Mostly Mary [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 Voices [0:22]

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

Mostly Uncle Frank [0:37]

Thank you, Mary, and welcome to Risk Parity Radio. If you have just stumbled in here, you will find that this podcast is kind of like a dive bar of personal finance and do-it-yourself investing.

Mostly Voices [0:53]

Expect the unexpected.

Mostly Uncle Frank [0:57]

There are basically two kinds of people that like to hang out in this little dive bar.

Mostly Voices [1:00]

You see in this world there's two kinds of people my friend.

Mostly Uncle Frank [1:04]

The smaller group are those who actually think the host is funny regardless of the content of the podcast. Funny how, how am I funny? These include friends and family and a number of people named Abby. Abby someone. Abby who? Abby normal. Abby Normal. The larger group includes a number of highly successful do-it-yourself investors, many of whom have accumulated multimillion dollar portfolios over a period of years. The best, Jerry, the best. And they are here to share information and to gather information to help them continue managing their portfolios as they go forward, particularly as they get to their distribution or decumulation phases of their financial life.

Mostly Voices [2:04]

What we do is if we need that extra push over the cliff, you know what we do? Put it up to 11, exactly.

Mostly Uncle Frank [2:11]

But whomever you are, you are welcome here.

Mostly Voices [2:15]

I have a feeling we're not in Kansas anymore. But now onward, episode 350.

Mostly Uncle Frank [2:24]

Today on Risk Parity Radio, we're just gonna try to get back in the saddle here again.

Mostly Voices [2:31]

I'd like you to meet the new sheriff of Rock Ridge. I'd be delighted. Wow.

Mostly Uncle Frank [2:35]

Since we've been off goofing around, well, not really goofing around, we did have a nice visit from one of my nieces and her family. Three small children. Why, what have children ever done for me?

Mostly Voices [2:50]

And her husband, of course.

Mostly Uncle Frank [2:53]

And we went to some monuments and some caves and some battlefields and some shopping and did a lot of fun things. Yes. But your emails are stacking up and it's probably time that I got back to answering a few of them.

Mostly Voices [3:09]

Looks like you've been missing a lot of work lately. I wouldn't say I've been missing it, Bob. And so without further ado, here I go once again with the email. And?

Mostly Uncle Frank [3:20]

First off, first off, we have an email from Jeffrey.

Mostly Voices [3:28]

Oh, gnarly. And Jeffrey writes, Frank, see the forwarded email below for a donation to the Father McKenna Center. Really top drawer. I have been looking under the hood of the various managed future ETFs. Most of them do trend following for a variety of asset classes, global stocks, global bonds, commodities and currencies. Given the large variety of assets these funds hold, either long or short, what would be the argument against just using a mix of these funds as your entire investment portfolio? Instead of holding assets like long-term treasuries or gold, which can have long periods of underperformance. Putting aside that these funds don't have a lot of history behind them right now, isn't the theory behind them something that could anchor a portfolio? Thanks, Jeffrey. Well, first off, thank you for being a donor to the Father McKenna Center.

Mostly Uncle Frank [4:31]

As most of you know, we do not have any sponsors on this podcast, but we do have a charity we support. It is called the Father McKenna Center and it supports hungry and homeless people in Washington, DC. Full disclosure, I am on the board of the charity and am the current treasurer. And if you give to the charity, you get to go to the front of the email line, as Jeffrey has done here. And our second emailer has also done today, which we'll get to in a little bit. But anyway, there are two ways to do that. You can either Go to the website directly, their donation page, or you can go to our support page at www.riskparriyradio.com and become a patron on Patreon. And either way, you'll get to go to the front of the line, as far as emails are concerned. Please note that in your email when you send it to me so that I can duly move you to the front of the line. But now let's get to your questions. This actually gets at a very interesting topic that is almost unknown to most amateur investors and is often misunderstood by professionals. And the topic is called skew. Surely you can't be serious.

Mostly Mary [5:43]

I am serious. And don't call me Shirley. Now, what is skew?

