Photo Credit: Carl Wycoff || It is a long way to the end of retirement.  People are getting ready for it.  Are you?


Assuming that you could throw stones on the financial internet, it would be hard to toss a stone and miss articles talking about how high the stock market is.  One good article from last week was Why Do U.S. Stocks Keep Hitting Records? Here Are Five Theories from the Wall Street Journal.  Here were the five theories:

  1. Stocks Reflect the Resurgent Health of American Corporations
  2. The Global Outlook Is Looking Brighter
  3. The U.S. Economy Is in a ‘Goldilocks’ Situation
  4. Passive Funds Are Propping Up Prices
  5. There Is No Alternative

Of this list, I think answers 1, 3 and 5 are correct, and 2 and 4 are wrong.  I have a few other answers that I think are right:

  1. Demographics are leading people to buy assets that will provide long-term cash flows. Monetary policy has led to asset price inflation, not goods price inflation.
  2. People are overestimating the resiliency of the political and social constructs that make all of this possible.
  3. The “Dumb Money” hasn’t arrived yet, but the sale of volatility by retail contradict that.

I disagree with point 2 from the WSJ article because a stronger global economy not only means that profits will rise, but also the cost of capital.  Depending on which factor is stronger, a stronger global economy can make stocks go up, down, or be neutral.

On point 4, I’ve written about that in Overvaluation is NOT Due to Passive Investing.  What matters more than the active/passive mix is the total shift in portfolio holdings into stocks versus everything else.  When people hold a lot of their portfolio in stocks, stock prices tend to be high.

The active/passive mix does have effect on the relative prices of securities in the indexes versus outside the indexes. The clearest place to see the impacts of ETFs and indexing is in bonds, where bonds that are in the indexes trade at lower yields and higher prices than similar non-index bonds.

With stocks, it is probably the same, but harder to prove; I wrote about this here.  In the short run, the companies in the popular indexes are getting a tailwind. That will turn into a headwind at some point, because the voting machine always eventually becomes a weighing machine.

Why are stocks high?

Profit margins are high because of productivity increases from the application of information technology.  Also, there is a lot of lower paid labor to employ globally which further depresses wage rates in developed countries.

Points 3 and 5 of the WSJ article are almost saying the same thing.  Interest rates are low.  They are low because inflation is low,, and general economic activity is not that robust.  As such, the cost of capital is low, people are willing to pay high prices for stocks and bonds relative to their cash flows.

Part of this stems from demographics, which was my first additional point.  For those that are retired or want to retire, there aren’t a lot of ways to transfer money earned in the present so that you can get the equivalent purchasing power or better far into the future.  There are a few commodities that you can store, like gold, but most can’t be stored.  Thus you can buy bonds if you don’t think inflation will be bad, or inflation-protected bonds if you can live with low real returns.  Money market funds will keep your principal stable, but also provide little return.  You can buy stocks if you are willing to get some inflation protection, and run the risk of a rising cost of capital at some point in the future.  Same for real estate, but substitute in rising mortgage rates.

A shift can happen when the marginal dollar produced by monetary policy shifts from being saved to being spent.  For now, monetary policy inflates asset prices, not goods prices (much).

My second point says that people are willing to spend more on stocks when they think that the system will remain stable for a long time.  That seems to be true today, but as I have pointed out before, it discounts the probability of trade wars, real wars, resurgent socialism, and bad future demographics.  Nations with shrinking populations tend to have poor asset returns.  Also, nations with unproductive cultures don’t tend to make economic progress.

My third point is equivocal.  I don’t see a lot of people yelling “buy stock!”  There’s a lot of disbelief in the market; this is what Jason Zweig was talking about in his most recent WSJ column.  That said, when I see lots of activity from people shorting volatility through exchange traded products in order to earn returns, it makes me wonder.  As I have said before, “Nothing brings out the financial worst in people like the lure of seemingly free money.”  Eventually those trades sting those that stay at the party too long.

So, where does that leave me?  The market is high, as my models indicate.  It may remain high for a while, and may get higher still.  That said, it would be historically unprecedented to remain in the top decile of valuations for more than three years.  It would be healthy to have the following:

  • A garden-variety recession
  • A garden-variety bear market
  • More varied sector/industry performance

Will we get any of those?  I don’t know.  I can tell you this, though.  For now, my asset allocation risk is on the low side for me, with stocks at around 70% (that is high for most people, but that is how I have lived my life).  If we get over the 95th percentile of valuations, I will hedge what I can.  For now, I reluctantly soldier on.

Picture Credit: Denise Krebs || What RFK said is not applicable to investing.  Safety First!  Don’t lose money!


Investment entities, both people and institutions, often say one thing and mean another with respect to risk.  They can keep a straight face with respect to minor market gyrations.  But major market changes leading to the possible or actual questioning of whether they will have enough money to meet stated goals is what really matters to them.

