Episode #103: The Asset Allocation Pyramid
Guest: Episode #103 has no guest. It’s a Mebisode.
Date Recorded: 4/19/18 | Run-Time: 24:43
Summary: We just finished a short paper that references the old nutritional “Food Pyramid” published by the FDA a couple decades ago. Given what we’ve learned about health-conscious eating in the years since, that old guideline now seems a bit off-base. In the same way, the investing wisdom of yesteryear now seems similarly misguided. Meb walks us through the white paper that delves into these ideas in this short, just-Meb episode, identifying how his “Investment Pyramid” looks today.
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Links from the Episode:
- 1:45 – Welcome and two announcements from Meb
- 2:04 – Most of Meb’s books are now free!
- 2:38 – Make sure you go to unclaimed.org and get money that is being held in state government coffers
- 4:17 – The Investment Pyramid
- 4:30 – The old Food Pyramid
- 6:37 – Blockchain analogy
- 7:14 – How the food pyramid applies to investing
- 8:42 – What your investment pyramid should look like today
- 10:16 – Sponsor: Inspirato
- 11:30 – Going through each layer
- 11:32 – Don’t do dumb things
- 12:16 – Proper diversification
- 13:16 – Have a rules-based plan
- 14:04 – “Office Hours Summary…You Are Not Alone” – Faber
- 14:08 – Implement with low cost funds and brokerage
- 15:14 – “Would You Pay Your Advisor $1,000,000 In Fees?” – Faber
- 15:17 – Implement tax aware investing
- 15:56 – “How Much Are Those Dividends Costing You?” – Faber
- 16:03 – Tilt away from market cap weights
- 17:33 – The personal finance pyramid
- 18:29 – Vanguard agrees to get your house in order first
- 19:10 – Breaking down the personal financial pyramid
- 19:13 – Fund an emergency account and pay down debt
- 19:25 – Business Insider article
- 20:28 – Track expenses, set a budget and save
- 20:57 – Max out your retirement
- 21:27 – Maybe buy a home
- 21:39 – Elroy Dimson Podcast Episode
- 21:44 – Global Investment Return Yearbook – Dimson, Staunton, Marsh
- 22:54 – Address your investments
- 23:15 – “The Best Way to Add Yield To Your Portfolio” – Faber
Transcript of Episode 103:
Welcome Message: Welcome to ‘The Meb Faber Show’, where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber’s the co-founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Sponsor: Today’s episode is brought to you by Inspirato, provider of the world’s most exclusive vacation homes. I just joined Inspirato, and I can tell you they go way beyond a typical vacation rental. It’s all the best parts of a vacation house. The space, the privacy, the kitchen and dining room, combined with the service you’d expect from a five-star hotel. That means premium linens and furnishings, plus daily housekeeping, an on-site concierge and much more. It really is the best of both worlds. From Turks and Caicos to Tuscany, you’ll find consistent luxury. Right now, our listeners can receive a thousand bucks towards their first trip to one of their exclusive vacation homes when they become an Inspirato member. You can call 310-773-9474 and mention Meb Faber. Or visit inspirato.com/mebsentme to learn more. That’s inpirato.com/mebsentme.
Meb: Welcome podcast listeners. Today we have Mebisode. That means no Jeff, no guests, just me, the melodic sound of my beautiful voice. We’re gonna read a new investment research piece that may or may not even be out by the time this podcast hits the air. So if not, you’re getting an early look. Before we get started, two announcements. One, all my books are free to download. All my ebooks, I control. So that’s four of them: ‘Shareholder Yield’, ‘Global Value’, ‘Global Asset Allocation’, and ‘Invest With the House’ are all free to download at cambriainvestments.com. If you’ve been following me on Twitter and on the blog, you know my increasing frustration with all the scams and nonsense going on on Amazon. I’ve had enough, I don’t care anymore, I’m foregoing all sorts of future revenue. Actually not that much. But making all of my books free. So if you go to cambriainvestments.com you can download those. Have at it. Let me know what you think.
Second, we just passed tax day. So what does that mean other than you being sad for sending all your hard-earned coin to the government? It means it’s my annual reminder to check out, see if any of the state governments have any of your property that’s being missing. So if you go to unclaimed.org, you can search your name, your parents’ name, your siblings, your children, anyone, hopefully not your ex-girlfriends, but search them. There’s billions of dollars sitting in state government coffers. Usually it’s a lost dividend or when you moved, your utility bill was overpaid, but we’ve had listeners and readers find over half a million dollars to date.