Mostly Uncle Frank [5:49]

In this context of investments, and funds, skew has a particular statistical meaning. And it's easier to actually describe what skew is measuring than to talk about skew in the abstract. So that's what I'm gonna do. What skew is measuring is how big is the average downturn for an asset in terms of returns versus how big is the average upturn. If an asset were completely balanced, where all of the positive outcomes were the same magnitude as all of the negative outcomes, it would have zero skew. If you can imagine a Gaussian bell curve distribution, it would look more or less like that. But that is actually not how most assets perform in real life. Most of them are skewed either one way or another, and most of the common ones that we talk about, like the stock market, are actually negatively skewed. So if you look at the measurement of skew on a fund profile that contains this statistic, it will be a negative number. And what is that describing? That is describing the fact that when the stock market has a downturn, usually it's very large, relative to the kind of upturns it has. As people say, the stock market goes up an escalator and goes down an elevator, or a cliff in the worst circumstances. And it's that kind of behavior that Skew is measuring. Now, that also clues you in, since the stock market has positive returns overall, What that means is that most of the time the stock market is going up, it's just not going up by leaps and bounds. It's going up a little bit at a time. People often say it climbs a wall of worry and then when there is some kind of downturn or crash it generally happens relatively quickly. So some of its fundamental characteristics are the stock market goes up about 70% of the time if you're looking at annual returns and goes down about 30% of the time. If you look at the average of those down years versus up years, the down years have a higher magnitude. They're larger than the up years are. And that average is out to a geometric return or compounded annual growth rate of somewhere between 10 and 11% in nominal terms. So what does this all have to do with managed futures? What it has to do with managed futures is that managed futures are one of the few assets with positive skew. And so they end up having kind of the opposite characteristics of the stock market. You only see winners in managed futures about 40% of the time, and 60% of the trades are losers. But the winners are much larger in magnitude than the losers. And so that's how it can have a positive return. And that is a product of the trend following or trading systems that Managed Futures Funds use primarily. And so it really does not matter for a Managed Futures Fund, whether it's following stocks or treasury bonds or gold or commodities or interest rates or whatever it is, because this characteristic is a consequence of the kind of trading system that is being employed. This is also why Managed Futures Funds follow so many different things. things. And what they argue about in Managed Futures Trend Following World is, well, how many markets should we be following? Because obviously it's a lot more work to follow a lot more markets, but you have some of the people in that world saying, well, you got to follow as many as possible, at least 100 or something like that. Another one saying, no, you can get the same basic results by following a lot fewer of them. And a fund like DBMF, which we talk about here, follows relatively few markets, as does KMLM. But there are other managed futures funds, including a new one called MFUT, which is from the famous Jerry Parker, if you know who that is in managed futures world. He's one of what they call the original turtle traders from the 1990s, and MEb Faber of Cambria Asset Management have put this fund together. I just heard about it last week. Anyway, that fund is going to follow hundreds of things probably, given what Parker likes to do, which is follow as many things as possible, including lots of individual stocks and things. But now with that long background explanation, let's get to your actual question here, which is why wouldn't you just use managed futures to run your whole portfolio? And the answer does go to this skew issue. In fact, people like Jerry Parker would say, let's just use managed futures for our whole portfolio. But those kind of portfolios have this kind of bizarre characteristic, at least bizarre for the average investor, that they tend to underperform or do poorly most of the time and then have a few years where they just have really outstanding returns. And that's how they make their bread and butter. And as it turns out, very few investors can actually stomach living with positive skew for most of their portfolio. Most investors would prefer to have something that looks more like the stock market overall in their portfolio that has a negative skew or a close to zero skew where you are making money most of the time, even if you have some large drawdowns occasionally. Part of what we are doing when we are constructing these portfolios is trying to get that natural skew of the stock market a bit closer to zero because that is also reflected in the fact that most of these risk parity style portfolios have shallower drawdowns in terms of how much the drawdown is, but they also have shorter drawdowns in terms of how long it lasts. With max drawdown time of only three to five years as opposed to, say, a 60/40 portfolio, which has a max drawdown time of something like 10 to 13 years. And that is actually reflected as the statistic of skew if you look at how skew is applied to overall portfolios, which you can get out of Portfolio Visualizer and other things. But when you have wondered what that metric is measuring and what it's about, that is what it's about. So while you could try to anchor a portfolio with a managed futures, strategy, it may be difficult both psychologically and as a practical management matter. Where this helps a lot though is when you think about diversification and the lack of correlation, one of the reasons that managed futures make such a good diversifier in a mostly stock portfolio is this characteristic that they are diversified in terms of skew So in a year like 2022, you'll see these managed futures funds have these excellent performances of 20 or 30%, whereas in most years they're having single digit performances, whether they're negative or positive. But this skew characteristic is one of the reasons that managed futures are often negatively correlated with typical stock and bond funds, which have that positive skew characteristic. So just getting to the last part of your question now, The problem is not that managed futures funds or this strategy does not have a long history. It has a 50-year or longer history now. And in fact, some people would say that this was what the economist David Ricardo talked about back in the early 19th century. So there is plenty of history to look at, including these people like Jerry Parker that have been doing this since the 1990s. What has made this strategy relatively unattractive for most investors for most of its history have been two things, one being this skew issue and being able to hold such things psychologically as the bulk of your portfolio, and the second being just a cost factor that it was either a lot of work to do it yourself or just cost too much if you were paying some hedge fund to do it, which is why it has not really been a useful investment until very recently now that we have a lot more of these funds at reasonable costs. So the next time you're looking at funds like this, I would be looking at that skew factor and also then see how that correlates or does not correlate with various stock funds. I think you'll find in most cases that something with a larger positive skew has a lower correlation with the stock market just as a general rule of thumb, with the exception of managed futures funds that are primarily trading stocks, which are actually fairly rare. Most of those strategies are used to trade things that are not stocks. Anyway, that was a very interesting topic. I'm glad you brought it up because it's something that we had not talked about before in all of our 350 episodes. So thank you for that suggestion, that opportunity, and thank you for your email.

