Mary and Voices [0:01]

A foolish consistency, is the hobgoblin of little minds, adored by little statesmen and philosophers and divines. If a man does not keep pace with his companions, perhaps it is because he hears a different drummer. A different drummer and now, coming to you from dead center, on your dial. Welcome to Risk Parity Radio, where we explore alternatives and asset allocations for the do-it-yourself investor, broadcasting to you now from the comfort of his easy chair. Here is your host, frank Vasquez.

Mostly Uncle Frank [0:37]

Thank you, mary, and welcome to Risk Parity Radio. If you have just stumbled in here, you will find that this podcast is kind of like a dive bar of personal finance and do-it-yourself investing. It's a relatively small place. It's just me and Mary in here and we only have a few mismatched bar stools and some easy chairs. We have no sponsors, we have no guests and we have no expansion plans. I don't think I'd like another job. There are basically two kinds of people that like to hang out in this little dive bar.

Mary and Voices [1:16]

You see, in this world there's two kinds of people.

Mostly Uncle Frank [1:19]

my friend, the smaller group are those who actually think the host is funny, regardless of the content of the podcast. Funny how? How am I funny? These include friends and family and a number of people named Abby, abby, someone, abby who? Abby normal, abby normal, I be normal, I be normal. The larger group includes a number of highly successful do-it-yourself investors, many of whom have accumulated multi-million dollar portfolios over a period of years the best, jerry, the best and they are here to share information and to gather information to help them continue managing their portfolios as they go forward, particularly as they get to their distribution or decumulation phases of their financial life. What we do is, if we need that extra push over the cliff, you know what we do Put it up to 11. 11, exactly. But whomever you are, you are welcome here. I have a feeling we're not in Kansas anymore. But now onward, episode 392.

Mary and Voices [2:40]

Merry New Year.

Mostly Uncle Frank [2:42]

Today on Risk Parody Radio. We're just going to get back to our regularly scheduled programming, which is answering your emails. You need somebody watching your back at all times, and so, without further ado, here I go once again with the email. And First off.

Mary and Voices [3:01]

First off, we have an email from Kyle, kyle, and Kyle writes Dear Frank and Mary, thank you for your discussion on my question, which was please discuss equal weight versus cap weighted indexed ETFs as it pertains to our goals here at Risk Parity Radio. I am back for another drubbing.

Mostly Uncle Frank [3:23]

Bow to your sensei. Bow to your sensei.

Mary and Voices [3:27]

Actually, I think you answered a different question than I intended, likely due to my lack of detail. Based on your discussion, I think my question was interpreted as suggesting that the equal weight ETF would be used as a single fund solution for diversification, similar to how some people mistakenly use VTI for that same purpose. My intent was actually to get your thoughts on an equal-weight fund as part of a diversified portfolio, such as using Invesco's S&P fund, RSP instead of SPY or VOO for 20% of a golden butterfly. That said in hindsight, my question was very lazy.

Mostly Uncle Frank [4:06]

Never his mind on where he was what he was doing.

Mary and Voices [4:18]

I didn't realize how much the size and value attributes for the ETF changed simply by shifting the weighting message. It completely changed the factor representation of the fund when applied to my S&P 500 example. Once I realized that I answered my own question, I would still be interested in any additional comment you had based on my ramblings here. Also, I think you touched on this in a previous episode a long time ago. Huh, what do you mean? They blew up the Death Star.

Mary and Voices [4:42]

But could you revisit the reason you chose VIOV as opposed to VBR for small cap value? I seem to remember that you preferred the small cap S&P 600 to the CRSP index, but can't remember why. Thanks again, kyle, don't let it go, cal.

Mostly Uncle Frank [5:03]

I want to hold you every morning. I love you every night, cow. Well, it seems like we've been hearing a lot from our friend Kyle these days and he has got to jump to the front of the email line because he is one of our donors to the Father McKenna Center. We don't have any sponsors here. We do have a charity. It's called the Father McKenna Center. It serves hungry and homeless people in Washington DC. Full disclosure. I am on the board of the charity and am the current treasurer.

