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 [0:36]

Thank you, Mary, and welcome to episode 76 of Risk Parity Radio. Today on Risk Parity Radio, it is time for our weekly portfolio reviews of the six sample portfolios that you can find at www.riskparityradio.com on the portfolios page. But before that, we have a couple of interesting emails. Here I go once again with the email. And so let's take a look at those. First one comes from Melissa W. Melissa W writes, Really enjoy your podcast. I am currently using Paul Merriman's 4-Fund Strategy and really like its simplicity as I'm not a math person. What do you think of that strategy as compared to your risk parity strategy? as one approaches retirement and drawdown. Well, thank you for that email that raises some interesting issues. Just for reference, the portfolio she's talking about is an all stock portfolio that is comprised of 25% a large cap blend, 25% a large cap value, 25% small cap blend, and 25% small cap value. And that is this for fund portfolio, for fund strategy we're talking about that Paul Merriman devised. It is kind of intermediate strategy. He's got this ultimate strategy that has about 10 funds in it. This one that's got about four and then the very simple two funds for life strategy. But anyway, what risk parity does is build on the shoulders of giants of people like Paul Merriman. And so there's no conflict here. But what we are talking about when we get to risk parity is not just the stocks in your portfolio, but the stocks, the bonds, and everything else in there and how it all mixes together. So you could take this fore fund portfolio and it would be a perfect thing to be the stock portion of a risk parity style portfolio. and there wouldn't be any conflict or issue there. I assume right now that you are in your accumulation stage, in which case you really don't need a Risk Parity style portfolio because you're not retiring anytime soon. And so if you can stomach the ups and downs of a 100% equity portfolio, the one you have is fine. It would be the same thing that I might recommend to somebody. You could have just one fund if you wanted to do it as simple as possible, but this for fun combo actually works quite well with the value stocks included in it. Now let's talk here about how Risk Parity Radio builds on these principles that we have obtained from people like Paul Merriman. We follow three principles here, and these are talked about back in episode seven if you want the full explanation of them. One of them is called the simplicity principle, which says you shouldn't make your portfolio any more complicated than it needs to be made. And you can see this nice four fund equity portfolio is a nice simple portfolio. The next principle we follow is the macro allocation principle. And what that says, then it comes from the book of Jack, Common Sense Investing by Jack Bogle, chapters 18 and 19. for your reference. And what that says is that for reasonably diversified portfolios, all reasonably diversified 100% equity portfolios are going to perform about 90% the same. All 80/20 portfolios are going to perform about 90% plus the same. Jack says 94%. All 60/40 portfolios that are reasonably diversified across their asset classes are going to perform about 90% the same. So we really need to focus on what those macro allocations are. And in this circumstance, you're talking about an accumulation portfolio. So your macro allocation is 100% zero for anything else. That's 100% equities. When you get to retirement, where Paul Merriman starts, and I'm going to link to a article of his in the show notes where he starts is with the traditional basic 60-40 stocks bonds type of portfolio. And that is kind of the baseline for where we actually start because that is what we're trying to do better than with risk parity style investing in a retirement style portfolio by adjusting macro allocations and then adding other things that are not stocks and bonds to it. Now, what we add here is the buddy system.

Mostly Voices [5:28]

No more flying solo. You need somebody watching your back at all times. Wait a second, you don't belong here.

Mostly Uncle Frank [5:35]

