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.

Mostly Uncle Frank [0:36]

Thank you, Mary, and welcome to episode 80 of Risk Parity Radio. Today on Risk Parity Radio, we are having a bonus episode so we can go through some more of the mailbag. Here I go once again with the email. And our first email is from Brian H. Brian H. Writes, hi, Frank, thanks for doing your podcast. podcast. I learned of it from the Choose FI podcast and have started at the beginning of yours and am chugging my way through. I am about 16 episodes in but have an opinion question for you. I am roughly 20 years out from retirement, plan on retiring at 55, and am wanting to use my taxable funds to bridge to the 59.5 age range so that I can begin to tap into my Roth. In your Choose FI segment you mentioned that roughly five years out is when you should start making sure that you have ample diversification to limit drawdowns on your portfolio. Also, I saw on your show notes your comparison on the Golden Butterfly to the traditional Boglehead 3-Fund portfolio in regards to total performance. Given that I am 20 years out, I'm trying to figure out what strategy would make sense to accumulate funds going into retirement and wanted to see if you thought that starting something like the Golden Butterfly now made sense or if I should be more highly weighted in stocks until I get to the 5 to 10 year range before retirement. The historical performance and minimal drawdown has me thinking that starting the Golden Butterfly now might make sense, but I do not want to miss out on the gains that can come from a portfolio that skews much higher towards stocks. Also in the Golden Butterfly I see there's a mix of Vanguard and non-Vanguard funds. Is there a way to be all Vanguard or highly weighted in Vanguard? I'm trying to optimize my portfolio to have the lowest fees I can and Vanguard does a good job of doing that. Hopefully you can help with these questions. Thanks again for your help and knowledge in this subject. Learning a ton. Brian. Well yes, I can help you in answering a few of these questions. First off, that episode you mentioned where we compare the Golden Butterfly to a traditional Boglehead 3 Fund Portfolio is episode 15. If anyone is looking for that. As to your main question, can you start with a golden butterfly portfolio now? And the answer is yes, you can. You should be aware that the golden butterfly historically has a real compounded annual growth rate going back to 1970 of 6.5%. That means 6.5% after inflation. So you'd add inflation to that. and that compares to a total stock market real compounded annual growth rate of 8.3%, which is elevated now because it's had a few good years. It's mostly been closer to 8% since 1970. So you are giving up some potential performance there. In exchange, you're getting about half of the volatility that you would see in a total stock market portfolio. So, I mean, the answer is if that kind of growth rate will get you to where you need to be in 20 years, yes, you could shift to that now. And for many people who would like to sleep better at night and not watch their portfolio go down 40% if they've got a lot of money in there already, it is fine to shift your portfolio from all stocks to a Golden Butterfly or some other Risk Parity style portfolio earlier on. That is more of a personal preference than anything else. Or you could go like halfway, if you will, take half the bonds and half of the gold that you would see in a Golden Butterfly type of portfolio. I could see somebody doing something like that where you would have 60% in stocks divided into the total stock market fund and the small cap value fund. And then the other 40% you could divide into the two bond funds and the gold fund. So it'd be about 13.33% each in those. And that would be kind of a halfway there solution, if you will. But it would give you a much smoother ride already if you are interested in having that. All right, then you asked about the Vanguard funds you could use in the Golden Butterfly. Four of those elements have Vanguard funds for them. So the Vanguard Short-Term Treasury Bond Fund is VGSH, that's the ETF. The Vanguard Long-Term Treasury Bond Fund is VGLT. And then you see from the sample portfolios we have VTI for the Total Stock Market Fund and VIOV for the Small Cap Value Fund. The only one that you can't do through Vanguard, do not believe is the gold fund. I don't think there's any Vanguard funds that cover that segment, so you would want to use either GDLM or BAR are the cheapest options for a gold fund. There are other ones, GLD and IAU, but they have slightly higher expense ratios. And so hopefully that answers your questions. Our next email is from Ian C and Ian writes, Message：I never thought I wanted to own bonds because I assumed my rental real estate would act like bonds. Now that I'm close to early retirement, I'm thinking more about volatility. How should I begin to think about transitioning to a risk parity portfolio in this scenario? 