Author Archive for Cullen Roche

The USA is Literally Falling Apart….

Good segment on 60 Minutes here exploring the very serious problem of America’s failing infrastructure.  Last week I noted that an infrastructure plan should be one of our “no-brainer” policy ideas.  If you want to see just how huge a problem this is then watch the 60 Minutes segment.  It’s frighteningly important that we start to deal with this problem in a big way. Unfortunately, myths about the USA being bankrupt or on the verge of a high inflation continue to keep us from implementing the necessary fixes….Not to mention the fact that our leading policy theorists seem to all think that the Fed is enacting this massively “stimulative” policy via QE so that leaves no room for fiscal policy.  It’s all misleading, hurting economic performance and making the country an unsafe place.

Source: 60 Minutes

Investing and the Intertemporal Conundrum

I went to see Interstellar last night.  I won’t ruin it for you, but if you’re in to things like time travel, intergalactic travel and space ships then you should probably go see it.  One of the central themes of the movie is relative time discrepancy.  Due to gravitational anomalies time in the movie is a relative unknown.

Naturally, this got me thinking about how this relates to money and investing.  Money, after all, is essentially a way of trading our time so we can obtain access to other needs and wants within the economy.  Investing in financial assets is a way of trading money now to obtain more money in the future.  Money and time aren’t just related.  They are two sides of the same coin.

Therefore, time is a key element in our investing lives.  But it’s also a relative unknown.  In my book I call this the “intertemporal conundrum” – the problem of time in a portfolio.   That is, we have our own relative time discrepancies in our financial lives.  The majority of academic models that discuss investing use a linear model of the financial world and apply financial asset allocations based on this linear thinking.  This is the essence of the rationale for “buy and hold” investing.  That is, in a linear system with a long enough time horizon stocks will have a more predictable and linear output.  That is intuitively obvious and factually true.  Of course, this model of the world assumes that it applies to our portfolios in a practical sense when, in reality, it doesn’t since our financial lives are actually a series of events and not the start and stop model that many use for planning.  Interestingly, day traders do the opposite.  They try to trade their way to the future thereby playing a game of low probabilities and high frictions generally resulting in financial ruin.

So what’s the problem here?  Well, our lives aren’t these clean linear experiences.  Our lives are a dynamic series of events (graduations, marriages, children, emergencies, retirement, elderly care, etc).  And since our savings portfolios are comprised of the repositories from which we decipher our ability to make choices about future spending then this repository can’t be all that dynamic.  It has to be somewhat stable.  The logic behind this is very simple.  If our investing timelines exist on a relatively short period (maybe 30-40 years?) and our earnings and spending needs are dynamic over that period then why would we apply a model of the world that implies that we can actually hold certain asset classes for the entirety of that time period?  More importantly, it begs the question whether anyone actually WANTS to hold that asset for the entirety of this investing period.  As Keynes said, in the long-run we are all dead and I don’t know about you, but I don’t work all day hoping to die with a casket full of unspent money.

And this is the danger of the ideas espoused by advocates of “the long-term” or the “short-term”.  These models try to distort time and often apply approaches that result in a highly impractical approach to portfolio management.  There has to be something in the middle.  Something more balanced that accounts for the dynamism of the financial system and our financial lives.  Anything else is impractical and defies the reality of the way our portfolios relate to our actual financial time frames.

Deep Thoughts from Howard Marks

I just wanted to pass on this great talk from Howard Marks at the CFA Institute.  He touched on a variety of different topics and many that I fully agree with:

  • Risk and reward are not necessarily correlated.  After all, if riskier assets could always be counted on to generate higher returns then they wouldn’t be riskier.  Therefore, volatility can’t be “risk”.  This is why so many academic models of the financial markets end up leading us astray.  Instead, Marks says that risk means there is a high probability of more uncertain outcomes.  You might have seen the chart below from Marks depicting this concept which basically shows that the distribution of uncertain outcomes increases as you take more risk.  This is a vast improvement on the idea of the efficient frontier which simply implies that more risk will generate more return which often leads people to think that they’ll do better simply by owning stocks “for the long-run” or something like that.


  • Marks notes that making predictions is incredibly difficult.  Instead, it’s better to focus on ways in which we can improve our probabilities of good outcomes.  Many times in the financial markets we’re better off knowing what we don’t know.
  • We’re all going to be wrong a significant amount.  One of the keys is ensuring that we don’t make significant mistakes.
  • You have to learn second level thinking which involves thinking differently and better.

I don’t agree with everything Marks says, but there’s a lot of good thinking here so give it a listen if you have some time.

3 No-Brainer Policies Our Government Won’t Implement

I catch a lot of flak for trying to remain politically agnostic.  Which is deserved I guess.  But when I talk about money and finance I generally try to remain operational in nature.  That is, I try my best to speak objectively from what I know about the world and not what I want that world to look like.  Well, I’ll deviate from that approach for this post, but let me be very clear that these are simply my personal opinions based on my understandings and someone who understands the world through the understandings that I generally espouse (see here) could come to very different conclusions.

