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🎲 Risk Parity: The Secret to a 5% Safe Withdrawal Rate! | Frank Vasquez 🏆
1.6k Plays2 months ago
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🔑 Risk Parity is an investment strategy that could reshape how you manage risk and increase your portfolio’s resilience. 🎯
In this episode, we discuss:
1️⃣ What is Risk Parity?: Discover how Risk Parity differs from traditional diversification and why it’s essential for a resilient portfolio.
2️⃣ Building a Risk Parity Portfolio: Learn how to implement this strategy with tools like ETFs and mutual funds, and explore the impact on your Safe Withdrawal Rate.
3️⃣ Retirement Planning with Risk Parity: Understand how Risk Parity can support your financial independence journey and enhance your retirement planning with a higher Safe Withdrawal Rate.
🔗 Frank's Links:
📚 Tyler's Risk Parity Portfolio Charts
🔗 David's Links:
🎧 Forget About Money on Apple Podcast
🎧 Forget About Money on Spotify
📜 Frank Vasquez Quotes:
💡 "Risk Parity is about balancing the risk, not just spreading capital—it's a smarter way to build a resilient portfolio." — Frank Vasquez
🔗 "By embracing Risk Parity, you could potentially increase your Safe Withdrawal Rate to 5%, offering more financial freedom in retirement." — Frank Vasquez
📝 Episode Highlights:
💡 Risk Parity vs. Traditional Diversification
🚀 Increasing Safe Withdrawal Rate to 5%
📈 Implementing Risk Parity with ETFs
🎯 Effective Portfolio Management Strategies
🌟 Optimizing Retirement Planning
#financialindependence #retirementplanning #investmentstrategies
🎧 Listen & Subscribe: Don't forget to subscribe to "Forget About Money" for more insightful episodes featuring experts like Frank Vasquez. Hit the bell icon 🔔 to get notified of new episodes!
Disclaimer: The discussion is intended for general educational and entertainment purposes and is not tax, legal, or investment advice for any individual.
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Transcript
Boosting Safe Withdrawal Rate with Risk Parity
00:00:00
Speaker
What is risk parity and how can we use it to craft our portfolios to boost our safe withdrawal rate from 4% to 5%? Here we go.
00:00:12
Speaker
Welcome to the Forget About Money podcast, where we encourage you to take action today so that you can focus on what matters most to you.
Frank Vasquez on Portfolio Management
00:00:19
Speaker
Today, our guest is Frank Vasquez, a former attorney and current financial podcaster as the voice behind Risk Parity Radio. With decades of experience of finance and a deep understanding of portfolio management, Frank's here to guide us through Risk Parity, the essentials of building a balanced, resilient investment strategy, and how we can use that in our own retirement. Welcome, Frank.
00:00:43
Speaker
Thank you. Thank you for inviting me. Frank, today we're going to discuss risk parity covering its core concepts and differences from traditional diversification, practical implementation with tools like ETFs and mutual funds, and how this strategy can support your path to financial independence and retirement planning.
Understanding Risk Parity Concepts
00:01:02
Speaker
So why don't we start with risk parity? It's a term that until just a few days ago, I somehow avoided seeing ever on a blog or a podcast,
00:01:14
Speaker
It was very interesting cause we hear about diversification all the time. But I didn't know this term risk parity. So can you start by defining what risk parity means in the context of portfolio management and how does it differ from traditional portfolio diversification strategies? Risk parity is a diversification strategy that was pioneered by Ray Dalio about three decades ago.
00:01:36
Speaker
and it started to be written about by academics and people in the hedge fund field about 20 years ago and has developed from there and now it is part of the core curriculum. If you get a CFA, there's a chapter on risk parity. The original concept that ah Dalia was looking at is how do we balance a set of assets Based on how essentially how risky or volatile they are and that was the original core concept is.
Hedge Fund vs DIY Risk Parity
00:02:11
Speaker
Not just taking say a 6040 portfolio, but modifying that and really looking at well what are the fundamental risk characteristics of each of these assets and then how can we balance them.
00:02:23
Speaker
Any portfolio what i've done with it is a little bit different because the original in the original concept of how hedge funds use this is they construct this balanced risk portfolio and then add leverage to it and that was the concept that's what bridge waters actually doing with this thing.
00:02:43
Speaker
For do-it-yourself investors, it made much more sense to not focus on levering up a very conservative portfolio, but modifying that with those principles of diversification with the goal that I have is to maximize the safe withdrawal rate. So I've taken that concept and modified it slightly.
00:03:06
Speaker
What we refer to a lot of my podcast is called the Holy Grail principle which comes from Ray Dalio and there's a nice little video where he explains it and that that is applying the principles that Harry Markowitz first developed back in the nineteen sixties about.
