Risk Parity Radio

Episode 409: The PFFA Fund, TSP Allocation Considerations And Those New-Fangled Return Stacked Funds

• Frank Vasquez • Season 5 • Episode 409

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In this episode we reflect on our recent meet-up and answer emails from Chris, Gigi and Mark.  We discuss preferred shares funds and PFFA in particular, considerations about allocations in a TSP based on goals and current progress in your financial life, and them thar new-fangled return stacked funds.

Links:

PFFA Summary:  PFFA – Virtus InfraCap US Preferred Stock ETF – ETF Stock Quote | Morningstar

Return Stacked Funds Page:  Home - Return Stacked® ETFs

Amusing Unedited AI-Bot Summary:

Welcome to the dive bar of personal finance and do-it-yourself investing, where Frank Vasquez serves up straight talk with a splash of humor. This episode tackles core investment principles that cut through the noise of complex financial products and contradictory advice.

Frank begins by exploring preferred shares funds, specifically PFFA, explaining why its 20% leverage delivers higher returns but also brings greater volatility and a concerning 2%+ expense ratio. This leads into a deeper discussion about when specialized investment vehicles make sense for different investors and why tax implications matter when considering preferred shares positions.

The heart of the episode focuses on a listener's TSP allocation question, which Frank uses to illustrate a fundamental investment truth: many investors start at the wrong end of the planning process. Rather than beginning with fund selection, Frank outlines the proper sequence: first determine your overall financial needs, then establish appropriate asset allocations, and only then select specific funds. He draws an important distinction between accumulation portfolios (where growth is paramount) and retirement portfolios (where volatility management becomes critical).

Throughout the conversation, Frank emphasizes that diversification primarily reduces volatility rather than enhances returns. This insight proves particularly valuable when evaluating new investment products like return-stacked ETFs that combine traditional assets with alternatives like managed futures and merger arbitrage. While intriguing, Frank suggests most investors would benefit more from simpler approaches with established track records.

Whether you're nearing retirement or still in accumulation mode, this episode delivers clear frameworks for making better investment decisions, reminding us that successful investing stems from understanding your unique financial situation rather than chasing complicated strategies. Want more straight talk on building effective portfolios? Subscribe, leave a review, or reach out to frank@riskparityradio.com with your questions.


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Voicds:

A foolish consistency, is the hobgoblin of little minds, adored by little statesmen and philosophers and divines. If a man does not keep pace with his companions, perhaps it is because he hears a different drummer.

Mary and Voices:

A different drummer and now, coming to you from dead center on your dial, welcome to Risk Parity Radio, where we explore alternatives and asset allocations for the do-it-yourself investor, Broadcasting to you now from the comfort of his easy chair. Here is your host, Frank Vasquez.

Mostly Uncle Frank:

Thank you, mary, and welcome to Risk Parity Radio. If you have just stumbled in here, you will find that this podcast is kind of like a dive bar of personal finance and do-it-yourself investing. It's a relatively small place. It's just me and Mary in here and we only have a few mismatched bar stools and some easy chairs. We have no sponsors, we have no guests and we have no expansion plans.

Voices:

I don't think I'd like another job.

Mostly Uncle Frank:

What we do have is a little free library of updated and unconflicted information for do-it-yourself investors.

Voicds:

Now, who's up for a trip to the library tomorrow?

Mostly Uncle Frank:

So please enjoy our mostly cold beer served in cans and our coffee served in old, chipped and cracked mugs, along with what our little free library has to offer.

Voicds:

Welcome Welcome.

Mostly Uncle Frank:

But now onward, episode 409. She's Real Fine, my 409.

Voices:

She's Real Fine, my 409. She's Real Fine, my 409.

Mostly Uncle Frank:

My 409, she's real fine. My 409, my 409. Today, on Risk Parity Radio.

Voices:

We are back from our travels in Cincinnati and we will be tending to your emails. Inconceivable.

Mostly Uncle Frank:

But before we get to that, I'd just like to thank the people that came out for our little meetup at Economy last weekend. It's actually the first time I've ever had any kind of a meetup for this program Inconceivable, although I have seen a number of people individually over the past few years. But Mary and I enjoyed meeting all of you at our little group and the other conversations we had there over the course of the few days, and I was especially enamored with the gifts that you gave us, which included a bucket, a couple of small flower pots and some pie pans.