That said, here are three things I think are absolute no-brainer policy changes.  But they’re also three things that will almost certainly not happen because the political environment is too messy to actually get policymakers to act:

1)  The government should implement a substantial infrastructure investment program.  It’s well known that the USA’s infrastructure is falling apart.  Our roads are old, our bridges are falling down and the substantial investments we made in past decades are depreciating rapidly.  If the USA were run like a smart corporation it would reinvest in these projects and bring them up to modern standards.  Of course, the US government has the luxury of not being a for-profit entity.  And since the USA is the world’s reserve currency with no debt denominated in a foreign currency it has the luxury of being able to spend without having to worry about foreign creditors declaring it bankrupt.  And with interest rates at record lows it only makes that much more sense that we would borrow the funds to implement these projects.  After all, the US government can sell bonds at 0% today.  The market is basically begging the government to issue more debt.

Why it won’t happen – politicians, pundits and economists are mostly convinced that the USA is bankrupt (which it most certainly isn’t).  Nevermind that this can’t operationally happen.  The US government’s balance sheet is nothing like a household’s balance sheet.  But the misinformation on this topic is so vast that any project that adds to the national debt will be sold as some “burden” on future generations or something that will potentially bankrupt the country.

2)  The government should pass broad middle class tax cuts.  The middle class can’t seem to catch a break.  The recent recovery has been uneven in a way that is most unusual.  And the median earners in this country just aren’t seeing the benefits that many other groups are.  A substantial middle class tax cut would reduce the balance sheet burden that many middle income earners continue to experience and help to drive more spending from what should be the engine of the economy.

Why it won’t happen – See above.  We are bankrupt, inflation is coming, the dollar will collapse, [insert failed prediction about negative impact of government debt here].

3)  Raise taxes on secondary market “investments”.  I have to apologize first to myself for this (because this would be a personal tax hike) and also to all of the people I work with who tend to be high net worth asset holders.  

As I’ve explained before there is really no sense in taxing secondary market “investments” favorably because secondary market “investing” is not really “investing” at all.  This idea exists largely because of the myth that secondary markets are where we make “investments”.  Of course, primary market investments are incredibly important and we should encourage primary market investment as that drives funding towards innovative endeavors.  But secondary market transactions are mostly just reallocations of saving between private parties that have no impact on whether firms make real investments in the future.  When most people “invest” in the stock market they’re really just allocating their savings.  The corporation doesn’t obtain money and really doesn’t care who owns the shares on the secondary market.  But because most people think of this as “investing” they think that this deserves special tax treatment because investment is so crucial to the prosperity of the country.  Unfortunately, the low taxes on dividends and capital gains often drives firms NOT to invest because they can return cash to their shareholders in a more tax friendly manner.  This policy of taxing secondary markets favorably doesn’t make much sense at an operational level, but it persists primarily because it helps the wealthy keep more from their primary sources of income.

Why it won’t happen – raising taxes on the wealthy asset holders in this country would be a wildly unpopular move and since most politicians receive huge funding from the wealthy this move would almost certainly never happen.

Updated Performance of the Global Financial Asset Portfolio

I’ve spent years here griping about how most people don’t benchmark properly and how we should stop comparing everything to the S&P 500.  The logic behind this thinking is simple – at the aggregate level there is only ONE portfolio of all outstanding financial assets.  Therefore, “the market” has to be comprised of all these financial assets.  When someone talks about the S&P 500 as “the market” they are really just referring to a selection of 500 American corporations that don’t represent all US stocks, global stocks or even close to all of the world’s financial assets.  So it makes no logical sense to focus on such a narrow slice of the financial assets that actually impact all of our lives.

If I had it my way the nightly news wouldn’t even mention the stock market or bond market.  Financial TV wouldn’t show the stock indices at the top of every headline.  Instead, we’d focus on this one aggregate index as the ultimate index.  That would give us all a much better idea of how our actual financial assets are changing on any given day, month or year.  But for some reason no one actually thinks of things in these aggregate terms.  Anyhow…

If this global financial asset portfolio is the most important index in the world then how is it doing?  Well, I’ve put together a pretty close replication that represents most of the world’s outstanding financial assets.  Keep in mind this is an aggregate that includes stocks, bonds, REITs, cash and other assets.  I have excluded non-financial assets of all types.  So this is still an approximation, but a much better perspective of an “index” than something like the stock index.  Here are the performance figures this year:

Global Financial Asset Portfolio

YTD: 6.89%

Annualized return: 7.88%

Std dev: 5.41

Sharpe Ratio: 1.78

We can compare that to the S&P 500 just for some further perspective:

S&P 500

Year to date performance: 12.85%

Annualized Return: 14.73%

Standard deviation: 12.02

Sharpe Ratio: 1.53



Just a bit of global perspective for you.

