What are you hoping to gain from this thread? Nobody here uses or would consider this method.
Responses like the one from @Systems101 are excellent. He had a very good, well-formed criticism. I hope for more of that.
Yet your response is to:
- Put words in my mouth (I neither called you stupid, nor did I accuse you of thinking the world is flat)
- Set up a 100% strawman to then tear it down?
Unfortunately, I need to do one more post to support this concern:
My motivation for posting here is to offer new impressionable investors, who might be silently reading along, a counter argument to a market-timing methodology that could be hazardous to their portfolio's health and performance.
My example about the world being flat is that all the logic in the world can't help you if the starting assumptions are wrong. I believe good research involves challenging your own assumptions, which means looking for contrary information. Most of what the OP is doing is looking for information that validates that the methodology reduces volatility. This is a
very narrow perspective. The graph the OP posted (which I also produced but didn't post - if you convert the return values to absolute values and then fit a line you will get the R-squared I talked about), as well as various articles will show the implied volatility of the VIX, to a limited degree, predicts realized volatility. The OP is therefore declaring success.
Unfortunately, I will maintain my point that the OP has not done enough research... It is this leap of "Since the VIX predicts volatility, my investment process works!" that I think is deeply flawed.
“If you do not know how to ask the right question, you discover nothing.” – W. Edwards Deming
Simply put, the OP is asking the wrong questions.
Let's start here:
But this is exactly what I'm hoping to achieve. Less start-date sensitively, less liquidation/draw timing sensitivity, less worry.
There are a ton of questions here that are important to ask.
- What is the best methodology of lowering volatility and maintaining as much return as possible?
The problem is you are running a test that says "Is my methodology better than 100% pure investment?" You have set it up as a False Dilemma. If we assume MPT is valid, the proper question is: "For the lowering of volatility, did I take an appropriate lowering of return to stay on the efficient frontier?" If we do an alternative test, we can formulate the question to show what I believe
@ILikeDividends was getting at: "Does having a variable rate of investment in the market to reduce volatility outperform having a fixed rate of investment (at some value that provides the desired volatility)?". Since you have provided NO data on other methodologies to reduce volatility, you didn't answer this critical question.
- Why are you sensitive to draw timing? or perhaps... Why are you concerned about a future risk in the present? or perhaps... Why are you assuming you have one investment methodology before, approaching, and after retirement?
Let's be clear: You are raising a real risk (volatility risk) - this is good. But volatility is a meaningful risk
only when you are forced to liquidate. This becomes important below.
Secondly, you are attempting to use a measure of that risk factor (VIX, which measures implied volatility) to alter your investments. I will address this below, but need to make one other point first.
You never asked "Am I sensitive to volatility risk?". It's like the Hurricane in Idaho example earlier: Can you imagine State Farm representative's response if you asked to get a hurricane addendum on insurance in Idaho? The risk is real while you are in the draw-down phase. It is also real right now, but you basically aren't exposed to it. It's why in corporate risk management, there are two columns: Impact and Probability. In both cases, the probability of a volatility event could be high, but in the accumulation phase, the impact (the probability of it being a problem) is almost precisely zero. Because we shouldn't assume we have to have one methodology, this then compounds onto the first question. You are paying for insurance (lower return) on a risk factor (volatility) that you may experience - but basically won't impact you - while you are in the accumulation phase. Why are you setting an investment methodology now when the probability of it being a problem is high mainly in the first 10 years after retirement? There is no reason to take on that opportunity cost of lower returns now.*
*This assumes your investment horizon is, in fact, retirement. Different rules may apply if you are saving for a house down payment, for example.
- Is this the best method for dealing with draw-down risk?
Also, there are already documented methods for dealing with the initial sensitivity to a market crash right after retirement: Rising Equity Glide Path. You don't need to prove the variable model better than the S&P500, you need to prove it better than the known alternatives. Again, you have brought NO data to the table.
Risk-parity funds do use VIX as a measure of variance.
