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You're diversified across stocks and bonds, but are you solving the right problem? Or instead, are you creating
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another investment pitfall to stumble into? That is part of Frank Vasquez's claim. And he's joining us today on this
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episode to talk about a possible solution, so-called risk parody portfolios. Welcome to Personal Finance
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for Long-Term Investors, where every episode teaches you personal finance and long-term investing in simple terms.
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Now, here's your host, Jesse Kramer. >> Hey, welcome to episode 144. I'm Jesse Kramer. I'm a financial planner. I work
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with retirees. I also work with busy professionals getting ready for retirement. And you can learn more at
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planwithjesse.com. Thank you to Unflapable 85, who left a five-star rating and a kind review on
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Apple Podcasts. Unflapable 85. Feel free to drop me an email to [email protected]
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and I'll get a super soft podcast t-shirt mailed to you. I don't have a big monologue today everybody, just a
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short monologue. I really do believe in investing in knowledge. You know, an investment in knowledge pays the best
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interest. And today's guest, Frank Vasquez, he knows a lot about investing and retirement planning, but his
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personal investment approach is relatively new to me, and I suspect will be new to some of you, too. But Frank's
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approach is founded in reason and logic and good data. So, I find myself really intrigued with what Frank has to say.
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And then whether I pursue his ideas in my own investing life, whether I pursue them or not, well, that's a different
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question. I really do believe in Warren Buffett's advice that you do not need to
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swing at every single pitch that's thrown your way in the investing world. So, whether we swing at Frank's pitch
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today or not, that's up to us. But what I do think is that risk parody portfolios are an intriguing pitch to be
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sure. And in the interest of sharing knowledge with all of you and learning more myself, I'm really glad that Frank
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accepted my invitation to join us today and explain the why and the what of risk
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parody portfolios. >> Frank, so we're going to have a fun conversation today. And before we talk
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about exactly what risk parody investing is or risk parity portfolios are, I kind
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of wanted to ground us with why. Meaning, you know, there are other portfolios, other investing styles out
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there that presumably will help people achieve their goals eventually, but maybe, and this is where I want you to I
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don't want to put too many words in your mouth, maybe those other portfolios aren't exactly solving the the right
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problem. And so the question to you is why risk parity portfolios? What's the problem that they solve the best that
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kind of has led you to investing in them and and teaching so many others about risk parity investing? Yeah, I do think
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we need to start at with a like really big picture goals here because this will inform the decision-m process as to why
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do this as opposed to something else and what the real options actually are. So,
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in my mind, the goal of retirement is to maximize your well-being for the rest of
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your life. It's kind of a big vague goal. Fortunately, we have a lot of research now as to how to go about doing
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that. you know, books like the five regrets of the dying, which is the Charlie Munger version of that, the
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inverted. I mean, when you're talking about money specifically, then the question becomes, well, how do we use
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our retirement money to maximize our well-being for the rest of our lives? And there's good research on that about
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how to spend money to improve your well-being. This comes from the most easiest place to find it is in Daniel
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Crosby's relatively new book soul of wealth. He's a psychologist um well respected works for Ryan which supplies
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lots of financial adviserss with >> content and and services. So according to that research and he's quoting other
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even more other research there are basically five things you can spend money on to improve your well-being. The
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first one's just the necessities of life. So, we can just put that one aside with this, you know, obviously
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>> food and shelter basically. >> Yeah, food, shelter, clothing, the whatever you think is necessary. If you
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think you need a Mercedes, maybe that's part of your necessities, but for most people, it's probably more on the food,
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shelter, and those sorts of necessities. So, beyond that though, there are four other
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things you can spend money on that will improve your well-being in life. One is on relationships. That's the number one.
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If you read any book about living a good life, they all come back to if you had good relationships, even if you were
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dead broke, you'll probably look back in your life and said, "I I had a good life." So, facilitating better
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relationships is is the number one after that. The next thing you can spend money
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on is experiences. And in particular, two kinds of experiences. One that would put you in some kind of a flow state. I
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mean, you just really love doing this. you're a runner or a biker or you're a creative, any sort of thing that that
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you just love doing just for the doing of it. But then also experiences that facilitate relationships as well that
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you're doing with other people and that you can get both at the same time if you're like singing in a choir or
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playing in a band. Those sorts of things will go to that. So you can spend money
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on those sorts of things. The third one is buying your time back. Essentially paying other people to do jobs you don't
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want to do. We have people that clean our house now and people that do the lawn. There are a lot of things I don't
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like doing and it's going to be different for other people. So like my wife loves to cook and that's part of
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her experience and flow state by picking out food, cooking it, making new things,
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all those sorts of things. For some other people, they really hate that. So maybe they outsource more of that and
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they like to go in their garden and work. But the principle there is let's look at my life and think about all the
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things I really don't like doing and let's see if we can use money to get rid of that and buy our time back. And then
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the then the fourth one is giving money away. Red Hot Chili Pepper 5. And that also comes in multiple forms. Charity
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begins at home. So it actually can start with family whether those are children.