1.8 million in investable assets, which are 100% equities right now, 100,000 in real estate syndications, 150,000 in cash and cash rental reserves, 750,000 in rental equity, 150,000 in primary home equity. All right, well it sounds like you're doing quite well there and what this looks like when you kind of break it down is that you have about 1 million in your real estate business assets, not including the home equity, the 150,000 and I have not included that as far as something you're going to be able to use in retirement just to be conservative about it. Forget about it. And then you've got 1.8 million in other investable assets. So what that works out to is essentially one-third of your investable assets are on the real estate side. Now that puts you in a very strong position going into retirement. And I would say that because you already have that, you don't really need these kind of alternative investments that we talk about here, such as REITs or commodities or the preferred shares funds or those sorts of things, because the real estate actually covers all that. That is an income producing side of what you've got there. You will need to calculate, of course, what your net income is from those business interests and then subtract that from your projected expenses because that gives you an idea of how much you need to cover then with this 1.8 right now that is in the equities. So given this mix, you probably could sally forth with leaving that in 100% equities, but it might be kind of an unpleasant experience during a stock market crash. particularly something like you saw in 1999 to 2003, where it just kept going down every year and it was very painful and you didn't see it just drop quickly and get back up quickly. So if you wanted to moderate that drawdown, the things to add to there probably would be long-term treasury bonds and gold would make the most sense because you don't need any of these other alternative assets. that we might be considering in a risk parity style portfolio. Now, how much you need is up to you. I mean, if you were going to transition this to more of a total risk parity style portfolio, you would have between 30 and 40% in long-term treasuries and gold combined. It doesn't sound like you really need that or want that and are willing to take more risk to get more reward out of those stocks. So you might take half of that, say put in 15% in long-term treasuries and 5% in gold and just call that a day. I would go model that over at portfolio charts in particular just to see compare what a total stock market 100% portfolio looks like compared to the ones I suggested with some long-term treasuries and some gold. in them. And I would also look at that retirement drawdown calculator they have there, because that also will help you think about, you know, what is your percentage of withdrawal strategy going to be? How much money are you going to be taking out of that annually? And then what is the likelihood that that would ever fail? But I think you're in really good shape. What I would concentrate on first is figuring out what those expenses are, how much are covered by the real estate business. and then how much needs to be covered by the stock component of this. And after that, it is more personal preference and how much risk you really want to take with it. Thank you for that email. All right, next up we have an email from Drew M. Drew M writes, Frank, first let me say that I love the high quality information content and entertainment you present in the show. It really is best in category level infotainment. I'm in my mid 40s, so I'm right in the late middle part of my accumulation phase. What advice would you give someone my age about incorporating risk parity principles into their accumulation phase portfolios? Also, what advice should I pass on to my children who are just beginning their investment journeys? Thank you for what you do. Drew M. All right, in answering the first part of your questions, I think if you go back to that first email we had in this show from Brian H, you're in kind of a similar situation where if you wanted to take some risk off the table, you could start doing that now and move more towards a risk parity style portfolio with the caveat that it will probably not grow as fast as a more aggressive portfolio. But a lot of that is going to be determined by how much you have accumulated already and how close you are to getting to the numbers that you need to support your expenses in retirement. So I would give you the same kind of advice that I gave to Brian that take a look at that and if you can switch or take some risk off the table, sleep better at night, if you want to do that, that's fine. Just make sure that you are going to get to your targets with what you've already got. And as for your children just beginning their investment journeys, well, there's a lot of things I could say there. Let's see if I can summarize a few of them. I think the process of investing or your investing lifetime is best described in an article written by Michael Kitces that I'll link to in the show notes. And he divides the investment journey into four segments that are overlapping, but the later ones become more important as you go forward. And those four segments are earning, saving, investing, and preserving your investments or managing your investments. At the beginning for kids who are just starting out, The earning and the saving is the most important thing. Obviously, they need to earn some money and go and develop themselves, some skills, and be able to earn some money. But the saving part is really where I think you can come in and give them some good advice because that really needs to get automated. There needs to be money going out of