Mostly Voices [15:33]

Second off.

Mostly Uncle Frank [15:38]

Second off, we have an email from Justin. Alive, it's alive.

Mostly Voices [15:41]

It's alive.

Mostly Uncle Frank [15:47]

And that's Justin of Risk Parity Chronicles.

Mostly Voices [15:55]

And Justin writes, Frank, hey, long time no email. I like to play my Patreon card and bump this to the front of the line if I may. Despite my absence from blogging about all things risk parity, I'm still a loyal listener of course, and wanted to send along some kudos for the Optre portfolio you announced recently. That's a real humdinger of a portfolio and I especially like the way you broke it down to basically a 2-1-1 of equities to fixed income to alts. I've been playing around with that as a basic construction myself. Your explanation of its construction, along with the comments elsewhere, explain why you stay away from leveraged funds with two asset classes in them, such as NTSX, or the return stacked suite of new ETFs. For what it's worth, I find it easy to do if you think of them mentally as two parts：one half that uses those blended funds and then small allocations to a bunch of ETFs that try to pinpoint one specific asset class or strategy. To wit, I wanted to send this along with my write-up of a portfolio I call the Station Wagon Portfolio, which follows the 2-1-1 approach more or less. Actually, 80% equities, 40% fixed income, 40% trend, 5% gold, and 5% tail risk, but uses two return stacked ETFs, RSST and RSSB to get there. The station wagon might fail your simplicity doctrine, mind you, but it works for me. Side note, I wasn't sure if you wanted to get more specific about the portfolio to your audience or not. Feel free to dive into it if you think your listeners would be interested. Also wanted to make sure you saw this new portfolio back tester which goes a bit farther back than Portfolio Visualizer does now, at least if you stick with the free version. Granted, it's not what Portfolio Visualizer once was, but I'm still glad to see this. Hopefully they'll add some functionality and maybe some older data going forward. Anyway, that's all I got. Keep up the good work, Justin. The best, Jerry. The best.

