[Editor's Note: This is a guest post from Kathryn Cicoletti, Founder of Makin'SenseBabe, LLC, where she tries to make learning money topics a more enjoyable experience. Prior to this endeavor, she spent 10 years working with an asset management firm evaluating hedge funds for possible investment. Her new company sells subscriptions ($12 a month) to investment tools, a monthly newsletter, and email access to her. The videos on the site (free to you) are a pretty fun way to learn a lot of good stuff about personal finance and investing.
This post was very different from most of the guest posts I see, and the initial draft came across as a damning indictment of a portfolio and its promoters. I could tell she was pretty fired up, so I figured the portfolio was investing in whole life insurance and loaded mutual funds or something. It wasn't, but the post is still pretty fun, and it will introduce the concept of a “risk parity” portfolio to many readers, so I'm going to run it. Kathryn and I have no financial relationship. ]
The job of a good graphic designer is to fill the gap between information and understanding. I didn’t come up with that myself. I stole that line from a movie I just watched called Design is One. The movie is about Italian designers Lella and Massimo Vignelli, who developed the American Airlines logo and the signage for the New York City subways. In the financial world there’s a huge gap between information and understanding that information. Bridging the gap between financial information and understanding it is not fun because you have to type more words to explain things, which I have just done. But the pain of typing too many words isn’t the real issue with bridging this gap. The real issue is most people who write financial articles are:
- Afraid that if they explain things in “laymans” terms, they look less sophisticated than their high-finance peers, and
- Out of touch with how few people, on their own, can bridge the gap between financial information and understanding because they don’t work in the financial world.
The latest culprit is Tony Robbins. He has a new book out, called MONEY Master the Game: 7 Simple Steps to Financial Freedom. I first read about this on Meb Faber’s blog back in October. A few days later I listened to Tim Ferriss interview Tony Robbins. Ferris and Robbins talk about Robbins’s in-depth conversations with some of the largest money managers in the world.
“Ray Dalio!” Founder of Bridgewater, “the largest hedge fund on the planet” says Robbins while talking to Ferriss. I knew we were in trouble when he started talking about hedge fund managers and planets in the same sentence. Here we go, I thought. And we went.
The All Weather Portfolio Explained
Robbins explained that the All Weather Portfolio starts with Dalio’s idea that there are really only four things that “move” asset prices: inflation, deflation, rising economic growth, and declining economic growth. Robbins then explains that he learned from Dalio that there are four possible economic “seasons” that will impact asset prices:
- Higher than expected inflation
- Lower than expected inflation (or even deflation)
- Higher than expected economic growth, and
- Lower than expected economic growth
The idea of a “risk parity portfolio” is that you should have 25% of your “risk” spread out between each of these economic environments, or seasons. Per Robbins, the key thing to pay attention to is “risk,” rather than dollar amount. Robbins says that since stocks can be roughly 2X riskier than bonds, his risk-based asset allocation (i.e. The All Weather Portfolio) places roughly twice as much money in bonds as in stocks. [The quantification of this is interesting, since it doesn't define the risk being discussed. For example, if the risk you're discussing is the risk of your portfolio not keeping up with inflation, short term treasury bonds and money market funds have lots of risk. But if your definition of risk is short-term volatility, or dispersion of possible returns, then obviously stocks have a lot more risk than bonds, probably more than 2X! -ed]
So taking into consideration risk, Dalio told Robbins that the All Weather Portfolio looks like this:
- Stocks: 30%
- Bonds: 55%
- Commodities: 7.5%
- Gold: 7.5%
Not The Permanent Portfolio
In some ways, The All Weather Portfolio concept is similar to “The Permanent Portfolio” that started back in the 80s. The Permanent Portfolio suggests 25% allocations split between four different asset classes. Specifically:
- 25% in U.S. stocks
- 25% in long-term U.S. Treasury Bonds
- 25% in cash
- 25% in precious metals (gold)
The two biggest differences between these two portfolios are:
- The original Permanent Portfolio includes a higher allocation to cash and metals like gold (zero and 15% respectively for the All Weather Portfolio).
- While the current allocations to The Permanent Portfolio are slightly different than this 25/25/25/25 split, The Permanent Portfolio does not use a risk based asset allocation strategy. Meaning, they divide up the assets evenly without taking into consideration that gold is much more volatile than bonds and should potentially have a lower allocation [not to mention the likelihood of each of the three scenarios- inflation, deflation and “tight money”- it is designed to address are different.-ed]
Issues with Robbins as a “Graphic Designer”
The most concerning part of this interview was when Robbins tries to be the graphic designer (fill the gap between information and understanding) and help us understand what that portfolio means:
“In laymans terms, you’re protected,” he says.
