Not Uncle Frank [0:01]

A foolish consistency, is the hobgoblin of little minds, adored by little statesmen and philosophers and divines.

Mostly Uncle Frank [0:10]

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 Risk Parity Radio. 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.

Not Uncle Frank [0:50]

Yeah, baby, yeah.

Mostly Uncle Frank [0:52]

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. Whoa, and you probably should check those out too, because we have the finest podcast audience available.

Mostly Mary [1:26]

Top drawer, really top drawer.

Mostly Uncle Frank [1:31]

Along with a host named after a hot dog.

Not Uncle Frank [1:34]

Lighten up Francis.

Mostly Uncle Frank [1:37]

But now onward to episode 362. Today, on Rescueri Radio, we're just going to do what we do best here, which is attend to your emails, and so, without further ado, here I go once again with the email. And First off. First off, we have an email from Robert.

Not Uncle Frank [1:59]

You're never home. You talk to your trucks more than you do me.

Mostly Mary [2:17]

You never even touch me anymore, bob. I just can't do this. And Robert writes McKenna Center as part of the Financial Quarterback Match Campaign. Much of my early professional background involved working with people experiencing homelessness and I'm glad you are using this outlet to support the McKenna Center's work. My wife and I are in the accumulation phase and we're interested in your perspective on how to approach our family's portfolio. For the last seven years we've utilized a BogleHeads three-fund index approach, with approximately 60% in US S&P or total market funds, 25% in total international funds ex-US and 15% in a total bond fund. In the last month I started purchasing VIOV in our Roth IRAs to gain additional small-cap exposure, but it's a negligible percentage of our portfolio for now.

Mostly Mary [3:07]

We're between 10 and 15 years from retirement and after listening to your podcast I realized that we don't need to have a bond fund during the accumulation phase. My current plan is to wait until the stock market goes down at least 15 to 20 percent, then shift the money invested in bonds to an S&P fund, which is the best option in my 401k account where the bonds are held. I would make this move now, but I'd rather not buy so close to all-time highs. I'm also considering putting 80 percent of our future investments towards US funds and 20 percent towards international to keep some non-US exposure, but perhaps this isn't needed.

Mostly Mary [3:50]

As I understand your perspective, broad large-cap international funds do not truly diversify a stock portfolio due to their strong correlation with the US stock market. Could you explain this a little further? I know there are countless arguments around whether to hold international funds in a portfolio and I'm trying to decide whether to maintain our exposure. So my question essentially boils down to this how would you advise us, having recently learned that the total bond and international index funds we hold in our portfolio may not be optimal? Thanks for your time and perspective, robert.

Mostly Uncle Frank [4:21]

Yes, we can Well. First off, thank you for your donation to the Father McKenna Center. As most of you know, we do not have any sponsors on this podcast, but we do have a charity that we support. It is the Father McKenna Center and it serves hungry and homeless people in Washington DC. Full disclosure. I am on the board and am the current treasurer. I do want to thank everyone who has participated in the financial quarterback matching drive. I still have not gotten the final numbers as to exactly how much we collected on that, but I'll let you know when I do. And because you are a donor to the Father McKenna Center, you got to go to the front of the line, because that's what I really have to offer you here.

Not Uncle Frank [5:08]

That and a nickel will get your hot cup a jack squat.

Mostly Uncle Frank [5:14]

Which is not a bad deal, because we're about two months behind on the emails right now. But getting to your email first, let's talk about these total international funds and why they are kind of suboptimal for diversification purposes, at least when your main holding is a US S&P 500 or a total market fund. So first, I still think a lot of people have this erroneous belief that a total international stock market fund and a total US stock market fund are significantly diversified and we need to actually look at some data so we can show you that that's not true, because people tell stories about this instead of actually looking at the data. And the best way to illustrate this is to go to Morningstar and to put in your funds each one of these things and then to go to the portfolio tab, if you will, and look at where they fall in what they call the style boxes, in terms of whether they're large or small cap and whether they are value or growth based, and what you'll see there is that a total international stock market fund like VXUS is a large cap blend fund, and then you'll also see that a S&P 500 or total US stock market fund is also pretty close to being a large cap blend fund. It leans towards growth and kind of sits on the line between blend and growth.

