Waking Up To Alternatives & A Bonus Topic

There are more and more articles getting on board with using liquid alternatives as fixed income substitutes and proxies. I've been banging this drum for more than ten years, since long before the term "liquid alternatives" came to be. 

If you remember talk of "record low interest rates" and "return-free risk" which is play on words for risk free rate of return then the eventual cracking of the bond market couldn't have been a shock. Here is a white paper from AQR about some alternative strategies that could work to offset equity market risk the way bonds used to and then this similar article by Larry Swedroe. There's a good bit of overlap between the two as well as what we have talking about here for years. 

I won't repeat the specifics of what I do in client accounts, you can look in the archives for that information, but I will make a few high level points. To invest in liquid alternatives, you need to put in the time to really understand the underlying strategy to better understand why it works so that you will then understand the times it doesn't work. No alternative strategy will "work" 100% of the time. Understand that if you are buying a fund with a strategy that has a negative correlation to the stock market, then that fund is likely to go down more often than not because the stock market goes up more often than not. 

An article that polled millennials about how much they think they'll need for retirement resurfaced after being published last summer. Half of the millennials they polled thought they would need $300,000 to retire. The millennial cohort ranges from 26-42 so simplistically, half of them are in their mid-20's-early 30's. I attribute the $300,000 number to some sort of selection bias for the poll as well as the possibility that the typical person that age cannot envision themselves at retirement age, something we've talked about before, not really understanding what $300,000 is and not having been exposed to retirement planning math.

Using today's dollars, if you wind up with $300,000 in retirement savings you will be much further ahead than most people and it certainly could kick off an income stream in conjunction with multiple other income streams but that would not, by itself, be a robust retirement fund. That might seem harsh but better to know than not know. 

Using the 4% rule, a $300,000 fund could kick out $1000/mo which combined with Social Security and maybe a well-cultivated secondary career could make for a comfortable retirement. But the $1000 plus just Social Security with nothing else would be less comfortable. 

If you're young, it's simple. Sock away as much as you can. This will enhance your optionality for when you're older and older will come much faster than you realize. As you get closer to retirement, take the time to learn math around portfolio sustainability cold. Learn it up, down and all around. Also, take the time to understand how your numbers could come up short, what the biggest threat to your retirement success is which could be money or psychology. Isolate those potential issues and then figure out how to get way out in front of them to minimize their potential impact. 

Everything You Need To Know About Timing The Stock Market

You can't reliably time the stock market. That's all you need to know.

It is not crazy to think that over some long investing career, through many stock market/economic cycles you'll end up timing one or two exactly right. "Not crazy to think" isn't a reliable investment process.

Here's what you can do. Buy more, whether it's a function of rebalancing or with new cash after large declines. With the S&P 500 down 20%-ish, is that the bottom? I have no idea but deploying a little more after that sort of decline will look good in a couple of years or so even if it looks terrible two months from now. 

Then at some other interval down past 20% from the top, buy more. Maybe that's at 25% from the top or 30% or something else but something. Again, will down 30% be the bottom? I have no idea but buying some down 30% will look good in a couple of years or so even if it looks terrible two months from now. 

When the S&P 500 was down about 15% I reduced the extent to which client portfolios are hedged which has the same effect of buying more. By removing part of our hedge we look a little more like the stock market than we did. Still hedged, not as hedged. If we get to a decline somewhere between 25% and 30% I will do more. At this point, I'm not sure we'll get there and I am not sure if a next trade in that range would be to buy or remove more hedge. At this point I think I just need to know when to take a next step and to start thinking about what that next step might be. 

If you still believe in American capitalism, I do, then you know this will stop going down at some point and then start to work higher. If you know this, then some sort of plan to rebalance or re-equitize makes sense. The point is not that you're expecting to nail a bottom but that buying an asset that is now noticeably cheaper than it was and that will go back to where at was, certainly at the index level even not every stock comes back.

The mindset is crucial here. Not speculating on when the bottom is in, but a systematic process for handling large declines in equity prices as part of a long term investment strategy.

Setting Your Own Schedule Gone Too Far?

