November 6, 2025 • 36 mins
In this episode we answer emails from Roman, Andrew and Iain. We discuss the plusses and minuses of leverage, volatility drag, and how leverage interacts with diversification and withdrawals, general observation on tax optimization via account buckets, small cap value index funds and Avantis/DFA merits, and modelling annuities versus mandatory versus discretionary spending in retirement.
LInks:
Father McKenna Center Donation Page: Donate - Father McKenna Center
Ben Felix Leverage Video: Investing With Leverage (Borrowing to Invest, Leveraged ETFs)
Leveraged ETFs Paper: Double-Digit Numerics - Articles - The Big Myth about Leveraged ETFs
Optimized Portfolios Article/Website: How To Beat the Market Using Leverage and Index Investing
Jim Sandidge Chaos Theory Applied to Drawdowns: RMJ081-ChaosAndRetirementSecurity.pdf
"Buffet's Alpha" Paper: Full article: Buffett’s Alpha
New Tax Planning In Early Retirement Book: Amazon.com: Tax Planning To and Through Early Retirement: 9798999841599: Garrett, Cody, Mullaney, Sean: Books
Merriman Best IN Class ETF Selections: Best ETFs 2025 | Merriman Financial Education Foundation
Breathless Unedited AI-Bot Summary:
Ever wonder why leverage looks brilliant during bull markets but feels brutal the moment you start withdrawing cash? We break down the promise and pitfalls of adding leverage to diversified, risk parity-style portfolios, then show how the math of volatility drag and sequence risk can quietly erode safe withdrawal rates. It’s an honest tour of what works in accumulation, what breaks in retirement, and how to engineer a calmer path without surrendering all upside.
We start with the straight talk: leverage and concentration are the two proven routes to outperformance, but only one of them can be paired safely with broad diversification. From hedge fund history to the “Aggressive 50/50” experiment, you’ll hear why high-octane blends can top the charts and then stall after deep losses, especially when distributions force selling at the worst times. We contrast that with return stacking and measured leverage, which aim for equity-like returns with better risk control, and we share practical tools—rebalancing discipline, cash buffers, and dynamic spending bands—to keep a drawdown portfolio intact.
Taxes matter just as much as tickers. We walk through Roth vs traditional contributions, why present marginal rates and future flexibility drive the choice, and how to place bonds smartly across tax buckets. On the equity side, we revisit small cap value: why classic S&P 600 value exposure is solid, and how AVUV and DFA’s profitability filters can sharpen the factor without turning it into active guesswork. Then we turn to spending: build the plan around real expenses, not theoretical annuities. Set a durable floor for essentials, keep a flexible layer for the fun stuff, and consider partial annuitization later in life if longevity and peace of mind are worth the trade.
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Voices (00:00):
A foolish consistency is the hub goblin of little mind,
adored by little statesmen andphilosophers and divines.
If a man does not keep pace withhis companions, perhaps it is
because he hears a differentdrummer.
A different drummer.
Mostly Queen Mary (00:18):
And now, coming to you from Dead Center
on your dial, welcome to RiskParity Radio, where we explore
alternatives and assetallocations for the
do-it-yourself investor.
Broadcasting to you now fromthe comfort of his easy chair,
here is your host, FrankVasquez.
Mostly Uncle Frank (00:37):
Thank you, Mary, and welcome to Risk Parity
Radio.
If you have just stumbled inhere, you will find that this
podcast is kind of like a divebar of personal finance and
do-it-yourself investing.
Voices (00:52):
Expect the unexpected.
Mostly Uncle Frank (00:55):
It's a relatively small place.
It's just me and Mary in here.
And we only have a fewmismatched bar stools and some
easy chairs.
We have no sponsors, we have noguests, and we have no
expansion plans.
Voices (01:10):
I don't think I'd like another job.
Mostly Uncle Frank (01:13):
What we do have is a little free library of
updated and unconflictedinformation for do-it-yourself
investors.
Voices (01:23):
Now, who's up for a trip to the library tomorrow?
Mostly Uncle Frank (01:27):
So please enjoy our mostly cold beer
served in cans and our coffeeserved in old chipped and
cracked mugs.
Along with what our little freelibrary has to offer.
Which is attend to your email.
(02:00):
Did you get that memo?
Voices (02:03):
Yeah, I got the memo.
Mostly Uncle Frank (02:04):
And so without further ado.
Voices (02:06):
Here I go once again with the email.
Mostly Uncle Frank (02:09):
And first off.
First off, we have an emailfrom Roman.
Voices (02:24):
All hail Caesar, Emperor of Rome, monarch of the Roman
Empire, ruler of the world.
Mostly Uncle Frank (02:32):
And Roman rights?
Mostly Queen Mary (02:34):
Please move this question to the front of
the line as I recently donatedto the Father McKenna Center.
Voices (02:40):
Groovy baby!
Mostly Queen Mary (02:42):
I recall hearing that there is no free
lunch in investing, with thepossible exception of
diversification, but it seems tome that leverage, when properly
applied to a diversifiedportfolio, is a strong contender
as well.
I have noted that yourleveraged sample portfolio, such
as the levered golden ratio orOPTRA, both support perpetual
withdrawal rates exceeding 5%long-term baseline for the
(03:05):
standard golden ratio portfolio.
This makes sense to me, sinceif you take a non-leveraged
portfolio that would otherwisesupport a 5% withdrawal rate and
lever it above 100% while stillmaintaining its overall
diversification, then you couldtheoretically proportionately
increase the withdrawal rateconsistent with the amount of
leverage.
(03:25):
For example, if 5% can besafely withdrawn from an
unleveraged portfolio with 100%exposure, 100% divided by 20
equals 5%, then a portfolio with120% exposure should support a
6% withdrawal rate.
120 times 5% equals 6%.
A portfolio with 140% exposureshould support a 7% withdrawal
(03:51):
rate.
140% times 5% equals 7%, and soon.
I'm sure this phenomenon doesnot go on forever, but assuming
a reasonable amount of overallleverage in a portfolio and
maintaining the appropriateratios of uncorrelated or weekly
correlated asset classes, isthis the right way to think
about the effect of leverage onthe withdrawal rate that a
(04:13):
portfolio can potentiallysupport?
Or am I overlooking somecritical pitfalls with this
approach?
If so, I am very interested inhearing what these might be.
Thank you for your show.
And I am one of those who wasinitially put off by all the
sound bites but eventually cameto enjoy them, Roman.
Mostly Uncle Frank (04:32):
Well, I'm glad you're enjoying the sound
bites.
After a fashion, as it were.
Voices (04:42):
Did you kill last week?
No.
Did you try to kill last week?
Yeah.
Now listen, this is your lastweek of unemployment insurance.
Either you kill somebody nextweek or we're gonna have to
change your status.
You got it?
Yeah.
Sign.
Mostly Uncle Frank (05:02):
But I'm even more glad that you're a donor
to the Father McKenna Center.
As most of you know, we do nothave any sponsors on this
podcast.
We do have a charity wesupport.
It's called the Father McKennaCenter, and it supports hungry
and homeless people inWashington, D.C.
Full disclosure, I'm on theboard of the charity and am the
current treasurer.
But if you give to the charity,you get to go to the front of
(05:24):
this email line, which is aboutthree months long.