* Yes, I know that quantifiable risk as standard deviation has limitations as does the use of Sharpe ratio, but these concepts at least provide us with some easily quantifiable metric by which we can analyze portfolios.   

Understanding Money

Just letting readers know that I’ve updated the “Understanding Money” section on the Orcam website.  My goal is to make this a comprehensive section of the site helping people better understand money, finance and economics.  If you have anything you’d like me to write about or if there are additions to the site that you think would be helpful then please email me at cullenroche AT or shoot me a message on Twitter.

I hope you find it helpful.

Assessing the Ray Dalio/Tony Robbins Portfolio

I was intrigued by this article on Yahoo Finance by Tony Robbins who cites his interview with Ray Dalio in his upcoming book.  I ordered the book despite the fact that the blurbs in the back struck me as outlandish.  For instance, the back cover says:

“Learn how you can apply a never-before-revealed investment strategy from the world’s largest hedge fund manager that has made money even when the markets crashed”.


“Invest like the wealthy where you participate in market gains but are guaranteed to never lose when the market drops”.

Yes, my eyes are rolling.  But let’s explore this in more detail before we just shrug it off.

First, the “never-before-revealed” strategy is Ray Dalio’s All Weather strategy.  It’s most certainly been revealed and widely distributed to those who actually track this stuff so “never” revealed is obviously just catchy terminology. In fact, there are now several funds that claim to do some version of this approach.  But look at what Robbins actually recommends in the article based on Dalio’s thinking – it’s a 55% bonds, 30% stocks, 15% commodities portfolio.  So let’s assess this a bit.

First, this is not the actual All Weather portfolio.  Dalio has been known to use dozens and more non-correlating assets.  In fact, Dalio is on record saying that the key to the approach is finding 15 or more sources of non-correlated returns:

“If you have 15 or more good, uncorrelated return streams — the math of that is such that if you go from 1 to 2 uncorrelated return streams. That you will reduce your risk by about 80% at about 15. And there’s a certain math to it; there’s a certain structure to it.”

The Yahoo Finance portfolio has 3, maybe 4 drivers.  This portfolio is just cookie cutter stocks, bonds and commodities.  There’s really nothing fancy going on here at all.

Second, the All Weather portfolio utilizes leverage to achieve risk parity.  Therefore, it’s obvious that the Yahoo Finance portfolio is not using the same degree of strategic diversification that Dalio implements in the All Weather portfolio.

Third, this portfolio is just a bond heavy portfolio.  Robbins mentions how “astonished” he was by the “back-tested” results of the portfolio.  Well, of course a bond heavy portfolio will perform well during the greatest bond bull market of the last 100 years.  And as I often mention, this is one of the dangers of back-testing.  The idea that that future will necessarily look like the past is ludicrously misleading.  And yes, bonds will not come close to generating the types of returns in the coming 30 years that they have in the past 30 years.  You just need an ounce of common sense to know that.

I hate to rain on the parade here (not like it matters since the book is selling so well), but this is not a newly revealed approach and it most certainly will not “guarantee” that you make money in the future.  In fact, if I had a gun to my head I’d bet the ranch that this bond heavy portfolio with a commodity tilt generates sub-optimal returns going forward.  We know that because the math on the low bond yields and the negative real returns of commodities makes it a high probability bet.

So please be careful reading this – I know the allure of a market guru can be strong.  But this portfolio is not a true representation of Ray Dalio’s All Weather portfolio so don’t go running into this idea thinking that you’ve found some “guarantee” of high returns.  That said, I look forward to reading Tony’s book.  I am sure there are tons of valuable insights in the book.


Some Thoughts on Risk Parity

The Investor’s Conundrum

Grantham’s Prudent Investor Portfolio

I found this section of GMO’s latest quarterly letter to be of particular interest.  Grantham discusses a “prudent investor” portfolio that can provide decent risk adjusted returns in a tough environment:

“Exhibit 1 shows an example of a portfolio that might be used in a world that excludes private equity and venture capital, and for a client who can do without a benchmark and can settle for owning a (hopefully) sensible long-term efficient portfolio.  Efficient, that is, in terms of trying to minimize risk per unit of estimated returns. As always, and particularly in this type of overpriced environment, there are no guarantees of success even if every GMO recommendation were to be implemented for, regrettably, we too are often imperfect.”


Hard to say what all of that amounts to precisely, but it’s logical that “alternative” could be option based strategies since Ben Inker spent quite a bit of time earlier in the note discussing those approaches.  Cash plus is just utilizing cash like a call option in all likelihood.  It’s impossible to properly judge a portfolio like this because we don’t know the actual components, but my guess is that it would perform a lot like a 60/40 with lower returns and slightly lower risks.  But that’s just a guess.  Anyhow, lots of good moving parts there to think about.  Read the full letter here.