Mary and Others [0:01]

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

AI Podcast Man [0:10]

If a man does not keep pace with his companions perhaps it is because he hears a different drummer, a different drummer.

Mary and Others [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.

Voices [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.

Mary and Others [1:26]

Top drawer, really top drawer.

Mostly Uncle Frank [1:31]

Along with a host named after a hot dog.

Mary and Others [1:34]

Lighten up Francis.

Mostly Uncle Frank [1:37]

But now onward, episode 384. Today, on Risk Parity Radio, we're going to do what we do best here, which is tend to your emails.

Mary and Others [1:47]

Looks like I picked the wrong week to put amphetamines.

Mostly Uncle Frank [1:50]

And we're also going to play around with some artificial intelligence.

Voices [1:53]

Surely you can't be serious.

Mostly Uncle Frank [1:55]

I am serious and don't call me Shirley, and so without further ado.

Voices [2:00]

Here I go once again with the email, and First off, and First off.

Mostly Uncle Frank [2:06]

First off, we have an email from Justin it's going to be huge. And Justin writes Frank and Alexi.

Mary and Others [2:15]

first off, happy Thanksgiving to you both. I know it's been a while, so in short, all things are good in the land of the rising sun and falling yen. I was reminded of my distance from the states when I heard about Alexi making the trek to DC and your scheduled night out. What I wouldn't give for a teleportation machine to join you both Beyond it is another dimension. That'd be a lot of fun.

Mary and Others [2:38]

You fell victim to one of the classic blunders.

Mary and Others [2:41]

Anyway, I thought I'd add something for the next pod.

Mary and Others [2:49]

And, yes, invoking Patreon contributor Cred to get this a quick airing.

Mary and Others [2:53]

Alexi's question about QQQ versus VUG reminds me that I did two blog posts on just this question and, to cut to the chase, I found that IWY iShares Russell Top 200 Growth Index was actually my choice for best large cap growth fund to be the other side of the barbell from SCV, basically more focused, more large cap growthy than VUG, while not being bound by the essentially arbitrary condition of QQQ that the equities be offered on one exchange versus another. Please toast to me on your night out. All the best, justin to stupidity.

Mary and Others [3:46]

Not quite done. The muscle aches, spasms, your joints feeling like they've been ripped out or replaced with shards of broken glass. Should I be writing any of this down? Your stomach fills with bile. When you vomit it feels like someone's forcing a white-hot hammer down your esophagus, tearing your flesh, blood dripping down the back of your throat, choking and gagging you with a slick, coppery taste of burnt pennies. I am an oncologist. I know If you did, you wouldn't be sitting here.

Mostly Uncle Frank [4:15]

Well, it's nice to hear from you, old friend. For those of you who do not know who Justin is, he is the author of the now dormant blog called Risk Parody Chronicles. That had a lot of interesting stuff up there when it was active.

Mary and Others [4:30]

The best, Jerry the best.

Mostly Uncle Frank [4:33]

It is now offline, although perhaps Alexi and I can induce him to republish it at some point. Looks like you've been missing a lot of work lately. I wouldn't say I've been missing it, Bob.

Mary and Others [4:49]

Because it was certainly worthwhile from our perspective.

Mostly Uncle Frank [4:53]

Perhaps we'll plot those machinations. When I have dinner with the dude on Friday, mary will also be there to ensure that Nothing illegal is attempted.

Voices [5:06]

Mary, Mary, why you buggin'?

Mostly Uncle Frank [5:10]

So Justin does get to go to the front of the line because he's one of our patrons on Patreon. If you don't know what that's all about, this podcast does not have any sponsors, but it does have a charity we support. It's called the Father McKenna Center. It serves hungry and homeless people in Washington DC. Full disclosure I am on the board and am the current treasurer. But if you give to the Father McKenna Center, you get to go to the front of the email line. There are really two ways to do that. One you can do it automatically through Patreon on our support page.

Voices [5:41]

I just did it and I'm ready to do it again.

Mostly Uncle Frank [5:43]

Don't tell me you don't do it. Or you can give to the center directly and I'll link to that again. But either way, if you do that and you tell me in your email that you've done that, I'll move you to the front of the email line.

Mary and Others [5:57]

Yes.

Mostly Uncle Frank [5:59]

We are also having our annual holiday program called Lessons and Carols, which will be on December 5th at 7 pm at the St Aloysius Church at 900 North Capitol Street in Washington DC, and if you're in the local area I invite you to come down for that. See what goes on down there. I believe we'll be having some hot chocolate and cookies afterwards. So this email is referring back to episode 382, where Alexei the dude had wrote in about whether QQQ was better than VUG for a large cap growth allocation. He likes QQQ. I kind of prefer VUG out of those two.

Mostly Uncle Frank [6:41]

But Justin makes a point that IWY may be even better, at least in terms of concentrated large cap growth. Now IWY is a little bit more expensive of a fund at 0.2 on the expense ratio, but it is more highly concentrated. It has fewer companies in it than VUG and so it's more concentrated. And I did run these three in the test folio asset analyzer which goes over correlations and recent performances and things, and you will see that IWY does indeed outperform VUG recently and I think that's largely due to its larger concentration in the Magnificent 7. So that does make sense to me and perhaps you're onto something there.

Mostly Uncle Frank [7:29]

You are correct, sir. Yes, it's interesting to note, though, that the corresponding small-cap value fund, iwn, is actually a much worse performer than the typical alternatives, which are IJS or VIOV or something like VBR. But I think it just goes to show you that no one provider of funds necessarily has a license on all of the best funds, and so it pays to look around. Anyway, I don't think you can go wrong with using any of those three as a large cap growth allocation, or maybe use more than one if you're really adventurous.