00:03:23
Speaker
uncorrelated assets and diversification because that is the only free lunch that you can get in portfolio construction is using diversification to lower risk without lowering your returns at least not too much right now we're talking about diversification.
00:03:41
Speaker
under the umbrella of risk parity, I think. so But what is the difference? So like we hear about diversification. So it's like, okay, do I have a REIT for real estate? Do I have a broad market index fund for equity? Do I have bonds? So to me, that's the first diversification. And of course, each of those has risk, but you're saying risk parity is a way to look at portfolio construct based on the risk profiles of each of those, not necessarily just having stuff Just having your assets across a bunch of different things that's diversification sort of the the classic concept was to not only look at just the difference business between the assets but. Looking at well how how risky is say a bond compared to a stock and let's put more bonds in then stocks into this portfolio.
00:04:32
Speaker
so we can balance out the risk characteristics and do that with all of the assets involved so it's a subset of the broader topic of diversification and and the most meaningful part of.
Asset Correlations in Risk Parity
00:04:47
Speaker
this approach really is looking fundamentally though at those correlations between the assets and that Holy Grail principle that Dalio talks about is look at the actual correlations between your assets and try to find. He talks about finding 15 uncorrelated assets.
00:05:06
Speaker
I think if you can come up with four or five, the that's um about as good as a do-it-yourself investor is probably going to do. um But it's it's definitely something we can do and something we do do, and that's how we develop a portfolio in particular to ah maximize the safe withdrawal rate is the goal that I have.
00:05:29
Speaker
Okay. So if I'm, we're part of the financial independence community and, and you know, JL Collins promotes, put everything in VTSEX or brought low cost, broad market index fund equivalent VTSEX kind of thing. And then at some point maybe consider bonds. I mean, that's kind of like the,
00:05:45
Speaker
broad guiding principle of most people in the financial independence community, I would say, or at least that's what's being promoted and for good reason. So how does how would you describe the risk parity of a portfolio like that?
Impact on Retirement Phases
00:06:02
Speaker
And then is that the ideal when talking about risk parity and maximizing your safe withdrawal rate?
00:06:08
Speaker
Yeah, no, that's I mean, that's a very simple portfolio is the kind of thing that Bill Bengen was working with when he first did the safe withdrawal rate um ah research back in the 1990s. What you'll see from that, depending on which kinds of stocks and which kinds of bonds you're using,
00:06:27
Speaker
There's various correlations going on there because different kinds of bonds have a different correlation to the stock market. But that that that is sort of the beginning of this concept.
00:06:40
Speaker
The where this matters is when you're talking about accumulation in a portfolio. If you are accumulating, you don't care very much about the volatility of the portfolio because you're not taking any money out of it. You're putting money into it. When you start taking money out of a portfolio, you start caring more about the overall volatility of the portfolio.
00:07:02
Speaker
And that overall volatility is influenced heavily by the mixture of assets you have in there and their correlations between each other. Okay, so you bring up a good point. Accumulation versus decumulation. So is risk parity something we should be worried about in the ah accumulation phase? Because you're saying this is a strategy used by hedge fund managers, and I'm assuming that people who invest with hedge fund managers want growth or accumulation, and that's that's the primary goal.
Transitioning to Retirement Portfolios
00:07:33
Speaker
Is it something we should just worry about during accumulation phase or both phases of accumulation and accumulation? and accumulation It's really something for decumulation. um Just speaking about hedge fund managers, they actually do all sorts of things because a lot of the money that they often manage is pension money. So they're not they're not generally talking about accumulating. They're generally talking about having a stable portfolio that generates significant or sufficient growth to allow for distributions to be made. So yes, this this concept, how I got to it was trying to figure out what kind of portfolio I wanted to hold in retirement. And so the it it does not matter that much for accumulation. For accumulation, as long as you can stomach it, 100% stocks over a period of decades is probably going to be the best ah any amateur is going to do.
00:08:29
Speaker
um i would go with what Paul Merriman recommends which is half S and&P 500 or large cap growth and half small cap value um and something like that works, works really well and works better than a single total market fund, at least historically.
00:08:45
Speaker
Okay, so with risk parity in across across a bunch of different asset classes, you're saying you're looking for the risk, the is I guess you wouldn't want an inverted a relationship or inverse relationship between assets, right? I'm thinking like, so what's what's the basic principle? So like if I had, you said five different assets, in your mind, what is the correlation between the risk parity of each of those assets and what you what what kind of linkages are you looking at in between each of those? Well, you are are looking at correlation numbers, first of all. ah Correlations are measured ah with a number that is between negative one and one. And so in order to calculate them, you take whatever data you have about these asset classes, put it into a calculator and there are plenty of them out there. You go to Portfolio Visualizer and find one. um And that will
00:09:41
Speaker
tell you of whether some whether two assets are highly correlated. They're moving in the same direction at the same time. They have a zero correlation, which means they move kind of randomly without reference to each other, or they have a negative correlation, which is relatively rare, but it does happen.