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In my in my experience I I support our parents, my parents. You can use money that way or you can actually give it to
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formal charities or work with charities. So in my case, I will combine the relationships and the and the charity
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together because I'm on the board of a charity and it serves hungry and homeless people and that also involves a
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podcast. So I'm integrating all these things and spending some money on that in in various ways and that improves my
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well-being. Then we need to talk about well how is retirement funded? We want to fund all of these things to improve
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our well-being. All these five things. And so if you look at the ways you can fund a retirement that there's basically
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three. They're hustling, hoarding, and harvesting. Three hes. Hustling is a very popular activity now in in fire
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communities. It's less popular than people think because we overindex on on people creating content and putting it
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out there. >> I was going to say some of the loud voices are hustling. they tend to
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overindex on hustling. So they're, you know, creating courses, they're getting sponsors, they're going to fin learning
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how to do all that. But it's essentially you keep working in some thing. They're
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the advantages and disadvantages to hustling because obviously you're not buying your time back. In fact, you're
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given more time away to get money. So in order for it to be actually worth your time, you have to get more out of it out
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of the relationship side or the flow state side of it. Some people are serial entrepreneurs. They just go from one
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thing to another. Grant Sabatier is that kind of person and so they get value out
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of that as an experience and out of their relationships and probably less out of the money.
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>> But some people are using that to support their retirement. So as part of their retirement funding, they are
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hustling. They are still working for money in in one form or another. The next way you can do it is hoarding,
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which is the way traditional personal finance works. >> Traditional personal finance, the goal
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is to accumulate, but then when you're when you've accumulated enough, you just keep accumulating. And you can define
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this numerically. essentially if somebody is spending 3% or less of the their accumulated assets and invested
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assets, they're essentially adopting a hoarding strategy because if you do that, it really doesn't matter that much
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how you've invested. You you can hold a 30-year TIPS ladder, you can hold an 8020 portfolio, you can hold just about
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anything you want and do it on base of personal preference within reason because the strategy is not how what
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you're doing with your asset. All that affects is how much is left when you're dead. The strategy is just to underspend
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the portfolio or and in many cases the model is to reach financial independence but then work a decade longer so you
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have at least twice as much as you need. And we can come back. I I definitely want to touch on safe withdrawal rates
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later. But some of that hoarding is either a function of traditional safe withdrawal rates being overconervative
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or maybe traditional safe withdrawal rates having such a wide range of outcomes that the conservative end of it
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is really conservative. And that's probably just also combined with people's loss aversion, right? A lot of
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us are biased for loss aversion or just it's a preference. But but hustling and hoarding are our preferences.
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preferences, >> your personal preferences that are implemented >> and and don't necessarily maximize those
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five pillars that you were just discussing. >> No, the hoarding can cause big problems
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with a number of these things, particularly on relationships because people get reputations and their spouse
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may be very upset about them not spending the money on whatever they want to spend the money on, whether it's a a
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new hot tub or a camper, whatever. This does also cause problems with parent child relationships. M
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>> there is a great researcher and um provides services a guy named Jim Grubman who specialized in really
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wealthy families and managing family wealth and he talks a lot about this that a lot of the practices that people
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use which are I'm just going to squirrel all this money away and I'm not going to
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tell anybody about often times the children will find out that they've been living a lower lifestyle than than they
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needed to and they find it out when they're about 40 and it really creates a horrible rift between the the adult
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child and the parent because the adult child is thinking you made me work through school when you could have
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afforded to send me to college and things like that. >> So hoarding over long periods of time
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can be very detrimental to personal relationships particularly at the family level. You're choosing to overaccumulate
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and not spend the money on something that somebody else thinks would be important to spend money on in terms of
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family dynamics. >> Put a pin in my devil's advocate argument here cuz I have a feeling
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you're going to come back and address this later. But what if the elder family member responds to what you just said,
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Frank, and says, "Well, I'm worried about running out of money. I I can't give it all the way to you while I'm 70
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and my child's 35, cuz here I am at 70. I might live till 90. I can't be giving it away right now. Do you want to come
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back and and address that concern later? >> I mean, the short answer is, well, yes,
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you can. You're just choosing not to. You're conflating a can't with a I don't want to. And often that times that's
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based on some scarcity mindset based on your childhood experience or other prior
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experiences. So, basically, you're reliving past experiences. >> Money scripts. Money scripts. You know,
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I just heard a uh a podcast from Schwab. It's called Choiceology. So, it's about
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decision-m and it was about Groucho Marx who speculated a lot in the 20s, lost big time in the in the Great Depression
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and then became a miser after that. >> Interesting. >> And it did cause problems with his
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personal relationship with his family. >> Yeah, I could see that. And the reason
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was based on that experience and that they were they were saying this is a cognitive
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>> this is a cognitive bias where based on some experience you are behaving in a
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way that is not the best way to behave later on because you're reflecting on this prior experience and but they're
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not related. >> Yeah. That mental scar tissue it seems it's probably ever present. We all
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probably have it and one of the hard parts is most of us are probably unaware. I probably have mental scar
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tissue that I couldn't define for you, Frank. And but someone who's not me and observes me for a few, I don't know,
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days, weeks, months, years probably be like, "Yeah, Jesse, you've got some you got some scar tissue you need to work
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through, whether it's financial or not." >> Well, yeah. That's why you don't want to
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hoard the money. You want to spend it on a therapist. >> Right. But by by definition, you are not
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using money for those five things or you're using less than you could. >> Yeah. So you are not maximizing those
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things. >> And and does that bring us to harvesting the third age? >> Yes, we will. Harvesting is simply
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getting the money out of your accumulated assets. And so if you are more efficient at that, then you can
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spend more money on these five things to improve your well-being because the other two choices often conflict or
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cause problems with that. Whereas there's almost no problem with harvesting unless you've overh harvest.