Mostly Uncle Frank [18:08]

Well, if you are going to get out something called a Station Wagon Portfolio, I'm just going to have to get out some National Lampoon's Vacation Clark Griswold references.

Mostly Voices [18:19]

This is the new Wagon Queen Family Truckster. Because there's nothing like the family truckster. Now I owe it to myself to tell you, Mr. Griswold, that if you're thinking of taking the tribe cross country, this is the automobile you should be using. The Wagon Queen Family Truckster. You think you hate it now, but wait'll you drive it. I will link to that portfolio description in the show notes so people can check it out.

Mostly Uncle Frank [18:49]

Without going into too much detail, it has 12 funds in it and it is organized along the lines you described, which is that kind of 2：1：1 ratio of stocks to bonds to alternatives, which is also the macro allocation of that Optima portfolio we talked about in episode 349. Our newest sample portfolio. One ring to rule them all. I think comparing those two portfolios is a good application of the macro allocation principle, which says that the overall returns of any given portfolio are often mostly determined by its macro allocations. How many stocks does it have in it percentage-wise? How many bonds does it have in it percentage-wise? And what are its alternatives? And then of course, whether there's any leverage being applied to it or not. I agree with you that I don't think it's simple enough for me or for most of our listeners, but 12 funds is not ridiculous since we know that most people are walking around with a junk drawer portfolio of 20 or 30 different things in it. But I think it's just an example of how many different ways there are to apply the three principles here：the Holy Grail Principle, the Macro Allocation Principle, and the simplicity principle to arrive at useful portfolios. And if you don't know what those are, you need to go back and listen to the first podcast of this series, which are episodes 1, 3, 5, 7, and 9, and they'll tell you all about those principles. I also still just personally dislike these composite funds, even though I know it's a convenient way to apply leverage where you have more than one kind of asset in a fund with leverage applied to it. I think that's partially why you end up with more funds than you may otherwise want or need, because it's more difficult to combine these composite funds with other things than it is to simply take more of the raw ingredients where every fund just represents kind of one thing or one idea, and you can combine them that way. But that is more of a personal and management preference than anything else. I cannot say that my preference is objectively better than using composite funds. And I've also got your link to this new back tester, which I will link to in the show notes so people can check that out. I have not checked it out myself yet, but the more the merrier in terms of back testers, especially free ones, as far as I'm concerned, because if you have more things to test your portfolio on, and they all come out the same way, then you have a lot more confidence in what you are constructing. So thank you for that reference. Finally, I would be remiss if I did not briefly explain to all of the audiences to who you are, at least the ones that do not know who you are. Justin is a long time listener who created a blog called Risk Parity Chronicles, which you can't go to right now because it's dormant. But hopefully we'll be resurrected in the future because it's a nice companion to this podcast. As I've said many times to people who have asked me for blogs or pages or collections of references, I don't think I'd like another job. Yeah, I'm too lazy to do that. It wouldn't be that much fun for me.

Mostly Voices [22:12]

Well, you haven't got the knack of being idly rich. You say you should do like me, just snooze and dream. Dream and snooze, the pleasures are unlimited.

Mostly Uncle Frank [22:22]

Justin has also made some useful videos under the Risk Parity Chronicles name that are on YouTube. And those are still there, and I would check those out because they involve some descriptions, some techniques, and some other things that people find useful, including doing an asset swap between taxable and non-taxable accounts that I think everybody needs to understand as a basic management technique when you have several different kinds of accounts and are trying to figure out how to get money out of one while maintaining the overall balance of a portfolio. So I will link to that one specifically in the show notes so you can check that out. Justin has been spending a lot more time with his family these days, but hopefully once he ships his teenage child off to college, It'll be able to get back and make us some more content that I'm sure we'll all enjoy.

Mostly Voices [23:22]

Oh, behave. Yeah, yeah, baby. So thank you for checking in.

Mostly Uncle Frank [23:34]

Thank you for your donations to the Father McKenna Center. And thank you for your email.

