18 November 2020

On today’s show, Robert Leonard sits down with entrepreneur and investor Chris Kawaja to learn about why and how he believes you should be investing your emergency fund, using The Ultimate Liquidity Portfolio strategy. Chris is a Stanford and Harvard graduate who worked at Goldman Sachs and Bridgewater Associates, which some may recognize as this super investor, and one of my favorite investors, Ray Dalio’s firm. Chris is also a successful entrepreneur, author, and real estate investor.



  • How money in a high-yield savings account, like an emergency fund, actually lose money over time.
  • Three major finance trends that have altered the investing landscape.
  • What is “The Ultimate Liquidity Portfolio” strategy?
  • How has this strategy performed in the last financial crisis?
  • Is it really necessary to have a mix of stocks and bonds in your portfolio to create wealth?
  • What are the “jobs” money has in one’s life?
  • And much, much more!


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Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

Intro  0:00

You’re listening to TIP.

Robert Leonard  0:02

On today’s show, I sat down with entrepreneur and investor Chris Kawaja to learn about why and how he believes you should be investing your emergency fund, using The Ultimate Liquidity Portfolio strategy. Chris is a Stanford and Harvard graduate who worked at Goldman Sachs and Bridgewater Associates, which some may recognize as this super investor, and one of my favorite investors, Ray Dalio’s firm. Chris is also a successful entrepreneur, author, and real estate investor. Chris definitely has an impressive background in entrepreneurship, investing, and academia. You’ll hear just how brilliant he is throughout the episode today. I’m very excited to share our conversation on his unique investing strategy.

Many people listening to the show know that you need an emergency fund but most experts recommend you stick that money in a mattress or in a high yield savings account then just leave it there for a rainy day. Chris’s strategy is actually more aggressive with your emergency fund money because he recommends you go against what most experts say and actually invest your emergency funds in the markets.

I’ll let Chris explain this in more detail in today’s episode, but it’s a concept that fascinates me because I’ve generally been one that was willing to invest my emergency fund against the recommendations of other experts. Without further delay, let’s get into this week’s fascinating conversation with Chris Kawaja.

Intro  1:24

You’re listening to Millennial Investing by The Investor’s Podcast Network, where your host, Robert Leonard, interviews successful entrepreneurs, business leaders, and investors to help educate and inspire the millennial generation.

Robert Leonard  1:46

Hey, everyone! Welcome to the show. As always, I’m your host, Robert Leonard. With me today, I have Chris Kawaja. Welcome to the show, Chris.

Chris Kawaja  1:55

Thanks, Robert. I appreciate you having me on.

Robert Leonard  1:57

Let’s start the conversation today by talking a bit about your background and how you got to where you are today.

Chris Kawaja  2:04

I grew up in Toronto, Canada. I was the son of two immigrants, one of whom was a finance professor. When I was 17, I was in my second last year of high school, but was on track to maybe graduate a year early. In February of that year, I left minus some temperatures and snow on the ground in Canada, landed in California, and visited Stanford where it was 75 degrees and people were in bikinis. My future was cemented from there.

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I then went to Stanford and left high school early. After Stanford, I worked on Wall Street at Goldman Sachs for a couple years. Then I worked at a startup. Well, it was a startup, then it’s now a pretty big company called Align Technology who makes Invisalign. Then, I went to business school at Harvard Business School. After that, I went back to Wall Street. I worked at a hedge fund called Bridgewater Associates with Ray Dalio. After that, I joined a bunch of partners and started to work in an entrepreneurial business where we’re all co-owners.

Now, I spend my time split between my online business, which is Big Chill, my blogging, and then my real estate and other investments. That’s where I got to where I am today. Obviously, that’s a condensed version. There are a lot of bumps and turns along the way, but that’s what’s got me here today, where I live in Northern California, about 25 minutes north of the city of San Francisco.

Robert Leonard  3:22

I certainly don’t blame you for wanting to make the move from Toronto to California for the weather. I’m a New Hampshire native so it is similarly cold here in the winter. I definitely understand the desire to move to where it’s warm.

Chris Kawaja  3:35

Absolutely. It sucks some people in and I just never turned back.

Robert Leonard  3:39

I think it’ll eventually get me too.

Given everything that’s going on in the economy right now, I think our conversation today is going to be pretty timely. In times like this, we hear a lot of people recommending having an emergency fund. I even recommend this myself pretty often. How can money in a high yield savings account, like an emergency fund actually lose money over time?

