Podcast: Cullen Roche — Inflation Risks & Investing for Retirement

Episode 64 of the NewRetirement podcast is an interview with Cullen Roche — Founder and Chief Investment Officer at Orcam Financial Group and Discipline Funds — and discusses inflation risk & investing for retirement and takes some listener questions.

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Full Transcript of Steve Chen’s Interview with Cullen Roche:

Steve: Welcome to The NewRetirement Podcast. Today, we’re going to be talking with Cullen Roche, the Founder and Chief Investment Officer at Orcam Financial Group and Discipline Funds, a financial advisory firm specializing in low-fee, global, macro-asset management. We’re going to discuss inflation risk and investing for retirement and take some listener questions. Cullen originally worked at Merrill Lynch early in his career, but got disillusioned with the wirehouse business model and then started his own firm. And he’s coming to us from San Diego, California. He’s also friends with Tyler from Define Financial who was recently on the podcast. And so with that, Cullen, welcome to our show. It’s great to have you join us.

Cullen: Steve, thanks for having me. It’s great to be here.

Steve: Yeah, it’s great. It’s more Twitter connection. First, I thought we’d talk a little bit about you and your background and how you got to where you are today, and then talk about inflation and deflation, what are the forces at work? And then a little bit about investing for retirement and your approach there, which I thought was pretty interesting. And then a couple questions and then we’ll just wrap it up. But just to jump into it, I noticed reading your bio that your first job was at Merrill Lynch, and then pretty quickly you left and then started your own company as a very young person. So, just was love to hear about how that process was and your thinking at that point.

Cullen: Yeah. It was funny. I lucked into a good position on a big team of guys. So, we were managing back then it was 500 million, which back then was a lot of money. This is the early 2000s, right after the dot-com bust. And I moved onto this team and we were doing … I mean, back then, the big wirehouses were super old school still. So, they were just transitioning into mostly fee-based planning. But, this team that I was working with was particularly old school. So, still doing stock picking, bond picking, charging commissions and really trying to turn over accounts more so than actually do financial planning and really think about everything in terms of strategic asset management.

Cullen: And so, this was around the time when iShares was just starting to roll out a bunch of new ETFs, and being young and fresh in the business, I was more up to speed with a lot of the new developments in the industry. And, we used to sell a lot of high fee mutual funds too and I could never figure out why … Just comparing the data and the performance of a lot of these funds, I couldn’t figure out why we were selling these high fee mutual funds and picking stocks, when so much of the data seemed to confirm that picking stocks is not usually a very effective strategy. And especially compared to index funds, a lot of these active high fee mutual funds were terrible. And so, I just disagreed with the way that we were managing our portfolios and the way that we were picking our assets.

Cullen: And so, I was only at Merrill for, I don’t know, 18 or 24 months, something like that before I got to the point where I had brought in enough business, where I realized that I could roll off … And even leaving back then, I left with, I don’t know, it was like $10 million. It was nothing, but it was idiotic in retrospect, but luckily worked out. But, even with a small account base like that, I realized that I could roll off all these accounts on my own, cut everyone’s fees virtually in half. Everyone was better off. And so, that was the position I got to-

Steve: If you were to zoom out and say, okay, let’s look at all retail investors today, how many do you think are still in that situation where they’re probably paying higher fees than they maybe should be? And what remains to be transitioned as a percentage of the overall market?

Cullen: I mean, a huge amount. I mean, a lot of this money is just so sticky in that people have long-term relationships with people. And a lot of people, I also think, just a lot more than we probably realize just don’t really realize the damage that high fees do, and aren’t aware of a lot of the newer, pretty sophisticated ways that people can build really diversified, really effective and low fee types of strategies, that would better serve them in the long run. And so, a lot of it is that people just, I think, probably don’t have a lot of the time to figure out a lot of this stuff.

Cullen: And a lot of it’s just that the industry creates a lot of stickiness in large part through complexity. We were masters of creating the illusion of sophistication through complexity at Merrill in a lot of the portfolios. Even a lot of low fee advisors … I don’t want to start bagging on everybody in the industry, but I see it all the time still in my business, when a new client comes to me and you’ll see 20, 30 index funds and individual stocks and I’m like, “Good Lord! We could be doing this same exact strategy. In fact, probably improving a lot of things with literally three, four, five index funds or ETFs.”

Steve: Yeah. Now, I’ve talked to J.L. Collins on this podcast and he’s like, “One fund, VTSAX. That solves all problems.” He actually has a lot of people. He sold 250,000 copies of his book. So-

Cullen: Yeah. I mean for the right person, I mean, I always defer towards simplicity. And so, yeah, the more that you can simplify everything and honestly dumb it down to a certain degree, not only does it make the management of it a lot more efficient, but it also, behaviorally for me, it becomes a lot more consistent with the way that most people should think about this, because so much of asset management and financial planning is, I think, simplifying things, consolidating things, just to make it more manageable. Because, people have so much other stuff going on in their lives that the last thing they need is to create huge amounts of sophistication and complexity through their financial plan, that just compounds everything else that’s going on in their life.

