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.

Collaborating With AI To Optimize Portfolio Construction

A few days ago, one of he advisors I subadvise for, asked me if I thought AI would replace us as advisors. Andrew Lo from MIT thinks that over the next five years AI will evolve to be able to make financial decisions for clients including meeting the fiduciary standard. My answer to my colleague was the same as I've said here which is that I am less concerned about being replaced as opposed to advisors who don't start to use it will probably get left behind. For now, maybe use it really just means play around with it which is fine. 

Below I pasted an exchange I had with Copilot about a portfolio consistent with what we often blog about. I asked for an analysis and opinion and then it asked follow up questions that I went along with. 

Evaluate the following investment portfolio and compare it to VBAIX. 15% in SPTM, 18% in SPMO, 15% in ACWX, 3% in BTAL, 4.5% in QLEIX, 4.5% in AQMIX, 2% in EMPIX, 2.4% in MERIX, 2% in SRDAX, 2% in PPFIX, 2% in JAAA, 2.4% in FLOT and the rest in BIL.

Your portfolio blends broad equity exposure, factor tilts, alternative strategies, and low-duration fixed income, with a cash-like buffer in BIL. Here's a breakdown:

Asset Type	Allocation	Description
Core Equities	48%	SPTM (15%), SPMO (18%), ACWX (15%)
Alternatives	12%	BTAL (3%), QLEIX (4.5%), AQMIX (4.5%)
Event-Driven & Arbitrage	6.4%	EMPIX (2%), MERIX (2.4%), SRDAX (2%)
Credit & Income	8.8%	PPFIX (2%), JAAA (2%), FLOT (2.4%), BIL residual (~17.8%)
Cash Equivalent	~17.8%	BIL (iShares Treasury ETF)

Performance Comparison vs. VBAIX

Metric	Your Portfolio (Est.)	VBAIX
1-Year Return	~13–15% (est.)	~11.5%
Volatility	Moderate	Moderate
Yield	~2.5–3.5%	~2.3%
Equity Exposure	~48%	60% (VTI)
Bond Exposure	~34%	40% (VBTLX)
Alternatives	~18%	None

Your portfolio has outperformed VBAIX over the past year, driven by strong returns from SPMO (~33%), QLEIX (~27%), and AQMIX (~6.9%). BTAL and EMPIX added diversification, while BIL and FLOT helped dampen volatility.

Strategic Insights

• Factor Tilt: SPMO adds momentum exposure, which has been a top-performing factor recently.
• Managed Futures & Long/Short: QLEIX and AQMIX offer uncorrelated alpha and downside protection.
• Event-Linked Bonds: EMPIX and MERIX provide yield with low correlation to traditional markets.
• Credit Layering: JAAA and PPFIX add investment-grade and private credit exposure.
• Liquidity Buffer: BIL ensures flexibility and capital preservation.

Compared to VBAIX

• Diversification: Your portfolio is more diversified across strategies and asset types.
• Risk Profile: Slightly lower equity beta, but more complexity due to alternatives.
• Return Potential: Higher upside in trending markets, especially with momentum and managed futures.
• Drawdown Protection: Better tail risk management via BTAL, AQMIX, and QLEIX.

Would you like a risk-adjusted performance simulation or a historical backtest approximation? I can also help you optimize this mix for different goals like income, volatility, or Sharpe ratio.

What adjustments can I make to enhance my portfolio?

 Tactical Adjustments

• Reduce Cash Drag: BIL (~17.8%) is useful for liquidity, but trimming it to ~10% could free up capital for higher-return assets.
• Boost Uncorrelated Alpha:
• Increase QLEIX or AQMIX to ~6% each for stronger managed futures exposure.
• Consider adding DBMF or KMLM for complementary quant strategies.
• Enhance Credit Yield:
• Shift part of BIL into short-duration high yield (e.g., SJNK) or floating-rate loans (e.g., FLRN) to improve income without adding much duration.
• 
  
•  deepen emerging market exposure beyond ACWX and EMPIX.

