Just Keep The Junk To A Minimum

The Washington Post wrote about ultra processed foods. The US appears to have less regulation around what ingredients can be used and increasingly over the the last 40 plus years we've seen ingredient lists on packaged food get longer as more and more seed oils get added to our food. 

As an example here is Skippy Peanut Butter's ingredients;

And Trader Joe's Peanut Butter's ingredients.

We eat Trader Joe's PB. Seed oils like the ones in Skippy are obesogenic and heavy in omega 6. Simplistically, Omega 6 is unhealthy and Omega 3 is healthy. Food has a ratio of Omega 6 to Omega 3. The higher the 6 to 3 ratio, the less healthy the food. Some food will have more Omega 3 than 6 but a ratio of like 2 or 3 to 1, Omega 6 to Omega 3 is considered healthier. Food processed with seed oils is usually much much higher than 2 or 3 to 1. This is the argument for keeping it simple and eating more foods with no ingredients that come from the edges of the super market not on the isles. 

The short version; just keep the junk to a minimum.

The President signed an executive order that creates a path to including crypto and private assets in 401k plans. This will sound like a contradiction but I agree with allowing this stuff into 401k plans, I just don't think too many people should buy for their 401k plans. 

I lean toward the idea that we should be free to make our own decisions, good, bad or otherwise. I've owned Bitcoin for a while. I have said of Bitcoin that the position started very small and that I will hold on until it either grows into a life-changing piece of money or craps out. At current levels, I would describe the position as a useful piece of money not life-changing. 

At my first post-college job at Lehman Brothers in 1989, one of the things I learned was to never take shares of an IPO that are offered to you. The generalization was that only IPOs you can't get shares of are the ones that are going to go up a lot.

I apply the exact same thought to private assets that will be available to retail investors via 401k plans or anything else. If you look you will find plenty of opinion pieces that the current push to make private assets available is about ginning up demand for product. 

The short version; just keep the junk to a minimum. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

A Difficult Decision

This post is fire related. 

On July 13th I wrote about the loss of the lodge at the North Rim of the Grand Canyon, it got burned over in the Dragon Bravo Fire. My wife and I have been up there probably a dozen times and we were due to be there this week too for short visit. 

As a matter of circumstance with personnel, Walker Fire was not available to send an engine up to that fire until today. That the fire is still going on all these weeks after it started is really something. 

Engine 83, pictured above headed up there today. 83 is a Type 3 Engine and for these types of assignments it can go out with either four or five firefighters. We only had four going and I anguished a bit over going in the fifth spot. 

In that July 13th post I used the word magical to describe the North Rim area. There was a calm and peacefulness to it that is hard to adequately describe but I think everyone feels it. Do you remember David Darst? He worked at Morgan Stanley and was on CNBC all time. The picture is from 2009, it was my only encounter with him and before we went on, we had a five minute conversation about the North Rim. He loved it too. 

This is the Supai Tunnel, it is about two miles down the North Kaibab Trail. My wife said she saw where the fire burned down to this point. It's about two miles down from the trailhead and parking lot. 

If the fire did burn as far down as the tunnel, then just about all the trees in this picture from Cathedral Point are gone.

The next picture is from Imperial Point. This area is a short distance from the lodge and North Kaibab trailhead and it too was burned over. The view wasn't impacted but the picture is taken from a forested area that is now gone.

Although the main area, the lodge and guest cabins are lost there was a real pull for me to want to go be part of the solution someway, somehow and while it may bug me that I didn't go, there are more reasons for me to have not gone. 

Day job related, this assignment would have been out on a truck doing structure protection (per the resource order that requested us) and the cell signal up there is almost non-existent. That contrasts with my two assignments as a liaison officer which is 90% in an office and if there is no cell signal the bring that in via a cell on wheels (COW) or lately with Starlink. When these assignments come in, personnel need to be prepared to stay for two weeks. Two weeks with internet every day would be doable, two weeks without internet would not. 

Walker Fire related, we have had what seems like a pretty weak rainy season, right now things are very dry and the Forest Service has the current fire danger as extreme. As the chief and living less than a mile from the station house where I can quickly get a truck out the door, taking off for two weeks while the fire danger is extreme seems like a bad idea.

In almost 23 years on the department, we've had three what I would say were legitimate infernos including this one in June which was the diciest of the three. We had water flowing on it within ten minutes of finding out this was happening. The smoke was much blacker a few minutes before I took this picture. 

Can a decision be both right and regretful at the same time? This one is. 

A Year Later, It Still Works

Last August we took a quick look at the Bridges Tactical ETF (BDGS). It's equity centric and has a process for risk on and risk off that allows it to vary its equity exposure and pairing that with cash proxies. Last summer it was 71% in cash proxies and today it appears to be 43% in cash proxies. Like last summer, the equity sleeve appears to have more volatility than the S&P 500. Most of the equity names are stocks that have 2x versions trading. Last summer I said it's sort of a capital efficiency effect or maybe a barbell effect. 

Since that first blog post, the fund has done pretty much exactly what it said it would do. Decent upcapture, so it lags plain vanilla market cap weighting, with less volatility. 

The comparison to HEQT still seems to be reasonable. Portfolios 3 and 4 also create the same effect. Portfolio 5 captures the current positioning but not fair to BDGS because the ETF can adjust the mix. Still though, Portfolio 5 is surprisingly close to BDGS' performance. 

