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 75 of Risk Parity Radio. Today on Risk Parity Radio, we are going to begin our analysis of SPLB, a long-term corporate bond fund. as suggested by one of our listeners, and we'll be using David Stein's 10 Questions to Master Successful Investing to go through that. But before we do that, we did have an email I wanted to respond to.

Mostly Voices [1:11]

Here I go once again with the email. And here we go with that.

Mostly Uncle Frank [1:15]

This one comes from Mark H. Mark H writes, My wife and I are 50 looking to retire in three to four years. Current portfolio is about 35% VTSAX in a regular Vanguard account, 45% privately held tech corp, wife's employer gains about 15% per year in recent years, which needs to be withdrawn at termination of employment, and the remainder in 401k equivalent accounts with 20% bonds, 20% international and 60% VTSAX and similar funds. We vest about another $150k in company stock each June through 2024. I have a state employee pension that I will be eligible to draw an annuity from as early as age 55. If I die before starting the annuity, my wife gets what I put in with no employer match, so there is some risk to deferring the annuity. Okay, this is an interesting situation, Mark. One thing I will direct you to, I just did another analysis like this for Chuck H. Back in episode 68, where we talked about some issues as to tax brackets, tax loss harvesting, and a basic framework for doing this kind of analysis and getting yourself together as you get towards retirement. So I would go back and listen to that. I will link to it in the show notes because it has a lot of other good links. But let's just step back and take a look at what your situation is. I think the first thing you need to do actually doesn't have much to do with your investments but is to figure out what your expenses are. Because that's really going to drive ultimately how you position this portfolio, which is a little bit complicated. So there are two ways to do that. And I would start with actually what you're spending right now, just to get a baseline, and then you can do a projection of what that's going to be like in the future. But there are basically two ways of doing that. You should do it from ground up, look at your expenses for the past year or past couple years, since if this is a weird year with COVID and figure out what those are. from a bottom-up perspective, but then also do it from a top-down perspective. And the way you do that is to take your tax return, look at your gross income, subtract the taxes off it, and then subtract everything you saved off of it. And that'll give you another number, and hopefully those numbers match. Now, if you don't want to go through all of this exercise, I would get somebody a financial planner to help you do this grind because you really need to know what that number is and then think about whether that's going to change or how that's going to change when you get to your retirement, which is only going to be in a few years. So I think most of those things are probably going to be similar. There'll be a few things that are different. The one thing you also need to account for is healthcare. You can price that by going to healthcare.gov or maybe you have that already through your state employee pension situation. But that's the other thing I would add into that. Okay, then once you have that number, we can go through the three steps that I talked about in episode 68, which are first to take inventory of what you have in your accounts, then arrange that inventory in the way you may think about taking it out during your retirement, especially in the early years, and then make any fine tuning or adjustments that you need to do with the idea that you will continually make adjustments as you go forward, particularly when you get past 59 and a half and have the opportunity to potentially start converting things to Roths. So the easiest way to account for an annuity, and I'm just going to assume right now that you're going to take that annuity or pension payment when you get to age 55 just for the purpose of this analysis. It doesn't mean you have to, but the easiest way to account for that is simply to subtract what that is off of your expenses. Because that is pretty much a sure thing. I can't speak for every state, but it's pretty much a sure thing that you can count on that money so you can just take it off your expenses and then you have that lower expense amount and that is kind of the amount that needs to be supported by your other assets. And so the most intriguing management issue here obviously is that privately held corporation. And it's not clear to me whether that money is coming out already taxed or it's coming out into some kind of retirement vehicle. So it's going to be a little bit different whichever one it is. But basically you need to manage that money and get it out and start converting it into other things. It's just too much to have in one asset, particularly when it pertains to one company. So if it makes sense to start converting some of it now, I would go ahead and do that. If it doesn't make sense tax wise, you may have