Implementing Risk Parity Strategies
00:10:01
Speaker
in which case when one is going up, the other one's going down. um and And so you take ah the group of assets, you look at all of the correlations not only, because there's obviously multiple pairings you're talking about if you're having multiple assets in a portfolio. All of this can be analyzed to determine what is a safe withdrawal rate that comes out of that, either historically or through a Monte Carlo simulation.
00:10:30
Speaker
um And so that is ultimately what you're looking at what you find is that when you combine very uncorrelated assets you get higher safe withdrawal rates and when you combine. Very highly correlated assets you get lower safe withdrawal rates.
00:10:48
Speaker
This research actually goes back to bangin's original research where he found just using those two assets stocks and bonds that if you went all the way bonds are all the way stocks the safe withdrawal rate went lower. And so it was ah it was looking at the mixture between the two of them that gave you a higher safe withdrawal rate that got over that original four percent where is if you were to hold say a hundred percent stocks in retirement you're safe withdrawal rates only about three point four percent.
00:11:17
Speaker
um And and that's that's sort of the starting point. And then then as you add other assets, you can improve the safe withdrawal rate. But it's not it's one of these things where you can't just look at a set of assets and guess what it is. You actually have to put them together and run some kind of analysis, usually a Monte Carlo simulation, but you can also do the historical simulation okay to make that determination.
00:11:45
Speaker
Yeah, I definitely want to get into more how to increase the safe withdrawal rate ah in a few minutes. like Can you give it an example, five assets and how they correlate to each other? I'm just trying to get the listener some idea if they were if they have different assets in their portfolio, do they have some of these and what's the chances that they actually, yeah how do they correlate to each other regarding risk parity?
00:12:09
Speaker
Okay, yeah, so if you take an asset like but the the stock market um and say, let's let's start with just an S and&P 500 fund. Now there are parts of the stock market that are less correlated to that than others. So if you are to take say small cap value and pair it up, those two things have, they're positively correlated. All stocks are positively correlated, but they have a lower correlation than just the large cap fund or a bunch of large cap funds.
00:12:42
Speaker
Other parts of the stock market sector wise are also show lower correlations such as rates such as utilities such as groups of insurance companies have a ah lower correlation to the overall market so you can look at those kind of subsets just in the stock market.
00:13:01
Speaker
Now you take that and then you take a an asset like treasury bonds. Treasury bonds have the lowest correlation of any kind of bond to stocks. And so if you're looking at a bunch of different kinds of bonds going from all the way from junk corporates to treasuries, you will find that looking at these correlation numbers, treasuries have the lowest correlation to those things.
00:13:28
Speaker
um If you add then something like an alternative asset like gold, that has a zero correlation to both stocks and bonds. um So that fits and can fit in into into there like that. You can construct a portfolio with just those three things that has a higher safe pat withdrawal rate. You said three things, but we talked about REITs, utilities, S and&P. Well, those ones are all part of the stock market.
00:13:53
Speaker
Okay. um So those, those are essentially sub asset classes ah of of the stock market. They are all going to be positively correlated, but some less positively correlated than other groupings. So okay the, the three from a macro allocation perspective, those are three asset classes. And then you break down the other one into a couple of different ones.
00:14:21
Speaker
Let's say I'm coming up on retirement and um' I've just discovered this risk parity and I'm optimistic because I got Frank Vasquez saying I can take out more money than I originally thought if I do X, Y, and Z with my portfolio. What are some tools out there that I can use or what kind of actions should I be taking?
00:14:40
Speaker
in order to kind of transition what I previously thought was just going to be a strict 4% rule or you know plus or minus a percentage or a fraction, excuse me, and to to this new, to me now, new, this new risk parity idea.
00:14:57
Speaker
Okay, well, you you need to first determine when you have won the game, as Bill Bernstein used to say, um and he used to say, but he still says, when you've won the game, you can stop playing. And so that is telling you when you have accumulated, say, 25 times, we'll just That's a good ballpark estimate, a conservative estimate. When you've accumulated in your investments 25 times your expenses, at least the expenses you expect to cover with that, you've won the game as far as that is concerned. At that point, you may not be ready to retire, but you could transition your portfolio to a retirement portfolio, whether that's a risk parity style portfolio or some other portfolio.
00:15:42
Speaker
and you could do that tomorrow. um It's usually the usually the best way that I advise people in transition is the best time to do a transition is One, you you know you've won the game or you're very close and can kind of glide in in the next few years with just a little bit of growth and and that your current portfolio is at or near an all-time high. And I think that is the danger people get into. They want to stay in that accumulation portfolio all the way up to retirement.