Voicds:

Groovy baby.

Mostly Uncle Frank:

Which, as you know, will help us build our illustrious home and garden portfolio. Ow, where you just take cash and you shove it in the buckets. And you take cash and you shove it in the flowerpots. And you take cash and you shove it in the pie pans this is pretty much the worst video ever made. And then you arrange them very tastefully and call that good planning for your retirement.

Voices:

Joey, have you ever been in a in a turkish prison?

Mostly Uncle Frank:

hopefully I can put together something like that and take a picture of it so we have something to reference for future use it's going to be very popular but this is why I can happily affirm that we do indeed have the finest podcast audience available.

Voicds:

It's top drawer, really top drawer.

Mostly Uncle Frank:

And I do appreciate your efforts, so thank you.

Voicds:

Let's go, Jerry go.

Mostly Uncle Frank:

But now, without further ado, here I go once again with the email. And First off we have an email from Chris. Chris K.

Voicds:

Ain't nothing wrong with that.

Mostly Uncle Frank:

And Chris K writes.

Mary and Voices:

Thank you for the show. I found it from your episode on Choose FI. I've listened to the foundational episodes and have been following Risk Parity Radio for a couple of months regularly. Your use of PFF and now PFFV has me questioning my choice of preferred stocks. I've held PFFA since I started, focusing on total return instead of shiny objects. It's more volatile than the other two but has a greater total return based on stockanalysiscom. Just wanted to share PFFA as a contender or to learn why it's not the best choice of those, chris.

Voicds:

As a public service. The Chris Rock Show proudly presents this educational video.

Mostly Uncle Frank:

Okay, so let's talk about PFFA. Well, first let's talk about preferred shares funds. We have talked about them before. We can go all the way back to episode nine, where we first discussed them. These can be useful if you have large taxable accounts and you need to stick something that's kind of bond-like, even though it's a stock, in a taxable account, mostly for the tax reasons that it typically or they typically pay qualified dividends like stocks, so they're not paying the ordinary income you would get out of bonds. But for most people they generally do not have a whole lot of use potential unless you are in a very high tax bracket. Now, the main feature that distinguishes PFFA from most other preferred shares fund is that it has leverage. In it you have a gambling problem.

Mostly Uncle Frank:

Yeah. So it has about 20% in leverage in it, which causes two things. First, you'll see, it has a higher return. It's more like 9% instead of 7%, which kind of goes with the fact that it's about 20% leverage. The other thing you should realize is it is a very high expense fee. That's over 2%.

Mostly Uncle Frank:

Then I'll link to the page on Morningstar where you can check this out, but that alone tends to discourage me from using this in any meaningful way, at least for any large allocation. It will have higher volatility, obviously, than other preferred shares funds due to that leverage in it. It also has a limited history, only going back to 2019. So, although we've seen it go through 2020 and 2022, we really haven't seen it go through an extended recessionary period, like you saw in the early 2000s, and it's not clear how it would perform in said period.

Mostly Uncle Frank:

Finally, I am not sure what the breakdown is within it between ordinary income, dividends and qualified dividends. Typically, when you're working with something with leverage, it will throw off ordinary income in addition to qualified dividends in this case, and there's no real way of looking that up very easily because it changes every year and they aren't going to predict what the breakdown is in advance. So that may be something you only know if you actually hold it. But if you did some research online, perhaps you could find it out. I just don't know of any easily readily available source to look that up. So at the bottom, I mean, if you were looking for something leveraged like that to put in a portfolio, it's probably a good choice for that. I'm just not sure how much or how many people would find that useful, given that usually people hold preferred shares to diminish the volatility of their portfolio instead of increasing it. So I would say it probably has some use to some people, but probably not too many people.

Voicds:

Well, you have a gambling problem.

Mostly Uncle Frank:

Anyway, it is an interesting topic because there are a lot of relatively new ETFs that have only come out since about 2018 or 2019 in various categories and, yes, we should look at them from time to time to see whether there is essentially something better out there than we're already holding for a particular slot in our portfolio. So it's good to be curious. Joey, do you ever hang around the gymnasium?

Voicds:

Do you like movies about gladiators?

Mostly Uncle Frank:

And thank you for your email.