So if you'd like to do that,there are two ways to give to
the charity.
First, you can go to thedonation page of the Father
McKenna website, which I'll linkto again in the show notes.
And second, you can go to thesupport page at
www.riskprediary.com and becomeone of our patrons on Patreon.
(05:48):
Either way, you get to go tothe front of the line, but
please do mention it in youremail, as Roman has done here,
so that I can duly move you tothe front of the line.
Voices (05:56):
Yes!
Mostly Uncle Frank (05:57):
But now let's get to that email.
Leverage is an interestingtopic that we have pondered
here, and I continue to ponder,since I really do not know what
the ultimate answers are as tothe optimal leverage in a
drawdown portfolio.
And that's kind of the $64,000question.
What's the answer?
What's the answer?
(06:18):
So here are some justconsiderations about this in
general.
There's a nice Ben Felix videothat I'll link to in the show
notes where he cites someacademic studies showing
basically if you want tooutperform markets, there are
two ways to do it.
You can either take aconcentration in something that
you think is going to outperformthe market, or you can take
(06:38):
leverage.
Now, of course, the mainproblem with taking leverage is
a lot of people who takeleverage blow up and lose all
their money.
And that's not good.
Voices (06:48):
You have a gambling problem.
Mostly Uncle Frank (06:50):
And that happens to even the finest
investors available famously tolong-term capital management
back in the late 1990s, whichwas a whole bunch of Nobel Prize
winners and other verysophisticated investors who put
too much leverage in some betson Russian currencies and
Russian debt, and it really blewup in their face.
Voices (07:12):
We can put that check in a money market mutual fund,
then we'll reinvest the earningsinto foreign currency accounts
with compounding interest, andit's gone.
Mostly Uncle Frank (07:21):
And that's happened to many others over
many years.
Voices (07:25):
Uh what?
It's gone.
It's all gone.
What's all gone?
The money in your account.
It didn't do too well, it'sgone.
Mostly Uncle Frank (07:32):
On the other hand, taking leverage has been
one of the cornerstones of howhedge funds traditionally used
risk parity style portfolios.
Because what they would do istake a very conservative
portfolio like that all-seasonsample portfolio, something that
looked like that, that had awhole lot of bonds in it, and
then add leverage to that tomake it have the same risk
(07:56):
profile as, say, the stockmarket, with the idea that it's
going to have that same riskprofile, but a lower volatility
overall, and so have essentiallya higher sharp ratio or be more
efficient in terms of riskversus reward.
And people who start with avery conservative portfolio and
add leverage to that typicallydo not blow up if they're
reasonably careful about it.
(08:18):
But one of the key drawbacks toleverage, particularly in a
drawdown portfolio, is what iscalled volatility drag.
And the easiest way toillustrate that is if you had a
portfolio that lost 10% of itsvalue in a year, in order to
make that back the next year, itwould have to make 11% back.
And that's not a very bigdifference.
(08:39):
But if that same portfolioloses 20% in a year, then in
order to make that back, it hasto get up 25%.
And the more it loses, the morevolatile a portfolio is, the
more it has this drag on gettingback to even.
And we've seen this in thesample portfolios, which is one
of the reasons I wanted toconstruct them to see how this
(09:01):
would all work out.
So if you look at the mostleveraged and the least
diversified of those sampleportfolios, which is the
aggressive 50-50, that wasmodeled after something that
it's called hedge fundy'sexcellent adventure, which was
popular about five years ago,and you can look up, which is
basically a portfolio ofcompletely leveraged funds
divided into a fund like youpro, three times leveraged S P
(09:25):
500 with it with a fund likeTMF, which is three times
leveraged Treasury bonds.
And that portfolio has been theworst performer out of the
sample portfolios, primarilybecause of this volatility drag.
That initially, when everythingwas going up, it performed the
best and it reached the highestpeak at that time.
But then when we had that crashin 2022, it essentially lost
(09:47):
half its value and has struggledsince then, largely due to the
volatility drag.
But the one thing that adds tothat is if you are taking money
out of a portfolio doingwithdrawals, it increases the
overall volatility of theportfolio and so drags it down
even more, essentially.
And since we were subjectingthat thing to an 8% withdrawal
(10:09):
rate originally and have beensubjecting it to 6% since it
went under its starting value,that has also contributed to its
underperformance.
So it's been an ugly experimenton paper, but it's been a very
educational experiment in howleverage and volatility actually
work.
Voices (10:27):
Well, you have a gambling problem.
Mostly Uncle Frank (10:31):
Now there's an important paper that we've
cited about this back in episode440, and it's written by a guy
named Jim Sandage, and it isapplying chaos theory
essentially to draw downportfolios and observing this
phenomenon that when you starttaking money out of a portfolio,
it naturally adds to thevolatility or chaos of the
(10:52):
portfolio.
Voices (10:54):
We're lords of chaos.
Mostly Uncle Frank (10:57):
And in order to essentially ameliorate that
problem, usually you need betterdiversification, essentially.
But I think that's one of thechallenges in adding leverage to
a drawdown portfolio.
It's this kind of like a doublewhammy on this potential
volatility drag.
I don't think it's nearly asmuch of a problem if you're
talking about an accumulationportfolio, because that has the
(11:18):
opposite effect.
If you are adding money into aportfolio, it naturally reduces
the overall volatility of theportfolio because it's
essentially like having this bigpile of cash on the side that
you are feeding into this thing.
Voices (11:32):
There's $250,000 lining the walls of the banana stand.
Mostly Uncle Frank (11:37):
Now, a couple other resources and
references we've talked aboutbefore.
One we did cite a paper onceabout the optimal leverage as
far as ETFs in a portfolio wasconcerned, and the author of
that article came out to a valueof two.
But I think they were talkingabout more of a static kind of
portfolio, not a drawdownportfolio.
(11:58):
The other reference that we'vemade is this site called
Optimize Portfolios, which talksall about leveraged portfolios
and leveraged ETFs used inportfolios, and I think that's a
useful site too.
Although I don't know thatthey've come to any grand
conclusions about using these ina retirement portfolio.
Now, more recently over thepast few years, there have been
(12:20):
variations on this theme,including what are called
return-stacked portfolios now,which take off on the risk
parity idea, but arecombinations of various assets
in levered forms and ETFs thatyou can kind of mix and match.
And they've now put out six oreight ETFs and I think have a
billion dollars in assets thatthey've accumulated over the
past three years.
(12:40):
That's Corey Hofstein andRodrigo Gordillo, and that's an
interesting concept or variationas well.
Although they are not promotingthose things for retirement
portfolios.
They're looking at them more asa way of essentially getting
stock market-like returnswithout taking stock market-like
risk.
And so that OPTRA portfolio,the last one that we've created,
(13:03):
we started in July 2024, is areturn-stacked style portfolio
and has effective leverage in itof about 32 to 45%, depending
on how you count it.
Voices (13:19):
And it's gone.
Poof.
Mostly Uncle Frank (13:23):
And it seems to be doing quite well in that
formulation.
If you look at something likethat levered golden ratio
portfolio, that's designed tohave leverage of approximately
1.6 to 1%.
The golden ratio.