There are six factors that go into any true risk analysis (I will handle them in order):

  1. Net Wealth Relative to Liabilities
  2. Time
  3. Liquidity
  4. Flexibility
  5. Investment-specific Factors
  6. Character of the Entity’s Decision-makers and their Incentives

Net Wealth Relative to Liabilities

The larger the surplus of assets over liabilities, the more relaxed and long-term focused an entity can be.  For the individual, that attempts to measure the amount needed to meet future obligations where future investment earnings are calculated at a conservative level — my initial rule of thumb is no more than 1% above the 10-year Treasury yield.

That said, for entities with well defined liabilities, like a defined benefit pension plan, a bank, or an insurance company, using 1% above the yield curve should be a maximum for investment earnings, even for existing fixed income assets.  Risk premiums will get taken into net wealth as they are earned.  They should not be planned as if they are guaranteed to occur.


The longer it is before payments need to be made, the more aggressive the investment posture can be.  Now, that can swing two ways — with a larger surplus, or more time before payments need to be made, there is more freedom to tactically overweight or underweight risky assets versus your normal investment posture.

That means that someone like Buffett is almost unconstrained, aside from paying off insurance claims and indebtedness.  Not so for most investment entities, which often learn that their estimates of when they need the money are overestimates, and in a crisis, may need liquidity sooner than they ever thought.


High quality assets that can easily be turned into spendable cash helps make net wealth more secure.  Unexpected cash outflows happen, and how do you meet those needs, particularly in a crisis?  If you’ve got more than enough cash-like assets, the rest of the portfolio can be more aggressive.  Remember, Buffett view cash as an option, because of what he can buy with it during a crisis.  The question is whether the low returns from holding cash will get more than compensated for by capital gains and income on the rest of the portfolio across a full market cycle.  Do the opportunistic purchases get made when the crisis comes?  Do they pay off?

Also, if net new assets are coming in, aggressiveness can increase somewhat, but it matters whether the assets have promises attached to them, or are additional surplus.  The former money must be invested coservatively, while surplus can be invested aggressively.


Some liabilities, or spending needs, can be deferred, at some level of cost or discomfort.  As an example, if retirement assets are not sufficient, then maybe discretionary expenses can be reduced.  Dreams often have to give way to reality.

Even in corporate situations, some payments can be stretched out with some increase in the cost of financing.  One has to be careful here, because the time you are forced to conserve liquidity is often the same time that everyone else must do it as well, which means the cost of doing so could be high.  That said, projects can be put on hold, realizing that growth will suffer; this can be a “choose your poison” type of situation, because it might cause the stock price to fall, with unpredictable second order effects.

Investment-specific Factors

Making good long term investments will enable a higher return over time, but concentration of ideas can in the short-run lead to underperformance.  So long as you don’t need cash soon, or you have a large surplus of net assets, such a posture can be maintained over the long haul.

The same thing applies to the need for income from investments.  investments can shoot less for income and more for capital gains if the need for spendable cash is low.  Or, less liquid investments can be purchased if they offer a significant return for giving up the liquidity.

Character of the Entity’s Decision-makers and their Incentives

The last issue, which many take first, but I think is last, is how skilled the investors are in dealing with panic/greed situations.  What is your subjective “risk tolerance?”  The reason I put this last, is that if you have done your job right, and properly sized the first five factors above, there will be enough surplus and liquidity that does not easily run away in a crisis.  When portfolios are constructed so that they are prepared for crises and manias, the subjective reactions are minimized because the call on cash during a crisis never gets great enough to force them to move.

A: “Are we adequate?”

B: “More than adequate.  We might even be able to take advantage of the crisis…”

The only “trouble” comes when almost everyone is prepared.  Then no significant crises come.  That theoretical problem is very high quality, but I don’t think the nature of mankind ever changes that much.


Pay attention to the risk factors of investing relative to your spending needs (or, liabilities).  Then you will be prepared for the inevitable storms that will come.

What could be more a propos to investing than a bubble spinner?

What could be more à propos to investing than a bubble spinner?


A letter from a “reader” that looked like he sent it to a lot of people:

Hello my name is XXX,
After looking through your website I have really been enjoying your content.
I am also involved in the investing space and wanted to ask a quick question.
I was curious as to what you think the biggest problems are for investors today?
For example do they not have enough investment choices? Do they just not have enough knowledge? Really anything that you have noticed.
I would love to hear your perspective on this. I really appreciate the help. If you have any questions feel free to ask. Thanks.

This was entitled “Love what your doing, my question will only take 2 minutes.”  I wrote back:

This is not a 2 minute question.