AI Podcast Woman [8:10]

It's all the same to you.

Mary and Others [8:14]

I'll drive that tanker.

Mostly Uncle Frank [8:16]

But that might be overkill. It certainly would be duplicative, but I will put the test folio link in the show notes so you can check these out. We will certainly have a toast to you on Friday and thank you for your email.

Mary and Others [8:33]

Day two, your white blood cells are gone, opening up your system to attack. Your temperature skyrockets. One second your skin feels like it's on fire. The next second it's entombed in ice. Every pain sensor in your body is firing at the same time, until agony isn't even a word or a concept. It's your only reality. You hallucinate, you dream of death, and then the race begins Again. Your body claw its way back in time before the hostile organisms and parasites claim you permanently. Win you live, lose you die.

Mostly Uncle Frank [9:14]

Now second off. Second off we have an email from Matt.

Mary and Others [9:21]

What does Matt Damon say on that Bitcoin? Commercial Fortune favors the brave. And Matt writes Hello Uncle Frank and Aunt Mary. I'm concerned that if Brad continues to refer people to you, he will no longer be considered the nicest guy in FI. I love me a good rant though.

Mary and Others [9:38]

I want you to be nice until it's time to not be nice.

Mary and Others [9:48]

On that note, I've been thinking more about CAPE ratios and would like you to take it to the woodshed, like you did with target date funds. I think there are at least two obvious issues with forecasting based on CAPE ratios. First, the simplest analysis of a stock would include its earnings, growth and a discount rate. None of those are constant. An analysis using only earnings is obviously insufficient, because both growth and value stocks have periods of excellent performance. A second issue is that the composition of each index changes over time. A large portion of the future returns of the S&P 500 will probably come from stocks not currently in the S&P 500 or are currently just a tiny fraction of the index. Many of the large cap growth tech stocks currently dominating the S&P have done so for a short time period when compared to an investing lifetime. This portion of the S&P's return is unrelated to CAPE ratios and more related to innovation in the economy. What do you think? Thanks for all you do, matt.

Mary and Others [10:49]

All right, dude, can we lay off the Matt David jokes?

Mostly Uncle Frank [10:50]

please, they're just getting old. Well, first off, I think Brad Barrett will always be the nicest guy of five. He just can't help himself. I don't think you're happy enough.

Mary and Others [11:04]

That's right, and I make a nice contrast, since I'm the meanest guy of five or have that reputation.

Mostly Uncle Frank [11:11]

Alright, you make some good points. First of all on the limitations of CAPE ratios, yes, one being that historically they have not been constant. In fact, historically the mean or average CAPE ratio has been rising, and that really is a symptom of the change in the kinds of companies that you find in the S&P 500, that have gone from industrial companies like railroads a long time ago to our information technology-laden world today, and every sector actually has its own average CAPE ratio and every kind of industry has its own kind of average CAPE ratio. So to think that all that could be captured by one number, that is, that meaningful, is kind of Pollyanna-ish and in fact it has not worked out very well as a predictive model. It's worked only in hindsight.

Mostly Uncle Frank [12:04]

Now I have done a deep dive on this before. That was episode 238, where we talked about it for a whole episode, the problems with it, the history of it, and there are a lot of links there, including the links showing the various average P-E ratios for sectors and industries. And we also talked about that in episode 284 and, briefly or a little bit, in episode 209, among others. But rather than repeating all that now, I thought what I would do with a nod to Brad Barrett, who first brought this to my attention is to use the large language model AI bot called Notebook LM that is out from Google right now and take episode 238 and reconstruct a podcast out of that. So these are two AI podcasters going through all the content in episode 238.

Mostly Uncle Frank [12:59]

And I think they did a pretty good job. They did mess up a few things. It sounds at one point like I'm advocating market timing and I do not advocate changing portfolios based on subjective factors you find in the markets, at least as to their baseline allocations, and you'll find it funny that they can't seem to agree or decide on how to pronounce cape. So there's sape and cape and all sorts of other pronunciations there, but you'll get the gist of it. Anyway, this is 20 minutes long if you did want to skip it, but I do think it's probably more entertaining than I usually am, or at least it sounds a lot more normal, would?

Mary and Others [13:40]

you mind telling me? Uh, would you mind telling me whose brain I did put in, and you won't be angry.

Mostly Uncle Frank [13:55]

I will not be angry, no-transcript.

AI Podcast Man [14:09]

Hey everyone, Welcome back. So you're trying to figure out if the KPE ratio is useful for planning your retirement or just another financial fad.

AI Podcast Woman [14:17]

Well, it's definitely been getting a lot of attention lately.

AI Podcast Man [14:20]

Yeah, that's for sure. So we did a deep dive into a really interesting discussion from Risk Parity Radio.

AI Podcast Woman [14:26]

Oh yeah, those guys are great. I love their take on alternative investing.

AI Podcast Man [14:29]

Me too, and we pulled out some of the most important points to help you make sense of it all.

AI Podcast Woman [14:34]

Awesome. I'm sure that'll be super helpful for our listeners.

AI Podcast Man [14:36]

Yeah, I hope so. I was especially fascinated by their critique of how academic economists approach personal finance.

AI Podcast Woman [14:44]

Yeah, that was pretty thought provoking. Sometimes it feels like they're living on a different planet.

AI Podcast Man [14:50]

Well, let's start with the basics. Okay, sounds good.

AI Podcast Woman [14:51]

What exactly is the SAP ratio and how is it supposed to help predict future stock market returns?

AI Podcast Man [14:58]

Right. So the SAP ratio, or cyclically adjusted price to earnings ratio, takes the current price of the S&P 500 and divides it by the average inflation adjusted earnings over the past 10 years. Ah, OK, so it's trying to give you a more stable view of valuations over a longer period.