Mostly Uncle Frank [6:47]

So you're talking about two funds that occupy the same area of that chart, which means they're really not well diversified. And you can also look at the correlation numbers on those things and find that they're not very well diversified either. That's another way to look at it, but I think this illustration, using the style boxes, shows you why. And then if you look under the hoods of these funds, what you see is that most of the large holdings in these funds are large multinational companies that do business all over the world, like Toyota or Taiwan Semiconductor or Amazon or NVIDIA, and that really the only difference between the total US fund and the total international fund is the sector makeup, that all of the big tech companies happen to be US companies, except for a couple like Taiwan Semiconductor. And if you normalized for that, these funds would look very similar, with lots of companies like Ford and Toyota and Unilever and Procter Gamble and banks lots of big banks. So you're really not getting much diversification in terms of what kinds of businesses are in these two funds.

Mostly Uncle Frank [8:02]

So what is the kind of diversification you're actually getting most of when you buy a total international fund. What it is mostly is currency diversification, and so if you know that the US dollar is increasing in value against foreign currencies or decreasing in value against foreign currencies, you know for certain whether international stocks are outperforming or underperforming domestic stocks, and if you were to normalize for that, you would see that these funds are almost exactly the same. So all you're really getting is this kind of currency speculation when you're just buying a total international fund to go with your total US fund, and maybe that's fine, maybe that's what you want, but the better way to speculate on currencies in a portfolio is actually to buy some gold or something like that, or managed futures. Using your stock allocation to be speculating on currencies is not really a good use of your stock allocation in a diversified portfolio. Forget about it, and I'd have to say this is one of the biggest foolish consistencies that we deal with in DIY investing.

Mostly Uncle Frank [9:15]

These kinds of portfolios were devised almost 20 years ago now, when the available funds were few, at least ones that were low cost and index based, and so this was probably the best you could do in, say, 2008 or 2009 in terms of constructing a diversified portfolio, but time did not sit still. Financial markets did not sit still. Diy investing did not sit still. And if you still think that is the best practice, you're wrong. It's two decades out of date and so just because somebody said this nearly 20 years ago as a model portfolio and a great idea doesn't mean it's the best thing anymore.

Mostly Uncle Frank [9:58]

It's like a BlackBerry or a fax machine. It's not as bad as a fax machine, but it's more like a BlackBerry or a fax machine. It's not as bad as a fax machine, but it's more like a BlackBerry. It's an obsolete portfolio construction because we can do a lot better. Today. We have a lot more funds and we're going to talk about them here in a minute. But it is kind of funny the reactions you get when you confront people with this information, some of which I just described to you. Instead of taking in the new information and modifying what they believe based on new information, they frequently reject it out of hand because it causes cognitive dissonance. It causes them to say I don't want to admit that what I have been doing is suboptimal, and so what they will reach for is either shibboleths like well, past performance is not indicative of future results, which is a neutral truism that doesn't mean anything, because it applies to everything.

Not Uncle Frank [10:55]

That is the straight stuff. Oh funk master.

Mostly Uncle Frank [10:58]

Or well, so-and-so, my idol or my club that I belong to or affiliate with and identify myself with as a part of self identity, you bogleheads. This is what we do there and this is all we can do there, because we'd be out of the club if we did something different. So we need to rely on this fallacy of an appeal to an authority that is obsolete and out of date. Anyway, fortunately, remedying this thing is not very hard if you want to hold international stocks, because we've got all this great work from the Merriman Foundation in particular, who have sifted through all of the available funds for factor diversification, both domestic and international, and they published a best-in-class list of ETFs that you can look at. I'll link to in the show notes To make it really easy to pick better funds than the total international fund to diversify a portfolio that is largely international, us total market or S&P 500.