Add Real Assets:
• Introduce 2–3% in timberland (WOOD) or farmland (FARMX) for inflation sensitivity and low correlation.
• Sharpen Factor Exposure:
• Replace part of SPTM with USMV (low volatility) or QUAL (quality factor) to balance SPMO’s momentum tilt.
• Global Diversification:

• Consider EMQQ or FM to deepen emerging market exposure beyond ACWX and EMPIX.

Strategic Rebalancing Ideas

Theme	Current	Suggested
Cash & Equivalents	~17.8%	↓ to ~10%
Managed Futures	9%	↑ to ~12%
Real Assets	0%	↑ to ~3–5%
Credit Layering	8.8%	↑ to ~10–12%
Equity Factors	Momentum-heavy	Add quality/low-vol

Optional Enhancements

• Tax Efficiency: Use tax-managed ETFs or municipal bond funds if applicable.
• Drawdown Control: Add tail-risk hedging via PUTW or TAIL if volatility spikes concern you.
• Dynamic Allocation: Consider a rules-based overlay that adjusts exposure based on macro signals (e.g., trend, volatility, carry).

Would you like me to simulate how these changes might affect your Sharpe ratio or downside capture? Or we could explore a version optimized for income, volatility, or regime resilience.

Absolutely, Roger — your portfolio already reflects a sophisticated blend of traditional and alternative exposures, but if you're looking to expand the toolkit, here are some alternative strategies worth exploring:

🧠 Liquid Alternatives (Mutual Funds & ETFs)

These offer hedge fund-like strategies in a regulated, accessible format:

• Market-Neutral Funds: Seek alpha from stock selection while neutralizing market beta (e.g., GRZZX, ADANX).
• Event-Driven Arbitrage: Exploit merger spreads and corporate actions (e.g., MERFX, SRDAX — which you already hold).
• Options-Based Strategies: Use covered calls, puts, or collars for income and downside protection (e.g., PUTW, JEPQ, QYLD).
• Trend-Following Managed Futures: Capture macro trends across asset classes (e.g., DBMF, KMLM, QLEIX).

Real Asset Alternatives

These provide inflation sensitivity and low correlation to equities:

• Farmland & Timberland: Via ETFs like FARMX, WOOD, or private REITs.
• Infrastructure: Global toll roads, airports, and utilities (e.g., TOLZ, IGF).
• Commodities: Broad exposure via PDBC, or targeted plays like GLDM (gold) or USCI (multi-commodity).

💼 Private Market Exposure (if eligible)

For accredited investors or via interval funds:

• Private Credit: Direct lending, mezzanine debt, or BDCs (e.g., OWL, ARCC).
• Private Equity: Growth-stage companies via funds like BXPE or platforms like Moonfare.
• Real Estate: Non-traded REITs or fractional platforms like Fundrise or AcreTrader.

Exotic & Niche Strategies

For deeper diversification and alpha hunting:

• Catastrophe Bonds: Low correlation to markets, tied to insurance events.
• Volatility Harvesting: Funds that sell volatility (e.g., SVOL, XVOL).
• Currency Carry: Exploit interest rate differentials (e.g., ICLN, CEW).
• Tokenized Assets: Fractional ownership of stocks or real estate via blockchain platforms.

🧩 Strategic Overlay Ideas

• Tail Risk Hedging: Add convexity via funds like TAIL or PFIX.
• Dynamic Allocation Models: Use quant overlays that adjust based on macro signals (trend, carry, volatility).
• Multi-Strategy Funds: Blend arbitrage, macro, and long/short in one vehicle (e.g., AQMNX, JDJAX).

Would you like me to model how adding one or more of these strategies could affect your portfolio’s Sharpe ratio, drawdown profile, or regime resilience? Or we could explore which combinations best complement your existing holdings.

Adding alternative strategies to your portfolio could enhance your Sharpe ratio — but the effect depends on how each strategy interacts with your existing holdings in terms of return, volatility, and correlation. Here's a breakdown of how different types of alternatives might influence your portfolio’s risk-adjusted performance

Potential Sharpe Ratio Enhancers

Strategy Type	Impact on Sharpe Ratio	Why It Helps
Managed Futures (e.g., DBMF, KMLM)	↑	Trend-following often performs well in volatile or bear markets, improving downside protection.
Market-Neutral Funds (e.g., GRZZX)	↑	Low correlation to equities; adds alpha without increasing beta.
Event-Driven Arbitrage (e.g., MERFX)	↑	Steady returns with low volatility; boosts numerator without inflating denominator.
Volatility Harvesting (e.g., SVOL)	↑	Monetizes fear premium; can generate income with modest risk.
Real Assets (e.g., WOOD, FARMX)	↑	Inflation-sensitive and diversifying; low correlation to stocks and bonds.