A year later the strategy seems to be valid. No strategy or fund can always be best and any strategy will at times struggle, that goes with the territory but it's hard to argue with a fund that does what it says it's going to do.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Buffer Mania

Reuters posted an article that could be summed up as man there's a lot of defined outcome and derivative income funds and they're getting more complex. These are fun to look at and although I don't really do much with them, I get a lot of questions from people outside the sphere of my day job (firefighters and friends). 

The theory of barbelling yield out of a narrow slice of the portfolio seems to hold some water, my only client use is intermittent and more of a volatility tool, I do not have any of the crazy high yielders in my ownership universe. I don't use any of the buffer funds, but I would caution that if you want to use them, do not expect them to be proxies for the equity market. I haven't looked at a ton of buffer funds but I do think some can continue to function as a low vol, low return type of exposure. 

This is a fun one. BALT is a large defined outcome fund that we've looked at before. IYW is broad based tech and a long time client holding. ROM is a 2X tech ETF from ProShares. Technology should go up more than the broad market on the way up and down more on the way down which is why I chose it for this exercise but oddly, the idea sort of works with consumer staples (XLP and UGE) too. Interestingly, the blend of BALT and 20% exposure tech is very underweight versus the S&P 500 and almost exactly in line with the tech exposure of VBAIX, so as big of a sector bet as you might think.

I would have thought that this sort of BALT/tech mix would have done worse than 60/40 in something like the popping of the internet bubble. Using XLK and client/personal holding MERFX as substitutes, the drawdown at the 2003 bottom was the same as plain vanilla 60/40. IYW started trading just after the 2000 peak and BALT just started in 2021.

IRL, putting 80% into one low volatility strategy seems insane to me. Below, Portfolio 2 has 8 different low vol strategies with 20% in IYW.

Testfol.io has VBAIX's CAGR since inception at 7.16% which is noticeably better than the 6.46% available in our back test but I don't think the skew creates too distorted of a picture. 

This variation of barbelling can work but despite the back test I think it would be quite risky.  

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

The Craziest Article I've Ever Read?

But first, a friend sent an article written by Pim van Vliet titled No Asset Is Safe But Some Lose Less. The first part of the article lays bare the loss of purchasing power by just holding cash or T-bills over very long time horizons. A useful rule of thumb for framing this effect is that at a 3% rate of price inflation, expenses will be 50% higher in 15 years. 

Cash is both optionality and protection against short term volatility but the drawback is as van Vliet says, a loss of purchasing power. A 50 year old sitting on $1 million in cash and nothing else will have a lot less purchasing power when they get to 70. 

The other day I mentioned that part of the asset allocation process is figuring out what portion of a portfolio needs to capture whatever the equity market will give over the relevant time period. Figuring out how much cash is appropriate is part of that process too and some apparent overlap between van Vliet and me would be how much to allocate to lower vol assets that should exceed the rate of inflation but without the full equity effects of growth and volatility. 

The second half of the article then makes the case for lower volatility stocks, van Vliet uses the term widows and orphans. 

SPLV and USMV target different versions of low volatility. SPLV simply owns low volatility stocks and USMV tries to optimize a portfolio of stocks with various attributes to deliver a lower volatility result. The results of both are valid in terms of generally delivering on the objective as well as the growth rate. In the period studied, inflation compounded at 2.60% so SPLV and USMV check that box too. It's not a realistic expectation that they could keep up with or outperform simple market cap weighting but the tradeoff is a smoother ride. 

As we've looked at before, the low volatility effect can be captured using client and personal holding BTAL combined with simple market cap weighting. I weighted the portfolios to get very similar returns as SPLV and USMV but with much noticeably less volatility. Portfolio 5 tries to add portable alpha using a 2x equity fund and client/personal holding MERIX. Again with that one I tried to target a similar return and even with the huge weighting to a levered fund the volatility is less than both SPLV and USMV.

If we dial up the volatility of Portfolios 4 and 5 to get closer to SPLV and USMV, the respective CAGRs for 4 and 5 go up to 13.32% and 13.39%. The idea with market cap weighting plus BTAL is the opportunity for more upcapture. It is not the core holding (SPLV or USMV) that is the governor, it is the hedging device, BTAL. Clearly though, just owning SPLV or USMV would be simpler.

Now the crazy article. It was kind of an advice profile at the WSJ for a 44 year old woman who wants to retire at 61, take Social Security at 67 and (here's the crazy part) wants to be able to afford to move into a "continuing care facility" at 70. Is it just me that thinks this is crazy? It makes no sense to me. There are other things in there that I will touch on that also don't quite add up, it makes wonder if this isn't real. 

The link removes the paywall so tell me if I am wrong but what person in their 40's targets wanting continuing care at 70? 

Starting at 61, she is eligible for a $5300/mo pension (she works for LA county). At 67 her Social Security will be $1500 is today's dollars from a previous employer or a spousal benefit. Her main job is a librarian and she side hustles as a librarian somewhere else. She has a mortgage on her place and a larger second mortgage so that she could buy her ex-husband out of their home. There's about $400,000 in home equity and another $240,000 in other IRAs, part of which I am assuming is her rollover from a previous employer. Something that also doesn't track is a $900 payment on a $15000 car loan but maybe it started as an $80,000 car loan or something.

The planner being asked to assess her situation doesn't think she'll be able to afford to buy into continuing care at 70. I still cannot wrap my head around this goal. At 44, maybe she doesn't understand what 70 is. We've talked about the theory of not understanding what it means to be older than your age plus 50%. So at 20, you wouldn't understand 35 and at 44, you wouldn't understand 70. That could be part of the equation. 