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Obviously, that is actually extremely rare for somebody who has had the wherewithal and conscientiousness to
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actually accumulate enough to retire with. >> Those people are not running out of
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money. Financial advisors from Michael Kites and everyone else is reporting the same problem is the opposite problem.
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>> Nobody's running out of money. When Dana Onspa was asked this question, you ever
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had a a a client that that you know ran out of money? She had one and it was basically somebody who was clearly
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overspending. They told them they were overspending, but they continued to do it anyway. It wasn't like there was an
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emergency arose and there was long-term care and they ran out of money or all the big bugaboos that you hear about in
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reality are not causing people to have problems. Mhm. >> The chances of you overh harvesting if
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you have any reasonable plan are very low. So the the kinds of people that I am dealing with and and speaking with
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are very averse to hustling. They want to harvest some of them have look at their situation and say you know I think
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we're hoarding and we want to give away more money. We want to do more things with our money. We want to start giving
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it to our children earlier on. We have charitable desires. I've thrown out a good goal, I think, for well-being in
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terms of giving money away would be to give away 1% every year that that you have in your mind. I have 1% that I'm
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going to spend every year on other people. And whether that's formal charities or your kids or
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>> and that's 1% of your net assets, right? That's not 1% of income. >> Correct. It's 1% of your net assets. So,
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we spend 5%. Which I divide up into necessities are or keep the lights on stuff is 3%. 1% is what I would call
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comfort expenses to pay the people to clean the house and do the yard work and buy the gym memberships and all the nice
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things. Go out to eat, take vacations, and then the remaining 1% is for extravagances and giving away basically.
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So, we were using part of that for renovation this year. And a lot of it since since I've been supporting my
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parents for 15 years, a lot of it's been going to them. They've lived a really long time. They're actually celebrating
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their 70th wedding wedding anniversary in >> Wow. >> My my father's 97 years old.
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>> Wow. >> And my mother's 92. >> Well, you've got some good jeans. And longevity is a a real factor in
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retirement as well. Here's a quick ad and then we'll get back to the show. Hey listeners, Jesse here. My team and I are
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preparing for episode 150 of the podcast, which we'll be recording in a couple weeks. And we thought it'd be fun
00:16:24
to do an ask me anything episode. Many of you know that my normal ask me anything episodes focus entirely on
00:16:30
retirement and financial planning questions. Well, we want episode 150 to be a little different. We're going to
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open it up to just about anything. Ask me anything you want. And I'm not slipping down the slope of becoming a
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self-absorbed influencer. But we figured, you know, once every 150 episodes or so, it could be fun to share
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a little more than tax rates and expense ratios. So, if you have a question, ask
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me anything. Simply send an email to jesse bestinterest.blog. Thank you. So, let's pivot and now talk a little bit
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about the what. Let's ground the audience with the typical constituents of one of these portfolios that you put
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together. And and I've been calling them risk parity portfolios. you host Risk Parody Radio. I know that that the
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nomenclature itself is somewhat a little bit gray and and so feel free if if it's
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worth going into the nomenclature itself, feel free, Frank. But more importantly, let's let's define the
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asset classes themselves that build up one of these portfolios. >> You start with stocks and bonds.
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>> A good start, we can say. Yeah. >> Just like everybody else. The way I would describe a portfolio that that I'm
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building, it's like if Bill Bangan and Ray Dallio had a baby portfolio. Okay. And for those for the listeners who
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don't quite know Bangan and Dallio, 10 seconds on each. Hey listeners, so we didn't end up coming back around to talk
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about who Ray Dallio is. So I'll do that here. Ray Dallio is the founder of Bridgewater Associates, which is the
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world's largest hedge fund. And it's made famous, he's famous for his concept of the all-weather portfolio.