Strategies That Require Careful Sizing

Strategy Type	Sharpe Ratio Impact	Considerations
Options-Based Income (e.g., QYLD, PUTW)	Neutral to ↑	May reduce volatility but cap upside; Sharpe may improve if income offsets muted returns.
Private Credit (e.g., OWL)	↑	Enhances yield, but liquidity and transparency risks must be managed.
Catastrophe Bonds	↑	Uncorrelated returns, but tail risks are event-driven and binary.
Currency Carry (e.g., CEW)	↑	Can boost returns, but sensitive to macro shocks and regime shifts.

Strategic Takeaways for Your Portfolio

• You already hold QLEIX, AQMIX, BTAL, MERIX, and SRDAX — all of which contribute positively to Sharpe via diversification and uncorrelated alpha.
• Adding DBMF or KMLM could deepen your managed futures sleeve and improve regime resilience.
• A small allocation to real assets or volatility harvesting could further smooth returns and hedge inflation or tail risk.

Would you like me to simulate how adding, say, 5% to DBMF and 3% to FARMX would affect your portfolio’s Sharpe ratio and drawdown profile? I can also compare it to VBAIX over different market regimes.

Awesome — let’s simulate the impact of adding 5% DBMF and 3% FARMX to your portfolio and compare it to VBAIX across key metrics.

📊 Portfolio Simulation: Sharpe Ratio & Drawdown Impact

Portfolio Variant	Est. Sharpe Ratio	Max Drawdown	Notes
Original Portfolio	~0.65–0.75	~-12%	Solid diversification with managed futures, arbitrage, and low-duration credit.
+5% DBMF, +3% FARMX	~0.72–0.82	~-10%	Improved regime resilience and inflation sensitivity.
VBAIX (Benchmark)	~0.55–0.65	~-14%	Traditional 60/40 mix with limited alternatives.

Why These Additions Help

• DBMF (Managed Futures):
• Negative beta to equities (≈ -0.09) and low correlation to bonds.
• Sharpe ratio ~0.37 with historical alpha to SG CTA Index.
• Helps in trendless or volatile regimes where traditional assets struggle.
• FARMX (Agricultural Productivity):

• Real asset exposure with inflation sensitivity.
• 1-year return ~14.5% and 5-year CAGR ~13.3%.
• Adds sector diversification and low overlap with core equity holdings.

🧩 Allocation Mechanics

To fund the 8% shift:

• Reduce BIL from ~17.8% to ~9.8%.
• Maintain core equity and credit exposures.
• Preserve liquidity and duration profile.

🚦 Strategic Outcome

• Higher Sharpe Ratio: Driven by uncorrelated alpha and real asset returns.
• Lower Drawdown: DBMF’s convexity and FARMX’s inflation hedge smooth volatility.
• Improved Regime Resilience: Better performance in stagflation, rate shocks, or commodity rallies.

Would you like to see how this mix performs across different macro regimes (e.g. rising rates, recession, inflation)? Or explore a version optimized for income or volatility?

Why These Additions Help

• DBMF (Managed Futures):
• Negative beta to equities (≈ -0.09) and low correlation to bonds.
• Sharpe ratio ~0.37 with historical alpha to SG CTA Index.
• Helps in trendless or volatile regimes where traditional assets struggle.
• FARMX (Agricultural Productivity):

• Real asset exposure with inflation sensitivity.
• 1-year return ~14.5% and 5-year CAGR ~13.3%.
• Adds sector diversification and low overlap with core equity holdings.

🧩 Allocation Mechanics

To fund the 8% shift:

• Reduce BIL from ~17.8% to ~9.8%.
• Maintain core equity and credit exposures.
• Preserve liquidity and duration profile.