Rex, get out of here. Forget about it. Now what we add here is the third principle, which is the holy grail principle. And that principle says that we should be looking at the overall asset correlations of everything in our portfolio to determine how we can diversify it the best, which has the effect of reducing the overall portfolio volatility. And so you get a higher risk reward ratio. So we're trying to get more reward for less risk when we're doing this. And the holy grail principle is what we add to the earlier things from Paul Mermin and others. to make that happen. So that's really what is value added for risk parity style investing that we're talking about here. Now, what I did to exemplify how this works is we can tweak Merriman portfolios and make them more risk parity like and see what happens with them. So if you go to that article that I'm linking to in the show notes, He talks about a 60/40 portfolio that is modified. Now he's taken the stock parts of it and modified it to make it look like his Paul Merriman ultimate portfolio. We are going to just assume that we're going to take for the stock portion the for fund portfolio that you are using. And so that is what we're going to use. Now on the bond side, what he does with that 40% is he agrees with me and others that your bonds should be in treasury bonds in a retirement style portfolio because those are the most diversified from your equities. But he focuses more on the shorter end of that. So he's got in that portfolio, half of it is in intermediate treasuries, and then another 30% is in short-term treasuries, and then 20% of his bonds are in TIPS. Now, when you map all of that out into a 100% portfolio, and I did this with an analysis on Portfolio Visualizer that I'm going to link to. So his 60/40 portfolio looks like with the four fund combo in it, 15% US large cap, 15% large cap value, 15% small cap, 15% small cap value. and then 20% in intermediate term treasuries, 12% in short term treasuries, and 8% in TIPS. And so you have 60 and 40 and then divided down into what I gave you before. Now to tweak this a little bit, we are just going to change the bond portion of this. We're going to leave those stocks, your four fund portfolio, exactly the same. And so we come up with a slightly different portfolio where all of the stock funds are the same, but instead of having the intermediate short term and treasuries and TIPS, we go with long-term treasuries and gold, which are more diversified from what he's got in there. So in our version of this 60/40 portfolio, we're going to have 25% in long-term treasury bonds, and 15% in gold. And then also for comparison purposes, I put on this portfolio visualizer comparison, what we call the Golden Ratio Portfolio, which is a sample portfolio on our portfolios page. And that one has 42% stocks divided into the total stock market, large cap growth and small cap value. It's got 26% in Long-term Treasuries, 16% in gold, 10% in REITs, and 6% in cash. And we ran these all against each other to see how they performed. And here are the basic results for that. And I should say this just goes back to 2001 because that's all the data that was available there. But anyway, if we take that Merriman for Fund 6040, including the Merriman Bond recommendations, Over this period, that had a compounded annual growth rate of 7.3%. Now with the risk parity tweak, that jumps to a compounded annual growth rate of 8.85%. And that compounded annual growth rate is basically the average growth for one year over the whole period of years. And so we're over 1.5% better per year. The standard deviation though, well the standard deviation is about the same I should say. It's 9.55 for the Merriman 6040 and with the Risk Parity Tweak it's 9.8. The best and worst years, you'll see that the regular Merriman has a best year of 23% positive and worst year of minus 18% approximately. With the Risk Parity Tweak, the best year goes up to 25%, but the worst year only is only 15%, not 18%, so it's better in that circumstance as well. And so you get a maximum drawdown, the original one is minus 31% with the risk parity tweak, it's minus 28%. This all comes out to yielding a sharp ratio of 0.64 for the original portfolio. and 0.77 for the one with the risk parity tweak. So you see it's a superior risk reward ratio there by making this risk parity tweak in this portfolio. But now let's compare that original Merriam portfolio to the Golden Ratio portfolio, one of our sample portfolios. Comounded annual growth rate of the original is 7.3%, The golden ratio has a compounded annual growth rate over this time period of 8.7%. So that is a 1.4% improvement. As I mentioned, the best year for the original merriman is 22.94% positive. It's almost the same thing for the golden ratio, plus 22.18%. The difference is on the worst year side, on the downside, because the original merriman portfolio we're talking about has a downside worst year of minus 18%, whereas the golden ratio only has a downside minus 12%. So it's the best of these three portfolios in that metric. You'll see from this that the golden ratio is slightly less in terms of compound and annual growth rate than that Merriman 4 fund 60/40 with the risk parity tweak in it. But when you go to the Sharpe ratio, the ultimate risk reward for this, the golden ratio is superior to either of the other two portfolios for this period. It has a Sharpe ratio of 0.84 compared to 0.64 for the original and 0.77 for the Merriman Forefund 6040 with the risk parity tweak. And so you can see all we've really done here is taken those original Merriman portfolios. We haven't changed the stock allocations at all. We're just working with the other investments in there and working with them on the Holy Grail principle to get that maximum diversification across the entire portfolio in a holistic way. And that gives you these better performances and better risk reward ratios. And so if you want to see another variation of that, we did some other Merriman