AI Podcast Woman [15:16]

Exactly, and the idea is that by looking at earnings over this longer time frame, you can smooth out those short term fluctuations and get a more accurate picture of a company's true earning power.

AI Podcast Man [15:27]

Okay, that makes sense, but how reliable is it?

AI Podcast Woman [15:30]

Right, that's the big question, especially for planning something as important as your retirement.

Mostly Uncle Frank [15:34]

Yeah, for sure.

AI Podcast Woman [15:35]

And one thing that jumped out at me from this podcast was the story about all those K-P ratio enthusiasts back in the early 2010s.

AI Podcast Man [15:43]

Oh yeah, the K-P crusaders, as they were sometimes called.

AI Podcast Woman [15:46]

Exactly. They were looking at the KP ratio and it was flashing all these warning signs, you know, suggesting the market was way overvalued and headed for a correction, and a lot of people were bracing for this major downturn based on those predictions.

AI Podcast Man [16:00]

So what happened?

AI Podcast Woman [16:01]

Well, the market didn't crash Really. Yeah, in fact, it went on to have a fantastic run for the rest of the decade.

AI Podcast Man [16:07]

Interesting.

AI Podcast Woman [16:08]

Which brings us to one of the key limitations of the K-P ratio. What's that? It's just not very reliable for short-term predictions.

AI Podcast Man [16:14]

Meaning anything less than 10 years.

AI Podcast Woman [16:16]

Right, and that's something they really emphasize in the podcast.

AI Podcast Man [16:19]

Huh. So even if the ATE ratio is high today, it doesn't necessarily mean the market is about to tank.

AI Podcast Woman [16:27]

Exactly.

AI Podcast Man [16:28]

So then, how can we actually use this thing?

AI Podcast Woman [16:30]

Well, that's what we're going to try to figure out.

AI Podcast Man [16:31]

Sounds good, I'm all ears. Okay great, and it's not just short-term predictions.

AI Podcast Woman [16:35]

Right. They also point out that it's not all that great for the very long-term either.

AI Podcast Man [16:40]

You know over 20 years. Okay, so where does that leave us? Yeah, is there kind of a sweet spot where the KPE ratio actually does have some predictive power?

AI Podcast Woman [16:53]

Well, the podcast host suggests there might be a window of usefulness between, say, 10 and 15 years out, oh, interesting.

AI Podcast Man [16:56]

But even then it's not a crystal wall, right? It can't tell you when a correction is going to happen.

AI Podcast Woman [17:00]

Just that it's statistically more likely within that time frame.

AI Podcast Man [17:03]

Exactly. It's more about understanding those probabilities than making pinpoint predictions.

Mostly Uncle Frank [17:09]

That makes sense.

AI Podcast Man [17:10]

And when it comes to your specific portfolio. There's another really important point they make.

AI Podcast Woman [17:14]

Okay, what's that?

AI Podcast Man [17:15]

The CPE ratio that everyone talks about.

AI Podcast Woman [17:17]

Yeah.

AI Podcast Man [17:17]

That's usually calculated for the S&P 500.

AI Podcast Woman [17:20]

Right, but you're probably not just invested in the S&P 500. Hopefully not, right? No, you've got a diversified portfolio with different holdings.

AI Podcast Man [17:27]

Exactly, and that's something a lot of people overlook.

AI Podcast Woman [17:30]

Yeah.

AI Podcast Man [17:30]

The KPE ratio for the S&P 500 might not be relevant to your individual portfolio.

AI Podcast Woman [17:36]

Especially if you've got things like small cap value stocks or international stocks or bonds.

AI Podcast Man [17:40]

Right, exactly.

AI Podcast Woman [17:41]

So even if we assume that the KP ratio has some predictive power for the overall market, we can't just blindly apply it to our own unique investment mix.

AI Podcast Man [17:54]

No, absolutely not.

AI Podcast Woman [17:55]

Okay, good to know.

AI Podcast Man [17:56]

And this brings us to another key point they make.

AI Podcast Woman [17:58]

Oh yeah.

AI Podcast Man [17:58]

What they call this elusive mean.

AI Podcast Woman [18:00]

The elusive mean.

AI Podcast Man [18:01]

Yeah, you see, a lot of the predictive power of the KP ratio rests on the idea that it should revert to its historical average. Okay, the mean over time.

AI Podcast Woman [18:10]

Right. So if it's high, it should eventually come down, and if it's low, it should eventually go up.

AI Podcast Man [18:14]

Exactly.

AI Podcast Woman [18:15]

Makes sense.

AI Podcast Man [18:16]

But as economists have dug deeper into this, they've realized that this historical mean isn't actually stable. Oh really, it fluctuates over time, oh, wow. Which makes it kind of an unreliable benchmark to begin with.

AI Podcast Woman [18:31]

So it's like trying to hit a moving target.

AI Podcast Man [18:33]

Yeah, basically.

AI Podcast Woman [18:34]

No wonder those predictions from the early 2010s were so far off.

AI Podcast Man [18:38]

Exactly. And to make things even more complicated, the KPE ratio doesn't account for the vast differences in historical price to earnings ratios across different sectors and industries.

AI Podcast Woman [18:50]

Yeah, okay, I can see how that would be a problem. I mean, different industries have different growth rates, different risk profiles, all sorts of factors that would affect their valuations.

AI Podcast Man [18:59]

Exactly. For example, they highlight how the energy sector historically has had a price-to-earnings ratio around 9.

AI Podcast Woman [19:07]

9, okay.

AI Podcast Man [19:08]

While the technology sector sits at 25.

AI Podcast Woman [19:10]

Wow, that's a huge difference.

AI Podcast Man [19:12]

Right. So trying to use this single aggregate CAPE ratio for the entire market is going to miss all those nuances.