My older siblings are 69, 71 and 73 and while I think they could all be exercising more, none of them are anywhere close to sniffing distance to needing some sort of continuing care. If you're 70 and reading this, you probably read that last sentence are thinking, no shit Sherlock. Of course bad things can happen to anyone at anytime but planning for age 70 when you're 44? This is presented as Plan A, not some sort of optionality-contingency. What is the logic here, if you know, please leave a comment. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

The Disillusionment Of Winning

David Epstein wrote about an interesting idea (new to me) called the arrival fallacy. The prompt was the recent press conference where Scottie Scheffler talked about the short lived joy, for him, that goes with winning a golf tournament. Winning is joyful for Scheffler but then "it's like, okay, now what are we going to eat for dinner?" 

This is relatable. I've talked before about my first job out of college at Lehman Brothers starting in the summer of 1989. I got into a program where you had six months to open 50 accounts that would go to one a broker that was your mentor. Open the 50 and then you become a broker. 

I can't begin to tell you how bad I was at cold calling and pitching people but I was able to get to 50 in four months which might have been a record, not sure about that but it was fast. Amusingly, someone came along shortly thereafter and did in a month. This guy could open accounts so easily that I swear he could get anyone to send him their last $10,000 to buy Texaco or Paramount (two of the stocks getting pitched in the office back then). It got to the point where they coached him to not open so many accounts because that's what he was doing, getting people to send their last, or only, $10,000 in to buy stock which didn't jibe with the business model. I moved on shortly thereafter but I am sure he went on to be wildly successful. 

When I completed this program, I got the offer for my own desk (jargon) on a Friday. I was ecstatic all weekend, legitimately ecstatic, I had arrived. I worked very hard and achieved a goal that I was told most people fail at. Then Monday morning came, I had to start over completely and I knew almost immediately that this was not what I wanted to do. I had arrived but really I hadn't done anything. 

This encounter with arrival fallacy was pivotal in my development as an adult. I've talked before about not really being a goal oriented person and that Monday morning feeling was a contributor. 

My approach has been more like putting in the work and following the progression toward wherever the work leads. With my day job, I started studying voraciously in the 80's, then all through the 90's when I was at Schwab not knowing where I would end up. The progression was going from a trader to portfolio manager. A huge kickstart came from writing, first getting published in Barron's in early 2004 and then starting to blog a few months later. Things worked out but there's never been any goals, I just stuck with it and went where it took me. 

Similarly I've never been believer in retirement numbers (goals) like "oh, I need $1.2 million to retire" because whatever you end up with is your retirement number, not some calculation out of Smart Money Magazine (remember that one?) you did in 1998. 

Sort of related, the NY Times had a commentary about writing letters, actually writing them, to your future self and the sort of introspection that goes with this subject or when you see what advice would you give to the 20 year old you? 

The actual commentary was not interesting but I think there is value in doing favors for the future you, doing whatever you can to make things easier for yourself when you're older, giving yourself as many options as you can. There can be a progression to this without having to overly focus on goals that could result in arrival fallacy.

While starting to save money in your 20's would be great, I don't know how many twenty-somethings make enough to do so. Hopefully though as you get into your 30's you can start to build something up in a 401k or the like. This is where financial optionality starts. At 30, it may not be possible to understand what it is to be 50 years old but 50 is coming and having sort sort of financial optionality akin to some level of financial independence is an unknown favor that 30 year old you is doing for the older you. It is an unknown favor because at 30 you probably have no idea or very little idea about what you will want at 50. 

Of course staying in good physical condition is part of this conversation. If 50 is going to come, would you rather be lean, strong and able bodied or the alternative? We all know people our age who look like action figures and people who are very sick, unable to do very much. While it is never too late to start, a lifetime of exercise is a huge physical favor and a huge financial favor. I don't think this needs to be goal oriented. I've been lifting weights very consistently my entire life. The metabolic benefits are endless and I want to be able to bend down and pick up heavy things for the rest of my life. If being able to deadlift X pounds or benchpress Y pounds motivates you, great, but being healthy doesn't have to involve goals. Great, you can deadlift some big number but as Scheffler might say, ok, now what are we going to eat for dinner?

A Fun Post For A Crappy Day

Friday was one of the craziest days in quite a while so let's keep it lighter with a few quick hits.

Barron's wrote about the so called Trump accounts which would be like IRA accounts for children up to age 18. These accounts could be funded up to $5000 stopping at age 18 and then left in the account to grow. It looks as though family and friends' contributions would not be tax deductible going in. There is also talk of a short window where the government would contribute $1000 to these accounts. I have not seen anything about how the $1000 would paid for. 

Let's game this out for someone who turned 18 in 1975, so today they would be 68 years old. Where coming up with an extra $5000 today might be difficult for a lot of people, lets assume $2000 instead. It looks like $2000 today would have been worth $181 in 1957 when this person was born. So assuming the same $181 contributed 18 times but not invested (due to the limitation of testfol.io), at 18 this person would have had $3258 in 1975 to put into an index fund. The first retail index fund hit in 1976 but please humor me.

The $3258 put into an index fund and just left alone would now be $896,000 after compounding at just under 12% all per testfol.io. This person almost wouldn't have needed to save for their retirement. There are plenty of behavioral mistakes that could get in the way of this sort of outcome and assuming the compounding number of 11.89% is correct, that seems too high to count on for the next 50 years. This sort of starting out type of account could still grow into a very meaningful piece of money.

