How to build your perfect portfolio with Cullen Roche

0:09Cullen Roche. Very excited to have you on the Investing Experts podcast. Always great to talk to you on Seeking Alpha, from which we have culled your writings over many, many years. So I'm a big long-term fan. You have recently written a book called Your Perfect Portfolio. Welcome to the show. Welcome back to Seeking Alpha. Hi, Irina. It's great to be here. I love the Seeking Alpha community. I've been, God, I think from the early days of right after the financial crisis, I've been contributing to Seeking Alpha. So it's one of the longest standing communities that have tolerated my ramblings. Celebrated, celebrated.

0:51And I've been around just as long. So yeah, Yeah. Great community, long-term community. So talk to us, first of all, for those that aren't familiar with your work, what you're about, why you want to write about investing, why that is something that you feel like you want to put out there. Yeah. And your journey to this moment, maybe briefly. Yeah. So I'm a financial advisor by background. And I think that a lot of my writing is the result of a curiosity, not only about how things work, but also trying to answer other people's curiosities and questions. And so, so much of it's interesting because all this kind of goes back to pragmatic capitalism, the original blog that I started back after the financial crisis, where I was explaining essentially the monetary dynamics that everyone was trying to decipher, you know, with the big programs, the Fed was unfurling.

1:45And I had unusual relationships and contacts back then that gave me a lot of insight, especially into what Japan had been doing. And so I was able to kind of translate a lot of this into the United States. And, and I, I guess I became well known for being more of a macroeconomic thinker, which is actually kind of weird to think about in retrospect, because it's not really, I'm not an economist, but I was, I was writing about it from a market practitioner's perspective because my contacts were in the world of trading, mostly in Japan. And they were relaying a lot of this to me and explaining it to me.

2:18And then I'm communicating and writing about my understanding of how all this is going to then transpire into the United States and impact everything. And so much of the I think the understandings from Japan were the opposite of what the mainstream media was saying at the time, where a lot of people thought QE was going to cause hyperinflation. It might cause interest rates to go up. And these guys in Japan who work for big trading desks are explaining to me like, no, we've been doing this for 20 years. It doesn't do any of that stuff. You've got to understand this at an operational level. And so, so much of my writing is really a desire to communicate how things work and answer some of these big, confusing questions that lead people to make sometimes really bad decisions in the financial markets.

3:03And to a large degree, trying to calm people and work more from sort of a first principles perspective. And so, you know, I wrote the paper Understanding the Modern Monetary System, which was very popular. And then my first book is largely expanding on that. I delve more into portfolio management specifically. And the latest book, Your Perfect Portfolio, is really focused purely on the portfolio construction aspect of this, where I've learned over the course of my career that, you know, I, as a financial advisor and the portfolio manager for my firm, I have spent a lot of time in my own business trying to build model portfolios and things that I can just plug and play to make my own life easier, where I can just sort of plug and play a portfolio into a client's life.

3:52And I've learned over time that it's not that easy. Everyone's different and everyone needs customization to some degree. and everybody's portfolio ends up being a little bit different for whatever reason. And so everybody's got to find their own perfect portfolio. And that's the main gist of the book is that no two portfolios are the same. You can't just buy something that's popular or what somebody else is promoting. And you have to really customize this and find something that's going to work for you. And so that's the main gist of the book and the reason that I wrote it. I would say now is a pretty perfect time to know what to do with your portfolio because there is so much confusion.

4:28and to the point about your macroeconomic background, you know, what better time to... There's so many misunderstandings and uncertainties. And I think a lot of fear points for people, even those that have felt pretty confident in their strategies up until now. Would you say that that's part of the reason why you wrote this book specifically now? Or why did you, would you say? Yes. The world has gotten, I think, especially from the financial market perspective, more difficult to navigate. And a big part of this is that I think that the especially I mean, gosh, when I started writing the book, when I really first started to try to put pen to paper, this was, I mean, three, four years ago.

