Mostly Voices [0:00]

A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines. If a man does not keep pace with his companions, perhaps it is because he hears a different drummer. A different drummer.

Mostly Mary [0:19]

And now, coming to you from dead center on your dial, welcome to Risk Parity Radio, where we explore alternatives and asset allocations for the do-it-yourself investor. Broadcasting to you now from the comfort of his easy chair, here is your host, Frank Vasquez.

Mostly Uncle Frank [0:37]

Thank you, Mary, and welcome to episode 34 of Risk Parity Radio. Today on Risk Parity Radio, we are going to reach into the mailbag for a couple of interesting questions, and then we'll have our weekly portfolio review. which is nice and quiet this week. But let's go into that mailbag and take a look at these questions. The first one comes from Alan T. And he asks, what is the perpetual withdrawal rate that you are referring to? Now the perpetual withdrawal rate is interesting. It is related to the safe withdrawal rate but is not the same. The perpetual withdrawal rate is defined as the percentage of portfolio balance that can be withdrawn at the end of each year while retaining the inflation adjusted portfolio balance. Now that differs from the safe withdrawal rate. The safe withdrawal rate is the percentage of the original portfolio balance that can be withdrawn at the end of each year with the inflation adjustment without the portfolio running out of money. So you can see the difference here is a safe withdrawal rate is talking about you just not running out of money at the end of whatever period that you have. So a safe withdrawal rate is usually on a period of 30 years is the typical period that is used. Now a perpetual withdrawal rate, the idea behind that is not that you will run out of money with it, it shall have the same amount of money as you started with, with an inflation adjustment. So the perpetual withdrawal rate is really the gold standard as far as a portfolio is concerned because the idea is whatever you started with, you are going to still end up with that amount. So as you can imagine, the perpetual withdrawal rate is always less than the safe withdrawal rate for any given period, but it gives you kind of a channel to work with that you know that if you go down to the perpetual withdrawal rate, you'll still have that money left over for your heirs or whatever, but you really have more flexibility in that in that you can go up to that safe withdrawal rate for the 30-year period. And the definitions I read to you are from the portfolio Visualizer website. Those are two of the metrics they use whenever you put a portfolio in there for analysis. It will spit out a safe withdrawal rate and a perpetual withdrawal rate in connection with those definitions. Now of course it is limited to the data set that you have so that if you're talking about a 10 or 15 or 20 year time series of data that's really not enough to come up with a definitive safe withdrawal rate or perpetual withdrawal rate. But as the Portfolio Visualizer site also references, these are best used as a comparison between two portfolios so you can see which one has the better safe withdrawal rate or perpetual withdrawal rate for a given period. If you do want to use these on a not a relative basis, but an absolute basis, you probably need to be going out to about that 50 years of data, which you will find on the Portfolio Charts site. And with some of the analyses you can do at Portfolio Visualizer, but you really want that much data to be looking at those numbers from a definitive perspective. And so looking at some of our sample portfolios, at least the ones where we have all of the data going back to 1974, if we look at the All Seasons portfolio, which is our most conservative portfolio that has a safe withdrawal rate since 1970 of 5. 6% in a permanent withdrawal rate or perpetual withdrawal rate, excuse me, of 3.8%. The Golden Butterfly has a safe withdrawal rate of 6.4% and a perpetual withdrawal rate of 5.3%. And then the Golden Ratio portfolio using that same data has a safe withdrawal rate of 6.0% and a perpetual withdrawal rate of 5.0%. What you should notice about those is that they do exceed the standard safe withdrawal rate of 4.0% for the 4% rule. And that is really the point of holding these kinds of portfolios is to get a higher projected safe withdrawal rate and perpetual withdrawal rate than you can out of a standard 60/40 style portfolio so that you can be more confident in your withdrawals and distributions from your portfolio, or you can actually take more money out and be a little bit more confident that that money is going to last either for your 30 years or forever and leave some of it to your heirs. Now the next question comes from Tommy V. And Tommy V asks for my thoughts on comments from Larry Swedroe in a recent interview of him by Morningstar. It's called the Long View is Their Podcast. And I will link to this interview in the show notes because Larry Swedroe is always worth listening to when it comes to portfolio construction for risk retirement style portfolios. And I will just read you this quote from the podcast and then we can talk about it. It says, Larry Swedroe said, Correlations tend to be regime dependent. So for example, often you'll hear the argument high yield diversifies. The problem is diversification always works in the wrong way for high yield. So let's say the average correlation is 0. 2, that's a positive 0.2. It becomes 1 in bad times when you need to go negative, so that doesn't help. Where with high quality bonds, the average correlation is around 0 and it becomes highly negative when we need it the most. So what Tommy V is asking about is what does that mean and does that imply that we can make adjustments based on the idea that the correlation coefficients are changing over time. So what Larry Swedroe is saying here, well first he's talking about two different kinds of bonds in this discussion. And if you go back to our bond episodes or bond analysis episodes, you'll also see this and you'll also see it in the correlation matrix. He's comparing high yield, which are corporate bonds with what he calls high quality bonds, and those are treasury bonds that he's referring to here really. And what he's saying is that these high yield bonds, these corporate bonds, and corporate bonds generally have a positive correlation with stocks. And they exhibit an even