AI Podcast Woman [19:20]

It's like trying to describe the average temperature of the entire planet.

AI Podcast Man [19:24]

Exactly.

AI Podcast Woman [19:25]

Like, technically you can do it, but it's not really very helpful if you're trying to decide what to pack for, you know, a trip to Alaska versus Hawaii, right.

AI Podcast Man [19:33]

Precisely.

AI Podcast Woman [19:34]

And I bet it gets even trickier when you start comparing KPE ratios across different countries.

AI Podcast Man [19:39]

Absolutely Risk. Parity Radio emphasizes that comparing KPE ratios across countries is extremely problematic.

AI Podcast Woman [19:46]

Yeah, You've got to factor in all those differences in industry mix you know, country risk local economic conditions.

AI Podcast Man [19:51]

Right, it's just not an apples to apples comparison.

AI Podcast Woman [19:54]

So for someone like you who's specifically interested in using the tape E ratio to inform your retirement planning, what's the takeaway here?

AI Podcast Man [20:03]

Well, that's where things get really interesting, because even if we assume that the KPE ratio worked perfectly, using it to determine a safe withdrawal rate might still be flawed.

AI Podcast Woman [20:13]

Wait, really, why is that?

AI Podcast Man [20:14]

Because the KPE ratio at its best is only a prediction about average market returns over a very long period. It doesn't tell you what's going to happen year to year, and in retirement you're making withdrawals every year.

AI Podcast Woman [20:27]

Right, Okay. So even if that long-term average return is positive, you know a prolonged market downturn early in your retirement could really derail your plans.

AI Podcast Man [20:39]

Exactly those early withdrawals during a downturn can deplete your principal so much faster.

AI Podcast Woman [20:45]

Wow Okay.

AI Podcast Man [20:46]

Potentially putting your long-term financial security at risk.

AI Podcast Woman [20:49]

So that's a really important point.

AI Podcast Man [20:51]

Yeah, and that leads us to another really interesting thing. They talk about, okay, their critique of how academic economists often approach personal finance.

AI Podcast Woman [21:01]

Yeah, this is the part I was really looking forward to I know Me too. They don't hold back in their criticism, do they?

AI Podcast Man [21:06]

Not really, yeah, but their point is that a lot of these economic models are based on these like idealized assumptions. Okay About human behavior, right, that just don't reflect the complexities of real life.

AI Podcast Woman [21:19]

Like this idea of consumption smoothing. Yes, exactly when you try to maintain this perfectly even level of spending throughout your entire life.

AI Podcast Man [21:30]

Yeah right, Like as if we can predict exactly how much we're going to earn and spend every year.

AI Podcast Woman [21:37]

Right For the next, like 50 years.

AI Podcast Man [21:39]

Yeah.

AI Podcast Woman [21:39]

It's just not realistic.

AI Podcast Man [21:40]

And it's this disconnect between theory and reality. Yeah, that, I think, makes the next part of the podcast so fascinating okay they introduced this concept called laplace's demon. Laplace's demon. This like thought experiment, okay, from centuries ago, envisioning this being with, like infinite knowledge, uh-huh able to predict the future perfectly that sounds a little spooky kind of yeah like something out of a science fiction novel.

AI Podcast Man [22:05]

Right, but it's more about illustrating the limitations of deterministic prediction. Okay, you know this belief that if we just had enough data, we could like perfectly foresee what the market is going to do.

AI Podcast Woman [22:16]

So, even with all of that knowledge, this demon wouldn't be able to get it right all the time.

AI Podcast Man [22:21]

Exactly, exactly, because, as science has progressed, we've realized that these complex systems, like the stock market, they're inherently unpredictable. They're constantly evolving and responding to new information, and even small changes can cascade into these big, unexpected outcomes.

AI Podcast Woman [22:42]

So it's like we're saying even with all the computing power in the world, we're still a long way from being able to predict something as chaotic as the market.

AI Podcast Man [22:51]

Exactly, and that's where the work of like Benoit Mandel brought and the Santa Fe Institute comes in. They study these complex systems, and they've shown that these systems often behave in ways that like defy these traditional economic models.

AI Podcast Woman [23:05]

So, instead of this nice orderly progression that some economists might assume, the market's more like this wild rollercoaster ride.

AI Podcast Man [23:14]

That's a great way to put it, and it's why those data-driven approaches we talked about earlier, like that Fama French model, are so important, because they don't try to predict the future, they look at historical patterns to identify the factors that have consistently driven market returns.

AI Podcast Woman [23:31]

So, instead of relying on these grand theories, they're looking at what's actually happened in the real world.

AI Podcast Man [23:37]

Precisely, and that's where Risk Parity Radio makes this distinction between what they call academic economics and. Yeah, and data-driven finance.

AI Podcast Woman [23:46]

And they use professors v body as an example of the former.

AI Podcast Man [23:50]

Yes, they point out that body's recommendations, while often well-intentioned, sometimes stem from these theoretical models that haven't always held up well in practice.

AI Podcast Woman [24:01]

Like that portfolio he recommended back in 2005.

AI Podcast Man [24:04]

Oh yeah.

AI Podcast Woman [24:04]

Right before the financial crisis. Uh-huh, yeah it Right before the financial crisis, uh-huh yeah, it didn't perform very well, to say the least.

AI Podcast Man [24:08]

It's a good reminder that even brilliant economists can get things wrong when they rely too heavily on these abstract models.

AI Podcast Woman [24:17]

Right.

AI Podcast Man [24:17]

That don't really account for real world market dynamics.

AI Podcast Woman [24:21]

Yeah, okay, so we've talked a lot about the SAPI ratios limitations.

Voices [24:25]

Yeah.