That said, it’s a decent question.  Here are my thoughts:

  • The biggest problem for investors is low future returns.  Bonds have low rates of returns, and equities have high valuations.  You’ll see more about equity valuations in my next post.
  • The second largest problem is investment monoculture — there is a handful of large cap growth stocks that dominate the major indexes, and there is a self-reinforcing cycle of cash flow going on now that is forcing their prices well above what can be justified in the long run.
  • Third is inadequate ability to diversify.  This is largely a function of the two problems listed before, and benchmarking and indexing, which has been correlating the markets more and more.  I’m not talking about short-term correlations — diversification applies of the time horizon of the assets, which is long.
  • Fourth is bad government and central bank policy.  The growth in government debt is the growth in unproductive capital, which drives the first problem.
  • Fifth, too many people are relying on investments to fund their future spending — that also exacerbates the first problem.

That’s all — if you can think of more, leave your suggestion in the comments.

PS — my apology to those I tweeted to on Friday about a post on equity valuations.  That will appear Saturday night.  Thanks.


This will be a short post, though I want to toss this question out to readers: what investment strategies do you know of that are simple, and work on average over the long-term?

Here are four (together with posts of mine on the topic):

1) Indexing

Index Investing is not Inherently Socialistic

Why Indexes are Capitalization-Weighted

Why do Value Investors Like to Index?

On Bond Investing, ETFs, Indexes, and the Current Market Environment

2) Buy-and-Hold

Buy-and-Hold Can’t Die

Buy-and-Hold Can’t Die, Redux

Buy and Hold Will Return — 2/15/2009 (what a time to write this)

Patience and a Little Courage

Risk vs Return — The Dirty Secret

3) The Permanent Portfolio

The Permanent Portfolio

Can the “Permanent Portfolio” Work Today?

Permanent Asset Allocation

4) Bond Ladders

On Bond Ladders

I chose these because they are simple.  Average people without a lot of training could do them.  There are other things that work, but aren’t necessarily simple, like value investing, momentum investing, low volatility investing, and a few other things that I will think of after I hit the “Publish” button.

That said, most people don’t need to work on investing.  They need to work on cash management, and I have written a small fleet of articles there.  Managing cash is simple, but it takes self-control, and that is what most people lack in their financial lives.

But for those that have gotten their cash under control, with a full buffer fund, the above strategies will help, and they aren’t hard.

Final note: I realize valuations are high now, so buy-and-hold is not as attractive as at other times.  I realize that interest rates are low, so bond ladders aren’t so great, seemingly.  Indexing may be overused.  Most of the elements of the Permanent Portfolio look unappealing.

But what’s the alternative, and simple enough for average people to do?  My answer is simple.  If they can buy and hold, these strategies will pay off over time, and far better than those that panic when things get bad.  There are few regularities in the markets more reliable than this.


I will admit, when I first read about the Permanent Portfolio in the late-80s, I was somewhat skeptical, but not totally dismissive.  Here is the classic Permanent Portfolio, equal proportions of:

  • S&P 500 stocks
  • The longest Treasury Bonds
  • Spot Gold
  • Money market funds

Think about Inflation, how do these assets do?

  • S&P 500 stocks – mediocre to pretty good
  • The longest Treasury Bonds – craters
  • Spot Gold – soars
  • Money market funds – keeps value, earns income

Think about Deflation, how do these assets do?

  • S&P 500 stocks – pretty poor to pretty good
  • The longest Treasury Bonds – soars
  • Spot Gold – craters
  • Money market funds – makes a modest amount, loses nothing

Long bonds and gold are volatile, but they are definitely negatively correlated in the long run.  The Permanent Portfolio concept attempts to balance the effects of inflation and deflation, and capture returns from the overshooting that these four asset classes do.

What did I do?

I got the returns data from 12/31/69 to 9/30/2011 on gold, T-bonds, T-bills, and stocks.  I created a hypothetical portfolio that started with 25% in each, rebalancing to 25% in each whenever an asset got to be more than 27.5% or less than 22.5% of the portfolio.  This was the only rebalancing strategy that I tested.  I did not do multiple tests and pick the best one, because that would induce more hindsight bias, where I torture the data to make it confess what I want.

I used a 10% band around 25% ( 22.5%-27.5%) figuring that it would rebalance the portfolio with moderate frequency.  Over the 566 months of the study, it rebalanced 102 times.  At the top of this article is a graphical summary of the results.

The smooth-ish gold line in the middle is the Permanent Portfolio.  Frankly, I was surprised at how well it did.  It did so well, that I decided to ask, what if we drop out the T-bills in order to leverage the idea.  It improves the returns by 1%, but kicks up the 12-month drawdown by 7%.  Probably not a good tradeoff, but pretty amazing that it beats stocks with lower than bond drawdowns.  That’s the light brown line.

ResultsS&P TRBond TRT-bill TRGold TRPP TRPP TR levered
Annualized Return10.40%8.38%4.77%7.82%8.80%9.93%
Max 12-mo drawdown-43.32%-22.66%0.02%-35.07%-7.65%-14.75%


Now the above calculations assume no fees.  If you decide to implement it using SPY, TLT, SHY and GLD, (or something similar) there will be some modest level of fees, and commission costs.