Steve: Yeah. 100%. I mean, just on a personal level, it’s like, I have a self-directed IRA. I have made some investments. Some of them actually have done pretty well and become more valuable. And then recently, I was looking at the fee structure, which is an AUM model. It’s really for administrative stuff. And I was like, “There’s now thousands of dollars a year in fees.” I’m like, “That seems like a lot of money,” because … And also I know there’s other newer versions of this that will do it for hundreds of dollars a year. And so I was like, “Okay. Why am I paying this fee? And is it worth it?” But I think that exists across so many millions of investors, and like, “Hey, you’ve done a great job savings … ” And look, there are fees in the industry. You have to pay for good, smart people to give you advice, but just make sure the value is there and being [crosstalk 00:06:54].

Cullen: Yeah. I mean, there’s places where the higher fees can make sense. I mean, if I could get access to Marc Andreessen’s funds … I mean, those are probably worth the fees, because he’s got unique access to unique people, things like that. So, there’s definitely spaces where higher fees make a lot of sense. But, when it comes to, for the most part, the secondary markets, the stock and bond markets and just building what I like to call savings portfolios for people, to me, more often than not the likelihood of getting what you pay for when you pay a very high fee of 1% or more per year, it … The likelihood of it paying off in the long run is substantially lower, relative to just putting together a somewhat Boglehead type of portfolio and letting it ride and making sure it’s behaviorally consistent, and consistent with your financial goals.

Steve: Yep. All right. Well, look, I do want to talk more with you about this and what you’re doing today. But first, I want to jump into a little bit more about inflation, how we got here? And, just to frame this up. So, there was a tweet recently from Jack Dorsey over at Square and Twitter. And so he was saying, “Hey, hyperinflation is coming.” And I saw you wrote an article that said, “Hey, actually no, hyperinflation is a very specific thing and there’s a lot of deflationary forces.” And I think it’s interesting, because a lot of folks on that are users they’ve been saving and investing. They’ve got to think about how to monetize that and create income from it. But inflation’s a big boogeyman that’s out there. And just would love your color on, your take on, what you see out there from, what are the real inflation risks? What are the macro drivers?

Cullen: The last 20 years has been specifically on interest-rate dynamics and what causes interest rates to move. So, we do a huge amount of research on things like quantitative easing and Federal Reserve policy. And, over time my conclusion has been that there’s really a bunch of big, secular headwinds, that are causing inflation to be relatively low on a secular basis. And, those include things like … Demographics is probably the biggest one. Technological trends put downward pressure on prices over time. Globalization is a big one that puts downward pressure on prices over time. And, and those are trends that … These things, for the most part, they didn’t really exist in the 1970s. And so, a lot of people like to talk about the 1970s as a comparable environment and a stagflationary environment. And the reality is that a lot of the big macro headwinds that we’re now seeing, those things, just … I mean they were in play to some degree, but a lot of them weren’t in play to the same degree that they are today.

Cullen: And so, what we typically tend to see in the last 20 years is that, typically, these bouts of inflation that we see, they occur around the government spending packages. And I think this is one of the things that a lot of people miss, is that the … One of the main drivers that people think is inflationary is central bank policy. And, what we know coming out of the 2008, 2009 crisis is that, well, central bank policy can be very powerful. The policies like quantitative easing are a lot less powerful than most people think. And I’ve explained this and I don’t want to get too wonky about it. But, the basic thinking is that the reason why those policies are not nearly as inflationary as people tend to assume is because, things like quantitative easing are more simple asset swaps, where the central bank expanding their balance sheet, they’re issuing bonds or they’re issuing reserves, I mean deposits, and they’re swapping them out with bonds.

Cullen: And so, from a private-sector perspective, the size of your balance sheet doesn’t change. The composition of it changes. And so, the idea that this should create inflation, to me, has never made sense. I mean, there’s technically more money in the economy, but you’ve swapped out fewer bonds. And so, it’s a lot like swapping a savings account for a checking account. And, do you feel richer or would you spend more money when you swap out a checking account for a savings account? I mean, there’s no real mechanism, transmission mechanism for causing you to spend more, or for this to cause high inflation. But, the lesson coming out of the pandemic is that fiscal policy, government spending and especially deficits, have a huge inflation impact.

Cullen: And so, I’ve been a lot more concerned about inflation coming out of the pandemic, primarily, because the fiscal packages were so significant. I mean, we spent, basically, $6 trillion excess, deficits, in the last two years. And so, these are huge, huge numbers. I mean, to put it in perspective relative to 2008, the Recovery Act was $800 billion. And so, these were huge, huge programs and you’re compounding that with a lot of the supply side issues. The supply constraints in terms of what we’re seeing with the ports. And a lot of companies just, I think they stepped back. They risked off their balance sheets in a lot of ways when the pandemic happened. And so, inventories got drawn very low and I think they’ve been somewhat slow to ramp things back up, for a number of reasons. The labor market has been slow to come back again. That has a stimulus impact, where the government was paying a lot of people to, basically, not work, to stay at home, to try to suffocate the virus and things like that.

