Avoiding Costly Mistakes

The annual number is out from Fidelity about how much money someone who is 65 today can expect to spend on healthcare expenses for the rest of their lives. The 2026 number is $185,500 per person so $371,000 per couple which is up 7.5% from last year's number. 

One little detail in there that I suspected but wasn't sure is that "a little under half (45%) of Fidelity’s total comes from Part B and Part D premiums" but that excludes a supplemental plan like Part G. That makes the numbers a little less scary. A married couple might be looking instead at $204,050. Grok says the median Part G premium in Arizona is $170-$220 per person for 2026. Figure $4800 for the year times a 30 year retirement adds up to $144,000 so then we're left worrying about $58,050 from the Fidelity number?

That doesn't sound so bad but I don't believe it. We mention this number every year when the update comes out but deconstructing this way makes it seem useless. All I can say, repeat actually, is that it is up to us to prevent/solve our health issues. Eat less sugar/carbs and lift weights. 

The median number of prescriptions for a 65 year old is 4.3. I've told stories about going on medical calls with the fire department and the couple of instances where older people were very proud of not taking any prescriptions (the calls were for accidents/injuries, not medical events). Taking up some good habits can reduce the number of meds people take or push the need to start taking meds to an older age. If we're partially debunking the Fidelity number, ok but we can save quite a bit of money if we can avoid the polypharmacy treadmill altogether or at the very least, delay when we start. 

Bloomberg columnist Kathryn Anne Edwards said she can fix Social Security in six words. "Scrap the cap, invest the rest." Edwards says getting rid of the cap, the income level at which people stop paying payroll tax currently at $185,000, would solve half the problem and she is optimistic that investing a portion of the money into the stock market would work out well, maybe leading to a cut in payroll taxes at some point. 

If they eliminate the cap, will you be affected by that? Would you be paying more? If they do nothing and payouts actually get cut in 2032, would you be adversely affected by that? Everyone would be impacted but would you be hurt is what I am asking. Something will have to give for them to fix it. What's worse for you? Paying more on the way in or getting less on the way out? Whichever one is worse for you is the one to plan for. 

My all in as self-employed is 12.4% (with Medicare it's 15.3%). It's not like I make $400,000-$500,000 but at that level someone might be paying an extra $26,660 to $39,060. Although there is a write-off to offset that (talk to your accountant) paying a lot more in payroll tax for many years might work out worse than getting your benefit cut. 

The Washington Post wrote about long term care and assisted living expenses cutting into the "great wealth transfer" that is supposed to occur over the next ten or 20 years. There were of course anecdotes that are truly sad about people living in some sort of facility for many years, more years than is typical, draining a family's finances. 

This sent me on a little bit of a hunt to try to learn more. Take my comments as these might be good questions to ask an elder law attorney not as being definitive or declarative. 

When people run out of assets, Medicaid then kicks in to pay the cost. "Assets" does not include IRA accounts once someone has begun taking RMDs. "Assets" does not include the primary residence with some conditions including that one spouse is still living in the house (there are a couple of others). 

Second homes apparently do count as assets and would need to be sold. 

In quite a few previous posts I've said there are a lot of things that people can get wrong about retirement and estate planning if they don't hire someone to help. It's learnable but mistakes in this realm can be very expensive and the point of primary residences is one of them. The primary residence may need to be shielded from the state/government reclaiming some portion of what they paid for your loved one's advanced care and they can come after it once the second spouse dies (there's a little more nuance). Depending on the state you live in, the property can be deeded in such a way or titled in a certain type of trust to shield from dollars being reclaimed. 

I looked this up on two different AI's and there were some conflicting answers but I am very confident that in many states this can be done but again, I think it requires an elder law attorney. One of the anecdotes in the article was of a 96 year old woman who has been in a facility for 15 years for dementia. Being brutal, I believe that is an extreme outlier for duration but thinking in terms of reclaiming versus a home's value, there'd be nothing left for the heirs. 