Chris Kawaja  4:02

This is the essential point and it’s really in a way, what we’re doing is we’re tricking ourselves by thinking that these low bank interest rates. I think, right now high yield savings earn 1.5%. The fact is, if you look over history, these don’t keep up with inflation, usually even before taxes.

What is brutal about high yield savings accounts is they’re taxed at the highest rate. If you add all of this together, and even mock up equivalence for what high yield savings accounts should look like, based on certain indices, you essentially come out at high yield savings accounts and lose money.

That’s a painful reality because people say, “Well, look, I put $10,000 in and I ended up with $10,200 a year later.” But if you went to go buy things and everything that cost $100 is now $103, you actually have lost money, especially after you go and have that $200 and you made *inaudible* made… You have to give some amount to the government, maybe that’s $75 or even $100.

Robert Leonard  4:57

I feel like a lot of people don’t often think about taxes when it comes to their high yield savings accounts. I think it’s talked about a lot in the investing community and in brokerage accounts, but not so much in the high yield savings account space. Do you think why might that be?

Chris Kawaja  5:12

I think part of it is that people assume it’s such a default for people to say, “Look, put six months of money into a high yield savings account and that’s your emergency fund.”

I think that gospel probably was appropriate a couple decades ago, before the advent of ETFs, commissions, free trading and all these other things, because it probably was a not terrible way to sort of preserve your money.

I think what’s happened is when there’s just gospel, if everybody says…. Everybody always wakes up in the morning and brushes their teeth. I don’t think people are questioning it a lot. And so, for that bucket of money, there’s been such gospel, such a belief in the right way to do it. It’s only recently that that belief really could have been challenged because of ETFs, because of a lot of other reasons.

I think people just haven’t thought about it because it just wasn’t something to think about. The best option was just throw it in a bank account that felt safe and move on.

Now, there are different fallacies like I talked about that I think make high yield savings, even more psychologically attractive and less financially attractive. That’s mainly to do with the fact that people don’t like the feeling of posts losing money so they think that a bank account is zero risk. But to me, the risk of an investment is when it can’t meet your goals.

For the case of an emergency fund, that’s meeting your needs when diversity arises. For the case of a retirement fund, that’s very simply, will it provide for retirement? And so, if you know the goal, then you very quickly learned that high yield savings are not the best avenue for preserving your emergency fund.

Robert Leonard  6:45

What are the three trends in finance that have radically altered the investing landscape so that savings accounts really just are no longer the best option for stashing cash?

Chris Kawaja  6:56

That’s a great question. I think the number one trend is ETFs. So if you had to invest, very simply, our portfolio recommends, let’s just say high level 88%, intermediate term bonds and 12% total stock market index. Now, if you tried to do that, let’s say 15 or 20 years ago, even if you found the cheapest mutual funds and the lowest minimums, just by definition, you’re going to have to be into it for $10,000-30,000.

Now, the fact is, most people’s emergency funds aren’t of that size, right? So the first trend is, instead of mutual funds, you have ETFs where you can get access to literally every company in the US stock market indices for pennies per year on a $1,000 investment. So your minimum investment might only have to be $74 in this top portion.

The first is the hurdle has gone down, as you’ve gone from mutual funds to ETFs. The second and this is pretty big is commissions have been driven down and now in a lot of cases have gone away.

Okay, so one thing that’s nice about a bank account is there’s not a commission making investment there. Now that there’s no longer commission on ETFs, it has a lot of the same effect.

There is a slight cost to an ETF, it’s the difference between the bid ask spread. We’re talking even 10s of pennies on $1, when we’re talking about what that cost is. The move from mutual funds to ETFs, the drive down and just this massive competition that’s been created by the brokerage industry like Fidelity, Vanguard, Robin Hood, you name it, to bring commissions really low.

Then I think just generally the access that investors have and the ease of use of online brokerages, it’s so easy to open an account now and to get this exposure that just didn’t exist before.

As far as one other trend that drives us away from high yield savings accounts, taxes just tend to go up. Tax rates now were a lot higher than they probably were 200 years ago. There weren’t really taxes at all, just very few taxes for funding the government.

I think generally speaking society aims to provide more and more for people when taxes go up. Yhat tax tends to be taken out, unfortunately, on inflation adjusted items. And so, the 2% inflation on such a low returning instrument as high yield savings, it just eats away your return over time.

Robert Leonard  9:22

You write about the ultimate liquidity portfolio and how it’s the ultimate investment strategy in uncertain times. I’d say that we’re in pretty uncertain times right now so I think this is going to be a good conversation to have.

First, what is the ultimate liquidity portfolio strategy? What kind of tracker does it have?

