawal rate because it's that lower volatility overall that is created in the portfolio by maximizing its diversification. that creates a higher safe withdrawal rate, even though the overall returns of the portfolio are going to be lower. But that's going to be true of just about any portfolio that's not 100% equities is going to have a lower compounded annual growth return over very long periods of time. So this paper, unlike Larry Swedroe's article, actually is an argument for holding gold in your portfolio.

Mostly Voices [14:20]

Surely you can't be serious. I am serious. And don't call me Shirley.

Mostly Uncle Frank [14:27]

Now let's go back to Larry Swedroe's article and read the last paragraph of it where he tries to sum up everything. And he says, that said, there have been periods when gold did act as a safe haven, just not reliably. It nonetheless cannot be considered portfolio insurance because insurance is meant to always be there when needed. Investors seeking to diversify their portfolios away from the risks of traditional stocks and bonds should consider other assets that have no or low correlations to stocks and bonds but have higher expected, though not guaranteed, real returns. Examples include reinsurance funds such as SRRIX, SHRIX, and X I L S X, private senior secured sponsored by leading private equity firms, floating rate credit funds like CCL FX and AQR style and risk premium funds, examples QSP RX and QRP RX. Okay, this paragraph is very interesting because it does reveal Some conflicts of interest that Larry Swedroe has in that he's talking his book here. He recommends these sorts of assets to the clients that he has. And he basically tells them, you should hold these things and not something like gold.

Mostly Voices [15:56]

That's the fact, Jack. That's the fact, Jack. And that is the real thrust of this article.

Mostly Uncle Frank [16:03]

Unfortunately, this does not hold up. And for two primary reasons. First, this straw man that he's thrown out there, that gold is supposed to be portfolio insurance. While somebody uneducated using the Dunning-Kruger effect might think that, an educated person who understands portfolio construction does not think that gold is portfolio insurance. Portfolio insurance is something like put options. on the S&P 500. But his real problem is that he can't say that the other things that he's suggesting work any better as portfolio insurance because they don't. Forget about it. So whether something is, quote, portfolio insurance, unquote, is a straw man and is not the useful standard here. The useful standard here is whether this is a diversified asset that will improve your portfolio in some way. And the some way we care about is whether it's going to improve its safe withdrawal rate overall. And now here's the real kicker. I went to Portfolio Visualizer and stuck in these suggestions he's got with some gold, with a total stock market fund for comparison purposes, into the correlation analyzer, which also kicks out returns, to see which of these things performed the best. And most of these things that he's suggesting just haven't been around that long. So, I mean, let's take a look at the pudding. If the proof is in the pudding, we ought to see it there. I'm happier than a pig in slop. And what we see there is Gold has a better performance than the other things he's suggesting. except for one of them that's only been around since 2019. But that one that's been around from 2019 has a correlation with the stock market of 0.6, whereas gold since that time has been 0.24. And then if you take that one out, you'll also see that gold is a better performer and has a similar low correlation than the other things he's suggesting. So the way I read this article is Larry Swedroe attempting to convince people that the alternatives that he is suggesting for a diversified portfolio listed in this last paragraph are better for your portfolio than a small gold allocation. Unfortunately, what he's put forth does not actually support that conclusion. Forget about it. And in fact, looking at the papers he cited and then an analysis of the other possibilities he suggested, suggests that you are better off holding a small amount of gold in your portfolio, despite the language that he uses to the contrary.

Mostly Voices [19:00]

That is the straight stuff, O' Funk Master.

Mostly Uncle Frank [19:03]

So this is a very interesting article. What's even more interesting is the things that are cited in it. But it does give us a chance to flex our critical thinking and reading skills. We had the tools, we had the talent.

Mostly Voices [19:16]

Which is always a welcome diversion.

Mostly Uncle Frank [19:20]

And so thank you for that email. I love gold.

Mostly Voices [19:26]

You're insane, Goldmember. And that's the way, -huh, huh, huh, I like it. Second off. Second off, we have an email from Barry.

Mostly Mary [19:41]

And Barry writes, hi, Frank and Mary, still very much enjoying the podcast. Here are my questions. Can you give an example of how someone would transition from a 60/40 portfolio to a risk parity portfolio, say, the Golden Butterfly? Would you do it all at once? Or given current market conditions, would you start selling out of the stock or bond side and what would you start buying? Can you give an example of how to take distributions from such a portfolio? Sell whatever is up? Is it similar for rebalancing, selling what's up and buying what's down to get back to target allocations? Thanks for all you do, Barry.