Mostly Uncle Frank [5:31]

But if you donate to the charity you get to go to the front of the email line. That's all I got to offer you here. Nothing else for sale. Not going to do it Wouldn't be prudent at this juncture. You can do that in a couple of ways. Kyle has chosen the Patreon method. You go to our support page at wwwriskparityradiocom and sign up on Patreon to become a regular donor. Or you can donate to the Father McKenna Center directly at their website on the donation page. Either way you do it, you get to go to the front of the email line, but please mention it in your email so I can. Du get to go to the front of the email line, but please mention it in your email so I can duly move it to the front of the line.

Mostly Uncle Frank [6:09]

Yes, and now getting to that email, kyle is first referring back to our discussion in episode 390 about equal weight funds and trying to use one fund solutions for your stock allocation in particular. I think the basic guideline is you want to have at least two funds, one that is value tilted and one that is growth tilted in a basic stock portfolio setup, and the easiest way to look at your assets or your funds and determine where they fall in terms of growth and value is to go to the free Morningstar site and put in your fund name or your stock name I should say ticker symbols and then look at the portfolio makeup and there are style boxes there. It looks like a tic-tac-toe board and it'll tell you is this growth, is this value, is it high or low? And if you have a pile of assets and you're wondering how to sort them out, I think the first good sort is to categorize them into growth and value and then kind of go from there. Now, talking about these particular value ETFs, you're mentioning VIOV as opposed to VBR and yes, your memory is correct that VIOV is based on what is called the S&P 600 small cap value index, whereas VBR is based on what is called the CRSP small cap value index. And there is also another index that is based on the Russell 2000, which is the Russell 2000 small cap value index. So there are really three indexes out there to choose from.

Mostly Uncle Frank [7:57]

The reason that you would not pick VBR over the other ones is it tends to bleed into mid caps. It's not all small caps that are in that index, the way it's constructed. And so, historically, vanguard had had a mutual fund that covered the CRSP index. In the early 2000s, ishares put out IJS, which was a S&P 600 small cap value index fund, and that one became much more popular because it's smaller and more valuey, if you will. And so Vanguard, realizing it needed to compete with that, created in addition to VBR VIOV, which is essentially the same thing as IJS, except it's a little cheaper, and that is the benefit we have these days.

Mostly Uncle Frank [8:48]

Usually there is more than one fund that can cover a particular index, and oftentimes one is just cheaper than the other one, and that's how they compete. Now, the other advantage that the S&P 600 index has is that it also has a profitability filter on top of it. So to make that index, a company has to be profitable, have positive earnings for the past four quarters, and so that tends to exclude the most unprofitable companies from the index. Now VBR and the Russell 2000-based index do not have a profitability factor, so you are getting some of those unprofitable companies in those indexes, and that is also another reason why the S&P 600 index has become the preferred index for small cap value, at least if you're looking for a broad index.

Mostly Uncle Frank [9:43]

Now there are other variations on that theme and improvements that people have made, including some of the DFA and Avantis funds, and Paul Merriman has a nice list of funds over at his website as possibilities what he calls best-in-class ETFs for various asset subclasses, and that is a good resource if you're looking for funds to pick in a particular asset class, and I'll link to that again in the show notes because it's that good With a name like Smucker's it has to be good. So hopefully that clarifies why the S&P 600 small cap value index is preferred over the other two broad-based indexes. And thank you for your email. I swear by the moon and the stars and the sky, I'll be there, Cal.

Mostly Uncle Frank [10:42]

Second off. Second off we have an email from Steve. Hey, Steve, and Steve writes.