5:16So this has been a long process. And back then, you know, my big problem back then was that the bond market was no longer a great diversifier. And so I was running into this problem a lot in my own practice where because of zero interest rate policy, the risks in the bond market were just elevated and unusual. And and so there was this was even before COVID happened and then COVID happened. And I mean, I had a series of events that sort of lopped me over the head during COVID where I had my first daughter during COVID. And and then, you know, COVID itself happens. And then I make this joke in the book.

5:48My mother in law got trapped with me, which was the biggest, probably the worst part about COVID because she was from she's from Paris and Paris, France. And so she got trapped with us when the international travel ban happened. And so I say that half in jest and half in truth. But I realized during this and also over the course of managing portfolios in the post-financial crisis period that the hardest part about portfolio management is navigating time. And I think this is the thing that everybody deals with in building their own portfolio is that they're navigating a series of confusing and unpredictable time horizons.

6:25And so a lot of the work that I did, especially with banks in the post-financial crisis period, was what we call asset liability matching or in the institutional space, they call it liability driven investing. And this is a very different process than what traditional retail asset management processes look like, where from an institutional perspective, banks and pension funds and some of these big institutions, they're trying very specifically to match assets to liabilities because they have very specific temporal outflows. And what I realized working with retail investors is that retail investors have all the same problems.

6:59It's just, it's not as perfectly quantifiable as, say, a bank's deposit outflows are over time. But retail investors go through the exact same thing where we're navigating all these different time horizons. And for me, the thing that really, I think, sort of woke me up to this was having my first daughter. And I realized that my time horizon now became very confusing, where I was no longer just thinking about me and my wife's time horizon, because that was really simple. It was, you know, we had good incomes and we were youngish and we have, you know, 30, 40 years potentially with a lot of our assets.

7:35We had the ability to be very aggressive and think very long term. So building a portfolio was relatively simple. And then when you have kids, you know, the everything gets thrown upside down and, you know, quite literally lots of things get thrown upside down, too. But I mean, from a portfolio management perspective, things get thrown upside down because all of a sudden you've got lots of different time horizons you need to think about. You need to think about, I need life insurance and I need estate planning and I need multi-generational planning. And my kids are going to go to college in 18 years, hopefully.

8:08And my kids are going to go to daycare in three or four years. And there's all these things that you start starting to measure over different time horizons. And that starts getting really confusing. And when you start implementing a portfolio to try to plan for all of this, you realize that you need lots of different forms of diversification. not just in the scope of like estate planning and life insurance, but also in the scope of the way that your portfolio has to be diversified. It has to be diversified in very strategic and specific ways. And so that was the other big nut that I was trying to crack in a lot of this.

8:43And I talk about in the book, lots of different, very different portfolio styles, whether it is a simple 100 % stock portfolio, which I frame as a very long-term portfolio to One chapter is called the T-bill and shill portfolio, which is basically a cash management portfolio. It might be a portfolio that you're managing entirely in a bank account or a cash management account, brokerage account, where you're just executing liquidity trades and whatnot. to much more elaborate and somewhat sophisticated strategies where some of them are pure tail risk hedging strategies, more like a trend following portfolio.

9:27There's an entire chapter on that to specific retirement planning strategies. And then the one that I talk about, which is my own strategy, is the defined duration strategy, which is this very structured asset liability matching portfolio that kind of covers the full gamut of all of these different time horizons and different styles. I was going to ask you about this present moment and what you think vis-a-vis the macro environment, vis-a-vis tech, vis-a-vis are we in a bubble, are we not, vis-a-vis the bond market, vis-a-vis so many things. But maybe it makes more sense to look at this present moment through the lens of various timelines.

10:08Do you feel like that may make more sense considering where you're coming from with it? I do because I think that that, I think it frames things in a perspective that is much more digestible where, for instance, when you, um, when you look at the valuations in the world today, they're very high, um, especially in aggregate because the United States valuations are so high due to technology valuations primarily, but the U S in general on average is just much higher than like the, the CAPE ratio in the United States is rough than 40 versus in foreign markets, for the most part, it's in the low to mid 20s, for instance.

