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. Thank you, Mary, and welcome to Risk Parity Radio.

Mostly Uncle Frank [0:44]

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. Yeah, baby, yeah!

Mostly Voices [0:51]

And the basic foundational episodes are episodes 1, 3,

Mostly Uncle Frank [0:55]

5, 7, and 9. Some of our listeners, including Karen and Chris, have identified additional episodes that you may consider foundational. And those are episodes 12, 14, 16, 19, 21, 56, 82, and 184. And you probably should check those out too because we have the finest podcast audience available.

Mostly Voices [1:28]

Top drawer, really top drawer.

Mostly Uncle Frank [1:31]

Along with a host named after a hot dog. Lighten up, Francis. But now, onward, episode 281. Today on Risk Parity Radio, looks like it's all about fiddling with portfolio analyzers.

Mostly Voices [1:48]

I am a scientist, not a philosopher.

Mostly Uncle Frank [1:52]

And a few emails here.

Mostly Voices [1:56]

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

Mostly Uncle Frank [2:02]

First off, we have an email from Jeff. And Jeff writes...

Mostly Mary [2:09]

Hi Frank, I had a couple of questions I hope you could answer regarding Portfolio Visualizer. Hearts and kidneys are Tinker Toys. I was messing around with a few of the Monte Carlo simulations and a few things seemed a bit odd to me. It seemed that swapping out international stocks in favor of only domestic stocks helped the safe withdrawal rate. I know US and non-US stocks are more correlated than in the past, so I was a bit surprised to see the discrepancy. For example, if my equity totals remained the same percentage of my overall allocation, let's say 60%, the safe withdrawal rate was more different than I would have expected if I had 40% US and 20% international stocks versus 60% all US allocation. Also, anytime I added REITs in place of almost any stocks or bonds, it seemed to make the safe withdrawal rate worse. I would love your thoughts as to why this would be the case, as I assumed REITs might add a small bit of diversity to a portfolio and help the safe withdrawal rate. Finally, what are your thoughts on what percentage success rate it would take for you to feel comfortable relying only on your portfolio for income. For example, when I run my simulations, I sometimes get a 99.5% or higher chance of success. And of course, that doesn't include any changes I could make along the way in case of a market turndown, such as cutting my expenses, et cetera. Is there a certain percentage threshold of success you would need to feel really comfortable? Part of me wants the simulations to reach 100%, but that seems like it may not be the best way to look at the situation. No more flying solo.

Mostly Voices [3:55]

You need somebody watching your back at all times.

Mostly Mary [3:59]

Thanks as always to you and Mary for the great podcast. Regards, Jeff.

Mostly Uncle Frank [4:05]

Well, Jeff, interesting questions. You have discovered one of the curious anomalies of Portfolio Visualizer. and you run into this when you start analyzing REITs on there, particularly in their asset analyzer. And the issue is this, their REIT data only goes back to 1994. So anytime you stick REITs into the mix, you're only getting an analysis maximum that goes back to 1994. With most other things, you'll get back to sometime in the 1970s. Although sometimes with international funds or international allocations, it will cut off in the 1980s. Why this matters in particular for REITs is that unless you are capturing data that goes all the way back to say the 1970s and the'70s and'80s were actually good decades for REITs. What you end up with is this anomalous drop in 2008 that really skews the returns for REITs overall if your data set is short and includes of that period. Now, I'll link to the Portfolio Visualizer print out of a 100% REIT portfolio. And if you look at that graph, you can see what I'm talking about. There is a somewhat similar but not as pronounced effect with respect to international stocks because that data in Portfolio Visualizer only goes back to 1986, which in fact was during one of the big bull markets for international stocks. A more interesting graph is actually to look at the performance of international stocks versus the relative value of the US dollar. Because if you look at something like that going back to the 1970s when we went off the gold standard, you'll see that they are very much inversely correlated. And that a lot of investing in just broad baskets of random international stocks is effectively a speculation on the value of the US dollar and what it's going to do next. which is one of the reasons just trying to diversify by picking international itself isn't usually very effective. What is more effective is that you focus on factors as well.

Mostly Voices [6:24]

So if you're looking at international small cap value, for example, I could have used a little more cowbell.

