A Lot Of Crazy Topped Off With A Little Sanity

Some quick hits today.

Barron's had advice about how to invest a Roth IRA for people unlikely to ever need that money who might have the "goal of passing on as much they can to their heirs." The article solicited input from Harold Evensky, William Bernstein and Larry Swedroe. Most of the advice was to just buy very plain vanilla, market cap weighted funds which of course makes sense. Swedroe included some serious alts in his recommendation including Cliffwater funds. 

The article isn't really an advice piece, it is a thought exercise. Buying Vanguard Total Stock Market Index ETF (VTI) is of course valid but not really something that merits an article in Barron's. It's far more interesting as a thought exercise to do something crazy.

A 50% allocation to the Direxion 3X Long Tech ETF (TECL) is crazy but the 50% to cash tops it off with a little sanity. Sticking with Barron's objective of leaving as much as they can to an heir, this mix gives the opportunity for crazy growth while building up what at first might be an emergency fund and then later a huge stockpile of cash as it rebalances to offer real, financial utility for the heir.

Quantpedia had an interesting article noting that most portfolios are under diversified based on a portfolio of ten common ETFs that have the following correlations;

Quantpedia plugged those ten ETFs into an equal weight portfolio because equal weighting creates the appearance of being well diversified. I am paraphrasing so if you have a better take on that please leave a comment. They ran the ten ETFs through some sort of tool for risk attribution. The way to read the following is that a 10% allocation to BITO, a Bitcoin ETF, contributes 29% of the risk.

Here I model out the equal weight version above along with Finominal's risk weighting against a couple of benchmarks.

I don't actually think anyone would build a portfolio that equal weighted those ten ETFs but doing so for the backtest does support the notion of being under diversified. The portfolio appears to look different but there's no differentiation on the way down. On the way up it lags meaningfully as does the risk weighted version. Finding adequate differentiation to actually add diversification takes some work and if you've been reading this site for a while you probably have a good idea of how I like to approach solving that problem.

Playing around with quadrant inspired portfolios notwithstanding, I think equal weighting is a tough way to make a living. We've looked at a few examples in the past where it can work but I don't love it. 

Here's one we probably haven't looked at before.

The correlations are very low which creates the opportunity for diversification. Modeling those four funds out with equal weighting looks good;

It's simple work to look at different funds and how they correlate to each other as a starting point if equal weighting appeals to you. The correlation matrix above is from Portfoliovisualizer.  QDSIX is a fund of funds so it's not 25% into one strategy but that would be difficult for me. Ditto cat bonds and gold. Weighting the four funds for risk contribution yields an interesting result for anyone who want to plug that into Finominal. 

And One River took a look at work from Meketa about making a portfolio more robust with first responder defensives, second responders and diversifiers. If that seems familiar, we did the same thing almost a year and a half ago. One River titled their piece The Perfect Hedge. Great title. The paper has an element of why say in 100 words what you can say in 1000 words. I didn't take anything new or too definitive from the paper but there comments about managed futures prompted me to try a different take on an idea we've looked at before. 

Managed futures is a big part of the Meketa framework and we obviously spend a ton of time on it here too.

QMHIX is relatively volatile, ABYIX might be the least volatile managed futures fund out there and RYMFX aside from being one with a long track record is in between the two others in terms of volatility. Comparing the blue and red lines, they appear to be (almost) perfectly negatively correlated. They take very different paths to a similar result. The yellow blend blends them together for an interesting result. It has just about all of VBAIX' upside with a much smoother ride. Unfortunately, the time period is cherry picked to omit a dreadful run for managed futures in the 2010's.

Maxing out the backtest actually isn't that bad. It doesn't capture VBAIX' upside too well but it's a decent absolute return type of result, CPI plus four and a quarter. 

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.

Stop The Stock Market, I Want To Get Off

This morning at fire training we did a complex water operation.