those paychecks into those IRAs or 401ks to start with. regularly. And if they can get that habit going, that is what's going to make things go. It's not possible to really do much with investments until you have saved a lot. And the target number I always like to think about as a rule of thumb is the annual salary or $100,000 is where you really need to push your savings to. And until you have that, you can just put all that long-term savings into One basic index fund, a VTSAX or any other total market S&P 500 fund, it really doesn't matter. And the reason it doesn't matter that much is because it needs to get growing, but really it's the saving at the beginning that is driving the increase in the balance of that fund. So if you're putting in $10,000 a year, your second year, you're doubling just by putting the money in there. whereas the growth of those investments is probably only going to be a maximum of 1 to 2,000. So it's really that saving that is driving the increase in the value of the investments there. And it's those habits, those habits of the regular saving that are the important things. So that takes care of the long term end of their investing journey on the short term and intermediate term end. you want to have two things. So that you have your long-term IRAs and 401 s and whatever they can put in there up to the max is great and they should do that. For the next habits you need to have a checking account obviously and that needs to have either a large quantity of money in there or in a related savings account that is essentially their emergency fund bucket. if you're looking for an amount to think about what belongs in that bucket, you can add up expenses and have a few months of expenses is one way to do it. Another way to do it is take the annual salary and divide it by eight or so, and that's a good number to have for someone in that circumstance. And so all of that should be accumulated in that checking or savings account. I would also have them open a regular taxable brokerage account, do it at Fidelity or Vanguard or Schwab or somewhere like that. And the idea of that is when they've accumulated more than that emergency fund in their checking and savings, the excess can then be rolled over into this taxable brokerage account. I like Fidelity for this because you can now buy fractional shares there. So even if they only have 50 bucks a month, they could put it in there and actually buy something that would be an investment. And as I've said, my eldest son has used a risk parity style portfolio in that taxable brokerage account to build up intermediate savings. And in his case, he was using that to build up those savings to make a down payment on a house so he could then house hack. and that gets me to a couple of book recommendations. One of those is the book Set for Life by Scott Trench, who talks about a lot of these basic principles and also about house hacking and how you could buy a house and rent out rooms to your friends or other roommates and in that manner begin to build even more wealth because your housing expenses potentially can all be covered by those roommates. The way my son did that is by living with people to begin with out of college and they were all renting a house together. And then he bought a house and they all moved to that house. So he had roommates already lined up, people he had already lived with and that made a lot of sense. So to the extent your son or daughter is moving out of your house, if they go live in a house, in a group situation with several other roommates to start, that's going to save them money for one thing, but it's also going to open up this potential opportunity. And I think actually this is the way that Paula Pancutt started with her real estate empire because she talks about living with some roommates and then looking and seeing across the way that a similar dwellings was available and they bought it and moved over there and she was on her way. So Set for Life by Scott Trench is a good book for that. Another good book for them to read is so Good They Can't Ignore youre by Cal Newport. I have my children read that when they graduate from high school. And what that book is about is finding yourself through developing skills. that if you tell somebody they should go follow their passion, 18 or 19 year old, most of them don't even know what their passion is yet because they haven't been out there, they haven't done anything, they haven't experienced stuff. So the better strategy in life is to go develop some skills in things that you are marginally interested in and start from there. And usually the passion will follow the development of skills in a particular area. so I highly recommend that book. So Good They Can't Ignore youe by Cal Newport. And then another nice book to read that my kids have enjoyed is the Choose FI book itself by the guys at Choose FI. It is kind of a summary of a lot of different books and it has a lot of different references in it, but it's a very easy read for somebody to sort of get their feet wet and give them some ideas and get their juices Flowing. There are many other books out there, many good books out there, but those are ones that seem to be most attractive to at least my kids. And then there's of course some age-old advice that of course you want to give them. Fat, drunk and stupid is no way to go through life, son.