10:43And this is a huge disparity. We've never seen anything like this, really. And the way that I like to communicate and frame this is, you know, when you ask, if you were to ask me, is there a bubble in technology? Is there a bubble in AI? I would say, I really, I have no idea. But if there is, there's a framework for thinking about this in a logical way where, for instance, in the late 1990s, we know there was a tech bubble then and valuations were similar in the tech world then. And looking back at that, you can say, well, okay, there was a bubble, but if you had bought the very tippy top of the NASDAQ bubble back in 2000 and held on to today, you've earned 8 % per year.

11:28So this was a bubble that collapsed. It fell 75, 80%. for the NASDAQ 100 at one point. But in the long run, the internet bubble, you know, or the enthusiasm over the internet at that point was very, very accurate in terms of the long run ramifications of what the internet would do to the valuations of the financial markets and just the economy in general. And so looking at that in the scope of today, I think you can say, okay, Well, if you're someone who owns a huge position in the NASDAQ 100, for instance, or the MAG 7 or something, or even the U.S. market relative to the foreign markets, well, your risk today, as I would frame it, is a temporal one.

12:12You've got a, from a financial planning perspective, you would say this element of the portfolio has the potential to expose you to a lot more sequence of returns risk. And so the potential for a bumpier ride in the NASDAQ 100 is elevated right now because the expectations are just so high. And so when you get weird, even macroeconomic events like, you know, all the geopolitical stuff that's kind of going on right now, whether it's tariffs or Greenland or, you know, whatever the narrative of the day might be, it creates a lot of volatility. And so valuations create high expectations, which creates a very thin margin for error inside of an environment like that.

12:52And that creates a temporal problem where if you've got very short time horizons, you've got a very unpredictable instrument inside of the NASDAQ 100. Whereas that investor, probably if you're very, very time sensitive, that investor needs a lot of other forms of diversification. They need a lot of other forms of insurance in their portfolio, whether that is owning something like T-bills or whether it's owning managed futures or, you know, something that's more of an insurance-like component on the portfolio. It could even be just owning more of the foreign markets where the expectations aren't as high, the valuations aren't as crazy, and maybe the downside isn't as significant.

13:29And so I think framing that as a temporal discussion, you know, it's interesting because if you were a very young investor, the idea of a NASDAQ bubble is probably largely irrelevant to you because if your runway for this instrument is 30 or 40 years, well, you can look at it and you can say, I don't really care what this does in the next 10 years. So if this is a bubble, well, I'm not investing for a bubble environment. I'm investing for the long run environment. And so even if you're that investor that's buying the very tippy top of the NASDAQ bubble right now, if you're a long term investor, it's kind of irrelevant.

14:05So I think you can you can frame this in the context of today's markets and you can digest it better if you can put it into a temporal context. And that's why I think thinking about things across different time horizons is so important. So let's break it down maybe. Let's start with maybe somebody who is on the younger side of things looking to probably be more aggressive, somebody saving for retirement, somebody closer to retirement. And then maybe if you think whatever else you think is worth discussing at this point, maybe something that's more misunderstood or maybe that people are very excited about at this point that you think perhaps they shouldn't be or maybe they should be.

14:47Where you think it is of most value for the most investors? Yeah. So let's start with a really young investor. I talk about a lot of strategies that are relevant to very young, very or even just very aggressive investors. You don't necessarily have to be old or young to have a very aggressive portfolio necessarily. You could be one thing that I talk about that I think is not talked about enough is that I talk about how your human capital is hugely important in the context of all this because your human capital is the thing that generates an income for you. And if you're someone who is, you know, let's say you're, you're 55 and you've got a huge income and you're working for another 10 years and you know, your, your portfolio is, is relatively large, but your income relative to your balance sheet is very, very large.

15:34Well, you've got a very different risk risk profile than somebody who has, say, a much lower income relative to even a large portfolio. Because your income that you're generating, I talk about, is a lot like having an implicit bond allocation in your portfolio, where when you've got a large fixed income from your literal income and your human capital and your job, what you're doing really is the example that I like to use sometimes is let's say that you make$100 ,000 a year. Well, that's similar to having a$1 million bond that earns 10 % per year. And so when you're in a situation like that, you have a very different risk profile than somebody that isn't working because you've got this implicit, large fixed income allocation.