Chris Kawaja  9:41

Great, so I love this portfolio because I think it’s very appropriate for what our emergency fund is trying to do.

Okay, what is it? It’s very simple. Although you could do it, I would caution you not to do it because I think you really need to believe in what you’re doing and people, they just hear something on a podcast and then implement it the next day. They are probably not likely to stick with it.

However, the ultimate equity portfolio on the surface is just 88% intermediate term bonds and there are a lot of ways to get access to that. Vanguard has ETFs and mutual funds that do that. We refer to those and you can just read on my blog, or refer to the book for what those are.

Then 12% of the US total stock market index. Again, VTSAX is a very common one that people use, but they’re a dime a dozen out there. Schwab has one, Vanguard has one, everybody has one. They have these very low trading fees.

So at a very high level, that’s what it is. But as far as the construction of it, it’s important that it’s really two different assets. In the book, we talk about raining and sunny has been, let’s say, you could create a perfect portfolio. Okay, you have certain chickens in your portfolio or farm.

Let’s say you’re trying to gather the maximum number of eggs very consistently. You need a consistent return, well, what you’d ideally have is a chicken that lays an egg every day it’s sunny, and another chicken lays an egg every day it’s not sunny. Then, even though you don’t know when it’s going to be sunny and rainy, you know every single day you’re going to get an egg.

Now, obviously, the investment world is a little more complicated than that. There’s no such thing as these perfectly matched investments but if you want to look historically, and we look back nine decades in our books, this mix of 88% intermediate term bonds, and it’s a very specific kind of intermediate term bonds. VGIT is the ticker for the ETF, if you just want to look up historical performance, this mix of 88% intermediate term bonds, and 12% stocks just has a wonderful track record.

The reason is when times are bad bonds tend to go up, and when times are good stocks tend to go up. And so, because of this ratio and because they have these different characteristics where they’re exposed, really in some ways to different moves in the interest rate cycle, which ultimately is driving the economy. It’s just a wonderful balance, and it’s extremely consistent. So that’s what it is and it’s designed mostly to be simple. There are ways to actually get more return than doing at 88-12, you could add a third short term bond fund and change your percentages.

Really a lot of what we talk about is how we create this behavior. It’s one thing to know it’s at 88% and 12%. It’s another thing to know why you’re sticking with it. It’s another thing to understand how it performed in every single downturn and in every single upturn, and really walk through that and understand it, because ultimately, and this is something I believe very passionately.

The thing that hurts people in their investing is their behavior. So we all know you should buy low and sell high, and yet everybody buys high and sells low. Look, maybe it’s only 98% of people but it’s pretty close to everybody.

There are very good reasons why that’s true but this is ultimately an emotional defense against that. It’s there to provide consistency and this ongoing income that really is comparable after tax over most periods to a high yield savings account, but then has this growth element because stocks do tend to grow over time.

Robert Leonard  12:56

When I hear about the portfolio consisting of that money, or that high of a percentage of bonds, it makes me wonder if that strategy fits towards younger demographics like millennials. I don’t tend to recommend bonds here on the show and you don’t hear a lot of people talk about that specifically for this type of demographic. So do you think that that strategy is good for millennials with that many bonds?

Chris Kawaja  13:18

Absolutely is, and let me explain what I mean by it being a good strategy. I think we have to think of our money in three different buckets. One of the biggest mistakes I see..

I’ve seen this a lot actually, in millennials, for whatever reason, is just the education that I received on Wall Street, in terms of bucket money seems to have not permeated to this generation. It’s something I talk a lot about when I speak with younger people and that’s that you have to think of money as doing a job.

Let’s just divide that into three basic jobs, just to keep it really simple. The first job is retirement. Okay, retirement is a job where long term at some distant point in the future, you’re going to need some amount of money that funds you with some income for a long time for that. That’s ultimately over time where you’ll build and where most of your portfolio will go.

For that job, stocks are great. Now, I wouldn’t recommend 100% stocks for that retirement portfolio. For the main reason being stocks don’t always go up. People say, “Well, you know, eventually they will go up after five years after 10 years,” to which my answer is, if you bought stocks in 1987 or 1989 in Japan, you’d still be underwater. So for anyone who had an investment horizon that was 33 years or less, that was a really bad idea.

I don’t believe in 100% stocks, but I believe that stocks are very appropriate for that long term portfolio because over time, stocks tend to perform about six to seven points above inflation. Whereas this portfolio tends to perform about three points above inflation versus short term securities and high yield savings, which tends to be at inflation, so those are the three categories.