Voicds:

Here's a horoscope for everyone Aquarius, you're gonna die. Capricorn, you're gonna die. Gemini, you're gonna die twice.

Mostly Uncle Frank:

Second off. Second off we have an email from Gigi, and Gigi writes.

Mary and Voices:

Hello Frank and Mary, numero uno and foremost thanks for all you do.

Voicds:

I continue to benefit greatly from your financial wisdom and love your sense of humor.

Mary and Voices:

She was raised to raise eyebrows, but Gigi more enjoyed raising the roof. Numero dos, if I may ask your opinion on TSP allocation? I am seven to 10 years away from retirement and currently contribute the maximum amount per year to my TSP. My current allocation is 10% G fund, short-term securities, 20% F bond fund, 10% S fund, 50% C fund and 10% I fund. After listening to your show, which I just recently found, I am questioning if I should be putting any money into the INF funds, since they don't appear to give me any significant diversification. I am now wondering if I should just invest in the C, s and G moving forward and purchase long-term treasuries outside of my retirement account. I will be receiving a pension and I have other accounts outside my job Roth and brokerage account. Any words of wisdom would be greatly appreciated. Sincerely, gigi. For context, the F fund follows the Bloomberg US Aggregate Bond Index. The C fund mirrors the X Hong Kong Index. The G fund is composed of short-term government securities and the S fund matches the Dow Jones US Completion Total Stock Market Index.

Voicds:

And what is a picture about gay Paris without Maurice Chevalier? He had once been the twinkle in grandmama's eye.

Voices:

We met at nine. We met at eight. I was on time Well.

Mostly Uncle Frank:

Gigi, first thank you for appreciating our sense of humor, as it tends to be an acquired taste. And not everyone him for forgiveness, and not everyone appreciates it.

Voicds:

Talk Amada, do not ask him for mercy.

Mostly Uncle Frank:

But we are really here for the ones who do.

Voicds:

Let's face it you can't talk, Amada anything.

Mostly Uncle Frank:

Or at least can tolerate it.

Voicds:

The Inquisition.

Voices:

What a show the.

Voicds:

Inquisition.

Mostly Uncle Frank:

Here we go. We know you raise an interesting question, but it really, in my mind, goes to the process or overall approach you want to take to these sorts of things, because you're looking at something which is kind of the last thing you consider and not the first thing. You consider that diversification amongst available funds is only something you think about after you've come up with the overall plan or idea of what you're doing. And this is a common mistake I think people jump to that. They think that the idea is they need to go pick funds and that's going to drive their plans or decision making process, when that is actually the last stage of planning or thought that you need to engage in, and the basic overall process should be let's have a plan, then let's have a portfolio with allocations to specific kinds of assets and then only then do we go and choose funds.

Mostly Uncle Frank:

And so it's difficult for me to actually give you much guidance here, because I don't know where exactly you stand in terms of how much money you've accumulated and how much money you actually need to retire. Now I can make an assumption, and I might assume, since you say you are seven to ten years away from retirement, that you are about halfway there in terms of how much you need to accumulate in invested assets, because it will take you about that long for your assets to double if you don't add any more money to them. So we could say you're at Bon Jovi Phi, or at least assume that. But in terms of the actual process, what you need to do is first look at your expenses and think about how those are going to change at retirement. If they're going to change, they typically go down, they don't go up.

Voicds:

That's the fact, Jack. That's the fact, Jack.

Mostly Uncle Frank:

And then, of those expenses that you expect to have, how much is going to be covered by this pension and other income sources. Because if a lot of your expenses are already covered by that, you end up having a lot more flexibility as to what you do with your invested accounts, whereas if you're primarily living off your invested accounts, then you really do want to focus on things like maximizing a safe withdrawal rate. And after you do those things, then you need to look at sort of where are you in this process? Are you a long ways from retirement? Then you're just accumulating away. Are you getting close within a few years of it? And you need to think about transitioning your portfolio from an accumulation portfolio to a retirement portfolio, because those are just two different things for two different purposes. The purpose of an accumulation portfolio is to accumulate, and you don't really care about the volatility that much, because you're putting money into the portfolio, you're not taking any out, whereas when you start taking the money out of the portfolio, all of a sudden you care a lot more about the volatility of the portfolio, which leads you to choose a much more diversified set of assets. And so I'm going to assume for the moment that you are still in kind of heavy accumulation, even though you might not be.