Mostly Uncle Frank [12:06]

And what makes the most sense there is because the S&P 500 and US total market is in that large cap blend to growth area.

Mostly Uncle Frank [12:17]

What you really want to have out of your international stocks is a value-based tilt and a smaller cap tilt, and so there's a great fund out there called AVDV that they've reviewed and recommend. That makes a whole lot of sense in this context. It is small cap value in international developed markets, and there are also a couple of other ones, one that is AVES, which is value generally in emerging markets, and that is also an option, and so both of those are going to have similar performances to a total international fund but be more diversified from the US total market or the S&P 500, and therefore just a better thing to put in a portfolio with that, because these kind of funds weren't around 20 years ago and I understand why people couldn't have used them before, but now that we're in the 2020s and we have all these better funds available, there's no reason not to use them, other than wanting to be foolishly consistent or be in the club.

Not Uncle Frank [13:25]

Please accept my resignation. I don't want to belong to any club that will accept me as a member.

Mostly Uncle Frank [13:31]

So if you want to maintain your international allocation but do it better, the easiest way is simply to swap out the international fund you have now and use some of these ETFs that are recommended by the Merriman Foundation, including AVDV and AVES, and that can also be part of your value-tilted allocation, because, ultimately, what you want to have in this portfolio is half of it be tilted towards growth, like this total market fund is, and half of it be tilted towards value, and some of that being small, because those kinds of portfolios have the best kind of diversification properties. Now, I'm actually very agnostic as to whether you have international exposure in your stock holdings or not. I have a little bit of it in our personal portfolios. I haven't found that it's made a whole lot of difference, and I do consider it largely a crapshoot as to whether the US dollar is going to be strong or weak, and that is going to determine most of the difference in performance anyway. So you should just do whatever you're comfortable with there, all right.

Mostly Uncle Frank [14:45]

Now let's talk about this bond fund. Now you only have 15% allocated to the total bond fund, and so having an 85-15 portfolio is a growth portfolio, and a lot of people hold those kind of things while they're accumulating, although you're correct, it's not optimal for accumulation. But honestly, whether a portfolio is 90-10 or 100-0 is almost a coin flip as to which one's going to do better in, say, a given decade. But if you're going to transition it, I probably would not try to market time it, although you could. What usually makes the most sense and feels the best psychologically is to simply schedule this and kind of dollar cost average it over a period of time so you don't have to worry about monitoring the market and just say, well, I'm going to move 2% every month or 3% every month for a period and that'll get you to where you're going in kind of the psychologically most comfortable manner, because I realize it's not very psychologically comfortable to just take that and move it right now when everything's at an all-time high.

Mostly Uncle Frank [15:53]

Now one thing that's not clear to me is whether you hold those bonds in a taxable account or a retirement account. They really do belong in a retirement account because they generate ordinary income and you don't want them in a taxable account because of the taxes. If you do decide to keep some bonds, for whatever reason, and are looking for maximum diversification from your stocks, I would look at the nice Vanguard treasury bond ETFs now, the little suite of them. They have that those work very well as the bond allocation in a portfolio, and those are VGSH for the shorter one, vgit for the intermediate one, which would be the most similar to BND, and then VGLT for the long-term one. And I realize you probably don't need any of those now, but I thought I would just mention it, so you had it there.

Not Uncle Frank [16:46]

Yes.

Mostly Uncle Frank [16:48]

And hopefully that all helps and thank you for your email.

Mostly Mary [16:52]

Frank. I'd like to thank Robert for his paragraphs. They're very nice.

Mostly Uncle Frank [16:57]

Mary, Mary, I need your huggin' Second off, Second off, we have an email from Jamie. Oh my gosh, oh my gosh.

Mostly Mary [17:21]

And Jamie writes Frank, I was perusing the DBMF summary prospectus sent to me recently. It says effective April 29, 2024, the IMGP DBI Managed Futures Strategy ETF's primary benchmark changed from the SGCTA index to the Bloomberg US Aggregate Bond Index. The SGCTA index is now the fund's secondary benchmark. Huh, why would a managed futures fund use a bond index as a benchmark?

