Remembering Harry Markowitz

Psychology, Beginner, Theory

The world lost a true investing legend recently when Harry Markowitz passed away at the wise old age of 95. Markowitz is widely known as the father of modern portfolio theory, and it’s impossible to overstate his significance not only to my own outlook on investing but also to the entire modern industry of portfolio management. He was a good man and a brilliant thinker, and his unique insights will continue to influence us for a very long time.

The FTX Lesson That All Investors Should Learn

Beginner, Theory

Any time there is lots of money involved in a particular market, there will inevitably be a subset of people that emerge to capitalize on the situation by exaggeration, deception, and outright theft. Madoff, Enron, Lehman Brothers, Tyco — history is littered with financial frauds that cost investors billions.

How does nobody see it coming? Unfortunately the world today isn’t as simple as obvious good guys and bad guys, and it’s sometimes impossible for normal people to tell respectable companies apart from carefully constructed marketing images. The good news is that there are a few simple steps you can take to protect yourself from the fallout when things go terribly wrong from events you never saw coming.

But before we get to the good stuff, let’s unwind the most recent example of financial corruption that every investor should educate themselves about — the rise and fall of FTX.

Harvesting the Fall: Why I Sold All My Bonds

Beginner, Theory

Investing is like riding a skateboard. It takes skill, balance, lots of practice, and a certain amount of fearlessness. You know for a fact that you’re going to fall sometimes, and yet you do it anyway because you understand that perseverance pays off. Still, even the best skaters know when and how to bail gracefully without getting hurt.

With bonds cratering this year amid rapidly rising interest rates, that portion of my portfolio is currently a sea of red. Bond purchases going back a full decade are suddenly underwater, and after surveying my options it quickly became evident that it’s time for a big change. So after much deliberation, this week I finally pulled the trigger and sold every long term bond in my portfolio. With a simple click of a button, a big chunk of my total holdings that I’ve depended on for years went straight to my cash balance and I realized a sizable capital loss in my account.

Then a few seconds later, I put all of that money into an extremely similar bond fund with much lower expenses. And I used those capital losses to also swap out my gold holdings with big capital gains completely tax free. The end result is that I took advantage of unique market conditions to maintain the same asset allocation that serves me very well while saving potentially thousands of dollars a year.

What — you thought I bailed on bonds entirely? Please. My portfolio continues to cruise on, and I landed that kickflip like a champ!

Here’s how you can, too.

All About TIPS: Real Returns and Inflated Expectations

Advanced, Theory

Now that inflation is raging at highs not seen in the last 40 years, it’s no wonder that investments which guard against inflation have been experiencing a massive influx of money. With billions of dollars of new inflows every month, Treasury Inflation-Protected Securities (commonly referred to as TIPS) have quickly become some of the hottest portfolio options for nervous investors. And since questions about TIPS on message boards and in my inbox are apparently directly proportional to those cash flows, this feels like a good time to dig into the topic and separate the measurable truth from what passes as common knowledge.

How do TIPS work? How often have they succeeded in generating a real return above inflation? And are they really better than normal bonds without the inflation protection? Stick with me, and I wager you’ll learn a few things that may surprise you.

How to Replace Income in Retirement

Retirement, Beginner, Theory

I had the distinct pleasure of spending time with my wife’s family this week. Between catching up on life events and helping with a few household chores, my father-in-law (let’s call him John) took the opportunity to ask his financially-minded visitor a question directly pertinent to his own immediate goals.

“How can I use my investments to cover the bills in retirement?”

I knew that John is a CPA and a knowledgeable investor who has actively traded his family accounts for years. So as a well-educated student of retirement finance, I naturally jumped in to an explanation of safe withdrawal rates, retirement spending methods, and how portfolio theory can be used to tweak the numbers to safely spend a certain percentage of his portfolio every year without fear of running out of money over his expected lifetime. John listened intently and replied with a deceptively simple follow-up question:

How do you guarantee that level of investment income every year?

That’s a terrific question, and the simple answer is you don’t have to. But that’s the exact moment I recognized my own investing bubble. The internet these days contains more information than ever about every nuance of retirement finance, but the gap between the theory debated by eggheads and John’s completely rational income-driven paradigm is just as perfectly normal as it is surprisingly wide to bridge.

I was talking about systems theory, and he just wanted to directly replace income. Which makes perfect sense! And I imagine many of you may have the same question.

So rather than jumping into a painfully long series on every possible way to tweak the numbers, let’s start with the basics. If you’ve ever wanted to know how to safely move beyond depending on regular work income to pay the bills, this article is for you.

Proven Ways to Protect Your Portfolio From Inflation

Beginner, Theory

Perhaps the single most impactful development in the financial world over the last several months is the rapid onset of high inflation. After a decade of particularly low inflation that even pushed negative in some countries, the ugly specter of quickly rising prices came roaring back late last year and has only gotten worse. As recently as March 2021, the annualized inflation in the US was at a historically typical 2.6%. But just one year later it skyrocketed all the way to 8.5%. That’s the highest it has been since 1981, and we can all feel its effects. Everything is just way more expensive today.