To be clear, this is outside the sphere of what I do. Hopefully this promotes awareness and can help you ask some good questions to avoid an expensive mistake. 

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.

Is It Safe To Extend Duration? (Hint: No)

Last week I got an email from an old school mutual fund company for a webinar they were having this morning that was going to look at fixed income with the title Beyond Duration: Diversify Your Fixed Income Alpha. 

With that title, I'm in, they're leading with the right things, let see where it goes. It was a pitch for a fund of theirs which is ok, that's common, maybe I can learn something or maybe it might be one to start the process to study for eventual inclusion in client accounts. BLNDX came from an email solicitation so I'm not dismissive of every email that comes in.

A few minutes in and the manager has been talking different things they've done to differentiate versus "core bond" or as we say here, AGG-like exposure. Ok, lets see what all this talk looks like. 

Over the entire 15 years, the fund clearly outperformed AGG but for all the talk about strategy and tactics, there's no differentiation and it rode the market all the way down in 2022. Yahoo shows the fund with a 4.00% trailing 12 month yield compared to 3.97% for AGG. The fund gets three stars, it is outperforming but if you agree that AGG is not answer then I don't see how this other fund could possibly be the answer either. 

You've probably seen where interest rates have taken a little bit of leg higher over the last couple of months or so. The ten year treasury now yields 4.65% and the 30 year is up to 5.15%.

The chart is price only. UTHY tracks the 30 year, UTEN the ten year and BOXX uses options to replicate the return of T-bills. Yes, I am banging the same drum. The potential yield from these longer dated proxies does not adequately compensate holders for the risk or the volatility. There has been no shortage of pundits since late 2022 saying that "now is finally the time to add duration" and that has been bad advice. 

USVN tracks the seven year treasury note which is pretty close to AGG. If an investor would put 40% into a bond fund with the word core in the name or a 5, 7 or ten year treasury ETF, maybe they would consider splitting that up into several different exposures with better yields and little to no interest rate risk. Doing so would actually be much less risky.

The returns are adjusted for inflation and while that return is attractive, the bigger focus is a much lower volatility, although not visible on this screen there is a much lower standard deviation, the drawdowns have been much shallower except for the Tariff Panic when the drawdown was slightly shallower not much shallower.

In relation to a couple of other posts lately, it's a funny coincidence that Portfolio 3 above has a return of CPI plus 5 even if just by 9 basis points. I would absolutely not rely on a mix of alternative income sectors and strategic alts intended to be income market substitutes to deliver CPI plus 5. Yeah it might happen, but I think counting on it would end badly. If the objective appeals to you, I think you're going to need a decent amount of equity beta and Portfolio 3 has none. 

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.

Cracking The TPA Code

We've tried a couple of times to get into the total portfolio approach (TPA) process for managing endowment/foundation accounts. It's sort of a nebulous concept but Meketa Investment Group did a good job of dissecting the concept to separate what might be useful for individual investors versus parts of it that don't apply. For example, there's a lot related to governance which is a whole involved thing that I only scratched the surface of in my time with the Del E. Webb Foundation.

Meketa says "TPA represents a meaningful evolution in how institutional investors can think about portfolio construction." Maybe it's a meaningful evolution or a little more humbly, a way to makes a few changes that can lead to a better understanding of what you own and a more wholistic approach to how you view your portfolio. 

It starts with a reference portfolio which I would say isn't that different than a benchmark. The public pension of New Zealand is an early proponent of TPA and its reference portfolio is 75% global equities, 5% New Zealand equities and 20% bonds. That's not their actual portfolio. The reference is more like asking, how do we add value versus just indexing 75/5/20? That is probably a simplification but states it very plainly and I think is useful for individual investors.