AI Podcast Woman [24:25]

And these potential pitfalls of relying too heavily on academic economic models. Right, but one thing I'm still curious about is this idea of country risk and how it relates to all this.

AI Podcast Man [24:37]

Yeah, that's a great question and Risk Parity Radio addresses this directly. Okay, they argue that using the CAPI ratio to compare valuations across different countries can be really misleading.

AI Podcast Woman [24:50]

So if a country like, say, Brazil has a lower CAPE ratio than the United States, does that automatically mean that Brazilian stocks are a better investment?

AI Podcast Man [25:01]

Not necessarily, because beyond just the numbers, you have to consider the broader political and economic context of each country. Things like political stability, regulatory frameworks, property rights All these things can significantly impact investment returns.

AI Podcast Woman [25:18]

Right, regardless of what that KPU ratio might suggest.

AI Podcast Man [25:21]

Exactly. A lower KPU ratio might simply reflect the higher risk that investors are pricing into those markets.

AI Podcast Woman [25:29]

That makes sense.

AI Podcast Man [25:29]

It really highlights the importance of taking this holistic view.

AI Podcast Woman [25:33]

Yeah.

AI Podcast Man [25:33]

When you're evaluating investment opportunities For sure. Don't just focus on a single metric like the KP ratio Right. Consider that bigger picture.

AI Podcast Woman [25:42]

Yeah.

AI Podcast Man [25:43]

Including those unique risks and opportunities associated with each market.

AI Podcast Woman [25:48]

So bringing it back to you and your retirement planning. How does all of this inform your thinking?

AI Podcast Man [25:54]

Well, for me, it reinforces the importance of diversification. You don't want to put all your eggs in one basket, whether that's a specific stock or a particular sector, or even a single country.

AI Podcast Woman [26:05]

Right, because spreading your investments across different asset classes, geographies, industries really helps to mitigate risk and smooth out those returns over time. Exactly.

AI Podcast Man [26:19]

And when it comes to determining that safe withdrawal rate, it's crucial to be realistic about the potential for market downturns.

AI Podcast Woman [26:27]

You mentioned earlier that even if that long-term average return is positive, a series of bad years early on can really deplete your principal, put your retirement plans at risk.

AI Podcast Man [26:38]

Right, it's called sequence of returns risk.

AI Podcast Woman [26:41]

Sequence of returns risk Okay.

AI Podcast Man [26:42]

And it's something that the APE ratio by itself can't really count for.

AI Podcast Woman [26:46]

Okay, so how can you protect yourself against that risk?

AI Podcast Man [26:50]

Well, one approach is to build a portfolio with a higher safe withdrawal rate, okay, meaning one that can withstand even these prolonged market downturns. And that's where those data-driven approaches we discussed earlier can be really helpful, by understanding the factors that have historically driven market returns.

Mary and Others [27:11]

Yeah.

AI Podcast Man [27:11]

You can construct a portfolio that's designed to be more resilient in the face of like different economic conditions.

AI Podcast Woman [27:18]

So it's not about trying to time the market perfectly or relying on any single metric to predict the future.

AI Podcast Man [27:24]

Exactly.

AI Podcast Woman [27:24]

It's about building that robust and adaptable portfolio that can weather different storms.

AI Podcast Man [27:29]

And this is where the Risk Parity Radio folks bring up another really fascinating point. Okay, this importance of understanding our own psychology and how it influences our financial decisions.

AI Podcast Woman [27:41]

Yes, they spend quite a bit of time talking about behavioral economics.

AI Podcast Man [27:45]

Me too.

AI Podcast Woman [27:46]

Which I always find super interesting.

AI Podcast Man [27:48]

And one of the things they highlight is this paradox of retirees who spent their entire lives diligently saving Right. But then become almost irrationally afraid to spend their money once they retire.

AI Podcast Woman [28:01]

It's like they've won the game, but they're too scared to claim their prize.

AI Podcast Man [28:05]

Right, I've even seen this with some of my own family members.

AI Podcast Woman [28:07]

Yeah, me too. It's a very real phenomenon.

AI Podcast Man [28:10]

And it suggests that there's this deep psychological disconnect between accumulating wealth and feeling comfortable actually enjoying it.

AI Podcast Woman [28:19]

So, if the traditional economic models fail to account for these very real human behaviors, what alternative frameworks can we use to make better financial decisions?

AI Podcast Man [28:31]

That's a great question and one that deserves further exploration, but I think the key takeaway from this deep dive is to approach any financial forecasting tool, including the KPU ratio, with a healthy dose of skepticism.

AI Podcast Woman [28:46]

Right. Don't rely on it as a crystal ball.

AI Podcast Man [28:48]

Exactly.

AI Podcast Woman [28:49]

Instead, focus on building that diversified portfolio, having a realistic safe withdrawal rate and, perhaps most importantly, remembering that personal finance isn't just about accumulating wealth.

AI Podcast Man [29:01]

Right.

AI Podcast Woman [29:01]

It's about using that wealth to live a fulfilling and enjoyable life.

AI Podcast Man [29:05]

Well said and I think this conversation raises an important question for everyone listening.

AI Podcast Woman [29:09]

What's that?

AI Podcast Man [29:09]

If the KPE ratio is this flawed tool for predicting future market returns and it seems like it is then what can we use instead to make these informed investment decisions for retirement?

AI Podcast Woman [29:23]

That's the million-dollar question, isn't it?

AI Podcast Man [29:25]

It is and, I have to admit, after this deep dive I'm feeling a little less confident in my own ability to predict the future of the market.

AI Podcast Woman [29:32]

But the good news is, I think this podcast has given us some valuable clues.

AI Podcast Man [29:36]

I agree.

