Taleb / Barbell Investing / Mortgage Payoff

[Snowman99]

These strange times have caused me to crack open Nassim Talebs works (Black Swan, Antifragile, etc.) during quarantine.

Taleb advocates a barbell investment strategy whereby  90% of assets are in low risk treasuries and the remaining 10% are in very high risk investments. The concept is to minimize exposure to negative black swans while keeping exposure to potential big wins. In other words, one should take advantage of risk when there is “nothing to lose” or when losses are minimal.

I was thinking how best to implement this in my own modified form  as a laymen (ie not advanced options trader like Taleb but middle class family with mortgage). My thoughts were to keep buying VTSAX to fund Roth IRA at $12k annually (company does not offer 401k) to take advantage of the tax benefits and keep exposure to equities, but to pay down mortgage (3.25% APR 30 yr) with anything beyond that.  Siding with the “don’t pay your mortgage” people previously I placed anything beyond IRA (about $30k annually) into VTSAX in a taxable account.

My take is that the Roth contributions I can easily be ok with throwing in there and forgetting about while taking advantage of the tax benefits.  Had I paid down mortgage instead of funding my taxable the past few years, however, I’d be in a much better position. Makes no sense to buy taxable bonds delivering crappy return when I can get a tax free and risk free  3.25% return (still crappy but better than negative) by paying mortgage.

Curious what people’s thoughts are on this strategy going forward at least until mortgage is paid off, whereupon strategy would re-evaluated.

Alternatively, now might be the time to “double down” on 100% equity exposure given that stocks are cheap and may be getting cheaper. Although this makes sense intellectually I would feel much better being debt free during this difficult time. Thanks.

[hodedofome]

There is nothing wrong with the psychological benefits of being debt free. Sure you could probably get a higher return by investing in the stock market than paying off mortgage but if it helps you sleep at night it’s worth it.

As far as Taleb goes, that strategy just had its best outperformance over buy and hold investing in years, and will most likely underperform buy and hold stocks for years before its needed again.

Diversified trend following (managed futures) had one of their best years ever in 2008, and proceeded to have underperformance for a decade afterwards.

[Snowman99]

There is nothing wrong with the psychological benefits of being debt free. Sure you could probably get a higher return by investing in the stock market than paying off mortgage but if it helps you sleep at night it’s worth it.

As far as Taleb goes, that strategy just had its best outperformance over buy and hold investing in years, and will most likely underperform buy and hold stocks for years before its needed again.

Diversified trend following (managed futures) had one of their best years ever in 2008, and proceeded to have underperformance for a decade afterwards.

I suppose to be effective over buying and holding VTSAX long term, one necessarily has to time the market short term, which as we all know here is next to impossible. Also worth considering if VTSAX can actually be considered “high risk” in a barbell scenario when (1) the investior intends to buy/hold long term and (2) the investor has enough dry powder whereby he doesn’t go bust if the market drops temporarily.

I should probably add that I had not yet fully committed to “not paying off the mortgage” but was going to table that decision to once the taxable had enough to pay the mortgage balance. That obviously had not occurred before the Coronavirus.

As I think this out, I think I’ll keep buying stock but once the taxable can make the payoff we will. Plenty of time to decide!

[MustacheAndaHalf]

Taleb advocates a barbell investment strategy whereby  90% of assets are in low risk treasuries and the remaining 10% are in very high risk investments.

I've only seen that portfolio mentioned when people discuss the theoretically lowest risk portfolio - the portfolio with the lowest volatility.

https://www.portfoliovisualizer.com/backtest-asset-class-allocation#analysisResults
Portfolio Visualizer, using 1981-2020 data :
90% bonds / 10% stocks, contribute 6k/year, after 40 years you might have 900k
10% bonds / 90% stocks, contribute 6k/year, after 40 years you might have 1500k
You can run other back tests, but I see +67% more money when those percentages are flipped.
Make sure the book you're reading shows how it's ideas performed against the S&P 500 over decades.  If it only uses short examples (1-10 years), or refuses to compete with the S&P 500... there might be a reason.

[Retire-Canada]

Alternatively, now might be the time to “double down” on 100% equity exposure given that stocks are cheap and may be getting cheaper. Although this makes sense intellectually I would feel much better being debt free during this difficult time. Thanks.

