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! And the basic foundational episodes are episodes 1, 3, 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 the finest podcast audience available.

Mostly Voices [1:27]

Top drawer, really top drawer, along with a

Mostly Uncle Frank [1:31]

host named after a hot dog. Lighten up, Francis. But now onward to episode 330. Today on Risk Parity Radio, we'll just be doing what we do best here, which is attend to your emails. Well, let's start the insanity. And so without further ado.

Mostly Voices [1:54]

Here I go once again with the email. And?

Mostly Uncle Frank [1:58]

First off. First off, we have an email from John.

Mostly Voices [2:03]

Long John Silver? I mean, I don't know what to say.

Mostly Uncle Frank [2:07]

And John writes.

Mostly Mary [2:11]

Hi Frank, thank you for responding to my two emails. You were right on the money with my mystery portfolio. 70% small cap value and 30% gold. You were also right about it not including leverage. At the time of those emails, I had not yet developed a gambling problem. You can't handle the gambling problem. The screenshot that included the 6.1% perpetual withdrawal rate was from before Portfolio Charts changed its approach to withdrawal rate calculation. So it's a little lower now. I made a donation, recommended a donor advised grant, to the Father McKenna Center. Yes. Over the last few weeks, I've listened to around 250 risk parity radio episodes, and I keep feeling compelled to send questions.

Mostly Voices [2:56]

Since before your sun burned hot in space and before your race was born, I have awaited a question.

Mostly Mary [3:07]

So I'm going to indulge in both of those behaviors. A charitable donation is the least I can do. I actually grew up in Vienna, Virginia, at the end of the Orange Line, and in high school was a regular volunteer at a DC soup kitchen, which was a formative experience for me. I'll be back in your inbox with more questions soon, I'm sure. Thanks again, John. P.S. at one point you referenced that some of your listeners listens at two times speed.

Mostly Voices [3:33]

And Jimmy two times, who got that nickname because he said everything twice, like, I'm gonna go get the papers, get the I actually listen to podcasts three times

Mostly Mary [3:41]

and I crank up a setting that trims any silence so it's effectively 3.25 times. You're insane, Gold Member. There are dozens of us. Dozens. PPS. Somewhere along the way, I decided that the always money in the banana stand clip belongs with withdrawing from the Golden Ratio Portfolio 6% cash. So in my head, it plays there every time.

Mostly Voices [4:09]

There's $250,000 lining the walls of the banana stand.

Mostly Uncle Frank [4:13]

Well, as you might guess, this is a follow-up to our answers to John's emails in episode 329.

Mostly Voices [4:20]

Groovy, baby.

Mostly Uncle Frank [4:25]

And since it gives me a chance to talk about the Father McKenna Center and you just made a donation, you go to the front of the line and we're going to talk about it again. Bing again! So thank you for doing that. As most of you know, we don't have any sponsors here. We do have a charity, and if you donate to the charity, you go to the front of the email line, as John has done this time around. The charity is the Father McKenna Center. It serves hungry and homeless people in Washington, D.C. And we are a 501c corporation. And full disclosure, I am on the board and am the current treasurer. Now as you mentioned, there are many ways to give to the Center. You can do it through the support page on Patreon at www.riskparityradio.com or you more serious donors who want the full benefit of the potential tax deductions should go straight to the Father McKenna website and go through that process. You mentioned a donor advised grant. That is a very good idea for donating to charity if you had any experience with donor advised funds. It is a way to basically create a personal fund and then fund the fund in any given year and you can continue to invest the money in that fund and then donate it to charities as you go along and as you see fit. An easy place to set one of those up is at Fidelity, but they also have them at other places. We also Accept donations in kind of securities, which is another option that I know people like to use because then you get the whole value of the stock you donate counts for the charitable deduction, but any capital gains that were associated with the stock are not counted on your taxes. So basically you get the charitable deduction without having to pay any capital gains taxes on that donation. and that is also the circumstance with QCDs, which you can do after you are 70, I believe, is the age these days, and you can donate directly out of your traditional retirement accounts without counting that as income for the year, which is also a good way to make a charitable donation and save on your taxes in the US. So however you do it, it is greatly appreciated. and it's nice to hear that you grew up in my neighborhood and also that you had formative experiences being a volunteer at a soup kitchen. Because one of the things that the Father McKenna Center actually does is provide those opportunities for people to volunteer. It is in a space owned by high school, Gonzaga College High School, and those students volunteer frequently at the center, as well as many others from around the area. And then we also have visiting groups from both high school and colleges who will come and volunteer as well. And so one of the reasons I chose to be involved with this particular charity is because it does provide those kind of volunteering opportunities to the young people. Young America, yes, sir. And as well as the old people, too. We have volunteers of many different ages.