Mostly Uncle Frank:

When you are thinking about accumulation, the most important principle to think about is actually the macro allocation principle. We have three principles here the Holy Grail principle, which deals pretty much. Look at the macro allocation of a portfolio as in how much percentage is in stocks as opposed to bonds or cash or something else. And all of those portfolios are going to perform pretty similarly over long periods of time if they're invested in low-cost index funds. And the real challenge there, or thought there, is well, make sure they're in low-cost index funds and go up to 100%, because the only reason you wouldn't want to be at 100% is if it feels too uncomfortable for you and you would panic in a downturn because you could be down 50% in 100% stock portfolio. And that happens probably every 20 years or so or less, although it hasn't happened recently. So when we think about the macro allocation principle and your portfolio, right now your portfolio is 70% in stocks and 30% in bonds. That is not really an aggressive accumulation portfolio. In fact it's a very conservative accumulation portfolio because typically you would have a higher percentage in stocks and that's the real factor here.

Mostly Uncle Frank:

That is the most important thing, not which funds you are in in particular. So my first thought is there's no reason for you to have anything allocated to a G fund in a TSP when you're trying to accumulate and grow the assets. A G fund is essentially a short-term bond fund or a cash-like fund. That is something that you would hold some of in retirement probably not more than 10% of your overall portfolio but it certainly is not part of accumulation. So if what you need to do is accumulation here, I would move that into stocks Now.

Mostly Uncle Frank:

The F-Fund is fine as an intermediate bond fund and it's perfectly acceptable to accumulate in something like an 80-20 portfolio, particularly if you are most of the way there and do not need a great deal more in growth. And that's part of what I don't know about your situation. If you were behind, I would say get into 100% stocks and keep accumulating as much as you can in terms of savings. If you are getting close, having 20% in bonds might be just fine. And again, it probably doesn't matter that much that it's in this particular bond fund during your accumulation phase, because it's a low-cost bond fund. You are not drawing down on this. You do not care as much about rebalancing it or maximizing diversification at this point by making sure it's in a treasury bond fund. So it is not a bad fund to hold as an accumulation bond fund to the extent you want a bond fund during accumulation, because the real reason you hold bonds during accumulation is just to sleep better at night. They're not going to outperform stocks All right.

Mostly Uncle Frank:

Now getting to these stock funds the C fund, the I fund and the S fund, which are the S&P 500 and international stock fund and essentially a small cap fund, let's first dispel this notion that diversification improves returns. Diversification by itself typically does not improve returns. Diversification by itself typically does not improve returns. With one exception, known as Shannon's Demon, which is if you have two things that perform about the same but they perform differently at different times and you rebalance them over time, you will get a bump in returns out of that scenario. But where diversification really matters is when you are drawing down on the portfolio and you're really concerned about reducing the overall volatility of the portfolio.

Mostly Uncle Frank:

Now diversification is what we call the Holy Grail principle here, which is the main foundation for constructing good retirement or drawdown portfolios. But it is not the major factor in constructing good accumulation portfolios, which is the macro allocation principle. So particularly over this time frame you're talking about seven to 10 years that is not long enough to really see any particular fund picking benefits. What I'm saying is that you could hold any combination of these three funds and which one is going to outperform any other combination you might hold over a 7 to 10 year period is kind of luck of the draw. You could ask yourself the question do I feel lucky? There is no magic formula for saying this particular allocation of these three funds over the next 7 to 10 years is going to outperform another one. So in the recent past obviously the C fund has been outperforming those other two funds. You go back to the early 2000,. Then the I and the S fund were outperforming the C fund. We don't know which kind of environment we're going to get in the next seven to ten years.

Voices:

We don't know. What do we know? You don't know, I don't know, nobody knows.