16:21And that creates a lot of free space in your portfolio where you can take a lot of risks. That person can be a lot more aggressive in their actual portfolio than somebody who doesn't have an income because they don't have this implicit fixed income allocation. They don't have the certainty of the job income that the other person does when you have that high income. And so, you know, but for the person who's young and is working and especially the person who's building their human capital, that person needs to be probably much more aggressive because not only do they have the time, but they've got time to build that human capital and that income and that they have that implicit fixed income position in their portfolio.

17:00where they're able to look at things like, one of the portfolios I talk about is the Warren Buffett portfolio where Buffett is 90-10 roughly in terms of stocks versus T-bills in his asset allocation roughly. And Buffett is obviously very aggressive. He's a stock picker. And I know a lot of people in Seeking Alpha like to pick stocks. And actually, if I have one regret about the book, it's that I didn't give people more of a framework specifically for picking stocks. But I did that very intentionally because I try to talk about portfolio construction not in a micro sense, but more in a macro portfolio construction sense.

17:33And so from a 90-10 perspective, the way Warren actually talks about it, he tells people to buy the S &P 500. So, you know, and I outline a number of different ways where you can do this, whether it's buying something like Vanguard Total World or buying a very diversified portfolio of ETFs, or whether it's even buying just Berkshire Hathaway. But the thing I talk about that's one of the big conclusions from the Warren Buffett portfolio is that it's very important to build a portfolio that is very structured across different entities too, in terms of the structure of the portfolio where you're utilizing very intelligent structures.

18:10And that's one of the big lessons from Buffett is that Buffett didn't just pick stocks really well. Buffett created a really innovative solution for housing his assets in terms of the way that he actually purchased insurance companies and was earning what we call an insurance float from the premiums. He was essentially getting interest-free loans from the way that the premiums were being paid. And then he's allocating this portfolio in this very interesting way where he's buying public equities rather than just keeping the cash on the corporate balance sheet and reinvesting it into Berkshire Hathaway itself.

18:44He's buying these other entities and diversifying the business in a very strategic way, which was extremely innovative at the time. And so So innovation inside of the way he was just doing everything was really crucial to the way Buffett succeeded. But at the heart of it, he had this 90 percent, what was essentially sort of a private equity and public equity portfolio. And he's taking leveraged risk inside of the portfolio, essentially, in this very aggressive way. And so, you know, trying to sort of expand on that, the next chapter in the book is the 100 percent stock portfolio. because I say, hey, Buffett liked to keep 10 % in T-bills sort of for strategic reasons and for cash flow purposes.

19:28But the question at the end of the Warren Buffett portfolio is why not 100 % stocks? And that's totally appropriate for somebody that has this very aggressive potential in a portfolio where you're then building a purely aggressive, 100 % stock, very aggressive. It's sort of a full gas, no breaks type of asset allocation where something like this might be very appropriate for, say, a long-term investor in an IRA account, a Roth IRA, certainly. This is a very long time horizon. Or just somebody, like I said, who has that high income that they've got a taxable brokerage account. And they're all stocks because they're very behaviorally comfortable with it.

20:09They like building a diversified, whether it's a stock picking portfolio or whether it's a diversified ETF portfolio, whatever it might be, that investor is very aggressive for a very strategic and intentional purpose. My favorite chapter to write in the book actually was an original strategy where I wrote about something that's called the forward cap portfolio. And this portfolio actually takes a little bit of my macroeconomic framework and expands on it where what I tried to do was I tried to build a portfolio that was 100 % stocks, that was very, very aggressive. And what it does is it tries to predict what the future market capitalization of the stock market will look like.

20:53So rather than, you know, the way I would frame a fund like the S &P 500, for instance, is that what you're essentially doing is you're skating with the puck. It's the current market capitalization of the financial markets. And this is a very good strategy. Skating with the puck is a great way to score lots of goals, obviously, but a potentially even better way to do all this is to try to be where the puck is going, as Wayne Gretzky once said. And so you're kind of trying to predict what the future capitalization of the financial markets might look like. And I took five sort of huge mega trends that are hugely diversified and hugely impactful.