The scenario is a fire in the background. The green truck to the far left gets there first and starts spraying water. Then the red truck second from the left get there and does two things, it sprays water on the fire and and fills up the green truck. Then the second red truck, second from the right, gets there to spray water and fill up the other red truck. Finally the water tender, brown truck at the far right, shows up and fills up the second red truck. 

It's not likely that we'd do this sort of operation with so many trucks but two trucks and a water tender is plausible. The utility of the drill was that we learned how to manage two different PSIs for a couple of the trucks, one PSI coming in and one going out, and generally raised overall understanding of how the pumps work beyond the basics of just getting water flowing. 

I think there is an analogy here to when we explore portfolio theory. Building out various types of all-weather, quadrant-inspired and all the rest can offer some insight into how different asset classes and strategies might interact with each other. I use this process as a lab to reenforce ideas about funds I already use and a way to learn about new funds. 

Obviously I've incorporated AI into this process as a way to check that I am not loading up on one risk unknowingly. For example, loading up on several funds that all take credit risk would not be something I'd want to do. 

On Friday night I was playing around with these two portfolios. I read something that led to my trying to come up with a "Stop The Stock Market, I Want To Get Off" portfolio. I came up with a complex version and a simple version.

I plugged a slightly different version into Copilot and it got most of the funds wrong. One time, Copilot said BLNDX was the best all weather fund there is. Friday night it thought it was a Blackrock fund. For APHPX it read the symbol wrong. It thought PPFIX was a PIMCO fund, it's not. It had the wrong AQR fund. I always have to tell it that SHRIX is a catastrophe bond so it got that one right. And it thought BALT was also a Blackrock fund. Maybe it went out to happy hour and wasn't expecting to have to work.

Then I went to Claude. Claude got the funds right but it made several assumptions that were more like incomplete observations than outright incorrect. It said that "APHPX and PPFIX share a family resemblance" and that they would probably react in the same negative manner to certain negative events like the Tariff Panic 15 months ago. 

Me: Has there been an instance where APHPX and PPFIX reacted similarly in a bad way to the same adverse market event? APHPX and PPFIX are practically uncorrelated.

Claude: Good pushback to check empirically rather than just accept my "family resemblance" framing at face value — and the data mostly backs you up... the evidence supports your claim more than it supports my earlier "they're cousins" framing.

There were others. The point is using AI should probably be an exchange, not just our taking in what it says. I asked what I thought were the obvious questions but there were probably others that could have been asked too. AI is learning but we need to learn too. 

Here's how the two versions of the "Stop The Stock Market, I Want To Get Off" did in a short backtest.

Neither the complex or simple version is going to keep up with 60/40 or the stock market but they are both less volatile than the IEI which is the 3-7 year treasury ETF and I believe they are capable of compounding decently above the rate of price inflation. Lately, I've been digging into foundation allocations and a frequent objective for foundation accounts is CPI plus 5%. We'll get into that more later this summer but both the complex and simple versions are in the ballpark of CPI plus 5%. That outcome with a very low volatility would be interesting if it can be pulled off. 

And speaking of AI....

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.

It's Not All Doom & Gloom

You've probably seen news accounts that Americans believe they will need $1.2 million in savings to maintain their lifestyle after they retire. Barron's reported on a survey from Schroders that details how few people expect to have that much when the time comes. 

A couple of nuggets; only 30% expect to have $1 million, half of those surveyed do not think they will have $500,000 and some other grim variations on the same theme. Before getting into this, I do believe people will figure it out and make it work because they have to. I'm saying with a glass half full sentiment, people will figure it out. 

Needing $1.2 million in today's dollars seems a little high to me as a number across society. That assumes a withdrawal amount of $48000-$60,000 or 4-5 %. Gemini estimates that people born between 1970 and 1980 will get $2400/mo or $28,800 per year in today's dollars for Social Security. That's per person so $4800/$57,600 per couple. Those numbers assume each partner is making $62,030 so the couple is grossing $124,060. 