to wait until you retire and don't have any income. and then begin the conversions then. But that is also the place where you are likely to take your initial distributions as you can spend that down to essentially reallocate it with the rest of your assets. And eventually, and this may take a few years, you will get to a situation where you won't have that anymore or will have and only a small portion of that anymore, whichever you'd like to keep, probably 5% of your portfolio would be a good ballpark to think about that kind of risk because it's an individual risk and it could go to zero. And whenever you have something that could go to zero, you want to make sure you're not putting too much into it. Okay, so for the rest of your portfolio, Then you need to think about two things. One of them dealt with very well in episode 68, which is tax location that essentially you want in the taxable side, your stocks and anything that's paying qualified dividends. And in your tax deferred accounts, you want things that are paying ordinary income for the most part. And it doesn't need to be all one way or all the other way. Just the general guideline in terms of what you should hold in your portfolio. The first thing I would do is take whatever you're holding now and go to the portfolio asset correlation analyzer at portfolio visualizer and see how correlated it is. Because that's the first question. What are these things doing and are they doing the same things? And then you'll need to decide how you want to modify that and maybe you can look at the sample portfolios here, if you're interested in this style of retirement portfolio construction, and what I mean by is the risk parity style, what you will be morphing to in that circumstance is something that looks a lot like 70% of your invested assets in a combination of stocks and treasury bonds, and then that other 30% in alternatives. which could include conservative things like short-term bond fund, it could include gold, it could include REITs, preferreds, perhaps a utilities fund, but that's what you're kind of looking at for that. And once you figure out sort of what you want to morph your retirement portfolio in, and I should say that a lot of that is determined by your expenses and how much your expenses are after that annuity payment. Because if you know what your big pool of financial assets are and you know what your expenses are, you'll know what is the percentage that you would need to withdraw from that portfolio. And you want to think about what's the most conservative version of that that I could use to meet my expenses. And by conservative, I mean lower percentages of your base stock funds. And then you can take more risk than that if you want, but that's kind of a base of where you want to go. There is also a good calculator that I referenced in episode 68 as well on portfolio charts. It's a retirement calculator. And you should think about taking whatever your projected portfolio is, putting it in there and seeing what the test driving looks like. if you took out a certain percentage with a withdrawal strategy, you can adjust the withdrawal strategies there. You can adjust the asset allocations there and get a good idea of what that would look like. And then after that, after you decide what you need to be in, I think you can start moving your stuff into it pretty soon now if you want to, because it's particularly the things that are in your retirement accounts. There's no tax consequences to it. So you might as well move those things around if you're going to be retiring in three or four years anyway. Your portfolio is probably at all time highs and this is the perfect time to make those kinds of adjustments. And it sounds like you can stay more on the conservative side with that simply because you've got this other large proportion in this tech corporation, which is still potentially very volatile. And so you want to make sure that, because that is a high-risk reward asset that the rest of the portfolio is not taking too much risk. Once you've won the game, you can stop playing. You'll know if you've won the game by doing that expense calculation, multiplying it times 25 to get an estimate, and figuring out whether what you have is going to cover that or not. But it sounds to me like your initial drawdowns will come out of that Tech Corp stock and potentially your taxable account, although it doesn't sound like you may need to necessarily go after that. You may also be able to use the rule of 55 to get at your 401ks at age 55 if you are working then and stop working in the year you turn age 55. But it doesn't sound like to me you're gonna necessarily need to access that money. and can just wait on it until you hit 59 and then start thinking about Roth conversions at that point in time, if it makes sense given what your income is. And finally, I did mention that if you needed help on the budgeting side, even just going through the drudgery of it, get a financial planner to help with that. I would also consult with a CPA. Hopefully you have one that helps you with your taxes. because there are a lot of tax issues regarding that private company stock when it comes out, when it