Mostly Uncle Frank:

We do know all of those funds are low-cost funds. So if you just wanted to stick with those allocations, that would probably be fine. Or if you wanted to move it more into the C or more into the S, it's probably not going to matter, at least in a way that we can predict at this point in time. Now, if you were talking more about like a 25-year forward-looking thing, then you would probably want to be thinking about well, could I pair up something like a large-cap growth fund with a small-cap value fund? But over a 7 to 10 year future period, you cannot say that one combination of low-cost index funds is going to necessarily beat another combination of low-cost index funds and they are all going to perform pretty well and they will probably help you reach your goals. But I would focus on keeping all your money as much as possible in the S, c and I funds. Now, you also mentioned you had other accounts and I wasn't sure what they were. But yes, you might hold other things outside, particularly if you wanted to say, hold more value-tilted funds. You don't really have value-tilted funds here. They're all blended funds, so you would need to do that. Outside of this, you should consider all of your invested assets together as one big portfolio, because that will help you tax optimize the whole portfolio. You want to make sure, in particular, that you are not carrying bonds in taxable accounts because they generate more taxes there. You want those in traditional retirement accounts and you want your best growing things typically in Roth accounts and you want things that pay low dividends or no dividends in your taxable account, particularly if they're qualified dividends. But that's always a secondary step. But I wouldn't be worried too much about diversification in this context, at least within this TSB, simply because I feel like you're under the same misimpression that many amateurs are under, which is that if I diversify things, I'm going to get better returns out of them. Typically, you're not going to get better returns on you. You're probably going to get similar returns out of them and over any period of a decade there'll be one part of the markets that outperforms other part of the markets and then there'll probably be something different in the next decade. There's no way of predicting what's going to come next. So overall, to the extent you want to be holding bonds at this stage, if you have a traditional retirement account outside the TSP, maybe those go in there. If you don't. They probably do go in here and they probably do go in the F fund because it's your best choice in this circumstance.

Mostly Uncle Frank:

If you want to diversify your stocks outside of these three funds, one thing you could do is put most of this in the C fund and then do your other funds in the Roth and brokerage account, where you have full control and you can pick exactly what you want and don't have to use this particular S fund and particular I fund, because I agree they are not the most diversified choices you could make from the C fund.

Mostly Uncle Frank:

If you're looking for diversified choices, the only thing I definitely would do, if you are still accumulating and have a long way to go, is not allocate anything to the G fund, because it's not really appropriate for accumulation Eventually, what you will probably do when you stop working there is roll your TSP into a traditional IRA and then you can buy whatever you want in there and there won't be any taxes involved or transaction fees, so that's a relatively easy process. Once you get there Now, since you are getting close, then I would probably revisit this in a few years to see whether you should not be converting to your retirement portfolio. At that point I just can't tell you one way or the other at this point because I don't know how close you are actually in terms of what you've accumulated and how much of your expenses are actually going to be covered by this pension and Social Security. So these are very common questions and I'm glad you asked them, gigi.

Voicds:

Gigi is dedicated to your zestful entertainment. A feast for your heart and senses in eye-thrilling cinemascope and metro color lilting with the exciting melodies of Lerner and Lowe.

Mostly Uncle Frank:

Give us a little break from the weirdo questions we get about preferred shares and return stack funds and things like that.

Voicds:

You are talking about the nonsensical ravings of a lunatic mind.

Mostly Uncle Frank:

Make us sound a little bit normal of a lunatic mind.

Voicds:

Make it sound a little bit normal. Are you saying that I put an abnormal brain into a seven and a half foot long, 54 inch wide gorilla? Is that what you're telling me? And so hopefully that helps and thank you for your email while you were trembling on the brink was I out yonder somewhere blinking at a star. Oh, oh, oh, oh, oh, oh, oh, oh, oh, oh, oh, oh, oh, oh, oh, oh, oh, oh, oh, oh, oh oh, oh, oh, oh Last off.

Mostly Uncle Frank:

Last off, an email from Mark.

Voicds:

All hail the commander of his majesty's Roman legions, the brave and noble Marcus Vindictus.

Mostly Uncle Frank:

And this is the third email from Mark in a set of three emails that he sent to me in January. And for his third email, mark writes Hi, Frank and Mary, New return-stacked ETFs.

Mary and Voices:

This is not a question, more of a heads-up, an invitation to comment, if you would like. The guys at Resolve Asset Management have a couple new alternative asset options. One is similar to their Bonds and Managed Futures ETF but instead of focusing on the price of managed futures, it focuses on the carry or yield of those futures. They claim that managed futures carry slash yield has diversification value from both their price-focused managed futures fund and stocks and bonds. I have no idea if that is true or not and we will only see over time, but I think it's an interesting thing to watch. They also have a fund that combines bonds and merger arbitrage. I have no idea what the long-term correlation of a merger arbitrage strategy to stocks and bonds is, but again, it might be an interesting thing to watch over time. Thanks, Mark.

