Listen Now:
The Smart Take:
In this episode, Tyler Emrick, CFA®, CFP®, takes a deep dive into the world of risk. Is filling out a simple questionnaire sufficient? How about telling your advisor, “I’m moderately conservative?” Don’t these seem fuzzy at best?
Hear how your perceived risk and diversification may differ – sometimes substantially – from mathematical reality. And be sure to listen in to how Tyler and the team at True Wealth can help you more appropriately find the right risk level, which probably should change over time, to best align your money to achieve your goals.
Here’s some of what we discuss in this episode:
- Risk applies to everyone we work with so there are no exceptions when it comes to this topic.
- What are the general rules for risk that the industry follows?
- The True Wealth Design process for building a plan and determining risk.
- How diversification and market conditions are used to construct a portfolio.
- What ongoing portfolio management should you be doing to manage risk as you move through life?
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The Hosts:
Kevin Kroskey, CFP®, MBA – About – Contact
Tyler Emrick, CFA®, CFP® – About – Contact
Episode Transcript:
Tyler Emrick:
Get ready for a deep dive into the world of risk management, to find out if simply filling out a questionnaire or telling your advisor that you’re conservative is enough to truly set you up for success, and how, often, clients’ perception of risk is different than the reality of their portfolio mix. That and more coming up today on this episode of Retire Smarter.
Walter Storholt:
Hey, welcome to another edition of Retire Smarter. Walter Storholt here with Tyler Emrick, wealth advisor, certified financial planner, and a chartered financial analyst at True Wealth Design, offices in Northeast Ohio, Southwest Florida, and the Greater Pittsburgh area, but from wherever you are, you can listen to this show and work with the team remotely, if you’d like. Go to truewealthdesign.com if you want to find out more information on how to do that.
Tyler mentioned we’re talking about risk and seeing how that aligns with our perceptions on today’s show. Going to be a good one. Can’t wait to dive into it all. Tyler, it is great to talk with you again.
You sounded a little sad when we first connected this morning to do the show. A little bit of the winter doldrums got you. You thought, at this point, the groundhog was supposed to not see that shadow.
Tyler Emrick:
It lied.
Walter Storholt:
We were supposed to have spring and sun.
Tyler Emrick:
It lied.
Walter Storholt:
It’s just not happening yet, huh?
Tyler Emrick:
No, not happening yet, but the family did get out to visit some of our extended family down South. We’re up in the Cleveland area, and most of my family and my wife’s family are down in the Columbus/Dayton area, which is, for those not familiar, maybe two and a half hours, three and a half hours south of Cleveland.
I got to thinking, man, how are we going to start out today? How am I going to introduce this idea of risk and risk management? The only thing that popped in my mind was, as I was driving down to see the family, we were meeting them for lunch, and we didn’t decide on exactly where we were going to go.
I don’t know if I’ve told you on the podcast yet but, for whatever reason… I have my two little girls. I have a four-year-old and a two-year-old. They love Applebee’s. I don’t know where that came from, why. I think I may have mentioned that before, but my whole ride down to Columbus, I’m trying to figure out how I can tell these two little girls that we’re not going to go to Applebee’s, and we’re going to go somewhere else, and how I can present it to them to get them excited, so we don’t go the opposite direction, have just a terrible drive, and a terrible lunch when we get there. I’m thinking, boy, that’s a perfect example of me trying to manage my risk in how this lunch is going to go. I don’t know if you’ve been there before but, boy, that’s the only thing that kind of popped in my mind.
Walter Storholt:
That is too funny. Mine is a little bit more of a different and funny kind of perspective with my in-laws. They are more… Well, they’re from Vietnam, and so this is… I’m more cultured now, at this point, Tyler, but in my early days, in my early days as a youngster and getting to know your in-laws, whenever we’d come to go eat somewhere, they were always picking places that I would never have picked before, and so it was always a risk to leave with them in control. So, much like a risk for your daughters to leave with you in control of the dinner spot, they would introduce me to some hole-in-the-wall kind of places. I appreciate them now. Boy, they’ve got the best food, but when you’re a person who’s not used to eating ethnic food, and you’re getting dragged to the holes-in-the-wall, and you’re like, boy, I don’t know about this.
Tyler Emrick:
Sure. It can be very hit or miss, I’m sure.
Walter Storholt:
Hit or miss. Yeah, a little intimidating.
Tyler Emrick:
And there’s always some wins, mm-hmm. I’m sure there were plenty of wins.