Mostly Uncle Frank [6:28]

But unfortunately we don't have all of the data for something like that either. Now there are a couple of workarounds you can use here. They're not perfect, but they are useful. With respect to REITs, what I like to do is use portfolio charts. So making sure that whatever I'm running in Portfolio Visualizer, I also go and run over it portfolio charts because that does have REIT data going back to the 1970s. And similarly with international stocks, although it does not seem to matter as much with respect to that. the other thing you should be mindful of using Portfolio Visualizer is to make sure when you're comparing different portfolios, you're doing them on the same time frame or time scale. And sometimes that just involves changing those dates because you always want to make sure that for whatever you're comparing, you're looking at it at the same time frame. And then after that, considering whether that time frame is long enough to be a good representative sample of what you might expect at some point in the future in some way, shape, or form. As they say, history does not repeat, but it rhymes. Now moving to your other question, my thoughts on success rates in Monte Carlo simulations. The usual standard that most financial advisors would use for this and that I think is reasonable to use is the 90% standard. so if it's in the 10th percentile and say the Portfolio Visualizer 10th percentile or greater, that would be considered a success. And that's for a couple reasons really. The first is that when you're looking at those tails, either 0 to 10 or 90 to 100 on a Monte Carlo simulation involving long series of data, those tails have never happened. Now it doesn't mean that they could never happen, but the likelihood that you're going to end up in the 0 to 10 or the 90 to 100 is vanishingly small and probably would involve wars or other cataclysmic dislocations. The other issue pertains to the word success rate at all because it's very misleading in this context. When you are just looking at a Monte Carlo simulation, usually it is increasing your expenses by the rate of inflation as in the original Bengen assumptions. And it is acting like you are not paying attention to anything. so that you would just keep spending down regardless of what the outcomes were. What that is really measuring is the probability that you would have to change course at some point along the way. Sometimes people like to use plane analogies. This is not the probability of crashing the plane. This is the probability that your plane is going to get rerouted because you would in fact make changes to the way you are spending money. And this gets to the inherent problem with Monte Carlo simulations, which is actually not a problem with the simulation itself, but as to how it's used or how it's interpreted. Those success rates that are spit out by these things should only be looked at as loose approximations, meaning that there is probably no statistical difference between 94% and 99%. But I think the better use of them is not so much to use those numbers as absolute figures for decision making, but use these simulations as a mechanism for comparing different portfolios under similar withdrawal conditions. So one of the things I like to do with them is take very high withdrawal rates, like 5%, 6%, 7%, apply them to various portfolios and compare them. and basically see which ones break first and which ones would last the longest. Because if you're using it that way, then you have a good mechanism for saying that this portfolio is a better portfolio to hold in retirement than this other portfolio that I might have held. And that is a nice objective criteria to use to judge portfolios by. Unfortunately, what I commonly hear from the personal finance world and elsewhere is not objective criteria, but A subjective crystal ball belief about which portfolios will perform well in the future based on somebody's projection about interest rates, stock market returns or something else. My name is Sonia.

Mostly Voices [11:02]

I'm going to be showing you the crystal ball and how to use it or how I use it.

Mostly Uncle Frank [11:10]

And once you go down that road, you can make any particular portfolio appear better or worse than any particular other one, depending on what you're assuming. In terms of a process for choosing a portfolio, though, I think it is kind of a bare minimum at this stage in the game. I mean, in the 2020s, when we have these free tools with all this data. And we have the tools, we have the talent. To be running your portfolio through the portfolio visualizer analyzers, through the portfolio charts analyzers, and through other ones to the extent that you can get them and use them. and not to focus on the absolute numbers so much as to focus on comparing one portfolio with another choice that you might make. Because what's nice about these analyzers is they peel away or get rid of a lot of the irrelevancies that some people sometimes impose into portfolio construction, including things like putting things in various buckets and other kind of mental accountings. These sorts of analyzers do help you Separate the wheat from the chaff, if you will.

Mostly Voices [12:14]

But what about your grandfather's work, sir? My grandfather's work was doodle!

Mostly Uncle Frank [12:18]

Hopefully that helps, and thank you for your email. Class is dismissed. Second off, we have an email from Micah. And Micah writes：hello, Frank and Mary.

Mostly Mary [12:57]

I've been a regular listener since the inception of Risk Parity Radio. Yeah, baby, yeah! I have enjoyed all your podcasts. Please keep up the great work. I'm a big fan of the Golden Butterfly portfolio and plan to implement a similar portfolio in the next 5-7 years. It may be a bit premature to consider this, but I plan to use a modified version of the Golden Butterfly with about 60% equities rather than 40%. This is because I believe our risk tolerance is a bit higher than Tyler's, and the income from our investments will be extra since all our household expenses will be covered by pensions. Whilst playing with Portfolio Visualizer, I found that if I massage the asset classes in percentages, I can get a modified version of the Golden Butterfly with 60% equities to beat the S&P 500 returns with nearly the same drawdowns as a typical 60/40 portfolio going all the way back to 1972. I have no original point to make or question to ask.

Mostly Voices [13:57]

Secondary latent personality displacement? Oh, great one. Yes, sir.