Cullen: And so, all of these big forces combined are the main reason why we’re seeing this five to 6% rate of headline inflation right now. But, the kicker going forward is that a lot of these trends are going to start reversing. So, we got a big employment number this morning. We’re seeing the labor market come roaring back. The next six months or so should be big, big numbers in the labor market. So, a lot of people, as the stimulus ends, they’re coming back into the labor force. And so that’s going to have, hopefully, a reducing impact on the rate of inflation.

Cullen: But, the other two big ones are that we should start to see the supply side issues, resolve themselves to some degree, in large part due to seasonal impacts. The supply constrained industries tend to peak in the early part of the year. January, February is typically the peak. And so, we should start to see a little bit of an improvement in inventories and things like that as the Q1, Q2 period moves on.

Cullen: And then, the big one is that you’re going to start seeing a statistically natural improvement in the rate of inflation, because the comparisons on a year-over-year basis are going to be versus … Relative to 2020 when the trough of inflation occurred, you were starting to get very high numbers, because the year over year numbers just looked exaggerated. You’re going to start seeing a little bit of the opposite effect here when we start getting into the summer of 2022, where the year-over-year comparisons on the summer trough of 2020 start looking very, very high on a relative basis. So you’re going to get a little bit of a reduction in the rate of inflation.

Steve: I mean, I see a lot of Doomsday talk around. I mean, there are whatever record number of boats off the port of LA and it’s all backed up. And some people are like, “This is never going to get resolved. It’s all hands on deck.” Other people are like, “No. It’s going to work itself out.”

Cullen: Yeah. It’s a huge, huge problem that these things take a long time to resolve. Like I said, a lot of that’s a seasonal factor, where you start to get a huge glut of supply, generally in the November, December, January, February period, in large part because of the holidays. And then that typically starts to fall off in the March, April period. And so, there should be some relief from just seasonal effects there. And then, hopefully, as the labor market comes back and they start getting a lot of this stuff online and people start mobilizing a lot of these things, hopefully, that gives us some relief too. So, there’s signs of some of this moderating already. So, hopefully we’ve seen the peak to a large degree and we start seeing a lot of these big trends reverse in the second quarter of, probably of next year.

Steve: Yeah. No, it’s great to get your context. So, just to play this back a little bit. So, 2008, 2009, the global financial crisis. GFC, $800 billion of stimulus, and it felt like we were doing QE forever, quantitative easing forever. And then pandemic comes around and then it’s $6 trillion of spending and also we cut taxes, so that creates the deficit. So, you’re saying that’s the underlying macro forces that are driving some of the inflation that we’re seeing now. Hopefully, not, quote, short transitory, maybe long transitory from your perspective, is what we might see. And then, what do you think about what is being discussed now with additional fiscal stimulus for spending for benefits, from the current administration? Do you think that’s going to have a follow-on effect here?

Cullen: The package they’ve been whittling down, the one that Manchin has been taking a hatchet to, slowly but surely over the course of the last few months? This is a long-term program, so I think it’s a 10-year spending package. So, they’re big numbers, but it’s nothing like the impact of the fiscal stimulus that the … I mean, the big ones from the pandemic were the unemployment benefits. The unemployment benefits were just … These were humongous packages that, we were literally paying people to home, basically. And, to a large degree, we were basically making them whole on their existing incomes. And so these were big, big numbers. The unemployment benefits, basically, started to expire in the end of September. And so, you’re starting to see this effect where people …

Cullen: I mean, a worryingly huge number of people in this country live paycheck to paycheck. And now that we’re getting into this period where the paychecks from the government have run out, people need to go source a new paycheck. And so, you’re starting to see a lot of people move back into the labor force. And so the Hutchins Center actually had a good piece on the fiscal impact. And, they estimated that at points in the last two years, government spending was adding up to 14% to GDP. It’s going to subtract 2.5% in 2022. So, that puts into perspective the relative impact of fiscal policy.

Cullen: So, it’s not going to suffocate the economy to the point of a recession in 2022, but this is going to cause a slowdown in consumer spending in 2022, relative to the last couple of years, which were really … The numbers on the consumer spending side were, I mean, almost unbelievable. So, you should see a bunch of moderation. So, you have a dual effect here, where you’re going to have a reduction in aggregate demand in 2022, and you should have an improving supply side of the issue here. So, a lot of this is going to be, not a full reversal of what happened in the two years, but you’re going to start to see a reversal of a lot of the big trends that we saw last year and this year.