For a normal stock and bond investor having a small stock allocation leads to a lot more failures when you run simulations against historical data. So to get to the same performance you'll need a lot more money. That equates to years more working before FIRE. I would not discount how you feel because as we've seen lately having the best investment plan in the world is worthless if you can't actually follow it due to fear/panic. That said I would not allow myself to work an extra 7 years for example because I was scared at the moment. I would acknowledge my fear and take the opportunity to explore both my own feelings and ways to mitigate the root concerns until I killed that fear and replaced it with a workable plan that addressed the underlying concerns.

So I would not be throwing around 100% stocks, 90/10 or 10/90 as my only options because the are pretty extreme. I like to look at my bond allocation in terms of year's of spending not a % of my portfolio. So I might end up with 100% stocks + 5 years of bonds as my allocation or 100% stocks + 3 years of bonds + a reliable PT side gig. Personally I'd rather have a big chunk of money that's liquid than a paid off mortgage. If you come down on the side of having a paid of mortgage before FIRE that's fine, but that's going to have to be supplemented by a portfolio of stocks to provide cash flow for the 30-50+ years of FIRE. Also keep in mind a mortgage is not a bond. If you drop $200K into a $300K mortgage and there is a crisis with your cash flow you are no better off than at $0K paid off that $300K mortgage. OTOH if you put $200K into bonds and you have a cash flow crisis you have many years of spending available to house and feed your family and you likely won't feel it's nearly as big a crisis.

You only benefit from paying down the mortgage fast once it is actually paid off, but you can't tell when the next crisis will happen and the next one may be inconveniently timed if you get unlucky. So even if paying down the mortgage fast is your strategy perhaps put some of the money into bonds or something else safe so that you don't get caught out. You can then dump that safe money into the mortgage to pay it off when you get close enough to the finish line.

As someone with a mortgage [$300K left out of $400K] I just stretched the amortization out from 15 years to 25 years and lowered my interest rate to get some really low payments. I'm happy to let inflation eat away at my debt rather than rushing to pay it off with today's much more valuable dollars than the ones I'll be paying in 10, 15, 20 or 25 years. With the reduced cash flow from low payments any housing stress is gone and I can direct more of my income to buying stocks. And that's what I am doing with every extra $1 I get...buying equities while they are on sale. However, I do have several years of spending in bonds and the potential to do side-gig PT work as well. So my defensive plan is diversified and deep.

[talltexan]

You need to reread Taleb. Being anti-fragile involves relying on "optionality" and "convexity". How are those expressed through your strategy?

Paying off the mortgage may make sense for your values, but $VTSAX is not the asset class Taleb advocates for the risky positions.

[ChpBstrd]

Yes, it makes more sense to pay off a 3.25% mortgage than to invest in treasuries yielding <2%. However, you’ll never retire at any reasonable WR by investing in things that yield so low. E.g. if inflation runs 2% over the next decade, and you earned 3.25% by paying down the mortgage, your real return would be <1.25%. Are you planning on a 1% WR?

So to execute the barbell strategy, you need some sort of 10x leveraged instrument with limited (100% or less) downside potential and unlimited upside potential. I.e. something where if you lose badly, the portfolio losses are up to 10%, but if you win this tiny allocation lifts the whole portfolio can gain 25% or more.

There simply is no way to get that sort of risk/return profile without using options. So if you’d like to do the barbell, I’d recommend investing in a few books, preferably out of print college textbooks (there’s lots of literary garbage on this subject with misinformation about easy riches). Then there’s the lazy way to learn about options: https://www.optionseducation/

[Telecaster]

And here's the thing:  You need to sit quietly on the sidelines while everyone else is making money until some big disaster hits and you get a huge payoff.   Psychologically, that is really tough. 

[hodedofome]

And here's the thing:  You need to sit quietly on the sidelines while everyone else is making money until some big disaster hits and you get a huge payoff.   Psychologically, that is really tough.

100% true. Taleb got lucky in that shortly after he started buying deep out of the money puts, the 1987 crash happened and he became financially independent overnight.

I’d say give it a year or two, wait for markets to be consistently hitting all time highs, wait for the VIX to be low, then consider a strategy like what Taleb did.