Now the other category, which is really easy, is your bank account, your checking account just to pay your bills, right? What’s the job of that? To pay your monthly bills. Real easy, okay. There is this middle bucket and it’s extremely important.

The reason it’s extremely important is and you have to think about it differently, what is the job of this bucket? The job of this bucket is to preserve the value of what you put in there after taxes. You want it to do that at the highest possible frequency.

And so, this portfolio was designed and the results show that over a three year period, if this is your emergency fund, you have a much greater chance of losing money in stocks than you do in this. It’s just extremely consistent.

So is my advice to go invest in stocks? Sure, for the retirement part of your portfolio, but the very first thing you should be doing in your investing strategy, obviously, after having enough money to pay your bills. The second thing I’d say is probably paying off high interest debt. But the first money you invest in should be in an emergency fund, before you’ve actually invested in your retirement portfolio.

And so, I’d say yes, absolutely. All millennials should have this. They should have it for their emergency fund. Once you have enough of an emergency fund, then great, please pour all your money into your retirement. That’s going to be the vast majority stocks.

I have some ideas on how it shouldn’t be 100% stocks that we discussed. But yes, absolutely, it’s appropriate because look, you’re having it to maximize your chance of preserving value of money. It’s not like a retirement fund, which is maximizing the long term growth. And for that, go ahead with volatile investments. Those are great.

In fact, when times are bad, it’s great for you, because you’re buying more shares every time you invest. So I think the question is, yes, it’s very appropriate for that bucket of money.

What’s the biggest mistake millennials make? Not putting money in different buckets. They’ve sloshed everything together and then you get confused. Afterwards, you don’t know what portion is which. And you say, “Well, should I do bonds?”

I think if you know the job, you know how you should invest. And yes, you need an emergency fund. The job of that is preserving capital. This is the best way I know how to do it.

Robert Leonard  16:51

You talked about it being important to understand the historical returns of strategy before investing in it. So when we talk about the ultimate liquidity portfolio, how is it performing right now? Then how did it perform over the last decade when we had such a strong bull market?

I would assume that over the last decade through the strong bull market, that a portfolio with 88% bonds probably got crushed by the broad stock market index, how has it performed?

Chris Kawaja  17:15

Over a 90 year period, and I know that feels super long, the reason I look at 90 years is because there are markets of all stripes. Okay, over a 90 year period, it’s a little less than 3% over inflation over the last, let’s say, 40 years, it’s a little more than 3% over inflation. It’s pretty consistent.

How is it performed in the last decade? Well, the last decade has actually been pretty good for stocks and bonds so it’s performed pretty much in line with that. I don’t have my exact annual performance notes in front of me, but you can just look back on the portfolio visualizer and pick any period that you’re interested in and see, it’s very consistent.

I think more important than that is to look at how it’s performed in times of crisis because the first thing is, this is designed to preserve your money. How has it done this year? It’s up this year. I don’t know what it is, as of today, but certainly a few percentage points. It’s about an average year to a slightly better than average year, just because bonds have done super well. So that’s the first thing.

The second thing is it does well, when you’re reading bad headlines. Why is that important? Because although people say, “Hey, I want to invest in stocks,” the biggest fallacy is that people look at an index fund and assume that that’s what the performance that they’re going to get.

However, study after study after study, and you can just look this up online, and you’ll get hundreds of hits, show that the average investor in the stock market and everyone thinks they’re better than average, but the average investor in the stock market underperforms the stock market by between two and five points.

So we talked about the stock market being let’s say six to seven points above inflation. We talked about this as being three points above inflation. If you subtract two to five points, you know, really the average investor is not getting the returns of stocks, or their turns of corporate bonds with all of the volatility that comes along with it.

I think your show does a really good job at educating people on how they can avoid that. But I can tell you that some of the very smartest people I know and I’m talking millionaires, guys who had plans on what they were going to do in the next downturn, these guys sold when the market crashed. They were selling in March when things were cheaper than we’ve ever seen.

So I recognize that people believe they’re going to behave a certain way. But in practice, they don’t and I think part of it is emotional. Part of it is just structural Look, when you lose your job you tend to cut your investment amounts, right? So they’re just some structural reasons why it’s hard to get those kinds of results that you see when you just look at an index fund.

Robert Leonard  19:37

How much of this strategy do you think has been shaped by your time that you spent with Ray Dalio at his firm Bridgewater Associates?

Chris Kawaja  19:45

I would say a lot of the strategy is informed by it. It’s probably in some ways, a very deep simplification of many of his principles.