 What Could Go Wrong

Now, what could go wrong with an analysis like this?  The first point is that the history could be unusual, and not be indicative of the future.  What was unusual about the period 1970-2017?

  • Went off the gold standard; individual holding of gold legalized.
  • High level of gold appreciation was historically abnormal.
  • Deregulation of money markets allowed greater volatility in short-term rates.
  • ZIRP crushed money market rates.
  • Federal Reserve micro-management of short-term rates led to undue certainty in the markets over the efficacy of monetary policy – “The Great Moderation.”
  • Volcker era interest rates were abnormal, but necessary to squeeze out inflation.
  • Low long Treasury rates today are abnormal, partially due to fear, and abnormal Fed policy.
  • Thus it would be unusual to see a lot more performance out of long Treasuries. The stellar returns of the past can’t be repeated.
  • Three hard falls in the stock market 1973-4, 2000-2, 2007-9, each with a comeback.
  • By the end of the period, profit margins for stocks were abnormally high, and overvaluations are significant.

But maybe the way to view the abnormalities of the period as being “tests” of the strategy.  If it can survive this many tests, perhaps it can survive the unknown tests of the future.

Other risks, however unlikely, include:

  • Holding gold could be made illegal again.
  • The T-bills and T-bonds have only one creditor, the US Government. Are there scenarios where they might default for political reasons?  I think in most scenarios bondholders get paid, but who can tell?
  • Stock markets can close for protracted periods of time; in principle, public corporations could be made illegal, as they are statutory creations.
  • The US as a society could become less creative & productive, leading to malaise in its markets. Think of how promising Argentina was 100 years ago.

But if risks this severe happen, almost no investment strategy will be any good.  If the US isn’t a desirable place to live, what other area of the world would be?  And how difficult would it be to transfer assets there?


The Permanent Portfolio strategy is about as promising as any that I have seen for preserving the value of assets through a wide number of macroeconomic scenarios.  The volatility is low enough that almost anyone could maintain it.  Finally, it’s pretty simple.  Makes me want to consider what sort of product could be made out of this.


Back to the Present

I delayed on posting this for a while — the original work was done five years ago.  In that time, there has been a decent amount of digital ink spilled on the Permanent Portfolio idea of Harry Browne’s.  I have two pieces written: Permanent Asset Allocation, and Can the “Permanent Portfolio” Work Today?

Part of the recent doubt on the concept has come from three sources:

  • Zero Interest rate policy [ZIRP] since late 2008, (6.8%/yr PP return)
  • The fall in Gold since late 2012 (2.7%/yr PP return), and
  • The fall in T-bonds in since mid-2016 (-4.7% annualized PP return).

Out of 46 calendar years, the strategy makes money in 41 of them, and loses money in 5 with the losses being small: 1.0% (2008), 1.9% (1994), 2.2% (2013), 3.6% (2015), and 4.5% (1981).  I don’t know about what other people think, but there might be a market for a strategy that loses ~2.6% 11% of the time, and makes 9%+ 89% of the time.

Here’s the thing, though — just because it succeeded in the past does not mean it will in the future.  There is a decent theory behind the Permanent Portfolio, but can it survive highly priced bonds and stocks?  My guess is yes.

Scenarios: 1) inflation runs, and the Fed falls behind the curve — cash and gold do well, bonds tank, and stocks muddle.  2) Growth stalls, and so does the Fed: bonds rally, cash and stocks muddle, and gold follows the course of inflation. 3) Growth runs, and the Fed swarms with hawks. Cash does well, and the rest muddle.

It’s hard, almost impossible to make them all do badly at the same time.  They react differently to changes in the macro-economy.


There are a lot of modified permanent portfolio ideas out there, most of which have done worse than the pure strategy.  This permanent portfolio strategy would be relatively pure.  I’m toying with the idea of a lower minimum ($25,000) separate account that would hold four funds and rebalance as stated above, with fees of 0.2% over the ETF fees.  To minimize taxes, high cost tax lots would be sold first.  My question is would there be interest for something like this?  I would be using a better set of ETFs than the ones that I listed above.

I write this, knowing that I was disappointed when I started out with my equity management.  Many indicated interest; few carried through.  Small accounts and a low fee structure do not add up to a scalable model unless two things happen: 1) enough accounts want it, and 2) all reporting services are provided by Interactive Brokers.


Besides, anyone could do the rebalancing strategy.  It’s not rocket science.  There are enough decent ETFs to use.  Would anyone truly want to pay 0.2%/yr on assets to have someone select the funds and do the rebalancing for him?  I wouldn’t.

What a difference a quarter makes!  As I said one quarter ago:

Are you ready to earn 6%/year until 9/30/2026?  The data from the Federal Reserve comes out with some delay.  If I had it instantly at the close of the third quarter, I would have said 6.37% — but with the run-up in prices since then, the returns decline to 6.01%/year.

So now I say:

Are you ready to earn 5%/year until 12/31/2026?  The data from the Federal Reserve comes out with some delay.  If I had it instantly at the close of the fourth quarter, I would have said 5.57% — but with the run-up in prices since then, the returns decline to 5.02%/year.