Which is similar to what is ina paper called Warren Buffett's
(13:43):
Alpha, which talks about you canmodel the performance of
Berkshire Hathaway as anapplication of leverage of 1.7
to 1 due to the way it uses thefloat of the insurance companies
in that structure.
Now that one has struggled abit, but it's recovered, and
it's mainly struggled simplybecause it had a very bad start
date right before 2022, whichreally took a toll in addition
(14:05):
to its original 7% withdrawalrate.
So overall, this is somethingI'm very curious about, but I
really do not have a definitiveanswer to.
It's kind of like one of thosequestions about what is the
optimal rebalancing strategy,and I don't think there's any
one answer to that either,because it kind of depends on
the whole makeup of theportfolio and the withdrawal
(14:25):
strategy itself.
I think that's probably true ofa topic like leverage as well.
That if you start with aconservative enough portfolio,
some leverage is probably goingto work pretty well.
But if the portfolio is eithertoo aggressive to begin with and
you apply leverage to it, oryou're just applying too much
leverage, like that aggressive50-50 portfolio, which I think
(14:46):
applies too much leverage,you're probably not going to
have good results due to thisvolatility drag.
Anyway, maybe one of youlisteners will figure all this
out and tell us when you do.
At least I hope you will.
Voices (15:01):
And uh after that I just sort of space out for about an
hour until I'm space out?
Yeah.
I just stare at my desk.
But it looks like I'm working.
Mostly Uncle Frank (15:13):
In the meantime, I will link to all of
these resources in the shownotes so you can check them out
because this is just a veryinteresting topic and something
I've been very curious aboutsince I first ran across Risk
Parity style portfolios back inlike 2010.
So hopefully that helps you alittle bit.
Thank you for being a donor tothe Father McKenna Center, and
(15:33):
thank you for your email.
Voices (15:36):
Next, occupation stand-up philosopher.
What?
Stand-up philosopher.
I coalesce the vapor of humanexperience into a viable and
logical comprehension.
Dependence is a very good city.
(16:13):
Very wonderful city, ancientcity.
You're gonna learn a lot ofdependence.
You wanna learn how to make avery ancient blind like this?
Second off.
Mostly Uncle Frank (16:27):
Second off, we have an email from Andrew.
And Andrew Wright.
Mostly Queen Mary (16:43):
Hello, Frank and Mary.
I first learned about yourpodcast after hearing you on a
Bigger Pockets Money episode andhave slowly been working
through all 460-plus episodes ofyour show ever since.
Voices (16:55):
Very sick man.
Mostly Queen Mary (16:56):
Thank you so much for the wealth of knowledge
you have provided to us averageDIY investors.
I am 32 and still in myaccumulation phase of life, but
closing in on my first milliondollars.
As I begin to think about howmy portfolio should look in the
future, I have started to takenote of how much money I have in
(17:19):
each tax bucket.
I have the unique opportunityto contribute to a Roth TSP
401k, so my after-tax Rothdollars make up about 45% of my
net worth, while traditionaldollars is only about 10%.
The remainder of my portfoliois 40% in a taxable brokerage
and 5% in cash.
I am almost entirely investedin SP 500 index funds.
(17:43):
My goal will be to eventuallymove towards a golden ratio
style portfolio with 42% stocksand 26% bonds.
Voices (17:52):
A number so perfect, perfect.
Mostly Queen Mary (17:57):
My question.
I know you've explained that wewant to hold things like bonds
in traditional accounts due tothe interest they generate, but
given my small traditionalbalance, I'm curious what your
thoughts might be on adding moreto traditional retirement
accounts instead of Roth to setmyself up for a more efficient
portfolio later.
Additionally, I was curious ifyou could explain a little more
(18:18):
about your reasoning for fundselection to fill the small cap
value spot, in particular AVUV,like you've recommended for
Mindy's portfolio, versus VIOVlike you have in the Golden
Ratio portfolio.
I believe I've listened to allyour material on small cap value
funds, but if I'm missingsomething, please feel free to
refer me accordingly.
Thanks again for all that youdo.
(18:40):
P.S.
I have made a contribution tothe Father McKenna Center.
I passed out lunches to thehomeless in the DC area through
my church growing up, so I'mhappy to help giving back in
this way.
Thank you, Sensei, Andrew.
Mostly Uncle Frank (18:57):
Well, thank you also for being a donor to
the Father McKenna Center,Andrew, and thank you for your
prior work in helping feedpeople around these parts in the
past.
Voices (19:08):
For me and the Lord, we've got an understanding.
We're on a mission from God.
Mostly Uncle Frank (19:16):
We've had a lot of activity at the Father
McKenna Center recently with allof these disruptions in the
government and the food programsthere.
We've had a lot more demand.
And fortunately, we've had alot more volunteers show up, and
so we've been having hundredsof people hand out thousands of
meals, and we appreciate all ofthe donations to allow us to buy
(19:37):
more food.
So thank you again for that.
Voices (19:43):
We don't have enough to eat.
Mostly Uncle Frank (20:42):
I wouldn't worry too much about how it's
going to be managed on the backend.
I think what you probably wantto be more conscious of is where
you are in the front end.
And if your tax rate is high,either because you make a lot of
money or you're in a state witha higher state income tax, you
probably want to use thosetraditional retirement accounts
to get that benefit up front.
(21:03):
Because when you retire, theadvantage of it is that since
you don't have regular ordinaryincome coming from a job, you
have a lot of flexibility as tohow much income you actually
show every year, depending onwhere the money is coming from.
And that can be managed.
So if you are in a higherincome bracket right now, I
(21:23):
would simply go for thetraditional up to the limits
you've got there.
If you're Roth eligible, that'snever a bad choice in the long
run.
Particularly since you canaccess those contributions to
the Roth without penalty, evenbefore retirement age, so that's
got another built-in advantageto it.
And I should saycongratulations for closing in
(21:44):
on your first million at age 32,because that is quite a nice
accomplishment.
Voices (21:50):
All we need to do is get your confidence back, so you
can make me more money.
Mostly Uncle Frank (21:55):
It wasn't clear what your timeline was
right now, but there's no reasonto be transitioning right away
unless you were planning onliving on that million dollars
or something like that.
But if you're still close to adecade away or some number like
that, I would just continue toinvest in your stock market
funds.
You might branch out into theother stock market funds that
(22:17):
you plan to be holding in thelong term, at least if you're
putting that in any kind of ataxable account, just to make it
easier to manage when you getthere.
But you certainly wouldn't beneeding to put any money into
bonds if you're not gettingclose to retiring or living off
the money, I should say, whetheryou're retiring or not.
One thing I would do if I wereyou is pick up the new book
about tax planning for earlyretirement, written by Cody
(22:41):
Garrett and Sean Mullaney,because I think it's gonna
answer a lot of the questionsyou have and clarify in your
mind as to the best choices interms of where to put your money
and then how you're going toaccess it later on.
What you'll learn from thatbook is take as many tax
advantages as you can get upfront because you're gonna be
able to manage it on thebackside fairly easily,
particularly if you're talkingabout a few million dollars and
(23:04):
not more than $10 million.
And yes, you can put bonds inRoths if that is where you
actually have room for them.
The truth is most people justdon't have that large of a Roth
account to work with, and sothat space is relatively
limited.
Okay, and your last questionwas about the choice of small
cap value funds.