Steve: Yeah. It’s great to get this context and hear it from your perspective at the super-macro level. But, yeah. I was getting some takeout sushi this week and they were like, “Yeah. We don’t have enough workers. A bunch of our people quit.” And you’re seeing headlines like, “Hey, American … ” These airlines are canceling flights. Southwest canceling tons of flights. So, why are these things all getting canceled? There’s not enough labor around. So, it feels like there’s still lots of people sitting on the sidelines. I mean, maybe that’s changing in the last couple weeks. And during the pandemic, definitely heard lots of stories of, yeah, folks are quitting their jobs, making more money sitting at home. And they’re just, yeah, getting paid to … Like, “I’m making 50,000 bucks to sit around and do nothing.” And just like, “Okay, that’s our tax dollars.” Or that’s our deficit, future tax dollars at work right now.”

Cullen: Yeah. Yeah, I mean hopefully, a lot of that starts to change in the next three to six months and you’re going to see … A lot of that’s good, because it’s you want to see more of a natural comeback in the economy here. And you want to see more things like private investment and consumer spending that are more endogenous to the private sector, rather than relying on the government to of feed everything going forward, because it’s not sustainable from an inflationary perspective. And so, hopefully, we start seeing some moderation in a lot of these big trends and the private sector starts to run with the baton more and more as 2022 goes on.

Steve: 100%. Yeah. So, actually this is a good segue into the next chunk of the discussion, which is how should people that are investing for retirement and think about this … And, from our discussions, it feels like you’re not 100% all passive index investor person. You’re obviously thinking a lot about the macro drivers and using that to influence how you position yourself and how that should change, probably more gradually over time-

Cullen: Nobody can truly afford to be a purely passive investor. And, I always tell people that I like to start from the framework of formulating what’s called a global financial asset portfolio. And that would be the portfolio that you could hold … If you could hold all of the market cap-weighted assets in the whole world, that would be the one truly passive portfolio. And, that portfolio is literally impossible to buy. So, everyone has to deviate from that portfolio and, in a lot of cases, it just makes total, rational sense to deviate from that portfolio.

Cullen: I’m a big behavioral finance advocate. So, to me, so much of asset management is about managing people’s expectations and managing people’s behavioral profile. Because, I don’t care if you have the best strategy in the world, if it’s behaviorally inappropriate for you and you can’t stick with, it’s a way worse strategy for you than a subpar portfolio that you end up actually sticking with through the good times and the bad times. And so, from a behavioral perspective, for me, I just believe that you have to customize every portfolio to a large degree. And, that’s a big reason why I focus so much on the macro drivers, is because I like to specifically compartmentalize risks for people in their portfolio, so that they understand really the big, long-term macro drivers that influence their portfolios.

Cullen: And so, for me personally, from a portfolio management perspective, I’ve become a big fan of bucketing strategies, where you take, basically, time horizons … And, I’m using what’s called an asset liability matching approach, basically, where I’m trying to, basically, run a general financial plan for people, figuring out what their expenditures are across certain time horizons and then matching assets to those expenditures and liability, so that they can have a certain degree of certainty, basically, that they’re going to have a certain amount of assets across all of these different time horizons.

Cullen: And so, I’ve become a big fan of bucketing assets in very simple, macro-oriented ways, that define specific time horizons. So, for instance, I like to think of the stock market like it’s a 30-year high yield bond. This is an instrument that, if you hold this thing for 20 or 30 years, the likelihood of you earning something like a five, six, 7% coupon, on average, over the long term is a very high probability bet. But, you’ve got to be willing to hold that instrument for a multi-decade period, because we also know that instrument inside of a one, five or even a 10-year period, that thing can be super volatile. You’re not getting that coupon every year. You can’t rely on getting that coupon, even over a 10-year period on average.

Cullen: But, if you extend that duration out and you think of that thing as a truly long-term type of bond, basically, you can build a portfolio where, if you’ve got long-term liabilities, for instance, if you’re a young person in an IRA … I mean, that’s why it makes a lot of sense to own an all-equity portfolios, because the likelihood of you having that amount of money in 30, 40, 50 years and not having a principle loss on it, is extremely high. And so, you can run all the way down the scale of different assets here, where cash is the instrument that, it provides you with basically no purchasing power protection, but it provides you with almost perfect nominal principle certainty. So, if you needed a cash outlay for something in three months, well, obviously you apply that to the short-term bucket.

Cullen: And so, I’m a big fan of building three or four different buckets for people and applying these time horizons to them, using very simple, typically, low-cost index funds. But, these are very custom portfolios to each person. And, it can be depend on whether or not these are taxable accounts or retirement accounts and whatnot. So, a lot of customization, a lot of personalization goes into asset management. And the timeline over which you manage all of this, the contributions, the withdrawals, all of this, the rebalancing. All of this requires a certain degree of activity and customization. And so, I like to defer towards simple. But, the reality is also that asset management and financial planning can be messy, because our lives are messy and our future needs are unpredictable and messy at times. And so, a certain degree of activity in a portfolio is fine, as long as it’s appropriate.

Steve: Right. No. I like the bucketing idea. I mean, I think it makes it psychologically easier for people to get what they’re doing and why.