risk parity tweak type things in episode 42. If you go back to that one, you can see a couple more of those to, I think, a Merriman Ultimate Portfolio. I should say you should also be listening to Paul Merriman's podcast called Sound Investing because it is an excellent podcast and I've drawn a lot of my pearls of wisdom from that. He's one of the most experienced investors and one of the best people to rely on for the do-it-yourselfer because he really steers you away from a lot of the pitfalls in the financial services industry. So thank you for that email, Melissa. I think it goes to a very interesting conversation, and I hope that will help you understand where you are and where you might be going and how you might use risk parity principles in your future. All right, the second email we have today is from Tony P. And it's kind of a long one, but I will read through it. Hi Frank, I've been listening to your podcast for a few months. I do enjoy the listener questions and your analysis and approach to that. I must say your interview and choose FI made your strategy and approach clearer to me. I've been in the accumulation phase and never understood the bond allocation or should I say could not rationalize it in my mind. Why would I choose an investment class that underperforms equities over the long term in recent years? In '08 and even in March 2020, bond prices fell at the same time as stocks. To me, they did not seem to be uncorrelated. Looking ahead, interest rates can only go up. This means bond prices will fall. I'm struggling with justifying allocating more to bonds. Looking at the Risk Parity Ultimate Portfolio, which has TLT at 11.4% and TMF at 2. 56%, Wouldn't it make sense to do an inverse of TLT and a TMF instead for the uncorrelated bond component? I get that bonds did great for the past decades, but with bond yields at historic lows, are we in unprecedented territory where we need to rethink the old rules? I think there is something I'm missing or not completely understanding relating to bond allocation. I have specifically focused on bonds as I have outside investment in real estate. So I choose not to add any REIT related components. I allocated a small percent to GNR, that's an ETF, they invest in natural resources as a proxy for PDVC. By the way, I've also stayed away from leverage and inverse ETFs while UPRO does great in a bull market, it would be pretty painful times three in a correction. The 10 plus year bull market might have some newer investors falsely believing that stocks only go up. Also, leveraged ETFs are not meant to be held for long periods in my opinion. Had a friend recently get burned with SRTY, that's an ultra short Russell ETF. He, like most of us, could not rationalize why the market keeps going up when employment, restaurant and general business downturn are at all time highs. Appreciate what you do, the podcast and the transparency on the portfolios and the strategy. Thank you. All right, I think we need to take this apart, whereas some other podcasters once said, unpack this. But let's start with a concept that is attributed to Mark Twain. And what this says is there are arguments about whether he said it first or not. It says, It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so. So, it ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so. Or there's a more ominous reading of this. You will find that it is you who are mistaken about a great many things. But I don't mean to pick on you, Tony. I don't think you're, I have a great many things wrong here, but there are a couple of things that you have misconceptions of that we need to clear up. The first one is your statement that in '08 and even during March '20 bond prices fell at the same time as stocks. That is exactly wrong, exactly wrong for the kinds of bonds that we hold in our risk parity style portfolios. And I think you really need to stop listening to people Frank Vasquez：who say these things, I don't know who you're listening to, but whoever it is is not giving you correct information. So let's correct that. We're going to look at the data. I'm going to put this in our show notes. It is a link to the data at Portfolio Visualizer of what actually happens with the kinds of bonds that we hold in our risk parity style portfolios, which are largely long-term treasuries. let's take a look. And so this link goes back to 1999 for these bonds, and it Compares them with a Vanguard 500 Index Fund for comparison purposes. And the easiest place to see this is on the annual returns bar charts that are there. And what you'll see is these things go in the opposite directions. So in 1999, that was a very good year for stocks. They were up. about 25%. These long-term treasuries were down about 5 to 7%. Then the stock market crashed in 2000. In 2000, the stock market was down about 7-8%. The long-term treasury bonds were up 20%. They were up 20%. 2001, stocks were down about 10%. The long-term treasuries were up. Looks like about five to seven percent. 2002 was a horrible year for stocks. They were down 20%. Long-term treasuries were up about 15 to 18%. And now let's go to those years that you mentioned. 2008, stock market was down about 40%. What happened to long-term treasuries? They're up 20%. 2009, when the recovery was going on, the stocks were back up 25%. Long-term treasuries were down 10%. these things move in the opposite direction most of the time. And if you looked at the six months when the stock market crashed last year or those first few months of the year when it was going on, in that crash period, the long-term treasury bonds were up between 25 and 30%, up between 25 and 30%. So they do not move the same way with stocks. I don't know who told you that. I don't know who told you that. But this is a very big problem for do-it-yourself investors because there's a lot of bad information out there. A lot of it's on YouTube. A lot of it's on financial TV. When you watch financial TV, either sounds like this. Or it sounds like this.