🚦 Strategic Outcome

• Higher Sharpe Ratio: Driven by uncorrelated alpha and real asset returns.
• Lower Drawdown: DBMF’s convexity and FARMX’s inflation hedge smooth volatility.
• Improved Regime Resilience: Better performance in stagflation, rate shocks, or commodity rallies.

Would you like to see how this mix performs across different macro regimes (e.g. rising rates, recession, inflation)? Or explore a version optimized for income or volatility?

Why These Additions Help

• DBMF (Managed Futures):
• Negative beta to equities (≈ -0.09) and low correlation to bonds.
• Sharpe ratio ~0.37 with historical alpha to SG CTA Index.
• Helps in trendless or volatile regimes where traditional assets struggle.
• FARMX (Agricultural Productivity):

• Real asset exposure with inflation sensitivity.
• 1-year return ~14.5% and 5-year CAGR ~13.3%.
• Adds sector diversification and low overlap with core equity holdings.

🧩 Allocation Mechanics

To fund the 8% shift:

• Reduce BIL from ~17.8% to ~9.8%.
• Maintain core equity and credit exposures.
• Preserve liquidity and duration profile.

🚦 Strategic Outcome

• Higher Sharpe Ratio: Driven by uncorrelated alpha and real asset returns.
• Lower Drawdown: DBMF’s convexity and FARMX’s inflation hedge smooth volatility.
• Improved Regime Resilience: Better performance in stagflation, rate shocks, or commodity rallies.

Would you like to see how this mix performs across different macro regimes (e.g. rising rates, recession, inflation)? Or explore a version optimized for income or volatility?

Why These Additions Help

• DBMF (Managed Futures):
• Negative beta to equities (≈ -0.09) and low correlation to bonds.
• Sharpe ratio ~0.37 with historical alpha to SG CTA Index.
• Helps in trendless or volatile regimes where traditional assets struggle.
• FARMX (Agricultural Productivity):

• Real asset exposure with inflation sensitivity.
• 1-year return ~14.5% and 5-year CAGR ~13.3%.
• Adds sector diversification and low overlap with core equity holdings.

🧩 Allocation Mechanics

To fund the 8% shift:

• Reduce BIL from ~17.8% to ~9.8%.
• Maintain core equity and credit exposures.
• Preserve liquidity and duration profile.

🚦 Strategic Outcome

• Higher Sharpe Ratio: Driven by uncorrelated alpha and real asset returns.
• Lower Drawdown: DBMF’s convexity and FARMX’s inflation hedge smooth volatility.
• Improved Regime Resilience: Better performance in stagflation, rate shocks, or commodity rallies.

Would you like to see how this mix performs across different macro regimes (e.g. rising rates, recession, inflation)? Or explore a version optimized for income or volatility?

Why These Additions Help

• DBMF (Managed Futures):
• Negative beta to equities (≈ -0.09) and low correlation to bonds.
• Sharpe ratio ~0.37 with historical alpha to SG CTA Index.
• Helps in trendless or volatile regimes where traditional assets struggle.
• FARMX (Agricultural Productivity):

• Real asset exposure with inflation sensitivity.
• 1-year return ~14.5% and 5-year CAGR ~13.3%.
• Adds sector diversification and low overlap with core equity holdings.

🧩 Allocation Mechanics

To fund the 8% shift:

• Reduce BIL from ~17.8% to ~9.8%.
• Maintain core equity and credit exposures.
• Preserve liquidity and duration profile.

🚦 Strategic Outcome

• Higher Sharpe Ratio: Driven by uncorrelated alpha and real asset returns.
• Lower Drawdown: DBMF’s convexity and FARMX’s inflation hedge smooth volatility.
• Improved Regime Resilience: Better performance in stagflation, rate shocks, or commodity rallies.

Would you like to see how this mix performs across different macro regimes (e.g. rising rates, recession, inflation)? Or explore a version optimized for income or volatility?

Why These Additions Help

• DBMF (Managed Futures):
• Negative beta to equities (≈ -0.09) and low correlation to bonds.
• Sharpe ratio ~0.37 with historical alpha to SG CTA Index.
• Helps in trendless or volatile regimes where traditional assets struggle.
• FARMX (Agricultural Productivity):

• Real asset exposure with inflation sensitivity.
• 1-year return ~14.5% and 5-year CAGR ~13.3%.
• Adds sector diversification and low overlap with core equity holdings.