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essentially a really big risk parody style portfolio. >> Yeah. Okay. So, Bill Bangan is the
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father of the 4% rule who had came up with the original concept back in the 1990s, but then has improved on it over
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the past 30 years and has done a lot of research showing what kinds of portfolios tend to have higher safe
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withdrawal rates and therefore you can harvest more out of them. So we use a lot of his research as guidelines and he
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recently wrote another book which summarized a lot of the the work he had done in say the past 20 years. Bangan
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1.0 was very helpful and it's what I started with when I was working to build this up back in like 2010. But bangan
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3.0 is really good and and has a lot of good guidelines. So, a couple of guidelines that come from him are have
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less than 10% in cash or cash equivalents or short-term bonds, whatever you want to call those things,
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because if you have more than that, it starts to drag down the the long-term perspective. You end up with a cash drag
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in your portfolio. >> Does that typically include an emergency fund, that 10% number,
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>> I would say when you get to retirement, you don't need an emergency fund anymore
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because it's you make that part of your overall portfolio because Got it. By definition, you're spending money out of
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your portfolio. So, yeah, >> you need to account for that. What is invariant there is it does not matter
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how you organize this cash. >> Whether you whether it's in ladders or in savings accounts or short-term bond
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funds or whether you put labels on it and say bucket one, bucket two, bucket three, or it's just one allocation, it
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doesn't matter. The rule stands no matter how you do it. He observed this back in the 1990s and he's retested it
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and everybody else who's done this kind of research sees that. The the next guideline he's come up with that shows
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for higher safe withdrawal rates is that the stock portion of the portfolio typically needs to be between 40ome% and
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70ome%. And what he's found is it's kind of a messa that you you go up when you get to 40 some percent. And it stays
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high, but then it drops if once you get up to into the 70s and have more of an accumulation kind of portfolio that's
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like 80 to 100% in stocks. The the more recent research he's also done on the stock portion of this shows that you
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need to diversify out of just large cap focused funds. Mhm. >> You can't just have a S&P 500 or a
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totally international large cap focused thing. You you need a few other components that we can talk about that a
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little more in a little bit. And then in terms of the bond component, it should be treasury bonds because they are the
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most diversified from from stocks of all the kinds of bonds. And actually, you want to minimize the number of bonds
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you're actually using. So having like 40% in bonds is is too much is not helping you because bonds are a low
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yielding asset and you're not holding them there for yield or income or anything else in a in a portfolio like
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this. The the basically the sole purpose of them is is a kind of recession insurance. So when you get the two the
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2020 or the 2008, you have something that is going up in capital value in your portfolio when you know the stocks
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are have an 80 to 90 or 100% chance of going down. >> Correct. Or addend what I'm about to say
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here. You are looking for assets that perform differently in different economic environments.
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>> That's correct. That is really why things are correlated or uncorrelated. I think there's a perception sometimes and
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maybe it's just people misspeaking or kind of speaking in truthiness that correlations are random or we don't know
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what's going to happen in the future. Therefore, we don't know what the correlations are being and when we we
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don't know. We don't know. Yes, you do. We know this. There's rafts and rafts of
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research on this. And what we know is that if you know what economic environment you're in, if you're in a
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recessionary environment, growth falling, inflation falling or in deflation, bonds are going to perform.
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Treasury bonds are going to perform well and stocks are going to perform poorly on a probabilistic basis like 100% of
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the time or close to it. There are basically four other economic or three other economic environments that are
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typically talked about in this context. This is often called a four quadrant model. So you can have increasing growth
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or decreasing growth and then increasing inflation or decreasing inflation. Most
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of the environments are fairly friendly to the stock market. If you have some kind of positive growth and moderate
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inflation, that's a good environment for the that's a Goldilocks environment. Everybody likes it. Uh stocks go up,
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bonds do fine, or they don't do anything and that works very well. where you really have problems is in a
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stagflationary environment like 2022 or high inflation and low growth. Typically
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when you get out to those the very high or very low inflation that's where you for instance you see stocks and bonds
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become positively correlated >> in higher inflation environments. So, we know all the all the different kinds of
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weather we can have, basically economic weather we can have, and we know what what does well in each kind of kind of
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weather. What we don't know is what the weather's going to be like tomorrow, >> right?
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>> And and and this is related tangentially or maybe directly to this whole all weather portfolio. that that's why these
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things are called all their portfolios because they they have things in them that will if not do well at least help
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the portfolio through the worst kinds of storms if you will and it is all based on the idea that history doesn't repeat
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but it rhymes and so we know what the kinds of weather is that we can have and we know what kinds of assets do well in
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those things so if we combine those in a reasonable manner we're going to have a more diversified
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portfolio which then is more resilient and you can take more money out. You can harvest more money out of it eventually
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where you get to on. >> Let's keep going then. So, so starts with stocks and bonds, but we need a
00:24:04
different type of raincoat or umbrella for some other weather conditions that that stocks and bonds might not protect
00:24:11
us from. Where do we go after stocks and bonds? >> So, you you're looking at alternative
00:24:16
assets, basically things that are not stocks and bonds. So, let's talk about what's not in this category. private
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equity, private debt, those are stocks and bonds, >> right? >> Private not public does not mean they're
00:24:28
they're not subject to the same economic forces, >> right? >> Or these weird products that people are
00:24:34
referring to as like ETF slop now that are it's stocks with some options overlay that's paying some income or
00:24:41
some kind of structured product or some kind of buffered thing. These things have been become very popular because
00:24:46
they're very lucrative to the people like JP Morgan that create them and they're very attractive to sell through
00:24:53
financial advisors because they have characteristics that are easy to market. So none of those things are alternative
00:25:00
assets in the way I would define it. To me, an alternative asset is something that is a zero correlation with stocks
00:25:07
and bonds. A zero correlation with both stocks and bonds. for the semi-math literate out there because correlation
00:25:14
can be positive or negative, Frank. But what you're saying is zero because it's it's neither positive nor negative
00:25:19
correlation. Correct. They could be moving in the same direction or a different direction from stocks or
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bonds. This is Ray Dallio's holy grail principle. This is just math that if you have a number of assets that are
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uncorrelated and you combine them, you essentially reduce the risk of the overall portfolio without reducing the
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returns as much. And so you get essentially a a diversification bonus. This is the whole point of
00:25:46
diversification to begin with. >> The one free lunch. It's the one free lunch. >> This is this is the free lunch. And so
00:25:53
when you were thinking about what does that mean in terms of characteristics and comparisons, the the holy grail or
00:25:59
gold standard here is zero correlation between whatever these assets are. So we're looking for things that have zero
00:26:06
correlation with both stocks and bonds. I should say another thing that does not
00:26:11
work for this is other kinds of bonds. You cannot use TIPS or some kind of corporate bond or some weird bond thing
00:26:18
or individual bonds. Those do not work for this purpose. Those are not alternative assets. The things that do
00:26:24
work the best historically have been gold has a zero correlation and managed futures or trend following which is a
00:26:33
strategy that typically involves both interest rates and commodities and can involve stocks. But that is a a
00:26:42
particular strategy that has been it's been around since the 1970s. It's been researched back a hundred years in terms
00:26:50
of data. It's been researched to death. And that strategy actually, it used to be too expensive for individuals to use.