A one percent drop is pretty significant.  It stems from one main factor, though — investors are allocating a larger percentage of their total net worth to stocks.  The amount in stocks moved from 38.00% to 38.75%, and is probably higher now.  Remember that these figures come out with a 10-week delay.

Remember that the measure in question covers both public and private equities, and is market value to the extent that it can be, and “fair value” where it can’t.  Bonds and most other assets tend to be a little easier to estimate.

So what does it mean for the ratio to move up from 38.00% to 38.75%?  Well, it can mean that equities have appreciated, which they have.  But corporations buy back stock, pay dividends, get acquired for cash which reduces the amount of stock outstanding, and places more cash in the hands of investors.  More cash in the hands of investors means more buying power, and that gets used by many long-term institutional investors who have fixed mandates to follow.  Gotta buy more if you hit the low end of your equity allocation.

And the opposite is true if new money gets put into businesses, whether through private equity, Public IPOs, etc.  One of the reasons this ratio went so high in 1998-2001 was the high rate of business formation.  People placed more money at risk as they thought they could strike it rich in the Dot-Com bubble.  The same was true of the Go-Go era in the late 1960s.

Remember here, that average returns are around 9.5%/year historically.  To be at 5.02% places us in the 88th percentile of valuations.  Also note that I will hedge what I can if expected 10-year returns get down to 3%/year, which corresponds to a ratio of 42.4% in stocks, and the 95th percentile of valuations.  (Note, all figures in this piece are nominal, not inflation-adjusted.)  At that level, past 10-year returns in the equity markets have been less than 1%, and in the short-to-intermediate run, quite poor.)

You can also note that short-term and 10-year Treasury yields have risen, lowering the valuation advantage versus cash and bonds.

I have a few more small things to add.  Here’s an article from the Wall Street Journal: Individual Investors Wade In as Stocks Soar.  The money shot:

The investors’ positioning suggests burgeoning optimism, with TD Ameritrade clients increasing their net exposure to stocks in February, buying bank shares and popular stocks such as Inc. and sending the retail brokerage’s Investor Movement Index to a fresh high in data going back to 2010. The index tracks investors’ exposure to stocks and bonds to gauge their sentiment.

“People went toe in the water, knee in the water and now many are probably above the waist for the first time,” said JJ Kinahan, chief market strategist at TD Ameritrade.

This is sad to say, but it is rare for a rally to end before the “dumb money” shows up in size.  Running a small asset management shop like I do, at times like this I suggest to clients that they might want more bonds (with me that’s short and high quality now), but few do that.  Asset allocation is the choice of my clients, not me.  That said, most of my clients are long-term investors like me, for which I give them kudos.

Then there is this piece over at called: Wall Street’s Buzz Over ‘Great Leader’ Trump Gives Shiller Dot-Com Deja Vu.  I want to see the next data point in this analysis, which won’t be available by mid-June, but I do think a lot of the rally can be chalked up to willingness to take more risk.

I do think that most people and corporations think that they will have a more profitable time under Trump rather than Obama.  That said, a lot of the advantage gets erased by a higher cost of debt capital, which is partly driven by the Fed, and partly by a potentially humongous deficit.  As I have said before though, politicians are typically limited in what they can do.  (And the few unlimited ones are typically destructive.)

Shiller’s position is driven at least partly by the weak CAPE model, and the rest by his interpretation of current events.  I don’t make much out of policy uncertainty indices, which are too new.  The VIX is low, but hey, it usually is when the market is near new highs.  Bull markets run on complacency.  Bear markets plunge on revealed credit risk threatening economic weakness.

One place I will agree with Shiller:

What Shiller will say now is that he’s refrained from adding to his own U.S. stock positions, emphasizing overseas markets instead.

That is what I am doing.  Where I part ways with Shiller for now is that I am not pressing the panic button.  Valuations are high, but not so high that I want to hedge or sell.

That’s all for now.  This series of posts generates more questions than most, so feel free to ask away in the comments section, or send me an email.  I will try to answer the best questions.


Late edit: changed bolded statement above from third to fourth quarter.


I am a fiduciary in my work that I do for my clients. I am also the largest investor in my own strategies, promising to keep a minimum of 80% of my liquid net worth in my strategies, and 50% of my total net worth in them (including my house, etc.).

I believe in eating my own cooking.  I also believe in treating my clients well.  I’ve treated part of this in an earlier post called It’s Their Money, where I describe how I try to give exiting clients a pleasant time on the way out.  For existing clients, I will also help them with situations where others are managing the money at no charge, no payment from another party, and no request that I manage any of those assets.  I do that because I want them to be treated well by me, and I know that getting good advice is hard.  As I wrote in a prior article The Problem of Small Accounts:

We all want financial advice.  Good advice.  And we want it for free.  That’s why we come to the Aleph Blog, where advice is regularly dispensed, and at no cost.