Walter Storholt:
So, where did you end up, and did you successfully make it through disappointment?
Tyler Emrick:
Well, I did. I kind of caved, and we called Applebee’s, and Applebee’s said it was going to be an hour, so I was kind of forced to make the decision. We did end up at BJ’s.
Walter Storholt:
Okay, so basically the same thing.
Tyler Emrick:
Yeah, basically the same thing, not much difference at all.
Walter Storholt:
Yeah, Ruby Tuesday or a Chili’s would’ve all done the trick, I think.
Tyler Emrick:
Yes. For whatever reason, I built it up so much, but the girls were like, “Oh, yeah. Let’s go. That sounds great, BJ’s.” As long as they’ve got chicken and broccoli, we’re good.
Walter Storholt:
They’re good. They’re good.
Tyler Emrick:
Yeah, [inaudible 00:04:17].
Walter Storholt:
What is it about Applebee’s? Because I had the same thing when I was a kid, loved Applebee’s.
Tyler Emrick:
Did you?
Walter Storholt:
Yeah, but I probably haven’t eaten at one in 20 years now.
Tyler Emrick:
Well, I used to… Oh, I gave it a bad rap, right? I went probably 20 years without going, too, but for whatever reason, man, their stuff-
Walter Storholt:
But growing up, we always went to the Applebee’s all the time. It was our place to hit up.
Tyler Emrick:
Yeah, eating good in the neighborhood. But, yeah, so this idea of risk and how individuals think of it, and how we manage it, a lot of times I think it comes up when you start thinking about life transitions, especially retirement, and how they start to think about, all right, what do we need to do? Are we going to have enough money to have a long and happy retirement? How does our portfolio risk look like? And so on and so forth.
It’s something that it applies to everyone in some way, shape, or form, and really just wanted to take some time today on the podcast just to dive into it a little bit and talk a little bit about how the industry looks at risk, talk a little bit about how True Wealth looks at risk, and then maybe get a little granular on some portfolio risk, and that’s how I see today’s episode going. Boy, I’ll tell you, it seems like in our industry, there is a multitude of ways that advisors look at families’ risk and how they try to quantify it. I don’t know if you’ve heard the old general rules, which I think I want to reach back on you, on a pretty old podcast Kevin did.
Walter Storholt:
Okay.
Tyler Emrick:
Do you remember the Retirement Rules Gone Awry one that he did, talking about risk and trying to use a general rule to do a portfolio?
Walter Storholt:
Yes. That’s where that old rule of 100 must live, right? When we first discussed that on the podcast, I think.
Tyler Emrick:
Look at you. Pretty good. Yeah, so it’s like, hey, the idea of taking your age and subtract it from 100, and that’s the amount of stock exposure that you should have in your portfolio. Now, of course, we don’t recommend using that.
Walter Storholt:
I like it when a rule is that easy. I like it.
Tyler Emrick:
Yes, simplicity is good. Sometimes, though, we don’t want to oversimplify. It can get us into a little bit of trouble. If that works, it just happens by coincidence. We think the idea of taking a little bit more detailed approach here can add quite a bit of value.
I think another way families might have run into this conversation with their advisors is the sitting down with an advisor and asking, “Well, how much risk do you like to take on? Are you conservative?” You ever ran into that one, Walt, where it’s like, “Hey, I’m a conservative investor,” or, “I’m an aggressive investor.”
Walter Storholt:
Yeah, the more broader definitions.
Tyler Emrick:
Absolutely, yes. Inevitably, I’ve sat down with a number of families over the years, and there is no issue with, I guess, describing your risk tolerance this way, but it leaves a lot to the imagination. What I mean by that is it’s not very quantitative. It’s very qualitative because what might be conservative to you might be aggressive to me.
I can’t tell you how many times I’ve sat down with individuals, a husband and wife, and the husband’s idea of risk might be, “Hey, I don’t want to lose $200,000,” and the wife’s idea of risk is, “Boy, if we lose $200,000, Tyler, I’m going to come after you. That’s ridiculous. There’s no way I’d feel comfortable with that.” They’re both saying, “Hey, we’re conservative,” but that definition of what conservative means to them is much, much different, depending on your preferences and where you come from.
There are not too many times I’ve sat down in a meeting where the family says, “Yeah, we’re extremely aggressive. We want to take on a whole lot of risk.” It’s normally that default to, “Hey, we’re pretty conservative,” or, “We’re moderate and middle of the road.”