More Barron's, they had a piece on healthcare costs which wasn't very interesting but there was a terrific comment to share. 

In my mid 80s, I'm working to enhance dividend and capital gains income by selling covered calls and cash secured puts on stocks and ETFs. This puts about 50% of our liquid assets to work. It generates nice returns on risk every week, month and year with, for me, minimum risks.

I've been doing this since shortly before we retired. It's a job and it's what I can do.

Everyone who is healthy, exercises, gets a lot of sleep and is able to do something to generate income during "retirement" should keep working as long as their brains and bodies will let them.

Only people with a lot of income yielding savings and investments (including great federal and state government pensions), can quit working, play, travel and pretend that what's going on in the world won't affect them or put them on Medicaid.

The first observation is that he has been making the effort to solve his own problem. I wouldn't focus on his strategy, maybe it's for you or maybe it's not, but his being part of the solution, realizing someone needs to do work on his portfolio, it sounds like he enjoys the challenge and maybe based on the rest of his comment, he's got the other aspects of his life dialed into. Taken as written, it's a great example of successful aging. 

Tidal ETFs (white label ETF provider) had a blog post about the manner in which derivative income ETFs and defined outcome (buffer) ETFs are making their way into an increasing number of portfolios. They note that investors are "no longer content with riding out volatility unhedged" and "raises questions about how asset managers and advisors are framing risk." You can get more color if you click through but it touches on some ideas we've been working with here forever and triggered an idea for a crazy portfolio idea.

Portfolios 1 and 2 obviously barbell the volatility and growth potential into narrower slices of the portfolio and when paired with BALT which is one of the larger buffer ETFs that we've looked at before. I would absolutely not count on BALT to capture the equity market over longer periods but it is pretty good at having low volatility and positive compounding. 

Instead of thinking of this as mostly a low vol alternative and levered equity, like we've talked about before, the 2x and 3x funds might be better thought of as equity with volatility overlays. At times, the volatility overlay will either help the portfolio or hurt it. It would have to overcome the volatility drag to be additive and logically, sometimes it will do that and at other times it would not. 

Tidal talked about different ways to use volatility and that's what the above idea tries to do. No matter how flawed the levered ETFs are, they worked out in this example to a reasonable outcome.

I saw this Tweet today;

 

MERIX is a client and personal holding. 

If you want blistering volatility, the APED ETF might be for you!

Just a quick word about today. I saw some pundits talking about what steps to take in case the last couple of days turns into something more protracted. We spend a lot of time here on ways to make portfolios more robust so that you don't have to react when crazy news hits that may or may not actually hurt markets. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

A New Building Block Of Retirement Planning

Erik Conley had a well written post about whether people might have too large of an emergency fund. He had a couple of very funny one-liners in there too. 

The big idea is the opportunity cost of being too conservatively allocated to cash. If you play around with different, decently long time periods you'll see that domestic equities compound somewhere between 8-11% where cash compounds compounds at maybe 3-4%, even less than that over the last ten years or so. 

If someone has $5 million in the bank and only needs to pull $100,000 out per year then 3-4% will more than get it done but that won't be too many people. Part of the asset allocation process is to figure out what portion of the total pie needs to capture the effect of whatever the stock market can deliver over the relevant time horizon. 

One way you might know you have too large of an emergency fund, Erik says, is that you haven't actually had an emergency. That's funny. Being serious, define your terms of what constitutes an emergency. I shared our story from late 2023 going a few months into 2024 where we had a problem with out septic system. All in it ended up costing close to $4000. Does that constitute an emergency? It obviously was not planned for. If the only way to pay for it would have been on a credit card then that might constitute an emergency. 

Earlier in 2023 we had several out of the ordinary car issues, a few things came up that added up to about $2500. We have all had these sorts of things happen. We've never had to shell out $50,000 or $100,000 for something unexpected. All I can think of being that expensive is something medical not covered by insurance or a family member in some sort of serious trouble. Something that big would be an emergency regardless of whether we have the money or not. 

How much money should people have in some sort of liquid vehicle for the less dramatic "emergencies" like the ones I mentioned above or to pay the bills in the face of a job loss? There's no single answer there for everyone. 

Erik doesn't think people need a year's worth of expenses set aside unless their job situation is very unstable. As we've looked at quite a few times lately, maybe everyone 55 and older's job is very unstable as a large portion older workers get their hand forced at work. At 40, maybe one year's worth of expenses might be excessive but at some age, people need to be ready to "retire" if they get crowded out from their career and can't replace their income. Here, retire could mean be ready to be extremely underemployed. Maybe the career job paid $150,000-$200,000 but what if that ends at 57 years old and the replacement job pays $60,000.

I talk a lot about cultivating and creating income streams and while I have done that personally, none of those would add up to replace what I make from my day job. Living well under our means would make that forced transition easier even if not truly easy. 

There are certain basic building blocks to life and personal finance/retirement planning. While I don't know whether people over 50 have always been vulnerable at work or if this is a new phenomenon but I think a building block of retirement planning needs to be building a contingency in case you can't retire on your own terms. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Don't Try This At Home

FIRE Funds Tweeted a lot of detail about its Income Target ETF (FIRI) which is a companion to its Wealth Builder ETF (FIRS) which I own a few shares. FIRS is the accumulation phase fund and FIRI is the decumulation phase fund. The context here is for Financial Independence/ Retire Early. 