AI Podcast Woman [29:37]

About where to look for answers.

AI Podcast Man [29:39]

And for me, one of those important takeaways is this emphasis on data-driven approaches. Instead of relying on those theoretical models that might not reflect that real-world complexity, we can look at that historical market data to identify those patterns and factors that have consistently driven returns.

AI Podcast Woman [30:00]

Like the Fama-French model we touched on earlier.

AI Podcast Man [30:02]

Yes, exactly.

AI Podcast Woman [30:03]

Can you remind us how that works? And how it might be useful for someone like you who's planning for retirement.

AI Podcast Man [30:08]

So the Fama-French model builds on that traditional capital asset pricing model, or CAPM, by adding two additional factors that have been shown to influence stock returns size and value.

AI Podcast Woman [30:22]

Okay, so size refers to the market capitalization of a company.

AI Podcast Man [30:26]

Right, basically how big it is.

AI Podcast Woman [30:27]

And value refers to.

AI Podcast Man [30:29]

Value stocks are those that are considered undervalued by the market.

AI Podcast Woman [30:32]

Okay.

AI Podcast Man [30:33]

Relative to their fundamentals, like earnings or book value. Fama and French found that historically smaller companies and value stocks have tended to outperform the broader market.

AI Podcast Woman [30:46]

So by tilting your portfolio towards these types of stocks, you might be able to increase your expected returns over the long run.

AI Podcast Man [30:54]

That's the idea. Of course, there's no guarantee that those factors will continue to outperform in the future, right? But by incorporating those insights into your investment strategy, you're essentially betting on those historical patterns repeating themselves.

AI Podcast Woman [31:07]

And it's not about picking individual winners or losers. It's about understanding the broader forces at play in the market and positioning yourself accordingly.

AI Podcast Man [31:16]

Exactly, and I think this ties in nicely with another key takeaway from the podcast the importance of having that robust and adaptable portfolio that can withstand different economic conditions.

AI Podcast Woman [31:29]

We talked about this in the context of determining a safe withdrawal rate, but can you elaborate on what a robust and adaptable portfolio actually looks like?

AI Podcast Man [31:37]

Well, it starts with diversification, as we've talked about. You don't want to have all your eggs in one basket.

AI Podcast Woman [31:42]

So spreading your investments across different asset classes, sectors, geographic regions. That makes sense.

AI Podcast Man [31:48]

Right and beyond diversification.

AI Podcast Woman [31:50]

Yeah.

AI Podcast Man [31:51]

It's also about having the flexibility to adjust your strategy as market conditions change. So, example, if inflation starts to pick up, you might want to increase your allocation to assets that tend to perform well in inflationary environments.

AI Podcast Woman [32:08]

Like commodities or real estate.

AI Podcast Man [32:10]

So it's not about setting your portfolio on autopilot and hoping for the best.

AI Podcast Woman [32:14]

No, it's about staying informed, being aware of those risks and opportunities out there and being willing to make those adjustments as needed.

Voices [32:23]

Okay.

AI Podcast Woman [32:24]

And this is where I think that understanding of behavioral economics that we discussed earlier becomes so crucial.

AI Podcast Man [32:30]

You mean being aware of our own biases?

AI Podcast Woman [32:33]

Yes.

AI Podcast Man [32:33]

And how they might lead us to make irrational financial decisions Exactly. For example, a lot of people have this tendency to sell their investments when the market is down.

AI Podcast Woman [32:44]

Oh yeah.

AI Podcast Man [32:45]

And buy when the market is up Right, which is the exact opposite of what you should be doing.

AI Podcast Woman [32:50]

Yeah, it's that fear and greed cycle that can really sabotage our long-term investment goals.

AI Podcast Man [32:55]

Right, and by understanding these behavioral patterns we can develop strategies to like mitigate their impact.

AI Podcast Woman [33:02]

So things like having a written investment plan.

AI Podcast Man [33:05]

Yes, exactly.

AI Podcast Woman [33:06]

You stick to, no matter what the market is doing.

AI Podcast Man [33:08]

Right, a little bit of pre-commitment.

AI Podcast Woman [33:10]

Yeah.

AI Podcast Man [33:10]

To help us stay disciplined when emotions are running high.

AI Podcast Woman [33:13]

And this is something that's especially important for retirees.

AI Podcast Man [33:16]

Yeah.

AI Podcast Woman [33:17]

Who might be more sensitive to market fluctuations?

AI Podcast Man [33:19]

Right. Because they're relying on their portfolio for income sensitive to market fluctuations because they're relying on their portfolio for income, exactly. And this brings us back to that fascinating observation for the podcast about those retirees who are afraid to spend their money.

AI Podcast Woman [33:31]

Yeah, even though they've accumulated this sizable nest egg, they're still living frugally and hoarding their wealth.

AI Podcast Man [33:38]

It's a real paradox, isn't it?

AI Podcast Woman [33:39]

It is They've achieved financial security, but they're not actually enjoying the fruits of their labor.

AI Podcast Man [33:45]

It makes you wonder what's the point of saving all that money if you're not going to use it to live this richer, more fulfilling life.

AI Podcast Woman [33:54]

And I think this highlights this key point that often gets lost in these technical discussions about investing. The purpose of money is to serve our lives.

AI Podcast Man [34:05]

Yes.

AI Podcast Woman [34:06]

Not the other way around. I love that that's such an important reminder it is. We shouldn't let fear or uncertainty keep us from enjoying the present moment Right and pursuing the things that matter most to us.

AI Podcast Man [34:18]

Absolutely, and I think this is where financial planning goes beyond just numbers and spreadsheets. Yeah, it becomes about aligning your investments with your values, your goals, your vision for the future.