Cullen: Yeah. I’m a big fan of rebalancing and just even … I actually, for a lot of my clients and my company, I rebalance it in an even more dynamic way than even a standard, say 60/ 40 index fund. And to me, so much of that is psychological. You don’t necessarily rebalance because you think that it’s going to generate better returns. You rebalance because it returns your asset allocation back to a profile that’s sustainable from a behavioral perspective.

Cullen: And that, I think, is the big kicker that a lot of people will miss that, especially during boom times, they’ll … I run into people nowadays who say, “Why own bonds at all? Why not just be a 100% equities?” And, what they’re doing is looking at the last three, four, five years of performance and they’re saying to themselves, “Well, if the stock market is just going to keep going up like this … ” And I’m like, “Stop! That’s not how this works. The stock market can and will … At some point, it will go through a downturn that scares the hell out of you, whether it’s even like a March 2020 type of event, or whether it’s the 1970s.

Cullen: The people who lived through the ’70s will tell you horror stories about the ups and downs of the stock market through the 1970s and how you got whipsawed. And behaviorally, if you couldn’t stick with that, the volatility … You were constantly moving in and out of them market and probably … How many people probably missed the entire run up in the ’80s and ’90s, because the ’70s scared the hell out of them?

Cullen: And so, a lot of this, you just have to, I think, set real, reasonable expectations. Work from a financial planning base. That’s one of, I think, the most important things, is that Pete, it’s so easy to get caught up in chasing the market and trying to generate the highest return. And, when you work from a planning-based foundation, you can set personal goals where you can say, “Okay, I need a three or 4% withdrawal rate going forward. And, I’m going to be comfortable with X dollars in the future. And if I generate a 6% return, going forward, and I do it within a certain risk profile, well, that’s good enough. That’s going to meet my financial goals.”

Cullen: Setting goals like that and working from a planning-based foundation, it helps you set realistic expectations for what you should expect from your portfolio going forward, so that you don’t fall into this trap of generating a six or 7% return, and then looking at your neighbor and talking to them and realizing, “Well, my neighbor’s doing 10, 15% or so. Why can’t I do that?” Because, then you get the temptation to alter your asset allocation in a way that it creates a deviation versus your risk profile. And then you find yourself in a period like March 2020, and you’re saying, “Well, this is uncomfortable. I don’t like this and I’m going to change my portfolio either back to my old profile.”

Cullen: Or worse, what I find is in a lot of cases, people will move all in or all out. And then, you miss all of the 2020 run up. You probably missed the 2021 run up and you just don’t know how to get back into the market. And, this is the psychological battle that so many people play. And, when you work from that planning-based foundation, it sets a realistic set of expectations that are sustainable, that help you stay the course through thick and thin.

Steve: Right. No. It’s a great way to frame it up. I was actually talking to a person on our team who works with me on the biz dev side, and he’s a user. And, we were talking about how to deal with the volatility and he is like, “Really with me, it’s like, I have a plan and I’ve thought about it. What am I going to do if it keeps going like this? Or if we see March 2020, or we see 2008-2009?” So, pre-thinking it and really … And, I think this is the big difference. You see a lot of tools where it’s like, “Oh, what would you do … ? Would you be okay if the market dropped 20%?” You see that in a form, you’re like, “Oh, yeah. Whatever.”

Steve: And this is where new investors versus previous investors, there’s a big difference. Someone who’s lived through it feels very differently. I remember in 2008, 2009, a friend of mine, he’s an executive. His family had gotten a lot of money. He walked into the coffee store one day. He was like, “Yeah, we are dropping hundreds of thousands of dollars a day,” sometimes. He had a fair amount of money and it’s like, you could just see the pain, in this massive level of like … And he was a little older. He’s like, “Holy smokes! Are we done for?” But, he had a plan, he stuck with it and then, of course, things came roaring back and they were okay. But, yeah, if you dump everything, which is what most retail investors do and why they actually end up with low or negative returns, in some cases, that’s when you pay the price. And then, you have all the cash and you’re like, “When do I get back I?” and all that stuff?

Cullen: Yeah.

Steve: So …

Cullen: It’s funny. Every risk profile has that question. Like, “Oh, the market falls 25%. How do you feel? What do you do?” And everyone answers this question the same way. They’re like, “Oh, that happens sometimes. I would probably buy more or I would sit tight.” And it’s like, “But would you really?” Because, I know the psychology of those environments, because I’ve talked to so many people in the throes of it and so many people … Like, when we were in March 2020, I mean, how many people were saying, “Well, this is the Spanish flu 2.0. Millions of people are about to die. And this is going to cause a legitimate depression.” I mean, I remember I was debunking great depression stories, it felt like, every week during the March 2020 lows. And so, the psychology, though, is that when the market falls 25% in the throes of it, you’re thinking

Cullen: And then when, when you’re in that environment and things are really scary and the financial system looks like it might literally fall apart, people are saying, “This really is the Great Depression. The stock market is going to fall 90%, like it did in 1930 or whatever.” And that’s the psychology. When you’re actually in it, most people are not sitting around thinking, “This is the bottom, I need to be aggressive.” Most people are thinking, “There’s a rational reason why the market is down this much and it’s scary as hell. And I’m worried that it’s going to get even scarier.”

