Friday, January 27, 2023

Short Takes: Podcasts, 2022 Returns, and more

I haven’t had many people ask me whether I’d consider hosting a podcast, but it’s come up enough to make me think about it.  I have some solid reasons for not doing a podcast: it’s way more work than I’m willing to do, and my voice isn’t good.  To illustrate the best reason, though, consider this hypothetical exchange:

MJ: Welcome to the podcast, Dr. G.

: I’m happy to be here.

MJ: Let’s get right to it.  Please describe your research interests.

Guest: I work on retirement decumulation strategies, safe withdrawal rates, and risk levels of equities.

MJ: From what data do you draw your conclusions?

: I use worldwide historical returns of stocks and bonds.

MJ: How do you deal with the challenge that we don’t have enough historical return data to directly draw statistically significant conclusions?

: Uh … I perform simulations drawing from the available pool of data.

MJ: So, you create seemingly plausible return histories to extrapolate from the small pool of available data.

Guest: Yes, … but I use methods widely accepted in the literature.

MJ: Isn’t it true that you have to make assumptions about the distribution of market returns, such as autocorrelations and the size of tails, to be able to perform simulations?

Guest: Well, yes, but I preserve the properties of the original data as much as possible.  In some simulations I draw blocks of returns selected at random.

MJ: Yes, I can see that you’re trying to preserve autocorrelations that way, but it still destroys long-term autocorrelation and the tendency for long-term valuation-based reversals.  For example, consider one block that ends in the depths of the great depression, and another that ends at the peak of the year 2000 tech boom.  Your simulation will make no distinction between these two states for the next block it draws.

Guest: There’s a limit to what I can do with the small amount of data available.

: Yes, that’s my point.

Guest: In other simulations, I treat the expected return over the next year as a random variable that drifts over time.

: Yes, and you assume a particular probability distribution for this drift.

Guest: I have to assume some kind of distribution.

MJ: Aren’t there many other possible sets of assumptions we could make about market return distributions that would ultimately lead to completely different conclusions about retirement decumulation strategies, safe withdrawal rates, and risk levels of equities?  In fact, aren't all your conclusions primarily attributable to your underlying return distribution assumptions rather than the actual historical return data?

Guest: [Fuming] Do you have a better idea?

MJ: Perhaps not.  We could try multiple approaches and see if they give similar results.  For example, we could use a model where the current stock market price-to-earnings ratio affects the distribution of the upcoming year’s return.  Another idea is to model corporate earnings growth separately from investor sentiment as expressed by the price-to-earnings ratio.

Guest: Good luck with that. [storms out]

Successful podcasters let their guests make arguments without challenging their ideas in any serious way.  Listeners might enjoy some fireworks, but few interesting guests would want to participate in a podcast like my example above.  My first guest might be my last.

Here are my posts for the past two weeks:

My Investment Return for 2022


Here are some short takes and some weekend reading:

Justin Bender
goes through model portfolio returns for 2022.  The losses in long-term bonds aren’t pretty.

The Blunt Bean Counter has some advice on doing a 2022 financial clean-up and a 2023 financial tune-up.

Monday, January 23, 2023


In his book Bullshift: How Optimism Bias Threatens Your Finances, Certified Financial Planner and portfolio manager John De Goey makes a strong case that investors and their advisors have a bias for optimistic return expectations that leads them to take on too much risk.  However, his conviction that we are headed into a prolonged bear market shows similar overconfidence in the other direction.  Readers would do well to recognize that actual results could be anywhere between these extremes and plan accordingly.

Problems in the financial advice industry

The following examples of De Goey’s criticism of the financial advice industry are spot-on.

“Investors often accept the advice of their advisers not because the logic put forward is so compelling but because it is based on a viewpoint that everyone seems to prefer. People simply want happy explanations to be true and are more likely to act if they buy into the happy ending being promised.”  We prefer to work with those who tell us what we want to hear.

Almost all advisers believe that “staying invested is good for investors -- and it usually is. What is less obvious is that it's generally good for the advisory firms, too.”  “In greater fool markets, people overextend themselves using margin and home equity lines of credit to buy more, paying virtually any price for fear of missing out (FOMO).”  When advisers encourage their clients to stay invested, it can be hard to tell if they are promoting the clients’ interests or their own.  However, when they encourage their clients to leverage into expensive markets, they are serving their own interests.