But… I can’t be personal, and give you advice that is tailored to your situation.  And in my writing here, much as I try to be highly honest, I am not acting as a fiduciary, even though I still make my writings hold to such a standard.

Ugh.  Here’s the problem.  Good advice costs money.  Really good advice costs a lot of money, and is worth it, if you have enough money to spread the cost over.

But when you have a small account, you have a problem in getting advice.  There is no way for someone who is fiduciary (like me) to make money addressing your concerns.  That is why I have a high minimum for investing: $100,000.  With that, I can spend time on clients, even helping them with assets from which I make no money.

What extra things have I done for clients over time?  I have:

  • Analyzed asset allocations.
  • Analyzed the performance of other managers.
  • Advised on changing jobs, negotiating salary, etc.
  • Explained the good and bad points of certain insurance companies and their policies, and suggested alternatives.
  • Analyzed chunky assets that they own elsewhere, aiding them in whether they keep, sell, or sell part of the asset.
  • Analyzed a variety of funky and normal investment strategies.
  • Advised on buying a building, and future business plans.
  • Told a client he was better off reinvesting the slack funds in his business that needed financing, rather than borrow and invest the funds with me.
  • Told a client to stop sending me money, and pay down his mortgage.  (He has since resumed sending money, but he is now debt-free.)

I take the fiduciary side of this seriously, and will tell clients that want to put a lot of their money in my stock strategy that they need less risk, and should put funds in my bond strategy, where I earn less.

I’ve got a lot already.  I don’t need to feather my nest at the expense of the best interests of my clients.

Over the last six years, around half of my clients have availed themselves of this help.  If you’ve read Aleph Blog for awhile, you know that I have analyzed a wide number of things.  Helping my clients also sharpens me for understanding the market as a whole, because issues come into focus when the situation of a family makes them concrete.

So informally, I am more than an “investments only” RIA [Registered Investment Advisor], but I only earn money off of my investment fees, and no other way.  Personally, I think that other “investments only” RIAs would mutually benefit their clients if they did this as well — it would help them understand the struggles that they go through, and inform their view of the economy.

Thus I say to my competitors: do you want to justify your fees?  This is a way to do it; perhaps you should consider it.


Having some people in an “investment only” shop that understand the basic questions that most clients face also has some crossover advantages when it comes to understanding financial companies, and different places that institutional money gets managed.  It gives you a better idea of the investment ecosystem that you live and work in.

Doctored Photo Credit: Marvin Isidore Macatol || And I say this is heresy!


My last post produced the following question:

What if your time horizon was 60 years? Would a 5% real return be achievable?

I am answering this as part of an irregular “think deeper” series on the problems of modeling investment over the very long term… the last entry was roughly six years ago.  It’s a good series of five articles, and this is number six.

On to the question.  The model forecasts over a ten-year period, and after that returns return to the long run average — about 9.5%/year nominal.  The naive answer would then be something like this: the model says over a 60-year period you should earn about 8.85%/year, considering that the first ten years, you should earn around 5.63%/year.  (Nominally, your initial investment will grow to be 161x+ as large.)   If you think this, you can earn a 5% real return if inflation over the 60 years averages 3.85%/year or less.  (Multiplying your capital in real terms by 18x+.)

Simple, right?

Now for the problems with this.  Let’s start with the limits of math.  No, I’m not going to teach you precalculus, though I have done that for a number of my kids.  What I am saying is that math reveals, but it also conceals.  In this case the math assumes that there is only one variable that affects returns for ten years — the proportion of investor asset held in stocks.  The result basically says that over a ten-year period, mean reversion will happen.  The proportion of investor asset held in stocks will return to an average level, and returns similar to the historical average will come thereafter.

Implicitly, this assumes that the return series underlying the regression is the perfectly normal return series, and the future will be just like it, only more so.  Let me tell you about some special things involved in the history of the last 71 years:

  • We have not lost a war on our home soil.
  • We have not had socialism to the destructive levels experienced by China under Mao, the USSR. North Korea, Cuba, etc.  (Ordinary socialism isn’t so damaging, though there are ethical reasons for not going that way.  People deserve freedom, not guarantees.  Note that stock returns in moderate socialist countries have been roughly as high as those in the US.  See the book Triumph of the Optimists.)
  • We have continued to have enough children, and they have become moderately productive workers.  Also, we have welcomed a lot of hard working and creative people to the US.
  • Technology has continued to improve, and along with it, labor productivity.
  • Adequate energy to multiply force and distribute knowledge is inexpensively available.
  • We have not experienced hyperinflation.

There are probably a few things that I have missed.  This is what I mean when I say the math conceals.  Every mathematical calculation abstracts quantity away from every other attribute, and considers it to be the only one worth analyzing.  Qualitative analysis is tougher and more necessary than quantitative analysis — we need it to give meaning to mathematical analyses.  (What are the limits?  What is it good for?  How can I use it?  How can I use it ethically?)