With consumer prices making news worldwide, it’s easy to feel helpless. Massive price tags on basic staples like food, gas, and rent have a way of humbling even the most efficient money manager and stressing household earners to the limit. And many investors with lots of money saved up no longer feel so confident either as both the stock and bond markets break under the weight of the new economic normal. It’s really tough out there!

While I don’t have a magic wand to make your grocery bill more affordable, I’m happy to help where I can. So let’s tackle the investing side. Not every asset and portfolio responds to inflation in the same way, and by learning more about how they operate we can find an asset allocation suitable to weather the current storm.

Unexpected Returns: Shannon’s Demon & the Rebalancing Bonus

Advanced, Theory

One of the core assumptions baked into all of the Portfolio Charts calculations is the idea that the portfolios are rebalanced once a year back to their target percentages. While that simple process seems rather mundane on the surface, there’s actually a bit of mathematical magic going on that often gets lost in broader portfolio discussions. Yes, maintaining your target asset allocation is an important part of risk management, but it goes so much deeper than that. What if I told you that, like a lonely plant in a barren desert, in the right conditions rebalancing can cause profits to seemingly appear out of nowhere?

That peculiar phenomenon can clearly have a major impact on the way people think about diversification in their investments. So let’s unpack the mystery and talk about the elusive rebalancing bonus.

Three Secret Ingredients of the Most Efficient Portfolios

Advanced, Featured, Theory

December is often the time of retrospection and yearly wrap-ups, with stories recapping events of the last year and looking forward to new opportunities. In the finance space, you’ll find endless collections of the top performers of the year and forecasts for the one to come. While that’s all interesting and comforting in its own ritualistic way, this holiday season I decided to revisit a bold question that’s much bigger than short-term market news cycles:

What do the most efficient portfolios in history have in common?

Truly understand that answer, and much of the market noise that worries you from day-to-day and year-to-year loses its power over not only your emotions but also your account balances. So if you’ve ever wanted to think beyond your investing assumptions and explore the data for proven ways to approach timeless portfolio problems, grab a cup of coffee and pull up a chair. This article is for you.

The Right Savings Rate Will Conquer Any Bear Market

Beginner, Charts, Goals, Theory

One of the things I like about the safe withdrawal rate is that it’s a rare financial metric that accounts for the worst case. While everyone else was comparing withdrawals to average returns, William Bengen had the foresight to study every investing period he could find and determine the maximum amount of money that a retiree could have safely withdrawn over 30 years even in the worst possible timeframe to retire. By flipping the problem from an exercise in chasing ever-shifting averages to studying worst-case scenarios, Bengen’s safe withdrawal rate really did make life after accumulation a lot safer for retirees.

Look at the title image of a pair of grain silos and imagine your comfort level with them filled with just enough grain to barely make it through an average year. Now picture them with enough grain to survive the worst famine on record. That’s a huge difference, and Bengen’s new perspective completely changed the way people think about retirement.

As helpful as that is, however, not everybody is in the phase of career and life where retirement is an impending concern. But I still find the approach enlightening, so let’s expand our thinking. Have you ever wondered what a similar metric might look like for accumulators seeking to guarantee long-term success in uncertain markets? Put another way, what percentage of your crop must you save in those silos every year in order to fill them by a certain date? And if the stored grain grows and shrinks on its own like money invested in stocks and bonds, how would that affect the results?

If that type of question feels as interesting to you as it does to me, this article is for you.

Find the Right Funds to Build a Great Portfolio

Beginner, Charts, Theory

When looking for opportunities to make new connections, there’s something to be said for looking like you know what you’re doing. One time when I was browsing the produce section of the local grocery store for a few peaches to add to the basket, a young kid sheepishly approached and asked for some friendly advice.

“Could you please explain how to find a good peach? I’m supposed to get some but have no idea what to look for.”

Now I realize people strike up random conversations at the store for all sorts of reasons, but I could tell he was out of his element. I got the impression he was under orders to bring home a certain list of items and was truly lacking the knowledge to do it correctly, and I was particularly impressed that he took the initiative to ask for help. I’m no chef by any means, but I was happy to offer my own experience of selecting them by feel and smell and letting any peach that is a little hard ripen for a few days before eating. With a few nice ones in-hand, we went our separate ways to enjoy a future sunny afternoon with a really tasty fruit.

Thinking back on that experience, I’ve always been keenly aware of how important it is to not only suggest an idea but to also offer enough information to make it actionable. So many financial voices lecture about investing concepts only to stop at the theoretical stage without bridging the gap to how normal people can act on those ideas. Sometimes it’s out of self-interest when their end goal is to drive readers to hire them for their financial services. Occasionally you run across a noble but detached research type who revels in unraveling the data but never actually makes the connection to anything that applies in the real world. And of course some people just like to talk without always fully understanding what they’re talking about. But regardless of the motivation, truly helping people is about so much more than simply convincing them that they should buy peaches without explaining how to actually do it. You have to take that next step.

In that same practical spirit, I’m really excited to share a new tool that I’ve been working on for a long time. If you’ve ever explored Portfolio Charts and found an asset allocation that looks perfect for you but struggled to figure out how to act on that knowledge, I now have just the thing to help. I call it the Fund Finder.