60/40...60?

Meb Faber hosted a fun podcast with Rodrigo Gordillo and Corey Hoffstein that dove very deep into managed futures and return stacking. Rod and Corey are very involved with various investment products (look at RDMIX and RSBT for more) that use managed futures to offer a return stacked strategy. 

Early on there was mention of building a 60/40 portfolio and then adding another 60% on top of that in managed futures. They position it as not leveraging up necessarily because managed futures' correlation to equities and fixed income is typically negative or there tends to be no correlation. That sort of correlation attribute is desirable for helping to manage portfolio volatility or put another way, to help smooth out the ride. Stocks are the thing that go up the most, most of the time. Occasionally they go down and when they do it makes sense to have a little exposure to things that tend to go up when stocks go down. 

So what about that 60/40/60 mix (equity/fixed income/managed futures)? We can backtest this back a good number of years on Portfolio Visualizer. The first pic shows the portfolio makeup.

 

VBAIX is the Vanguard Balanced Index Fund which is a proxy for a 60/40 portfolio. Here are the results.

 

The long term stats are very similar. Going year by year it was almost a split as to which portfolio outperformed. There were three years where VBAIX outperformed by 500 basis points or more and there were three years where Portfolio 1 outperformed by 500 basis points or more. Two of the three where Portfolio 1 outperformed were 2008 and 2022 which supports the idea of managed futures offering a form of crisis alpha.  

This is all very interesting stuff. When I listen to or read about this theory there seems to be a lot of reliance on back testing or more fairly, looking back at real world results. Part of the success of both came from yields going down pretty steadily until last year. The CAGR for AGG wasn't so hot but rates going down like that is unlikely to be repeated. With yields so low for much of the time studied, the cash in managed futures funds got no yield to speak and now it does. That point came up in the podcast and they didn't think it was too big of a deal because inflation is now much higher. So maybe not an advantage in real yield but is an advantage in terms of nominal yield. Both issues potentially skewed the past results and if not repeated going forward, may make the future of this strategy less reliable.

A concern with levering up 60% into one strategy is that something that no one can see coming crushes, in the case, managed futures. There was a pretty violent whipsaw in March when shorter term treasuries had a counter trend move. That caused a lot of the funds in the space to go down close to 10%. Why couldn't something even worse happen? Actually allocating 60% to some sort of diversifier seems like poor risk management. 

Now I am adding a third portfolio as follows with the results. BTAL and MERFX are personal and client holdings.

 

Is comparing 70% in stocks to portfolios with 60% a fair comparison? Decide for yourself but I feel like this is an example of leveraging down. BTAL is long short equity in such a way that it tends to go up when stocks go down. MERFX is in there as a cash proxy, there are plenty of things to sub in as cash proxies. The standard deviation of Portfolio 3 is the same as 60/40 with a higher CAGR so I think it is comparable to 60/40.

Stocks go up the most, most of the time. 70% then becomes an overweight versus a more typical 60% so ok a little more risk in the face of a 2008 type of decline. The 10% weighting to BTAL takes nowhere near the risk of 60% into managed futures obviously. I have been a fan of managed futures since the Financial Crisis, I have faith in it but bad things happen to narrower strategies every so often for reasons that no one could get out in front of and the risk of going so heavy, even if there was no leverage, seems unnecessary. 

The influence of the podcast might be to use managed futures in some proportion, or not, and maybe to do some work on how to use leverage in a way that doesn't expose you to getting blown up in some sort of black swan, maybe instead, "leveraging down" as I've talked about it before.

For any advisors reading this, I believe it is crucial to expand the base of what you know in terms of how to construct portfolios. Stay curious and keep moving forward. I recently became aware of an advisor I know getting caught with a lot of longer term bonds that have now been crushed after last year. The exact scenario I have been describing for years, clients are forced to wait in these bonds until they mature in the 2030's with below market yields between now and then. Of course they could get bailed out if yields go back down to where they were a few years ago but that is a big if. 

Disclaimer stuff, all of this is a theoretical way to explore portfolio construction. 

They're Coming For Our Social Security

Barron's has a close look at three options to "fix" Social Security. The article touches on ideas we've been talking about here and other places for many years. A point I made in the last few weeks was that it's a good bet that whatever ends up getting done will be unpopular in that large swaths of people will feel like the fixes are unfair.

This post is sort of a list of points that I thought were noteworthy and wanted to expand upon or otherwise weigh in. 

The current working assumption of when the trust fund will run out of money outflows will exceed inflows is 2034. This has been a moving target for a while. So 11 years until there is real trouble? Moving target? For a while the working assumption was 2035. The point though is there is no way this should catch anyone off guard. Whatever the true magnitude of the problem, we have 11 years to figure this out and we've known there was some sort of problem for ages. We have plenty of time to individually solve our own problem. 