If you’ve read me long enough, you know that I view economies and financial markets as ecosystems.  Ecosystems are stable within limits.  Ecosystems also can only develop so quickly; there may be no limits to growth, but there are limits to the speed of growth in mature economies and financial systems.

Thus the question: will these excellent conditions continue?  My belief is that mankind never truly changes, and that history teaches us that all governments and most cultures eventually die.  When they do, most or all economic arrangements tend to break, especially complex ones like financial markets.

But here are three more limits, and they are more local:

  • Can you really hold for 60 years, reinvesting and never taking a material amount out?
  • Will the number investing in the equity markets remain small?
  • Will stock be offered and retired at ordinary prices?


Most people can’t lock money away for that long without touching it to some degree.  Some of the assets may get liquidated because of panic, personal emergency needs, etc.  Besides, why be a miser?  Warren Buffett, one of the greatest compounders of all time, might have ended up happier if he had spent less time compounding, and more time on his family.  It would have been better to take a small part of it, and use it to make others happy then, and not wait to be the one of the most famous philanthropists of the 21st century before touching it.

Second, returns may be smaller in the future because more pursue them.  One reason the rewards for being a capitalist are large on average is that there are relatively few of them.  Also, I have sometimes wondered if stock returns will fall when the whole world is employed, and there is no more cheap labor to be had.  Should that bold scenario ever come to pass, labor would have more bargaining power in aggregate, and profits would likely fall.

Finally, you have to recognize that the equity return statistics are somewhat overstated.  I’m not sure how much, but I think it is enough to reduce returns by 1%+.  Equity tends to be offered for initial purchase expensively, and tends to get retired inexpensively.  Businessmen are rational and tend to go public when stock valuations are high, pay employees in stock when valuations are high, and do stock deals when valuations are high.  They tend to go private when stock valuations are low, pay employees cash in ordinary times, and do cash deals when valuations are low.

As a result, though someone that buys and holds the stock index does best, less money is in the index when stocks are low, and a lot more when stocks are high.

Inflation Over 60 Years?

I mentioned the risk of hyperinflation above, but who can tell what inflation will do over 60 years?  If the market survives, I feel confident that stocks would outperform inflation — but how much is the open question.  We haven’t paid the price for loose monetary policy yet.  A 1% rise in inflation tends to cut stock returns by 2% for a year in real terms, but then businesses adjust and pass through higher prices.  Vice-versa when inflation falls.

Right now the 30-year forecast for inflation is around 2.1%/year, but that has bounced around considerably even within a calm environment.  My estimate of inflation over a 60-year period would be the weakest element of this analysis; you can’t tell what the politicians and central bankers will do, and they aren’t sure themselves.


Yes, you could earn 5% real returns on your money over a 60-year period… potentially.  It would take hard work, discipline, cleverness, frugality, and a cast iron stomach for risk.  You would need to be one of the few doing it.  It would also require the continued prosperity of the US and global economies.  We don’t prosper in a vacuum.

Thus in closing I will tell you that yes, you could do it, but there is a large probability of failure.  Don’t count on buying that grand villa on the Adriatic Sea in your eighties, should you have the strength to enjoy it.


I recently received two sets of questions from readers. Here we go:


I am a one-time financial professional now running a modest “home office” operation in the GHI area.  I have been reading your blog posts for a couple years now, and genuinely appreciate your efforts to bring accessible, thoughtful, and modestly stated insights to a space too often lacking all three characteristics.  If I didn’t enjoy your financial posts so much, I’d request that you bring your approach to the political arena – but that’s a different discussion altogether…

I am writing today with two questions about your work on the elegant market valuation approach you’ve credited to @Jesse_Livermore.   I apologize in advance for any naivety evidenced by my lack of statistical background…

  1. I noticed that you constructed a “homemade” total return index – perhaps to get you data back to the 1950s.  Do you see any issue using SPXTR index (I see data back to 1986)?  The 10yr return r-squared appears to be above .91 vs. investor allocation variable since that date.
  2. The most current Fed/FRED data is from Q32016.  It appears that the Q42016 data will be released early March (including perhaps “re-available” data sets for each of required components ).  While I appreciate that the metric is not necessarily intended as a short-term market timing device, I am curious whether you have any interim device(s) you use to estimate data – especially as the latest data approaches 6 months in age & the market has moved significantly?

I appreciate your thoughts & especially your continued posts…


These questions are about the Estimating Future Stock Returns posts.  On question 1, I am pulling the data from Shiller’s data.  I don’t have a better data feed, but that should be the S&P 500 data, or pretty near it.  It goes all the way back to the start of the Z.1 series, and I would rather keep things consistent, then try to fuse two similar series.