(23:24):
So when I set up the originalsample portfolios, I really
wanted to be focused on assetclasses themselves and index
funds that represented them andnot get wound up in fund
choices.
So I intentionally pickedessentially the most popular
small cap value index being usedtoday, which is the S P 600
(23:46):
small cap value index, and thatis reflected by the fund VIOV
and also the fund IJS.
Now, funds like the AvantisFund AVUV were relatively new at
that time, and it wasn't clearhow they were going to perform
in relation to the index.
The theory behind them, though,had been around for quite a
(24:08):
while because this is from theDFA funds, and what DFA had been
doing since the 1990s is takingessentially what would be like
a small cap index and thenputting a profitability filter
on top of it to essentially getrid of the worst companies and
modify the whole process so it'sstill algorithmic, they're
(24:30):
still using a formula togenerate it, but they're trying
to be more efficient about it.
So DFA had originally onlyoffered its funds in mutual fund
form, and the way theirbusiness model worked is that
they only worked with financialadvisors, so you had to
essentially go to a DFA-approvedfinancial advisor to get access
to DFA funds.
(24:51):
Now it's interesting, some ofthe people who were at DFA
wanted to branch out and startoffering regular ETFs, and there
was a dispute or something.
Anyway, some of the people leftthere, went and formed Avantis,
and started issuing these ETFsthat are essentially doing the
same sorts of things.
DFA has now got religion, ifyou were, and started offering
(25:13):
its own ETFs because its oldbusiness model just didn't work
anymore.
This is part of the evolutionof ETFs and why we're living in
kind of a golden age that you'reable to get cheaper and cheaper
fun choices, good fun choicesof a whole bunch of things that
you didn't have access to beforeor were prohibitively
expensive.
And now these things arerelatively cheap.
(25:34):
You used to be paying like 1%for them, and now you're paying
0.2 in most cases.
So over the past several years,AVUV has kind of proven itself
when you compare it to theperformance of regular small cap
index funds as having someadvantages due to its additional
profitability or quality filteron it.
And so that is why today Iwould say if you're going to
(25:57):
pick a small cap value fund,that's probably one of the
better ones you could pick.
There's also a DFA version ofthat out there now.
A good place to find these bestin class kind of fund choices
is the Merriman ETF website.
They go and analyze these fundsas well as a bunch of index
funds and compare them andpublish their findings every
(26:19):
couple of years, essentiallysaying these are the best in
class depending on what youwant.
So I would say there is a kindof growing consensus that at
least in the areas of small capvalue and international value,
that these DFA and Avantis fundsare at least slightly better
than index funds after fees, andmaybe substantially better.
(26:39):
So that is what I would picktoday, and it is in fact what we
have in a lot of our personalaccounts.
But I did originally want touse standard index funds to show
that the methodology behindthis risk parity style investing
was based on asset classes andnot based on fun picking.
Because the truth is there area lot of good choices for funds,
(27:01):
and that that is the tail ofthe dog, and not the real make
or break choice when it comesdown to things.
You always want to choose assetclasses first, allocate them,
and then make fun choices afterthat.
As the last thing you do, notthe first thing you do.
So hopefully that explanationhelps.
And thank you for your email.
Voices (27:42):
If you don't do your revision properly, you know what
will happen.
Mostly Uncle Frank (27:51):
And Ian Wright.
Mostly Queen Mary (27:53):
Hi, Frank and Mary.
Thanks for all the clarity andcourage you bring to the world
of retirement investing.
It's much appreciated.
I've been reading Bill Bangin'snew book, and it got me
thinking about withdrawalstrategies, fixed rate with cost
of living adjustments, fixedpercentage, annuities, and so
on.
I like the idea of a lifetimeinflation-linked annuity,
(28:14):
longevity risk solved,predictable income, but I don't
like handing over all mycapital, paying high fees, or
trusting one insurance companyforever.
So here's my idea.
Let's say I'm 65 with a millionpounds invested in a sensible
risk parity style portfolio.
I pretend to buy an annuity bytaking the going
(28:35):
inflation-linked rate, say 5%,and paying myself half of that,
2.5%, or 25,000 pounds a yearwith cost of living adjustment
for essentials.
Then for discretionaryspending, I take a sustainable
withdrawal rate, say 6%, andagain use half, 3%, or 30,000
(28:56):
pounds, recalculated annuallyfrom the portfolio value.
This way, my essentials arecovered with a stable income and
my discretionary spendingadjusts with the markets.
Is this a reasonable hybridapproach or am I
over-engineering things?
Voices (29:13):
We have barb the jets, but cannot hold them for long.
The grand shakes.
Mostly Uncle Frank (29:32):
He asks.
That's what you have to do intheory because.
(29:59):
Because you don't have any realexpenses that you are working
with or real life you're tryingto fund.
The way it actually works inpractice is the other way around
that first you figure out howmuch your life costs, then you
divide that up intodiscretionary costs and
mandatory costs, and then youfigure out how your portfolio or
(30:20):
other resources are going tocover those costs.
So to me, what you are sayingis that half of your annual
expenses are of the mandatorykind, which are covered by this
2.5% you point to, and half arediscretionary, which would be
covered by the other 2.5 to 3%,I guess.
And I found that's pretty closeto the way things work out.
(30:42):
The reality is that for mostretirees, about 60% of their
expenses are in the mandatorycategory, and about 40% are in
the discretionary category.
And that's pretty true for us.
So I use what I call a 311 planthat 3% are designated for
mandatory expenses.
We have 1% that we call comfortexpenses, and then we have
(31:06):
another 1% that we callextravagances that can change
every year.
But I think that's probably asdetailed as you need to be in
terms of the actual division ofthe distributions.
Because I can tell you we donot carve out 3% and plop it in
like one account to paymandatory expenses out of and
(31:27):
then take the other 2% and putit in some kind of discretionary
account.
That we just put it all in onething and spend it and then look
at it afterwards to see thatwe're still kind of in line with
where we thought we should be.
Because obviously this changesfrom month to month as to where
this money is actually going.
So I don't think putting arigid framework on it as you
(31:48):
described is necessarily allthat helpful.
You can just kind of do it on amore flexible basis, just
making sure as you go you canaccount for where the money is
actually going.
Because obviously if yourmandatories increase by some
amount, you're going to need tocut back on your
discretionaries.
Or if you have somecatastrophe, you just may need
(32:09):
to cut back on discretionariesanyway.
But you have the ability to dothat whether you put it into a
rigid framework or just aflexible framework.
The one thing I should say isthat at least in the United
States, we do not have lifetimeinflation-linked annuities.
Nobody will sell you one ofthose.
You can have ones that arefixed in their increases, like a
(32:30):
1% or 2% or 3% added cola, butno insurance company will sell
you one that's based on the CPIor something like that.
We have our Social Security,which does that.
And I do not know what you havein the UK, but we cannot buy
such a thing here.
Voices (32:45):
Snap, snap, green, green, wink, wink, nudge, notch
signal.
Mostly Uncle Frank (32:48):
I think we will be considering when we get
to about age 70 whether we wantto take some of our money and
put it into a simple annuity orsimple annuities to add to what
we're getting from SocialSecurity than to cover some kind
of base or floor kind ofexpenses.