If this is an Arizona couple, they would be netting $97,502/yr or $8125/mo after putting 4% into their 401ks. If the couple born in 1970 bought a house in 2005 at age 35, the median mortgage payment would have been $1255 in the Phoenix/Scottsdale/Mesa area. Assuming 30 years, the mortgage would be paid off in 2035 when they are 65 and thinking about retiring. 

If they spend all $8125 every month, then their expenses in today's dollars would drop to $6870/mo after the mortgage is paid off. They are getting $4800/mo in Social Security so everything being constant, their retirement account only needs to generate $2870/mo or $34,440/yr. That means their retirement accounts would need to be $688,800 to sustain a 5% withdrawal rate, just over half of the generic $1.2 million. 

If their current spend includes two car payments, maybe they can get down to one car payment or maybe no car payments. If their kids successfully launch, then that would bring down their expenses a little more. The $2400 times 2 is their age 67 amount. If one of them waits one year longer to retire and take SS, then that $2400 would actually be $2592/mo. If they both delay a year then $4800 would become $5184/mo. 

Going through this exercise, I realize there's little to no margin for error and they are vulnerable if SS gets cut but it's not a desperate situation either. If this couple has a $30,000 gap between their Social Security and their spending needs and only have $100,000 saved, yes that will be a difficult place to be with some painful decisions to make. The example we built, there's a $34,000 gap and while having $1.2 million would be great, the scenario can do well with much less. 

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.

Text Book, Meet Real World

Allison Schrager from Bloomberg is not a fan of people targeting a magic number for their retirement goal. She says it puts the focus on wealth when it should be on income. 

My take on this has always been that while some sort of number helps in the accumulation process, it provides some context. Once you actually retire, the thing that matters is what you actually wind up with. That is your reality whether you are ahead or behind whatever goal you had. 

Apparently, Schrager places a lot more importance on income being precisely predictable than we typically do here which leads her to long term bonds as an important solution. Schrager says "If you focus on a number, however, you’re likely to suffer from a mismatch. That’s because you’re maximizing the wrong thing — wealth instead of income." She means a mismatch of liabilities. 

In a word, no. That is might be correct in the textbook but I would say not in real life.

I think my sample size is large enough in terms of years and number of clients that people are not constantly analyzing how much they take. They start with some amount for a few years and then might say they need to increase the dollars they take. If someone is in the 4-5% withdrawal range then they are going to be just fine with their withdrawal rate. Their equity exposure, whether low/normal/high, will very likely provide enough growth to counteract Schrager's concern. 

Per Gemini, in rolling ten year periods since 1900, bonds have only outperformed stocks 7% of the time. The 7% were concentrated in the great depression and the lost decade of the 2000's. According to testfol.io, in the 1930's despite the volatility and enormous declines, stocks compounded negatively by only 12 basis points. The lost decade was a little worse with nowhere near the same volatility. 

This places an emphasis on owning some equities, yes, but more importantly dialing in the correct allocation to equities for your tolerances. In the 20 years ending 12/31/2014, domestic equities compounded at 9.87% per testfol.io. I chose that period because it takes in really good times and really challenging times. If in the first 20 years of your retirement, equities only compound at half that rate, that would still be better than spending a 4-5% coupon for the same period. $100,000 in equities would grow to $265,000 in 20 years or stand at $117,000 if they had been taking 4% out every year versus having $100,000 in bond principal after 20 years. While 100% in equities might not be the right answer, having nothing in equities is not the right answer either.

Our example assumed a weak growth rate. Since 1900, only 20-23% of ten year rolling periods have stocks compounded at 5% or less. 

Again, dial in the correct equity exposure. 

While we devote a tremendous amount of time on how to build the yield sleeve of a portfolio, long bonds can work all the same even though I would say long bonds are far from optimal. 

A portfolio can be constructed for someone who is stock market skittish with a decent allocation to equities which could be 30-40% with a larger portion in some sort of yield engine mix and some cash left over to mitigate sequence of return risk. 

Here's an example with equities dialed down. I just used market cap weighting for the equities, nothing special.

