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 [0:18]

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. Thank you, Mary, and welcome to episode six of Risk Parity Radio.

Mostly Uncle Frank [0:44]

It is time for our weekly portfolio review of our six sample portfolios, and after that we'll be talking about the Golden Ratio portfolio in particular. Looking at the first portfolio, the All Seasons portfolio, this is our most conservative portfolio. And you can see these portfolios at the website www.riskparitario.com, just click on the portfolios tab there and you'll go to that page. So the All Seasons portfolio for the week was up 0.8% and you can see how stable it was performing as kind of expected. It is still up 2.3% for the period since inception, which was just last month. And it is still being led by the gold portion of that portfolio. The next portfolio is the Golden Butterfly portfolio. And that portfolio is up 2.2%. last week. And you can see just looking at the Friday returns, which are to the left of the overall returns when you go to the website and take a look at it, you see that you had things going up and things going down. Gold had a bad day on Friday, small cap value had a good day on Friday, the overall stock market was pretty flat. other things were flat or down. And so it ends up being flat for the day. And this is a typical kind of performance you'll see out of a risk parity portfolio. Many days it will not move a whole lot, keeping the volatility down. But it is still up 6.2% for the period of existence, which is less than a month now. And it is led by the gold allocation in that portfolio and the small cap value allocation, which seems to be having some legs right now, at least recently. The next portfolio is the Golden Ratio portfolio that we will be discussing in more depth later on in this episode. And looking at that one, that one is up 2% for the week, up 6.2% for the year. to 6% since inception last month. And you can see also that Friday is a good example of a typical day for this. It is down 0.05% or $4.96 with different components moving in different directions, including the stock market allocations to small cap value going up, the 1-2 large cap growth going down, you see the REITs going up, the gold going down, and the bonds kind of holding there slightly lower. And this also is a good example of how these portfolios typically perform. They are just much more stable and much more steady than you will find in a typical heavily weighted stock market portfolio. Looking at the next portfolio, the Risk Parity Ultimate, and this one has the most asset classes in it with 12 different funds. And you can see that this one also is very stable. It is up 1.45% for the week, a total of 5.32%. And if you look at the returns for Friday, it is down 0.05% because about half of its components, actually exactly half of its components, six of them are down and six of them are up. And this is the kind of performance you'll typically see on a daily basis from one of these types of portfolios with it going up as a bias long term, but short term often being flat. So for instance, on Friday, the bonds were down, the gold was down, most of the stocks were up, the REITs were up, the preferred shares were up, and the investment in the ETF VXX, which is volatility, was down that day. Although it was up earlier in the day, it's a very volatile component of that portfolio by itself. Looking at the fifth portfolio, the Accelerated Permanent Portfolio. Now this one is our portfolio leader so far in the less than a month that we've had these things going. It is up 8.44% since inception and was up 1.9% last week. And you can see how using the leveraged funds here makes this a little bit more volatile. It's more akin to the volatility of a stock market. But you also see how this can be to your advantage. Overall so far the gold portion is up 12.3%, the bonds portion is up 7.13%, and the stock portion is up 11.8% with the preferred shares at positive 3.2%. Now you wouldn't expect these things to all move in a positive direction all the time and in fact on Friday again you see half of the portfolio going down and half the portfolio going up. And so it was down 1% on Friday consistent with the kind of volatility that you'll have in a portfolio like this. In the aggressive 50/50 our last portfolio which is 50% stock based and 50% bond based. It is up 6.78% for the time it's been in existence since last month and is up 1.7% for the week. And on Friday you can see again we have a split with two components going down the bond components and two components going up the stock components. It was down 0.78% on the day. So again, this is a leveraged portfolio, but it has about the same volatility as the stock market with projected overall returns in excess of 10% when we get to discussing this one in a few weeks. We'll go through that in a lot more detail. So now let's focus on the Golden Ratio Portfolio, which is our portfolio of the week. First thing, why is it called the Golden Ratio Portfolio and what is the Golden Ratio? The Golden Ratio is an ancient constant that is used in mathematics. It is known by the ancients to be visually pleasing in architecture. If you proportion things, one direction being the Golden Ratio and the other direction being one, it looks good. It also appears very many places in nature and appears all over the place as you start to look at things. It technically, and I'll give you a little bit of the math here, but we'll also link to the show notes to the Wikipedia entry about it because it's pretty comprehensive. So it solves an equation that is x squared equals x plus 1, and the golden ratio is the number that if you put in there that equation would be true. So it gives you some interesting properties. In fact, 1.618 is the golden ratio. If you square the golden ratio, multiply it times itself, you get 2. 