We've talked here, in terms of just having a plain vanilla 60/40 portfolio or adding different exposures to try to improve against just buying VBAIX. Improve against VBAIX could mean several different things like outperforming, being less volatile and so on. We add BTAL and managed futures along with a couple of other things to try to smooth out the ride. That will either add value over the long term or not (I believe it does) versus just buying VBAIX. While the NZ reference portfolio is a simple 75/5/20, the fund allocates about 15% to private equity. Indexing 75/5/20 would get it done but they believe adding private equity will be better than just indexing 75/5/20. It also owns 10,000 hectares of farmland, again the managers must believe they are adding value versus indexing 75/5/20. 

It is not clear to me that adopting a reference portfolio is different than benchmarking. It seems instead like creating a more accurate benchmark. For example, the Permanent Portfolio Fund (PRPFX) is a quadrant based strategy that invests 25% equally into stocks, long bonds, gold and cash. Sort of. It is an actively managed fund and can take some liberties. It benchmarks to both the S&P 500 and a 3 month T-bill index. If it were to adopt TPA with a reference portfolio then maybe the reference would be 25% to SPY, 25% TLT, 25% in GLD and 25% in some sort of cash proxy. Then as the managers make active decisions, I think it has owned silver off and on for example, they'd be able to measure the effect of those active decisions. 

The most useful concept from TPA is the central premise is that the portfolio should be managed as a single unit rather than as a collection of separate holdings. Focus on the bottom line of the portfolio not how the individual holdings are doing. Things like BTAL, managed futures and gold are probably not going to be your best performers. If they are your best performers then chances are things in the world aren't going very well. Long time readers, how many times have I said that phrase? 

It is quite clear that holding the right type of diversifiers will smooth out the ride over the long term. If you believe in the concept of diversifiers smoothing out the ride then your view of BTAL or whatever you use is that it is insurance. It's role is to go up when stocks go down. Yes, in some random event that may not happen, but its contribution (that is a key word for TPA) is protection against declines. 

We've talked many times about tech and consumer discretionary tending to outperform the broad market over the long term. Their contribution is to provide a lot of a portfolio's growth. A utility stock or food stock's contribution is to be a little steadier and maybe provide some yield to the portfolio. 

In a TPA construct, each holding contributes something to the bottom line result of the portfolio which are terms we've talked about many times before. Calling it TPA might just be a fancy way to rephrase and old concept, rephrase a top down concept anyway. 

Another component of TPA is risk budgeting. That can mean anything but the application is to quantify the risk taken by deviating from your reference portfolio. Risk in this context equates to tracking error not necessarily return, yeah that's fuzzy. I will need spend a little more time digging into that to see how it could be applied to individual investor accounts. 

Last thing for today is this screengrab.

The Future Fund of Australia references CPI plus 4-5 which is interesting in the context of a couple of our recent 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.

CPI Plus 5; Digging Deeper

The other day I mentioned wanting spend a little more time on the endowment/foundation model that seeks an absolute sort of return of CPI plus some number, like CPI plus 5% as what I believe is a common objective in this realm. 

The Alaska Permanent Fund switched to CPI plus 5% at some point along the way. In 2011 there's no overt mention of this objective in its documentation but now when you load the page it says "Achieve a minimum of 5.0% annualized excess return over CPI over a market cycle, net of all fees." 

It's most recent report shows this target allocation;

• Public Equities 32%
• Fixed Income 20%
• Private Equity 18%
• Real Estate 11%
• Private Credit 10%
• Absolute Return 7%
• Tactical Opportunity 1%
• Cash 1%

Has it been working?

The results have been mixed, five years yes and five years no in the last ten. Over the last ten years though it did meet its objective with 2021 being a big contributor to the ten year result but not the sole reason. 

Backtesting the Alaska Permanent probably isn't productive because of  occasional changes in mandates and allocations that happen every so often but not as often as CalPERS which seems overhaul itself every couple of years. 