00:16:14
Speaker
That is dangerous because if you have that stock market crash right before you're about to retire, then you have a problem.
Managing a Risk Parity Portfolio
00:16:22
Speaker
Whereas if you've already made the transition before you actually retire and have your portfolio all lined up and ready to go, um, then you can kind of just glide into it. So usually people are looking at this somewhere, I would say five years before retirement, but it could be longer if you if you make it earlier, um because I know people that will accumulate in a portfolio like this, knowing that they want to, they don't mind it taking longer. They just like the fact that it's a lot less volatile than a typical accumulation portfolio. yeah you That's a great point. And one, I don't know that I've ever really thought about is once you've reached enough, whatever that is for you, no matter what your age or no matter
00:17:13
Speaker
what your time horizon is for, you know, officially retiring. Once you have enough, go ahead and consider doing that. Even if you wanted to keep working rather than continue to, to, to accumulate. That's the most sensible thing to do. Okay. Um, because, because if you're getting more than enough, then you have to be wondering, well, what is the purpose of this? Am I, am I trying to die with the most money? What, what, what am I trying to do?
00:17:39
Speaker
And I'm thinking even practically speaking, let's say i you had a time horizon, and you you decided you're gonna work till 50 or 55 and let's say 55 and you get enough, you know, 25X at 50.
00:17:54
Speaker
But you still want to work some more. So even if you were to transition your entire portfolio over into a risk parity portfolio at 50 years old, I mean, that next five years, I mean, you'd probably still see some gains. It's still in a corallia it's not that it doesn't, it's not that it stops growing. ah What you'll find is that it it grows a little slower, but what you get is a lot less volatility in the portfolios. So it doesn't go, it doesn't go down up and down up and down nearly as much.
00:18:24
Speaker
And if you're still saving, you know, if you're still working and making money for that next five years from 50 to 55, then I mean that, that, ah that allows you to sleep well at night too. If you've got, you know, a hundred thousand dollars or more or whatever your' in your checking account, you know, so. Exactly. You want to, you want to avoid being either fearful or greedy.
00:18:40
Speaker
And if you are continuing to accumulate when you don't have to anymore in a risky portfolio, that is being greedy. And you want to, that's probably not the the right way to approach this if you're thinking about the purpose of your money um to support a life and not just to be more money. In the financial independence community, many people They are do-it-yourselfers. They manage their own portfolios. And so this is probably who we're talking to ah specifically for this you know podcast audience. However, there's the masses out there too. So if somebody who wasn't a do-it-yourself investor ah decided, okay, I like what Frank Vasquez is talking about here. I want to do that with my portfolio, but I don't want to manage each asset class. Look, go in, ah you know rebalance, or I don't even know exactly how you would manage that, but do you periodically rebalance?
00:19:35
Speaker
ah but they just don't want to do all that work. Are there just straight up ETFs or mutual funds that are managed with this principle? And do you would you advise somebody who doesn't want to manage their own portfolio go that route? There are there are such funds, but I would not use them. okay this This is not hard. ah we're We're talking about holding somewhere between five and 10 ETFs, um setting up ah deciding what your allocations are going to be at the beginning, and then just rebalancing them, say, once a year. So in theory, you could be looking at this portfolio once a year and rebalancing it back to its original um configuration. um But i
Risk Parity Models Overview
00:20:25
Speaker
but i I do want to dispel the idea that what I'm talking about is hard, it's not hard.
00:20:30
Speaker
um it's If you can handle a portfolio with a few things in it, and I think most people who are do-it this is actually easier than i what I see a lot of people doing. Most of my listeners are people like you described.
00:20:49
Speaker
They have been do it yourself investors for quite a while. They are quite successful at it. They have millions of dollars. They are looking for what else is there and now how can I maximize my use of this money? Um, and so the, uh, uh, the, the, the basics of constructing any portfolio and rebalancing it also apply to these. Um, and we're not trying to,
00:21:17
Speaker
you know, make moves based on what the Fed is doing or anything like that. The idea is to what you call naive diversification in terms of we're going to set up a portfolio with these allocations and these percentages, and then we're going to stick with that. So instead of it being a 60-40 portfolio, it'll be a 2020-2020 portfolio, or a 42-26-16-10-6. But those allocations that you come up with um ah tell you are our our most of the management of the whole thing. I've gone to your website,
00:22:01
Speaker
And I've checked it out and you've got at riskparityradio.com backslash portfolios. There's a list of portfolios and I don't pretend to understand all of it, but in general, are there models, risk parity portfolio models that someone can emulate, somebody's already done all the homework, and they can have some basic assumptions you know from back-testing how their performance may or may not be and how that affects their safe withdrawal rate. Can you just go through some of those models if that if that is the case? Yeah, you'll find these models and in various places, and and I've really adopted them for the the purpose of the of the website.