Which is incredible. We were tweeting the other day and adding it up, and we were getting to 30, 40, 50,000. We even had a financial advisor email in and said he’s found over $150,000 for his clients in lost assets. And I guarantee you, if you’re an advisor, there’s nothing that clients like more than you finding them found money, especially because it comes from the government. So it was really great to hear a bunch of people email, tweet. If you don’t believe me by the way, go look at my Twitter stream. A lot of people finding 100, 1,000, we had someone find $8,000. So if you guys find anything meaningful, well over 100, but certainly 1,000 or 10,000, you owe me a beer or you can send Jeff and I a present and we’ll certainly give you a shout out on the podcast. But anyway, see what you find, it’s fun and who knows, you may hit the jackpot. We’ve had, the highest single finding so far is a family that had a trust they didn’t know about. It was $80,000. Check it out, let me know what you find, even if it’s five bucks.
All right. So what’s our research piece today? We haven’t decided on a name, and so this may be a little rough. But in general, here’s the three ideas. It’s either gonna be called ‘Your Investment Diet’, ‘The Investing Pyramid’, or perhaps ‘The Asset Allocation Pyramid’. And usually, you don’t wanna use the word pyramid when referring to anything investment related. So maybe we’ll change it. But those are the three ideas. Let me take a swig of Diet Mountain Dew and then we’ll get started.
All right, if you’re over the age of 30, you probably remember the USDA’s food pyramid. It represented the best thinking at that time as to how Americans should structure their diets for optimum health. And in the piece, we then have a picture of this pyramid. And if you’re young and you may not remember this, just picture a big triangle, something like the Egyptian pyramids. And at the base, there’s about four layers of this triangle. The base is what most, what at the time what the USDA thought, the government thought most Americans should consume most of their calories from. And the next level with less, all the way up to the top, which should be used sparingly.
In the pyramid, the base level was bread, cereal, rice, and pasta. You should have 6 to 11 servings. Next up, fruit and vegetables, okay, that’s pretty good. Following then, meats, poultry, fish, dry bean, eggs, nuts, and that one’s in parallel with milk, yogurt, and cheese. And at the top, fats, oils, and sweets used sparingly. So, I’m not sure what the correct diet is for most people, but consuming most of your calories from muffins, pasta, bagels, and cereal, it’s probably not it. Is the correct diet Paleo? If so, the old food pyramid is exactly upside down, where you’re supposed to get a lot of your calories from protein and fats. Or is it the Mediterranean diet, in which case, it’s more sideways. Perhaps the right answer is simply caloric restriction and intermittent fasting. In which case, any food allocation is likely just too big by a third. So, whatever the ultimate right answer is, we know one thing for sure, we’re closer to it today than we were 30 years ago. The more we learn about nutrition, human metabolism, and genetics, the better we get at creating a healthy diet.
This is not to suggest that there aren’t discrepancies in the literature. One week we’re told that consuming large amounts protein is good for us, the next, maybe it’s terrible. But food research and nutrition science paint a more nuanced picture of the body, and with that, create more informed conversations about what constitutes a healthy diet. Of course, having the discipline to implement that diet, totally a separate issue. So the other day I heard an analogy from Nimal Ravikant [SP] who was talking not about food pyramids, but about blockchain technology. And in the analogy he referenced the way that amber layers compound, so think back to the old Jurassic Park, with the mosquito stuck in amber and many layers sort of surrounding that mosquito. So, how they build upon previous layers. And so, I believe there’s a similar cumulative dynamic when it comes to learning. The food pyramid from yesterday, though flawed, was a requisite layer from which our nutrition is built, moving us closer to the healthier diets of today. In essence, yesteryear’s mistakes became the foundation for today’s breakthroughs. What does this have to do with investing? Well, similar to the food pyramid, the best investment thing you had 50 years ago probably seems a little bit silly and outdated to us now, given the layers of knowledge that have accumulated in the years since. So for instance, 50 years ago, the investing pyramid probably looked like this. And we have another pyramid, and I’ll start from the bottom and go to the top.
So the bottom and the base of the pyramid was you’re probably counting on your employee defined benefit retirement plan as well as social security. You actually don’t have those defined benefit plans nearly as much today. In the next layer, you probably call your reputable broker from EF Hutton, maybe Dean Witter, and have him suggest some U.S. stocks and bonds. Next layer up, you probably then buy a basket of blue chip U.S. stocks that pay a good dividend. Next up, you probably follow the advice of family members, neighbours, get their suggestions, and then at top, you may invest in some talented star mutual fund manager. So you could argue a number of different variations of this pyramid, but I think it’s in the ballpark. Ideas like modern portfolio theory, buy and hold, Nifty 50, were all part of the conversation at the time. So one could make the case that buying a home and utilizing your pension should be included. But they may fall more into the personal finance arena, I don’t know. Given that, we’ll come back to them later. As for now, I wanna focus on blue blood investing concepts.
