Mostly Voices [0:00]

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

Mostly Mary [0:19]

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

Mostly Uncle Frank [0:37]

Thank you, Mary, and welcome to episode 51 of Risk Parity Radio. Today on Risk Parity Radio, we are going to answer a couple of listener questions, and these questions spawn some more philosophical musings about portfolios and accumulation. But we'll just get right to it. The first question comes from our listener, Luke S. And he writes, hi Frank, I'm curious to hear your thoughts on when someone should add bonds, per annum, ideally treasuries, closed per annum, to their portfolio. My current plan is to steadily increase them as my overall portfolio value grows. For example, if my retirement number is 1 million, then I would start with a 100% stock allocation and add in 10% in Treasuries every 250,000. 100% stocks from 0 to 250,000, 90% stocks plus 10% long-term Treasuries from 250,000 to 500,000, 76% stocks plus 19% long-term treasuries plus 5% gold from 500,000 to 750,000 and 63% stocks, 23% long-term treasuries, 10% gold, and 4% short-term treasuries from 750,000 to 1 million. And then finally, 51% stocks, 26% long-term treasuries, 15% gold. 8% short-term Treasuries at 1 million plus. Am I adding in treasury funds too soon? Am I adding in gold too soon? Thank you for your feedback, Luke. Now this raises a plethora of interesting issues about accumulation, and obviously he's doing what I would recommend starting with a 100% stock portfolio and you're just getting started out accumulating for some period of time and then eventually converting that into a risk parity style portfolio when you become financially independent or retired or planning on using that money and you want to just preserve it for the long term. What's interesting about this though is that to a certain extent it doesn't matter as much as you might think how you go about on this conversion. And to illustrate this, I went to portfolio charts and you should go and you'll have to do this on your own because I can't link to something that's already with put the numbers in it. So you have to go put the numbers in yourself. I will link to the page where you can put in your own portfolio and analyze it. And as part of the analysis there, you can look at what's called a financial independence calculator. and put in a savings rate, and then look at how long it would take to get to financial independence using that calculator. And so what I did is I decided, well, let's look at both ends of the spectrum that he's talking about. Let's put in 100% stocks, and then let's put in a portfolio that started as a risk parity style portfolio, basically starting what he ended up with, and see what that would look like in terms of accumulation. So, if you look at an 100% stock portfolio, and I just use the basic total stock market here for comparison purposes, and what you get out of that, and this is based on a 50-year analysis of data, is that you will get to financial independence on average in about 23 years, but there's an extremely large variance. You could get to that number in as early as 16 and a half years or as long as 29 and a half years. but the average is 23 years. And you can see that on that graph that it starts narrow and then it expands way out as to show you the variance in holding that kind of portfolio. And that is with a 8.3% compounded annual growth rate, that's a real rate after inflation, for that portfolio. But then I decided, well, let's look at the other end of that spectrum. Let's take what he plans on ending up with, which is 51% stocks, 26% long-term treasuries, 15% gold, and 8% short-term treasuries. Now, if you were to accumulate in that style of a portfolio, you'll see the variance is much less. And so the shortest period is 21 and a half years, and the longest period is 26.5 years. And so that variance is only five years that it's going to be a steady climb. The average is actually 24 years. And think about that. If you compare the two of them, it's only a year difference between the two of them in terms of the average. You get the more predictability, obviously, with the more diversified portfolio. Now, obviously, you can also put in all of the variations that he had and you're going to get things that are in between these two portfolios in terms of accumulation. So why is that? Why are they so much more similar than you might think? And that's a good question to contemplate. And when you contemplate that and think about how an accumulation phase or accumulation portfolio works going from zero to some number, you realize that it's essentially two features. It's mostly about the cash contributions in the beginning years of it. In fact, the cash contributions will dominate for a number of years until you get out to maybe 10 years of contributing. And I'm assuming you're contributing similar amounts just for the sake of thinking about this for this purpose. And so that's the first feature of it. But then the second feature of it is it's mostly about compounding at the end. And so on a time scale, if you are doubling every nine years, say you're at an 8% compounded annual growth rate using the rule of 72, you're only going to get halfway there when you're 9 years out. And to get in the rest of that time, the preceding years are probably going to be somewhere in the 20-year time frame just to get halfway there. The other thing to think about here and why a younger person who is starting out really wants to be aggressive and have lots of equities in their portfolio. is because you are essentially sitting on a big pile of future cash at the beginning of your journey. And that's all you have. Your portfolio is essentially 100% in cash and you don't have access to it yet because it's going to come in over time as you earn it and then put it into your portfolio. So if you think about it that way, those first few contributions are just reducing that pile of cash by relatively small amounts. And so a decade in, you are still only maybe 25% to 30% in stocks, and the rest of it is still in this future cash pile. When you think about it that way, you realize that it's not very risky or aggressive. to put all of your money into stocks to begin with because you just don't have that much money to put in versus how much money you'll have to put in later. And what this tells you basically, if you want a rule of thumb, is that you