But that decision for us isreally going to be based mostly
(33:09):
on how healthy we feel we areand whether we feel like we're
going to be living a very longtime, which in our families is a
distinct possibility.
So for us it's going to be moreof a financial decision based
on projected longevity than onany kind of cash flow
management.
So you are free to think aboutthis in the way you've
described, but I don't thinkit's necessarily necessary.
Voices (33:33):
Necessaire?
Is it necessary for me to drinkmy own urine?
Probably not.
No.
But I do it anyway because it'ssterile and I like the taste.
Mostly Uncle Frank (33:45):
It is something that's good to think
about, just to make sure thatyou've got all your ducks in a
row.
So thank you for yourobservations.
And thank you for your email.
But now I see our signal isbeginning to fade.
If you have comments orquestions for me, please send
(34:09):
them to Frank atRiskPartyRader.com.
That email is Frank atRiskPartyRader.com.
Or you can go to the websitewww.riskpartyrador.com.
Put your message into thecontact form, and I'll get it
that way.
If you haven't had a chance todo it, please go to your
favorite podcast provider andlike, subscribe, give me some
stars, a follow, a review.
(34:30):
That would be great.
Okay.
Thank you once again for tuningin.
This is Frank Vasquez with RiskParty Radio signing off.
Mostly Queen Mary (36:12):
Please consult with your own advisors
before taking any actions basedon any information you have
heard here, making sure to takeinto account your own personal
circumstances.
A foolish consistency is the hub goblin of little mind,
adored by little statesmen andphilosophers and divines.
If a man does not keep pace withhis companions, perhaps it is
because he hears a differentdrummer.
A different drummer.
Mostly Queen Mary (00:18):
And now, coming to you from Dead Center
on your dial, welcome to RiskParity Radio, where we explore
alternatives and assetallocations for the
do-it-yourself investor.
Broadcasting to you now fromthe comfort of his easy chair,
here is your host, FrankVasquez.
Mostly Uncle Frank (00:37):
Thank you, Mary, and welcome to Risk Parity
Radio.
If you have just stumbled inhere, you will find that this
podcast is kind of like a divebar of personal finance and
do-it-yourself investing.
Voices (00:52):
Expect the unexpected.
Mostly Uncle Frank (00:55):
It's a relatively small place.
It's just me and Mary in here.
And we only have a fewmismatched bar stools and some
easy chairs.
We have no sponsors, we have noguests, and we have no
expansion plans.
Voices (01:10):
I don't think I'd like another job.
Mostly Uncle Frank (01:13):
What we do have is a little free library of
updated and unconflictedinformation for do-it-yourself
investors.
Voices (01:23):
Now, who's up for a trip to the library tomorrow?
Mostly Uncle Frank (01:27):
So please enjoy our mostly cold beer
served in cans and our coffeeserved in old chipped and
cracked mugs.
Along with what our little freelibrary has to offer.
Which is attend to your email.
(02:00):
Did you get that memo?
Voices (02:03):
Yeah, I got the memo.
Mostly Uncle Frank (02:04):
And so without further ado.
Voices (02:06):
Here I go once again with the email.
Mostly Uncle Frank (02:09):
And first off.
First off, we have an emailfrom Roman.
Voices (02:24):
All hail Caesar, Emperor of Rome, monarch of the Roman
Empire, ruler of the world.
Mostly Uncle Frank (02:32):
And Roman rights?
Mostly Queen Mary (02:34):
Please move this question to the front of
the line as I recently donatedto the Father McKenna Center.
Voices (02:40):
Groovy baby!
Mostly Queen Mary (02:42):
I recall hearing that there is no free
lunch in investing, with thepossible exception of
diversification, but it seems tome that leverage, when properly
applied to a diversifiedportfolio, is a strong contender
as well.
I have noted that yourleveraged sample portfolio, such
as the levered golden ratio orOPTRA, both support perpetual
withdrawal rates exceeding 5%long-term baseline for the
(03:05):
standard golden ratio portfolio.
This makes sense to me, sinceif you take a non-leveraged
portfolio that would otherwisesupport a 5% withdrawal rate and
lever it above 100% while stillmaintaining its overall
diversification, then you couldtheoretically proportionately
increase the withdrawal rateconsistent with the amount of
leverage.
(03:25):
For example, if 5% can besafely withdrawn from an
unleveraged portfolio with 100%exposure, 100% divided by 20
equals 5%, then a portfolio with120% exposure should support a
6% withdrawal rate.
120 times 5% equals 6%.
A portfolio with 140% exposureshould support a 7% withdrawal
(03:51):
rate.
140% times 5% equals 7%, and soon.
I'm sure this phenomenon doesnot go on forever, but assuming
a reasonable amount of overallleverage in a portfolio and
maintaining the appropriateratios of uncorrelated or weekly
correlated asset classes, isthis the right way to think
about the effect of leverage onthe withdrawal rate that a
(04:13):
portfolio can potentiallysupport?
Or am I overlooking somecritical pitfalls with this
approach?
If so, I am very interested inhearing what these might be.
Thank you for your show.
And I am one of those who wasinitially put off by all the
sound bites but eventually cameto enjoy them, Roman.
Mostly Uncle Frank (04:32):
Well, I'm glad you're enjoying the sound
bites.
After a fashion, as it were.
Voices (04:42):
Did you kill last week?
No.
Did you try to kill last week?
Yeah.
Now listen, this is your lastweek of unemployment insurance.
Either you kill somebody nextweek or we're gonna have to
change your status.
You got it?
Yeah.
Sign.
Mostly Uncle Frank (05:02):
But I'm even more glad that you're a donor
to the Father McKenna Center.
As most of you know, we do nothave any sponsors on this
podcast.
We do have a charity wesupport.
It's called the Father McKennaCenter, and it supports hungry
and homeless people inWashington, D.C.
Full disclosure, I'm on theboard of the charity and am the
current treasurer.
But if you give to the charity,you get to go to the front of
(05:24):
this email line, which is aboutthree months long.
So if you'd like to do that,there are two ways to give to
the charity.
First, you can go to thedonation page of the Father
McKenna website, which I'll linkto again in the show notes.
And second, you can go to thesupport page at
www.riskprediary.com and becomeone of our patrons on Patreon.
(05:48):
Either way, you get to go tothe front of the line, but
please do mention it in youremail, as Roman has done here,
so that I can duly move you tothe front of the line.
Voices (05:56):
Yes!
Mostly Uncle Frank (05:57):
But now let's get to that email.
Leverage is an interestingtopic that we have pondered
here, and I continue to ponder,since I really do not know what
the ultimate answers are as tothe optimal leverage in a
drawdown portfolio.
And that's kind of the $64,000question.
What's the answer?
What's the answer?
(06:18):
So here are some justconsiderations about this in
general.
There's a nice Ben Felix videothat I'll link to in the show
notes where he cites someacademic studies showing
basically if you want tooutperform markets, there are
two ways to do it.
You can either take aconcentration in something that
you think is going to outperformthe market, or you can take
(06:38):
leverage.
Now, of course, the mainproblem with taking leverage is
a lot of people who takeleverage blow up and lose all
their money.
And that's not good.
Voices (06:48):
You have a gambling problem.