As for question 2, Making adjustments for time elapsed from the end of the quarter is important, because the estimate is stale by 70-165 days or so.  I treat it like a 10-year zero coupon bond and look at the return since the end of the quarter.  I could be more exact than this, adjusting for the exact period and dividends, but the surprise from the unknown change in investor behavior which is larger than any of the adjustment simplifications.  I take the return since the end of the last reported quarter and divide by ten, and subtract it from my ten year return estimate.  Simple, understandable, and usable, particularly when the adjustment only has to wait for 3 more months to be refreshed.

PS — don’t suggest that I write on politics.  I annoy too many people with my comments on that already. 😉

Now for the next question:

I have a quick question. If an investor told you they wanted a 3% real return (i.e., return after inflation) on their investments, do you consider that conservative? Average? Aggressive? I was looking at some data and it seems on the conservative side.


Perhaps this should go in the “dirty secrets” bin.  Many analyses get done using real return statistics.  I think those are bogus, because inflation and investment returns are weakly related when it comes to risk assets like stocks and any other investment with business risk, even in the long run.  Cash and high-quality bonds are different.  So are precious metals and commodities as a whole.  Individual commodities that are not precious metals have returns that are weakly related to inflation.  Their returns depend more on their individual pricing cycle than on inflation.

I’m happier projecting inflation and real bond returns, and after that, projecting the nominal returns using my models.  I typically do scenarios rather than simulation models because the simulations are too opaque, and I am skeptical that the historical relationships of the past are all that useful without careful handling.

Let’s answer this question to a first approximation, though.  Start with the 10-year breakeven inflation rate which is around 2.0%.  Add to that a 10-year average life modification of the Barclays’ Aggregate, which I estimate would yield about 3.0%.  Then go the the stock model, which at 9/30/16 projected 6.37%/yr returns.  The market is up 7.4% since then in price terms.  Divide by ten and subtract, and we now project 5.6%/year returns.

So, stocks forecast 3.6% “real” returns, and bonds 1.0%/year returns over the next 10 years.  To earn a 3% real return, you would have to invest 77% in stocks and 23% in 10-year high-quality bonds.  That’s aggressive, but potentially achievable.  The 3% real return is a point estimate — there is a lot of noise around it.  Inflation can change sharply upward, or there could be a market panic near the end of the 10-year period.  You might also need the money in the midst of a drawdown.  There are many ways that a base scenario could go wrong.

You might say that using stocks and bonds only is too simple.  I do that because I don’t trust return most risk and return estimates for more complex models, especially the correlation matrices.  I know of three organizations that I think have good models — T. Rowe Price, Research Affiliates, and GMO.  They look at asset returns like I do — asking what the non-speculative returns would be off of the underlying assets and starting there.  I.e. if you bought and held them w/reinvestment of their cash flows, how much would the return be after ten years?

Earning 3% real returns is possible, and not that absurd, but it is a little on the high side unless you like holding 77% in stocks and 23% in 10-year high-quality bonds, and can bear with the volatility.

That’s all for now.

Well, this market is nothing if not special.  The S&P 500 has gone 84 trading days without a loss of 1% or more.  As you can see in the table below, that ranks it #17 of all streaks since 1950.  If it can last through February 27th, it will be the longest streak since 1995.  If it can last through March 23rd, it will be the longest streak since 1966.  The all-time record (since 1950) would take us all the way to June.

Here’s another way to think about this — look at the VIX.  It closed today at 10.85.  Sleepy, sleepy… no risk to be found.  When you don’t have any significant falls in the market, the VIX tends to sag.  Aside from the election, which is an exception to the rule, the last two peaks of the VIX over the last six months were after 1%+ drops in the S&P 500.

The same would apply to credit spreads, which are also tight.  No one expects a change in liquidity, a credit event, a national security incident, etc.  But as I commented on Friday:

This is an awkward time when you have a lot of people arguing that the market CAN’T GO HIGHER!  Let me tell you, it can go higher.

Will it go higher?  Who knows?

Should it go higher?  That’s the better question, and may help with the prior question.  If you’re thinking strictly about absolute valuation, it shouldn’t go higher — we’re in the mid-80s on a percentile basis.  On a relative valuation basis, where are you going to go?  On a momentum basis, it should go higher.  It’s not a rip-roarer in terms of angle of ascent, which bodes well for it.  The rallies that fail tend to be more violent, and this one is kinda timid.

We sometimes ask in investing “who has the most to lose?”  As in my tweet above, that very well could be asset allocators with low stock allocations that conclude that they need to chase the rally.  Or, retail waking up to how great this bull market has been, concluding that they have been missing out on “free money.”

Truth, I’m not hearing many people at all banging the drum for this rally.  There is a lot of skepticism.

As for me, I don’t care much.  It’s not a core skill of mine, nor is it a part of my business.  I am finding cheap stocks still, and I will keep investing through thick and thin, unless the 10-year forecast model that I use says future returns are below 3%/year.  Then I will hedge, and encourage my clients to do so as well.

Until then, the game is on.  Let’s see how far this streak goes.


Streaks of over 50 days since 1950