00:26:59
>> That's the managed futures you're saying is too expensive. Okay. >> This is when I first looked at this back
00:27:03
in 2010. It's like, oh, that's a good option except you got to put your money in this hedge fund and pay 2 and 20 or
00:27:09
some or if you buy a mutual fund version of this, it's going to be 2 3 4%. it it
00:27:15
wasn't worthwhile for an individual to do that. Now we have effectively since about 2019 when they changed the ETF
00:27:24
rules so you can put all kinds of things in ETFs now we have the the equivalent of an index fund or a couple of index
00:27:30
funds that do this >> interesting. Okay. that track something called the society gunner index sockgen
00:27:39
>> which is basically a compendium of all of the the hedge funds that do these kind of strategies what these funds do
00:27:46
is replicate that >> got it >> mathematically so it's it's like having an index fund that does that
00:27:52
>> of managed futures in a way >> yes it's yes >> hey listeners I just wanted to add some
00:27:57
color to what managed futures are because they're the strangest asset class we're talking about here on
00:28:02
today's episode of managed futures is diversification and crisis protection. That's why they exist. So in managed
00:28:08
futures, portfolio managers are trading futures contracts, which are a little bit strange to understand in and of
00:28:13
themselves across different asset classes like commodities and currencies and interest rates and stocks in order
00:28:19
to hedge risks, to hedge their bets, and to attempt to zigg while the market sags. We know, for example, that managed
00:28:25
futures are going to underperform during bull markets. That's by design. But we also know that they'll perform quite
00:28:31
well during market crashes. Also, by design, managed futures have a low correlation to stocks and bonds, and
00:28:36
they historically tend to perform well during periods of market stress. What you end up with is something that has,
00:28:43
you know, roughly 7 to 8% expected returns with a zero correlation to both stocks and bonds. It's it's very
00:28:50
attractive for this purpose. So, what I found is that if you just have stocks and bonds, Bill Bangan has been able to
00:28:58
get the safe withdrawal rate up to 4.7%. If you add in something like gold or managed futures in a I would say between
00:29:05
10 and 25% in alternative seems to work the best. You can get up to 5% or more than 5% on a safe withdrawal rate
00:29:13
calculation. One of the next things he's going to do because Benan does hold some
00:29:18
hold some gold himself is analyze that that more closely. So that's that's that's coming. He's
00:29:28
promised. >> Okay. Okay, >> he's getting up there in age though. So, I can tell you the answer. We already
00:29:34
know the answer because other people have done the research, but it's if you if you just add gold to a portfolio, it
00:29:40
adds.3 to.5% on a safe withdrawal rate. >> On a safe withdrawal rate basis. Interesting.
00:29:46
>> Yeah. Yeah. That goes back a 100redyear research. >> Mhm. >> Um actually Carson Yesa did that
00:29:51
research as part of his safe withdrawal rate series number 34. >> Here's a quick ad and then we'll get
00:29:56
back to the show. Serious question. Why do podcasters constantly ask for ratings
00:30:02
and reviews? Yes, they do help highlight our shows to new listeners. They help strangers find us on Apple Podcast and
00:30:08
Spotify. It's totally true and a good reason to ask for ratings and reviews. But I have something more important, at
00:30:14
least more important to me. I want to know if you like this stuff. I want to know if you like my podcast episodes, my
00:30:21
monologues, my guests, the information I share with you and the stories I tell. I
00:30:25
want to improve and make your listening more enjoyable in the process. So yeah, I would love to read your reviews. And
00:30:31
sure, if you throw a rating in there, too, that's great. If you like what I'm doing, please share it with me. It's
00:30:37
such a great feeling to read your feedback. I'd love to read your review or see a rating on Apple Podcasts or
00:30:43
Spotify. Thank you. Again, I'm playing devil's advocate here. I hope that's okay. I've got a copy of uh Charlie
00:30:49
Mer's Almanac at home. I'm a big Warren and Charlie guy, as I know. I know. I've
00:30:54
heard you quote Charlie at least a bunch. And they they both have or both had you know that Charlie Monger's
00:31:00
passed away but they both had an opinion about gold. So I'll pick on gold as my devil's advocate argument here where
00:31:04
they'd say you know gold has no intrinsic value. You have to hope someone comes along later and pays you
00:31:09
more for it. Gold has had long periods of underperformance. Granted it's also recently had a outrageous period of I
00:31:16
guess you would call it overperformance then. But the point is that okay I could
00:31:19
make an argument to say that gold is a quote unquote suboptimal asset. So the question is, do I need to hold these
00:31:26
quote unquote suboptimal assets in order to create this risk parody portfolio or
00:31:33
am I just asking a wrong question? Is my question in and of itself missing the mark? What do you say to that, Frank?