Mostly Uncle Frank (06:50):
And that happens to even the finest
investors available famously tolong-term capital management
back in the late 1990s, whichwas a whole bunch of Nobel Prize
winners and other verysophisticated investors who put
too much leverage in some betson Russian currencies and
Russian debt, and it really blewup in their face.
Voices (07:12):
We can put that check in a money market mutual fund,
then we'll reinvest the earningsinto foreign currency accounts
with compounding interest, andit's gone.
Mostly Uncle Frank (07:21):
And that's happened to many others over
many years.
Voices (07:25):
Uh what?
It's gone.
It's all gone.
What's all gone?
The money in your account.
It didn't do too well, it'sgone.
Mostly Uncle Frank (07:32):
On the other hand, taking leverage has been
one of the cornerstones of howhedge funds traditionally used
risk parity style portfolios.
Because what they would do istake a very conservative
portfolio like that all-seasonsample portfolio, something that
looked like that, that had awhole lot of bonds in it, and
then add leverage to that tomake it have the same risk
(07:56):
profile as, say, the stockmarket, with the idea that it's
going to have that same riskprofile, but a lower volatility
overall, and so have essentiallya higher sharp ratio or be more
efficient in terms of riskversus reward.
And people who start with avery conservative portfolio and
add leverage to that typicallydo not blow up if they're
reasonably careful about it.
(08:18):
But one of the key drawbacks toleverage, particularly in a
drawdown portfolio, is what iscalled volatility drag.
And the easiest way toillustrate that is if you had a
portfolio that lost 10% of itsvalue in a year, in order to
make that back the next year, itwould have to make 11% back.
And that's not a very bigdifference.
(08:39):
But if that same portfolioloses 20% in a year, then in
order to make that back, it hasto get up 25%.
And the more it loses, the morevolatile a portfolio is, the
more it has this drag on gettingback to even.
And we've seen this in thesample portfolios, which is one
of the reasons I wanted toconstruct them to see how this
(09:01):
would all work out.
So if you look at the mostleveraged and the least
diversified of those sampleportfolios, which is the
aggressive 50-50, that wasmodeled after something that
it's called hedge fundy'sexcellent adventure, which was
popular about five years ago,and you can look up, which is
basically a portfolio ofcompletely leveraged funds
divided into a fund like youpro, three times leveraged S P
(09:25):
500 with it with a fund likeTMF, which is three times
leveraged Treasury bonds.
And that portfolio has been theworst performer out of the
sample portfolios, primarilybecause of this volatility drag.
That initially, when everythingwas going up, it performed the
best and it reached the highestpeak at that time.
But then when we had that crashin 2022, it essentially lost
(09:47):
half its value and has struggledsince then, largely due to the
volatility drag.
But the one thing that adds tothat is if you are taking money
out of a portfolio doingwithdrawals, it increases the
overall volatility of theportfolio and so drags it down
even more, essentially.
And since we were subjectingthat thing to an 8% withdrawal
(10:09):
rate originally and have beensubjecting it to 6% since it
went under its starting value,that has also contributed to its
underperformance.
So it's been an ugly experimenton paper, but it's been a very
educational experiment in howleverage and volatility actually
work.
Voices (10:27):
Well, you have a gambling problem.
Mostly Uncle Frank (10:31):
Now there's an important paper that we've
cited about this back in episode440, and it's written by a guy
named Jim Sandage, and it isapplying chaos theory
essentially to draw downportfolios and observing this
phenomenon that when you starttaking money out of a portfolio,
it naturally adds to thevolatility or chaos of the
(10:52):
portfolio.
Voices (10:54):
We're lords of chaos.
Mostly Uncle Frank (10:57):
And in order to essentially ameliorate that
problem, usually you need betterdiversification, essentially.
But I think that's one of thechallenges in adding leverage to
a drawdown portfolio.
It's this kind of like a doublewhammy on this potential
volatility drag.
I don't think it's nearly asmuch of a problem if you're
talking about an accumulationportfolio, because that has the
(11:18):
opposite effect.
If you are adding money into aportfolio, it naturally reduces
the overall volatility of theportfolio because it's
essentially like having this bigpile of cash on the side that
you are feeding into this thing.
Voices (11:32):
There's $250,000 lining the walls of the banana stand.
Mostly Uncle Frank (11:37):
Now, a couple other resources and
references we've talked aboutbefore.
One we did cite a paper onceabout the optimal leverage as
far as ETFs in a portfolio wasconcerned, and the author of
that article came out to a valueof two.
But I think they were talkingabout more of a static kind of
portfolio, not a drawdownportfolio.
(11:58):
The other reference that we'vemade is this site called
Optimize Portfolios, which talksall about leveraged portfolios
and leveraged ETFs used inportfolios, and I think that's a
useful site too.
Although I don't know thatthey've come to any grand
conclusions about using these ina retirement portfolio.
Now, more recently over thepast few years, there have been
(12:20):
variations on this theme,including what are called
return-stacked portfolios now,which take off on the risk
parity idea, but arecombinations of various assets
in levered forms and ETFs thatyou can kind of mix and match.
And they've now put out six oreight ETFs and I think have a
billion dollars in assets thatthey've accumulated over the
past three years.
(12:40):
That's Corey Hofstein andRodrigo Gordillo, and that's an
interesting concept or variationas well.
Although they are not promotingthose things for retirement
portfolios.
They're looking at them more asa way of essentially getting
stock market-like returnswithout taking stock market-like
risk.
And so that OPTRA portfolio,the last one that we've created,
(13:03):
we started in July 2024, is areturn-stacked style portfolio
and has effective leverage in itof about 32 to 45%, depending
on how you count it.
Voices (13:19):
And it's gone.
Poof.
Mostly Uncle Frank (13:23):
And it seems to be doing quite well in that
formulation.
If you look at something likethat levered golden ratio
portfolio, that's designed tohave leverage of approximately
1.6 to 1%.
The golden ratio.
Which is similar to what is ina paper called Warren Buffett's
(13:43):
Alpha, which talks about you canmodel the performance of
Berkshire Hathaway as anapplication of leverage of 1.7
to 1 due to the way it uses thefloat of the insurance companies
in that structure.
Now that one has struggled abit, but it's recovered, and
it's mainly struggled simplybecause it had a very bad start
date right before 2022, whichreally took a toll in addition
(14:05):
to its original 7% withdrawalrate.
So overall, this is somethingI'm very curious about, but I
really do not have a definitiveanswer to.
It's kind of like one of thosequestions about what is the
optimal rebalancing strategy,and I don't think there's any
one answer to that either,because it kind of depends on
the whole makeup of theportfolio and the withdrawal
(14:25):
strategy itself.
I think that's probably true ofa topic like leverage as well.
That if you start with aconservative enough portfolio,
some leverage is probably goingto work pretty well.
But if the portfolio is eithertoo aggressive to begin with and
you apply leverage to it, oryou're just applying too much
leverage, like that aggressive50-50 portfolio, which I think
(14:46):
applies too much leverage,you're probably not going to
have good results due to thisvolatility drag.
Anyway, maybe one of youlisteners will figure all this
out and tell us when you do.
At least I hope you will.
Voices (15:01):
And uh after that I just sort of space out for about an
hour until I'm space out?
Yeah.
I just stare at my desk.
But it looks like I'm working.