The article mentions the political complexity here. There are two points. One is that a politician who votes to cut benefits or raise the retirement age will probably lose some voter support. Maybe enough to lose their seats, maybe not but <skepticism coming> they care more about keeping their jobs than anything else. Another type of political complexity that exists, and this applies to many issues, is that the problems are bigger than what can be solved in one political cycle. Legislation that passes now could get repealed later. Of course there can be flawed legislation but it can be difficult to make progress.

If congress does nothing, then starting in 2034 incoming payroll taxes would cover 80% of retiree payouts implying a 20% cut. I don't know if it is that linear but that is what Barron's said. 

Cutting benefits and raising taxes are the two most talked about way to fix it. Keep in mind that extending the full retirement age (FRA) to 68 or 69 or whatever is a de facto benefit cut. There's been talk of raising the cap on payroll taxes. Right now, once an earner gets to $160,000 +/- they don't pay payroll tax on further income. The working idea usually is to exempt income between $160,000 up to some higher level from payroll tax and then having it kick back in at that higher income. Biden as talked about exempting between $160,000 and $400,000. Simply raising it in blanket fashion would be a pretty big hit for someone making $200,000, paying 7.65% or 15.3% if self employed on dollars $160k-$200k.

It is generally accepted that the various ideas around extending the retirement age and increasing taxes would solve much of the problem. The last sentence is about the math involved not about the right and wrong of any of it which we'll get to. 

Now comes the grim numbers about how much we have collectively saved for retirement. "Nearly half of U.S. households headed by someone aged 55 and over have no retirement savings, according to the U.S. Government Accountability Office. And many of those that have managed to save don’t have enough. The median nest egg for a family headed by someone aged 60 to 65, with household income of $71,000 to $126,000, was about $150,000" and among high income earners the median balance is $535,000. 

A $500,000 balance implies a $20,000 income assuming the 4% rule. That can certainly get the job done but telling a "high earner" that anything more than $20,000/yr is imprudent will be some harsh reality. There are several proposals floating around congress to expand the program to pay out more money. Obviously that deepens the potential hole coming and creates the need to further mitigate the threat. More taxes on workers? FRA of 72? I don't know. There is a mention of adding a tax to capital gains taxes to go toward SS. I hadn't heard that one before. 

Finally at the end of the article was an idea that I have been talking about for ages, like going back to the original version of this site in 2004 which is means testing. Not to be taken as my favoring that idea, I've just long thought it is inevitable and as I have also talked about, I think it will come down lower on the wealth scale than you'd intuitively think. One study cited by Barron's on this talked about a 46% means test cut for "middle income" retirees and a 67% cut for retirees with "higher wage histories." That study though talked about a 25 year implementation for that. 

That's just one idea on means testing. I don't know what it would actually look like, I just think something along these lines is coming.  One positive part of this means testing study is that it assumes that starting at age 62, the employee no longer pays payroll tax. 

After I started to write this post I saw another article that I thought had some relevance from Yahoo. It was about various challenges or disruptions that people have in retirement ranging from health issues to unexpected expenses and other things you might expect to make retirement difficult including the psychology of retiring. 

We can take action ahead of time to lower the odds of these disruptions befalling us. We've been writing about this for ages too. Things related to taking care of ourselves, pursuing varied interests beyond our day jobs through life, making a conscious effort to enhance our resiliency and optionality, finding purpose for your life and I'll add one which is figuring out how to live in the moment, that is appreciating what we have when we have it. A very undramatic example of this is all the championships that Boston teams won from 2002 until 2018 and we'll see what the Celtics can pull off this year. All four teams won with the Patriots and Red Sox winning multiple championships. That much winning was awesome but not sustainable. I appreciated it for what it was in real time. Now apply that to the important things in life like relationships, volunteer work if you do any and so on.

Circling back to the right and wrong as anyone might think about it regarding the possible changes to the Social Security program. I have no argument to make against the unfairness of possible changes or the possibility that some will view it as immoral or any other negative sentiment that people might feel. The attitude here has always been that changes will be foisted upon us, they will be "unfair" to some portion of the population. It is not realistic to think that any of us individually can change the outcome of whatever might happen. Personally, I am not going to get upset about things that are beyond my control. It is far more productive to be realistic about possible changes and get to work on some sort of Plan B in case any changes do have a material impact on your situation. This is eleven years away, it's not like you don't have time to figure it out. 

I'll close out referring to a couple of the comments on the Yahoo article. In the article itself, there were a couple of suggestions about working with financial advisors. The comments are always skeptical of doing so which I can understand but a couple of them pointed to avoiding advisors who don't walk the walk. Kind of like it's hard to take diet advice seriously from a doctor who is overweight, the comments were saying that advisors should have their financial houses in order which I agree with. I love the idea of that sort of accountability, it seems very Talebian. 

Making The Most Of Your Optionality

Something I may not have talked about here but earlier in the year the firm where I have been for 19 years got in serious trouble. More specifically, the two partners of the firm (I've never been a partner/principal) got into different types of trouble over the same incident. The non-partner advisors (that's what I was) were not in any type of trouble but we had to find a new place to land to continue to practice. 