So the above pyramid is likely what our parents and/or grandparents considered good investment protocol back in the day. However, we’ve learned a great deal about investing in the subsequent years, not just through academic papers and books, but practitioner experience as well. So what should the food pyramid look like today? So here’s my slightly biased opinion as to what your investment diet, what your investment pyramid should look like. I think the base should be ‘Don’t do dumb things’. Meaning, don’t put all of your portfolio into one stock. Don’t take on a bunch of debt to buy cryptocurrencies, etc., etc. Basically, do no harm. The next level, I think you want a global portfolio across stocks, bonds, and real estate. You want all the ingredients, then go into a cookie, baking, and I think without any of those, your portfolio is potentially sub-optimum.
Next, you wanna have a rules-based plan and rebalance accordingly. We talk a lot about this, the references to a quarterback going to the line of scrimmage. You wanna have the plan ahead of time, so you’re not making decisions on the fly. Next, you wanna implement these first three layers with low-cost funds, through low-cost brokerage and trading. So all the costs, minimise as much as you can. We’ve seen in the last, particularly 10 years, but really in the last 10 to 20 how important fees are. More and more literature’s coming out there. Next, you wanna make sure you implement this in a tax-aware way. So whether you use tax loss harvesting, whether you put different investments in taxable accounts and tax exempt, etc. you wanna be very mindful of taxes because they are important too. And lastly, when you start to get to the top of the pyramid, then you start to do what we call a lot of the tilts. Tilting towards value, tilting towards momentum, maybe using trend following, a lot of these approaches that add value, but kind of building the base and a lot of these things ahead of it are probably more important.
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Meb: So let’s briefly touch on each layer. When we said, ‘Don’t do dumb things’, the foundation of a long-term healthy portfolio is in many ways simply avoiding a self-inflicted explosion. We’ve all read the studies and aware that left to ourselves, we’ll often find a way to vastly underperform investment benchmarks. However, many of us still can’t seem to get out of our own way. Whether we chase the latest hot stock, double down on the trainwreck investment because it just has to bounce soon, or getting swept up in a herd mentality buying frenzy, when fundamentals are screaming the opposite, we still find ways to hurt ourselves. You begin to avoid these outcomes with the help of two things, awareness and certainly humility. Awareness is no more than simple recognition that you’re inclined to hurt your portfolio. Humility is what enables you to accept that reality and to seek a better way. Which leads to our next layer, diversifying globally across stocks, bonds and real assets. So that’s self-explanatory and simple. So everyone does it, right? Unfortunately, no. The portfolios of most investors manifest an abundance of home country bias. This isn’t a uniquely an American phenomenon. It happens across almost every country around the globe. We’ve talked a lot about this on the pod and in our free book, ‘Global Asset Allocation’. The problem is home country bias isn’t patriotic, it’s dangerous and exposes your wealth to unnecessary risks. You can just ask the Chinese and Russian investors who lost everything when their governments turned communist last century and shut down the stock markets. Or ask Japanese investors who saw their stock market go sideways for decades. Or even more recently, ask Russian, Greece and Cypriot investors who had massive drawdowns in their stock markets. Of course, diversifying by geography isn’t the only challenge. The kind of robust portfolio will help you sleep at night requires proper asset diversification as well. For instance, many investors are overweight in equities. That’s been great for the last nine years. What about the next nine?
So the next layer, have a rules-based plan and re-balance accordingly. But what are you gonna do when one of your assets drops 40%? What about when another one out-performs and begins to dominate your portfolio weighting? What happens if you inherit half a million bucks, how are you gonna put it to work? How will your allocations change as you approach retirement? For most of us, portfolios aren’t a set it and forget it thing. They require a bit of maintenance. Fortunately, this doesn’t have to take up tons of time. A yearly checkup might be all that’s required. But the idea is simply to have an awareness of where you want your portfolio to take you. Engineer it for that result, then establish regular diagnostics to make sure it’s accomplishing its purpose. The question becomes, do you have a written-down plan? I’m sure the answer for most of you is no. We’ve talked about this a lot. So get on it. We’ve covered this topic recently in our article, ‘You Are Not Alone’. Check it out. We’ll put a hyperlink in the show notes.