618, which is 1 plus the golden ratio. And if you divide the golden ratio into 1, 1 over the golden ratio, you get 0.618. 618, which is the golden ratio minus one. So these proportions have been found to be useful in allocations for portfolios. If you consider what is the 60-40 stock bond portfolio, that actually is a portfolio that is pretty much proportioned into the golden ratio to be a true golden ratio portfolio that would be a 62/38 because the ratio between 62 and 38 is the golden ratio. One thing I like about the golden ratio, it is represented by the Greek letter phi, which is a nice coincidence because if you're phi or choosing phi, the golden ratio is your friend. Now, How did we structure the Golden Ratio portfolio? We use the Golden Ratio to develop the proportions in the portfolio of the various components. And so when I constructed this, and the first time I did it was about four years ago, we were looking to take five asset classes, differing asset classes, and arrange them in a portfolio that would be robust and provide a lot of diversification, leading to a higher projected safe withdrawal rate was the goal here. And I had looked at the permanent portfolio, which we discussed a bit in episode three, and at the golden butterfly portfolio, which we discussed last week in episode four. and discovered that we could proportion to get to 100% a portfolio of five asset classes based on the golden ratio if the components were 42% of one thing, 26% of another, 16% of another, 10% of another, and 6% of the fifth component. Now all of those numbers added together equal 100. But they are all proportioned to the golden ratio. So if you take 42 and divide it by the golden ratio, you get the 26. And then you take the 26 and you divide that by the golden ratio and you get the 16. And then if you take the 16 and divide it by the golden ratio, you get the 10%. And then you take the 10% and you divide that by the golden ratio and you get the 6%. So it's a very orderly collection of asset allocations. It also has an interesting property that if you add the two asset allocations below, they add to the next one above, which is another property, the golden ratio. What I mean by that is if you're looking going up the scale, you start with six and ten, you add six and ten and you get 16, which is the next one on the list. You add 10 and 16, you get to 26, which is the next one on the list. and if you add the 16 and the 26%, you get to the 42, which is the next one on the list. And that is because the golden ratio is also the solution to what is known as the Fibonacci sequence, if you're familiar with that sequence of numbers that is added to itself and increases along the way. Then the question became what asset classes should go in each one of these components? Now, looking at other portfolios, it is pretty obvious that the stock market is going to be your best driver of returns and is the natural portfolio component to put in at the 42%. And so we put that one in at the 42%. And then the next consideration was, well, what is the most negatively correlated asset to the stock market? and what you get is long-term treasury bonds. And so we put the long-term treasury bonds in at the 26% allocation. Then you're looking at another asset class and you're thinking, well, what can I put in here that is diversified from both stocks and bonds? And really the most diversified thing from both stocks and bonds happens to be gold or precious metals. And so we put that in as the third component at 16%. And then you have the two lower components and they can actually could actually be composed of a number of things. I've toyed with different types of asset classes that can go in at the 10 and at the six. One of those is REITs, another one is preferred shares. Those both are nice income producing asset allocations that fit very well in at the 10 or at the six. The other thing that you want to consider is do you want some cash in this portfolio, which is what we've done in the sample portfolios, put that in as the 6%. Because if you're thinking you're drawing down 6%, if you were using the 4% rule, it's going to be about 1.5 years worth of cash there that you can draw down on, even if the rest of the portfolio is not performing well that year. And so it makes a nice allocation to have there. So in the sample portfolio, and you can take a look at this online at the portfolio page at www.riskparityradio.com, you will see we've got a stock market asset class, and you could put as many different stock funds in there as you want to. You could comprise that of individual shares if you wanted to, you could just make it one total market fund. It's not really that critical for the purposes of constructing this kind of portfolio, exactly what those components are. You do want them to be low cost and as diverse as possible generally. So we picked three nice funds. One is the Vanguard Large Cap Growth Fund. Another one is the Vanguard Small Cap Value Fund. So those are VUG and VIOV. And those worked well together because they are pretty much completely diverse. The VUG has all of your big companies in it, the FAANG stocks and all of those sorts of things. The VIOV is a lot of your disfavored