probably want to ride the pony in terms of being aggressive until you get at least halfway to this number that you've come up with and then think about reducing your exposures at that point in time. And that's a a pretty good rule of thumb because you're talking about a much more compressed time frame after you get to that halfway point. But this leads us to sort of more philosophical questions about what are we actually trying to do here in accumulating these portfolios? And I think there's a myth and a reality of wealth accumulation going on here. The myth of wealth accumulation going on here is that It's all directed at one goal that we are going to accumulate this certain amount of money, and then we're going to completely stop accumulating and start living on that money for the rest of our lives. And that's all there is and there isn't any more. And the projections that are commonly used, the 4% rule and those things like that are based on that myth. that you're going to accumulate for this one period, and then you're going to stop, and then you're going to deaccumulate after that, and that's all you're allowed to do. Now, the reality of wealth accumulation is that it's a lot messier. Most people are not going to stop accumulating when they hit a particular number, even if they think that that is going to be sufficient for them for the rest of their lives. They may be in in the middle of a career, they may have other ideas, other businesses that they want to run, other ways of making money. So it's fairly unrealistic to think that anybody's just going to accumulate like mad to a certain point and then stop after that. What does that reality lead you to? It leads you to starting to think about your overall wealth accumulation in two different pots, if you will. And one of those pots is the money that you need to have to live on, that money that will give you the autonomy not to have to go out and make more money or work for somebody else or do something you don't want to do. And then there's the money besides that. Now, the way I like to think about this comes out of a movie. and it's not a very good movie, but it has a couple of really great scenes. And it's called the Gambler. And in one of these scenes, John Goodman is in it and he plays this kind of mob boss, loan shark guy, but he's also almost a financial mentor to the main character played by Mark Wahlberg, who is just bad with his money and he gambles it. and he will make millions of dollars and then lose millions of dollars. And that's why he's got to come to Goodman to get more money. I'm going to have to paraphrase what he says in this scene. I will link to it in the show notes. It's several places on YouTube. But what he talks about and what he tells the Mark Wahlberg character is that if you get to a certain point, if you accumulate a certain amount of money, You need to treat that as what he calls your fortress of solitude. That, in my mind, is your risk parity style portfolio, that fortress of solitude that's going to last you however long it needs to last. And you take that money and you invest it wisely, not so that you can stop accumulating, but so that you can take more risks with the other money that you accumulate in that other pot. You can take speculations, or you can just go off and boondoggle it and spend it on hobbies, travel, or whatever. But the point of the matter is that it's better to think about your money accumulated or your wealth in these two pots, that you want to build that fortress of solitude, in my mind put it in a risk parity style portfolio, or something with very low variance, and then any risks you take take them from that position having that fortress. Now if you don't know what to do with the money, just add more wings onto the Fortress of Solitude. There's nothing to say you just can't keep building it out until you have another idea and then maybe you tear down the wing and go off and speculate or do a boondoggle or do whatever you want with it. But whatever you do, you don't want to end up like Marge Simpson. You have a gambling problem. That's true. Or the character in that movie played by Mark Wahlberg. Another way of saying what I've just said is that when you've won the game, you need to stop playing or at least stop playing so hard. Take some of your chips off the table. Which brings me back to Luke's question and his plan is a good plan. It should work just fine. It will get you there in a nice reasonable amount of time without too much trouble, and that's okay. In terms of what would be sort of the outer limits of what I would recommend for somebody who was trying to get to an accumulation of a certain size and then convert it into a risk parity style portfolio. I would say once you get to about five years out from when you think you're going to stop working or start relying on that money in some ways, that is the time that you should be converting to that risk parity style portfolio. If you hit your number at some point along the way early, just convert that portion right then and there, and then you can take the rest and speculate with it or Boondoggle it, but however you'd like to treat that other money, and since you have more money coming in, so you could increase your lifestyle if you wanted to. Really, the key factor here is not getting caught in those sequence of return risks. And so when you get up to close to what you think is your number, you should take your risk off the table. You don't want to have a 50% downturn just because you want to ride the pony a couple more years. So you would want to convert that as soon as you are getting close and your portfolio is near an all-time highs. Because the other mistake that people make is they keep riding the pony. Then they fall off the pony because of a downturn and they think, oh, I'm off the pony now. Now is the time I should be reconfiguring my assets and that's exactly the wrong time to do it. The time to do it is when there's nothing going on and everything is rosy, but you are getting close to where you think you need to be. So you make these decisions based on your own personal situation. and not on what the market is doing other than you're feeling good about where you are. But if you'd rather have a smoother glide path, like Luke has described, moving a few things over as you go up the ladder there, that is fine too. That should work just as well. And we saw from the analysis that it's really to be a