Mary and Voices [10:52]

Hi Frank and Mary. In playing around with Testfolio, I found that using managed futures in the Golden Butterfly portfolio in lieu of the 20% short-term bonds increases the compound annual growth rate while simultaneously lowering the maximum drawdowns on the ELSER index. This seems to be a significant improvement on an already easy-to-hold portfolio. However, is the backtest data for which Testfolio uses the simulated tickers DBMFX or KMLMX simply too short to provide a useful guide? In addition, I know you have said in the past that the ideal portfolios have about 20 to 25 percent in alternatives. Using managed futures in the golden butterfly would, in combination with the 20 percent gold, make the alternatives allotment 40 percent. Is that too much? Finally, would such a portfolio make a good medium-term accumulation bucket or would the relatively high allocation to manage futures make for too many tax or other issues that would not be present when simply using the short-term treasuries? Thanks for your thoughts, steve. Hey, steve.

Mostly Uncle Frank [12:01]

Well now, this is an interesting question. Just to orient everyone, just so you know what's in the golden butterfly portfolio, it has 40% in stocks, half of that is in a total stock market fund and half of that is in a small cap value fund long-term treasuries and half is in short-term treasuries and 20% in gold. And what Steve is proposing to do here is substitute managed futures for the short-term bonds in this portfolio. First, ask your preliminary question whether the simulated tickers DBMFX or KMLMX, which go back to, I think, 2003 and 1993 respectively, whether that's too short to provide a useful guide. I don't think so in the case of those, because it is well known that managed futures had a bad decade between 2010 and 2020. And that's really what you want to have in any kind of analysis is at least one bad performance period, and I can tell you that other people have done studies with managed futures going back like 100 years. I think AQR has done something like that, and the past 30 years or so have been relatively typical in terms of performances. So I think it's reasonable for that asset class.

Mostly Uncle Frank [13:25]

It would be nice to include something like the 1970s, but if you go back to the 1970s, you'll actually see that managed futures is one of the best performers and so by not including that, you are actually giving it less credit than it probably deserves.

Mostly Uncle Frank [13:40]

You'll worry more about the 1970s for including things like stocks and bonds, which both struggled there, except for some of the value stocks which did all right. So just looking at your proposal here, I'm not surprised that overall, the portfolio does better with an allocation to managed futures than to short-term bonds, because what is going on in that portfolio with the short-term bonds is that is essentially just like ballast and it is both dampening the returns and the volatility of the portfolio. You can also see that this portfolio is kind of on the conservative end of proposed drawdown or intermediate holding portfolios, in that it's only got 40% in stocks in it. Now, as to your question, is 40% too much to allocate to gold and managed futures? I would say yes, probably, especially if you are actually drawing down off this thing. I'm not sure it's too much in terms of just kind of an intermediate accumulation portfolio, because that's a slightly different animal intermediate accumulation portfolio, because that's a slightly different animal.

Mostly Uncle Frank [14:59]

But if you're looking for a drawdown portfolio, usually you want to keep your alternatives to 25% or less in total. And if you do something like 50% in equities, 25% in long-term treasury bonds and then the remaining 25% divided into the golden managed futures, you'll get something that looks kind of like a golden ratio portfolio actually, because the real difference between those portfolios is one has a lot of short-term bonds and one barely has any or doesn't need to have any. But if you're going to ditch the 20% in short-term bonds, I would probably spread that over the other assets and not just make it all managed futures. I will tell you that there are many people out there that do recommend much higher allocations to things like managed futures up to 20%, I think. If you talk to Corey Hofstein they would say have less gold and have more managed futures. But at that point in time you're getting more to preferences, I think, getting more to preferences, I think. And I wonder in some of those recommendations whether people aren't just kind of talking their own book, because they tend to work in the managed futures area. So you could definitely try something like this.