This from the Tweet caught my eye, "...seeks to provide a 4% target annual income level using a 'barbell strategy' to balance high-yielding income assets with low-volatility cash-like instruments." We talk about barbelling yield and growth regularly here. FIRI portfolio is mostly standard fixed income strategies but slight twists on the larger fixed income ETFs like AGG or MBS with a few crazy high yielders to barbell the yield.

Let's take all that as a prompt to build a portfolio that combines capital efficiency, a short biased long short and a bunch of higher yielders with just a little bit in a crazy high yielder. I built two versions of a very similar portfolio as follows. They are the same except that Portfolio 1 has 10% in YieldMax GDX (GDXY) and 10% in Bank Loans (BKLN) and Portfolio 2 has just 5% in GDXY and 15% in BKLN.

MVPL toggles between owning 1x S&P 500 and 2x S&P 500 so this is where capital efficiency comes in. Client/personal holding BTAL is the short biased hedge, BRW is growthy and yields about 12%, SJNK and BKLN (BKLN is in my ownership universe), high yield and bank loans, both yield in the high sevens, SHRIX owns catastrophe bonds and yields 14% and GDXY is the one crazy high yielder which Yahoo shows as "yielding" 49%. Using GDXY avoids the tech sector and single stock risk. Gold miners have more potential for defensive attributes than the typical tech stock.

I backtested with a large dollar amount like it was something someone would try to live off of for some period, willing to accept some depletion.

The made up portfolios for this post are pretty crazy but the volatility and beta numbers are not insane. The portfolios outperform but very little of the outperformance is from the leverage of MVPL. Apples to apples comparing of MVPL/BTAL and VOO for the same period had the MVPL/BTAL combo ahead by only 71 basis points with a little more volatility but a smaller drawdown.

The fixed income is where the outperformance came from.

The Sharpe Ratios of Portfolios 1 and 2 tell you that the bump up in volatility is well worth it for the extra total return. SJNK, BRW, SHRIX and BKLN were all around in 2022 and had declines ranging from -2.51% to -5.50% compared to -13.03% for AGG.

BRW didn't have a problem on a total return (price only it was down 16%) with rates going up in 2022 but it is an actively managed fund of funds so if it made a good decision in 2022, it could get that decision wrong if rates take another meaningful leg higher. The other three fixed income do have risks associated with them to be sure but interest rate risk isn't one of them. GDXY should be expected to be a depleting asset for the most part but if GDX goes on a prolonged run higher then GDXY might be able to tread water sideways.

This chart captures that point. GDXY went down last year but this year is trading sideways as GDX has gone up a lot.

Where the advantage of MVPL/BTAL is only very slight versus plain vanilla S&P 500, the results would look very similar using SPY or VOO and avoiding the complexity of the leverage/hedge combo. 

The idea with today's exercise was to make kind of a crazy blend to produce a lot of yield that could be offset by the growth component that might all add up to a return after distributions that was a little ahead of inflation. Yes, the period available to backtest is ridiculously short but in the short time we have, the two versions price only were up 5.57% and 6.65% respectively versus 2.32% as shown by testfol.io.

That was a fun exercise, what would you add or change to improve the result?

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Car Fires and Long/Short Equity

Bob Elliott wrote a blog post in support of the new Unlimited Equity Long/Short ETF (HFEQ). HFEQ uses a replication process, this from the blog post spells out the logic.

Many allocators eschew the concept of low-cost alpha indexing approaches like what is described above with the hope that they can find individual managers that will outperform their peers.  But over time, a lower cost indexing approach to investing in managers creates a higher probability outperformance relative to peers. That is a product of the inherent diversification benefits of an index approach which can improve return consistency, paired with a lower fee structure allowing the investor to harvest more of the alpha generated.

I don't think I have a nit pick with the idea but obviously a replication of something will at times be right in line, lag at other times and come out ahead in other periods. We see this with the various managed futures replicators. This reality is neither negative nor positive but more about having the correct expectations. 

Here are a couple of performance tables of what Bob is talking about, notice the different time frames.

The annualized outperformance is greater from the period starting in 2002 so the version of long/short that Bob is talking about was very additive during the "lost decade," less so since then as equities have done much better than in the 2000s. 

Related is a link from Crystal Capital Partners that gives a little more details abput different kinds of long short in the context of trying to sell some sort of hedge fund access. Yes, it is a salesy piece but there is some information there too. 

The starting point from Crystal is that the change in the inflationary outlook that hurt bonds in 2022 and persists today has diluted the diversification benefits of the plain vanilla 60/40 portfolio. They took quick, but useful, looks at pairs trading (statistical arbitrage), mean reversions (their look was a little narrower than we've looked at previously) and merger arbitrage which we look at constantly.

By utilizing strategies that have minimal exposure to inflationary pressures, quantitative hedge funds have been a steady pillar in investors’ portfolios amidst periods of market turmoil. A group of 53 quantitative hedge funds measured by Goldman Sachs’s prime-brokerage unit delivered annualized returns to investors of 9.9% over the past 5 years with minimal volatility and nearly no correlation to the broader stock market

I would not get hung up on the use of 'quantitative hedge fund' and instead think about these as tools targeting specific outcomes to be evaluated based on whether they deliver on their intended outcomes. 