The outcome was uncertain for a short time. It all worked out pretty quickly thankfully but during that window of uncertainty I had to figure some things out in case we were unable to land anywhere. 

I was still 56 when this started in the middle of winter. Could I retire if it came to that? I've said quite a few times here before that I probably could make it work but we'd probably have to reduce discretionary spending. That was the worst it was going to get. The rental income from our Airbnb just about covers our fixed monthly expenses so maybe we'd have to take $1000 or so out in most months to cover the difference, more when we buy propane every fall. This would not have been optimal but we'd have been able to last for quite a while in that scenario. 

Keeping tabs on how long we might be able to last before going into retirement accounts is something I check in on periodically. Our old firm disappearing was definitely a black swan but true to what I've been writing about for ages, I was prepared for something bad to happen without know what that might be. 

Part of a Plan B that I have talked about was to work in some capacity on large fires as part of an Incident Management Team (IMT). This little scare I had was a good kick in the pants to try to put that in place if needed. Try is the operative word as I had to be "approved" to be a liaison officer trainee. I was approved, I know a few qualified liaison officers (you are considered qualified after you successfully complete the training) which can hopefully be the gateway to getting trainee assignments on fires. So far there haven't been any fires which is odd but can happen. My plan with this for now is to be available for one assignment later this summer after the fire season in Arizona ends. I'd essentially be taking a vacation and spending my time working as a liaison the way other people might go work for Habitat for Humanity. Just like always, I'd be very reachable if clients needed anything. 

Liaison is pretty high up on the org chart so the pay is very generous. A couple of full two week assignments per year would more than fill the spending gap mentioned above. Part of what liaisons do is help little fire departments like mine navigate through a serious event and I love the idea of paying that back after all the help I have received over the years. The downside is being away from home, away from my wife. 

This part of the story supports the idea of taking a long runway to monetize a hobby or in my case a volunteer endeavor. There is other work I could do on fires that would pay less than liaison so I realize how fortunate I am but it is the byproduct of 20 years total, 11 years as a decent fire chief mostly making friends along the way. Networking matters here. 

In starting to work through the various what-ifs of this situation I realized something about health insurance that might be useful to anyone who ends up in a similar situation that doesn't work out as well as mine did. For health insurance I need to either go to healthcare.gov or get temporary insurance. We do not qualify for any sort of subsidy through ACA so we've been going with temporary, which is to say lousy, insurance. We pay about $700/mo for a free physical and what amounts to catastrophic coverage. We are very lucky that we can get away with lousy insurance but we can. The last time I looked for a plan on healthcare.gov it was about $1500/mo which again is unsubsidized. 

When you read articles about retirement planning, there will frequently be discussion about catching up in your 60's to hopefully turn what is really just an emergency fund into a more robust retirement fund. Now contrast that with all the anecdotes of people in their 50's and 60's who are forced into retirement or to otherwise take a serious hit to income which is what I was facing.

The scenario of being 50's or 60's with a decent retirement nest egg, having the house paid off with no other debt is plausible with a couple of good decisions early on. If you don't need to catch up on your retirement savings thanks to actions taken when you were younger then you have a lot more optionality when facing a serious decline in income. You maybe have even more optionality in this scenario related to paying a lot less for health insurance. 

Look at your expenses, hopefully you have some sort of spreadsheet for this. With no mortgage, your health insurance premium is probably your biggest expense. Your income is now uncertain, you look at your expenses and realize you might be able to save a lot on health insurance if your modified adjusted gross income goes down a lot. I tried to find information on this but no matter where I searched I would have gone all the way through to talking to a sales person which I didn't want to do. Based on past recollections, I think a MAGI of $50,000-$60,000 might cut that $1500/mo down to maybe $400-$500 which if correct would be a huge drop, it would even be a noticeable drop versus the $700 we're spending on our lousy insurance. The $2400-$3600/yr saved, if my numbers are correct, in our situation is meaningful. 

If someone in this situation is just pulling from savings every month then their MAGI could be much lower, further lowering the cost of health insurance. 

It might be too optimistic to call this a windfall but it is an incremental benefit that stems from the work done to enhance optionality.This is almost an outcome where less income and being semi-retired would be the better outcome. 

I had all of this in place if I needed it. My situation is going the other way. I have absorbed the clients from the partners at the old firm into my practice. This was not something I ever planned on. The extra income will be nice but optionality meant I didn't need this to happen which allows for providing unconflicted help to anyone who needs it and say ok to any of their clients who didn't. 

This all could have been much worse stress-wise. The pre-planning I've been writing about for 19 years of blogging meant my only worry was about not being able to help clients any longer. That was resolved quickly and so the rest was gravy.  

This is not a pitch of any sort, I would be very hard pressed to add anyone new, take this as more of an accountability check for people who've been reading me for a while that I do walk the walk of what I say.