Mostly Voices [7:43]

Coma. Why I go in and out of Comas all the time? Including people who are in their 80s. French toast, please. Is it coma painful? Oh heck no. You relive long lost summers, kiss girls from high school. It's like one of those TV shows where they show a bunch of clips from old episodes. Anyway, getting back to the banana stand and the rest of your email. Always money in the banana stand.

Mostly Uncle Frank [8:11]

I'm impressed by your listening abilities on 2X and faster speeds. It's not something that I think I could do. Man's got to know his limitations. I'm a 1.5X-er when it comes to most of this. But I do tend to listen to podcasts all day long, like a radio in the background.

Mostly Voices [8:32]

You are ridiculous.

Mostly Uncle Frank [8:41]

Well, he's so ridiculous that the Bears are gonna bring somebody in there I was glad I guessed right on your mystery portfolio, which you had as 70% small cap value and 30% gold. I did try those and it didn't come out exactly how you had posted it, but I know he did change the calculations recently, making them more conservative for the most part. There is also a new article on that which is of interest to international investors in particular, talking about best allocations for people in other countries outside of the US. And what's interesting about that analysis, I have not gone through it, is that high proportions of gold tend to work out very well for those kinds of portfolios in terms of safe withdrawal rates. I'll link to that in the show notes so you can check it out. It's a long and detailed article. And so I don't have too many things to say about it right now. I'm sure it'll come up in the future. Anyway, I look forward to your future questions.

Mostly Voices [9:42]

I love gold.

Mostly Uncle Frank [9:47]

And thank you for your email. Second off. Second off, we have an email from Eli.

Mostly Voices [10:09]

Eli Porter. Does my sermon bore you? Yes, Father. If you feel you could do better, would you like to come forward and share your thoughts with us?

Mostly Mary [10:25]

Thank you, Father.

Mostly Uncle Frank [10:29]

And Eli writes, hi Frank, thanks for putting out such a great podcast and

Mostly Mary [10:33]

for supporting such a valuable cause. I've just made a donation to the Father McKenna Center. Yeah, baby, yeah! I hold a decent amount of long-term bonds in my portfolio and like the risk reward profile that they are providing. Not to get political, but I am concerned about a spike to inflation depending on the outcome of the election. I'm thinking of a scenario with expansionary fiscal policy, increased tariffs, and loss of Fed independence. If I wanted to tilt my portfolio away from long-term bonds to express this opinion, which asset classes should I consider as a replacement? I am thinking gold or commodities, but not sure if they have the right risk reward that I'm looking for. Can I model this with the portfolio charts? Thanks for your consideration, Eli. Malachi.

Mostly Voices [11:22]

He wants you, too, Malachi.

Mostly Uncle Frank [11:31]

Well, a lot of writers in these days are donators to the Father McKenna Center, and I appreciate everything you do.

Mostly Voices [11:35]

The best, Jerry. The best.

Mostly Uncle Frank [11:40]

You are all managing to crowd out the rest and go hopscotching to the front of the line, but. I think it's a fair deal, all things considered. Now getting to your email, that's kind of funny. I have another email in the pile where somebody is thinking that they want to increase their exposure to long-term bonds because they believe there's going to be a recession in the future. You know what I have to say to both of you.

Mostly Voices [12:06]

You have a gambling problem.

Mostly Uncle Frank [12:09]

And I wonder who's got the better crystal ball.

Mostly Voices [12:13]

this is the one that I tend to use more often. I have a calcite ball and I have a black obsidian one here.

Mostly Uncle Frank [12:21]