difference of a few years, which may not make much of a difference if you're in the middle of a career anyway. So, Luke, I would say you're doing good and just keep doing what you're doing. Keep on, keep it on. Now let's move on to our second question, a little less more involved this time. This one comes from Matt R. And he says, hi, Frank. I just listened to episode 50 and had this thought as you reviewed the portfolio's performance. Now, after several months of overseeing these portfolios, would you construct the experimental portfolios differently today than when you did back in July? Regards, Matt. And just to review what he is referring to, these are two of the sample portfolios over at the website www.riskparityradio.com that we review every week. and the two experimental portfolios are the ones that use leveraged funds in them. One of those portfolios is called the Accelerated Permanent Portfolio, and it is 25% in UPRO a leveraged S&P 500 fund, 27.5% in TMF a leveraged bond fund, and then it's got 25% in preferred shares, PFF is the fund, and 22.5% in a gold fund, GLDM, and those preferred shares in gold fund are basically ballasted for the rest of the portfolio, which really is a lot more volatile. And the other experimental portfolio we have in there is called the Aggressive 50/50, which is essentially 50% bonds and 50% stocks the way it is divided up. It is 33% UPRO, that leveraged stock fund, 33% TMF the Leverage Bond Fund. And then as that ballast again, it's got 17% in VGIT, which is just a simple intermediate treasury bond fund and 17% in the preferred shares stock fund PFF, giving you 50% stocks and 50% bonds if you divide it up that way. Now to answer your question, Matt, I don't think I would have changed what I use for those portfolios. And the reason is this, they are purposely not optimized. I wanted to keep them simple and similar to other portfolios that were out there in the world. And so one of the most common portfolios in retirement is a 50/50 portfolio, stocks and bonds. In fact, that is something say that Paul Merriman holds in his 70s and he's very happy with and he takes 5% out of it every year and it works fine that way. I just wanted to see in for that portfolio, what if you took a standard portfolio like that and just stuck some leverage in it to see how it would perform. Now the other portfolio is based on the old permanent portfolio that Harry Brown came up with in the late 1970s, which was originally 25% stocks, 25% long-term treasuries, 25% gold, and 25% short-term treasuries. That is a very conservative kind of boring portfolio that does perform adequately over time. But again, it's so conservative that most people would not really want to hold it. long term, I thought that, well, if you applied some leverage though to that conservative portfolio, what would that look like? And so that is the basis for the accelerated permanent portfolio. The idea of both those portfolios was to take something that was off the shelf, very conservative, and then add some leverage to it. The other thing that I wanted to avoid was doing much of any optimization of those portfolios because I really wanted to see how they perform based more on the leverage in those funds and less on some kind of optimization of particularized funds. And so they are designed to be very basic in that way. And so if you were going to construct one of those portfolios, you might do a little bit more optimization than what you see there for my own part. And I wouldn't recommend you actually use these experimental portfolios for anything other than something that would fall in that speculation category, things that do not need to be part of your fortress of solitude, if you will, but are something that you want to experiment with. And for me and for us, I do have one of these, but it is in a Roth account that we never expect to touch and is likely to be left to our heirs when we pass away, hopefully 30 or 40 years from now. And so we don't anticipate actually ever using that money. So what I've done in that account just so you can think about alternatives, is I've created a experimental portfolio that looks like 26% UPRO and 26% TMF for a total of 52% or half of it. And the remaining 48% then is divided up into what would be a very conservative permanent portfolio kind of portfolio if you looked at it on its own. And the reason I like to use 48% by the way is because it divides evenly into two, three, four, and six. So you can easily pie it up into other different things and still have whole numbers, which for whatever reason I like to have whole numbers. So that's why I use 52% for the leverage part of this and 48% for the conservative part of this. But anyway, in the conservative part of this, there is 12% in small cap value, and you can use VIoV or IJS for that. 12% in a preferred shares fund, PFF I'm using. 12% in intermediate treasuries, VGIT, and 12% in gold, which you can use BAR or GLDM if you'd like to for that. and I've got that on a rebalancing schedule where I look at it every month. And if something has moved more than 6% from its target allocation, then it's time to rebalance that portfolio. What you'll see from that, if you run it through some of those calculators, is it gives about the same kinds of performance as the experimental portfolios on the site, but it's a little more conservative, a little more stable, if you will, but I've not gone much beyond that. I still want to keep those portfolios as simple as possible. But again, I am not making any recommendations to you. I am just providing you with some ideas from my amateur do-it-yourself perspective. But now I see our signal is beginning to fade. I wanted to I want to thank Luke and Matt for those very interesting questions. When I read things like that, it always sets off lots of different ideas and thoughts in my brain. If you have a question or comment, please send it by email to frank@riskparityradio.com that's frank@riskparityradio.com or you can go to the website www.riskparityradio.com and fill out the contact form and I will get your message that way. We will pick up next time this weekend with our weekly portfolio review and since it's also the end of the month we'll be talking about distributions out of the sample portfolios for February.

Mostly Mary [25:02]

Thank you for tuning in. This is Frank Vasquez with Risk Parity Radio signing off. 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.