The equity market has of course rocketed off the April low so it makes sense that the short bias long/short strategy would go down. Absolute return long/short has been successfully immune from all the volatility and the long bias long/short has generally captured the rocketing. The one that can switch its bias is probably a tougher hold, that's not a fund I've ever considered but with something like that, its investors probably need to hold on no matter what.

To extent these strategies are tools, you need to use the right tool. Just as a short bias fund is likely to go down when stocks are rallying, I wouldn't count on a long bias fund to go up when stocks are falling. A long bias fund certainly could but I would not expect it. 

A quick fire department analogy that might fit with knowing what tool to choose. A little after midnight last night, we got dispatched out for an vehicle accident in between our service area headed out of Walker and Prescott Fire Department's service area. We were a little closer but shortening the story, the ambulance company got there before we did. Right before I got to the station house, our dispatcher said the ambulance company was already there. 

I was second to arrive at the station house and our ambulance was already out, ready to go. Knowing there was already an ambulance there, I made the decision to take one of our engines (a fire truck) instead. We were not going to be providing medical care in this scenario but if the accident scene was a little more complicated than had been called in, we'd be able to address the situation more directly. 

We're getting to the end of the call, the sheriff released us (it was their scene, they were in command) and just as we're starting to roll, flames started coming out of the crumpled hood. We ran a line down the embankment and were able to put out in a few minutes. I processed the information I had and decided what tool would give us more optionality for the circumstance. It would have been awkward to have been there, have the car catch fire and the fire department not able to do much about it, not sure one fire extinguisher would have been enough compared to the 100 or so gallons we sprayed on it. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

The Retirement Equation

Three different personal finance/retirement articles to look at today.

First, Barron's looked at taking mini-retirements every so often starting at a youngish age. The immediately conceded that the correct word is sabbatical. They did a fair pro and con of the idea. 

The cons related to not having the flexibility at work to do this, the drawback of having to quit and then reenter the workforce and not just the interruption of savings contributions but also potentially pulling from savings to make the economics of the sabbatical work. There is the potential have a real retirement planning setback from having pull from savings for some number of months. 

One negative not discussed and you know what, negative might not be the right word, but late 20's into our 30's up to some age we pay our dues. This is when things should be tougher and I don't think bailing out at 29 because the position immediately after the first entry level job was difficult is a great idea. It does nothing to help someone develop resilience. Moving up the ladder at that age is a different thing and not what I am talking about. Do the difficult thing with one reward being fewer jobs listed on the resume. Six employers in nine years raises questions. If you're 30 years old, reading that last sentence and thinking he doesn't know what he's talking about, fair enough but I'm closer in age to the person likely to make the hiring decision at your next employer, and if they don't understand, that is a problem for you not them. 

While taking a sabbatical at a relatively young age might draw mixed reactions, I would not shy away from the occasional, calculated risk. I took a couple of fairly big risks in my early and mid 30's. I built up a little bit of a war chest to get through but this was in part buying a call option on myself and betting the risk would pay off. Getting back into the workforce at 35 might be difficult but it would be easier than trying to get back in at 55. 

The Wall Street Journal wrote about the extent to which people are using their 401ks as emergency funds citing data from Vanguard putting the number at 4.8% of participants taking money out early one way or another. Vanguard also reported that about 1/3 of people who change jobs take all the money out, this must be a younger cohort but the article didn't specify. 

A common reason for taking money out is to pay off debt with a couple shared anecdotes in the article where people did just that and are glad they did. The thing to watch out for of course is paying off the debt and then going right back into debt. Never having credit card debt again is of course commendable but using retirement money to pay off debt only to go right back into debt is bad spot to be in. If their behavior isn't (self) corrected then nothing really gets solved. 

Taking money out can of course be expensive. There are a couple of hardship exemptions that might relieve some of that expense but under age 59 1/2 and these withdrawals are both taxable and subject to a 10% penalty. Certain hardships waive the penalty. 

The comments on the Journal article were mostly opposed to the idea but there one comment with an interesting theory. Basically, if you get the employer match and then at some point you take money out for something, the employer match is subsidizing the tax and the penalty. He didn't say this but the vesting plan could get in the way of this but either way, it's an interesting idea. 

I won't say that taking money out early is universally bad but there are negative tradeoffs and there is potential for serious mistakes. 

The final article came from Yahoo and was provocatively titled Working Longer Won't Save Your Retirement and featured ideas and opinions from Teresa Ghilarducci. Ghilarducci gets interviewed frequently and I always find her comments interesting because I find myself disagreeing with the majority of what she says. Her commentaries always read as being quite far to the left. On some things I am liberal and other things I am pretty conservative and on this subject I guess I am conservative. 

She doesn't appear to be saying working longer doesn't work, more like it is an unfair burden to place on many workers for quite a few different reasons. The article actually talks a lot about white people having better outcomes and I didn't really know what to make of that. Was it racist or not racist, honest to God I am not sure?

I don't think I will ever be able to get on board with any solution that doesn't involve people trying to solve their own problem. Yes, not every one will be able to do so but plenty have that ability. Ghilarducci talked about people being unable to work to older ages for various reasons including that the stress induced from certain jobs can adversely impact health outcomes. Ok, that is an interesting idea. 

Are you on track retirement savings-wise with not much margin for error or maybe a little behind? What do you do for work? Do you dislike it? Are you aware of how much stress it might be causing? How old are you? Following that line of questions like a flow path, if you need some sort of income beyond (reduced) Social Security and portfolio income to make it work and staying in your current job is not feasible for any reason, what can you do starting now to solve that problem?