“There are likely to be plenty of smiling faces and favourable long-term outlooks when you meet with financial professionals.”  “In most businesses, the phrase ‘under-promise and over-deliver’ is championed. When it comes to financial advice, however, many people choose to work with whoever can set the highest expectation while still seeming plausible.”  Investors shape the way the financial advice industry operates by seeking out optimistic projections.

“A significant portion of traditional financial advice is designed to manage liabilities for the advice-givers, not manage risk for the recipient.”

“Many advisers chase past performance, run concentrated portfolios, and pay little or no attention to product cost," and they "often pursue these strategies with their own portfolios, even after they had retired from the business. They were not giving poor advice because they were conflicted, immoral, or improperly incentivized. They were doing so because they firmly believed it was good advice. They literally did not know any better.”

De Goey also does a good job explaining the problems with embedded commissions, why disclosure of conflicts of interest doesn’t work, and why we need a carbon tax.

Staying invested

On the subject of market timing, De Goey writes “there must surely be times when selling makes sense.”  Whether selling makes sense depends on the observer.  Consider a simplified investing game.  We draw a card from a deck.  If it is a heart, your portfolio drops 1%, and if not it goes up 1%.  It’s not hard to make a case here that investors would do well to always remain invested in this game.

It seems that the assertion “there must surely be times when selling makes sense” is incorrect in this case.  What would it take for it to make sense to “sell” in this game?  One answer is that a close observer of the card shuffling might see that the odds of the next card being a heart exceeds 50%.  While most players would not have this information, it is those who know more (or think they know more) who might choose not to gamble on the next card.

Another reason to not play this game is if the investor is only allowed to draw a few more cards but has already reached a desired portfolio level and doesn’t want to take a chance that the last few cards will be hearts.  Outside of these possibilities, the advice to always be invested seems good.

Returning to the real world, staying invested is the default best choice because being invested usually beats sitting in cash.  One exception is the investor who has no more need to take risks.  Another exception is when we believe we have sufficient insight into the market’s future that we can see that being invested likely won’t outperform cash.

Deciding to sell out of the market temporarily is an expression of confidence in our read of the market’s near-term future.  When others choose not to sell, they don’t have this confidence that markets will perform poorly.  Sellers either have superior reading skills, or they are overconfident and likely wrong.  It’s hard to tell which.  Whether markets decline or not, it’s still hard to tell whether selling was a good decision based on the information available at the time.

Elevated stock markets

Before December 2021, my DIY financial plan was to remain invested through all markets.  As stock markets became increasingly expensive, I thought more about this plan.  I realized that it was based on the expectation that markets would stay in a “reasonable range.”  What would I do if stock prices kept rising to ever crazier levels?

In the end I formed a plan that had me tapering stock ownership as the blended CAPE of world stocks exceeded 25.  So, during “normal” times I would stay invested, and during crazy times, I would slowly shift out of stocks in proportion to how high prices became.  I was a market timer.  My target stock allocation was 80%, but at the CAPE’s highest point after making this change, my chosen formula had dropped my stock allocation to 73%.  That’s not much of a shift, but it did reduce my 2022 investment losses by 1.3 percentage points.

So, I agree with De Goey that selling sometimes makes sense.  Although I prefer a formulaic smooth taper rather than a sudden sell-off of some fraction of a portfolio.  I didn’t share De Goey’s conviction that a market drop was definitely coming.  I had benefited from the run-up in stock prices, believed that the odds of a significant drop were elevated, and was happy to protect some of my gains in cash.  I had no idea how high stocks would go and took a middle-of-the-road approach where I was happy to give up some upside to reduce the possible downside.  “Sound financial planning should involve thinking ahead and taking into account positive and negative scenarios.”  “Options should be weighed on a balance of probabilities basis where there are a range of possible outcomes.”

As of early 2022, “the United States had the following: 5 percent of global population, 15 percent of global public companies, 25 percent of global GDP, 60 percent of global market cap, 80 percent of average U.S. investor allocation, the world's most expensive stock markets.”  These indicators “point to a high likelihood that a bubble had formed.”  I see these indicators as a sign that risk was elevated, but I didn’t believe that a crash was certain.

