Innovative Ideas For Portfolio Construction

Innovative Ideas For Portfolio Construction: IndexUniverse ran an interview with Bill Bernstein that raised a couple of very interesting and useful points. I tend to draw very different conclusions than Bernstein but there is still a wealth of knowledge from him to learn from.

First interesting item was from his recent book "that you really cannot rest easy until you’ve got 25 years’ worth of living expenses saved up in safe assets." So this would seem to not be a stock market portfolio but things like cash and short dated fixed income. The post from the other day included a quote about having 20 years saved up which I am familiar with, one reader thought it was more like 12 years which I don't recall having heard before.

If someone has 25 years of expenses saved then they probably don't need much, if any stock market exposure. Some sort of strategy with a heavy reliance on TIPS even if that includes foreign TIPS would probably get the job done. The quote says having 25 years of expenses saved but hopefully everyone will get social security too so then the money saved just needs to keep up with inflation...for the most part. This line of thinking has an element of game over and avoidance of unnecessary risks. If you actually have 25 years of your expenses saved, how much stock market exposure do you need?

Bernstein is also a big fan of treasury bills. His comments have nothing to do with valuations as obviously a yield of zero isn't  very compelling but where t-bills are concerned the only cost for expensive t-bills is that of opportunity. Because of the short maturity the price doesn't really drop if yields go up. Bernstein quoted Warren Buffet on t-bills to support his belief of the opportunity to deploy that they represent.

He also mentioned a book called Expert Political Judgement by Philip Tetlock, specifically Tetlock's finding that "vehemence and the absence of nuance are markers for forecasting inaccuracy." This lead to a brief discussion about Peter Schiff and his $5000 gold call.

Bernstein then expressed interest in a book called Lifecycle Investing by Barry Nalebuff and Ian Ayres. One of their conclusions was that as Bernstein put the idea "that young people should leverage 2-to-1 in the stock market, not just invest 100 percent in stocks but leverage 2-to-1." This would be done using deep in the money LEAPs, calls obviously. Presumably instead of buying 100 shares at $50 you would buy two long dated calls struck at $25. There would probably be very little premium beyond intrinsic value unless the stock was very volatile. This could also be done with ETFs if the strike prices are available (the book uses an example with SPY).

Bernstein says of Nalebuff and Ayres "he trick is they are right. They’ve run the numbers six ways from Sunday. And they basically snuff out all the objections, all the theoretical objections to the technique. I’ve run the numbers my own way and have come to the same conclusion." Here is a link to the book on Amazon. Part of the work here is to think of salary as a bond portfolio. I skimmed through most of what was available from the preview and I could not find a precise definition of young. The example given was of a 25 year old law student but it was not clear from the preview when an investor would then change the allocation.

I believe I mentioned this concept one other time. Like any other strategy, if the numbers are compelling it will draw an audience. The idea may not be right for you but success can be had many different ways and that is important to remember in reading about something different from what you do in trying to learn something new. For example why not buy one long dated in the money call with no time premium  instead of 100 shares for a stock that pays no dividend? The money not spent buying stock could be put in TIPS or t-bills. As a note we do not do this trade in separate accounts or the ETF we manage but the above is not insane, potentially life-ruining recklessness.

A recurring theme on this site is people needing to figure out innovative solutions that fit their lives to have a better chance for a successful financial plan. This pertains to creating income streams and also portfolio construction as covered in the above interview. This is a very useful type of content.

The picture is from the other day, I was out doing a couple of errands and the green Cadillac was parked in front of a gas station.

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