Notes from Tony Robbins’ “Money: Master the Game” book (Chapter 5)

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Alright alright alright, welcome to the chapter 5 summary. This one is about stability: building a portfolio that resists changing weathers.

Introduction

Tony starts by enticing us with an upcoming portfolio that provides:

• Extraordinary returns — 9.88% per year between 1974 and 2013 (time of writing)
• Safety — would have only lost money 4 times out of those 40 years
• Low volatility — the worst loss experienced by this portfolio in 40 years was 3.93%

What kind of investment portfolio would one need to have to be absolutely certain that it would perform well in good times and in bad — across all economic environments?

A lot of what is discussed here is centred around the strategies of Ray Dalio. He has had strong returns every year and is prepared to face surprises. After all, his mantra is to “expect surprises” and he perpetually asks himself “what do I not know” to stay ahead of the game.

The All Weather portfolio

Tony starts by recalling his interview with Ray Dalio.

Be careful of balanced portfolios

The first principle here is balanced portfolios and how they really work in practice. If your portfolio invests 50% into bonds, i.e. a safe option, and 50% in stocks, i.e. a risky option, then safety and risk are not at all divided equally.

Stocks are three times as volatile as bonds. If the stocks soar then you’re extremely lucky; if they implode then there goes your money. You can’t divide investments purely on percentages to achieve stability, rather you need to account for the risk associated with each instrument you put money on.

Don’t confuse correlation and causation

Don’t spend too much time looking into correlation between different investments: that will get you too close to the trying to beat the market mentality. Sure sometimes investment A will rise and B will go down and have a seemingly pattern to do so — but that will be pure correlation, not the downfall of investment B caused by the success of A.

Data has shown that these relationships are for the most part random and as we have been discussing you’re better off betting on stability through diversification.

The All Weather approach

Ray also shared the fundamental four environments that drive the price fluctuation in financial assets:

• Higher than expected inflation (rising prices)
• Lower than expected inflation (deflation)
• Higher than expected economic growth (rising)
• Lower than expected economic growth (declining)

As such, Ray typically envisions four potential portfolios at any point — the key factor is to hold 25% risk in each.

Surprises are inevitable because, once again, no one will be able to beat the market. There will always be an element of some investments losing money, but also an element of others performing surprisingly well. The diversification and the contained risk will help you weather bad seasons.

Take the next list with a grain of salt because it is 10 years old at this point, but Ray also shared a list of prefered financial instruments for each environment:

• Inflation: commodities / gold inflation linked bonds
• Deflation: treasure bonds, stocks
• Rising economic growth: stocks, corporate bonds, commodities / gold
• Declining economic growth: treasury bonds, inflation linked bonds

A sample All Weather portfolio

Again, be mindful this is now 10-years old, but here is the portfolio provided by Ray:

• 30% in stocks — S&P 500, index funds, etc.
• 15% in intermediate term bonds — 7 to 10 years
• 40% in long term bonds — 20 to 25 years
• 7.5% in gold
• 7.5% in commodities

And now some notes about the percentages:

• Relatively low percentage of stocks to accommodate the risk associated
• Huge stake in bonds to counter volatility — the variable to balance is risk, not the amount invested
• A small piece in gold and commodities because they will fare well with inflation and economic growth, but carry volatility much like stocks

And last but not least, there is an element of rebalancing to happen at regular interval as discussed in previous chapters. Tony adds that you might want to have a fiduciary help you undertake this continuous process.

Variability in results

Tony and Ray provide a sample portfolio diversification, but not exact investments — that means, for example, there are better index funds to invest than others. Tony raises three of these points to keep in mind:

• It’s crucial to find the most efficient and cost-effective representations for each percentage of the portfolio
• The portfolio must be monitored continuously and rebalanced annually
• There will be times when the portfolio will not be most optimally tax-efficient

Further portfolio examples

Tony interviewed more financial legends and they agreed to share their own variations of the All Weather portfolio.

Here is the variation from David Swensen:

• 20% US total stock index
• 20% Foreign markets index
• 20% US REIT index (real estate)
• 15% US long-term treasuries index
• 15% US treasury-inflation protected index
• 10% Emerging markets stock index

Here is the variation from Burton Malkiel:

• 33% US total bond index
• 27% US total stock index
• 14% Foreign markets index
• 14% Emerging markets stock index
• 12% US REIT index (real estate)

Here is the variation from John “Jack” Bogle:

• 65% US total stock index
• 35% Intermediate-term US bond market index

Annuities

The second topic of chapter 5 is annuities. Tony spends time to explain what they are in greater detail and how they can be a good investment when used properly.

What is an annuity?

As a brief reminder from chapter 2, annuity is a product typically sold by insurance companies that will pay you dividends over a period of time, often as another income stream during retirement.

You make an initial investment with which the company invests on various financial instruments like stocks, mutual funds, and/or bonds. The payments can start immediately or at a later pre-agreed point in time dependant on the type of annuity.

Immediate annuities

This kind is the best for those at retirement age and beyond. You pay a lump sum today and receive an exact amount every month.

This is a good investment option because the longevity on the target audience for retirement is wildly variable — financially known as mortality credits.

The reality is, some annuity buyers will die earlier than others, which leaves more of the initial investment on the table that doesn’t need to be paid back to the deceased, thus directly paying off some of the risk taken by the insurance company.

Deferred annuities

This one gives you the option to receive the income at a later point. The investment, either a lump sum or multiple instalments, will be on a tax-free environment for you to claim the income when you decide (tax-deferred income to be clear). So you can invest now and claim at 40 or 50 years old and know exactly how much you will receive then from this source.

But there are multiple subtypes of deferred annuities if you will, and Tony has kindly highlighted the most relevant:

• Deferred income annuity: make a lump sum investment today to claim much later in life, also known as a longevity insurance
• Fixed indexed annuity: returns are linked to the performance of a market index where you get a percentage of the upside but at least break even when the market underperforms
• Hybrid annuity: money gets invested in a tax-efficient low cost index fund portfolio, but if the market flops and you run out of money then the insurance company will start paying you — technically “hybrid” is not a real category, this is more a hybrid between fixed and variable annuities
• Variable annuity: ignore them due to high costs in fees and the underlying investments made against expensive mutual funds

Tony gives the Fixed Indexed Annuity (FIA) option a lot of emphasis because it follows the upside without downside mantra. If the market does well then you receive additional income based on (part of) that upside; but if the market is going down you still don’t lose money because the insurance company will cover you.

With everything said and done, the idea is still to hold out as long as possible on claiming the periodic income. We are on a trend to live longer lives so the longer you can hold out on claiming the annuity, the longer you can afford to live retirement with peace of mind about your finances. If you save enough to last from 65-ish to 80, then you can claim the annuity at 80 and use that as your steady income.

Living trust

Last piece of information right at the end of the chapter. A living trust is used to protect your family from legalities upon your death and/or incapacitation. This will prevent your assets from probate — a costly and lengthy process where courts sort your assets through public record.

Closing thoughts

Chapter 5 put two big pieces of financial stability in the forefront: the All Seasons portfolio which leverages diversified investments to weather turbulent financial periods and (fixed indexed) annuities for extended peace of mind during retirement.

Chapter 6 promises to be the unveiling of the interviews with top investors! Looking forward to further knowledge gains from these titans of the industry.