Voicds:

Hearts and kidneys are tinker toys.

Mostly Uncle Frank:

Well, thank you for mentioning that, Mark. Yeah, I would say that I'm very interested to see how these return-stacked funds develop over time. I think the concept is sound. Basically, they're just adding alternatives to what would ordinarily be a straight stock and bond portfolio. They're doing it such that you can add it as leverage and use these things not only for retirement scenarios but for accumulation. Sample portfolio we created, called Optra, is in the same line, if you will.

Mostly Uncle Frank:

With these kinds of funds and this kind of return stacked concept, I do wonder whether they are getting ahead of themselves. Now, the main issue I have with the way they've constructed their funds. Their funds are always at least two assets, so they've got like bonds and futures or stocks and futures, and while that sounds appealing on its surface, it actually makes things more difficult to rebalance if you are putting that together with other things in a portfolio and you always have to be mindful, well, what is that actual play like in terms of an overall allocation with other things? So I think it inadvertently makes management more difficult, Although I can see you constructing a very simple portfolio where you basically have one or two stock funds and then you have a return stack fund, that is say, bonds and managed futures. The other place where I think they may be getting a little bit carried away is the variety of alternative asset classes. They're talking about Not only managed futures but carry strategies and merger arbitrage and all sorts of other things.

Voicds:

If you have a taste for terror. You have a date with Carrie.

Mostly Uncle Frank:

You have a date with carrie, I think this could end up being a alternatives tail wagging, a portfolio dog, because I still see, and we'll always see, stocks as the main driver of the kinds of portfolios we're interested in that have growth potential over time and everything else in there as some kind of diversification mechanism, starting with bonds but then also some of these other alternatives, and I just don't think you probably need that many of them or that they should occupy that great of a percentage of the portfolio certainly not more than about a quarter of it, I would think. So. I think that, honestly, holding an allocation to gold and then one of these other strategies and I prefer managed futures is probably going to be more than enough for most people. Of course, you, as my listeners, oftentimes like to combine all sorts of things, including carry and volatility and other ideas from various corners of the investment universe.

Mary and Voices:

What does Matt Damon say on that Bitcoin? Commercial Fortune favors the brave.

Mostly Uncle Frank:

I think I'm mostly going to sit on the sidelines and watch with some curiosity as to how these things develop over the next decade or so, because I do think we'll get some clarity over time, since most of these kinds of ETFs have really not been around for more than about six or seven years tops, and most of them have been around for only two or three years. So I think it's mostly just something to be watched so that we might learn something from others' mistakes or successes without having to take any risk in it ourselves.

Mostly Uncle Frank:

Not going to do it Wouldn't be prudent at this juncture, and so those are my comments and thank you for your email.

Voicds:

You're going to end up eating a steady diet of government cheese and living in a van down by the river.

Mostly Uncle Frank:

But now I see our signal is beginning to fade. If you have comments or questions for me, please send them to frank at riskparityradiocom. That email is frank at riskparityradiocom. Or you can go to the website wwwriskparityradiocom. Put your message into the contact form and I'll get it that way. If you haven't had a chance to do it, please go to your favorite podcast provider and like subscribe. Give me some stars, a follow, a review.

Mary and Voices:

That would be great Okay.

Mostly Uncle Frank:

Thank you once again for tuning in. This is Frank Vasquez with Risk Party Radio.

Voices:

Signing off. She doesn't care. I'm glad that I'm not young anymore. No more frustration. No star-crossed lover am I? No aggravation, Just one reluctant reply, Lady, goodbye. The fountain of youth is dull as paint. Methuselah is my patron saint. I've never been so comfortable before. Oh how long. Glad that I'm not young anymore.

Mary and Voices:

The Risk Parody Radio Show is hosted by Frank Vasquez. The content provided is for entertainment and informational purposes only and does not constitute financial, investment tax or legal advice. Please consult with your own advisors before taking any actions based on any information you have heard here, making sure to take into account your own personal circumstances.

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