When markets start to decline

“If no one can reliably know for sure what will happen, why does the industry almost always offer the same counsel when the downward trend begins?”

Implicit in this question is the belief that we can tell whether we’re in a period when near future prices are rising or falling.  Markets routinely zig-zag.  During bull markets, there are days, weeks, and even months of declines, but when we look back over a strong year, we forget about these short declines.  But the truth is that we never know whether recent trends will continue or reverse.

De Goey’s question above assumes that we know markets are declining and it’s just a question of how low they will go.  I can see the logic of shifting away from stocks as their prices rise to great heights because average returns over the following decade could be dismal, but I can’t predict short-term market moves.

Conviction that the market will crash

‘In the post-Covid-19 world, there was considerable evidence that the market run-up of 2020 and 2021 would not end well.  Some advisers did little to manage risk in anticipation of a major drop.”

I’ve never looked at economic conditions and felt certain that markets would drop.  My assessment of the probabilities may change over time, but I’m never certain.  I have managed the risk in my portfolio by choosing an asset allocation.  If I shared De Goey’s conviction about a major drop, I might have acted, but I didn’t share this conviction.

Back on 2020 Jan. 6, De Goey announced on Twitter that “I’m putting a significant portion of my clients’ equity positions into inverse notes.”  Whether this was the right call based on the information available at the time is unanswerable with any certainty.  Reasonable people can disagree.  However, the results since then at least show that market timing is a difficult game: in the past 3 years, my unleveraged portfolio is up an annual compound average of 6.1% nominally, and 1.9% in real terms.  If De Goey had reversed his position near the bottom of the short-term market crash, he could have profited handsomely.  On the other hand, those who simply held on fared reasonably well.

“Advisers, like everybody else, need to be more humble.”  This is inconsistent with DeGoey’s 2021 May 11 call to “Get Out!”.  Staying invested because we don’t know what will happen is more consistent with being humble than making a high-conviction call that markets will crash.

CAPE as a market predictor

“CAPE readings are often extremely accurate in predicting future long-term annualized returns.”  This isn’t true.  What little data we have shows some correlation, but it is weak.

We should listen when “Shiller says his cyclically adjusted price earnings (CAPE) calculations are not useful for the purpose of market timing.”


The author discusses DALBAR’s annual analysis of investor behaviour.  DALBAR's methodology is so shockingly bad that most people find it hard to believe when it’s described.  Using DALBAR's methodology to analyze your returns over the past decade, if you got an inheritance 5 years ago, you’d be judged a poor investor for missing the returns in the first half of the decade.  In fact, all the money you've saved from your pay to invest should have been invested on the day of your birth.  Anything less is a sign that your lifetime investment behaviour is poor.

“I have asked their representatives for a breakdown between the performance of investors with advisers and investors without. DALBAR says the research does not offer that degree of granularity.”  De Goey is right to be skeptical of DALBAR’s results, but the problems are far worse than a lack of granularity.  DALBAR’s flawed methodology would unfairly make adviser results look bad too.  If you had handed your inheritance over to an adviser, that adviser would have missed the returns in the first half of the decade as well.

Other bad outcomes

“The concern is how people might react to what could go down as the biggest, deepest, longest downturn of their lives. What if the drop was more than 60 percent and the markets were nowhere close to their previous levels five years after the drop started?”  

I can play that game too.  What if governments start printing money like crazy causing massive inflation and making hoarded cash and other fixed income products worthless?  What if the only things left with value are businesses, real estate, and physical objects?  In this scenario, being in the stock market is what will save you.

It’s not that I believe this scenario is likely.  It’s that we can’t go too far down the road telling ourselves a single story.  There are many possibilities for what will happen in the future.


In parts of the book, it becomes apparent that De Goey feels strongly that he made the right calls and that he was somehow cheated out of being proven right.  The following quotes illustrate this feeling.

“Even before anyone ever heard of Covid-19, many felt a recession was possible or probable. The pandemic merely hastened what these people felt was inevitable when markets tumbled in early 2020. Then, like fairy-tale heroes, central bankers came riding to the rescue.”

“By rights, the world should have entered a recession in early 2020, but central bankers delayed that recession.”