Mostly Voices [19:37]

That would be great. Mmkay?

Mostly Uncle Frank [19:41]

All right, and our last email for today will be the one from Lana. And Lana writes, hello Frank, I listen to your podcast off and on when I have free time. I haven't gotten to all your episodes yet, but I do have a question that you may be able to answer. Regarding a risk parity portfolio and the interesting challenge of higher expected inflation in the near future, how would you invest in equities to mitigate or take advantage of higher inflation? In the equities part of a risk parity portfolio, what types of ETFs would be better to add, just trying to figure out how to rebalance my portfolio. Thank you. Well, thank you for that email. As you know, we need to avoid the tendency to look at crystal balls or look for crystal balls to predict inflation or anything else.

Mostly Mary [20:29]

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

Mostly Uncle Frank [20:33]

But I'm glad you asked the question the way you did because there are things that should be in a risk parity style portfolio that perform well in inflationary environments. And that's the way we need to think about this. We should not take our portfolio and adjust it for just one outcome, but have things in there that work for all different kinds of economic environments, whether they are inflationary or deflationary. With my trusty quarter staff. Actually, it's a buck and a quarter quarter staff, but I'm not telling him that. Now, for these risk parity style portfolios, if you look in the sample portfolios, you'll see a few things that do well in inflationary times. First of all, stocks generally do well with moderate inflation. When I'm talking about moderate inflation between 1% to 5%, the kind of inflation that we've had for the past 20 some years or more, I think you have to go back to sometime in the 1990s to even get to 4%. We may have that this year. But it's unclear as to whether that will be sustained or it's just a result of coming out of the COVID trough. But looking more closely at stocks, what tends to do well during inflationary times is small cap value stocks as a category. If you look at what happened and you should do this, you want to know what performs well in an inflationary environment. The best way to do that is go back to take data from the 1970s and look at what was doing well in that environment, particularly the environment after the recession of 73-74. So anything that's performing well between the years of about 1975 to 1985, when you were experiencing the higher inflation that was going up and then it came down in the 80s, but was sort of at the peak up and down point there, is going to do well. If you look at portfolio charts, they do have data going back there to 1970 and you can plug in 100% small cap value and see what that looked like and you'll see that it performed well and was having positive returns all the way from 75 up to 87 until that crash in 87. So small cap value is a place to put some of your portfolio. that will help you out in an inflationary environment. REITs are also a good place to be in an inflationary environment. They also performed well in that kind of environment because the value of their properties tend to go up. They can raise their rents as time goes on, and so they're well positioned to do that. If you want to look at individual REITs and go to the REIT episodes we had, You can find those on the podcast page of the website www.riskparityradio.com. There's a little index there in the front to tell you which episodes go with which things. But I'll also link to a correlation analysis for individual REITs and the ones that were performed well in an inflationary environment are the ones that are going to be the most correlated with stocks. And they will be things like Warehousing, which invests in timber and is a 100% in the last 12 months or things like Lamar Advertising, which does billboards. There are a number of things that work well in an economy that is moving quickly and those are two of them. The other thing that works well in an inflationary environment is commodities. Like a commodities fund like PDVC. There's another one called COM that's pretty interesting. but if you have some commodities in your portfolio, they will perform well in an inflationary environment. They're deceiving because over the past 10 years, we have not had that kind of environment and those funds have performed very poorly. But if you look in the past six months or so, many of them are up 30 to 40% and the ones that we have in our sample portfolio is doing quite well. And finally, the other asset class that we have in our sample portfolios that does well in some inflationary environments is gold. And gold is interesting because it can perform well in both inflationary and deflationary environments. What it's most sensitive to is what is called the real interest rate, which is the nominal interest rate that you see minus inflation. And