smaller companies that do well over time. And we took another fund we added to this called USMV. Now, what is that? That is a minimum volatility fund that is designed to essentially mimic the behavior or performance of the S&P 500, but has less volatility over time. And so that fund has about 200 shares, different stock components in it, and they are all things that you'd recognize, including things like Microsoft and McDonald's and Procter and Gamble and Coca-Cola and many others of that nature. But it is a lower volatility version of the S&P 500 essentially. And so we took that 42% and divided it up into three for each of those funds, and that makes 14% as the base amount for that. And if you look at that portfolio, you can see that It's been a good month for small cap value. It's up 12.13% in less than a month. And the other ones aren't doing bad. They're at 3% and 4%. But if you have funds like this, you'll likely get variances in performance, but an overall smooth performance that can be rebalanced later on. Now for the bond portion of this, we go with long-term treasury bonds because they are the most diverse from the stock market. We will be having an entire show just on bond funds and how they behave because different ones behave very differently. So what we've used is the ETF TLT and that is 26% of the portfolio. That is the most popular long-term treasury bond fund. You can find ones that are even longer term such as extended duration value fund from Vanguard or even further out on the scale there, or intermediate bond funds, but they really aren't as diverse from the stock funds as TLT and a typical long-term bond fund like that. So we went with GLDM for the gold portion of this. GLDM is a A gold fund that mimics GLD. It's just a miniature version of that put out by the same operators who put those things together. So it has a lower share price, but that's about it. And so that is the 16%. And then we went within this sample portfolio a REIT fund for the 10% and we used R E E T and that is just a kind of placeholder refund. It's a global refund, so it includes not only domestic US REITs, but a lot of international REITs. Now, you could take that and take it apart. You might use something like VNQ and VQI, the Vanguard funds for that, or you might pick individual REITs because there are many types of individual REITs and they don't just cover real estate per se. Some of them are into data storage or cell towers or public storage units or even timber. And a variety of those REITs could be put in there. We just went with one fund for the purpose of this sample portfolio to make it easy to look at. And then we also have 6% which is in the just the Fidelity Government Money Market SPAXS, SPAXX fund, which is just the thing they sweep the cash into. And so it will sit there in cash and that's what we're taking out of as we draw down on it. This portfolio will be rebalanced once a year and so you'll be able to see how that works. And in any given year you would expect some of these components to go down and some of them to go up. They will move in the opposite direction. Now, if you were constructing your own version of this, you have a lot of different opportunities if you wanted to put other things, particularly in that smaller aspect of the portfolio, that 10% or that 6%. And you could break down those two things into even more components. Suppose you wanted to put some cryptocurrency in there. You could put 1% or 2% of that in there. You could put preferred shares. You could put Master Limited Partnerships, or maybe you just want to take that component out and invest it in peer-to-peer lending or something else entirely if you can keep track of it. But that is really where you put your small either income producing things or more speculative things because the main part of this portfolio is really the stocks, the long-term Treasuries, and the gold and everything else is going to be kind of icing on the cake for that. Now let's talk about how this portfolio has performed in the past doing Monte Carlo simulations and back tests and comparing it to other typical portfolios. We went over to portfolio charts where they have 50 years of data that you can analyze and put this thing in there. And what it shows is that for a 30-year projected safe withdrawal rate for this portfolio, it is 5.9% and a projected permanent withdrawal rate is 4.8%. And so that's what you could expect to be able to withdraw from this kind of portfolio on an annual basis and be safe with it. Now we'll compare that to a total stock market fund portfolio and the typical 60/40 portfolio. First of all, before we do that, the average compounded annual growth rate for this portfolio is about 6.9% after inflation. So it's close to 7% after inflation. Now that compares with the total stock market's compounded annual growth rate of 8% after inflation and a 60/40 stock bond portfolio would have a compounded annual growth rate of 6.1% after inflation. And again, all of this information is taken from the Portfolio Analyzer at Portfolio Charts. So this is where things get interesting because you might expect a portfolio with a higher compounded annual growth rate to also have a higher safe withdrawal rate. But in fact, that is not the case because the volatility of the portfolio can bring down that safe withdrawal rate to a lower figure than something that has actually a lower compounded annual growth rate like this Golden Ratio portfolio. So in comparison, the total stock market portfolio has the compounded annual growth rate of 