Mostly Uncle Frank (15:13):
In the meantime, I will link to all of
these resources in the shownotes so you can check them out
because this is just a veryinteresting topic and something
I've been very curious aboutsince I first ran across Risk
Parity style portfolios back inlike 2010.
So hopefully that helps you alittle bit.
Thank you for being a donor tothe Father McKenna Center, and
(15:33):
thank you for your email.
Voices (15:36):
Next, occupation stand-up philosopher.
What?
Stand-up philosopher.
I coalesce the vapor of humanexperience into a viable and
logical comprehension.
Dependence is a very good city.
(16:13):
Very wonderful city, ancientcity.
You're gonna learn a lot ofdependence.
You wanna learn how to make avery ancient blind like this?
Second off.
Mostly Uncle Frank (16:27):
Second off, we have an email from Andrew.
And Andrew Wright.
Mostly Queen Mary (16:43):
Hello, Frank and Mary.
I first learned about yourpodcast after hearing you on a
Bigger Pockets Money episode andhave slowly been working
through all 460-plus episodes ofyour show ever since.
Voices (16:55):
Very sick man.
Mostly Queen Mary (16:56):
Thank you so much for the wealth of knowledge
you have provided to us averageDIY investors.
I am 32 and still in myaccumulation phase of life, but
closing in on my first milliondollars.
As I begin to think about howmy portfolio should look in the
future, I have started to takenote of how much money I have in
(17:19):
each tax bucket.
I have the unique opportunityto contribute to a Roth TSP
401k, so my after-tax Rothdollars make up about 45% of my
net worth, while traditionaldollars is only about 10%.
The remainder of my portfoliois 40% in a taxable brokerage
and 5% in cash.
I am almost entirely investedin SP 500 index funds.
(17:43):
My goal will be to eventuallymove towards a golden ratio
style portfolio with 42% stocksand 26% bonds.
Voices (17:52):
A number so perfect, perfect.
Mostly Queen Mary (17:57):
My question.
I know you've explained that wewant to hold things like bonds
in traditional accounts due tothe interest they generate, but
given my small traditionalbalance, I'm curious what your
thoughts might be on adding moreto traditional retirement
accounts instead of Roth to setmyself up for a more efficient
portfolio later.
Additionally, I was curious ifyou could explain a little more
(18:18):
about your reasoning for fundselection to fill the small cap
value spot, in particular AVUV,like you've recommended for
Mindy's portfolio, versus VIOVlike you have in the Golden
Ratio portfolio.
I believe I've listened to allyour material on small cap value
funds, but if I'm missingsomething, please feel free to
refer me accordingly.
Thanks again for all that youdo.
(18:40):
P.S.
I have made a contribution tothe Father McKenna Center.
I passed out lunches to thehomeless in the DC area through
my church growing up, so I'mhappy to help giving back in
this way.
Thank you, Sensei, Andrew.
Mostly Uncle Frank (18:57):
Well, thank you also for being a donor to
the Father McKenna Center,Andrew, and thank you for your
prior work in helping feedpeople around these parts in the
past.
Voices (19:08):
For me and the Lord, we've got an understanding.
We're on a mission from God.
Mostly Uncle Frank (19:16):
We've had a lot of activity at the Father
McKenna Center recently with allof these disruptions in the
government and the food programsthere.
We've had a lot more demand.
And fortunately, we've had alot more volunteers show up, and
so we've been having hundredsof people hand out thousands of
meals, and we appreciate all ofthe donations to allow us to buy
(19:37):
more food.
So thank you again for that.
Voices (19:43):
We don't have enough to eat.
Mostly Uncle Frank (20:42):
I wouldn't worry too much about how it's
going to be managed on the backend.
I think what you probably wantto be more conscious of is where
you are in the front end.
And if your tax rate is high,either because you make a lot of
money or you're in a state witha higher state income tax, you
probably want to use thosetraditional retirement accounts
to get that benefit up front.
(21:03):
Because when you retire, theadvantage of it is that since
you don't have regular ordinaryincome coming from a job, you
have a lot of flexibility as tohow much income you actually
show every year, depending onwhere the money is coming from.
And that can be managed.
So if you are in a higherincome bracket right now, I
(21:23):
would simply go for thetraditional up to the limits
you've got there.
If you're Roth eligible, that'snever a bad choice in the long
run.
Particularly since you canaccess those contributions to
the Roth without penalty, evenbefore retirement age, so that's
got another built-in advantageto it.
And I should saycongratulations for closing in
(21:44):
on your first million at age 32,because that is quite a nice
accomplishment.
Voices (21:50):
All we need to do is get your confidence back, so you
can make me more money.
Mostly Uncle Frank (21:55):
It wasn't clear what your timeline was
right now, but there's no reasonto be transitioning right away
unless you were planning onliving on that million dollars
or something like that.
But if you're still close to adecade away or some number like
that, I would just continue toinvest in your stock market
funds.
You might branch out into theother stock market funds that
(22:17):
you plan to be holding in thelong term, at least if you're
putting that in any kind of ataxable account, just to make it
easier to manage when you getthere.
But you certainly wouldn't beneeding to put any money into
bonds if you're not gettingclose to retiring or living off
the money, I should say, whetheryou're retiring or not.
One thing I would do if I wereyou is pick up the new book
about tax planning for earlyretirement, written by Cody
(22:41):
Garrett and Sean Mullaney,because I think it's gonna
answer a lot of the questionsyou have and clarify in your
mind as to the best choices interms of where to put your money
and then how you're going toaccess it later on.
What you'll learn from thatbook is take as many tax
advantages as you can get upfront because you're gonna be
able to manage it on thebackside fairly easily,
particularly if you're talkingabout a few million dollars and
(23:04):
not more than $10 million.
And yes, you can put bonds inRoths if that is where you
actually have room for them.
The truth is most people justdon't have that large of a Roth
account to work with, and sothat space is relatively
limited.
Okay, and your last questionwas about the choice of small
cap value funds.
(23:24):
So when I set up the originalsample portfolios, I really
wanted to be focused on assetclasses themselves and index
funds that represented them andnot get wound up in fund
choices.
So I intentionally pickedessentially the most popular
small cap value index being usedtoday, which is the S P 600
(23:46):
small cap value index, and thatis reflected by the fund VIOV
and also the fund IJS.
Now, funds like the AvantisFund AVUV were relatively new at
that time, and it wasn't clearhow they were going to perform
in relation to the index.
The theory behind them, though,had been around for quite a
(24:08):
while because this is from theDFA funds, and what DFA had been
doing since the 1990s is takingessentially what would be like
a small cap index and thenputting a profitability filter
on top of it to essentially getrid of the worst companies and
modify the whole process so it'sstill algorithmic, they're
(24:30):
still using a formula togenerate it, but they're trying
to be more efficient about it.
So DFA had originally onlyoffered its funds in mutual fund
form, and the way theirbusiness model worked is that
they only worked with financialadvisors, so you had to
essentially go to a DFA-approvedfinancial advisor to get access
to DFA funds.
(24:51):
Now it's interesting, some ofthe people who were at DFA
wanted to branch out and startoffering regular ETFs, and there
was a dispute or something.
Anyway, some of the people leftthere, went and formed Avantis,
and started issuing these ETFsthat are essentially doing the
same sorts of things.