The one thing Ray, and I don’t think he would say this, if you interviewed him but if you look behind what he’s doing, probably his advice would sound something like everybody’s a little bit too in love with stocks, and everybody’s a little too overexposed to stocks. We feel that when we enter a downturn.

Ray always said his goal and his dream was to find, I think he said 20 to 40, uncorrelated investments. The thing about stocks is stocks are highly correlated. Stock markets tend to go up in sync, and they tend to go down in sync. There’s a little bit of difference between this and that. However, in a bad year for the stock market, it is mostly bad for most stocks, for a bunch of reasons. And so, people are a little bit too in love with stocks.

What Ray, I think, I’d say a couple things. The first is this value of seeking things that don’t correlate with each other. For me, a little bit of that is expressed in the ultimate liquidity portfolio but a lot of it is expressed in just how I invest everywhere.

My real estate investments are highly uncorrelated with each other. I invest in different regions. I invest in different industries. Likewise, in my personal investing, I have oil royalties. I have legal settlements that I’m invested in. I mean, you name it, I’m probably invested in it.

If it has a high after inflation returns, and is uncorrelated, I’m interested. There are a couple disadvantages to being in those quotes. Disadvantages that I happen to think are advantages. That’s when people say, “Well, it’s not liquid.” Well, I would tell you that liquidity is the reason for bad behavior in the stock market. When it costs you 6% to sell your real estate investment, chances are you’re going to hang in there.

So the first thing is uncorrelated investments. I really have pursued that with vigor ever since I worked with Ray. I think it’s a great insight that he has on that.

The second is this fallacy of nominal returns. There are several fallacies in investing. Pne of the ones I really harp on is that everybody values gains less than they feel pain for losses, when in fact there are charts that show and there’s an estimate that says, “Losing $1 or losing $5 is two and a half times as painful as gaining $5 for people.”

So this is totally illogical but it’s also the reason high yield savings accounts exist because it’s like, people walk into a casino. There are a bunch of games and somebody says, “Well, in this game, no matter what, you’re not going to lose money.” What they don’t tell you is that when you walk out of the casino your hundred bucks becomes 102 bucks and a bouncer hit you up for a buck on the way. And when you came outside, everything was 103 bucks, it was 100 bucks before. Though it feels really good not to lose money.

Just really hammering in, what matters is what you can buy with the money. If the idea of an emergency fund is let’s say, a fridge breaks, and I need to go buy a fridge. A fridge goes from $500 bucks to $525 bucks in a time when your emergency fund didn’t grow, and you’ve lost money. There’s this idea you have to keep feeding the monster.

I think the fact that nominal returns, everybody weighs nominal pre tax returns against each other. They’re really scared of nominal losses but you really have to look at the after tax, real return on money. And so, wherever possible, and the data is hard to find. You’ll see in my book that I’m constantly caveating, in this case, I had to use nominal, real was complicated or got distorted.

However, it’s really important to understand what the real return is because that’s all the matters. It doesn’t matter that you have the same number of dollars in your account. What matters is were you able to do the job that I was required to do, which is covering an emergency. So those are the two things I learned from him, the two biggest things.

Also honestly just break everything down to its base concepts. Then don’t be afraid to face the pain of what you’ve done wrong, because that’s where you grow. Pain is really where the growth is. I think Ray believes that to a very extreme extent, and it can be hard to swallow, but it accelerated my learning. Once I accepted that I had to be wrong a lot of the time and learn from those mistakes.

Robert Leonard  23:48

With this ultimate liquidity portfolio, what do you see as some of the major risks of this strategy that investors should be aware of?

Chris Kawaja  23:55

So the biggest risk with anything that gets back tested and has all this theoretical support is that maybe the world has changed in some fundamental way that just structurally changes.

One characteristic that’s just an element of the portfolio is obviously the performance tends to get driven by bonds. And so, we talked about a 90 year period, and really in the first 40 years, interest rates were going up and bonds didn’t do very well. That’s why you have that slightly lower performance, more of a 2% return versus… let’s call 2% plus or minus versus three and a quarter percent plus or minus, since bonds have been having decreasing interest rates.

So I think what the risk is right now is bonds are at really extremely low interest rates right now. There are a lot of reasons for that we can go into and the portfolio has never been tested when the seven year bond yield is 0.5%. Most likely what I think it does…

By the way, low yields helps stocks in a number of ways. One is it makes them more competitive when you’re looking at dividends. The other is it tends to drive the borrowing costs of companies down. So there are some advantages to having these low rates that will transfer to the other party or portfolio.