Mostly Uncle Frank [17:55]

Thanks, jamie.

Mostly Uncle Frank [18:04]

Well, jamie, the answer is I have no earthly idea as to why they picked those particular indexes and those particular orders, why they picked those particular indexes and those particular orders.

Mostly Uncle Frank [18:13]

I will tell you that these kind of forms, because they are filed with the SEC, are fly-specked endlessly by corporate lawyers, and so what is in them generally has everything to do with what the lawyers think is the right thing to report, because these kind of disclosures are something that a fund manager can get sued over if there's anything inaccurate or inappropriate in them. Personally, I've never relied on any benchmarks and any prospecti or prospectuses, simply because they often are not that accurate in my experience. And so the better way to approach this, at least with most funds I'm not sure you can do it with a managed futures fund, but for stock and bond funds, you go to, like Morningstar, look at the portfolio construction and see sort of where does it fall in terms of sectors, in terms of factors, and then you can compare it with something that's appropriate in the same factor or sector makeup. So I guess what I'm saying is don't worry yourself over it, because I don't think it really matters for any practical purpose in the end.

Not Uncle Frank [19:18]

Forget about it.

Mostly Uncle Frank [19:21]

What you're really going to be ultimately, comparing a fund like DBMF to or other funds in the same category like KMLM or MFUT or CTA and a lot of those are relatively new, but that's what I would be looking at. You certainly would not use DBMF as a substitute for a bond fund under any circumstances, because it's not a bond fund. Sorry, I couldn't be of more help on that, but thank you for your email Last off. Last off, we have an email from Richard, dr Richard, in fact.

Not Uncle Frank [20:07]

Yes, oh, richard, I'm so happy, hold me.

Mostly Uncle Frank [20:13]

And Dr Richard writes.

Mostly Mary [20:16]

Loved. Your Trogdor recording Brought back great memories. It's still how I draw a dragon.

Not Uncle Frank [20:22]

To begin, draw an S for snake or dragon or whatever. Next we'll draw a more different S for the head. Put a top mark on a long V, then you add some legs. Draw on a couple of arms Whoa, wait a minute. I think I need to start over. This thing doesn't look natural.

Mostly Mary [20:51]

So I've been running through your podcast and I think I'm in an unusual situation. I'm looking at retiring or taking a bit to reset from a high-stress, high-income job and I'm moving to the southern coast of Spain at 39. Geological arbitrage for the win.

Not Uncle Frank [21:07]

Yeah, baby, yeah. Geological arbitrage for the win. Yeah, baby, yeah.

Mostly Mary [21:10]

While I can always go back to work if I want to, I'd hate to leave my current job and have to go back to work because of money issues, as my current situation took decades to build up. I've always been nearly all stocks but have shifted into a risk parity portfolio. I personally don't love the idea of leverage but still need to be a bit more aggressive since I have a longer timeline, potentially 60 years. I did some portfolio optimization through Portfolio Visualizer. However, some friends have said I'm just curve fitting what's worked best for the last 50 years.

Mostly Mary [21:44]

The portfolio I put together, I think, carries a lot of your basic principles 70% stocks, 35% large cap growth, 35% small cap value, 20% long-term treasuries, 10% gold. This spits out a 5.7% safe withdrawal rate and a 4.95% permanent withdrawal rate. On Monte Carlo simulations, I actually couldn't find a five-year period since the 70s where it went down with a 5% withdrawal. It seems aggressive. Slash safe with the principles you discussed of very non-correlated assets 40 to 70% stocks, higher end as need, bigger returns, but getting a bit nervous as practice sale and final deadline approaches that I'm missing something important. Bit nervous as practice sale and final deadline approaches that I'm missing something important. What do you think of this portfolio and would you change anything?

Not Uncle Frank [22:39]

Thanks, again for what you do and feel free to visit me in Malaga Lease starts in October.

Mostly Uncle Frank [22:46]

Groovy baby.