Walter Storholt:
Interesting that you get these very specific rules, but then most people have these very broad approaches to the whole problem of being a conservative or aggressive investor, and they may not even have the right grasp on what those definitions mean in the first place.
Tyler Emrick:
Well, it is. It’s challenging. As with anything that we do here at True Wealth Design, the idea of trying to take those challenging concepts and boil them down and get them down into some numbers that we can actually use to help us facilitate and get you into the right situation or the right portfolio, whatever the case may be. I think there’s quite a bit of value add.
As an industry standpoint, hey, we started with maybe this general rule. Hey, take 100, subtract your age, and that’s your stock portfolio. Then we moved onto this idea of, hey, let’s put you into a risk tolerance and put a definition on, hey, are you conservative, moderate, or aggressive? We’ve sort of morphed into, over the years, of… Actually, now a lot of companies are taking risk tolerance questionnaires. Have you ever ran into that one, Walt, before? Where you sit down and fill out a questionnaire that tells you how risky you are?
Walter Storholt:
Yeah, I’ve heard, not only heard about that but then whole companies and industries have been created around helping someone determine their risk level or tolerance and all sorts of different other buzzwords, right?
Tyler Emrick:
It is, yes. The idea of those questionnaires is to really take the mystification out of, hey, am I conservative or am I aggressive? And try to ask you tangible questions around, well, what’s your time horizon? What’s your comfortability with losing money? What did you do during maybe the last market downturn? And through these questions, try to get a framework or an idea for what type of risk level you should be taking with your portfolio. A lot of times, they’ll take all those questions and then give you a score, and that score will identify where you fall on the range of risk.
I think these things really are good in theory, and certainly, they can be a starting point but, as with anything, I think we need to take it maybe one or two steps further, to truly hone in and find that portfolio that’s going to be right for you because, just as anything else, I don’t know about you, but sometimes I can get swayed with just purely by the way some of those questions are worded. It might sway my answer one way or the other, or push me in a direction that maybe doesn’t meet exactly the way that I feel.
Sometimes, I mean, our industries are very highly regulated, which is a good thing, but I feel like some of these firms are using these almost as a CYA to make sure that they’re covered and okay, and sometimes can be used to push some products that maybe didn’t quite fit the family’s needs or the investor’s needs but, hey, they have that questionnaire to lean back on to say, “Hey, look, you filled this out. This tells me that this is an appropriate investment for you.” I’m not saying, of course, everybody uses them that way, Walt, but you do have to be a little bit careful on how we apply these things and how we are using them in the framework to set yourself up and set your family up for success going forward.
Walter Storholt:
Interesting that you can get these risk numbers in different ways, but then you can use that information in different ways, as well, so even if you got the same risk number, let’s say, as another advisor, you might actually choose to utilize that information a little bit differently, even if it’s the same number.
Tyler Emrick:
Sure, absolutely. Well, and that leads us to a wonderful segue on, well, hey, how do we do it here at True Wealth Design, and what do we feel like is probably the best path to get you to a place to feel comfortable about the amount of risk that you’re taking on inside of your portfolio and with your investments. No surprise, here, Walt. We’ve got to start with a financial plan. Have you heard that one before?
Walter Storholt:
Always goes back to the plan. We know that.
Tyler Emrick:
You got it, right? People tend to hire us when they get serious about retirement, tend to be in their mid-50s, and they’re coming to us. When we start working with families, it’s very important for us to have some type of basis to make these decisions off of.
Our idea and our framework, that’s starting with some type of financial plan to help us with that. We’ve done a multitude of episodes on our financial planning process, but for those of you who maybe haven’t heard this term before, financial plan, or are trying to figure out, “Well, hey, what is Tyler thinking about here?” In its most basic form, what a financial plan is, is simply taking your assets, taking an idea of your goals and your spending and what you’re trying to accomplish and just extrapolating that out over the next 20-30 years, and using that extrapolation to run tests to try to figure out and draw inferences from, well, how good of a place are you in, and what are some of the pitfalls and some of the obstacles that you’re going to have to come up and deal with as you think about a long, happy, healthy retirement.
These things can be everything from, “Hey, we’ve got a big car purchase coming up down the road. How do we plan for that?” So, cash flow related. They can be tax-related. The financial plan, as we start to run that projection and take that 1,000-foot view, we’re going to be able to glean information on how your taxes are going to change over time and starting to plan for that.
But another thing, or another use case, for that financial plan is to really use it to determine how should you be invested, and how much risk should you be taking on? This is more of us taking that approach to try to get away from the qualitative and get closer to that quantitative, numbers-driven data, to help us determine.