Next layer, implement with low-cost funds and a low-cost brokerage. This is a wonderful time to be an investor. In the past several decades we’ve seen an investment cost gutted. Broker commissions used to cost hundreds or even thousands of dollars per trade depending on your investment size. Today, it’s a fraction of that. The advent of ETFs and other aggregated investment products give investors exposure to broad asset classes that weren’t even possible 30 years ago. We have it easy compared to our parents and grandparents. Yet too many investors are still paying far too much for no good reason. For instance, do you know there’s an SP index fund that still charges over 2% when you could buy practically the same thing for less than 0.05%? Essentially free at this point. And what about advisors? How much are you paying yours? Don’t misunderstand, many advisors are worth every penny they charge. Yet others that do not offer value-added services outside of asset allocation, not so much. Unless right now, in the moment, you know exactly how much you’re paying your advisor and paying for your funds and you’re confident it’s a worthy expense, there’s a chance you’re overpaying. Check out an old article on the topic, ‘Would you pay your advisor $1 million in fees’?
Next level, implement tax-aware investing. One of the great final frontiers in investing is capturing the elusive tax alpha, or rather, reducing its injurious effects. Rob Arnott of Research Affiliates recently gave a wonderful presentation on the subject, we’ll hyperlink. One of the takeaways with the effect of taxes based on portfolio turnover and how much the alpha was [inaudible 00:15:38] simply to break even due to this turnover. And there’s another great piece from Morningstar, we’ll hyperlink. So, how often do we think about this? How often do we implement this reality into our aforementioned investment plan? Are your various investments domiciled in the right accounts? Taxable versus tax exempt. This is another reason, by the way, to never hold high yield dividends stocks in taxable accounts. Shame on you. We’ve got another link there.
Next step in the layer, tilt away from market cap weights. If you’ve followed me for any length of time, you’re likely aware of my preference of practically anything other than a market cap weighting. Why invest purely due to size? In my opinion, and that of many experts out there, tilting towards value and momentum and trend will likely lead to far better long-term performance.
So what’s your pyramid? I’m not claiming my pyramid is the investment pyramid. There’s obviously a million ways to approach investing. They’re probably as different from one another is the Paleo diet is from the Mediterranean diet. Heck, you could only have one layer on the pyramid which is like invest in a bunch of bank CDs, and that’s totally fine if it fits your needs. Same way a lot of diets are totally fine if it fits your body type and person. And probably 50 years from now, we’ll probably find out that there are certain diets for certain people, and probably better investment plans for others as well. So as our collective knowledge has compounded over the years it’s hopefully made all of us better investors than we’d otherwise be. Given this, whatever investment approach you choose today, and its associated pyramid, it’s still likely to share most of the same broad elements as mine, differing mostly in the specific weightings of those elements. That’s great because as long as you get the big muscle movements in investing correct, the rest generally takes care of itself. In other words, thanks to those that have come before us, even the misguided investing pyramids today hopefully put the broad pieces in place. We’ll check back in 50 years. And you know, my allocation, and we talk publicly about how I invest my money, is the Trinity Portfolio, but who knows? Maybe crypto will be your new base.
But let’s talk about the personal finance pyramid. Because now to this point, we’ve been focused purely on investing. But for many people, the impact of personal finance choices swamps that of investment choices. And I’m of the opinion that the vast majority of people should spend near zero time on their investments. This is because, for the average person, the demand on the household’s free cash flow is so high, that the amount of money usually left over after expenses which might be allocated to investing is so small that it will have little overall lifestyle impact, and at least for many years, until the power of compounding might take over the heavy lifting.
Indeed, the average person’s personal finance pyramid and investment allocation would likely occupy only the highest level of that pyramid. In other words, only once you get your house in order do your investments come into play. That doesn’t mean that investing decisions aren’t worth considering. But for most, the basic day-to-day financial decisions make the most difference. And Vanguard agrees, and there’s a nice hyperlink there. So below, we might examine what an effective personal finance pyramid might be for most individuals. So, if you look at the bottom layer, something like fund an emergency account, and also pay down or eliminate high-interest debt. Maybe above that, track expenses, set a budget and save. Above that, max out your retirement in tax-exempt investment accounts. Above that, maybe buy a home if it’s reasonable. We often say that there’s a lot of great reasons to buy a home, not necessarily financial ones. And above that, finally, you get to addressing your investments. So you can kinda see the investment pyramid moving into the top level of the overall financial pyramid. So let’s quickly touch on these as well, same way we did with the investment one.