Not Uncle Frank [22:46]

Well, if you're going to mention Trogdor again, you're really going to get into a can of worms here. Okay, starting again the same way, s more different S Close it up real good at the top for his head and then, using consummate Vs, give him teeth, spinities and angry eyebrows, and you can add smoke or fire or maybe some wings. You know, if he's a wingling dragon, let's put one of those beefy arms back on him for good measure. That looks really good Coming out of the back of his neck there. Now he needs a name. How about Togdor the Burninator? Oh yeah, check out all his majesty.

Mostly Uncle Frank [23:30]

Those little cartoons were some of our kids' favorite things to look at and repeat over and over again when they were growing up, and it's one of the reasons they're featured on this podcast. So there's lots of family nostalgia involved there.

Mostly Mary [23:47]

That's not an improvement. Congratulations on moving to Spain. Family nostalgia involved there.

Mostly Uncle Frank [23:49]

That's not an improvement. Congratulations on moving to Spain. That's where Mary and I had our honeymoon Over 30 years ago, in fact.

Not Uncle Frank [23:58]

Marriage, marriage, marriage is what brings us together today.

Mostly Uncle Frank [24:06]

It was a lot less popular then than it is today. But now let's tend to your questions here. So you have a portfolio that is 35% large cap growth, 35% small cap value, 20% long-term treasuries and 10% gold, and that is a good portfolio that should yield about a 5% safe withdrawal rate over the past 100 years or so. What I would do, in addition to what you've done already, is download the toolbox from early retirement now, because when I've run portfolios like this in there I have got safe withdrawal rates of about 5%. It is a little bit difficult to use, in particular putting in the large cap growth small cap value variations, because it's not intuitive the way that works, but hopefully you can figure it out with the instructions. Now it is on the more aggressive end of portfolios in terms of the stock allocation. That 70% is usually the upper limit for good safe withdrawal rates. That 70% is usually the upper limit for good safe withdrawal rates because they tend to deteriorate when you go higher than that due to the volatility of the stocks. So I would not expect this thing to perform much differently than something that would say 60% stocks. It will have higher returns in good years, but it will be more volatile in bad years, but it will be more volatile in bad years.

Mostly Uncle Frank [25:32]

Bill Bangan thinks that the optimal amount of stocks for a highest safe withdrawal rate are somewhere between 50 and 60 percent, but other people have disagreed and the range seems to be between 40 and 70 percent.

Mostly Uncle Frank [25:42]

I think the most important part about that stock allocation, though, is your division into growth and value, because that really gives you an extra form of diversification that would not be there if you were using simply an S&P 500 fund, for example.

Mostly Uncle Frank [25:58]

If you want an illustration of that, you can compare what value funds like a small cap value fund and a large cap growth fund did in 2022, because that is a very good example of how diversified these factor allocations can be, and you do want to be able to rebalance those over time against each other. Now, I'm assuming you're also using variable kind of withdrawal strategies in terms of the money coming out, and those can include using guardrails, for example, where you would not take out as much when the portfolio was performing particularly badly and then would take out more later, and I would think that your personal rate of inflation would be less than that of the CPI, which is what this is based on, and both of those withdrawal strategies will give you between 0.5 to 1.2 extra percent on your safe withdrawal rate, which essentially acts as a buffer. I do have to laugh at what your friends say. I'm wondering if any of them are named Sonia.

Mostly Mary [27:06]

My name's Sonia. I'm going to be showing you the crystal ball and how to use it, or how I use it because this is actually not curve fitting.

Mostly Uncle Frank [27:16]

When you're using that lengthy amount of data and you're only using some broad asset classes. It would be curve fitting if you had 10 different funds or things like that that were very idiosyncratic, because the more different kinds of things you stick into a portfolio, the more you're going to have a problem with curve fitting. You don't have a problem with curve fitting when you only have a few things in the portfolio and you have a very long series of data, particularly when the asset classes are as broad as the ones you're talking about. So in other words, your friends don't understand how that part of it works.