Or just wait for the “50 Cent” trader to come back. His timing has been impeccable!

https://www.reuters.com/article/us-usa-stocks-volatility/options-trades-pointing-to-50-cent-accumulate-ahead-of-super-tuesday-idUSKBN206323

Here is one idea of how to run a strategy like Taleb

https://www.portfoliovisualizer.com/backtest-portfolio?s=y&timePeriod=4&startYear=1985&firstMonth=1&endYear=2020&lastMonth=12&calendarAligned=true&includeYTD=false&initialAmount=10000&annualOperation=0&annualAdjustment=0&inflationAdjusted=true&annualPercentage=0.0&frequency=4&rebalanceType=3&absoluteDeviation=5.0&relativeDeviation=25.0&showYield=false&reinvestDividends=true&portfolioNames=false&portfolioName1=Portfolio+1&portfolioName2=Portfolio+2&portfolioName3=Portfolio+3&symbol1=SPXL&allocation1_1=90&symbol2=TVIX&allocation2_1=10

And here’s another way:

90% TLT 10% short VXX.

[dcheesi]

Yes, it makes more sense to pay off a 3.25% mortgage than to invest in treasuries yielding <2%. However, you’ll never retire at any reasonable WR by investing in things that yield so low. E.g. if inflation runs 2% over the next decade, and you earned 3.25% by paying down the mortgage, your real return would be <1.25%. Are you planning on a 1% WR?

So to execute the barbell strategy, you need some sort of 10x leveraged instrument with limited (100% or less) downside potential and unlimited upside potential. I.e. something where if you lose badly, the portfolio losses are up to 10%, but if you win this tiny allocation lifts the whole portfolio can gain 25% or more.

There simply is no way to get that sort of risk/return profile without using options. So if you’d like to do the barbell, I’d recommend investing in a few books, preferably out of print college textbooks (there’s lots of literary garbage on this subject with misinformation about easy riches). Then there’s the lazy way to learn about options: https://www.optionseducation/

The other thing is that paying extra principal on your mortgage (as opposed to paying it off entirely) leaves you open to another rare-event loss scenario: You lose your source of income. Since 90% of your surplus income went into principal payments, all of that money is tied up in equity, and you don't have enough additional wealth to pay off your mortgage (otherwise you'd have done so already). You can't take out a HELOC since you have no income. Eventually, you can no longer make your mortgage payments, and wind up losing the house and all of that equity you built up.

OTOH, if you'd invested in treasuries, you could have liquidated those holdings to keep up with your mortgage payments, preserving your equity and place of residence for an extended period until you were able to find a new source of income.

[talltexan]

And here's the thing:  You need to sit quietly on the sidelines while everyone else is making money until some big disaster hits and you get a huge payoff.   Psychologically, that is really tough.

Indeed, there are many strategies that can provide excitement and a possibility of outperforming, but you have to make peace with the long stretches where you will be behind and lose your willingness to persist in the strategy.

[Stachless]

My take on Taleb's Barbell Strategy is not so much as having a chance to outperform, but rather the complete elimination of 'blowing up', where decades of accumulated capital disappear in a single afternoon.

[jonoliver]

I think Taleb's critique on Modern Portfolio Theory is compelling.

"conservative" vs "aggressive" portfolios are only marginally different from each other because they are both exposed to fat tail events. These portfolios pretend you can calculate the tail risks, where the barbell is a bit more honest. You have years of safety in your 90% cash position, and then you have incredibly convex possibilities in the 10%. The trick is, for an average family you probably need to have a net worth of at least 500K for that 10% risky portion to be meaningful.

That said, your typical FIRE portfolio of just buying the total stock market is probably the best, most efficient version of adhering to MPT, and you'll probably do fine in the end.

However, there are still some very fragile properties of this portfolio. Only in recent human history has one been able to simply buy the whole stock market. It's hard to compare todays returns on "the stock market" to even a few decades ago because those returns were based on a world where only a few people had access to that kind of investing.

Where MMM and Taleb agree, your best potential for return is in starting your own business.

Personally, I feel fine staying out of the market, except it kind of renders IRAs/401ks useless.

[chevy1956]

My take is that the data proves that this is a poor option the vast majority of the time. That means for the same amount of money I have a much greater chance of running out of money in retirement compared to a simple stock/bond/cash/portfolio.

I have a 90/10 overall portfolio. I've managed to hold onto everything over the last year and even FIRE in that time. That 10% gives me a couple of years of not spending any stocks and I'm fine with that as my safety net in relation to the market crashing.