Mostly Voices [20:49]

Fire and brimstone coming down from the skies. Rivers and seas boiling. 40 years of darkness, earthquakes, volcanoes, the dead rising from the grave. Human sacrifice, dogs and cats living together, mass hysteria.

Mostly Uncle Frank [21:00]

Those are not useful things or sources to use for your investing.

Mostly Voices [21:05]

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

Mostly Uncle Frank [21:13]

Okay, then you also say in your email, Looking ahead, interest rates can only go up. This means bond prices will fall. If you are investing based on your prognostication of interest rates, that is what we would call crystal ball investing. My name's Sonia.

Mostly Voices [21:28]

I'm going to be showing you the crystal ball and how to use it or how I use it.

Mostly Uncle Frank [21:32]

Now, if you go back to episode nine, we talked through what are bad investing processes or bad ways to construct a portfolio. One of the bad ways to construct a portfolio is to base it on your ability to prognosticate about the future. And so if your portfolio is only set up for an environment where interest rates go up, what happens if they stay the same for the rest of your life? What happens if they go negative like they have in some other countries? Are you prepared for that? Are you prepared for what happens when you are wrong like the people who have been saying that interest rates are going up for the past 15 to 20 years and they're wrong every year. What we are doing here is trying to construct portfolios that are agnostic as to that question. They will do well if interest rates go up. They will do well if interest rates go down. They will do well if interest rates stay the same. And what you should know if you look at interest rates, Their primary pattern is not to go up or down. They do that over very long periods of time. Their primary pattern year to year is to oscillate. They go up when the economy is doing well and getting better, and then they go into the tank when the stock market crashes and you have 2008s or March 2020s, and that's when your long-term treasury bonds explode to the upside. You sell those high, you buy the stocks low. lather, rinse, repeat. That's how this works. So that is why you have to have something in your portfolio that is going to perform well when the economy is doing poorly, unless you think that the economy is never going to do poorly again. Now, there are a couple of episodes that you might want to listen to also about these debates about interest rates. Episode 67 and episode 69 which also lead you to a podcast by David Stein at Money for the Rest of Us. His podcast is number 337 where he goes into this very same question and he finds there are people that are prognosticating that interest rates are going to go to zero and they're well-known people been analyzing this forever. Some say they're going to go back up, some say they're going to be a 2% at the end of the year. I have a friend who has tens of millions of dollars. who believes they're going to 1% at the end of the year. And so he's out buying zero coupon bonds right now.

Mostly Voices [24:13]

Does that mean we should be basing our investing on these prognostications? I'm going to be showing you the crystal ball and how to use it. I think not.

Mostly Uncle Frank [24:17]

We should simply have things in our portfolio that are going to perform well in any of these kinds of environments and then rebalance them. And so we win whatever happens. And you want to win whatever happens, not if your prognostication is right. Okay, next part of this. Would it make sense to do an inverse TLT and a TMF in a bond portion of a portfolio? And the answer to that is no. And this goes back to the Holy Grail principle. We should not be looking at each component of a portfolio in isolation. I think this is a problem that still persists in the financial services industry. Or with financial advisors, they look at one part of the portfolio, okay, here's the stock portfolio and we're going to jigger it this way. And then they go over to the bond portfolio and we're going to jigger it this way. And then we have these other things over here. And they never bother to look at the whole thing. And so if you look at the whole thing, what you would realize is that you do not want inverse bond ETFs in your portfolio because they're just highly correlated with stocks. And so, what you would want would be just fewer bonds and more stocks if you were trying to balance it out that way. That's an example of something that doesn't belong in a portfolio if you look at the whole thing. If you just had a portfolio that was only bonds, yeah, you might consider something like that, but it makes no sense at all in a global strategically allocated portfolio. that is adjusted for correlations across all of the assets. Next comment, are we in unprecedented territory where we need to think the old rules? Well, I consulted my magic eight ball.