Mostly Mary [14:01]

But I thought that it was worth noting that a well-diversified portfolio can potentially beat the returns of the mighty S&P 500 while also reducing the standard deviation by 30%. Additionally, the SWD for this portfolio was 6.33% versus the S&P 500 at 4.17% versus a traditional 60/40 at 4.24%. Here are the components of this modified version of the S&P 500：30% total US stock market, 30% US small value, 13.3% cash replacing short treasuries to get back to 1972, 13.4% 10-year US treasuries replacing long treasuries to get back to 1972, 13.3% gold. Here's a link so you don't have to punch in the data. Cheers and thank you for listening to the nonsensical ravings of a lunatic mind.

Mostly Voices [15:01]

Abby someone. Abby someone. Abby who? Abby normal.

Mostly Mary [15:09]

Micah, somewhere in a very remote facility in the Alaska wilderness.

Mostly Uncle Frank [15:27]

Well, Micah, welcome in from the cold and thank you for stopping by. I do see you appear on some of the boards on Facebook and I'm very glad that you wrote in to talk about what you're doing. And what you're doing is very interesting and is a good example of what I would hope people would be able to use the information they get here for to create their own Diversified portfolios that are better than something else that they might have been shown or otherwise might have used. Your portfolio is very similar to what the value stock geek calls the weird portfolio, which Tyler has also put up at portfolio charts. I'll link to that in the show notes. That is also a portfolio that is 60% in stocks and does have similar risk return characteristics to what you've proposed here. I would also go ahead and look at the Risk Return Analyzer at Portfolio Charts, which compares your portfolio to a whole bunch of other ones. Basically all of the 18 or 19 that Tyler's put up at Portfolio Charts, from traditional 60/40s to Merrimans to Schwed Rose to Bogle Heads 3 Funds and other things. And you'll see if you put your portfolio in there that it does perform very much better than most of those and is up in the categories with golden butterflies in the weird portfolio, especially when you're talking about safe withdrawal rates and perpetual withdrawal rates. I will link to your backtest in the show notes. It looked really good going all the way back to 1972. Now part of this is because there is a sweet spot for the amount of equities in a portfolio that seems to yield the safe withdrawal rates when combined with other assets. And lots of people have looked at this, including the Bill Bengen's of the world, the Wade Fales of the world, and many others. And what they'll generally tell you is that the portfolios that have between, say, 40% and 70% in equities tend to have the highest safe withdrawal rates. I know Bill Bengen thinks the optimal amount is actually 55%, but to me this is more of a matter of preference as to how conservative or aggressive that you really want to be. The other thing that you've done that really does seem to improve portfolio performance and safe withdrawal rates is to take part of it in value tilt it. So having half of your stock allocation be small cap value does greatly improve its characteristics.

Mostly Voices [18:07]

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

Mostly Uncle Frank [18:11]

And that does tend to follow the teachings of Paul Merriman. If you look at the Merriman Ultimate or all of the variations of that down to the Simple 2 Fund portfolio, they always involve a 50% allocation to value. What I mean by 50% is half of the stocks are allocated towards value. Whether that's domestic, international, or some other value. Usually there's some small in there too. Now you also mentioned that your household expenses are expected to be covered by pensions. Yes. And what that really means is you could hold whatever you wanted. And when I say whatever you wanted, you could be holding something that is almost all stocks as if it were an accumulation portfolio like Warren Buffett's famous 90-10 to leave to heirs. But the reason he can afford to do that is precisely because his expenses are already covered. And so that kind of portfolio held in retirement is an implied or revealed preference that you wish to die with as much money as possible and leave as much money as possible when you're dead, which is what a lot of personal finance gurus actually do. even though they don't want to talk about it. What you've done here is actually increased your opportunities for spending more of it while you're alive. Groovy, baby!

Mostly Voices [19:31]

Which I think makes the most sense, actually.

Mostly Uncle Frank [19:36]

And it's why a portfolio like this, designed for spending or to maximize spending or a withdrawal rate, makes more sense to me. Because I do want to spend more of it or most of it or give it away. Before I'm dead. Dead is dead. And it seems you agree with that sentiment as well.

Mostly Voices [19:56]

That is the straight stuff, O Funkmaster. So again, welcome to our little dive bar here.

Mostly Uncle Frank [20:03]

I think a lot of people may like your variation because it's simple, easy to understand, and not so far off from what somebody might typically hold. Like some of the strange concoctions from our friend Alexei. But anyway, have a good day in the wilderness, and thank you for your email. Last off. Last off, we have an email from Chris. Cornbread. Ain't nothing wrong with that.

Mostly Mary [21:18]

And Chris writes：hi Frank, I liked the episode 278 with the portfolio review. Why do you think the Golden Butterfly has the best results so far among all your test portfolios? And would you use it personally? I find its safe withdrawal rate of 7.46% historically quite impressive, but a little too good to be true.