When I saw these words: “you’re protected,” my heartburn started to flare up. Playing on peoples’ fears and positioning this portfolio as if it’s their saving grace is just wrong. There is not a single strategy, including hiding your money under your mattress, that you can use to tell investors “you’re protected.” This is a broad-brush statement that Robbins uses for The All Weather Portfolio that just isn’t true.
But rather than rant on about all the ridiculous statements Robbins made about this All Weather Strategy, I will walk you through the important points you need to know if you’re thinking of implementing this investment strategy with your money.
Breaking It Down
I listed Robbins’s and Dalio’s key points from their conversation and then, wearing one or more of the following three hats, explain the issue with the point:
- Explainer – I am the Italian graphic designer in this case, building a bridge with the information Robbins gives you so you can understand what he’s saying.
- Endorse – Robbins/Dalio has a good point.
- Kindly calling BS – This part of the strategy doesn’t make sense i.e. be careful.
All of these quotes are from this article and Ferriss’s podcast interview with Robbins.
Claim: The Backtested Portfolio had Fewer Down Years Than the S&P 500
“(Dalio’s) Pure Alpha Fund, according to Barron’s, has lost money only 3 times in 20 years, and in 2010 he produced 40% returns for his key clients.”
Endorse – the S&P has lost money 4 times in the last 20 years through 2013. One point for Dalio/Robbins. Write that down because I think it’s the only one.
Claim: Every Investment Has A Season, so Put 55% of your Money Into Bonds
Dalio: (to Robbins)
“Tony, when looking back through history, there is one thing we can see with absolute certainty: every investment has an ideal environment in which it flourishes. In other words, there’s a season for everything.”
Explainer – Remember if you own a bond that just means you gave out a loan to, say, to a company or a government. They pay you interest in return. If it’s a 10-year bond, they pay you interest for 10 years, then you get back the money you loaned them. If you own a bond and you’re receiving 5% in interest per year and the company now only pays 3% in interest per year to whoever gives them a loan (buys a new bond), your bond is more valuable because it pays higher interest. This is why when interest rates decline, exisiting bonds increase in value.
Kindly calling BS– This is the most hysterical part of this whole thing. Dalio lets the cat out of the bag but Robbins ignores it. The All Weather Portfolio suggests a 55% allocation to bonds. With interest rates steadily declining, we have been in a bull market for bonds for the last 30+ years. So when Dailio says “every investment has an ideal environment,” we have been in an ideal environment for bonds which is 55% of the portfolio! He serves it up for us, but Robbins missed this. A 55% allocation to bonds AFTER interest rates have been declining for the last 30+ years, giving bonds a huge tailwind, is not an “all weather” allocation. That’s a one-season allocation that needs a new (lower) allocation to reflect where we are in the interest rate cycle.
Claim: You Can Make Up For The Lower Returns of Bonds By Using Long Term Bonds
“I quickly remembered (why there is such a large percentage in bonds) it’s about balancing risk, not the dollar amounts. And by going out to longer-term (duration) bonds this allocation will bring a potential for higher returns.”
Explainer – the longer the time frame you loan out your money (say 30 years instead of 5 years), the higher the interest rate you will receive. This is because you have to be compensated for having your money tied up for a longer period of time. Unfortunately, when interest rates rise, all bonds lose value immediately, but long term bonds lose far more than short term bonds.
Kindly calling BS – Where are my Tums? Again, they are completely disregarding interest rate risk because this has not shown up over the last thirty-years. These allocations are looking at what has worked over the last thirty-years, i.e. driving while looking in the rear view mirror. Call me at 1-800- KathrynsBackTestRUs and I can put together a great historical track record allocating 55% of my money to an asset class that was a shoe-in over the last thirty years. [To be fair, while bonds have had a heck of a run over the last 30 years, despite the falling interest rate “tailwind,” they were outperformed by stocks and real estate over that time period.-ed]
Claim: Commodities and Gold Protect Against Inflation
“He rounded out the portfolio with 7.5% in gold and 7.5% in commodities. You need to have a piece of that portfolio that will do well with accelerated inflation so you would want a percentage in gold and commodities. “These have high volatility. Because there are environments where rapid inflation can hurt both stocks and bonds.”
Explainer – Robbins is trying to say that gold and commodities have a low correlation to stocks and bonds in an inflationary environment.