Mostly Voices [25:58]

My name's Sonia.

Mostly Uncle Frank [26:02]

And it gave me the only answer that you should ever legitimately take from a magic eight ball. And that is number four on the list of answers there. and it says, cannot predict now. Cannot predict now. So if you are in an environment where you can't predict whether the old rules apply or not, what are you going to do? What are you going to do? You're going to make up new rules, going to listen to some guru, going to guess, or are you going to construct a portfolio that's going to perform well regardless of what happens? I think the latter choice is the better choice because we don't care about being right. what we care about is our portfolios and how they perform, whether we're right or we're wrong about what happens in the future, or whether the rules apply, which rules apply. All right, then let's take a look at this ETF GNR as a proxy for PDBC. What GNR is, is a natural resources ETF, and it holds a number of companies that are largely in the oil and gas extraction businesses and the mining businesses. and a few other things in there, but it's largely those two areas and it is companies. And so when you run a correlation analysis, and I will link to this in the show notes, what you see is that it has a positive correlation with the stock market of about 0.81. So it's over 80% correlated with the stock market. And that compares to this commodities fund we've been using. There are many commodities funds. This isn't necessarily the greatest one, but PDVC has a correlation with the stock market of 0.57. The reason it's different is that it has more agricultural products in it. It's more ag-related than the GNR. You could use either one of these to a certain extent. I think the PDVC is better from a correlation or a non-correlation perspective. when you look at it in that way. And then finally, let's talk about these leverage funds. Yes, I agree that these leverage funds are risky. That's why we only put them in experimental portfolios, because I don't know how they're going to perform over very long periods of time. Although they did seem to perform properly, or as you might expect, at least UPRO and TMF did during last March. I would really avoid any of those ultra short or short leveraged ETFs like SRTY your friend got into because those things are really janky and they blow up for various reasons because they're based on all sorts of futures and options contracts. So yes, I would be careful with those and only use them either in small measure or in something that you can afford to to lose or to afford to have do badly. You don't want to put all your eggs in a basket that has not been proven for more than about 10 or 12 years. I'm actually surprised that some of these leveraged ETFs have worked as well as they have, but we'll see. The jury is always out on those. But thank you for that email. I hope you didn't take my critiques too personally. I do get excited about these things. But it's mostly because I think that there's a lot of misinformation out there because people don't bother to look at actual data and instead they tell stories or they hear stories that are dramatic and attractive and the financial media does a good job in making things dramatic and attractive to attract eyeballs and listeners.

Mostly Voices [29:50]

Dogs and cats living together, mass hysteria!

Mostly Uncle Frank [29:54]

So they can sell whatever products that are also on that program. They're really not there to provide good advice, they are there to provide entertainment. And you should take all of that as entertainment. That's not how any of this works. And really do your own research. and the other people that profit immensely from these sorts of narratives are people who are trying to sell you things. Because usually there's a pitch that goes, the world is ending, it's going to end in this fashion, are you prepared for it? Well, you will be prepared if you Buy my insurance contract or physical metals or some other thing that they are promoting and selling. You need somebody watching your back at all times. And so you always need to ask yourself when you hear something, a dramatic narrative from somebody, how do they make their money? Why are they saying that? What is their intrinsic motivation for it?

Mostly Voices [31:06]

A, B, C, A always B, B, C closing. Always be closing. Always be closing. Because only one thing counts in this life. Get them to sign on the line which is dotted.

Mostly Uncle Frank [31:30]

And if you think through that, why are they doing what they're doing? You'll oftentimes realize they're not interested in truth seeking. You can't handle the truth. They are not interested in providing accurate information. That doesn't help them. What helps them is to provide something that markets their position, whether it's because they want to sell objects or contracts or just books and get themselves on programs.