Mostly Voices [23:38]

Oh, all new cars do that. I'll take care of that in a second. You may think you hate it now, honey, but where do you drive it? Whoa, an airbag. Last off. Last off, we have an email from Matt.

Mostly Uncle Frank [23:57]

What does Matt Damon say on that Bitcoin commercial? Fortune favors the brave.

Mostly Voices [24:05]

And Matt writes, Uncle Frank and Aunt Mary, thanks again for the most excellent podcast. Longtime listener, almost becoming a frequent emailer. I would like your thoughts on the most common personal finance question, whether to invest or pay off debt. The math is superficially simple. If the rate of return exceeds the interest rate, then it's better to invest. If the debt is a credit card at 25% or a mortgage from a few years ago at 3%, it's easy to determine. For interest rates in between, the question is more difficult and may require some sort of crystal ball. I hear rules from good sources like paying down debt if it's above 6% or 8% or some other number, regardless of the current economic and interest rate environment. My understanding is that they are assuming an average nominal return for the stock market of, say, 10% and reducing it to account for risk. However, is that the right assumption to make about the future? Should we instead assume an average real return or an average risk premium going forward? I know that the CAPE ratio is not useful, but are there other metrics which are useful for forecasting? If one assumes an average risk premium for the future, then investing versus paying down the debt would probably involve some comparison of the spread between your interest rate and the current Fed rate. P.S. One of my favorite sound bites is Chris Rock's horoscope reading of youf're Gonna Die. I've been thinking of that with all the doom in your emails about the death of the dollar or US economy. Thanks, Matt. Here's a horoscope for everyone. Aquarius, you're gonna die. Capricorn, you're gonna die. Gemini, you're gonna die twice.

Mostly Uncle Frank [25:49]

Ah, so it's that age-old question of should I pay off my debts or should I invest?

Mostly Voices [25:56]

You keep using the word. I do not think it means what you think it means. And the answer, of course, is not binary.

Mostly Uncle Frank [26:03]

The answer is both. But that doesn't really answer the question because you still have to prioritize what you're doing first. And those simple rules of thumb do actually work pretty well. I mean, if you have high interest debt that is either double digit or in the high single digits, yeah, you probably need to pay that off as a priority. And if your debt is very low, in the less than 5% range, and particularly the 3% or 4% range, then it's not really hurting you much. And you're going to be better off investing there. It's that mid-range stuff that is kind of flip a coin. Because depending on how long it would take the debt off, that's what you're really kind of trying to measure. If I know I can pay this debt off in five years, the volatility of the stock market is still pretty darn high in any given five year period. And there's really no way to know at the beginning of that five year period whether you'd be better off investing the money or paying off the debt for that period. And sometimes you just get lucky. Lucky? This happened to us over 20 years ago when we bought the house we were in and interest rates on mortgages at that time were around what they are right now in the 7% kind of range. So when we bought the house we thought two things. We got a variable rate mortgage which lowered the interest rate but then we had the idea that we were going to pay it off relatively soon within five to seven years to mitigate any risk that interest rates would go up considerably more. Now since this was in 2002 and the next five to seven years included the 2008 crash, this was in fact a very good time to be paying down a mortgage and not investing money in the stock market. Gosh. But we could have not known that in 2002. Mortgage rates were also kind of in that mid-range at that point in time. I mean, in hindsight, what we should have done is pay down that mortgage and then when interest rates fell to almost nothing around 2010, refinance the whole thing. But again, we didn't know that. We didn't know that interest rates were going to stay really low for a decade. Nobody knew that.

Mostly Mary [28:28]

Napoleon, like anyone can even know that.

Mostly Uncle Frank [28:32]

And what I'm trying to say with that example is getting to your overall question, is there any way to time the right choice for these things? The answer is no, there isn't. And really, the reason the answer is no is because you cannot predict what the short-term returns of your investments are going to be, even if you're more or less certain about the status of your debt. Because if you could actually make those kinds of forecasts, you could make a whole lot of money really fast by trading options and futures in various interest rate or credit markets and quickly become one of the wealthiest people in the world, because those markets are very large and very liquid. But since we know people really can't do that, even though they talk about it all day long on financial media, it's better not to be fooling ourselves with these caped crystal balls or interest rate crystal balls or fed crystal balls or whatever kind of crystal ball you have about forecasting interest rates.