00:22:39
Speaker
Um, so the original model or sort of classic, uh, portfolio is the one that Ray Dalio described to Tony Robbins and money master the game. And that is known as the all seasons or all weather portfolio. And so that is the first one listed there that I believe is too conservative for most people. It only has 30% in stocks in it. Um, but that, that was the classic risk parity idea.
00:23:06
Speaker
Now, the next one listed on there is called the Golden Butterfly. That comes from ah a gentleman named Tyler who runs a very excellent site called Portfolio Charts, where he also has about 19 different portfolios.
00:23:22
Speaker
some of them traditional Bogle head, 60-40 other things. And then he's got some of these risk parity style portfolios, including um what he calls the golden butterfly, which is 20% in ah total stock market fund, 20% in small cap value, 20% each in long long and short treasury bonds, and the remaining 20% in gold.
00:23:48
Speaker
Um, that one's been out there since 2016. Uh, it's, it's funny. Some of these people are sort of original five people from days. I'm old enough to be pre-money mustache and early retirement extreme is where we all hung out together on that board.
00:24:08
Speaker
and That's where I met Tyler and I saw when he created this thing in 2016 and this whole website with all of this data. so you could You could make these things and analyze them and do these sorts of things. so this The Golden Butterfly is actually kind of an original five portfolio, and but believe it or not.
00:24:28
Speaker
um the um and so I've got another one there I call the Golden Ratio, which is my sort of contribution ah to this. and Then we have some other ones that are more sort of experimental um that I've ah picked up and some of them have some leverage in them. ah Those are more just for like experimentation because of there my audience is very diverse in terms of their preferences and risk tolerance in portfolio construction. And some of them want to use leveraged funds. um And so there is a site called Optimize Portfolios, which talks a whole lot about all of those kinds of
00:25:12
Speaker
um portfolios. We've got a few of those, but most people really focus on the golden butterfly and golden ratio kind of portfolios at the website because those are easy to understand, easy to implement, and a lot of the people who have used what we've got there have ultimately adopted something like those kinds of portfolios.
00:25:35
Speaker
Thanks. Yeah, I'm definitely going to take a look closer look at those. there is a there When you look at the description of the portfolio, it tells you where it came from. I didn't invent any of this stuff. I just brought it together um in in one place. um And I'm using it for this particular purpose of maximizing my safe withdrawal rate in retirement. So which brings me to the next question. How do these risk parity portfolios increase or decrease or affect the safe withdrawal rate? And can you state specifically as compared to what we're normally talking about in the 4% rule?
00:26:10
Speaker
Yeah, they're they're over 5% is the short answer for things like the golden butterfly and golden ratio. And and this is this is an interesting topic because if you follow Bill Bengen,
00:26:21
Speaker
And his development, I think most people in the five community think that Bill Bengen's work ended in the 1990s with the 4% rule. And that was the end. That's not true. Bill Bengen continued to develop and, and showed that if you added more diverse components to portfolios, the last ones he was working with in about 2020, 2021 were at 4.7 or 4.8%. Um, so the, um,
00:26:51
Speaker
This idea that were somehow stuck with four percent because somebody did some research thirty years ago is it's false. then What i'm working with is ah one way to solve that problem or be able to increase your spending.
00:27:08
Speaker
There are some people who think that the 4% rule is too too low, some people think it's too high, and these are all really smart people, but this is the first time I'm even hearing, which is amazing to me again, that 5% is really where the mark can be with a with a less risky portfolio. So
Spending Habits and Withdrawal Rates
00:27:25
Speaker
why is it not being promoted more?
00:27:28
Speaker
That's an interesting question. And in order to get to it, I have to ask you, what do you think is the actual withdrawal strategy, the primary thing that all of the people you talk to are doing, whether it's JL Collins or Paul Merriman or yourself or even Warren Buffett?
00:27:44
Speaker
what What you all, to me, you all have the same strategy. Take it when you need it. That's my strategy, probably. is out of all right Your strategy is don't spend much money. Well, that's how you got there, right? But that's not, that's not the ideal retirement. That is, that is in fact what most guru types in personal finance. And that is what they are actually doing in their personal life. They are taking much less than say 3% out of a portfolio. If you are taking 3% or less out of a portfolio, you can do all kinds of things. You can have a portfolio that's 25% stocks like Bill Bernstein. You can have one that's 80% stocks like JL Collins. You can have 50 50 like Paul Merriman.
00:28:28
Speaker
you can do anything you want. and So what that tells you is that, the the there the this is i this is in my mind, this is the reason that this has not been explored because most people in the Fi community fundamentally have difficulty spending money and they're not spending money and anything works. You don't need to you don't need to have any special kind of portfolio if you're spending 3 percent or less.