Mostly Uncle Frank [16:15]

And finally, you ask this tax question whether that higher allocation would make it too tax inefficient. Managed futures do typically tend to be tax inefficient in that they issue essentially 5% in dividends, usually over the course of the year or at the end of the year, which is subject to ordinary income tax. But I wouldn't think that would be very significant unless this is a very large portfolio or you have a very high other income coming in, simply because the thing you're replacing is also going to be subject to ordinary income tax. So the delta between the two of them isn't that great. Anyway, it's always interesting to see what you listeners come up with as you experiment with some of these things, and I really think that Testfolio has made it a lot easier to model portfolios with managed features in them, because it has much more data than Portfolio Visualizer did with respect to that particular asset class, because in Portfolio Visualizer you actually had to use the ticker symbols, whereas Testfolio, essentially, has created an asset class ticker to use for it.

Mostly Uncle Frank [17:26]

Testfolio essentially has created an asset class ticker to use for it. So very interesting ideas there, and thank you for your email. I'll get you, hey, steve, if it's the last thing I do Last off.

Mary and Voices [17:45]

Last off, we have an email from James. Hey Jim, baby, I see you brought up reinforcements. And James writes Hello Frank, a discussion on buckets, flowerpots or whatever else we would like to call them. Nowadays, Kitsis writes. Yet when such a decision rules strategy is paired with simple rebalancing, it turns out that the outcome is no better than merely managing the portfolio on a total return basis, without the decision rules at all. That's the fact, Jack. That's the fact, Jack. Thanks, James. Well, I'm waiting for you, Jimmy boy.

Mostly Uncle Frank [18:21]

Okay, just to orient everyone here, james is citing to an article written by Michael Kitsis and the article is actually 10 years old, which we'll talk about in a minute but it's analyzing whether putting assets in buckets or creating some kind of bucket strategy has any impact a real impact on the performance of a portfolio, and the conclusion is it does not.

Mary and Voices [18:47]

That's not how it works. That's not how any of this works.

Mostly Uncle Frank [18:52]

At least if you are also rebalancing the portfolio periodically, because whatever you're doing in the buckets gets kind of wiped out by the rebalancing. And if you're not rebalancing periodically, then you have to have some kind of complex strategy as to which buckets you're taking from, when you're going to refill one or the other and how that's all going to work out, based on the performance of the assets, how much money you're taking out and other considerations about the structure of the portfolio. And this does get to one of my pet peeves that we still have like a bad penny that keeps turning up this idea floating around out there that putting your assets into designated buckets, ladders, hoses and flower pots or whatever other things you want to call them. Some people give them food references, like pie cakes and things like that, but whatever you're doing with that, that is not an exercise in portfolio improvement.

Mary and Voices [19:57]

That's not an improvement.

Mostly Uncle Frank [19:59]

Or changing how the assets perform. It's a labeling exercise. How the assets perform. It's a labeling exercise. Clear your mind, empty it of all thoughts until you're doing absolutely nothing. But I think over time people have come up with a lot of erroneous beliefs about what that does and what it does not do. It does not make your portfolio perform any better. Full stop, forget about it. Your portfolio will perform based on the assets themselves, whether you label them or put them in buckets, as opposed to just putting them all on a pie chart and saying I have a 15% allocation to this or that or the other. But let's talk about the history of this first of all.

Mostly Uncle Frank [20:56]

The original bucket strategy was invented by a financial advisor named Harold Vinsky and this is over 30 years ago and he did not invent it as something that was supposed to improve performance of the portfolio. In fact, he recognized it probably detracted from the performance of the portfolio. The original bucket strategy he invented was simply to carve off at the beginning of a period, say a year or a quarter, the amount of cash the client would need to spend in that quarter, put it in cash and then just spend out of that, and the reason he came up with that is because of the psychology that clients would get worried seeing their real assets in the portfolio go up and down and be concerned that because they were going up and down, that was going to be a problem. As a financial advisor he recognized no, it wasn't really a problem over long periods of time that the portfolio was well-constructed. But in order to assuage this psychological problem his clients were having, he came up with this idea of a cash bucket that we're going to have this cash bucket that we refill periodically and then just spend out of that. And that was fine as a psychological tool. But it's morphed into this cottage industry almost of ridiculous ideas that having multiple buckets of cash, bonds and other things and lining them up in a row and creating a series of labels and complicated rules for filling them and unfilling them is going to somehow improve the performance of the portfolio or, worse yet, solve sequence of returns risk. This does not solve sequence of returns risk. It never has and it never will Forget about it. And you know somebody is screwing up and they don't understand how this works.