Mostly Uncle Frank [20:23]

Sure, I'd be happy to answer these questions. So the first one in terms of a transition, the first question is whether your current portfolio is at or near an all-time high and you feel like now is a time that you want to make a shift to your drawdown portfolio. If those two things are true, you could make the shift immediately because basically you'd be selling high and going from something that's more aggressive to something that's less aggressive in terms of its stock allocation. Now that's the easy case. For a harder case, might be you're holding it now and it hasn't fully recovered yet. Although it might have depending on what the makeup of this 60/40 looks like. In that case, the first thing you're looking at is, well, what are the commonalities of the portfolio you have now with the one that you are going to, whether it's the golden butterfly or something else? So, for example, if you had a 60% portfolio, stock portfolio, that was all VTI, a total stock market fund, and you wanted to keep that as part of the golden butterfly, which you could, obviously you don't need to change that part of the portfolio. Similarly, if you were going from an allocation of 40% bonds, which is in a total bond fund that is diversified across durations from short to long, you can probably go in one step to the kind of 40% bond portfolio that's in the Golden Butterfly because it is also 40% It is also in fact divided into long and short. It just doesn't have a medium portion in it. So those two allocations, the 40% bond allocation are in fact similar overall. The reason that it's better for you in the Golden Butterfly is that it allows for more rebalancing and easy access to that short-term bond fund, which you may be relying on in the second half of your question. Now, after you've made those kind of easy determinations, suppose you have your 40% total bond fund, you could just sell that, buy your long and short-term treasuries, be done with that part of it, then you also have this 60% VTI portion of it, you leave 20% of that there, and then the only thing you're really transitioning is the 40% that is going into gold and the small cap value fund. Now in theory, there is really no way of knowing whether it's good to do that right away or good to do it over a period of time. At least there's no way of knowing, except in hindsight, assuming we're talking about a period of less than 10 years. What that means is you can do whatever is most comfortable for you. A lot of times people are still contributing to a portfolio like this. So the easiest thing to do is build out the missing components first while they are transferring the other components over a period of time and building out the components that they're missing. I think psychologically it's just easier to do it over time. Set either a monthly or a quarterly calendar saying on these dates I'm going to sell this much of this part of the portfolio and buy these other assets. and just keep doing that until you have transitioned your portfolio. Now, I wish I had a magic calendar formula to tell you exactly what to do there, but the truth is I don't, and the truth is such a thing does not exist. So I think you should just do whatever is most comfortable with, so long as you're getting to where you need or want to be before you're actually pulling the plug on retiring. Because ideally you get your assets into their retirement configuration before you pull the plug on other income and you start living on this portfolio. So if you weren't going to retire or rely on this portfolio for the next five years, you could do all of this over the next five years if you really wanted to. I would probably speed it up a little bit.

Mostly Voices [24:34]

Down the quarter mile of death in their 7,000 horsepower nitro burning suicide machines. as they shake hands with the devil when they scream through the burning gates of hell.

Mostly Uncle Frank [24:47]

Now, moving to your second question, which we have answered before, but I'm happy to answer again, because it does go to some basic management techniques. And you'll see the basic two options if you look at how the Golden Butterfly sample portfolio is managed versus how the Golden Ratio portfolio is managed, because I set these up intentionally to do the two different things that you can commonly do. Now, the way that Golden Butterfly portfolio, the sample one is managed in terms of distributions is to be looking at whatever is performing the best since the last rebalancing and then take the distribution from that, assuming there hasn't cash been built up enough to take it out of dividends, which is always your first option. Turn off all of your reinvesting of dividends because you're gonna use that cash first as it comes out and then look at the assets and see what, if any, needs to be sold in order to fill out the distribution. Now we do this monthly here. You could do it quarterly if you wanted to. It's not that sensitive. And the reason it's not that sensitive is simply because you know you're going to be rebalancing the whole thing at the end of the year anyway. So in effect, this is just an advance on the rebalancing in most cases. because in most cases you'll have one of these asset classes outperforming the other ones for a number of months or even an entire year. And then you'll just have to do less rebalancing when it comes to rebalancing time. Now the other method is even simpler. It's the one we use for the golden ratio, which is simply to take out of the short term assets for the whole year and then replenish that at the end of the year at rebalancing time. take out of it for the next year. That is actually the original bucket strategy from Harold Evensky, who found that his clients were much more psychologically capable of withstanding drawdowns if they knew that their expenses for the next year were covered. So in that case, if you look at the way we manage that portfolio, 6% of it is in a money market. We take the distribution out of that portion of the portfolio every month. and then when we get to rebalancing, which is going to happen in July, we will refill that up to the 6% and then start taking out of it again for the next year. And you could do a similar thing with the Golden Butterfly portfolio. You could just be taking out of the short-term bond fund all year long and then rebalance and replenish that at the end of the year. It would have the same effect. Now, whether you do it one way or another, is mostly psychology and personal preference as to how often you want to be looking at your portfolio and fiddling with it. There is some research, recent research, to suggest that because the date of rebalancing could have random effects on a portfolio, it's better to do more of it throughout the year. And that would suggest that taking from the highest or best performer each month is a slightly better procedure in terms of reducing overall volatility than just dealing with it once a year and taking out of the cash portion or short-term bond portion. I cannot say that that research is definitive because it was mostly tested on things like options portfolios and other things like that. I believe we talked about this some time ago, a few months ago. Something by Corey Hoffstein. I'll see if I can find that and link to it again. It was a YouTube video with references about this. But people have been doing it both ways and it's worked out well both ways. Of course people do go both ways. Because it is actually more of a management technique or a minor thing than something that is going to affect the overall performance of the portfolio. In terms of the portfolio construction. So hopefully that helps. And thank you for your email.