However, what I believe may happen in the future is that future returns may not be beating inflation by this same three plus percent. Do I still think it’s a great preserver of value? Absolutely. I think that the growth element, the return on the bonds, may create a bit of an issue.

So what’s the biggest risk? It’s the same risk as with any historical look at things and just like people look at US stocks and say stocks have always gone up.

The world can change and I’m mindful of that change. Once I really feel like there’s something that challenges the basic notions, and maybe I’ll post something else, but it’s worked pretty well for 90 years so I’m not rushing to change it.

Though if I just say one thing, and I’m not super worried about it, that would be the one thing I have my eye on, is this possibly a negative interest rate environment somehow impacts things in a way that the past 90 years just can’t capture?

Robert Leonard  26:09

How do you see this portfolio performing over the next a decade? If we see a reversion to higher interest rates? I mean, right now we’re in, like you’ve said, a historically low interest rate environment. They could go further, they could go potentially negative like you’re seeing in other parts of the world.

Though what if that doesn’t happen? What if we start to the interest rates start to climb back up? How do you see that impacting a portfolio like this with such a high exposure to bonds?

Chris Kawaja  26:35

So two things. The first is just to comment on history. Anybody who’s investing I recommend they become a student of history, and of financial history. I go through some examples in my book, but really, it’s important to become a student of history.

One thing you’ll notice is that nobody has ever really escaped because this is a recent phenomenon. We have about 33 years of experience. Japan has never escaped low interest rates, and we certainly, the US, have not managed to escape low interest rates.

One of the things I’d say is, people assume that just because interest rates have historically been 3-6% that they’ll go back there. What I would tell you is that the evidence is there’s somewhat of an anchor, and it seems really, really hard to get interest rates back up.

Okay, I’m not saying they won’t go up a little bit but if you look, the Fed’s attempt to raise rates, I think it was December 2018, if I am getting my dates correct. They raised rates about 25 or 50 basis points, and they had to come right back down and cut it again.

I think it’s just really hard in practice to raise interest rates. That’s the first thing.

Look, the yield curve is telling you that interest rates are not going up in the next 10 years. Now, it could be that it’s wrong. If they do go up, remember, two things happen. Yes, the value of your bonds goes down, that absolutely does happen. But a second thing happens. If we were to issue bonds at 10% today, you’d be getting a 10% coupon which would go towards your return.

An offsetting fact, and this is why bonds add so much stability to a portfolio. An offsetting feature is that you’d be collecting bigger coupons. If interest rates went to 4% or 5%, you’d be getting a 4% to 5% interest rate on that part of your portfolio.

Again, it’s not a huge consolation, but bonds, they’re not going to crash 50%. That’s just a very hard thing for bonds to do. They’ve never done that.

Bonds tend to have corrections and stocks tend to have crashes.

Look, if I had to forecast it, my best guess is we’re going to be more in the inflation plus a couple percent range, not inflation, plus three or four. But really, you never know. The key here is will it preserve value better than a portfolio of all stocks will preserve value, even then a portfolio of all bonds will have preserved value better than a high yield savings account?

I’m pretty confident that it will do that, whether that’s for any given one month period, three month period, one year period, or three year period.

Robert Leonard  28:54

Are there ways to further optimize this portfolio to increase returns? And if so, what are they and what are some of the reasons that someone might not want to do that?

Chris Kawaja  29:04

Beautiful question. I’m guessing you may have read my book because I talk about this a lot. If not, you may have taken my video course.

The challenge here is that our biggest enemy in investing, and I know you’ve had lots of people talk about this, our biggest enemy is our desire to do something, right? Our desire to really turn things and make things more complicated, etc.

The answer is yes, there are many ways to improve the performance of this portfolio but the vast majority of the benefit and what I’d recommend the vast majority of people is just keep it simple and simple really just looks like 88% intermediate bonds, 12% total stock market index invested in the Vanguard securities rebalanced once a year.

There are a couple ways to improve the portfolio. The one that I think is most interesting, and most applicable because this doesn’t just apply to this is to harvest tax losses.

The easiest thing to do is when you rebalance. So let’s say you started your emergency fund on July 1,  2020. What I say in the book is you should set a date, but let’s call it June 25 of 2021, a little less than a year ahead of time, why do you do that?

Because if a portion of your portfolio went down, then you sell those shares. You actually capture a tax loss. You can capture that as an ordinary loss against your ordinary income, versus as a long term loss, which is going to be at a lower rate.