more positive correlation with stocks when stocks are declining or crashing. So that ordinarily the average correlation looks like about a plus 0.2, but it gets much and much closer to 1. What he's saying is therefore those kinds of bonds really aren't helping you diversify because they fail to diversify when you need them the most when the stock market is crashing. Whereas what he says about these high quality bonds or these treasury bonds that we would recommend is that they tend to have a correlation that's slightly negative or around zero. but that goes even more negative when the stock market crashes. And so what is happening there is your treasury bonds are increasing in value when the stock market is crashing, which is exactly what you want for diversification. It's the purpose of having a diversified portfolio and putting these kinds of bonds in a portfolio. And so the critique here and what he is saying throughout this part of this podcast is that you really need to look closely at what you are putting in your portfolio and whether it is truly diversified from your stock allocation, which is assumed to be your main allocation in the portfolio. And that if you don't pick the right bonds, they're not going to really help you out when you need them most. And that is why we tend to avoid most of the corporate bonds in our risk parity style portfolios and really focus on those long term and intermediate term treasuries because they offer that kind of diversification when you need it most. And then the other aspect of what Tommy V is asking here is, shouldn't we focus on those times when those correlations are needed the most in these bad periods for the stock market. Because wouldn't that really give us the outer bounds of what diversification is doing for us? And I think he's correct that we would like to be able to focus on that. Unfortunately, the data does not make this very easy to do. Correlations do change over time. But they don't change very quickly and they don't change in a necessarily predictable manner so that you will find periods when you'll see positive correlations between Treasuries and stocks. You'll usually not find that many of them. And it is true that when those stocks are declining, the Treasuries are usually performing the best. As we saw in March when they were up 20% on the year when the stock market was down 30 or 40% and it really made a big difference in a risk parity style portfolio then. So this is one of those places where I would say it would be great if we could zoom in and focus on correlations with that granular detail. But realistically, I don't think we're able to do that and we don't want to overuse or overfit data. because that would lead us to basically being able to predict the past very well but not be able to predict the future very well. The more that you take your past data as gospel about the future and look at it in a granular way, the more variance you're going to have as to whether that approach is going to be predictive of the future. So in this case, from a predictive point of view, it is probably better just to use the entire data set and look at that sort of average correlation between two asset classes for whatever amount of data you have, because that will give you sort of the best device for having a decent prediction on what's going to happen in the future. If you only look at one little slice of that data, you are likely to be misled as to whether that will actually occur or not. We can't say that this observation that Schweddy made holds true in every environment where stocks are declining. And if you look back to the 1970s, for example, you would say that it really was only partially true at that point in time. And that gets you to the other point is that you probably need something in your portfolio besides stocks and bonds, which is going to be your gold or commodities or some other thing that is going to perform well in those very disturbing environments that you found in periods like the 1970s. Now in addition to this very astute observation from Larry Swedroe in this podcast, there were a couple of other things he said that are really worth focusing on and I'm when I link to this I will link to where it starts this conversation at about halfway through it about the 30-minute mark of the conversation, although what we've been talking about is about the 37-minute mark and those two other things were one that He's really moving their focus and the way they do things toward a more risk parity style of portfolio construction and getting away from that old 60/40 idea simply because you really need you have the tools now to diversify your portfolios better using the risk parity ideas and that that old 60/40 really doesn't cut it anymore. And I see this as part of an evolution that I think that we will get there and it may take 10 years before the idea of risk parity becomes the dominant idea. Right now the dominant idea is still just to have this kind of 60/40 stock bond mix and that comes from the best we could do in the 1970s and the 1980s. But we can do better now. We know more now. We have more tools at our disposal. We have more ETFs we can easily choose from. And so there's no reason to be stuck in the past with that. And I think Larry Swedroe has recognized that and he does reference going to a risk parity style portfolio. I mean, he's talking in that conversation about different types of assets that you would want to put in here, ones you would want to avoid. The other thing that he raises that I think is very important is that one of the biggest mistakes his clients continue to make is to decide what funds to invest in based on 1, 3, 5 or 10 year time frames. performance within those time frames in the recent past. As he says quite clearly in this podcast, that 10-year time frame is still just statistically noise in terms of whether you can rely on that to predict the future. So to the extent you are looking at those easily found metrics that unfortunately they always push forward when you look up any fund it says 1-3-5 and 10. Those really are not something you can hang your hat on and you should be hanging your hat on. What you should be doing is looking at the longest time frame you can and then figuring out how that asset class fits in your portfolio with your other asset classes. And he laments that, you know, they lose some clients, you know, every year because they look back and see, well, you didn't perform as well in the past three years as this fund my buddy's using. And he's saying there's not a whole lot he can do about that except just try to educate people because this is a place where There is a lot of financial mis-wisdom out there as to how to use these metrics and how to construct a portfolio and that those metrics really are not that reliable and so are not, should not be the basis for choosing a particular fund. And with that now let's turn to our Portfolio reviews of the six sample portfolios you can find at the website www.riskparityradio.com on the portfolios page. And it was a relatively quiet week here, just going through what the overall markets were doing and you'll see how this plays into the sample portfolios. The S&P was down 0.77% last week, the NASDAQ was up 0.22% last week, so not much movement there. Gold was down 0. 