A Disordered Mind Makes Mutual Fund Salad

Good portfolios are parsimonious portfolios. They accomplish their objectives with as few moving parts as possible. This is not simplicity, per se. It is economy of effort.

Parsimony is a difficult thing in the financial world. There are lots of ways to skin the proverbial cat. There is constant temptation to tinker at the margins. Armies of salespeople are paid handsomely to convince you to fiddle with things.

If your mind is disordered and cluttered, you will manifest that in your physical environment. Random stuff will accumulate. It will become difficult to distinguish value from kitsch.

Eliminating clutter takes energy. A disordered mind neither uses nor generates energy efficiently. It does not properly recharge over time. Over time, energy reserves deplete. Eventually they will be exhausted. This is not sustainable. We all know this on an instinctive level. It is why burnout follows a particular pattern. The burnout source consumes so much energy there is nothing left for anything other than managing that stress. We cope by shutting off non-essential functions and activities. It is a desperate, last ditch strategy to preserve a dwindling energy reserve.

Cultivating parsimony is hard work. This is obvious to anyone who writes. People who do not write tend to think the hard thing is generating output. Output is certainly a matter of consistency and discipline. But provided you put in the time, it’s not especially difficult to vomit up volumes of material. The trick is distilling that first draft puke into something worth reading. For every word I’ve posted publicly, I’ve probably trashed at least ten words of raw output. Maybe a hundred.

Parsimonious portfolios remain focused on targeting specific sources of risk and return. The antithesis of parsimony in portfolio construction is what some call “mutual fund salad.” A mutual fund salad is a giant bowl of positions tossed together.

Mmm, a taste of everything! It’s diversified!

Mutual fund salads are often sold. They are rarely bought. They result from clever salespeople convincing well-meaning investors to add little bits and baubles to portfolios. Sometimes this is a “new” asset class. Other times it’s a tactical trade. Often it’s stuff people like to own to feel smart and special that they can brag about at parties.

In my case, I became enamored of little satellite ideas to the point where they began to swamp my portfolio. This was a direct product of my professional burnout. I may not be able to implement any ideas and work, but no one’s going to stop me from doing what I want in my PA! My disordered mind had manifested in my finances.

All portfolios are subject to a certain degree of entropy over time. They require regular pruning to avoid degenerating into mutual fund salad. An investor in a disordered state of mind cannot prune effectively. She may not be able to summon the activation energy to prune at all. For me, burnout was the culprit. It also happens when someone invests on tilt.

“Tilt” is a gambling term. When you are on tilt you are playing emotionally. Usually too aggressively. In case it isn’t immediately obvious, you should never, ever gamble on tilt.

The archetypical tilted investor is the professional money manager who eats a big drawdown and tries to make it back quickly, with aggressive bets. This is no different from “putting it all on black” at the roulette table. You would be surprised (on second thought, maybe not) how many allegedly sophisticated investment operations are just elaborate martingale systems. You can also get tilted just by watching other people get rich. Particularly if they’re getting rich in stupid ways. Back in the day, when Druckenmiller lost a bundle on dot com stocks, he was playing on tilt (he also was self-aware enough to acknowledge it afterward).

This happens on the risk-averse end of the spectrum, too. Sometimes, due to bad experiences or personal biases, investors cannot bring themselves to put on an appropriate level of risk. I’ve seen this happen after significant mistakes (which is understandable). I’ve also seen it happen when an investor anchors heavily on his priors. These priors can be rooted in past history or finance theory. This is, perhaps, a less dangerous form of tilt than being hyper aggro. Scared money usually just sits in cash. So it’s not going to zero. But it is subject to significant opportunity costs over time. “Scared money don’t make money,” as they say.

This is all just a long-winded way of saying your emotional state can have a significant impact on your investment decision-making. On its face that’s a trivial observation. Doesn’t even qualify as insight. There are probably 10,000 finance writers typing essentially that same sentence right now. It’s behavioral finance 101 material. Axiomatic.