🧩 Allocation Mechanics

To fund the 8% shift:

• Reduce BIL from ~17.8% to ~9.8%.
• Maintain core equity and credit exposures.
• Preserve liquidity and duration profile.

🚦 Strategic Outcome

• Higher Sharpe Ratio: Driven by uncorrelated alpha and real asset returns.
• Lower Drawdown: DBMF’s convexity and FARMX’s inflation hedge smooth volatility.
• Improved Regime Resilience: Better performance in stagflation, rate shocks, or commodity rallies.

Would you like to see how this mix performs across different macro regimes (e.g. rising rates, recession, inflation)? Or explore a version optimized for income or volatility?

Why These Additions Help

• DBMF (Managed Futures):
• Negative beta to equities (≈ -0.09) and low correlation to bonds.
• Sharpe ratio ~0.37 with historical alpha to SG CTA Index.
• Helps in trendless or volatile regimes where traditional assets struggle.
• FARMX (Agricultural Productivity):
• Real asset exposure with inflation sensitivity.
• 1-year return ~14.5% and 5-year CAGR ~13.3%.
• Adds sector diversification and low overlap with core equity holdings

FARMX appears to holding farming related stocks not real assets and FARMX appears to have kind of a high correlation to the S&P 500, is my observation incorrect?

You're absolutely right to question that, Roger — and your observation is spot-on.

FARMX (Fidelity Agricultural Productivity Fund) primarily holds publicly traded equities of companies involved in agricultural productivity, such as Deere & Co, Corteva, Nutrien, and Archer-Daniels-Midland. These are farming-related industrial and consumer defensive stocks, not direct ownership of farmland or timberland. So despite the agricultural theme, FARMX is not a real asset fund in the traditional sense.

As for correlation to the S&P 500, FARMX has a beta of ~0.95, which suggests a high correlation to broader equity markets. Its sector tilts — especially toward industrials and consumer defensives — reinforce that linkage. While it may offer thematic exposure to agriculture, it doesn’t behave like a diversifier in the way that private farmland, timber REITs, or real asset ETFs might.

If you're aiming for true real asset diversification, you might consider:

• FARMX for thematic equity exposure
• FARMX + FARMX-style stocks for tactical tilts
• But for low correlation and inflation sensitivity, look at FARMX alternatives like FARMX-style REITs, private farmland platforms, or timber ETFs like WOOD.

Ok, Roger back now. The pasting of all that was clunky. I couldn't figure out how to copy the entire conversation and there are a few bits I left out. Who knows whether my use was effective, I am early in my learning process but it certainly seemed like a collaborative effort with me bouncing ideas off of Copilot and then challenging its suggestion of FARMX which seems to be procyclical and so it has kind of a high correlation to equities. 

I'd never heard of FARMX though so plugging it in as a diversifier and comparing to BTAL and COM, FARMX does help some. Maybe we can play around with it in future blog posts.

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 Hedged Equity Replace 60/40?

A bunch of quick hits today.

Bob Elliott from Unlimited Funds blogged that for Q2 2025, equity long/short was the best performing hedge fund strategy and that managed futures was the worst. This is why it is important to diversify your diversifiers. A 20% allocation to managed futures would have made that first week or two in April even more difficult.

Larry Swedroe had a helpful post looking that the problems and risks of holding levered and inverse funds longer than the one day reset periods that most of them have. Yes, the vast majority do deviate away from what they "should" do over longer periods. But invoking Karl Popper, it only takes one negative to disprove a theory.

100% SPY compounded slightly better than 50% 2x S&P 500/50% cash but the 2x/cash combo's volatility dropped by more than the CAGR it gave up and the max drawdown was a little less. The worst deviation between the two was in 2020 when Portfolio 2 lagged by 740 basis points. Of the other 19 full and partial years available to study, the two were within 100 basis points of each other seven times. The deviation was greater than 300 basis points only three times, including 2020.

The Simplify Short Term Treasury Futures Strategy ETF (TUA) is another one that disproves the theory. The way TUA leveraged up, 20% in TUA and 80% cash "should" look like UTWO. 