Putnam had a suite of funds that pursued this sort of thing including the Putnam Absolute Return 500 Fund that had symbol PJMDX. It targeted a real return of 5%. There was another one that targeted a 3% real return and another that targeted a real return of 7%.

The thesis for these funds came out of the Financial Crisis as a way to get returns without traumatic volatility. The failure of the suite was that they were too conservatively allocated, not enough exposure to equities. PJMDX' lifetime CAGR was 2.21 versus an inflation rate over that period of 1.75%. The standard deviation was low though at 3.35%. Cash plus fixed income ran at 75-90% of the fund. The execution really was a misfire. 

A lot of the back story here came from Gemini. It asked if I wanted to look at "modern" ETFs that achieve CPI plus 5. It offered NYLI Hedge Multi-Tracker ETF (QAI), State Street Multi Asset Real Return ETF (RLY) and Unlimited Hedge Multi Strategy Tracker (HFND). Since HFND's inception, the three funds have been at least 5% ahead of inflation but going back further, QAI and RLY haven't been anywhere close to that result going back to 2012. 

Obviously owning a lot of equities should exceed CPI plus 5% over any medium or longer time horizon but the way I am trying to apply CPI plus 5 is to smooth out the ride to have shallower drawdowns understanding that the tradeoff will probably be less upside. 

Here's a piece of research from Fidelity that says a foundation that is "70% equity/30% bond portfolio of public assets is likely to fall short of that $5 million annual goal 66% of the time" with the context being $100 million in assets. Even covering 4% will fall short 20% of the time.

Comparing 70/30, SPY/IEF to inflation on testfol.io for 50 years, 70/30 was better than CPI plus 5 in 33 of the last 50 full years so a little better than what Fidelity found. The average compounding over 50 years was 10.73% versus 3.59% for inflation. CPI plus 7.14%. If we look at the more common 60/40 mix, it exceeded inflation by 5 in 31 out of 50 individual years compounding at 10.24%. CPI plus 6.65%.

Similar to 75/50, this becomes a pursuit to try to achieve the desired outcome with a little less volatility or maybe to reduce the drawdown that you'd expect from 70/30 or 60/40.

To do this we could combine funds like BLNDX, QDSIX and APHPX or a few other funds. This is BLNDX plus QDSIX.

That has worked looking back and it might work going forward but what this sort of thing, just mixing a bunch of alts, is that you probably don't years like 70/30 up 20 or more percent versus 2-3% for inflation. There were quite a few of those years which gives more margin of error versus targeting CPI plus 5 and never getting more than CPI plus 7 to help offset the years where going all alts actually declines for whatever reason. 

Where I believe the answer lies is in figuring out how to blend enough simple equity beta and the volatility that goes with it along side alts with the potential for adequate returns in the CPI plus 5 construct. A lot of bonds yielding four point something percent obviously won't do in terms of return contributed to the portfolio but a small slice allocated to something T-bill-ish might help with volatility.

The following Portfolio 1 allocates 50% to S&P 500, 25% to managed futures, 15% to merger arb, 5% to BTAL and 5% to gold using funds that allow for a relatively long backtest.

The long term numbers work. Going year by year, Portfolio 1 achieved CPI plus 5 in 11 out of 17 full and partial years. VBAIX did it 12 times and PRPFX did it nine times. 

To the extent this appeals to anyone, we have a much better opportunity to create this sort of institutional effect in our own portfolios because of how funds have evolved to become more  sophisticated with access to strategies that just were not accessible before. 

As indicated above, this is a variation on 75/50. It's an interesting thought exercise and ultimately has had some influence on how portfolios are constructed but I think the answer is influence not going all in. PJMDX went all in and obviously failed. This is not simple stuff but I am optimistic we are figuring it out. 

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

A Lot Of Crazy Topped Off With A Little Sanity

Some quick hits today.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Stop The Stock Market, I Want To Get Off

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

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

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

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

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

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

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

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

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

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

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

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

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

And speaking of AI....