Mostly Voices [28:52]

Last off.

Mostly Uncle Frank [28:55]

Last off, we have an email from Rob. And Rob writes, I just discovered your podcast.

Mostly Mary [29:03]

It is fortunate timing for me as I am retiring later this year. I have listened to your foundational episodes and only a few more as well, so forgive me if this question has already been addressed or if the topic is uninteresting to you. I will soon face the question of taking a pension versus a lump sum. This will happen early next year, so I don't have the specific offers yet. But I recently heard the 6% rule of thumb, where a lump sum may be more advantageous if the monthly annuity offer falls below 6% of the lump sum offer. I am not asking for specific advice, but am curious if this rule had any merit. If it makes any difference, I will not be relying on this pension for retirement, as I have about $4 million in brokerage and 401 funds as well. Thanks for your excellent podcast. It has made an impression.

Mostly Uncle Frank [29:58]

Well, Rob, I do not believe I've ever heard of a 6% rule of thumb when it comes to a pension. I think the way that you should evaluate this is as if you are going to buy an annuity on the open market so you can compare what you would get as a lump sum. If you were to take that amount of money, go to the open market and buy an annuity, and would that then yield more or less than what the annuity payout, the monthly annuity payout would be if you were just to take the annuity from the company. Fortunately, you can do that exercise at immediateannuities.com, I will link to that in the show notes. But what is critical about this is knowing what your age is and what your gender is because those are the main factors that determine what an annuity payout is. The older you are and the more male you are, the higher the payout is. because you're not going to live as long and therefore they have to pay less money over time. But that is the way to evaluate this mathematically. Compare it, the lump sum you're going to get, what you could buy in the open market for that versus what the monthly payment is that you're going to get. Now that in and itself does not tell you whether to take the lump sum or the monthly payment, which is more about the rest of your finances and how you would use this or not use it. if you are not going to use this for retirement, I probably would not take it then as a monthly payment because you're going to have to pay taxes on that monthly payment is what it comes down to. And you're not going to be able to control that. Now, if you were going to use it and basically said, oh, between this monthly payment and Social Security, that'll cover my, say, Baseline expenses. or most of them, that might be a good reason to take it just because it's easier to manage that way, particularly if you're in a lower tax bracket anyway. But there's also another option that I don't think enough people think about, which is this：just because the annuity is offered to you now doesn't mean you can't get an annuity or a similar annuity later. And what I mean by that is you could take the lump sum now, invest it in some way, and then decide five years later, oh, I really want an annuity. And then you just go out in the open market and buy yourself an annuity. So there's no sort of use it or lose it quality to taking the monthly stream of income now. And to me, I think if I'm young enough, it makes more sense not to take the income stream now, but to take the lump sum invested in some way. and then decide later, which Mary and I are going to do when we get close to 70, look at our health, our expenses, or other living arrangements, whatever we're doing at that point in time. And at that point in time, decide whether we want to buy a simple premium immediate annuity or a deferred one or a QLAC with some of our RMD money, because that leaves us all the optionality while we're younger. And the annuity that you buy later in life is going to give you a higher monthly payment. just because you're older and are going to die sooner. You're gonna die. So, summing up the answer to your question, no, I don't think this so-called 6% rule of thumb has any merit and that you should simply analyze this based on your own personal circumstances. The other issue I guess we hadn't talked about is whether you could take this as a joint life annuity with your spouse, if that's of any interest to you. because that you can also price at immediateannuities.com and that may be of more interest depending on your health. But again, you can also just buy that later too if you really want one. You're gonna die twice. Interesting question. Hopefully that helps and thank you for your email. You're gonna die. 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, 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, a follow. That would be great. M'kay? Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio.

Mostly Voices [34:47]

Signing off. I think you've made your point, Goldfinger. Thank you for the demonstration. Choose your next wicicism carefully, Mr. Bond. It may be your last. The purpose of our two previous encounters is It is now very clear to me. I do not intend to be distracted by another. Good night, Mr.

Mostly Mary [35:07]

Bond. 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.