Mostly Voices [29:36]

As you can see, I've got several here, a really big one here. Which is huge.

Mostly Uncle Frank [29:42]

Because if it works out, it's not because you had any skill in doing that. It's because you were lucky. Like we were with the paying off the house early. You could ask yourself a question.

Mostly Voices [29:57]

Do I feel lucky?

Mostly Uncle Frank [30:00]

But let me just leave you with what I think is a better overall rule of thumb. for dealing with this, particularly when you're young and you have a bunch of debt and you're wondering what to do with it or what to pay off first and all that sort of stuff. And this is an observation I've made that if you look at statistically the makeup or asset profile of wealthy Americans versus middle class Americans, you see it starkly different and the stark difference is this. Wealthy Americans tend to have only about 10 to 15% of their net worth tied up in their residences or consumption items. And they have most of their money invested in businesses, productive real estate and the stock market or liquid investments. Middle class Americans have the exact opposite profile. In which generally half or more of half of their net worth is actually tied up in their residence. And then they have a lot tied up in consumption items like automobiles and they have relatively little percentage wise in terms of actual investments. Honestly, as stupid as a stupid does. And I think those two things are related and what they are related to if you look at two people starting in their 20s or 30s, If you have one that is diligently investing most of its money and not using most of its money to put into a residence by paying down a low rate mortgage, and then you compare that with somebody who is taking most of their money and paying off their house instead of investing, they have disparate outcomes. And one becomes very wealthy and the other one becomes middle class. And then when it's time to retire, The middle class person is all of a sudden stuck with this illiquid asset that they need to get their money out of. Are you stupid or something? Whereas the person with liquid invested assets just needs to reorganize them and then is good to go essentially. So if you want some rules of thumb there, since you know what the goal is to have most of your assets invested in liquid assets or businesses or productive real estate, a good rule of thumb is a four to one rule. Now, first pay off that high interest debt. If you have credit card debt, yes, pay that off. I'm talking about when you get down to large fixed rate, low interest things like your mortgage that are left or if you have low interest student loans or something like that. When you get to that, A good rule of thumb is to take 80% of the money that you can either invest or pay off debt with and put that towards investments. And then take the other 20% or less and use that as extra debt payment to pay the debt down. And if you do it that way, you are much more likely to end up like the wealthy American than the middle class American when you get to age 60. This of course may be very different for people who do not live in the United States because they do not generally have access to 30 year fixed rate mortgages. So your calculus is going to be different if you're not in the US. And so this does satisfy one of my favorite maxims, probably one of the few that I've ever invented myself, which is when you are faced with two good opportunities and you don't know which one is going to be better in the future, the answer is to try to do some of both. So the answer is not do all A or do all B, but simply do both and then come up with a reasonable method or basis for the actual allocation of doing both, as I have just described in this case. Anyway, that's just a bit of Uncle Frank's hoary wisdom.

Mostly Voices [34:02]

You are talking about the nonsensical ravings of a lunatic mind. And hopefully it was useful.

Mostly Uncle Frank [34:11]

Forget about it. Hopefully it helps, and thank you for your email.

Mostly Voices [34:18]

My dad said he listened to Matt Damon and lost all his money. Yes, everyone did, but they were brave in doing so. But now I see our signal is beginning to fade.

Mostly Uncle Frank [34:26]

Sorry the releases have been a little sporadic recently. But I think we'll be back more on the two a week releases going forward, at least for the next month or two. And we will get to all your emails eventually. They are still stacked up from May, I'm afraid. It's not that I'm lazy. It's that I just don't care. But if you do have comments or questions, 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 follow or a review. That would be great. Mmmkay? Thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio. Signing off.

Mostly Voices [36:00]

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.