AI Podcast Woman [34:31]

So, instead of obsessing over the CP ratio or trying to predict the unpredictable, we should focus on creating a financial plan that supports the life we want to live, both today and in the years to come.

AI Podcast Man [34:45]

Well said and I hope that's the biggest takeaway for everyone listening today Don't get too caught up in those technical details or the latest market fads.

AI Podcast Woman [34:54]

Focus on the bigger picture, develop a sound investment strategy and most importantly, remember to enjoy the journey.

AI Podcast Man [35:03]

That's fantastic advice. And speaking of enjoying the journey, Okay. We're going to wrap up this deep dive now.

AI Podcast Woman [35:08]

Sounds good.

AI Podcast Man [35:09]

So you can get back to doing just that.

AI Podcast Woman [35:11]

If you'd like to learn more about any of the topics we cover today, we'll include links to all the resources mentioned in this episode on our website.

AI Podcast Man [35:18]

And we always love hearing from you.

AI Podcast Woman [35:20]

So please feel free to connect with us on social media.

AI Podcast Man [35:23]

Yes.

AI Podcast Woman [35:24]

Let us know what resonated with you from this discussion.

AI Podcast Man [35:26]

Thanks for joining us on this deep dive.

AI Podcast Woman [35:28]

We'll see you next time.

AI Podcast Man [35:29]

Until next time, keep learning, keep questioning and keep investing in your own financial well-being.

Mostly Uncle Frank [35:59]

And now back to our regularly scheduled program.

Mary and Others [36:03]

You are talking about the nonsensical ravings of a lunatic mind.

Mostly Uncle Frank [36:09]

If you want more on this, I suggest you do go back to episode 238, because you'll find a whole bunch of links there with a lot of information about these things, and that way I don't have to include all those links again to this podcast. It's not that I'm lazy, it's that I just don't care.

Mostly Uncle Frank [36:27]

And you'll find that at the podcast page of the website wwwriskparadisecom, or go to the RSS feed and you'll also find them there which you can link to from the podcast page. But thank you for bringing this to our attention again and thank you for your email.

Mary and Others [36:47]

Last off.

Mostly Uncle Frank [36:49]

Last off, we have an email from Donald Actually two emails, so we're combining into one.

Voices [36:55]

Double your pleasure, double your fun with double good, double good, double mint gum.

Mary and Others [37:03]

And Donald writes Mr Vasquez, I wanted to thank you for your thoughtful podcast. It has provided many hours of education and entertainment. I often let the episodes stack up so that I can listen to them when we are at sea and I am unable to download any new podcasts. To download any new podcasts Below my signature block you will find my question regarding long term treasury bonds. Again, thank you for all you do. I hope I will be able to shake your hand someday at an FI event.

Mary and Others [37:37]

Dear Frank, I first came in contact with the concept of risk parity style portfolios over a decade ago via Harry Brown's permanent portfolio. That early exposure has shaped how I view various asset classes and the economic environment for which they are most useful. Consequently, I have long viewed long-term treasury bonds as a hedge against deflation. Putting aside the probability of a deflationary environment, I am beginning to question the need for long-term bonds as a deflation hedge for someone who will receive an inflation-adjusted federal pension in the future. I will be eligible for an inflation-adjusted military pension in approximately four years that will adjust upward for inflation but not downward for deflation. This pension would cover most, if not all, of my spending needs.

Mary and Others [38:24]

I am 50 and have a current accumulation portfolio with the following allocation 10% cash equivalents. 15% in each of the following Total US market VTI. Total international VXUS. Us small cap Value AVUV. International Small Cap Value AVDV. Gold, gldm, long-term Treasuries EDV. Is there a reason I am missing that would suggest a need for long-term bonds? If I were to scrap that portion of my allocation, would you think it is better to substitute an alternate asset class or divide the allocation amongst the remaining non-cash assets? Thank you for your thoughtful podcast and many thanks to Mary for reading our emails, often of epic length. Kindest regards, donald.

Mary and Others [39:33]

Well, if you didn't catch it? Donald is in the United States Navy and spends his time at sea for a good portion of what he does.

Mostly Uncle Frank [39:36]

Ship ahoy. And so, being an American, I want to thank you for what you do for us, along with the other listeners who, I intimate, are involved in service in the Armed Forces, including Pete. But now getting to your question. First, it's kind of interesting. Your portfolio actually resembles the pinwheel portfolio that we talked about in the last episode.

Voices [40:03]

Who you calling pinhead?

Mostly Uncle Frank [40:06]

And that you can find at the Portfolio Charts website, so you may want to check that out. If you haven't, and if you've listened to the introductory episodes, particularly episodes 1, 3, and 5, you will hear a discussion of the evolution of portfolios and risk parity portfolios. I do also think that harry brown's permanent portfolio was the first kind of stab at doing what we're trying to do here. I think it was greatly improved upon and formalized when the hedge fund community got a hold of it, especially what they did at Bridgewater back in the 90s, and then others have built on since then. You are correct that the main purpose for long-term treasury bonds or treasury bonds in these kind of portfolios is as a deflation hedge, or really what I think of them, as is recession insurance, that if you believe we are going to have recessions in the future, then having some of those in your portfolio will be the thing that increases in value when everything else is going down due to a recession. Now, of course, they are out of favor now because we really haven't had a significant recession. We did have the COVID mini-recession, but there was so much stimulus brought in by the government and the central banks that it really shocked us right out of that right away. So we haven't seen significant recessions since about 2008. There's been miniature downturns in the meantime, and so inevitably, when you haven't seen something for a while, people think it's permanently gone away. And there's a lot of headlines about oh, this is the new paradigm or the new something or other, and since these bonds have performed really bad in the past few years, they're going to perform really bad forever and never, evermore. And this is the fallacy or error of using a rear view mirror from one to ten years as a predictive device. It generally does not work, and so a fundamental idea we have here is that let's just hold things for all of the kinds of environments that we are likely to encounter over the next 10, 20, 30 years and not worry about predicting which one is going to come next or when it's going to come or how big it's going to be.