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

It's Not All Doom & Gloom

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

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

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

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

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

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

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

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

Text Book, Meet Real World

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

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

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

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

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

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

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

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

Again, dial in the correct equity exposure. 

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

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

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

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

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

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

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

Simple, Not Easy

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

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

This comment stood out as exhibiting a common behavior. 

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

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

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

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

Closed End Funds Are Complex

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

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

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

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

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

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

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

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

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

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

Crazy Allocations

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

Here's the premise;

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

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

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

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

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

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

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

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

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

Here's one comment from the article;

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

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

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

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

Deep Portfolio Theory

We've looked at the Cambria Trinity ETF (TRTY) a couple of times lately. I am intrigued by the allocation at a high level which is 35% trend, 25% equities, 25% fixed income and 15% alternatives. We've looked at the asset mix many times, and I think it works. Cambria's research supports that it works of course, the fund wouldn't exist if they researched it and it floundered. 

A similar backtest to what we've done many times.

The results are consistent with what we usually see.

A consistent result is that the strategy works better than the actual fund most of the time. TRTY has had a couple of very strong years mixed in but as a long term hold, TRTY lags a long way behind Portfolio 1 but with much more volatility. 

So, what's missing? I asked both Copilot and Claude. At first, Copilot blamed TRTY's lag on the mechanics of managed futures trading. That answer made no sense since Portfolios 1 and 2 have the same weighting to managed futures. It took quite a bit of back and forth to convey the point. 

Claude seemed to blame it on heavy equity factor weightings with a lot to shareholder yield. The way the fund is put together, Claude says it is complexity without a clear edge and that the way the factors are assembled makes it overly vulnerable to certain market environments.

When I figured out how to tell Copilot it was looking at this incorrectly, I told it I believe TRTY is too complex relative to the concept. It replied that TRTY is over engineered with too much structural friction. Both Portfolios 1 and 2 are simpler it said. The "too complex" answer felt more genuine coming from Claude because it was unsolicited versus my telling Copilot what I thought. 

Related to managed futures, iM Global Partners filed for an ETF that would leverage up to hold 30% in US equities and 100% in managed futures. This is the firm that runs the DBMF ETF. I saw one comment on the Tweet that brought this to my attention, it described this as being risk parity. That's a good observation, there's something to it, maybe it's risk parity influenced or risk parity adjacent?

On testfol.io, we can simulate DBMF back to 2000.

I am very surprised the result is so good. 

This second look includes a more diversified mix of managed futures funds instead of 77% in one fund (yikes) and AQRIX which used to be AQR Risk Parity and still is risk parity influenced.

There have been some long stretches where managed futures really was a pain trade but it's hard to argue with the underlying premise of the filing. 

A final iteration in Portfolio 3 which takes the filing, reduces the managed futures/equity sleeve down proportionately to 60% of the portfolio and combines it with 40% in fixed income.

Portfolio 3 is pretty close to a 75/50 version of VBAIX. The way it weighs out, Portfolio 3 is risk parity adjacent or inspired which along with Trinity's allocation is another idea that I find very intriguing. 

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.

Is The World Ready For Betting Market ETFs?

A couple of quick hits tonight. 

I stumbled across a generic asset allocation from a huge firm ($100 billion AUM) that no one's heard of. The mix isn't radically different from other large asset managers and they use private assets to round out the mix but as is often the case, we can rebuild their idea using brokerage accessible funds. 

The build out of their idea includes the usual suspects of funds we use for blogging purposes.

With a little more time to spend, I think this could be improved but it is still pretty interesting. 

We've talked a couple of times about an ETF idea whose strategy would be to place many bets, talking thousands, on various betting markets, not necessarily seeing each bet out to the end but more like moving in and out as pricing changes. I imagine this as some sort systematic implementation that if it went well, might have an absolute return sort of result that would be a little better than T-bills.