00:31:38
>> Yeah. Well, there's several things going on here. Well, you don't have to, but
00:31:42
you'll end up with something like Bill Bangan proposes and and it won't be quite as good as something that does
00:31:48
have an alternative asset in it. So yes, you can do that. Charlie Munger is very
00:31:53
interesting to me because we were part of a very small club. We both went to Caltech and then became lawyers.
00:32:00
>> Yeah. >> There's probably only like less than a thousand people in walking around on
00:32:07
Earth that that >> are in that club that have that that have that that characterization. What
00:32:13
you need to know about what they do. Okay. First, what is their retirement strategy? Is it hustling? Is it
00:32:20
harvesting? Or is it hoarding? I see. Okay. >> Their strategy is hoarding because
00:32:25
they're they have so much money that they can they underspend and >> Oh, you're saying Warren and you're
00:32:30
saying Warren and Charlie hoarding. >> Yes. Yes. Got it. And hustle. I mean, they worked until their death.
00:32:35
>> They hustled. But that's why Warren Buffett says I don't want my heirs to be trying to pick stocks cuz they're not
00:32:41
going to be able to do it. I would prefer them to hold a 9010 portfolio. 90% in the S&P 500 and 10% in Treasury
00:32:49
bonds. And so that 9010 portfolio works fine if your strategy is hoarding because you're never gonna outspend it.
00:32:56
You can have a 100% in stocks if you're spending a fraction of a percent in in their case
00:33:04
because of how much money they actually have. So they don't have any need for harvesting or a strategy that that
00:33:11
emphasizes we need to get as much money out of this as we can because because they're billionaires and I'm not a
00:33:17
billionaire. Yet, I'm wealthy enough to have a good harvesting strategy and live a good life. I am not wealthy
00:33:28
enough to be able to hold a 9010 portfolio and not worry about a big market crash, which is what they
00:33:35
actually I say that cuz that's what Warren Buffett actually recommends civilians do if they have enough money.
00:33:42
They're they're correct that gold is not a it doesn't generate an income, but that doesn't mean it doesn't have any
00:33:49
value. This is a place where there's a lot of Dunning Krueger problems in >> retail financial advisors don't know
00:33:58
this. What they don't know is this. There are many methods of doing valuation. There's a false notion that
00:34:05
it comes from a misinterpretation of what Munger and Buffett say is that well if I can't do a discounted cash flow or
00:34:12
a net present value on this asset I don't know what it's worth and I can't value it therefore I shouldn't invest in
00:34:18
it. You can't do that kind of valuation. U I spent 30 years working with valuation experts. There are many
00:34:28
different ways of valuing assets, including ones that don't generate cash flows. The most common one you're
00:34:36
familiar with is when you go buy a house to live in. >> Yeah. >> How do you value that? You're not doing
00:34:42
a discounted cash flow analysis. >> Correct. >> And you're not saying, "Well, I can't do
00:34:46
a discounted cash flow analysis, therefore, I'm never going to buy a house to live in." that that is
00:34:51
effectively what people are saying when I hear them say, "I can't do a discounted cash flow analysis on gold.
00:34:56
Therefore, I'm not going to invest in it." That represents an ignorance in how things are valued. So in that
00:35:03
circumstance, you would use a market value or I mean you'd look around and this is what appraisers do for things
00:35:09
like property and art and gold and everything else that just because it doesn't have a cash flow does not mean
00:35:16
there are not established ways of doing valuations for whatever this is. In fact, for gold itself and gold mining,
00:35:27
there are massive codes put out. I had to learn this stuff because I had a case about a gold mine in Usbekiststan about
00:35:34
how to value gold in the ground. People are investing in mines and mining companies. They need to value things
00:35:40
like gold and silver. Whatever the product's going to be, they got to put a value on that. And as part of that
00:35:46
valuation, they've developed these very detailed methodologies for doing stuff like that. You will find that's true in
00:35:55
just about any kind of environment where something's being appraised. And it's interesting. I don't see this argument
00:36:02
or this problem, this mental hangup amongst people at an in who work at an institutional level about things like
00:36:10
gold and commodities. So a good person to follow in that respect would be David Stein who now he he runs money for the
00:36:18
rest of us. He's written one of the best books for individual investors to read is money for the rest of us that's come
00:36:25
out in the past few years. He comes from an institutional environment. He's recently recounted this in an
00:36:31
interview. He was asked, "Have you changed your mind about anything?" He says, "Yeah, after I came out of the
00:36:37
environment, I was, you know, I was looking at things like gold and in 2012, I changed my mind on the usefulness of
00:36:43
that in a portfolio." >> He became more optimistic, you're saying. >> Yeah. He said, he said, "Okay, I can see
00:36:48
how this is used that although you could characterize it as a speculation cuz it doesn't produce
00:36:54
an income, that doesn't mean it doesn't have a value or a purpose." And so I follow people like that. the the people
00:37:01
that I will rely on the most are people that have come from an institutional framework who invest at the highest
00:37:09
levels and so they are not subject to these essentially emotional reactions to things like gold. If you read
00:37:18
aspirational investor he will tell you and show you how gold can be used for certain kinds of portfolios that look a
00:37:25
lot like the portfolios that I talk about. Um, so, so all of this stuff, uh, although people come up with objections