00:28:55
Speaker
So the first question is, do you want to spend more money? um And if you do want to spend more money, that is where you start thinking about, how do I change my portfolio construction? How do I change my withdrawal rules in terms of guideposts or other ways of um adjusting your withdrawals over time? But to me, that that is, if you're asking, the Fi community still lives in a bubble about this.
00:29:25
Speaker
And for a long time, there was almost a ah bidding war, um an unhealthy bidding war in two two respects. In accumulation, the unhealthy bidding war is who can have the highest savings rate? yeah Let's all talk about who can have the highest savings. Oh, I have 50%.
00:29:41
Speaker
Oh, I have 70 percent. Oh, you're not counting it the right way. Oh, true. Yeah, that that same thought process goes on on the on the decumulation side. It's like, well, I'm spending four percent. Well, I'm I can do better than that. I can spend three percent. Well, I'm i'm at two point five. I'm at one. I'm close to one. I'm not spending any money at all.
00:30:04
Speaker
if If your goal is to not spend money and what economists would call a revealed preference, a revealed preference is what is the um objective, most likely consequence of your action, regardless of what you say you're doing. If you are not spending money, your revealed preference, and this is the preference of a great majority of the fire community, is to die with the most money possible.
00:30:33
Speaker
because that is your that is the most natural consequence of not spending your money. um I never wanted to be in that category, but I have found that one of the big resistances and why people look to anything or cling to anything that sounds more conservative is because fundamentally they don't want to spend their money. They don't want to, they don't want to let go of it. So if, if they can find an article that says, Oh, things are going to be worse in the future because of a Cape ratio, a lot of them, a lot of people just glom onto that. It's like, Oh yeah. Yeah. That that's why I'm only spending 2.5%. And they never bothered to ask is that
00:31:15
Speaker
true, is that valid? There are a lot of scare articles written um about this topic. We are just getting to that point. There was a problem also in the industry itself, the personal finance industry. So if you go back, say, to 2013 and look at articles written by people like David Blanchett and Wade Fow and those people, they were saying at the time,
00:31:42
Speaker
Oh, well, looking at the evaluations, it looks like it's only going to be a 3% rule. 10 years later, they were like, yeah, I thought that was wrong. Let's not talk about it. Blanchett's now ah saying things like, yeah, we should really be talking about 5% spending. We should probably be talking about 5% spending.
00:32:02
Speaker
I'm just trying to make this shift in my mind about, okay, if 5% works, what kind of conversations that we do we have in the financial independence community or even in personal finance communities at large? How does that impact those other conversations? And and I don't really know, other than but kind of like what you said, I think it's practically it's yeah yeah it's the mindset of save, save, save. And then, you know, like,
00:32:27
Speaker
savings rates, higher the better, no matter what, as you're doing your accumulation phase and then spend as least as you can in your decumulation phase. I guess if that's gonna be your bar as maybe behaviorally, it it kind of pans out that way for many. But looking at the numbers, I think two things. One, if you're saying a 5% safe withdrawal rate is very doable, then that changes a lot because that means you can retire sooner or you don't need as much to retire. You can retire sooner or do other things. so So we should just go back, you know, like there's a, like if you're in a document, you know, select find this and then replace with this, you know, like just go back and replace all 4% with 5% and then does it still make sense? That'd be very, that's something I'm going to be looking forward to thinking through as I continue to read content and and think through different things.
Risk Parity vs Annuities
00:33:16
Speaker
ah Risk and the accumulation phase is, or in retirement, is is definitely a fear that a lot of people have. And annuities are one way that some people can
00:33:27
Speaker
mitigate that downside risk. However, this conversation that you and I are having right now sort of competes with the conversation I just had with Stan the Annuity Man, which he he he made some good points. Stan the Annuity Man also said the same quote that Dr. Bill Bernstein said, when you've won the game, stop playing. Or if you've won the game, why are you still playing? You know, something to that effect. And Stan talks about just getting an annuity and cover your income floor and then have ah say liability and a, I don't think he said risk. I don't know. I can't remember exactly what it was, but basically, you know, have a portion of your portfolio and annuities have the other portion and.
00:34:07
Speaker
equities, the annuity serves as you're mitigating your downside risk for a market return or market volatility. But you're saying that if you can reduce risk via other means, which is through risk parity, you may not need an annuity, or at least that would also address some of the downside risk factors of the market. So what are your thoughts on annuities and does it have a role? I like so Stan a lot because he really makes a lot of sense with respect to annuities and one of the things the most important things he says is if you are under fifty. You should not be touching annuities and the reason and how they fit in how i fit them into portfolio ideas. Is remember that and and the the payout of an annuity i'm talking like a speed up but basic vanilla.