Mostly Uncle Frank [22:50]

When you hear them say or write and this is very common in personal finance land they will say I'm having this bucket so that I can survive an average downturn of the stock market. An average downturn of the stock market which they downturn, of the stock market, which they always say is like, well, it's like three years. If I have a three-year bucket, that's enough. Wrong, that is not the problem. Any portfolio can survive a three-year average downturn of the stock market.

Mostly Uncle Frank [23:19]

The problem you're facing and the reason it's a 4% rule and not a 5% rule or a much higher rule, is because you don't care about the average downturn. You care about the longest downturn, the worst downturns, which are a decade long. And if you are constructing buckets of cash to cover a decade-long downturn, you are seriously degrading the overall performance of the portfolio because it's just too much cash. Once you get over about 10% in cash in a portfolio, it tends to degrade the long-term performance of the portfolio. We've known that since Bill Bangan's first study back in 1994. It's still true today. Everybody that's looked at it says the same thing. If you do it yourself, you'll see the same thing.

Mostly Uncle Frank [24:16]

So putting your pile of cash in some kind of bucket, ladder, flower pot or whatever you want to call it is not going to solve sequence of returns risk, it's just not. And so if it's not solving that, then what is it doing? Hello, hello, anybody home, I think, mcfly, I think All it is is a psychological security blanket. That's all it is, that's all it ever was, all it ever is, all it's ever going to be.

Mary and Voices [24:46]

And you may ask yourself am I right, am I wrong? And you may say to yourself my God, what have I done?

Mostly Uncle Frank [24:54]

But it's almost like a disease. It's like bucket-itis that people think if they swill this cocktail out of this bucket, it's going to make them feel better or perform better or something like that. And it's going to make them feel better or perform better or something like that. And it's pervasive. It's like I picked the wrong week to quit drinking and I hear people talking like this that ought to know better. I'll call one out. It's christine benz at morningstar. She gets up there on stage or on podcasts and says things like well, I like this bucket strategy where you have a couple years of cash, then like eight years of bonds and then the rest of it is stocks. If you break that down, it's just a 60-40 portfolio. It's just a 60-40 portfolio. Saying that it's in these buckets doesn't make it perform any better or any worse. It's not helpful. Forget about it. It's masking what is really going on. The magic man Now you see me.

Mary and Voices [25:54]

Now, you don't.

Mostly Uncle Frank [25:55]

That was the stupidest nickname I've ever heard and, by the way, she doesn't follow that anyway, which is what bothers me the most about a lot of these recommendations. I hear that the people spouting them do not follow them personally. Let me tell you something if you're not going to eat your own cooking, I'm not going to eat it either. That goes without saying.

Mary and Voices [26:16]

Oof.

Mostly Uncle Frank [26:18]

And nobody should eat the cooking from a chef who won't eat their own cooking. There's a cake in the oven so sweet and delicious won't eat their own cooking.

Mostly Uncle Frank [26:44]

Here's what I see ends up happening with this Because this bucketing of assets doesn't work and often distorts the amount of cash in a portfolio by raising it above that 10%, the real solution adopted by these bucketers ends up being don't spend much money. Don't spend much money, just spend less. Have all the money you need for your actual portfolio and then have this additional allocation to cash as this bucket. So basically, you've got like a 3% withdrawal rate, and if you have a 3% withdrawal rate, you're going to be fine, and it's not because you have a bucket.