Endorse but Still Kindly calling BS – two points:
1) They’re suggesting you put 15% of your portfolio in an asset class that is going to make money in an environment that we’re nowhere close to experiencing. The Fed is targeting inflation near 2.5%. Meaning, they would like prices to be rising 2.5% year-over-year. This is their sweet spot for where they think inflation needs to be in order to feel “ok” about the economy and unemployment. If prices are going down (deflation), that’s bad because it means demand is low, and that’s not good for the economy. Look at that chart. We are nowhere near an inflationary environment.
2). His last sentence doesn’t even make sense: “These have high volatility. Because there are environments where rapid inflation can hurt both stocks and bonds.”
Commodities have high volatility because they have huge swings in performance (up or down) at any given moment regardless of if we’re in an inflationary environment or not. If there are concerns over liquidity in the market and you just want your cash back fast, gold can sell-off when stocks sell-off, regardless of anything to do with inflation.
Commodities having large swings in performance (aka “volatility) is not dependent on rapid inflation. What is he talking about. [My best guess is he meant to say this: “[Gold and commodities] do have high volatility…[But]… there are environments where rapid inflation can hurt both stocks and bonds.”-ed] Ok I will end with this because this is already too long….. Claim: You Should Use Back-tested Data to Design Your Portfolio Robbins:
“When my own investment team showed me the “back-tested” performance numbers of this All Seasons portfolio I was astonished. I will never forget it.”
Kindly calling BS: I think you should. I am very familiar with back-tested performance. In fact, I raised a lot of money using back-tested performance. Most institutional investors understand the meaning of back-testing, and that past performance is no indicator of future performance. I know because I was raked over the coals in many board meetings by trustees for using a back-tested track record. Institutional and other sophisticated investors understand the limitations of back-testing and will murder you for it in the boardroom when you’re pitching to them. If they do decide to invest in a strategy that doesn’t have a current track record and all they have to go on is back-tested numbers, they know it. However, retail investors, such as those who will buy Tony Robbins’s book, typically do not understand the limitations of back-tested track-records. Why would you? You don’t have a board, you don’t have an investment staff, you don’t have a CIO, you don’t have an investment consult telling you this. [Although most doctors get this intuitively, due to their courses in evidence-based medicine where retrospective studies are readily shown to be inferior to prospective studies. -ed] Sure you have a financial advisor but most of the time they just want you to buy this fund or that fund and could care less if there is no “real” track record. [I hope you don't have an “advisor” like this. Please fire him if you do.-ed] Ray Dalio deals with large institutional investors. Those are the biggest clients. They will ask the above questions. The retail community is going to get slammed if they rely only on this back-tested track record to make their investment decisions.
While this post might look like I have a thing against Tony Robbins, I don’t at all. The guy has a gift for making people feel better and he happens to make a ton of money doing it. Good for him. I have watched a lot of his videos and could be convinced to slit my feet and then go run a marathon if he told me too. But that is why we need to be so careful with this new book of his. Robbins is a force. And he is very convincing. So just do your research, bridge the gap with all this information and be your own designer to make sure you understand all of it before blindly buying into this all weather strategy.
[Editor's Note: Wasn't that fun? I've written before about dozens and dozens of reasonable portfolios. There is no such thing as Portfolio Nirvana. Couple any reasonable portfolio with an adequate savings rate and sufficient discipline to stick with it and you are likely to reach your goals. My big beef with very conservative portfolios such as The All Weather Portfolio are that the expected returns are so low. Commodities and precious metals have long-term expected returns close to the rate of inflation (minus expenses.) At current interest rates, bonds have expected real returns of -1.5 to + 1.5. Having 70% of the portfolio in assets that aren't provided any significant growth after inflation means that you will have to compose nearly the entire portfolio of brute savings, a feat that is out of reach for all but the most frugal savers.
However, if you've already got all the money you need and/or can't stand to lose money in more volatile investments like stocks and real estate, then this type of portfolio might be for you. Some of Kathryn's criticisms could be interpreted as advocating timing the market (i.e. interest rates must go up so you shouldn't invest so much in bonds.) Unlike Kathryn, and I suppose a bit like Robbins, I actually like the idea of a static asset allocation that doesn't change based on market predictions, interest rates, or valuations, even if I'm not a huge fan of this particular static allocation, at least for an investor in the accumulation phase.]
What do you think? Do you read or listen to Robbins? What do you think? Do you invest in the All Weather Portfolio? Why or why not? Comment below!