Mostly Voices [31:54]

You're sitting out there waiting to give you their money? Or you're gonna take it? A lot of that's just self-marketing.

Mostly Uncle Frank [32:01]

Forget about it. And again, every time I hear a lot of that stuff, it sounds to me like this. A bunch of people chanting the same thing marching in lockstep without an original thought in their brain. But now let us go to the weekly portfolio review after all that. And not much happened this week, but we will go through it efficiently in the markets the S&P was down 0.13% and then the Nasdaq was down 0.25% gold was down 0.03% so almost flat TLT the long-term treasury bond ETF was up 0.61% REITs were the big winner last week our fund REET was up 2.1% for the week Commodities also recovered they were up 0.88% and that's PDBC, that commodity ETF that we use, and preferred shares represented by PFF were flat. So going through our sample portfolios from the portfolios page, the All Seasons, which is our most conservative portfolio and is only 30% in stocks, was up 0.31% for the week. It is up 5. 4-5% since inception last July. The Golden Butterfly, our next portfolio in one of our more standard risk parity style portfolios you might actually use in a retirement scenario. This one was up 0.16% for the week and is up 18.29% since inception last July. And I should remind you this is comprised of about 40% stocks, 40% in treasury bonds divided equally into long-term and short-term and then 20% in gold. And now going to the Golden Ratio portfolio, which we talked about briefly in answer to the first question on a projection. This one was up 0.32% for the week. It is up 16.51% since inception last July. You'll notice very similar performances for all these portfolios last week. The Risk Parity Ultimate, which is our most complicated portfolio, it's about 40% in stocks. 25% in Treasuries, and then it's got 10% in gold, 10% in REITs, 12.5% in preferred shares, PFF, and a volatility fund, VXX, is the last 2.5% of it. It was up 0.33% for the week. It is up 15.56% since inception last July. And now going to our two experimental portfolios that use those leveraged ETFs. The first one is the Accelerated Permanent Portfolio. This one's 27% leveraged. Treasury bonds, it's TMF, 25% UPRO, the leveraged stock fund, and then it's got 25% in preferred shares, PFF, and 22.5% in gold, GLDM. This was up a whopping 0.19% for the week. It is up 12.74% since inception last July. and our final portfolio, which is usually the most volatile but wasn't very volatile this week. This is the aggressive 5050. This one is 33% UPRO, the leveraged stock fund, 33% TMF, the leveraged bond fund. And then as the ballast, it's got 17% in PFF, the preferred shares fund, and 17% in a intermediate term treasury bond fund, VGIT. and so this one was up 0.32% for the week. It is up 15.97% since inception last July. And that concludes our portfolio review. Next week we'll be getting back to a monthly distribution and so we'll see how that pans out. It looks like all the portfolios advanced this past month so we'll get a little bit more in the distribution this time. But now I see our signal is beginning to fade. I did receive a couple of emails about taxes and brokerage accounts this week. I think I will do a little mini tax show just on how they work in ordinary brokerage accounts. I think there's some confusion and I'm going to keep it very basic because I know that for some people they are just opening one of these accounts for the first time and they're only used to using IRAs or 401 s and so don't really understand how it all works. So I think we'll do that this week and look at those two emails and then get back to our analysis of that long-term corporate bond fund SPL B and see what else comes through the transom. If you would like to contact me, I welcome your comments. Send them to frank@riskparityradio.com that's an email frank@riskparityradio.com or if you like, you can go to the website www.riskparityradio.com and fill out the contact form and I'll get your message that way. I think we'll exceed 30,000 downloads for this podcast today and it is well up into the top 100 in investing and business podcasts which is just extraordinary given how I'm running it out of my house on a shoestring, and it's all me. But I'm very grateful for all of you listeners. If you hadn't had a chance to go and leave it a five-star review over at Apple Podcasts, wherever you pick this up, I would really appreciate that, and that'll help spread the word even more. So thank you again. Thank you for listening in. This is Frank Vasquez with Risk Parity Radio. Signing off.

Mostly Mary [38:09]

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.