“Instead of allowing for the traditional ebb and flow of market cyclicality, central bankers and finance ministers seemed determined to keep the good times rolling for as long as possible using whatever means they had.”

These quotes make the following observation seem ironic: “Individuals low in self-awareness might attribute failure externally.”


At its best, Bullshift warns investors about their own biases as well as biases in the investment industry.  At its worst, it is an extended attempt to justify a market call that didn't work out.  Readers would do well to be wary of their preference for rosy predictions, but they should also be wary of doomsday predictions.

Monday, January 16, 2023

My Investment Return for 2022

My portfolio lost 4.9% in 2022, while my benchmark return was a loss of 6.2%.  This small gap came from my decision to shift to bonds based on a formula using the blended Cyclically-Adjusted Price-to-Earnings (CAPE) ratio of the world’s stocks.  After deciding on this CAPE-based approach, all the portfolio adjustments were decided by a spreadsheet, not my own hunches.  I started the year 20% in fixed income, it grew to a high of 27% as the spreadsheet told me to sell stocks, and now it’s back to 20% after the spreadsheet said to buy back stocks.  This cut my losses in 2022 by 1.3 percentage points.

My return also looks good compared to most stock/bond portfolios because I avoided the rout in long-term bonds.  My fixed income consists of high-interest savings accounts (not at big banks), a couple of GICs, and short-term bonds.  If long-term bonds ever look attractive enough, I may choose to own them.  My thinking for now is that I prefer the safe part of my portfolio to be very safe, and I certainly didn’t want to own long-term bonds back when yields were insanely low.

Another thing that helped my results look a little better is that I measure my returns in Canadian dollars, and the U.S. dollar appreciated relative to the Canadian dollar during 2022.  Even though my U.S. stocks lost money, they appeared to lose less money when measured in Canadian dollars.

One measure that doesn’t look very good this year is that my real return (after adjusting for inflation) was a loss of 11.0%.  I prefer to think in terms of real returns because what matters to me is what I can buy with my money.  So, while I hope to achieve somewhere close to a 3% average annual compound return, I fell behind significantly this year.  However, stocks have performed well since I retired, so I’m still on the upside of sequence-of-returns risk.

The following chart shows the cumulative real returns for my portfolio and my benchmark since I started investing on my own rather than working with financial advisors.  Each dollar I had in my portfolio in 1994 that remained invested over this entire period has doubled in purchasing power three times now.  The power of compounding shows itself over long periods.

Through all of the recent market turmoil, my calculated safe withdrawal rate (adjusted for inflation) has remained amazingly stable.  This is because I adjust the assumed future stock market returns based on the current blended CAPE of the world’s stocks.  As stocks rose, my spreadsheet assumed lower future returns, and as stocks fell, the assumed future returns rose again.

I try not to look at my portfolio spreadsheet too often, but when I do, I rarely look at my net worth.  I focus on the monthly dollar amount of my after-tax safe withdrawal rate.  I find this amount much more meaningful than the net worth figure that feels disconnected from day-to-day living.

Friday, January 13, 2023

Short Takes: Private Equity Volatility Laundering, Problem Mortgages, and more

What a difference a year makes.  During the COVID-19 lockdowns, many people saved a lot of money, either from their pay (if they were lucky enough to keep their jobs) or from government payments.  As the world opened up, people started spending this money and businesses couldn’t keep up.  These businesses still can’t get all the new employees they want but the problem has eased considerably compared to a year ago.  I saw a small example in Florida recently.  I was in a burger chain restaurant and saw a sign saying they were looking for employees at $12 per hour.  Last March, the sign in this same restaurant offered $18 per hour and implored workers to “START RIGHT NOW!”

Here are some short takes and some weekend reading:

Cliff Asness accuses private equity investors and managers of “volatility laundering.”  Failing to value private equity frequently and accurately creates the illusion of smooth returns.

Scotiabank’s new President and CEO Scott Thomson explains how they identify potential problem mortgage customers.  Currently, he sees about 1 in 40 as being “vulnerable.”  It’s not clear how many of these vulnerable customers are likely to default under different interest rate scenarios.

Robb Engen at Boomer and Echo
tells us what type of investing headlines to ignore.