Yikes.
Even if I take this as correct (I lack knowledge of how exactly they measure risk, so make no opinion on it), it is extremely scary to jump from "Risk parity funds use VIX" to "I should take my *entire portfolio* and treat it like a risk parity fund". Even if you someone believes in using Risk Parity, I suspect they believe it should be *one part* of an overall portfolio, not *the entire* portfolio.
Here's the implied question in your behavior:
- Why should your entire portfolio be treated as a Risk Parity fund, rather than risk parity being one factor in a multi-factor portfolio?
Again, no data.
OK. So one of the bigger issues that has been brought up is that VIX is not actually predictive of future variance in the S&P 500. So I charted it out.
This is another one of those things that should raise red flags for those following along at home. Folks have pointed out that the VIX doesn't predict market *performance*, but did anyone actually make that claim that it wasn't predictive of future variance? I even stated the R-squared was around 0.2, so I actually supported the same claim you are making. The problem is: So what? What is the logic chain that makes that information valuable? (and remember, it has to be *relatively valuable* to other strategies, not just *absolutely valuable* vs the S&P 500). I just happen to think the claim (about implied volatility predicting future volatility) is useless in the face of known alternatives and the questions listed above.
That's why I picked the 50% loss limit. The system optimizes for that level of risk tolerance.
Ah, the wonders of marketing. There is little to no basis for their 50% claim, especially if it is backtested only into the 1990s. Keep in mind the losses in '29-'32 were WAY bigger than 2008. What they have done is provided you a slider to choose a loss limit. There are some statistics around this to give it an air of legitimacy, but in reality, it's part of an oft-used marketing scheme called (among other things) "Fake Precision". This gives you a precise value to give you an air of comfort that they know what they are doing. This is designed to lower your stress level and validate that the service you are buying is performing a useful function for you... while actually providing no guarantee of accuracy in return. I can query 10 people and average their answers as to the height of the Statue of Liberty to the nearest millimeter, but Wikipedia is likely to give me a much more accurate answer (albeit with less precision). You should want an accurate answer, not a precise one.
Said another way: You are giving up returns in exchange for a false sense of security. If this helps you sleep at night, then perhaps that false sense does have real economic value for you. Some people are willing to pay prices for things like that (you can find threads here about robo-advisors and the comfort of those services). I actually don't have any problem with people doing that
as long as they understand they are not reducing their risk, they are merely paying for their emotional comfort with lower returns. If you both go in with eyes open, and make sure to educate others you are encouraging to follow you with the truth, then it's all good.
Since folks here are maximizing return and accepting the volatility, I don't know why anyone here would be interested in using the VIX as you describe.
If everyone here literally has 100% of their liquid assets in stock indexes all the time, then sure, you're right.
As noted earlier, this is setting up and tearing down a strawman. To be more clear: Each individual should pick a portfolio that is appropriate for their risk tolerance. Within that, we accept the volatility as appropriate for the risk we have chosen. Again, I am not using volatility as risk here, as that simplification for economics papers has some nasty logic holes.
Also, let's be clear on one more concern: Why are they selling the methodology $8 at a time? If it's really "that good", then they should keep it a secret. Once a secret is out, the market prices in that information, and the edge goes away.
Overall, you are spending a lot of effort to prove you are correct, but you have not yet taken on the effort to really tear down your own assumptions or identify where you are making leaps of logic that don't hold water. It really feels like you are "shifting the burden" (Getting lots of practice with my logical fallacies today!) to have us prove your methodology wrong. As I've pointed out, there is a LOT of evidence that passive investing is the way to go... so the obligation is on *you* to prove that the VIX is not, as you put it, "useless garbage". The data shows implied volatility predicts real volatility... assume we accept that... but you haven't connected that point to any action that is more useful than other already known options.
Not sure there is much more for me to add here. Hopefully that post is sufficient warning to others to at least do a lot more of their own research before buying into an active methodology.