Carl Richards put up a couple of Tweets that at first intrigued me and then puzzled the hell out of me. Richards has (had?) a gig writing for the NY Times. His Twitter bio says "Helping Real Financial Advisors build lifestyle businesses." 

His idea is for advisors to have balance in their lives as opposed to working 80 or 100 hours per week. On its face, based on the description, any advisor would to hear more about this. They may not want to pull back on their time spent depending on the priority they assign to growing their business. 

The first Tweet I saw from Richards said "I'm running an experiment to see of I can get all my work done in 8 blocks of 90 minutes per week." Reading that, I don't take it literally, I take it as being about how to add efficiencies to become more productive. Maybe he does mean it literally trying to get everything done in 12 hours/wk. The second Tweet said "Have you built a lifestyle business that allows you to ski on Thursday, or mountain bike on Wednesday, or surf everyday?"

I can accept there are potentially multiple layers here. When your advisor isn't tracking the market as implied in Richards' Tweets, the message to clients is don't obsess over your portfolio, it is constructed to weather the markets' ups and downs. He is letting ergodicity work for his clients' portfolios. Although I am little more tactical than that, this point resonates. 

His approach raises several questions though. Here I am assuming he is living that second quote with his practice. If you've hired an advisor, how comfortable are you with the idea that they work three, partial days per week? Do you want someone who appears to be doing this part time? 

I spend a lot of time reading and staying current on markets. Where I feel I get freedom, which is a huge life priority, is that I enjoy the research process immensely and I spend no time trying to drum up new clients. Michael Batnick had a blog post ages ago that included an estimate that the typical advisors spends 70% of their time prospecting. Removing that provides tremendous freedom to spend more time on what I like doing, the research, the learning as well as outside endeavors that give my life balance. 

Two more practical issues with working so part time as an advisor; maybe this is my hangup but I want to minimize the number of times I have to say "I don't know" when a client asks about something directly related to markets or something that could influence markets. I may not always have an answer and there's plenty I am not an expert on but I don't see how I could be reasonably informed working just 12 hours per week.

The other more practical issue is customer service matters. I can't imagine any client wants to wait two days before their issue starts to get worked on. Clients need money or some sort of documentation or have a non-portfolio question about their account or anything else, if he is really making them wait as implied from his Tweets, that seems like terrible customer service. 

Being in touch with markets and being able to address client issues right away works for me. There was a recent challenge on NotePD about productivity hacks and avoiding distractions. I made a related list with the qualifier that I'm doing it all wrong. I answer client emails right away, fire department emails too for that matter. 

There is a balance to be struck between quality of life, doing a good job, having time to do the things you enjoy and time to take care of yourself. These are all priorities for me. If Richards is actually running his practice as implied, I am quite certain he makes it work, that would be the groove that works for him. More important than whatever observations I might make about how he runs his practice or any observations he might make about me and my practice, is that we all figure out what sort of groove works best for ourselves. Part of my groove is that I love the time spent researching and learning. While 18 year old me would be shocked at how much I love to study and learn that is how I've developed and am lucky enough to have created a lifestyle where I can spend a lot of time doing that. Figure yourself out in the same way and try to create a lifestyle around that to find the balance you want.

Sequence Risk and Allocations

Barron's had a couple of good articles over the weekend, one was an interview with Harold Evensky about sequence of return risk and the other was about the death of the 60/40 portfolio. 

The Evensky article attributed the well known bucket strategy to him. I always though that was from Ray Lucia but either way. The context in the article I'm referencing was how much cash to set aside to cover expenses. The balance to be struck is between being able to endure a prolonged decline and too much cash being a drag on returns.

The article is a good read. I would stress there is no single right answer for everyone. The comments belie this with some people liking ten years of cash set aside while others questioning having even one year's cash needs set aside. If you do some research, I think you'll find that the average bear market has been 24-30 months. The great recession, as bad as it was, found a bottom in just 18 months. 

Not every financial plan has the luxury of setting aside multiple years worth of cash needs. If you have just enough saved to allow for a 4% withdrawal rate with no great margin for error then five years worth of expenses seems problematic.