00:34:55
Speaker
Is based largely on your age and the older you get the higher the payout is going to be so when you're fifty. The payout is only gonna be like three or four percent and it's not adjusted for inflation when you get to age seventy even if you get a joint annuity.
00:35:16
Speaker
The pad is something like seven percent in in which case it becomes a very useful tool and i think around that time is when we plan to be looking at.
00:35:27
Speaker
annuities to see whether it makes sense for us. And oddly enough, and this is I think something that the annuity industry certainly doesn't want to address, is what matters for you and whether annuity is going to be good for you is how long do you think you're going to live? Are are you healthy? do ah Does longevity run in your family? My father's 95 years old.
00:35:52
Speaker
but the The older you get the more interesting and more useful it becomes, um because also your inflation risk goes down simply because you're not gonna live as long. The problem with dealing with these early on, they're they're twofold, the people buy them too early. And then people get sold annuities as, oh, we'll we'll create this annuity and it'll be there accumulating and you'll turn it on later. um To me, that doesn't make any sense at all. The annuities aren't scarce.
00:36:26
Speaker
When you want one, there's going to be one available. um And so it makes a whole lot more sense to me is to hold off on thinking about annuities until you're very much older and then be looking at how healthy you are, what you, ah ah you and your spouse um and sort of.
00:36:45
Speaker
What else do you have going on there? Because using that as a supplement to Social Security to get you at some floor um does make a lot of sense, particularly when they start having payouts that are in the 7% or 8% range. It does make a whole lot of sense when they're earlier. There's another interesting thought I always have about annuities, though.
00:37:09
Speaker
And this goes back to our early discussion. If you are spending like 3% or less of your portfolio, you you might be better off just buying the annuity because you could spend less money on that, get the same amount of money since you're not going to be spending it anyway. um So I think annuities actually make more sense the lower your withdrawals are percentage wise because you could take only ah a piece of your portfolio that would cover all of your expenses and then you don't need to worry about the rest of your portfolio. You can do whatever you want with it because since you're not spending much money anyway, um the the annuity can take care of it.
00:37:51
Speaker
um so that the So I think these these are interesting tools. i don't think that I don't think that the financial services industry does you any any favors in the way they recommend using them.
00:38:06
Speaker
i don't think I don't think they're being used in the right way and the right way to use them for me is to wait until you're much older and then look at these look at this as ah as a supplemental thing you might want to you might want to look into at that point in time.
00:38:22
Speaker
But you mentioned at some point in the future, you may consider at least explore the option of an annuity, but you're also big into this risk parity portfolio management. I mean, you're clearly, if you were to like Google risk parity, you come up, one, your podcast has named that, but second, you've got some material out there. So you are, you do come up in the conversation. So you're,
00:38:42
Speaker
You know, you're a credible source and perhaps even in your own portfolio, you're living that out and you're seeing things. ah You're getting data points that you're using to make your own personal financial decisions. Let's fast forward. How old are you right now? I'll be 60 in October.
00:38:58
Speaker
Okay, so let's say roughly 60. And maybe 70, you start looking at an annuities, or at least you start opening that up. Well, you have 10 more years of data and living through your drawdown, if you that' if that's how you're getting your income right now. I'm assuming you're using your risk parity models in some way. yeah yeah If you can get 5% safe withdrawal rate, why would you ever consider it an annuity? And if you've got the track record to prove and be confident in that, but because an annuity, if you die well, then you lose you you very likely will lose a portion of that rather than sending it onto generational wealth purposes.
00:39:33
Speaker
Well, I guess the short answer is because I'm not greedy and I'm not trying to prove something with ah with with the portfolio, that it's serving a particular purpose right now that an annuity could not serve. um I also need to think about my wife.
00:39:50
Speaker
um She's perfectly capable of managing this. and It's written down, so she's got it in addition to be able to listen to me talk in 360 episodes of Risk Parity Radio.
Future Financial Needs and Life Goals
00:40:03
Speaker
but But there are other considerations at that at that point in time that i think um the ah I think the goal there needs to be more designed for who I become as a 70-year-old.
00:40:18
Speaker
and and Maybe I'm less capable um of ah dealing with it for some reason. um the i hope um One of the main purposes of of my podcast was simply to lay this material down for our grown children.
00:40:36
Speaker
um so they can they can use it. And I would hope that if I do become incapable, they'll be able to step in and and manage the portfolio the way I would have. oh but these but But there's a a number of considerations as to why you might change what you're doing.
00:40:56
Speaker
And there there are also some other issues that have to do with just the way spending works as you get older. And and this is, you know, one of the other ah myths or lies or things that people need to get wrap their heads around is that your spending is likely to decline as you get older in real terms. Your experience of inflation is likely to be one to 2% less than the CPI.