Ghilarducci wants the government to step up with some sort of new plan as a supplement to Social Security where people contribute 1% of their income and the government matches 3%. Ok, how do we pay for that? The article didn't get around to how to pay for this new program. 

I probably come off as harsh in these posts but letting my fate rest in the hands of the government to fix it is unacceptable. Yes, something might happen to Social Security that is beyond our control but how we solve other parts of the retirement equation doesn't have to be. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Late Career Resiliency

The Wall Street Journal took up the conversation about people close to typical retirement age being forced out earlier than they expected. The article notes the difficulty in getting any job (it takes longer) and the low odds of making the same income. There was also discussion about lower job quality which they defined as a job with no benefits, or as I think was also implied, a job with lousy benefits. 

This is an important subject and the solution is homegrown resiliency against the unexpected. No one is going to solve your problem for you. This is where the idea of independence, differentiated from having a lot of money comes in. Morgan Housel said to Shane Parrish that "rich is making your payments, wealthy is independence."⁣ I would also add the importance of health and fitness to this equation. 

There is overlap with this topic and the FI/RE movement, financial independence/retire early idea that has become popular in the last few years. When I read stories about people who FIRE'd at a young age, they almost never have actually retired. They typically accumulate impressive sums for their age living very frugally which I equate to paying dues and then figuring out how to cobble together several side hustles or may just one pretty good side hustle which allows them to own their time and have optionality to go without income for a time, maybe a long time. 

These stories sometimes don't add up, like this one, but it does seem like a lot of the FI/RE proponents have figured out the resiliency an optionality aspect which is something that people close to typical retirement age who get forced out early also need to do. 

Like with many things, this is an area where planning for everything to go as hoped for is a mistake waiting to happen. No one needs resiliency in the face of very good luck or outcomes. Resiliency is protection against the things that can't be seen coming. 

Something bad could happen to the company where I hang my shingle and I probably wouldn't get a ton of advanced notice. I am convinced they are doing all the right things but I don't know what kind of trouble they would get into if someone else hanging their shingle there like me was doing something terrible, they miss it somehow and then it gets caught during a normal SEC review (firms registered with the SEC are subject to some sort of regular review). Beyond that, I don't try to guess what could go wrong so much trying to prepare if something goes wrong. 

A couple of related follow ups. I've been saying that above some certain age, people won't be impacted by any sort of cut to Social Security payouts. Senator Bill Cassidy who has come up with a bipartisan idea working with Tim Kaine, told Barron's that if/when cuts come, everyone will be impacted. 

My belief on this came from several reads, quite a few years ago from people I believe had less motivation to spin and scare people than a sitting US Senator. But in the same vane as above, it would be better to plan for it being cut than not. Agreed, there would be absolute hell to pay if they imposed a cut but I would suggest including an assessment of your retirement planning numbers that assumes there is a cut. 

One thing I've said that appears to be correct is that if you find yourself out of work, chances are health insurance through healthcare.gov will be very cheap or even free. I plugged in my scenario without my day job income, so I assumed our rental income plus the stipend I believe I will be getting from the Del E Webb Foundation next year and for a silver plan, the linked calculator said we'd pay $329/mo and that a bronze plan would be $0/mo. 

I don't expect to need to worry about this but it is a tangible example of the importance of staying fit and healthy. I don't know, but I can't imagine the bronze plan is too much worse than what we've had for quite a while now. If your financial back was against the wall, would you be interested in free health insurance? It sounds like a terrible idea for someone who is not healthy and needs to go to the doctor frequently but it sounds like a godsend for someone who is healthy and just goes for a physical every year or two. Yes there might be some sort of bigger than normal rate increase for 2026, but at low income levels, I think the plans would be cheap.

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.

Can We Make An ETF Out Of This Strategy?

I had the idea to revisit long/short pairings and get AI's opinion. The specific long/short idea is to put 50% into a common stock and 50% into the corresponding 1x inverse fund. So Amazon/AMZD, Alphabet/GSLS, Microsoft/MSFD and Apple/AAPD. My thinking is this should be some sort of absolute-ish return. I compared those four to the AQR Diversified Arbitrage Fund (ADAIX).

All the inverse funds are from Direxion and the backtest isn't uselessly short. Direxion has many other funds and other providers also have single stock inverse funds. I omitted Tesla from the above chart to avoid crazy-CEO risk but it looked nothing like these four. The volatility was 24% as testfol.io measures it. 

The four that I chose, were random and they appear to work in the context of doing what I thought they might. I then played around with several others and they didn't work in terms of looking like an absolute return result. 

NVDD has been trading about a year less than the first backtested ETFs. The volatility of NVDA/NVDD is 25% as testfol.io measures it. A similar pairing involving Netflix was also up a lot with a lot of volatility. 

The first four had very low correlations to the S&P 500, the Aggregate Bond Index and even ADAIX. They have legitimately been differentiated return streams which would be the appeal. In April of this year, the respective declines were low single digits other than AAPL/AAPD which was down 5.77%. The NVDA/NVDD pair fell 13% versus 25% for the common.

As I started to think about this for today's post, I asked Copilot about AMZN/AMZD:

what effect is captured by putting equal dollar amounts into AMZN and AMZD?

Putting equal dollar amounts into AMZN (Amazon stock) and AMZD (Direxion Daily AMZN Bear 1X Shares ETF) creates a fascinating tug-of-war that essentially attempts to neutralize directional exposure to Amazon’s price movements—at least in theory, and only for a single day.