I'm not in the ten years camp for the typical investor/retiree. If the average bear market goes back to 24-30 months then I like the idea of two years if it makes sense in a "drag on returns" context. If you have $2 million but only need to take $50,000-$60,000/yr then sure two years makes sense, I should say the math for two years makes sense. If you do any sort of hedging whether that is the way I do it (and write about all the time) or some other way, the hedges can be a source of cash if the market does go down. If the stock market drops 30% and something you use for protection goes up 25% or 30% or more you can sell it for cash. There is less need to protect against a large decline after a large decline and 30% down is pretty big. This is potentially a way to avoid selling low if only one year's worth of cash set aside is the best path based on a thin margin for error. 

The article about 60/40 featured opinions from KKR and if you want to be cynical you could title it "Company that sells liquid alt funds thinks investors should have 30% the type of liquid alt funds it sells." 

This is old ground for us of course. The consequence for the risk of buying longer dated bonds for many years now finally matters. An indexed 60/40, which includes intermediate and longer bonds, has offered no protection in the current market event. Alts, the right kind of alts, selectively chosen alts, don't discount lucky alts, have offered protection. I'm all in on alts in terms of believing in them, not in terms of 30%, but using them requires work. You have to understand what makes them work so you can understand what would make them not work. 

Even still, there can be no guarantee, sometime the right exposure might just not do well in some sort of event that hits the stock market. Gold is a good example. I describe gold the same way all the time, it has the historical tendency of going up when stocks go down. It happens often enough that I believe in it. Gold should offer protection but it will not do so every time. For any given event, it may not work. That doesn't necessarily change the idea that it will work more often than not. If you can't live with that uncertainty, then yeah, don't use gold.

I Hate Target Date Funds

Alternative titles for this post could be I Still Hate Target Date Funds or Target Date Funds Suck.

When target date funds first hit the market, my reaction was negative because there will be times during the stock market cycle where you will want to adjust your mix of stocks, bonds and cash but not necessarily do so as prescribed based just on the academic process to create fund in the first place. 

Then came the financial crisis and another issue that popped up is that they all have different glide paths reducing stock exposure to favor more fixed income. One fund with a target date of 2032 might today have 70% in stocks while another might have 55%. 

Our firm got a good sized 401k plan as an account before the financial crisis was over due to how poorly their target date funds did as the stock market imploded. Target funds now are not looking so hot and discussed in this article at Marketwatch. Very coincidentally, a college buddy asked for my two cents on his 2030 target date fund. It was a little over 60% in stocks so just kind of a coincidence that it's close to 60/40. I would note that a small portion was allocated to a TIPS fund. The YTD performance when I looked a couple of weeks ago was that the 60/40 mix was down about as much as the S&P 500 because most of the bond exposure was longer dated so the fund was (still is, I imagine) taking a lot of interest rate risk.

The chart compares the S&P 500 VBAIX which is a fund proxy for a 60/40 portfolio, an aggregate bond index fund (AGG) and the iShares 10-20 Year Treasury ETF (TLT).

 

Taking interest rate risk has looked a whole lot like taking equity market risk. A thing I like to say is if everything you own goes up together, then they are likely to go down together too and that appears to be happening in the chart and by extension a lot of target date funds. 

I've been writing for many years about not wanting meaningful exposure interest rate risk. In the last couple of weeks, I've done a little buying of shorter duration fixed income getting close to 2.5% for less than two years compared to less than 2% for ten years not that long ago. Target date funds don't really allow for that sort of engagement and based on their long term track record, that only seems to matter when things go bad in the market like the financial crisis or now. Put differently, they don't offer protection when you need protection. 

If your 401k only has target date funds, I guess I'd ask for a more robust offering but I would forget about matching up when you think you're going to retire with the fund you choose. Decide how much you want in equities and then use the furthest out target date fund for your equity exposure. A 2060 fund is going to have a lot in equities. If there's no fund offered that avoids interest rate risk then I'd just have a money market. You'll have to decide the allocation between stocks and money market of course but I would continue to avoid meaningful exposure to interest rate risk for a while still.