00:41:23
Speaker
So when you hear people shoving these giant inflation numbers in their never retirement calculator, you're doing it wrong. ah You should be figuring on a lower ah inflation rate. what of this matters for me is you know ah One of the expenses we have right now is we support my parents. That expense is not is going to go away at some point because they are 95 and 90 right now.
00:41:51
Speaker
um But one of the reasons that I took this course of action trying to maximize how much we could spend out of our portfolio is because there are things I need and want to spend money on now that ah need to be done now. um and So that having that extra percent allows us to to do those sorts of things.
00:42:15
Speaker
that we that we wouldn't be able to do if we were to hamstrung ourselves and say we can only spend 3% of this portfolio because somebody said something about a cape ratio. So so there their real world problems to be solved that I think need to take um be front and center, that we're not just doing this because it's intellectually interesting, even though I do find it intellectually interesting. But there's an ultimate purpose and an ultimate um
00:42:48
Speaker
goal of of being able to spend more money now knowing that we're going to spend less money later anyway. um I'm also a firm believer in giving away money while you're alive. My podcast supports a charity and i'm all i'm all we're already giving our grown children parts of their inheritance. that That doesn't need to be sitting in our accounts not doing anything. It can grow very nicely in their broth IRAs.
00:43:16
Speaker
You need to think about the life purposes of the money and then back into what you're doing with it in terms of a portfolio rather than thinking of it as like, well, I'm winning with this and I need to keep winning because there's nothing really to win.
00:43:31
Speaker
Yeah, it's it's interesting the different perspectives, all the different age groups of people you have the conversations with because you mentioned ah Bill Bernstein, and I don't even know if you know this, but he is the very next episode that's going to be released on my podcast we just recorded last week. And It will be ah released on YouTube, you know, this week or i say last week as somebody's listening to this. And so it was, it's great that you brought him up, but talking to him, talking to Stan, talking to Paul, talking to Paul Merriman, talking to Jill Collins, talking to you.
00:44:03
Speaker
who are a few years more mature than I am, but it does represent a, I'm noticing a shift in mindset just based on age. So like we might, you know, I say, and I'm like right on the cusp. I'm like, I'm not like 25 or 35, I'm 46. So I'm kind of ah on that cusp, that transition over to maybe more mature wisdom of of the next group.
00:44:24
Speaker
ah And I think I'm getting there quicker because I'm having these conversations. But my point is, when you first discover financial independence and you're gung-ho and you say never retire calculators, that's kind of funny. I don't think I've ever heard that phrase, but I get the point. You're trying to solve for every scenario and win a game and compete. And there is a gamesmanship to getting to the accumulation, but the natural transition is too.
00:44:49
Speaker
shift to, okay, great, money is money. It's a tool. What are we gonna use this for now? And it needs to... So there's a transition from like the getting it, which is fun for most people, I think. Fun, exciting ah for some people might be boring, but ah you know they get to that point and then they're like, okay, now what? Well, now you got it. Now you can focus more on life design and the next 40 years of your life and and how do you wanna play that out? How do you how are you gonna not only use money, but think about money for that next 40 years, 50 years of your life. and So that's why I really appreciate this conversation.
00:45:21
Speaker
Yeah, I mean, there there are a lot of a lot of things to think about. um and I mean, most people in the Fi community do have like the the natural savers gene. I call them ants has ants and grasshoppers. Ants are the natural savers and grasshoppers are the ah natural spenders that comes from one of ESOP's fables. ah But but you you do at some point you really want to be an ant hopper. it's um that That you can do both based on what your ultimate goals are in life, aside from the money, using the money as as the tool and not the goal. Frank, before we end this episode, is there anything else that you'd like to share with the audience? Well, I will make a plug for ah the charity that my podcast supports. um the but My podcast started as a hobby,
00:46:16
Speaker
But we support a charity that I'm on the board of. It's called the Father McKenna Center. and it ah serves home hungry and homeless people in Washington DC. It's a small charity. We have lots and lots of volunteers though. and If you're charitably inclined and and like this message, i I would invite anyone to you know help us out because this is this is also a good way to dispose of your money while you are alive and not wait until you are dead before donating.
00:46:48
Speaker
right Frank, and I think that's representative of the your giving spirit and your willingness to you put good back out in the world. I've seen that through all of your Facebook comments. That's always added value to me as I'm going. so Some of those are awfully caustic, but I always tell people, you know, I'm kind of like Shrek and ogres have layers.
00:47:08
Speaker
And I appreciate you taking the time today to talk to me about risk parity and how we can learn about risk parity and increase our safe withdrawal rate without too much ah more worry. So that was news to me and I'm excited about looking into that a little bit more and we'll have all the links or many links in the show notes. So if if this information is interesting to you, scroll down, click a couple links, learn more. Thank you very much, Frank, for being here today. You're quite welcome. And thank you all for watching and listening.