Mary and Voices [27:24]

That's not how it works. That's not how any of this works.

Mostly Uncle Frank [27:29]

It's because you're not spending much money and if you have a portfolio like that, you can hold anything. You can hold 100% stocks, you can hold 30% stocks. You can have 16 buckets if you want them, it's not going to matter. But that is not your strategy. The buckets, ladders, flower pots and hoses are not what make your strategy work. Your strategy works because you're not spending much money and if you don't want to spend money and die at your highest net worth, that's fine.

Mostly Uncle Frank [27:59]

Dead is dead. But recognize that is what you're doing. You're leaving your life on the table in favor of hoarding money in buckets. That's what you're doing. That is the straight stuff, oh, funk master. So don't kid yourself and don't be running around telling other people they ought to do this because it's not a good idea. It just isn't. It's highly misleading and it's highly inefficient. But you know who likes it. A lot of financial advisors like it. They're sitting out there waiting to give you their money. Are you going to take it? The reason they like it is it's easy to explain and it goes down easy and, as Harold Levinsky found 30 years ago when he constructed the original strategy, it does create a psychological security blanket, but that's all it is, it's psychology, it's not investing.

Mary and Voices [28:55]

Because only one thing counts in this life Get them to sign on the line which is dotted.

Mostly Uncle Frank [29:02]

It's just psychology. It's not efficient investing.

Mostly Uncle Frank [29:10]

The end Always be closing, always be closing. So thank you for bringing this to our attention. I'll tell you what really galls me about this is Michael Kitsis has written a number of articles about these, and these articles are not new anymore, and so if you are in this space personal finance or you are advising people and you have not taken into account these findings in this research that are well known, you're either not managing your own portfolio very well or you're giving bad advice to somebody else, and I know that might make your job easier as a financial advisor to come up with these labels with buckets, ladders, hoses, flower pots, pie cakes and whatever else you want to call these things If you have a milkshake and I have a milkshake and I have a straw.

Mary and Voices [30:05]

There it is. That's a straw. You see, watch it.

Mostly Uncle Frank [30:09]

But if you're being honest with your clients, you're basically just telling them to not spend much money Makes your job a whole lot easier if they're not spending much money. If you're getting AUM, you're getting paid more too. How about that? How about that? My straw reaches across the room and starts to drink your milkshake. I drink your milkshake. I drink it up. Isn't that convenient?

Mary and Voices [30:48]

Ooh, how convenient.

Mostly Uncle Frank [30:50]

So thank you for bringing this to our attention again, james. It's always worth reviewing, as this bad penny keeps turning up and we keep having to play whack-a-mole with it. I don't expect that to change anytime soon, and so thank you for your email, but now I see our signal is beginning to fade, to change anytime soon, and so thank you for your email, but now I see our signal is beginning to fade. Release the hounds. If you have comments or questions for me, please send them to frankatriskparityradarcom. That email is frankatriskparityradarcom. Or you can go to the website wwwriskparityradarcom. Put your message into the contact form and I'll get it. That way. We are kind of backed up on the emails, since I took some time off during the holidays and we are still in November with the main group of them. So if I haven't answered yours yet, it is probably somewhere in the queue. Bad news the fog is getting thicker.

Mary and Voices [31:51]

And Leon's getting larger.

Mostly Uncle Frank [31:56]

And also, in the meantime, if you haven't had a chance to do it, please go to your favorite podcast provider and like subscribe. Give me some stars, a follow, a review that would be great. Okay, thank you once again for tuning in. This is Frank Vasquez, with Risk Parity Radio Signing off.

Mary and Voices [32:20]

So just chill to the next episode. The Risk Parody Radio Show is hosted by Frank Vasquez. The content provided is for entertainment and informational purposes only and does not constitute financial investment, tax or legal advice. Please consult with your own advisors before taking any actions based on any information you have heard here, making sure to take into account your own personal circumstances.