99% last week. The best performer last week was in fact the long-term treasury bonds represented by TLT and those were up 2.1% last week. A REITs represented by our Global REIT Fund, R E E T, were flat last week. Now how did this translate into the risk parity style portfolios on our sample page there? Well we see the All Seasons portfolio, which has a lot of bonds in it, was up 0.9% for the week and that portfolio is up 2.5% since inception I realize looking at the printouts from Fidelity that they do not accurately reflect the numbers since inception. So I've now included those separately on the descriptions on the website there and are giving you the correct numbers that are not adjusted for transactions like the Fidelity numbers on the printouts do. So anyway, so you can see that that Portfolio is, as we've always said, perhaps a little bit too conservative with not enough stocks in it. It only has 30% stocks in it, but it is holding its own since July. It's up 2.5%. It needs to have 4% annually to deal with its distribution rate. We're only taking out 4% on that one. Now going to the next portfolio, the golden butterfly portfolio. This one is the one with the 20% total stock market, 20% small cap value, 20% long-term treasuries, 20% short-term treasuries, and 20% gold. This one was up 1.0% last week, and most of these portfolios were up a little bit, and that is how you really want to see these performing. It is up 8.4% since inception in July. Now that compares to a total stock market portfolio would have been up about 10. 8%, but this portfolio has only 40% stocks. So you can see that the risk reward of a portfolio like this is much better than a total stock market portfolio because you're getting 80% of the performance with only 40 or 50% of the risk profile of that. And that's really the point of these portfolios as well illustrated here, that you're not sacrificing a whole lot of return, but you are getting a whole lot less volatility, which allows you to take out larger distributions if you'd like. And we are taking out distributions from this at the rate of 5% annually. Now the next one is the Golden Ratio Portfolio. This is the one that is 42% stocks divided into three categories. Long term, I'm sorry, large cap growth. small cap value and a minimum volatility fund that tracks the S&P 500. So that's 42% of the portfolio, then there's 26% of the portfolio in long-term treasury bonds represented by TLT, 16% in gold represented by GLDM, and 10% in REITs represented by R E E T. and then there's 6% in cash where the drawdowns are coming out of. And this one was up 0.7% last week and it is up 7.8% since inception in July. So it is also performing nicely given its risk reward characteristics. And especially since it's got that 6% cash just sitting there taking care of the distributions. Now the next portfolio is the Risk Parity Ultimate Portfolio. I won't go through all 12 of these funds, but it is essentially 40% stocks, 25% long-term treasury bonds, 10% gold, 10% in REITs, 12. 5% in a preferred shares stock fund and then 2.5% in a volatility fund. And it was up 0.8% last week and has been up 7.2% since inception in July. And we are pulling out of this fund at a higher rate than the previous two. We're going out at a 6% annualized rate and it's having no trouble keeping up with that. so far. And then we're getting to our two experimental portfolios, which have the leveraged funds in them. The first one being the Accelerated Permanent Portfolio, and that one has 25% in UPRO Leveraged Stock Fund, 27.5% in TMF, a leveraged bond fund, and 25% in PFF, the preferred shares stock fund that pays the monthly dividends, and we have 22. 5% in gold represented by the fund GLDM, and this one was up 0.7% last week and is up 8.3% since inception in July. And then finally we go to the aggressive 50/50. Now this Fund was actually rebalanced this past week. It hit a rebalancing band. And so we rebalanced it on Monday to get it back to its starting allocation. And so it now again has 33% in UPRO this leveraged stock fund, 33% in this leveraged long-term treasury fund, 17% in PFF, the Preferred Shares Fund, and 17% in the Vanguard Intermediate Term Treasury Fund. And this rebalancing was at a good time for it, so it went up 1.6% for the week. It is up 9.5% since inception in July. If you looked at these six portfolios and eventually we'll be putting more of this information up on the website. You can also check out their volatility characteristics. All of these portfolios have essentially been above water for almost all of the days since they have been in use since July. There's only been, I think, one or two ending weeks where we saw them dip below the original $10,000 that was in each one of them. And so that gives you, that goes along with that perpetual withdrawal rate idea that what you really want to be seeing out of your portfolios from a perpetual withdrawal rate is that they seldom, if ever, go below where they started and if they do they don't stay down there very long, which is what we're seeing with these portfolios. But I see now that our signal is beginning to fade. It was nice to get some mail in the mailbag to answer today. If you've got questions or comments, you can send them to me at my email. That's frank@riskparityradio.com, frank@riskparityradio. com, or you can go to the website and fill out the contact form like Alan T did this week. and that is right there at www.riskparadioradio.com. Thank you for tuning in. This is Frank Vasquez with Risk Parity Radio, signing off.

Mostly Mary [27:09]

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.