Anyway, it's difficult actually to model something that is actually inflation focused on portfolio charts because you have hit on the two best things for that golden commodities. Commodities reacts much more quickly to an inflationary environment than gold does. Gold goes all over the place and keeps up with inflation in the long term, but does not always shine. Ha ha. Ha ha. Right when inflation is being reported. Forget about it. So you end up with things like gold is reaching an all-time high right now, And that's the way, -huh, -huh, I like it, Kashi on the sunshine band. But it was kind of just bumping along when we were seeing reports of 9% inflation in the past couple of years. Now we have talked in the past about funds that are specifically designed to take advantage of rising interest rates in inflationary environments. And those are RRH, RISR and PFIX. PFIX is the most volatile of those and the most direct in terms of expressing that opinion. I would go back and listen to episodes 248, 237, and 197, and we did do a 10 question analysis of RRH in particular, but I view all of those things as largely very specific bet kind of things because they are in the very alternative category of investments. What I expect would also work very well in an inflationary environment and did in 2022 was managed futures. And a couple of those funds are DBMF and KMLM. And the reason those work well is because they tend to track interest rates. on a trending basis and also commodity prices on a trending basis. And so end up performing well if there is a sustained inflationary environment or a sustained deflationary environment. And I'd be much more inclined to use those as a kind of general holding in a risk parity style portfolio than I would any of these more kind of speculative things that I just talked about, and we talked about in prior episodes. And in fact, I think an allocation to managed futures is a much better choice than a straight commodities fund because it just tends to cover more ground and tend to work better overall with respect to that asset class. The problem with the commodities asset class is that it has these ridiculously outstanding performance in inflationary environments and then most of the time is just kind of a dog in your portfolio and just lies around there. Managed futures tend to have a more consistent performance over time and a higher expected return overall. Now, unfortunately, you cannot model those on portfolio charts. You can do some modeling of them at Portfolio Visualizer, although there aren't a whole lot of good managed futures funds that go back that far in time. One is MFTFX, which is the Arrow Managed Futures Fund, which you can use for modeling purposes in Portfolio Visualizer. But I don't think I would actually invest in that. I think I would go with DBMF or KMLM if you're going to choose a managed futures fund, because those two are more index-like and have lower fees overall. Anyway, I would not recommend as a overall strategy trying to make macro predictions like this or relying on people that make macro predictions like this. Because my experience is that they are just as often wrong as correct and often wrong at the wrong times. Wrong! Wrong? Wrong, right? Wrong! Many people who do make this kind of forecast are what Philip Tetlock of Superforecasters fame calls a hedgehog, which is somebody that basically has this one big theory about how the world works and applies it over and over again regardless of the situation and so ends up being kind of like a broken clock where if you're predicting a recession every year, yeah, you're gonna be right a few times. Eventually you're gonna be right, but you're gonna be wrong most of the time. Wrong! Conversely, if all you do is predict that the stock market is going to go up every year, you're going to be wrong about a third of the time. But you're gonna be right more often than wrong.

Mostly Voices [17:07]

Inconceivable.

Mostly Uncle Frank [17:11]

And so there are hedgehogs out there that are inflationistas that are constantly predicting inflation will be more than it has been in the past. And some of those people have been saying that for over a decade and then they get to a year like 2022 and say, See, I was right. I knew I'd be right. You can't handle the truth. The problem is that unless you are right on the timing as well as the prediction, you are wrong. Wrong! That does not count as being right. Forget about it. If you're wrong for 10 years and then you're right for one year, that is not being right. That is being wrong. Wrong! Wrong! Wrong! And one of the nice things these days about having the internet and lots of historical materials, if you will, is that you can take a look and go back in time and check out any particular guru's track record. And you really want to pay attention to how often have they been wrong, because all you will get from themselves and the financial media is, oh look, so and so was right this year.

Mostly Voices [18:22]

That's not an improvement.

Mostly Uncle Frank [18:26]

But unless you are accounting for all of the times that they were wrong in their predictions, you are doing what it's called ignoring base rates or basically miscalculating the denominator of a prediction or a predictor. And that's just a bad decision making process. You never want to do that.

Mostly Voices [18:44]

You need somebody watching your back at all times.

Mostly Uncle Frank [18:48]

Anyway, good luck with your speculations.

Mostly Voices [18:52]

You're gonna end up eating a steady diet of government cheese and living in a van down by the river.

Mostly Uncle Frank [19:00]

and thank you for your email.

Mostly Voices [19:04]

Contemplate this on the tree of woe.

Mostly Uncle Frank [19:08]

Last off. Last off. We have an email from George. Meet George Jensen. Actually, it was a different George and the different George writes.

Mostly Mary [19:27]

Hi Frank, I believe I heard you mention Shannon's demon on a recent episode. I believe this email perfectly encapsulates why a very diversified risk parity portfolio consisting of high volatility, low correlated asset classes with rebalancing deadbands outperforms with lower overall volatility, important in a drawdown retirement portfolio. Keep up the good work, George. You are correct, sir.

Mostly Voices [19:54]

Yes.