Steve: Right. Yeah. What you’re raising is the biggest argument for not being all-equity. The fact that, if you’re 60 years old, you’ve saved a couple million bucks, if you’re … There’s real exposure. Yeah. The market’s gone up some, will go up 20%. But if the market goes down by half, how are you going to feel about that? And can you deal with it? And will that change the rest of your life?

Cullen: And consider the outliers too? I’m optimistic generally to a fault, but I still have a plan for really bad outcomes. Any good financial planner will recommend life insurance at points in your life, because even though you don’t plan on dying, you have to actually plan for the low probability that you might die earlier than you think. And so, the same thing with the stock and market where, who knows what could happen? We could go through a period where the stock market falls and goes down for five, 10 years. It’s very unlikely, but you don’t want to have a portfolio that isn’t positioned at all for that potential reality, because if you find yourself in that situation, then you start making the big psychological mistakes. Or, you start getting forced into making these really punitive changes to your portfolio that have really, really negative, long-term ramifications.

Steve: Right. Yeah, it’s so interesting the psychology of this and also the generational knowledge here. What I see happening is there are corrections, but they’re happening faster. And so, a whole bunch of investors, especially younger investors have seen, oh, the market goes down, but then it comes roaring back. That’s very different from true capitulation. True capitulation is, everyone is like, “It’s over. Game over.” And we saw that in 2008, 2009. People were like, “The whole financial system’s going to break. It’s going to stop working.” And that’s where people are like … And they’re scared out of their minds. That’s when you’re like, “The bottom’s in,” because people throw in the towel and they quit. And that’s actually when blood in the streets. Right? Warren Buffet, like, you got to make your put your money to work. And that’s how you get outsider’s returns.

Steve: So-

Cullen: Mm-hmm (affirmative).

Steve: Anyway. Anyway, I would love to talk a little bit more about like what you’re doing with Discipline Funds. And you’re trying to, I think, systemize a lot out of what you’re describing here. But, are you trying to do that in one fund? Or is this going to be a series of funds, because you with the bucket strategy, you’re talking about putting people in different allocations for different time horizons.

Cullen: Yeah. I mean, it depends. I mean, on the success of my business, I guess, in the long run. I mean, ideally I would love to get my fee structures down to … God! I mean, I’d love to be a true Vanguard apples-to-apples competitor at some point. But, obviously, as a startup fund manager, there’s a lot of scaling that needs to be done before you can make something like that viable. But, the way that I’m building the company now is that, essentially … So, the Discipline Fund is a fund of funds. So, we actually hold other funds, typically six funds inside of a single fund. And so, the reason I started this whole thing is because I’ve been managing separately managed accounts for years and building these relatively simple four or five or six-fund ETF portfolios, where you run into the difficulties of a lot of the necessary activity that goes into a portfolio.

Cullen: So, for instance, right now I’m running into a huge number of cases where the equity positions need to be rebalanced, but you have taxable events that are going to occur, if you rebalance the portfolios. And some of these equity portfolios have humongous gains. And so, it’s really hard from a customization perspective, because you want to rebalance a portfolio, but you also don’t want to pay taxes on the portfolio. And so, little things like that, that I’ve run into over the years that are just inefficiencies in the way of managing these portfolios, that … The Discipline Fund solves a lot of these problems in that the way that an ETF rebalances is very tax efficient, because we can now … What I’ve basically done is, I’ve taken six ETFs, wrapped them into one ETF, and now I can rebalance the portfolios internally, inside of the ETF. And so this isn’t kicking off capital gains to the underlying investors.

Cullen: And so, what’s cool, though, about the specific fund that I’ve developed here with the Discipline Fund, is that it rebalances in a counter-cyclical manner, meaning that, basically, as the equity market booms, this fund is … It has a 50:50 benchmark and it’s typically rebalancing against the predominant trend in the equity market for the most part, over very long periods of time. And so, for instance, right now, the fund is a 44% equity weighting, relative to its 50:50. This portfolio actually rebalances in a little bit of a counter-cyclical way and equities on the low end, which would be an extremely, extremely crazy environment. Like, something like the peak of 1999 is the only time where something like that could even happen.

Cullen: But, what I’m doing specifically is, I’m taking, basically, a core and satellite approach, where typically if you were applying three buckets to these portfolios … And, let’s say you’ve got a core piece and there’s two satellites, let’s say an aggressive component and a liquidity bucket and then a big core holding. Well, what’s cool with the Discipline Fund is that it inverts the core and satellite strategy, basically. Where, in a typical core and satellite strategy, you have to rebalance your cores or your satellites, I mean. And so, typically the equity piece is growing a bunch and you have to shave some of that down over time, and you have to rebalance it back into the core piece and the liquidity bucket, for instance.