You then want losses at a high rate and gains at a low rate. Essentially, what you can do is capture your gains at a lower rate, and have your gains tax a low rate and have your losses tax or tax benefit at a higher rate.

One is what I’ve called this tax arbitrage. What’s cool about it, because we’re using ETFs, is you can do it through, you’re essentially trading like securities and not reduce your exposure at all. So you can sell on day 360 and buy something very similar on day 360. Then 30 days later, you can switch back without avoiding wash sales.

I don’t know if you’re familiar with the wash sale rule but it’s if you take a loss and then buy the security back within 30 days, you’re not eligible for recording that loss on your taxes. This is a really cool way because it’s ETFs. You can just buy a very similar ETF, when you sell things, and you don’t have a wash sale, which is a really big tax savings.

So one of those tax things to look at depends on the year. The good news is, in really terrible years, that tax advantage is much bigger. When people are inclined to do something, namely sell the one thing they can do, I say, “Hey, don’t go out and sell things and just rebalance and take advantage of tax losses.” Those are a couple easy ways.

There are other tweaks you can do that get into the more esoteric and complicated dynamic. I mean, one thing is, there are three ETF portfolios that perform slightly better. Again, rebalancing between three ETFs, managing three ETFs, that’s its own complexity. I ask people, “Don’t you just want this automatic pilot?”

The other thing, and this is a very subtle thing, when you add that third item, that third ETF, you become more correlated with the stock market. So that means that your portfolio is going down more often when the headlines are bad. A big part of this portfolio.

Again, I mentioned it is getting the right behaviors. To get the right behaviors, you want things that are really kind of neutra, when you’re reading the bad stock market headlines, and possibly even good, because it just has this emotional benefit to keep you calm which is really important because often, you’re tapping into your emergency fund when you’re most nervous because you just lost your job. So this emotional stability, this emotional side of it, I think is really important.

So yes, you can tweak it. Yes, I talked about how to tweak it in the book. But no, I don’t really think it applies, I can tell you that. I’m a pretty sophisticated investor, I just keep it at 88-12, real simple annual rebalancing, no problem, super simple.

Robert Leonard  32:53

Earlier, we talked about the different jobs that money has, how much are Americans losing each year by not investing emergency funds properly?

Chris Kawaja  33:02

I looked at this once and I don’t have the number of my fingertips but the amount of money Americans have in savings accounts is on the order of several hundred billion. So that’s a huge number. I actually happen to think it’s quite a bit bigger than that, because I think people have mattress cash or money in checking accounts.

But let’s assume for the sake of argument, it’s $300 billion. This allows you to earn, let’s just say on an after tax basis, let’s just even conservatively say 1.67%, just that calculation alone says there’s $5 billion a year being left on the table by having your money in high yield savings.

Now, I’d argue it happens to be a lot more than that, because of a bunch of other features of high yield savings accounts. There’s money spent advertising, high yield savings coming in and a bunch of other things that are happening, but broadly speaking, it is in the billions of dollars. That’s why I told you before we started recording, I didn’t write this book to make money. I mean, I get income from a bunch of other places.

It was really just about this message that was so important to share that the book times have changed: don’t listen to this generic advice and think for yourself. Get an emergency fund going. I just think it can be a really, really useful aspect of someone’s portfolio.

Robert Leonard  34:19

Why do you think many millennials haven’t followed that advice over the last 10 years or so? Do you think that’s going to change going forward?

Chris Kawaja  34:27

Why haven’t millennials done this is because we’ve been in a great stock market period, and people do what they always do, which is they buy more stocks when stocks go up. That’s why we end up buying high and selling low because it’s very hard to be at a party and hear about your friend who’s made a ton of money in the stock market and not want to do the same thing.

And so, I think that’s one reason is just it’s been so compelling to be in the stock market has been this exciting time. Millennials a lot of them haven’t experienced a crash in their investing career. It takes people often to have gone through a crash understand the need or to have had an emergency to understand the need for an emergency plan.

I think that’s the biggest reason is really this performance chasing, which is just a trait of everybody. It’s not just millennials, it’s everybody. Also just experience, the people who tend to have emergency funds or people who’ve been through emergencies and understand the need for it.

Hopefully, rather than learning from it directly, you can learn by watching friends lose a job, or learn from just reading my book or some other book.

Though I think that people will certainly after this kind of crash, just like they do in every crash, take much more into account,first of all, how exposed they are to stocks. Second of all, what they’re going to do in an emergency.