needs to be sold, when it can be sold for capital gains. And then I wasn't sure whether any of it is actually behind a tax deferred structure, which gives you a different pile of issues. And hopefully, if that's the case, then you would just move it into an IRA and convert it into other things. because you won't be paying any taxes on the sale of it anyway. All right, now getting to this analysis of SPLB, and this comes from an email from Jason D. And he writes, Looks like income taxes is likely what is pushing you to choose PFF over SPLB, but the correlations to the stock market look better for SPLB. Maybe hold SPLB and tax deferred slash exempt accounts and PFF in taxable accounts. And I thought that we should do a full analysis of SPLB because that it's better to really do whenever you're considering an investment to go through a full analysis. We use David Stein's 10 questions here. There are many other processes for that, but the point of it is you need to fully understand whatever it is you're considering and then also how it lines up with the other things in your portfolio. So we will get to that comparison with PFF. I'm not sure we'll get to it this episode, but we'll get there eventually because that will be a consideration. But let's start at the beginning. Now, if you are interested in bonds generally and bond funds, we did a nice couple of episodes, episodes 14 and 16. looking at sort of the overall universe of bond funds and which ones are correlated and which ones are not and how they tend to work with other assets and what you might do in connection with them. And so you should definitely go listen to that if you are interested in bonds. We did not talk about too much about this one specifically, so let's get at it. All right, question one：what is it? Well, SPLB is a long-term corporate bond ETF. So it holds longer-term bonds issued by corporations, large corporations for the most part. Most of these seem to be in the 10-year range, and it follows what is called the Bloomberg Barclays US Long-Term Corporate Bond Index, which is designed to measure the performance of U.S. corporate bonds that have a maturity of greater than or equal to 10 years. So 10 years plus. The index is a component of the Bloomberg Barclays U.S. corporate index and includes investment grade, fixed rate, taxable U.S. dollar denominated debt with 300 million or more of par amount outstanding issued by U.S. and non-U.S. industrial, utility, and financial institutions. and that's enough of that. This is from the fact sheet that I will link to in the show notes, but it is a basic long-term corporate bond fund. Okay, question two. Is it an investment, a speculation, or a gamble? Now, recall what the definitions are, and David Stein has very specific definitions for this. And investment is something that produces an income. So it's a business or a debt instrument typically. A speculation is something that does not produce income but may be worth more later, like gold or commodities or artwork or something like that. And what is a gamble? A gamble is something that has a negative expectation. It's casino, it's the lottery, it's something that you would expect to lose money on. binary options fall into that category as well. If you've ever heard of them, stay away from those. Okay, so it's obvious that this is a investment. It is bonds. It is high grade corporate bonds. You expect them to pay an income. Okay, question three. What is the upside? Well, there are two upsides here, and you need to think about both of them. because the one you think is important actually isn't the one that's the most important. The obvious one is the interest rates, the overall interest rate that this bond fund pays. And right now it is yielding 3.46% with 2315 holdings and a adjusted duration of 15.02 years. So that's one of the upsides. The other upside is related to that duration and it is capital appreciation and this affects long-term bonds in particular. In fact, the capital movement of long-term bonds usually overshadows and outweighs the interest rate paid. The interest rate paid is actually just like a little bonus almost. And the reason that is, is that these bonds are volatile and so they can move up and down in value depending on what the overall interest rate in the economy is. So when long-term interest rates are going up, there is a rule of thumb that a bond will appreciate or depreciate about its duration times whatever the interest rate movement is. So that means if interest rates were to go up 1% and we have a duration here of 15 years, it is likely that this will go down in value 15%. They do move opposite to the interest rate, but when the interest rate is going down 1%, this will increase in value by 15%. And that is just a global rule of thumb, it actually gets more compressed as you get closer to zero, but we don't need to go into that right now. Suffice it to say the upside is the interest rate plus the possibility of capital appreciation. All right, number four, what is the downside? Well, the downside is the opposite of what I just told you. You could get depreciation from this. So when interest rates are going up, the value of this fund will decline. And if