00:37:34
to it, you really need to think about what is, what is the background of the person that's making this objection and
00:37:40
do they really know what they're talking about? Because most of them don't. And if you go up a level to people like the
00:37:47
Ray Alias in the world or the or or AQR or or or Ashman Chabra or or or even David Stein who's gone from
00:37:55
institutional to to personal, they don't have a problem, a a visceral reaction to assets that
00:38:03
aren't stocks or bonds. Instead, they they look at the whole they they look at what it is, how it would fit, does it
00:38:11
have a demand that causes it to have value. In gold's case, most of the demand actually comes from central
00:38:17
banks. So, it's an international asset. The uh so the it's not and it's had a demand for as long as there have been
00:38:26
humans walking around using money. Um so that's not likely to go away. >> And it's totally fair. I mean, I I
00:38:33
recognize the fact that the discounted cash flow, net present value modeling has limitations to it, and sometimes you
00:38:40
just have to say, I've got a pound of gold sitting on my desk. Could I walk out my door and sell it for something
00:38:45
today? Yeah. >> If the answer is yes, then it clearly has a value. I mean, cuz I I think to
00:38:49
myself where Buffett would be famous for his, you know, he he waits for that perfect strike. He doesn't jump at every
00:38:56
chance. and maybe he would say I don't understand this value valuation method or I don't trust this particular
00:39:01
valuationist method as much as I trust the other valuation methods I use and okay more more power to them
00:39:07
>> yeah somebody like that has so much skill that they don't need anything other than the the it's like somebody
00:39:13
who's a very successful business person like Mark Zuckerberg or something like that
00:39:19
>> he doesn't need gold >> right >> he's not listening to this podcast I get skill in building this company and it's
00:39:28
got all these shares. The uh of course these people don't think it would be kind of silly for them to be wasting
00:39:35
their time when they have these superior skills that you and I don't have. >> That's what we need to re we don't have
00:39:41
these skills. That's why I'm using diversification that I can actually do as opposed to trying to be Warren
00:39:47
Buffett because I'm I'm not vain enough to think I have that kind of skill. I can combine assets. That that that's my
00:39:53
level of skill. in ETF form. I can I can do that. I can handle that. There's a lot of
00:40:00
misinformation about gold >> that that people circulate. How old are you, by the way?
00:40:05
>> 36. 36 years old. >> So, you were born in >> 90. >> 90. Okay. So, often times I people hear
00:40:12
people say gold is so volatile. It's like eight times more volatile than the stock market. I've heard that before.
00:40:18
What do you think has been more volatile in your lifetime, gold or the stock market? Well, not that you're leading
00:40:24
the witness, but I'm going to have to guess the stock market. >> Yeah. And and the thing is, you can look
00:40:29
this up in 5 seconds. >> Yeah. Sure. Sure. You go to Tesfolio and and look up any of these assets. So, a
00:40:35
lot of the things people say are just not true. And that's a big problem. People believe and repeat things that
00:40:41
just aren't true. They're truthy. That's Stephen Cover says they're truthy in that. Yeah, you can find a period where
00:40:50
gold had a very was a very volatile thing. You can also find what would you say if I if I said I'd like you to
00:40:56
invest in this asset, but it can drop 20% in one day. Would you invest in that? >> Well, sounds like it has some risk. If
00:41:03
that's all I know, it sounds risky to me. >> Yeah. You know what that asset's called?
00:41:07
>> Stocks is my guess. >> The stock market. >> 1987. It dropped over 20% in one day.
00:41:13
I've got a headline on my wall. Panic. So, the truth is that gold is no more volatile than the stock market. In fact,
00:41:19
it's been less volatile in your lifetime. You have to go back to the 1970s when it was first became tradable.
00:41:27
Even then, if you go all the way back to the data set to 1968, it has about the same volatility with the stock market.
00:41:34
In this century, it actually has lower volatility and better returns than the stock market. So in the 21st century,
00:41:42
gold has been a better thing to hold than the S&P 500. Will that continue? Will that change? For my purposes, I
00:41:49
look at all of the data we have, which goes back to 1968. I can see that goal as a compounded annual growth rate or
00:41:56
return of like 8%, 7 or 8%. It's less than the 10% you get out of the stock market, but it's it's much more than
00:42:05
bonds. And it has a volatility that's reasonable. It's not eight times the stock market. It's about what the stock
00:42:12
market is. And then mo most importantly is okay. So it's uncorrelated with both stocks and bonds. So I can put it in a
00:42:19
portfolio and and get that diversification bonus essentially out of it that apply Ray Dalio's holy grail
00:42:27
principle by finding uncorrelated assets and combining them. That's why it works
00:42:31
the way it does. And that's kind of the truth as opposed to the truthy. The other thing I I should caution people is
00:42:37
that is a long-term asset. What people are doing with gold is they're going to Costco and buying these bars and they're
00:42:45
putting them in the ground and then they're trading things and they're doing it next month and they're trying to
00:42:50
predict the the price. It's like no. That that's just a bad practice with any asset that we're talking about being
00:42:56
long-term investors here. So we're talking about a minimum of a decade for holding period and really more at least
00:43:08
25 years. >> Yeah. This is a retirement portfolio, right? This is a retirement portfolio.