Cullen: Whereas, with the Discipline Fund, what’s cool about this fund is that it’s rebalancing internally. And so as the equity piece is growing, the discipline fund is actually growing the other direction a little bit. And so, what it’s doing is, it’s creating not only a more consistent risk profile for the investor, but it’s reducing the future tax liability of the investor through capital gains rebalancing. So, it’s created a little bit more of a tax efficient way of building core-and-satellite and bucketing type approaches, where I’m able to build these super, super diverse portfolios, because the Discipline Fund is so diversified. I mean, it’s 10,000 plus underlying stocks and bonds in a global allocation and so, this thing is super diverse. But, it’s basically inverting the way that I typically build core-and-satellite strategies.

Steve: Okay. Got it. Does it work for both? I mean, it sounds like it’s optimized for taxable, but, can people … ? I mean, most of our users have a lot of their assets in qualified 401k IRA and so forth.

Cullen: Yeah. This fund is really, it’s for people who, they know that they have be behavioral biases where, maybe in a period like right now they’re a little uncomfortable with the stock market being as high as it is. And so, this thing is almost operating as a behavioral hedge, the way that it rebalances. But, because of its tax efficiency, it’s definitely a more valuable holding inside of a tax account, just because of the way that it rebalances so tax efficiently.

Steve: Got it. Cool. No. It’s super helpful and we’ll point to it. So, I know you’re just getting rolling here, but they can learn more about you’re writing and what you’re trying to do here. Right, I want to move on to a couple of user questions and then we’ll go to wrap up. But-

Cullen: Sure.

Steve: So, we had a user Robert Chase. He’s like, “Should we dump all bonds and bond funds that are at, or below, inflation rates and just buy stocks instead?” It’s a little bit back to what you were talking about earlier.

Cullen: I like to really apply specific goals for what certain asset classes do. To me, the bond market is … You can build the bond market out almost from the cash market, basically, to zero duration bonds, which are crazy volatile. They almost look like stocks. I mean, junk bonds, basically, are stocks to a certain degree, in terms of the way they perform. So, you can build these things out on certain scales. But, for the most part, to me, the bond market is not an inflation hedge. To me, the bond market is a liquidity and income generating-type of hedge, where … You have a lot more certainty inside of a bond portfolio than you do in an equity portfolio. And so, again, you’ve got to use the right types of bonds. I mean, to me, when I put together a risk profile and I see junk bonds in a portfolio, I literally list those in the equity-like bucket.

Cullen: So, when I’m putting together an asset allocation, I will actually put junk bonds into the equity component, in terms of where their risks are coming from and what the risks are like, because they’re so equity-like when the market is going through a traumatic event. So, like 2008, junk bonds are down 30% in that environment, which is a very stock-like performance. And so, you have to compartmentalize these things. But, to me, bonds are not an inflation hedge. I’m not a big fan of even bonds that try to provide an inflation hedge, because a lot of the bonds that will provide an inflation hedge over the long term will not provide you with stability at times when you actually need them to. And so, typically for me, I’m building portfolios that are really bar-belled in a sense, in that most people need probably a liquidity bucket, where they’ve got some certainty of income, usually through high quality investment grade bonds … Corporate bonds are still yielding two, three, 4% in a lot of cases in this environment.

Cullen: So, these things are still generating reasonable amounts of income, relative to say short-term treasuries, or T-Bills or anything like that. So, those are a long-term income generating component of a portfolio that’s still, in my opinion, very appropriate for many people. And then, on the other end of the barbell, you’ve got long-term treasury bonds, which … In my view, most investors should not deviate from holding long-term treasury bonds, which is a little counterintuitive, especially with all the narratives going on today. But, mainly because long-term treasury bonds are the primary safe haven when the global financial system starts to look like it’s buckling a little bit.

Cullen: And you see this consistently through, even periods like March 2020, through the financial crisis. Long-term treasury bonds are … They’re a truly inverse correlated asset class. And so to me, you have to be careful about how much exposure you have to them, obviously. Because, in the long run, you’re generating a very low amount of income, relative to the amount of volatility that they will incur over time. But, you hold bonds because, specifically long-term bonds, because they provide you with a hedge when you need them to provide you with a hedge. And so, a lot of inflation-protected bonds and junk bonds and things like that, that will provide you with probably better relative real returns, they’re good. They’re good enough as an inflation hedge in the long term. But to me, that’s what the. Basically, buying a stream of income from corporations who are always marking up prices for consumers who need a certain amount of liquidity and want a certain amount of safe income, the bond market is a perfectly appropriate portfolio for certain people.