Here’s what’s going on:

🧠 Mechanics of the Strategy

• AMZN gives you 1x exposure to Amazon’s stock performance.
• AMZD is designed to deliver -1x daily inverse exposure to AMZN, using swaps and derivatives.
• By allocating equal dollars to both, you’re offsetting gains and losses from AMZN’s daily moves.

⚠️ But Here’s the Catch

• Daily reset risk: AMZD resets its exposure every day. Over time, especially in volatile markets, this leads to compounding effects that distort the expected outcome.
• Volatility drag: If AMZN fluctuates up and down, the compounding can erode value in both positions—even if AMZN ends up flat over time.
• Expense ratios: AMZD has a relatively high expense ratio (~1.02%), which adds a slow bleed to the strategy.
• Not a true hedge: This isn’t a long-term hedge. It’s more like a daily market-neutral bet with embedded decay.

🧪 What You’re Capturing

• Short-term volatility exposure: You’re effectively betting on mean reversion or low volatility in AMZN.
• Compounding asymmetry: Over time, the inverse ETF may underperform due to daily resets, even if AMZN trends downward.

Would you like to model how this plays out over a week or month with hypothetical returns? I can walk you through the math or simulate a few scenarios.

What would be a hypothetical return, standard deviation and maximum drawdown over the last five years?

To estimate the hypothetical performance of a 50/50 dollar-weighted portfolio of AMZN and AMZD over the past five years, we can combine their historical metrics and account for the compounding effects of AMZD’s daily inverse exposure.

Here’s a breakdown based on available data:

📈 Hypothetical 5-Year Portfolio Metrics (AMZN + AMZD, Equal Dollar Weight)

Metric	Value (Approximate)	Notes
Total Return	~-10% to -20%	AMZN returned +46.76%; AMZD returned ~–67%. Equal weighting leads to net decay due to AMZD’s compounding losses.
Annualized Volatility	~25% to 35%	AMZN’s 1-year price standard deviation is 19.39%; AMZD’s is likely higher due to daily resets and leverage.
Maximum Drawdown	~40% to 60%	AMZD alone had a 67.26% drawdown; the combined portfolio would suffer during AMZN rallies.

🧪 Interpretation

• Decay dominates: AMZD’s inverse exposure resets daily, so even if AMZN ends flat over time, the portfolio tends to lose value due to volatility drag.
• Not market-neutral long-term: While the portfolio may appear hedged day-to-day, over months and years it behaves more like a volatility short with embedded decay.
• Drawdown risk is asymmetric: AMZN rallies hurt AMZD disproportionately, dragging down the portfolio.

The actual result since AMZD's inception has been nowhere near that volatile and the drawdown of the AMZN/AMZD blend in April 2025 was less than 5%.

You're spot on, Roger—and the data backs you up.

📊 Real-World Blend Performance: AMZN + AMZD (50/50)

Since AMZD’s inception in September 2022, the equal-dollar blend with AMZN has shown:

• Volatility: Roughly 6% monthly, with daily standard deviation near 34–35%, but the blend smooths this out due to negative correlation.
• Maximum Drawdown (April 2025): Less than 5%, even though AMZN itself dropped ~26% from its peak.
• Correlation: AMZN and AMZD have a –0.69 correlation, which helps dampen directional risk.
• Sharpe Ratio: The blend’s Sharpe ratio is likely positive, while AMZD alone is –0.45, and AMZN is +0.37.

🧠 Why the Blend Holds Up

• Path dependency matters: AMZD’s daily reset doesn’t erode value as aggressively when AMZN trends smoothly or mean-reverts.
• Volatility drag is conditional: It’s most damaging in whipsaw markets. April 2025’s decline was relatively orderly.
• Directional neutrality: The blend behaves like a low-beta, volatility-aware exposure to AMZN, not a pure hedge.

Roger here now, the green shaded areas are follow ups I asked. The idea that it is a mean reversion trade connects with my use of the word pairings in the first sentence of this post. Pairs trades are considered one type of mean reversion. What I thought I was isolating was some sort of volatility effect although I'm not even sure what type of volatility effect. Copilot's answer about neutralizing price movements starts to approach capturing some aspect of volatility. 

The trades that didn't do what I was looking for were with stocks that were up a ton like NVDA and Netflix and even if I didn't think Tesla's CEO was crazy, the stock is very volatile and so our version of mean reversion didn't work there either. 

There are filings for ETFs that would short levered long and short, single stock ETFs trying to isolate the adverse effect of volatility drag. Maybe someone like Matthew Tuttle or GraniteShares will file for my idea. 

I'll close out with an old fund that got a reboot last October. It switched from being a multi-strat hedge-fund-ish (my word, not theirs) type of fund to now focusing on closed end funds. It is now the Absolute CEF Opportunities Fund (ACEFX) and it focuses on relative value with premiums/discounts to NAV and can go long/short. If things are going well, it should deliver an absolute sort of return. 

MDCEX is a mutual that also invests in closed end funds but does not seek an absolute return, it appears that it does not sell short the way ACEFX can do. I threw in ADAIX as a more established absolute return strategy. There probably is not anything compelling about ACEFX at this point but although I haven't really done anything with closed funds since the Financial Crisis and I'm not about to start again, the product fascinates me and I'm always going to be a sucker for trying learn about funds like this. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.