Really, what I do in my book is I walk people through the steps of figuring out how much that fund should be and the good news is, for a lot of millennials, it doesn’t have to be six months of expenses. We walk through that but really, the answer is it’s dependent on your situation. Particularly for the younger branch of the millennials, they don’t have the kinds of employment and expense situations that require such a huge amount of money so it’s very attainable.

I think it’s just most important to have some kind of backup and understand, look, things aren’t always going to go well, just because they’ve gone well, since 2008 to 2009, you know, 11 years is a huge bull market but we’re in a new world. We’re in a new world, we’re going to face bear markets again.

The good news is, you actually want bear markets for your retirement portfolio because presumably, if you are doing the right thing, they’re investing a little bit at a time, and you just bought something on sale. So there is good news, and a silver lining to this to this market crash. That’s that millennials are not near retirement, for the most part. If they are then they work for some startup, make a big amount of money, and they don’t really care but millennials tend not to be close to retirement.

Having then a dip in the performance of stocks is actually a really good thing. It doesn’t feel like it when you’re going through it but it is good news.

Robert Leonard  36:52

All of the information that we learned from great guests, such as yourself on the show is always super helpful. I think it’s really important to learn but I think the other component that’s really important is actually putting what we learn in these episodes into action. That’s what I always recommend for people listening to the show today is to take something that we learned throughout the episode, and go put it into action.

Chris, what would be one thing that after listening to this episode today that a millennial should go out and do to get themselves closer towards retirement, financial freedom, or just optimizing their portfolio?

Chris Kawaja  37:25

I’m going to say something that probably isn’t what you expect. Of course, you’re going to think that I’m going to say, “Hey, put your money in an emergency fund.” But I think the most important thing when you’re new to investing, and by definition, if you’re a millennial, you have much more of your investment life ahead of you than behind you.

I think the most important thing is to journal about what your experience was, particularly the emotional side and what your instincts were. During this last crash, you just experienced one of the best lessons, one of the best learning periods you’re going to have, they’re not going to come along that often.

However, if you’re realistic, and you journal about what happened and how you felt, it’ll tell you so much about the kind of investor you are, because a lot of investing, it really has to be personal to you. How much are you willing to tolerate risk? I can tell you, this just taught a bunch of people that they were a little more risk averse than they thought and that’s fine. You can invest appropriately for that.

The biggest thing is really try to learn from this learning experience, both in terms of what’s on the stock market. Also we’re coming out of shelter in place now, with shelter in place really deleted a lot of distractions. It’s given us this special opportunity to learn from our past.

I would just say, learn from the past. Then more importantly, put in place systems, whatever those are for you, not just to learn about investing, and this is life advice. The most important thing you can do is figure out how to be a great learner.

Whatever it is for you to do that, which typically has to involve self awareness, and a willingness to be wrong, and then reflection, if you can get that and you can get people around you to help you reflect and help you sharpen the tools, you have so much of your investing life ahead of you. This is all about how to get better.

Yes, you maybe took a hit in March. Yes, you don’t like looking at your retirement portfolio. That is not going to matter. This is about you getting smarter, getting better, improving. It’s why you’re listening to this podcast, by definition. If you’re listening to this, you’re already on the right train.

I’m just saying, keep riding that train, keep learning and be reflective and then have systems in your life not just for learning about investing, but learning about everything. Learning about how to be better at your job. Even in my case, how do I be a better dad? If you have that ability, nothing’s going to stop you.

Robert Leonard  39:36

I always love learning about new strategies and just different ways to invest. So thank you for doing a deep dive into the ultimate liquidity portfolio with me and for those listening to the show today. For those that want to connect with you further after the episode, where can they go to find you?

Chris Kawaja  39:52

There’s several different ways but I’m best known for my Friday newsletters and those are 90-second reads that really summarize the best ideas I’ve heard that week.  There’s almost one post about finance and then I have four other categories. There’s a random category, I have a quote, I have something on fitness, mindfulness, etc.

So it’s all the areas that I’m interested in. The entire time it takes to read is 60 to 90 seconds. I have a very high retention rate because it doesn’t bore people. I try to make it really insightful. it relates to posts on my blog and things like that.

Number one is go to upwarding.com  and sign up for my newsletter. People can send me an email through upwarding.com. I try to respond to all the messages that I do read 100% of them. That’s an easy way to get a hold of me.

Robert Leonard  40:40

Chris, thanks so much for coming on the show. Really appreciate it.

Chris Kawaja  40:43

Appreciate it. Thanks for everything you’re doing for the community. Great stuff.

Robert Leonard  40:47

Alright guys, that’s all I had for this week’s episode of Millennial Investing. I’ll see you again next week.

Outro  40:53

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