Leverage in pursuit of a portable alpha strategy can work, I am just not a fan of how some of the recent funds implement it. 

Speaking of Simplify, they had a Tweet promoting their Hedged Equity ETF (HEQT) and comparing to to a plain vanilla 60/40 like you might get from VBAIX.

Long story short, JHEQX is a proxy for HEQT with a longer track record. There have been three years of meaningful deviation between JHEQX and VBAIX. In 2022 that deviation favored JHEQX by 800 basis points and in 2019 and this year, the deviation favored VBAIX. Nothing can always be best. Is one better than the other? That's hard to say but JHEQX/HEQT as a replacement for VBAIX seems like a valid observation. 

And we'll close out on an email I received touting a model portfolio that gave specific allocations, not symbols but market segments. The model also allocates just over 1/3 to individual stocks which you don't see very often. I built out a replication as follows;

For real estate the model says it uses private real estate but VNQ is a simple ETF.

It's possible that whatever they can access for "private real estate" can differentiate but with what we can see, the drivers for differentiation are the common stocks not the bunch of ETFs compared to just putting all that into ACWI. In the 14 full and partial years to look at, Portfolios 1 and 2 varied by more than 200 basis points four times. The model compounded by 32 basis points less than Portfolio 2 and with more volatility but the Sharpe Ratios were pretty close. 

Yes, it is possible that the actual ETFs they choose could turn out to collectively be better mouse traps but this is a key thing to look for; differentiation. There's very little differentiation and what little there is does not favor the model. I don't think there's much advantage to owning a bunch of ETFs to get the same 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.

Purposeful Solutions

Abnormal Returns linked to a brutal article by Stat chronicling the increasing number of suicides in "older men" per the CDC. The first half of the article gives some real food for thought but the second half turns into a very political editorial so fair warning if politics aren't your thing.

The crux of the CDC study focused on men over 75 butStat noted that "suicide rates have risen steadily for two decades among men 55 and older." One expert blamed what he called the Five D's which are depression, disease, disability, disconnection and deadly means. 

The article really is a continuation of the conversation we've been having here as more people and research come to some very obvious conclusions. Taking up some good habits or maybe even just losing some bad habits can address at least four of the Five D's. Sidebar, this is a serious blog post but Five D's makes me think of the movie Dodgeball.

There are no absolutes as I always say but anything along these lines I share has been researched and published. That the research has been done is indisputable, of course anyone may draw a different conclusion about researched conclusions. This list on Twitter is where I get a lot of related content. 

• Depression: there are countless studies connecting vigorous exercise to relieving depression. I am not saying it can solve depression for everyone but if 21 million Americans suffer from depression (per NIMH in 2021) and an exercise program can solve it for 10-20%, of that population, that seems like a huge win.
• Disease: we learn as children that we should exercise and to not eat too much sugar. The list of problems prevented or solved by good body composition and a healthy metabolism is endless.
• Disability: chronic maladies often lead to some sort of disability and that sort of disability is what can possibly be addressed with behavior modification. Someone who gets hurt is certainly a different story and there are of course medical issues/events that have nothing to do with behavior modification. 
• Disconnection: if you have any interest in successful aging, you've read something about the importance of social connections. Loneliness is a killer. 
• Deadly means: this refers to access to guns and where the article then takes a very political turn. This part is outside the scope of what interests me so I'll leave it alone.

Related to disconnection, on the way back from our offsite fire training yesterday, one of the firefighters referred to volunteering with the department as her third space. She has her home life, work and firefighting. I'd never heard the term before so I looked it up. She said space but the Google result came up with place.

We've explored the third space concept I think, I've used the word constituencies and talked about being a polyinterested (a play on words for polymath). 

Volunteering anywhere checks a lot of boxes in terms of interaction, engagement, being mentally challenged and maybe even physically challenged. Obviously I am going to make a plug for volunteer firefighting.

From yesterday's training, about a third of the department plus three recruits. I'm by the cab wearing a white helmet. Social engagement, purposeful activity, a need to stay fit, a chance for a small income and we get to do a lot of cool stuff. 

A combo like that addresses a lot of what is covered in the first half of the Stat article. 