00:43:13
>> So we need to hold that essentially forever as one of the assets in the portfolio. And you sell it high and you
00:43:20
buy it low. So >> I for rebalancing >> I've held gold since 2015 and and so it's
00:43:28
doubled or triple. I can't remember which right now, but I've been selling it for the past three or four years.
00:43:34
We've been living on it in our retirement. >> Yeah, >> because it's gone up the most.
00:43:38
>> You sell the thing that goes up the most and buy other things. Buy you buy bonds
00:43:43
because they've been terrible. >> That's the nature though of a of different assets performing differently
00:43:50
and rebalancing. >> That's how you're supposed to manage a retirement portfolio. And the it goes
00:43:54
back to the four quadrants, the economic regimes that you kind of go through over
00:43:58
time. We don't know what the weather's going to be tomorrow. And I've got six other questions I wanted to go through.
00:44:03
But I do think that either means maybe we find time to do a part two in a few months or maybe we send the listeners
00:44:10
right now over to Risk Parody Radio because, you know, we've only scratched the surface here today. If a memory
00:44:17
serves me, there are specific episodes that are good places for listeners to start if they haven't tuned in to Risk
00:44:22
Purity Radio before. Can you tell us what's going on? >> Episodes 1, 3, 5, 7, and 9 are the base
00:44:29
episodes that tell you where this comes from, what the history of it is, why you
00:44:35
do it this way. I direct people there first. There are over 500 episodes now, but you can search all the episodes at
00:44:44
the website. I had a listener that actually brilliantly redid my whole website. The whole thing is searchable
00:44:51
now. I would say it's not for every It's not everybody's cup of tea. I have about
00:44:54
3,000 listeners now and the the reviews are either five star, one star. This is the best podcast I ever listened
00:45:01
to and I love the sound clips and it's very funny and it's very informative or this is probably the worst thing I've
00:45:07
ever heard. It sounds like it was made by a 10-year-old with ADHD. Well, listeners, you can reach out to me or
00:45:14
Frank and let me know what you think about Risk Fair Radio. We will put all the relevant links that you mentioned
00:45:18
there, Frank, into the show notes. Thank you so much again for joining us here on
00:45:22
Personal Finance for Long-Term Investors. >> You're quite welcome. >> Listeners, I have one parting thought
00:45:26
today. If this episode intrigued you and you want to hear more from Frank, please
00:45:30
drop me an email. I'll try to invite him back on the show because, as you heard me say, we only scratched the surface of
00:45:35
risk parody portfolios today and I'm always a fan of learning more. At this point, I still see risk parity investing
00:45:40
as a topic that I'm learning more about. I'm open-minded to, but something I don't fully understand yet, and
00:45:46
therefore, I'm not enacting it in my own portfolios, at least not yet. My current
00:45:49
thinking is that risk parity solves a specific and important problem. And that problem is how to dependably increase a
00:45:56
retireese spending, even if during bad market conditions. That's a big problem. It's important. It's what Frank was
00:46:01
talking about when he was talking about hustling and hoarding and harvesting. But what I'm currently chewing on,
00:46:05
though, I'm thinking about that term hoarding. It has a bit of a negative connotation of course, but is that the
00:46:11
right word to define retirees who feel comfortable relying on mainly stocks and bonds? I'm not sure. I think it's
00:46:17
important to think about the words we choose and not to let the label hoarding maybe unduly influence us over the
00:46:23
underlying behavior. Because one of my takeaways from Frank's work is this. You must be entirely comfortable with your
00:46:30
investing strategy. If it's 100% stocks and you're entirely comfortable with that, great. If it's a traditional 60/40
00:46:36
portfolio and you're entirely comfortable with it, great. Or if it's a risk parody portfolio and you're
00:46:41
entirely comfortable with it, that's great, too. Maybe it's rental homes and stocks and bonds, fine. The point is, if
00:46:47
your portfolio is something that you are not comfortable with, that is a dangerous thing. I'm still doing the
00:46:52
work personally on risk parity portfolios, and I'm really glad to learn from Frank and others like him. I hope
00:46:57
maybe you feel the same. So, thank you as always for listening to Personal Finance for Long-Term Investors. Thanks
00:47:03
for tuning in to this episode of Personal Finance for Long-Term Investors. If you have a question for
00:47:08
Jesse to answer on a future episode, send him an email over at his blog, The Best Interest. His email address is
00:47:15
[email protected]. Again, that's jessevestinterest.blog. Did you enjoy the show? Subscribe, rate,
00:47:23
and review the podcast wherever you listen. This helps others find the show and invest in knowledge themselves, and
00:47:30
we really appreciate it. We'll catch you on the next episode of Personal Finance
00:47:34
for Long-Term Investors. Personal Finance for Long-Term Investors is a personal podcast meant for education and
00:47:40
entertainment. It should not be taken as financial advice and it's not prescriptive of your financial
00:47:46
situation.