Prudent Investing as Savings Allocation and Temporal Conundrum

Key Quotes

"I think that a lot of people go into portfolio construction in search of the perfect portfolio and they they think of this from the perspective of really I think the way that people oftentimes sell a strategy to them that there's this idea that there's some sort of like holy grail out there that a strategy that will serve everybody well and I think people oftentimes bounce around from strategy to strategy thinking they're going to land on that one portfolio that you know is consistent with some famous macroeconomic guy or some famous investor and they're going to then adopt this portfolio and be able to stick with it over the course of my career I've just sort of realized that I've worked with so many thousands of different investors over the course of my career that I've in retrospect I think virtually none of their portfolios have ended up being exactly the same and that's in large part because we're all just different people we have different goals we have different needs we have different time horizons and so everyone's portfolio is a little bit different"

Cullen Roche explains that the concept of a "perfect portfolio" is a misconception, as individual circumstances like goals, needs, and time horizons mean that each person's ideal portfolio will differ. Roche's observation stems from his extensive experience working with numerous investors, none of whom ended up with identical portfolios.

"Your investment portfolio should more appropriately be thought of as a savings portfolio. What do you mean by that? What's weird this is actually it kind of a rollover from my first book when I wrote pragmatic capitalism I had this struggle where I was writing a book that was it was really both about macroeconomics and about investing and the weird thing is that in the field of economics the word investment has a totally different meaning than it does in the field of finance and in the macroeconomic world the term investment means to spend for future production and that's done by firms and firms will interestingly they fund a lot of investment by issuing shares of stock and so you know you might sell stock or you know issue bonds or something like that to fund investment spending so that the firm can go out and you know generate a return on investment in the long run and hopefully the value of that is reflected in the share value and they repay interest on the bonds through income based on their investment spending and the interesting thing though is that the people who buy those securities on the secondary market are not necessarily funding investment in any real way what they're actually doing is they're buying an instrument that reflects the value of savings the investment spending from the firm actually generates the value that accrues to the shares and so it's interesting thinking about this perspective because the the word investing is not really what someone does when they're buying shares of you know xyz stock on the secondary market they are quite literally they're reallocating some of their savings into an instrument that will reflect the value of the firm's investing"

Cullen Roche clarifies that in a macroeconomic context, "investment" refers to a firm's spending for future production, which is distinct from how individuals typically view investing in financial markets. Roche argues that when individuals buy securities on a secondary market, they are reallocating their savings, not directly funding new investment by firms. This perspective reframes investing as a more prudent act of savings rather than a speculative endeavor.

"And so I tried to present this in terms of something closer to hey this is the amount of money that you're actually going to be putting in your pocket rather than you know the amount of money that is sort of a paper gain that is a number in the media that sounds really appealing but in real life in terms of our ability to actually consume goods and services in the future is really like an irrelevant number"

Cullen Roche explains his deliberate choice to present all financial analysis on an inflation-adjusted basis, emphasizing that real returns are what truly matter for an investor's ability to consume goods and services. Roche highlights that headline numbers often cited in the media fail to account for inflation, fees, and taxes, which significantly reduce the actual purchasing power of investment gains.

"And so Harry Brown kind of makes this portfolio famous because of its its outsized relative performance but then it it goes through a series of transformations over time where over the course of the next 40 years it survives over this very traumatic period it goes through world war ii and then it goes through the 1970s interestingly a guy named John Bogle gets hired by Walter Morgan to then run the Wellington Fund and Bogle weirdly actually turns the fund into a very aggressive sort of like 70 30 or 75 25 fund coming out of the 1960s sort of chasing performance and the fund struggles through the 1970s because the 70s were a pretty traumatic period for stocks and bonds but the fund comes out of the 70s and then has a 40 year run that is like unheard of we all know that 60 40 is kind of like the gold standard now and so this fund has been through a lot of sort of like trials and tribulations but it has stood the test of time and and it all sort of began with the great depression and Walter Morgan feeling like he didn't want to go through getting burned by the stock market and so he creates this balanced index that it hasn't always been exactly a 60 40 but it has on average looked a lot like a 60 40 bond portfolio and has been a very balanced and reliable portfolio throughout history"

Cullen Roche traces the historical development of the 60/40 portfolio, attributing its rise to prominence to Walter Morgan's Wellington Fund, which demonstrated relative resilience during the Great Depression. Roche notes the fund's subsequent transformations, including John Bogle's management, and highlights its enduring performance through various market cycles, solidifying its status as a benchmark portfolio.

"And so I've created this concept that I called defined duration which tries to actually quantify a reasonable time horizon over which to judge an instrument like the stock market or it can be applied to virtually any instrument but the stock and bond markets are where it's most quantifiable and what I'm basically doing is I'm estimating an expected future return based on a potential max drawdown real terms and what we're really trying to measure is sequence of returns risk so in financial planning and especially retirement planning sequence of returns risk is kind of like the holy grail giving somebody certainty of their ability to retire across time and I'm trying to measure what is the sequence risk of a portfolio and how can someone apply that then in a way where they can actually build a portfolio that matches their desired sequence risk to certain assets"

Cullen Roche introduces his concept of "defined duration" as a method to quantify a reasonable time horizon for judging assets like stocks and bonds, with a particular focus on measuring sequence of returns risk. Roche explains that this framework is crucial for financial and retirement planning, aiming to provide individuals with certainty about their ability to fund their needs over time by matching their desired risk tolerance to specific assets.

"I think a lot of people will look at their portfolio and they want the whole thing to be perfect and