8%, which is larger than the Golden Ratio's compounded annual growth rate of 6.9%. But the total stock market portfolio has a safe withdrawal rate of only 4.3%, which is much less than the safe withdrawal rate for the Golden Ratio portfolio, which is 5.9%. And in fact, comparing those two, the Golden Ratio portfolio essentially has 30% better safe withdrawal rate than a total stock market portfolio. and that means that you can either take a lot more out of this portfolio in retirement or you don't need as much to retire with this portfolio as you would if you were operating with the total stock market portfolio. And the comparison to the permanent withdrawal rates is similar. The permanent withdrawal rate, essentially forever for a total stock market portfolio, is only 3.5%. The permanent withdrawal rate for the Golden Ratio Portfolio is 4.8%, which again is about 30% better than the total stock market portfolio. Turning to the 60/40 portfolio, now this portfolio, Stocks Bonds, which is the typical retirement portfolio, has a compounded annual growth rate of 6.1%, so it's about 0.8% less than the Golden Ratio Portfolio. It has a safe withdrawal rate of 4.5%, which is better than the total stock market portfolio, but not anywhere near the safe withdrawal rate for the Golden Ratio Portfolio. And again, you're looking at about a 30% difference comparing 5.9% 30-year safe withdrawal rate for the Golden Ratio to 4.5% 30-year safe withdrawal rate for the 60/40 portfolio. And the permanent withdrawal rate for the 60/40 portfolio is no better than that of the stock market overall. It is only 3.5%, whereas the permanent withdrawal rate for the golden ratio portfolio is 4.8%. So you see that for a drawdown portfolio, the golden ratio portfolio is vastly superior to either of those other options. And if you look in detail as to why that is the case, why it is the case is that over that 50-year period that we're talking about from 1970, the maximum drawdown for the Golden Ratio Portfolio was only 16%, which compares to something like 40% for the total stock market and something like 25 to 30% for the 60/40 portfolio. And the length of that drawdown was only three and a half years. The worst year for the worst sequence of years for the Golden Ratio Portfolio was in fact 1973 to 1976. Comparing that to the Total Stock Market Portfolio or the 60/40 Portfolio, both of those could have potential drawdowns that last longer than a decade. which could be devastating to somebody who is trying to begin retirement on such portfolios. And if you look at more modern times, put it that way, the last 20 years, the Golden Ratio Portfolio has only had five negative years in the last 20 and has only been down more than 10% I believe in 2008. Now we also took this portfolio and ran it through the analyzer at Portfolio Visualizer to do a little back test. Now this back test does not cover as long of a period of time. It only goes for about the past 10 years. But during that time it had a compounded annual growth rate of 8.92%. The best year was 21.66%. and the worst year was a mere minus 3.56%. That also includes the current year, the maximum drawdown for the Golden Ratio Portfolio over the past 10 years was only 8.3%, which occurred just this past March. So you can see that this portfolio is a sleep at night portfolio because it is unlikely to have those serious drawdowns. And that ultimately is why you can have more confidence in it and have a higher safe withdrawal rate if you take from it regularly as we are doing with our sample portfolios every month. So that wraps up the Golden Ratio Portfolio. It is one of the base portfolios that I use for our investments. and it has proven to be a very nice portfolio for that. The other use of this portfolio is for medium term investments. And what I mean by that is if you were trying to save for perhaps a house or some large purchase over the course of say five years or some figure along those lines, this would be a good portfolio to save your money and you're going to get a decent return out of it. And the chances of it being down or being down significantly when you need the money are relatively small, particularly if you can wait just a little longer if you have to for it to come back up. I've seen this portfolio used for that purpose. It works very well as kind of a medium term portfolio. So if you were in your accumulation phase, and you don't really need this portfolio in your accumulation phase, you should be more focused on getting the growth out of stocks. But if you're in your accumulation phase and you have a different set of goals in mind for some kind of purchase that you need to make in five years or so, this is a good option for doing that. Because the only other options that are usually presented are, we'll keep it all in cash, or put it all in the stock market. Both of those options are sub-optimal because obviously the cash component doesn't really make you any money along the way and the stock component is too risky because it could be down significantly when you need the money. If you put that money instead into a golden ratio style portfolio, you're likely to get some nice growth and then also have that money there when you need it. And now I see that our signal is fading and it is coming time for us to say goodbye. Tune in next time to Risk Parity Radio, where we will discuss all things risk parity from the theory to the practice. This is Frank Vasquez for Risk Parity Radio, signing off.

Mostly Mary [29:44]

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.