First of all, fund an emergency account. Pay down or eliminate high-interest debt. So at the bottom, we’re just trying to create a solid foundation. Some cash in the bank and an escape from crippling debt payments. There’s a recent article in Business Insider that reported that Americans under 35 had just $1,500 saved. What happens when someone runs into a stop sign and plows into your car? You break few bones, and 1,500 bucks, that probably vapourises. Having enough money to cover emergencies is a first step. And then once you have a few bucks in the bank, paying off your high-interest debt is also important. How are you supposed to build up your own reserves when all your money’s going to your lenders? I read David Ramsey recommend to his listeners they should pay off smaller debt amounts first rather than high-interest accounts in order to build momentum to get some quick wins on closing down your debts. But by the numbers, choosing high-interest accounts first is the smarter way to go. But if paying off smaller accounts is the behavioral trick needed to get moving, I’m all for it. He calls it ‘The Snowball Approach’. The most important takeaway is simply escaping any kind of toxic debt. And if you think about it, if you have debt that costs you 10, 15, 20%, that is a guaranteed 10, 15, 20% return just paying it down. What are the chances you’re gonna get a 10, 15, 20% return on the stock market or investing? Probably pretty hard.
Next, track expenses, set a budget, and save. Personal finance 101, so I’m not gonna spill tons of ink and words here on it. But first, know what you’re spending your money on right now. In order to do that, you have to track where your dollars are going. Should you be spending your money as you’re doing currently? Once you make that decision, set a budget that makes saving money a priority. After all, if you’re spending everything you make on basic day-to-day living, where will the dollars be you’ll need to come from when it comes time to fund the other layers of the pyramid? Next, you need to max out retirement and tax-exempt investment accounts. A 401(k) employer match is free money, and to the extent you can, fund up to the match limit to take advantage of this great perk. Plus, allocating your retirement plan maximises the ability of your investing dollars to compound for you. This advice might seem obvious, but something like two-thirds of Americans aren’t saving any money in a 401(k). Vanguard claims that just 4% of people earning below 50K max out their 401(k). For people earning between 50 and 100K, that number climbs to just 11%.
Next up, think about buying a home. For years, the common belief is purchasing a home is the ultimate investment. It might be the ultimate emotional investment, but numbers don’t really support the first takeaway. Professor Dimson, who we just had on the podcast in conjunction with some of his co-authors, came out with the global investment yearbook 2018 and this new edition includes new data on residential real estate with some sobering statistics. First, as many of us will all too well remember, in the U.S., house prices fell by more than a third in real terms during the last global financial crisis. Certainly a tough drawdown for anyone who’d been cash poor, house-rich during that time. What about longer term appreciation? Isn’t your home a great wealth generator in the long term? On average, it’s not. The article, which we’ll put in the show notes, shows the average long-term yearly returns from residential real estate for the past 120 years, about 1.3%. Now that’s real after inflation, but really that’s kind of like a bond-like yield. And then that’s, by the way, that’s separate if you then rent out that house, then you get up to stock-like yields. But if you’re buying a house, the appreciation is roughly in line with bonds. Not bad, and a totally reasonable investment to make. Particularly if you’re gonna spend that money elsewhere, it’s nice for a lot of people because it’s an automated savings vehicle. But if you’re looking at it for pure investment appreciation, it’s probably not the best place. So there’s a lot of reasons why investing in a home may make sense, but assuming great returns is one of them could be solely misinformed.
So the next level, finally and only finally do you actually investment decisions come into play. And think about that, the entire pyramid at the onset of the paper only occupies the top level of this new personal finance pyramid. Yet so many of us spend tons of time languishing over the market decisions, and I’ve said before, I don’t believe this is the best use of your time or mental energies. We did a piece which we’ll link in the show notes called ‘The Best Way to Add Yield to Your Portfolio’, and basically demonstrated that unless you have about $10 million or more, you should basically be spending almost no time on your investments. That time is better spent, used elsewhere. So how do your investment and personal finance pyramids look? Do you have one? Full disclosure, this article has been camouflaged way of hitting upon an important point I’ve made many times, yet from a new angle. The critical importance of having a deliberate plan for your money, whether investing money, or personal finance money. It could be a formally written down investment plan, or a goofy personal finance pyramid graphic. The takeaway’s the same, where are your dollars going, in what order, and why. It aligns with the old saying, ‘Show me your calendar and your chequebook, and I’ll show you what you really care about’. So many of us are flying blind out there, but by taking a few extra minutes to write down your own plan of attack, it doesn’t have to be you.
All right. Thanks for listening, friends. That wasn’t too bad, only 20 minutes. And if you’re listening to me at 2X, that’s hey, that’s probably only 10 minutes. We’ll wrap it up and wanted to say you can always find the podcast at mebfaber.com/podcast. You can download and listen to the episodes, we love the reviews, we read all of them, I promise. I’m using a new app currently, ‘Breaker’ is the new one we’re checking out. Hope it’s got some ratings, so hopefully, rate some of our episodes, let us know what you think. Thanks for listening friends, and good investing.