DFA has now got religion, ifyou were, and started offering
(25:13):
its own ETFs because its oldbusiness model just didn't work
anymore.
This is part of the evolutionof ETFs and why we're living in
kind of a golden age that you'reable to get cheaper and cheaper
fun choices, good fun choicesof a whole bunch of things that
you didn't have access to beforeor were prohibitively
expensive.
And now these things arerelatively cheap.
(25:34):
You used to be paying like 1%for them, and now you're paying
0.2 in most cases.
So over the past several years,AVUV has kind of proven itself
when you compare it to theperformance of regular small cap
index funds as having someadvantages due to its additional
profitability or quality filteron it.
And so that is why today Iwould say if you're going to
(25:57):
pick a small cap value fund,that's probably one of the
better ones you could pick.
There's also a DFA version ofthat out there now.
A good place to find these bestin class kind of fund choices
is the Merriman ETF website.
They go and analyze these fundsas well as a bunch of index
funds and compare them andpublish their findings every
(26:19):
couple of years, essentiallysaying these are the best in
class depending on what youwant.
So I would say there is a kindof growing consensus that at
least in the areas of small capvalue and international value,
that these DFA and Avantis fundsare at least slightly better
than index funds after fees, andmaybe substantially better.
(26:39):
So that is what I would picktoday, and it is in fact what we
have in a lot of our personalaccounts.
But I did originally want touse standard index funds to show
that the methodology behindthis risk parity style investing
was based on asset classes andnot based on fun picking.
Because the truth is there area lot of good choices for funds,
(27:01):
and that that is the tail ofthe dog, and not the real make
or break choice when it comesdown to things.
You always want to choose assetclasses first, allocate them,
and then make fun choices afterthat.
As the last thing you do, notthe first thing you do.
So hopefully that explanationhelps.
And thank you for your email.
Voices (27:42):
If you don't do your revision properly, you know what
will happen.
Mostly Uncle Frank (27:51):
And Ian Wright.
Mostly Queen Mary (27:53):
Hi, Frank and Mary.
Thanks for all the clarity andcourage you bring to the world
of retirement investing.
It's much appreciated.
I've been reading Bill Bangin'snew book, and it got me
thinking about withdrawalstrategies, fixed rate with cost
of living adjustments, fixedpercentage, annuities, and so
on.
I like the idea of a lifetimeinflation-linked annuity,
(28:14):
longevity risk solved,predictable income, but I don't
like handing over all mycapital, paying high fees, or
trusting one insurance companyforever.
So here's my idea.
Let's say I'm 65 with a millionpounds invested in a sensible
risk parity style portfolio.
I pretend to buy an annuity bytaking the going
(28:35):
inflation-linked rate, say 5%,and paying myself half of that,
2.5%, or 25,000 pounds a yearwith cost of living adjustment
for essentials.
Then for discretionaryspending, I take a sustainable
withdrawal rate, say 6%, andagain use half, 3%, or 30,000
(28:56):
pounds, recalculated annuallyfrom the portfolio value.
This way, my essentials arecovered with a stable income and
my discretionary spendingadjusts with the markets.
Is this a reasonable hybridapproach or am I
over-engineering things?
Voices (29:13):
We have barb the jets, but cannot hold them for long.
The grand shakes.
Mostly Uncle Frank (29:32):
He asks.
That's what you have to do intheory because.
(29:59):
Because you don't have any realexpenses that you are working
with or real life you're tryingto fund.
The way it actually works inpractice is the other way around
that first you figure out howmuch your life costs, then you
divide that up intodiscretionary costs and
mandatory costs, and then youfigure out how your portfolio or
(30:20):
other resources are going tocover those costs.
So to me, what you are sayingis that half of your annual
expenses are of the mandatorykind, which are covered by this
2.5% you point to, and half arediscretionary, which would be
covered by the other 2.5 to 3%,I guess.
And I found that's pretty closeto the way things work out.
(30:42):
The reality is that for mostretirees, about 60% of their
expenses are in the mandatorycategory, and about 40% are in
the discretionary category.
And that's pretty true for us.
So I use what I call a 311 planthat 3% are designated for
mandatory expenses.
We have 1% that we call comfortexpenses, and then we have
(31:06):
another 1% that we callextravagances that can change
every year.
But I think that's probably asdetailed as you need to be in
terms of the actual division ofthe distributions.
Because I can tell you we donot carve out 3% and plop it in
like one account to paymandatory expenses out of and
(31:27):
then take the other 2% and putit in some kind of discretionary
account.
That we just put it all in onething and spend it and then look
at it afterwards to see thatwe're still kind of in line with
where we thought we should be.
Because obviously this changesfrom month to month as to where
this money is actually going.
So I don't think putting arigid framework on it as you
(31:48):
described is necessarily allthat helpful.
You can just kind of do it on amore flexible basis, just
making sure as you go you canaccount for where the money is
actually going.
Because obviously if yourmandatories increase by some
amount, you're going to need tocut back on your
discretionaries.
Or if you have somecatastrophe, you just may need
(32:09):
to cut back on discretionariesanyway.
But you have the ability to dothat whether you put it into a
rigid framework or just aflexible framework.
The one thing I should say isthat at least in the United
States, we do not have lifetimeinflation-linked annuities.
Nobody will sell you one ofthose.
You can have ones that arefixed in their increases, like a
(32:30):
1% or 2% or 3% added cola, butno insurance company will sell
you one that's based on the CPIor something like that.
We have our Social Security,which does that.
And I do not know what you havein the UK, but we cannot buy
such a thing here.
Voices (32:45):
Snap, snap, green, green, wink, wink, nudge, notch
signal.
Mostly Uncle Frank (32:48):
I think we will be considering when we get
to about age 70 whether we wantto take some of our money and
put it into a simple annuity orsimple annuities to add to what
we're getting from SocialSecurity than to cover some kind
of base or floor kind ofexpenses.
But that decision for us isreally going to be based mostly
(33:09):
on how healthy we feel we areand whether we feel like we're
going to be living a very longtime, which in our families is a
distinct possibility.
So for us it's going to be moreof a financial decision based
on projected longevity than onany kind of cash flow
management.
So you are free to think aboutthis in the way you've
described, but I don't thinkit's necessarily necessary.
Voices (33:33):
Necessaire?
Is it necessary for me to drinkmy own urine?
Probably not.
No.
But I do it anyway because it'ssterile and I like the taste.
Mostly Uncle Frank (33:45):
It is something that's good to think
about, just to make sure thatyou've got all your ducks in a
row.
So thank you for yourobservations.
And thank you for your email.
But now I see our signal isbeginning to fade.
If you have comments orquestions for me, please send
(34:09):
them to Frank atRiskPartyRader.com.
That email is Frank atRiskPartyRader.com.
Or you can go to the websitewww.riskpartyrador.com.
Put your message into thecontact form, and I'll get it
that way.
If you haven't had a chance todo it, please go to your
favorite podcast provider andlike, subscribe, give me some
stars, a follow, a review.
(34:30):
That would be great.
Okay.
Thank you once again for tuningin.
This is Frank Vasquez with RiskParty Radio signing off.
Mostly Queen Mary (36:12):
Please consult with your own advisors
before taking any actions basedon any information you have
heard here, making sure to takeinto account your own personal
circumstances.
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