AOM is a 40/60 ETF which is closer to the allocation we built today. Plugging Portfolio 1 into Finominal, it lags behind whatever they have for 40/60 for a shorter period but their benchmark is far more volatile.

The equity portion, large or small, will double eventually. Maybe it will take a long time or maybe quickly. In the period studied on testfol.io, the S&P was up 257%. While I would not bet on another 257% over the next nine years, it will keep growing if it can be left alone.

This might address Schrager's concern, letting the yield engine do just that, pay out some yield. If someone barely has accumulated enough for their retirement then they are going to need to have a normal allocation to equities or make a big change somewhere else like maybe continuing to work. 

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.

Simple, Not Easy

As you read and research on the internet, I think it is very useful to read the comments. Always read the comments, sometimes there is more value in the comments than the content. Yahoo has an article about about people who accumulated money without engaging an advisor but as they turn the corner toward actually retiring, they are starting to turn toward advisors for help. 

The comments are mostly dismissive of needing an advisor. I've tried to be consistent in saying that someone needs to do the work for your retirement. Hire an advisor or don't hire one but if not, you need to do the work to be your own advisor, there are a lot of things that are easy to get wrong and those mistakes could be very expensive. 

This comment stood out as exhibiting a common behavior. 

If he retired on July 14, 2010, exactly 16 years ago, then he is probably confusing a bull market and being for being a smart investor. And even if that doesn't apply to him, it applies to plenty of people. In the last 16 years the S&P 500 has compounded at 14.95%, an 80/20 portfolio using IEF for bonds, compounded at 12.52% and a 60/40 using IEF compounded at 10.03%. Going back as a far as we can on testfol.io for those three, the long term growth rates have been 10.55%, 9.91% and 9.12% respectively.  I can recall several blog posts over the last few years that mentions how my few clients who are overspenders have been bailed out by a strong longer term bull market.

If in the last 16 years, the S&P 500 compounded at 4%, then I suspect he'd be whistling a different tune in terms of how easy investing is. Investing can be simple; build a portfolio that is properly allocated for your tolerances, has a reasonable basis for believing it can work and then don't panic. That's simple, it's only one sentence, but not necessarily easy. 

As a matter of personal philosophy, I try to be introspective, self-aware, with everything. Life is good at humbling people from time to time and this comment appears to lack self-awareness. Overestimating our abilities often ends badly. 

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.

Closed End Funds Are Complex

This is an important chart from Bespoke in today's premarket email. It captures something I've mentioned just a couple times over the years because it is a rare occurrence. When markets get up to 20% above their 200 day moving average it isn't sustainable. At that level the underlying is very over extended and some sort of reversion becomes extremely likely. 

This really is rare. The last time it happened to the S&P 500 was late 2021. I heeded that signal and added an inverse fund which helped in 2022. The chart shows a similar over extension for the South Korean market driven primarily by SK Hynix and Samsung. Currently, the S&P 500 is nowhere near this far above its 200 DMA. Bear markets or large declines can still occur with being this extended, this is just a simple and I believe reliable indicator for the rare occasion it happens. 

Next is an interesting story about the XAI Floating Rate & Alternative Income Trust (XFLT) which is subadvised by Octagon Credit Investors. The fund is doing poorly and Bloomberg reports that Octagon is in danger of being removed as the manager. There is a lot to the story but the very quick summary is that the "problem is not the asset mix, but XFLT’s structure, execution, and governance." Here's the allocation mix per CEFconnect. 

Another tab on the CEFconnect page says the leverage is only 40%.

XFLT is currently at a 20% discount to its NAV. The fund pays out 15% of its market price, historically, very little of that has been ROC. Distributions have been trending lower for a little while. There was some sort of distortion in the data in March so the back test stops at 3/1/2026. Since that date, XFLT has had a very volatile ride to a 2% gain on a price basis. The total return is negative of course but not catastrophically so. If an investor took out all the distributions, they'd only have 1/3 of their money left which would be a catastrophe if they didn't understand how going ex-dividend works and how closed end fund NAVs tend to erode with high yields. 