Mostly Uncle Frank [42:37]

But I always like to go to base rates here, because that is a fundamental idea in decision making overall that you should always look at the base rate of the occurrence of anything when trying to decide how probable is it to happen in the future, and then, to the extent you modify that probability, you do it from the base rate and not from something out of the air. That probability. You do it from the base rate and not from something out of the air. And here we know the stock market tends to go up about 70 percent of the time and so you're not really having recessions in those periods of times.

Mostly Uncle Frank [43:10]

It goes down about 30 percent of the time, but only half of those times, or less than half of those, are really serious kind of recession market crash scenarios, really serious kind of recession market crash scenarios. So it's basically got a one in nine chance as a base rate, if you didn't know anything else, of occurring. So, unless you believe in one of these fundamental change paradigm stories, you would have to believe that the chances in any given year of a recession occurring are about one in nine. So it's likely to happen sometime during your retirement and likely to happen more than once, and maybe the government will intervene big time, like it did in 2020, or maybe it won't, or maybe the government will cause the recession. We don't know.

Voices [43:54]

You never know what you're going to get.

Mostly Uncle Frank [43:57]

So if you were planning on living off the portfolio, I would not leave out treasury bonds as one of your allocations, because I think it would make your portfolio too volatile and too focused on the growth side of things. That being said, you do have a different situation, since you're talking about a federal pension that you're going to get, and so this portfolio you're talking about may not be necessary for your living expenses, your baseline living expenses, and if you can live off the pension such that you would be taking 3% or less out of the portfolio, you can probably hold just about anything you would want, including a portfolio that doesn't have any treasury bonds in it. Now, that portfolio will be a lot more volatile than it otherwise would be, but you can get away with it if you don't really need to be taking 4%, 5%, 6% out of the portfolio on a regular basis. And this does really get at the fundamental idea of matching your investments to whatever lifestyle goals you have, your investments to whatever lifestyle goals you have, because recall that the goal of what we're trying to achieve here is to construct portfolios that you can take the most money out of steadily ie, they have the highest projected safe withdrawal rates, but if you're in a different situation, where that is not necessary or that is not desired for whatever reason maybe you want to leave a large inheritance then you can hold just about anything. If your withdrawal rate from the portfolio is less than 3%, I would say and I mean anything within reason you can't be holding a bunch of individual stocks or speculative investments, but if you hold a bunch of broad-based index funds and a few other things, you can do that, just be aware that you are taking something that is going to have a higher volatility and may have a much longer time to recover if it suffers a deep drawdown.

Mostly Uncle Frank [45:51]

Because it's funny, that is what I see people in real life actually doing.

Mostly Uncle Frank [45:55]

Their real strategy is to not spend too much money out of their portfolio, keep it less than 3%, and then they can kind of do whatever they want with the portfolio within reason after that.

Mostly Uncle Frank [46:07]

What's funny to me is what they typically do is come up with all these kinds of window dressings and weird things involving buckets of cash and flower pots and hoses and ladders of bonds this, that Powerpots and hoses and ladders of bonds, this, that Very complicated things that they think are the secret to their withdrawal strategy, when the real withdrawal strategy is don't spend much money. Don't spend much money always works, but intellectually it's not interesting and, as a practical matter, if your goal is to spend the money while you're alive, that's not what you want. You want a strategy that allows you to spend more money, not less money. Unfortunately, I think a lot of financial advisors also like these don't spend money strategies, and whenever I hear them saying things like well, you need an extra five years of cash bolted onto the front of this or some other kind of window dressing like that, it sounds to me like they're just protecting their AUM fees because it's in their best interest to make sure the portfolio is growing at all times, because that's where their bread is buttered.

Mary and Others [47:23]

I have a straw. There it is, is that's a straw?

Mostly Uncle Frank [47:25]

you see, watching my straw reaches across the room and starts to drink your milkshake as charlie munger used to like say, if you can show me what the incentives are, I will tell you what the behavior is likely to be.

Mary and Others [47:49]

I drink your milkshake, I drink it up.

Mostly Uncle Frank [47:57]

So I think you've got a lot of options here, particularly since, as you say, the pension is going to cover most or all of your spending needs, and so the portfolio doesn't need to cover them. And if that's the case, then you do not need treasury bonds in your portfolio. You could have a 100% stock portfolio and get away with it. It just might be a rough ride.

Mary and Others [48:17]

Do you think anybody wants?

Mostly Uncle Frank [48:18]

a roundhouse kick to the face while I'm wearing these bad boys Forget about it. Or, as I like to say, you might consider spending more money.

Voices [48:28]

Yo our secret to success is right here in our new booklet how to Make More Money Without Using your Money.

Mostly Uncle Frank [48:38]

And if you don't know where to spend it, giving Tuesday was this week and the Father McKenna Center is available for donations, just saying.

Mary and Others [48:46]

Ooh, how convenient.

Mostly Uncle Frank [48:48]

Hopefully this helps. I'm glad you're enjoying the podcast 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 at riskparityradiocom. That email is frank at riskparityradiocom. 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 Priority Radio, signing off.

Voices [49:31]

We met in a chat room. Now our love can fully bloom. Sure, the World Wide Web is great, but you, you make me salivate. Yes, I love technology, but not as much as you, you see, but I still love technology, always and forever. Our love is like a flock of doves flying up to heaven above, Always and forever. Always and forever. Yes, our love is truly great. Always and forever.

Mary and Others [50:22]

The Risk Parody 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.