Yet, I do think it’s easy for more sophisticated investors to lull themselves into a false sense of security around susceptibility to emotional swings and states of mind. We’ve done the academic coursework. We know the pitfalls. Surely we’re smarter than that?

3Q23 Permanent Portfolio Update

Yikes! There’s no denying it. It’s been a tough stretch (see performance data here). The TL;DR is we are dismally failing the “Why Not Just Put It All In SPY?” Test at the moment. But since I haven’t posted on the portfolio in a while, this is a good opportunity to take a deeper dive into recent performance.


What Happened Here?

The current numbers are pretty shit. Not “I put it all on PTON in 2020” shit. But definitely not good. A few things contributed to this. Some of them bother me more than others.

The S&P 500 has been an incredible performer. This doesn’t bother me at all. In fact, I benefit from it since S&P 500 futures are part of the portfolio. It just makes for an ugly comp.

Interest rate hikes whacked the portfolio. Drawdown hasn’t been much worse than my comps in this rising rate period. Especially considering this is a levered portfolio. The portfolio just hasn’t caught the sharp rebounds the S&P 500 delivered. A muted 2021 was the major point of divergence. To a lesser extent, this repeated in 2022. I am optimistic higher expected returns in fixed income will benefit the portfolio in the longer term. But getting here was painful.

On the other hand, this was an excellent stress test. The theoretical underpinning of this strategy is leveraging uncorrelated assets. When the correlations of those assets go up, and the price direction of the assets is down… well… that is not a recipe for great short-term performance. The gold allocation is supposed to help with this. And it did. At least to an extent. Gold was essentially flat in 2022 in US dollar terms. Many asset classes drew down double digits. Gold did better than zero in terms of most other currencies. But I’m a US dollar-based investor. So I’ve just got to suck that up.

Dumb Mistakes. This is one burns me up. Almost everything I’ve done to fiddle with the allocation at the margins has destroyed value. When I made adjustments based on trend metrics, I missed some of the COVID rebound. When I sprinkled in some satellite strategies, those strategies didn’t deliver. I should have kept it simple. I knew this. I’ve written about it! But I was in a terrible frame of mind for much of the past two years. This showed up in the portfolio, which became bloated, sloppy and confused. (note to self: revisit this in a future post)

What To Do About It?

For the most part, there’s not much to change here. I remain confident in the basic principles underpinning the strategy. What I’m doing is simplifying things. When I left my job, I cleared all the flotsam and jetsam out of the portfolio. I replaced most of it with NTSI, which is the developed international equity version of the core NTSX holding. I also consolidated some into my EM equity allocation (I am an incorrigible EM equity bagholder). Keep it simple, stupid! The result is essentially a 60/30/30 portfolio.

Allocation as of 10/18/2023

Burnout City

I stopped writing for a while.

In 2023, my job finally burned me out. I’m not going to get into the details of the how and why. The purpose of this post is not to grind axes. It’s to (hopefully) mark a new beginning.

First, a few words on burnout, how much it sucks. Burnout is the slow erosion of the human spirit. It is a kind of soul-death. The most painful point of the burnout journey was realizing my creative drive had been extinguished. Cynicism had permeated every fiber of my being. The glass was not half empty. The glass was completely empty. If there did happen to be a glass out there with some liquid left in it, it was only a matter of time before someone dumped it out.

Me, burned out

It’s all so clear in hindsight. In retrospect, the first thing to go was my creative drive. This didn’t happen overnight. It happened slowly. Incrementally. I just kind of lost the will the write. What’s the point in writing when everything is fake (like my job)? What’s the point in trying when everything is just a dumb political game in the end (also like at my job)? By the time I realized what happened, I was too demoralized to even look for a new job. I had become utterly incapable of relating to any kind of work in a positive way. It is impossible to create anything in that state of mind.

About a month ago, I resigned. Miserable as I was, it was still tough to go. I left good money on the table. I left friends behind. I imagine it’s kind of what getting divorced feels like.

But now I’ve got open road in front of me. This is the first thing I’ve written post-burnout. After about a month, I can feel the old creative mojo coming back.

I’m ready for a new adventure.

Hopefully the first of many.