Steve: Yeah. So just to play this back, it’s, you’ve got equity exposure, the market tanks, people are basically taking that money as it’s … They’re selling it. If they run to the safe haven, they’re buying long-term government bonds. Therefore, those prices go up and if you’re already positioned there, then you’re going to see some appreciation there to counteract what’s happening in the equity market. But then, I guess, on the flip side, you have to basically rebalance out of them again, if the market starts coming back. And, is there a way to automate that? Or …

Cullen: You could. You could buy an ETF called the Discipline Fund. No. Actually, the bond component of the Discipline Fund literally does that. So, it will tilt the durations, based on what the interest rate risk is. So, like right now, the way that the fund works is like, we’re a little bit more exposed to long-term treasury bonds than we are on average, because, as the equity sleeve trims down, what it’s basically saying is that economic risks are increasing to some degree. And so, I mean, we still have a 14% slice of long-term bonds in our overall portfolio, so it’s a relatively small slice. But, that’s a pretty good barometer of the way that I view what someone’s exposure to the bond market should be like. Because, you want that you want that hedge in case we have an environment like a March 2020, where that’s the part of your portfolio that, when everything else looks terrible, that’s the part that’s going to look good. It’s going to help you stay sane and stay the course, when everything else is falling apart.

Steve: So, just think of bonds as buying insurance, basically? Or, essentially-

Cullen: Exactly. They’re cheap income-generating insurance, where you don’t have to pay an arm and a leg for a covered call rating strategy or a put strategy or something like, that will consistently whittle down your returns on average every year, even during the good times.

Steve: Yeah. Got it. Yeah. So, last question here is actually from David. It’s related to this. It’s your opinion on I bonds and TIPS, versus treasuries. Do you have an opinion there?

Cullen: Again, I think you have to, I think, compartmentalize them the right way. I think that for people who want bonds for income … I mean, I bonds are fantastic. I wish they didn’t have limits on them like they do, because … What’s the limit now? I think it’s $10,000.

Steve: Yeah. I was just looking at. It’s $10,000 a year, personal security number. If you have a million bucks, it’s like, whatever.

Cullen: Yeah. It’s almost like, what’s the point? I mean, is it even worth the effort of having the treasury direct account? So, yeah, in theory, I love I bonds, but the problem is that you just can’t get enough exposure to actually have a meaningful difference. And so, they’re great. I like TIPS. I think the problem with TIPS is that, to me, treasury bonds are there to provide you with a hedge when you need the hedge. And what you’ll find with TIPS is that a lot of the times when the equity market goes down, TIPS won’t provide you with that inversely correlated hedge that true plain, vanilla treasury bonds do. And so, again, I think it’s about compartmentalizing the risks and knowing what part of your portfolio is doing what, when you need it to be doing that.

Cullen: And I think that for people who know that their plain, vanilla treasury bonds are there to provide a hedge when the bad times come, basically, that’s a very different allocation than owning TIPS, which will generally just consistently pay you income in an inflation-adjusted way more consistently during the good times. They won’t necessarily pay the outsider’s returns during the bad times. So, if you understand that and you want some stable, a little bit more inflation-adjusted asset allocation in your portfolio, that’s totally fine. Just know that these are two different types of instruments when things are bad. And I think that’s the big kicker.

Steve: Right. Right. No. it’s good to know. And I think most people are really concerned about hedging when things are bad, versus the long duration or the long-term inflation risk. Okay, cool. Well, this was really helpful. So, as we wrap up any final color commentary for you, as you think about the future of investing and retirement planning? And, how the world may change over the next five years?

Cullen: My fees are super were low and I thought that the industry would change a lot faster than it has. But, I mean, my perpetual prediction is that people are moving more towards low-fee products. And, especially on the planning side, I think people are moving more towards, especially low fee. I think DIY stuff is going to become increasingly popular.

Cullen: As a financial advisor, I’m very aware of the reality that I don’t think my industry is going to be nearly as big in 30 years as it is today. And so, people like me, maybe we won’t go away, but I think there’s going to be a lot more DIY development over the course of the next 20, 30 years, especially as … Like, you guys are working on great technology and so many other people are too, where a lot of this is. Yeah. Although it’s great to work with a professional, I think in 10, 15 years, maybe even sooner than that, you’re going to have so many tools available for a really low cost, that the ability to be able to put together really sophisticated financial plans and asset allocations that are applied from those, are going to be abundant. And people are going to be able to do a lot of their financial planning on their own. So, I think that’s the future. The fees are going to continue to come down and I think DIY stuff is going to boom.

Steve: So Cullen, thanks for being on our show and Davorin Robison, thanks for being our sound engineer. For the folks that are listening, appreciate your time. Hopefully found this useful. And if you made it this far, definitely will point you on, in the show notes, back to Cullen’s site and what he’s doing with Discipline Funds, which is kind of interesting and new. And then also, obviously, hope everyone checks out our planning platform and community. And, finally, we’re definitely trying to build the audience here. So, all reviews online are welcome. Any sharing of this podcast is super welcome. With that, thank you very much and have a great day.

NewRetirement Planner

Do it yourself retirement planning: easy, comprehensive, reliable

NewRetirement Planner

Take financial wellness into your own hands and do it yourself retirement planning: easy, comprehensive, reliable.

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