Mostly Mary [27:54]

That's not how it works. That's not how any of this works.

Mostly Uncle Frank [27:58]

And this is why the Fama-French analysis and factor investing has shown to be working, at least for these three-factor and five-factor models.

Mostly Uncle Frank [28:11]

It doesn't work for every factor that somebody ever came up with, because there are hundreds of factors that academics have examined, but the ones that we know and love being small versus large and growth versus value do have meaning and do work pretty well over very long periods of time. The question I always have for people who say things like that is that well, okay, let's just take your proposed portfolio and compare it to this one on whatever metrics you want to compare it on. Because that's the issue here. You're not taking a portfolio and just saying it's this or nothing. You are always comparing it to another portfolio. And the kinds of portfolios that are typically looked at the simple ones, which are just, say, s&p 500 and bonds, just don't perform as well as these more diversified ones on basically any metric that you can apply to them, and you could say that they are just as curve-fitted as this one in many respects because they are large cap tilted.

Mostly Mary [29:16]

You can actually feel the energy from your ball by just putting your hands in and out.

Mostly Uncle Frank [29:22]

And have other idiosyncrasies. So what I'm getting at here is this is another one of these kind of neutral truisms like past performance is not indicative of future results. When you're just saying that and saying, well, that applies to your portfolio, well, it applies to every portfolio, so what meaning does it have? That is not a basis for comparison between two portfolios.

Mostly Mary [29:48]

Now you can also use the ball to connect to the spirit world.

Mostly Uncle Frank [29:52]

Now the rigorous way you would test for curve fitting is this you would take a segment of data, come up with a portfolio that performs well in that segment of data and then take a different segment of data and run it through that and see whether the performances are similar. You can actually do that with what you're doing, since you have the 50-year set of data. If you go compare it with the 100-year set of data or the earlier set of data that goes back to the 1920s, you're going to get similar results. The reason you're getting similar results is these things are ultimately based on performance during particular economic environments.

Mostly Uncle Frank [30:32]

The advantage of using something that goes back to 1970 is that you've covered just about every economic environment you're likely to have outside of nuclear war, because you've had inflationary environments like the 1970s. You've had deflationary environments, like the early 2000s, and those are the two problem areas. For decades where the stock market performs pretty well, like the 80s, 90s or 20-teens, you're not going to have any problem whatsoever almost with any kind of portfolio that has a lot of stocks in it. So these casual criticisms your friend sonja is leveling upon you don't hold a lot of water and don't actually answer the question as to, well, what kind of portfolio should you hold, if not the one that you've come up with, a really big one here, which is huge. My suspicions is that sonia is just afraid to spend money, and so is projecting her fear upon you, which I find common in these quarters, leading to people having 2.5% safe withdrawal rates and things like that.

Mostly Mary [31:41]

That's not an improvement.

Mostly Uncle Frank [31:44]

Anyway, congratulations on your big move, and I would like to go to Malaga, but it probably won't be this year, and thank you for your email.

Not Uncle Frank [31:56]

Trogdor strikes again.

Mostly Uncle Frank [31:59]

But now I see our signal is beginning to fade. I'm not sure we're going to have a podcast this weekend. We shall see. Mary and I have about five nieces and nephews to take care of and she's already off to work on that issue. But I will be joining her in the next couple days. But in the meantime, if you have comments or questions for me, please send them to frank at riskparityradarcom. That email is frank at riskparityradarcom. Or you can go to the website, wwwriskparityradiocom, 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, a review. That would be great. Okay, thank you once again for tuning in. This is Frank Vasquez with Risk Parity Radio, signing off Trogdor.

Not Uncle Frank [32:56]

Trogdor. Trogdor was a man. I mean he was a dragon man. I mean he was a dragon man. I mean he was just a dragon, but he was still Tronca, tronca, burninating the countryside, Burninating the peasants, burninating all the people in the thatched roof cottages, thatched roof cottages, and the truck door comes in the night.

Mostly Mary [33:52]

And the truck door comes in the night.