Mostly Uncle Frank [19:57]

Well, thank you for this article about Shannon's Demon. I thought it was very interesting. I was able to actually find a link for it, which I'll include in the show notes. This was a forwarded email from an outfit called Market Sentiment. And they had also linked in the show notes to the article from Portfolio Charts and another little paper that I found interesting, which I will all link to in the show notes. For those of you who haven't heard about this, even though we've been talking about it a lot recently, Shannon's Demon refers to some work by Claude Shannon, who was basically the father of information science. And it's basically an analysis that shows the value of using diversified assets and rebalancing them. that you can in fact get a higher return if you have two assets that are uncorrelated or negatively correlated and you rebalance them as they go up and down relative to each other, you will get a higher return out of that exercise than holding either one of them by itself. Now, when we take this concept and use it as a mental model in the Charlie Munger parlance, and then apply that to our principles. We see where this fits in and it is between the conflict that can arise between what we call the Holy Grail principle, which is all about using diversification to your best advantage, and the simplicity principle, which is all about keeping your costs low and making sure that you've not created something that's too difficult to manage. And there is a conflict there because one of the issues with personal finance in particular, and if you go back to the first decade of the 21st century, the kinds of portfolios people came up with were all of these two and three fund varieties with the ideas like, well, I only want one fund to rule them all. I only want one stock fund. I only want one bond fund. As if that were the only or most important principle to apply. And the truth is, it's just not because the Holy Grail principle about diversification is the most important principle.

Mostly Voices [22:17]

That's the fact, Jack! That's the fact, Jack!

Mostly Uncle Frank [22:25]

And the simplicity principle needs to take a back seat or be subsidiary to that. Where this has changed a lot in recent times, particularly with the rise of ETFs and no fee trading, is that the cost of doing rebalancing and having more diversified portfolios has gone down to essentially nothing, which means that a lot of reasons for just holding one thing and holding it forever have kind of gone away along with those transaction costs. and the fact that since markets are electronic and more liquid these days, the spreads on trading popular ETFs are essentially a penny. So that issue has also gone away in terms of trading costs. But Shannon's demon is also why it's better to have a few funds in each category, at least the big categories. So when you're talking about your stock allocations, It actually is not advantageous to have just one stock fund. Surely you can't be serious. I am serious. And don't call me Shirley. Because you can't rebalance one stock fund by itself. It's more advantageous to have at least two that are likely to perform differently in different environments. And the easiest two to hold for that is a large cap growth and a small cap value. And you can hold more than two. But then you really need to be paying attention to are these two things actually diversified in terms of having lower correlations or some hope that they would perform differently in different environments to make rebalancing worthwhile. And if you have too many things, you just end up having too many overlapping things that are not taking advantage of what we learned from Shans Demon. But this is also why on the bond side of things that you really want to keep your very short term assets separate from your intermediate and long term bonds because they're doing two different things. And one is fundamentally stable but low return, whereas the other one is relatively unstable but potentially higher return. And you want to be able to rebalance those two things in addition to rebalancing them against your stock holdings, and then whatever else you add to this, whether it's gold or managed futures or some speculative inflation fund like PFIX, all of these things play into your portfolio construction. And what Shannon's demon is telling us that in the implementation of the Holy Grail principle in terms of diversification, you do want to be paying attention to these things and having enough different things in the portfolio that rebalancing becomes worthwhile and actually has a positive impact on overall performance. And you don't really get that or get much of that if you are holding things that kind of live together or live near each other in terms of factors and other things. And that's why just having a total US stock market fund and a total international stock market fund is not really giving you that much diversification. It's not really taking advantage of the lessons of Shannon's demon that you would want to be asking yourself, well, how can I make this better diversified so that these things actually perform more differently over time? And one of the ways you would do that with international funds versus a total US fund or S&P 500 is to tilt your international funds toward the value factor. which you can now easily do with funds from Avantis and DFA if you'd like to do that. But anyway, applying Shannon's Demon as a mental model shows us and informs us how to organize our basic principles, Holy Grail macro allocation and simplicity, and that the Holy Grail principle must take precedence over the simplicity principle. in order to achieve the best outcomes in portfolio construction.

Mostly Voices [26:35]

Winner, winner, chicken dinner.

Mostly Uncle Frank [26:39]

So while you and your friends may love the story of simplicity and the narrative that has been told about it, the beatings will continue until morale improves. Daddy is home. The hard cold math of it tells us that it is not the be all and end all of principles in investing or in portfolio construction. Thank you for bringing this to our attention. As I mentioned, I will provide the links so you can all check them out. And thank you for your email. 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. And then slide over to the support page and give some money to the Father McKenna Center. And tell me about that too. Let's do it. Let's do it. If you haven't had a chance to do it, please go to your favorite podcast provider and like, subscribe, give me some stars or review. Follow. That would be great. Okay. Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio signing off.

Mostly Mary [28:23]

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.