when that is going down or going negative, Gold tends to perform well. And so you go back to the 1970s, that was gold's heyday when it was going from $35 an ounce at the beginning of the decade up to $800 at the end of the decade. And a lot of that was riding on this rapidly increasing inflation that was increasing faster than the growth rate of the economy. The other time that gold performed well was in a deflationary environment where the economy was going down faster than the rate of inflation was going down and that occurred in the early 2000s in particular in that decade from 2000 to 2010. So having some gold will take care of the sort of dislocating runaway inflation kind of environments where both stocks and bonds may not be doing well. If you want to get more granular into the sectors that do well, From the stock market in inflationary environments, there typically are the financial sector, which does well when the yield curve is expanding. So banks can pay a low interest rate to depositors and charge a much higher interest rate to borrowers on the longer end. So that helps them out. That includes banks and insurance companies and those sorts of things. And then the material sector and the industrial sector also do well in the energy sector. tends to do well in inflationary environments because anything that is dealing with a raw material and producing it and selling it tends to do well when commodity prices are going up. So if you look at the sample portfolios, you can see, for example, the Golden Butterfly portfolio has 20% in the small cap value fund and 20% in gold. and that kind of covers these inflationary environments. The Golden Ratio Portfolio has 14% in a small cap value, 10% in REITs, 16% in gold, and another 14% generally in value stocks in this low volatility fund. So it covers the inflationary environment with those sorts of things. And then if you look at the Risk Parity Ultimate Portfolio, you see 10% REITs in there, 12.5% small cap value, 10% in gold, 12.5% in other value stocks. And so all of those things tend to perform well in inflationary environments or when inflation is increasing. I should say the environment really is determined not so much on the headline number of what the inflation is, but whether it is increasing and how fast it's increasing or it's decreasing or how fast it's decreasing. So it's not the number itself, but which direction it's going and how quickly it's going that way. But thank you for that question because it does get at a very important point for portfolios and portfolio construction. I think too many people look at a portfolio and their reaction is to remove anything in the portfolio that doesn't do well in inflationary times and that is not the right way to go about it because then you're just going to end up with a concentrated correlated kind of portfolio that's not very well diversified. The better approach is simply to have different things in the portfolio that perform well both some in inflationary environments and some in deflationary environments and some in kind of these ordinary inflation type environments such as we've been experiencing for the past 20 years or so when we're talking about 2 or 3% inflation. So the answer to portfolio construction is not get rid of my treasury bonds because there might be inflation. That's the wrong answer. You should keep the treasury bonds because there might be deflation and you don't have a crystal ball.

Mostly Mary [29:06]

My name's Sonia.

Mostly Uncle Frank [29:10]

You should just add or have these other things like we just discussed that deal with the inflationary environment. So as we've seen recently when the treasury bonds were going down in value. We saw the small cap value stocks in these portfolios go up in value more than the treasury bonds were going down, which yields a positive result. And that is the hallmark of a truly diversified portfolio, that something will be going down at the same time when other things are going up. Am I right or am I right or am I right? Right, right, right. But now I see our signal is beginning to fade. I believe in our next episode we will be beginning our 10 question analysis of a real estate fund that was suggested by one of our listeners in addition to tackling a couple more emails. If you have questions or comments for me, you can send them to frank@riskparityradio.com that email is frank@riskparityradio.com or you can go to the website www.riskparadioradio. com and put in your message into the contact form and I will get it that way.

Mostly Voices [30:22]

If you can dodge a wrench, you can dodge a ball.

Mostly Uncle Frank [30:26]

If you hadn't had a chance to, please go to the Apple podcasts and or where you get this podcast and leave a five-star review because it really helps out a lot. That would be great.

Mostly Voices [30:38]

Okay? Thank you once again for tuning in.

Mostly Mary [30:42]

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.