Closed end funds are more complex than they appear to be. Here are a couple of very old CEFs. Very little volatility price only but they both end up losing the vast majority of their NAVs if the dividends are not reinvested. 

If you want to dig in more to CEF complexity, you can look into Saba's and Matisse's respective strategies.  

If XFLT is a poorly run fund then it might fail as part of a bridge to some financial milestone but the fund is eight years old and there's still 33% of the original investment left after taking out a lot of yield. Eight years is a very long time in relation to bridging to something like Social Security or starting RMDs. 

Again, this outcome is only catastrophic for people who don't understand how these work. People often are seduced by big yields not realizing the tradeoffs. 

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.

Crazy Allocations

James McIntosh wrote How To Invest When The Global Crises Never Stop. Catchy title, I'm in. 

Here's the premise;

More war. More political conflict. More weather disasters. The future looks grim, and for investors there’s worse: The standard ways to protect against such shocks might not work.

Many of the comments just tore into him over this, especially the part about the weather, there's a little more about weather further on in the article. He notes that bonds haven't been working because of shocks that are either causing price inflation or threaten to cause price inflation. I've talked about bonds not working ad nauseum for years so I won't relitigate that one other than this quote which is almost identical to what we've been talking about, "plenty of investors agree that bond yields need to be a lot higher than they were to compensate both for the newfound volatility of inflation."

There is also an acknowledgement that gold hasn't been working as a defensive or hedge since the war started. This is exactly when gold should be working; whatever is going on with the Iran War plus the concerns about inflation, gold should be working. Maybe we can find an explanation for why gold isn't working but whether we can or not, it won't change the reality, it's not helping. It is a perfect microcosm for why you diversify your diversifiers. After only a few months, maybe a 25% weighting in gold wouldn't be too painful, the Permanent Portfolio Mutual Fund (PRPFX) is only down 3% in the last three month. If this extends for a while though, a huge weight to gold looks like an unforced error.

“If you just need to buy and hold something for the next decade I think you just have to accept that it’s going to be a bumpier ride than in the past.” 

That's an interesting point. The hold for the next decade is not anything new for my approach, I have quite a few client holdings that have been in there for more than 20 years but preparing for a bumpier ride is probably something more people should do. A lot of our study focuses on how to build and prepare for a bumpier ride in case the scenario the WSJ is framing actually happens. 

Hopefully the writing here is clear that when you diversify your diversifiers you increase the odds of having something or a few things that are working when something like gold is not. There's a quick mention of hedge funds in the context of being diversifiers in the article. It's a vague term but things like managed futures, various forms of arbitrage and systematic macro that we talk about here are hedge fund-like to be sure and are easily accessible through ETFs and mutual funds. That shouldn't be taken as short cut to learning what these funds actually do, but many of them do function as differentiators, as legitimate diversifiers. 

We play around with all sorts of crazy allocations here. The following "Crazy Mix" has no plain vanilla equity or bond exposure.

For all the worry expressed in the article, of course equities might do great. Someone not wanting or needing a "normal" allocation to equities might build out with more alternatives but for people who need something close to "normal" equity exposure, if they try instead to build a portfolio just with alts, I think their portfolio needs to work much harder to get close to plain-vanilla equities' return. A lot more needs to go right for the funds in the "Crazy Mix" portfolio to keep up with plain vanilla. 

This is a different way of articulating the point we regularly make about not getting too far away from equities if you need equity market growth for your numbers to work. 

Here's one comment from the article;

50% Stocks / 50% Bonds / I can’t think of anything else

A 50/50 mix is valid and can get the job done but you can't think of anything else? I am guessing this guessing this guy is his own advisor. Guy, take a little time to learn about some other things. If nothing else, it might embolden your beliefs but can't think of anything else? Yikes.

Another reader had thoughts about equities and TIPS with allocation percentages depending on the age of the investor and suggested a couple of ETFs. If TIPS appeal to you, go for it but I would strongly suggest individual issues not ETFs.

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.