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.

"Yield Magicians"

Jason Zweig went after some of the crazy high yielding derivative income funds. I don't use any of the YieldMax funds or any of the other crazy high yielders but obviously I have fun looking at them.

The one firefighter I mentioned on Saturday where our conversation drifted into investing and finance is a big fan of the derivative income funds and owns several but he didn't mention YieldMax specifically. A lot of people own them based on the AUM in the space.

Zweig isolated a couple in particular including the YieldMax Moderna Option Income Strategy ETF (MRNY) noting that MRNY fell "80% from May 2024 to May 2025." 

I'm not sure the catastrophe here was using MRNY. If you are ever going to use one of the crazy high yielders, you have to be favorably disposed to the underlying common stock. The catastrophe was caused by being favorably disposed to Moderna. To the left of the chart you can see where the covered call strategy really capped the upside of the spike in the common stock but MRNY total return has been quite close the rest of the time. 

MRNY is not best thought of as a proxy for MRNA, it is a product that sells the volatility of MRNA.

In the period backtested, I would say MRNY's total return was much closer to the common that I would have expected which might be because there was rarely capped upside. 

Over the last 12 months, Netflix (NFLX) has been up 88%. Using the same timeframe as Zweig for backtesting;

It's not terribly apparent on the chart where the total return line was capped from the call writing but obviously the total return lagged the common by a wide margin. Again though, NFLY is not the common stock it is a product that sells the volatility of the common stock. 

Last one, a stock that had a fine 12 months, not a barn burner like Netflix and not a catastrophe like Moderna.

Again, the lag for APLY total return is meaningful but something that yields 26.85% (per the YieldMax website), is very unlikely to keep up with that yield. We've talked about these as sort of being depleting assets. In a portfolio that tries to barbell a lot of yield out of a narrow slice of the portfolio, a crazy high yielder should be expected to go down and then reverse split eventually like the Tesla YieldMax has done. Sized very small, the depletion would not be problematic for the portfolio, it would be a big chunk of the portfolio's yield.

A crazy higher yielder that sells the volatility of some common stock isn't going to go to zero unless the underlying common goes to zero. The crazy high yielder might go down a lot, will probably go down a lot and then reverse split (repeated for emphasis), that is probably the right expectation as long as the common doesn't go to zero. 

Elisabeth Kashner from Factset is quoted in the Zweig article as saying "It’s risky enough to go into a single volatile stock." The crazy high yielders are almost like a bond <ducks out of the way>. If you buy a stock like Moderna, Netflix or Apple (maybe to a slightly lesser extent) you are expecting it to outperform. If you buy a YieldMax all you need is for the common to not drop 80% (or some other catastrophically bad amount). A stock that is sideways or down a little is not a catastrophe for a YieldMax product, the stock doesn't need to go up for relatively favorable outcome for the YieldMax...kind of like a bond. Obviously the volatility profile of a YieldMax fund will be nothing like that of a bond for the same company.  

I have no idea what JP Morgan stock will do over the next 12 months but it is a good bet it won't go out of business. Buying a short term JPM bond on that basis isn't a terrible idea. To buy the JP Morgan YieldMax (JPMO), you'd need some basis to believe the common won't crater but the YieldMax as an asset likely to deplete at some rate of speed won't implode on a total return basis if the stock meanders or even struggles. Down 80% like with Moderna, yeah there's no way to paint that favorably. 

A quick technical note is that YieldMax funds are not simply a covered call. The funds maintain an options combo of being long a call and short a put to create a synthetic long position and then sell a call option above the strike of the long call. If you don't know what any of that means, you should probably learn before doing any other research.

A more serious issue is one that Dave Nadig has isolated a few times which relates to the YieldMax distributions being recharacterized after the fact. The JPMO fund page shows that the 6/18 distribution was 87.32% return of capital and the rest as income. Believing that to be the case and then it changing later would be difficult to keep up with. 

I am extremely unlikely to ever use a YieldMax fund beyond some sort of experiment in my own account (have not done this) but I think it is important to look at them through the right lens. And even if I don't ever use a YieldMax product, maybe the next iteration of derivative income funds is more usable or maybe the iteration after that. 

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.