21:33And the big five trends are technology is eating the world. Human beings are eating the world. Emerging markets are eating the world. Healthcare is eating the eaters. And the final one is decentralization is eating centralization. And what I did was I took each of these huge five macroeconomic trends and I extrapolated a data point into the future. So for instance, with the technology is eating the world, this is a famous Marc Andreessen quote for people who are familiar with his work. Like he, what I basically did was I took e-commerce sales as a percentage of total retail sales. And I looked at it and I said, you know, can you extrapolate this out into the future and try to predict what is the size of the technology sector going to look like in the future?

22:19And at present, that figure is roughly like 18%. So as a percentage of total retail sales, e-commerce is only 18 % right now. This has been a trend that basically since 1999 has increased from very, very systematically from zero to 18 percent. And extrapolating this out into the, you know, the very far future, this number gets to like 50 percent by the year 2055. And so extrapolating that out, you can roughly say that, OK, well, the size of the of the technology sector, it could it could double. It could more than double going out 30 or 40 years. Essentially, in 30 or 40 years, every single firm in the economy is going to have a technological look to it.

23:05And and I don't think that's unreasonable at all. I think it might actually be overly pessimistic about how fast a lot of this is going to change, especially with the changes in AI and how rapidly some of these things are changing. And so extrapolating that out, what you would do is you would look at, for instance, the technology sector as a component of the current market cap of the S &P 500. And you say, well, right now the market cap is in the low 30%. I'm going to buy, when I'm allocating my assets, I'm going to allocate 50 % of my assets to technology rather than taking the current market cap.

23:40And so in doing so, you're kind of skating to where the market capitalization is going to go. And in doing so, you're likely to earn higher returns because as the market capitalization of technology grows in the tech sector, you will have essentially already captured, or you will have skated to where the puck is going in that aspect. And so you're going to capture more of that market cap increase over time because of that. But this is a hyper aggressive portfolio. It's very, very aggressive. And one of the things I was really interested or sort of shocked by in backtesting this was that I put together the five megatrends and I picked the assets for it.

24:17And then when I actually ran the backtest for it, this is a global portfolio also, by the way. So I was doubly shocked by the performance of it because it beats the pants off of everything. And so it was really interesting to run the back test because I didn't fit assets and returns to the portfolio. I actually built it blind and then picked the assets. And lo and behold, it turned out to just perform really well. And the thing that was most interesting about it was that it's a global portfolio. And it's still, it beats things like the S &P 500 because it's, even though it's a global portfolio And virtually nothing global has beaten the S &P 500 because the returns from the S &P 500, especially over the last 10 years, have been so much better than anything that's had foreign diversification.

25:03But again, it's a hyper-aggressive, I mean, this is a pedal to the metal type of portfolio that I would say it could expose people to just huge amounts of sequence of return risk over the course of the next 10 years. But this is it's a portfolio that I think is built on reasonable macroeconomic foundations. But it also ends up being it's crazy diversified. I think the thing ended up in the end, it ended up owning over like 10 ,000 different underlying instruments, even though it's comprised of of basically what is it? Eight different ETFs, basically, that are very broadly diversified. So, you know, thinking of these things across time horizons, those are sort of the examples of the very, very aggressive sort of long term types of portfolios that the book talks about.

25:50Do you want to get into other ones specifically? Yeah, I mean, the the other end of the spectrum was another one that I thought was kind of interesting to construct was actually the most boring one in the book, which is the T-bill and chill portfolio. And I thought, I'm sort of, I'm militantly critical of things like high yield savings accounts and CDs and even some money market funds because it's interesting working. I'm very hands-on with cash with people I work with largely because I'm managing a lot of outflows for people that are living on their portfolios and whatnot. And I try to be very hands-on with cash because I think that cash is one of the most mismanaged portfolios that most people have.

26:30A lot of people think that high yield savings accounts and CDs are these great sort of magical products. And the truth is that they're not. In a lot of cases, they're actually a really raw deal. In a lot of cases, they're the highest fee portfolio that banks issue to clients. Because what banks are basically doing is banks are basically buying T-bills and then they're giving you a cut of the action. And so in a lot of these situations, the banks are buying T-bills. They're getting the state income tax benefit because T-bills aren't taxed at the state income level. And they're giving people a slice.