Been about six months since I started, so I was reflecting on my purpose: am I advancing the cause I started with? Can I do that better? In a nutshell, I’m recommitting RPC as a place where DIY investors can learn more about alternative asset allocations that go beyond the 60/40.
Imagine it’s 5,000 years ago and you’re hanging out with family and friends in a cave. There is a campfire in the center, with people seated around enjoying the campfire for warmth and light. People discuss the fire, its obvious pros (unbeatable mood lighting, cozy, great for roasting walrus steaks) and then its drawbacks (lots of smoke, inconsistent light, can burn everything down if you’re not careful, etc). For sure, campfires have some issues. Then a few travelers come in, with some pretty weird ideas:
“How about we try to figure out a way to create a small hole leading to the outside to draw the smoke away?”
“How about we use some smoke to get those stinging flying things out of their nest and then collect the wax that we find? Then we can get a piece of rope or something, dip it in the wax and light that on fire?”
“How about after eating one of those walrus on the beach, we save the fat, put it in a clay pot, then put the rope in and light it?”
One by one they come in, and one by one you send them away, for your conversation is really just about the fire. Fire good, fire bad, fire hot, fire not, round and round we go.
Wouldn’t you at least want to ask more questions about the other ideas? Even better, test them and discover their own pros and cons? Wouldn’t you want to shift the conversation to include the other ideas?
Well, if these people were the ancestors of a lot of people writing about finance, probably not. Instead of the campfire and its alternatives, it would be the 4% rule based on a 60/40 portfolio, 24 hours a day, 7 days a week. No time for alternative allocation, not energy for exploring other assets - we're just making the case that the 4% rule is problematic, for the umpteenth time.
As I think back to the past six months, I began thinking of just how hard it has been to push the conversation forward at times. It seems like for every alternative voice out there, there are ten experts who go right back to the 4% rule and the 60/40.
But there are alternatives!!!
Hopefully, Risk Parity Chronicles can be a site where DIY investors, especially beginners, can learn about and then think through these “new” ideas. It’s not necessarily a promise that the alternatives are inevitably better, or that all the pros and cons are known (for the record, I’d much prefer to cook over the campfire instead of the walrus oil lamp!) but simply that beating the dead horse of the old ideas simply won’t do. Unfortunately, I see so much out there oriented towards DIY investors that just goes over the 60/40 portfolio ad nauseum, seemingly unaware that other ideas exist.
Frank Vasquez made this point if different form last week, and it’s worth a listen (up to about the 10 minute mark).
The gist is that the financial talking heads have various motivations for overly pessimistic takes about spending in retirement that ignore alternative approaches. One example is the tendency to use a 60/40 portfolio to test assumptions about safe withdrawal rates, even though we have strong evidence suggesting there are better models of portfolio construction to maximize those rates. Even these very same experts will say their own tests reveal a gain by including small-cap value, for instance, but then go right back to saying that the 4% rule is doomed, as proven by their backtest…without small-cap value. What?? As Vasquez says…
So, what are we doing here at RPC?
To move the discussion beyond the 4% and the 60/40, here are some topics that RPC is committed to exploring in the weeks and months (and years?) ahead.
Investors can:
- Use other asset allocation strategies, namely Risk Parity and similar approaches, such as Return Stacking. Putting different portfolios through their paces is what the test portfolios are all about, and you can read about them generally here, or check out some of my original portfolios like the RPC Stability, the RPC Income, or the RPC Growth.
- Include additional asset classes in their portfolios, beyond just stocks and bonds. This is the goal of my “preferred assets” posts like this piece on managed futures, this on semi-direct real estate investing platforms like Groundfloor or FundRise. Stay tuned as I explore preferred shares, Business Development Company shares, and more.
- Choose better individual assets within asset classes, even among the old stalwarts of stocks and bonds. Again, this is covered in the “preferred assets” posts such as this on small-cap value or this on international equities.
- Test different approaches to rebalancing. How we withdraw from portfolios and whether, when and how we rebalance can make a big difference in portfolio management. Beginners may like this spreadsheet for rebalancing, or this piece on strategic asset allocation, and I’ll be looking at various flexible spending rules soon.
- Consider the situation and develop a sense of when to use what. The point is not really to say one portfolio is “good” and another “bad” but rather, to determine who might benefit from what type of investments at what time. There is too much blanket thinking in this space, when so much really comes down to the two most accurate words in English: “It depends.” I have gotten towards this previously in my thoughts on RP in the decumulation stage and the accumulation stage; in the future, I’d like to cover transitions from one portfolio to another.
- Make spending assumptions with better, more realistic inflation numbers. Using an inflation framework based on economy-wide CPI numbers gives you a very rough sense of how rising prices impact the economy, but that isn’t always useful for the question of how much YOU can or will spend in retirement. The “retirement spending smile” might more accurately reflect the spending retirees actually do, and can inform better assumptions of how you might spend from a portfolio in the decumulation stage. This is not an area I have covered yet much in RPC, but will soon.
- And finally, listen to other voices in the investing space who have unique perspectives. The Risk Parity Resources section has hopefully amplified and simplified some important voices out there, with more to come. For example, you can read brief pieces reviewing Risk Parity Radio, and papers by Ray Dalio and the others at Bridgewater, Edward Qian, and Brian Hurst, among many others. These are the “travelers” who visited the cave in the metaphor above, and they deserve a full hearing.
It’s an ambitious agenda, but one that I hope will have some benefit to someone out there. Feel free to suggest new ideas and avenues to explore - I’m always eager for emails and questions at riskparitychronicles@gmail.com, or else on Twitter at @rp_chronicles, at least until Elon takes over!