This filing isn't exactly that but it's a step in that direction. 

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.

Compound And Chill

We'll start with a success story from the Wall Street Journal about a 60 year old Costco employee who has accumulated $1 million in his 401k. He says he could probably retire but doesn't want to yet. I'd say he could probably make it work if he was desperate to retire but it would not be stress free unless his wife has at least half as much in her 401k. 

The way I read the article, he just contributed every pay period (still does), left it alone and it compounded. It doesn't sound like he did anything brilliant to get to this outcome and more importantly, it doesn't sound like he did anything stupid and it compounded into a lot of money. 

There's no mention of how he invested, presumably just index funds but it's just a 401k and most 401k plans' fund choices are far from optimal for various reasons but that's ok, it got the job done, he has far more money than he ever expected just by getting out of the way and letting it compound. 

An investment portfolio doesn't have to be optimal, it just needs to have some valid and reasonable basis to believe it can get the job done. I am not a fan of any product that includes AGG like bond exposure or bonds with duration (VBAIX and target date funds), they are far from optimal but they are valid and can get the job done. 

Here's an interesting study I put together that I think speaks to compounding with suboptimal allocations combined with a slightly higher withdrawal rate and beginning retirement at an unfortunate time.

I went with replicating the Cambria Trinity ETF (TRTY) because I attribute "XXX and Chill" to Meb Faber tweeting about TRTY. The study starts January 3, 2000, starts with $1 million and assumes a 5% withdrawal rate (1.25% every calendar quarter). 

Each portfolio has its pros and cons. The TRTY replication has obviously had a much smoother ride but with Portfolio 1, the investor is today almost $250,000 ahead of the TRTY replication. The starting date is about as bad as it could have been. The stock market cut in half twice in eight years but despite even taking 5% out, each portfolio has a lot more than when they started. If these people retired at a normalish age in 2000, then 26 and half years in to their retirement, they probably don't have another 26 and half years in front of them. In terms of dollars and cents, this is a successful retirement outcome.

Each portfolio clearly had drawbacks, repeated for emphasis, but the compounding worked. The drawbacks didn't invalidate the allocations and the results got the job done. 

Just compound and chill. 

And because I think it's related, an anecdote about a bridge strategy that a client is using as part of their early years retirement plan involving an inherited IRA. The law changed a few years ago requiring inherited IRAs to be emptied out in ten years (does not apply to spouses). If the inherited IRA is even sort of large, it makes sense to spread the withdrawals out over at least a few years to probably pay less in taxes. 

Taking out $300,000 all at once for example would probably kick many of us into a higher bracket versus spreading that $300,000 over five or six years. When the client was 64, he's 67 now, he started taking out a monthly distribution that annualized out to 19%. He's at the same distribution amount after three years and one month and his distribution now annualize out to 33% of his remaining inherited IRA balance. 

There's of course a sequence of return issue looking forward. We're attempting to manage the risk, getting a few months in front of his distributions but if the market does something hideous then his balance might not last three more years, if the market does something heroically great, then maybe he gets 4-5 more years out of the account. 

When we talk about bridging to a milestone like Social Security with an account that has to deplete (inherited IRA), the roughly six years we're working with in this example is a successful outcome. The client already takes Social Security so it is simply an example but his story is a template for how this can work. 

If this could be you, trying to plan what you believe is the best time to take Social Security, an inherited IRA that is bigger than an emergency fund gives you some optionality that maybe you didn't have. 

I'll pivot to my Social Security numbers to explore the optionality. My age 62 amount is $2725/mo. If I could sustain $3000-$3500 monthly distributions for three years from my inherited IRA (I don't actually have an inherited IRA) with that amount being sufficient for my needs, in three years my SS payout would have gone up to $3456/mo by waiting. 

Taking it at 62 still might be the answer you come up with but having the optionality is pretty handy, I always want more optionality if possible.

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.