Mostly Uncle Frank [21:37]

Well, this is a good follow-up on what we just talked about in the previous emails. First, let's talk about this safe withdrawal rate of 7.46%. I'm not sure what group of data you ran that on. I think it's a little bit less than that, depending on the time frame you're talking about. But really, the point should be is that the safe withdrawal rate for that portfolio is higher than other kinds of portfolios that you might use. over similar lengthy time periods, 30, 40, 50 years. And so the point of it is, and the point of all this is, is that wouldn't you rather start with something that has performed much better in the past than something else, regardless of what you think the future might bring? Now that being said, I do not personally use it because I'm like Micah and I want to be a little bit more aggressive in my allocation and have a higher stock allocation. So what we use in our personal accounts is something that looks more like the Golden Ratio portfolio, but also has a few of those alternative assets that you'll find in the Risk Parity Ultimate portfolio, although not in as large of proportions, I would say, for the most part. I also think that the golden butterflies 20% allocation to short-term bonds, maybe a little bit excessive. But on the other hand, that is one of the reasons it's performed the best out of the sample portfolios in the time period we've been using them. And that's because the year 2022 was in fact one of the worst years in the last 40 or 50 for any kind of portfolio that's composed largely of stocks and bonds. So anything that had a larger exposure to short-term bonds and cash probably outperformed something else. That being said, I would not read too much into the current performances of any of the sample portfolios because the timeframes we're talking about just a few years is not really long enough to say anything definitive about any portfolio. And one of the issues we have in these simulations is that we have not even been through a complete economic cycle. So we have not seen or gone through a recessionary period with any of these portfolios yet. Most of them were initiated in July 2020, which is essentially after the recovery from a recessionary period. So in order to have at least some decent way of comparing them, you would want to see them go all the way through from the growth period that we saw, to the inflationary period. And now, at least I've been told, we're going to have some kind of recession in the next six months or a year or something. And I'm sure that will be true eventually. And then the portfolios will recover after that. And at that point, that will be an excellent point at which to compare these portfolios and other possibilities of what you might hold because you've got a whole economic cycle to go through. Now it's much better actually to be using much longer time frames of 10, 20, 30, 40, 50 years. Now besides being lighter on most risk assets, that portfolio is heavy on gold, and gold has performed pretty well in the past few years here, at least compared to other kinds of assets. And that again may be more of a product of the times we are in at the moment. Because as we talked about back in, I think, episode 40, the long term or 100 year analysis seems to show that somewhere between 10 and 15% in gold is probably the optimal amount for a basic stock bond portfolio. But when things are strange like they have been or were in the 1970s or the early 2000s, having a larger allocation to gold is going to help. I love gold. But in the end, this portfolio that Tyler came up with, the Golden Butterfly, is a very nice portfolio, particularly for somebody who wants to take a conservative approach. And so I'm not surprised that it's doing the best overall given the recent history of markets, particularly with the worst bond market in 40 or 80 or 100 years or whatever people were saying about it last year. But it also is interesting to compare, you know, the experience that we've had day to day, week to week, month to month, year to year, since we started running these things with what it looks like when you're looking at 40 or 50 years of data on a graph. It just feels different. And the impressions you get are different because our human tendency is always to overweight what is going on in the present. In terms of thinking of what's going to happen in the future, we're always over-weighting what has gone on in the recent past. It's the recency bias that we all have. That is why we want to come up with a reasonable allocations for our portfolios and then stick with them. through thick and thin because it's actually the jumping around in the recency bias that is the biggest bugaboo for most do-it-yourself investors and why they tend to underperform even what they're holding. The whole experience of 2023 is a pretty good example of that because people who jumped around at the end of 2022 on the forecast that 2023 would be just as bad or worse I really messed themselves up. My dad said he listened to Matt Damon and lost all his money.

Mostly Voices [27:36]

Yes, everyone did, but they were brave in doing so.

Mostly Uncle Frank [27:39]

Whereas people that have stayed the course and just followed their rebalancing schedules are going to be just fine over time. But hopefully that provides a little bit more perspective and thank you for your email. And now I see our signal is beginning to fade. If you have comments or questions for me, please send them to frank@riskparityraider.com that email is frank@riskparityraider.com or you can go to the website www.riskparityraider.com and put your message into the contact form and I'll get it that way. We 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. Mmkay? Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio. Signing off.

Mostly Voices [28:35]

Hey, Shell, you know it's kind of funny. Texas always seems so big, but you know you're in the largest state of the union when you're anchored down in Anchorage, Alaska. Down in Anchorage.

Mostly Mary [29:10]

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.