the interest rates go up 1%, this fund is likely to decline by about 15%. It goes up half a percent, it's likely to decline by 7.5%. So that's the downside. the other downside is the expense fee. This is not much of a downside. This has an expense fee of 0.07%. So it's in the very lowest of expenses in terms of a fund. And so that's a very good expense ratio for any fund. And that's really what's favorable about this, because if you compare this to, say, a managed fund, A managed bond fund might have expenses in excess of 1%, which is a huge drag on a bond fund that is only paying a nominal rate of 3.4%. So you really, if you're going to invest in bonds, make sure you're doing it through index bond funds and not through some managed nonsense because you're going to be losing money if you do that just on that. I will also be linking to a summary prospectus for this. which contains more details all of the various risk factors that would apply to this. All right, question five, who is on the other side of the trade? Well, we're talking about an ETF, so it's the world at large who trades in bond funds. Most of these kind of bonds are held by institutions, lots of insurance companies and pensions and other things like that would hold large swaths of corporate bonds. They're not as popular for individuals for the most part outside of being held within a aggregate bond fund or a total bond fund. But this is not one of those. This is a specific long-term corporate bond fund. All right, what is the investment vehicle? This is question six. The investment vehicle is an ETF. And what's great about ETFs is they're easy to trade. We have no fee trading now. you could trade fractional shares of them if you wanted to. And the other great thing about ETFs is they're well regulated, so there is always established materials that need to be published about the ETF. They're easy to look up, it's easy to find out information about an ETF. That's why we really like to have those as the basis for most of our investments because Then we can tell what they are. And we know that if somebody is not being honest with the SEC, they're going to get in a lot of trouble, which gives them a lot of incentive to be very honest and forthcoming. And so the ETF investment vehicle is a favored vehicle for a do-it-yourself investor. Question seven. What does it take to be successful? Not a whole lot of effort. You can read the fact sheet and the summary prospectus. You just go to your account, buy this if you want it, and hold it. And you would want to put it in an allocation in your portfolio. And so when it goes down in value, you would probably be buying more. When it goes up in capital value, you would probably be selling some and you'd be collecting that interest, that ordinary income on it. And so all it takes to do that is to use your brokerage. All right, question eight, who is getting a cut? Well, who is getting a cut here? We talked about that expense ratio, it's 0.07%. Other than that, there doesn't appear to be any cuts being taken out here. You shouldn't be paying any commissions to trade this fund. And if you are, I'm sorry for you and you probably need to go to a different brokerage, but that should be the only cut being taken out of it. The other cut you need to be aware of is this is taxed at ordinary income. When I say that, that's the 3. 4% that is taxed at ordinary income. If you were to buy and or sell this and realize a gain or a loss, that would be a capital gain or a capital loss and would be subject to those rules. so if it's held for more than a year it's at a much lower rate. That does not count as ordinary income, but you need to be aware of that, that the IRS is going to get a cut eventually unless this is behind a tax deferred account, in which case it will not be taxed either on the income or the capital gains. But I see our signal is beginning to fade and so we will we will finish this next time, rather in two episodes, we will be doing our weekly portfolio review this weekend and do some more emails, and then we'll pick this up next week in the midweek session, or one of the midweek sessions. And we will be answering the final two questions, which are the most interesting, question nine, how does it impact your portfolio, and ten, should you invest? but we will save those for a suspenseful next time.

Mostly Mary [24:47]

Real wrath of God type stuff.

Mostly Uncle Frank [24:51]

If you have questions or comments for me, you can send them to frank@riskparadioradio.com that's an email frank@riskparadioradio.com or you can go over to the website www.riskparadioradio.com and there is a contact form and you can just Fill that out, put in your message, and I'll get it that way. As I mentioned, we will be picking up this weekend with our weekly portfolio reviews and some more emails. This podcast is becoming more and more popular, and I appreciate all of the listeners. And if you have not done so, if you would go to Apple Podcasts and leave a five-star review, that would be great. Okay? Thank you again for tuning in. This is Frank Vasquez with Risk Parity Radio. Signing off.

Mostly Mary [25:43]

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.