The first number that we try to glean from that financial plan, and again, I just ran through that very quickly. There are a lot more details and certainly a lot more that goes into that financial plan, but just for us to get us an idea, one of the things that come out of that financial plan is trying to identify what you’re required rate of return on your portfolio is to accomplish all those goals. When you think of required return, Walt, it’s pretty simple there, but what pops into mind, anything in particular?
Walter Storholt:
In terms of what percentages?
Tyler Emrick:
Yeah, what percentages, or what do you think that means to you?
Walter Storholt:
Oh, like I need X amount of return on my dollars so that I can pay my bills and not run out of money, no matter how long I live.
Tyler Emrick:
You nailed it, yep.
Walter Storholt:
Oh, okay.
Tyler Emrick:
Exactly right. Hey, can you pull your money out and put it under the mattress and not earn another dime on it?
Walter Storholt:
Probably not. That’s risky.
Tyler Emrick:
Yep. Yeah, it’s very risky.
Walter Storholt:
That’s its own risk, right?
Tyler Emrick:
Or do you need to get some type of return, say 4 or 5 or 6% return per year to accomplish those goals that you’ve set for yourself? Of course, it takes-
Walter Storholt:
Or if you’re needing 10 or 12 or 15%, then that opens up another conversation, right?
Tyler Emrick:
It does. Well, and when we run through a plan like that, to where the required returns are high, well then that can help us drive into a conversation of, “Well, hey, what are your spending goals? When are you trying to retire? What are these actual goals, and how can we work the plan to fit it into what you’re trying to accomplish? Whether that’s you work a little bit longer, you save a little bit more, or whatever the case may be.” Of course, the earlier that we do that, Walt, the more time that we have to circle back and try to get us to where we want to be.
That required return number, I think, is extremely impactful and very helpful, as we’re trying to identify and think about how much risk we should be taking on because, well, if we need to get 4 or 5% return on our money, then certainly we can’t leave it in cash and be able to accomplish that, historically, as you had mentioned before, so it really helps us and gives us a starting point for that portfolio construction and identifying that proper stock, bond, and other investment mix.
Now, the other thing that we look at, and we derive from that financial plan after we have that required return, is we’re going to look at your financial capacity. I like to think of this almost as in terms of lifestyle risk. Well, what do I mean by that? It’s essentially the idea of, well, when we run your financial plan, what’s the risk that you’re going to need to adjust your goals, adjust your spending? Is there scenarios that we run that come back and say, “Hey, you might need to cut your travel short a few years. Hey, you might need to adjust what you’re planning to gift here,” or whatever the case may be. We call it lifestyle risk.
For those individuals that have a very high required rate of return to make their plan work, they’re going to have more of that lifestyle risk inherently inside of their plan, because if returns don’t go their way, or they retire into a bad market, because we all know that those average annual returns are not linear, and the sequence of how you get your returns is very, very important.
I mean, you could ask individuals that retired back in 2008-2009 into the last great financial crisis and how much pain, if your portfolio loses quite a bit early in retirement, how much that can adjust and change those financial plan results.
We want to test that, and we want to look into that to see how does your plan look, and how much financial capacity do we have in there? What’s the risk, again, that you’ll need to adjust those goals? The way that we do that is through a bear market test, which is simply us taking your financial plan and saying, “Hey, what if you do retire into a very poor market? What if you retire in 2008? What if you retire into a March of 2020 when we learned about COVID and the market dropped by 30%? How does that impact your plan results, and do you have to, or is there a risk of you having to adjust your spending goals or your financial plan in some way to make it work and make sure that those results stay successful?”
Walter Storholt:
A lot of different angles, as usual, that you’ve got to analyze and figure out, and then all kind of… It seems like you can kind of test it off of somebody’s risk level, whether that be a feeling or an actual number that has been created through different conversations and tests and those kinds of things.
Tyler Emrick:
Yep.
Walter Storholt:
You’re always putting the plan through that litmus test of how it responds to that risk. Okay, if our required rate of return is a lot lower, that tells us right there that we don’t need as much risk to accomplish our goals, where we’re moving into a riskier situation if that requirement is higher, and that changes the dynamic of the conversation a lot.
Tyler Emrick:
It does. It really helps you hone into, well, where should you be, from a risk standpoint? What we like about it is it really starts with the numbers. Then, what that allows us to do is, once we communicate where a family or a client is, in regards to those required return numbers, and how does the results look when we run that bear market test, and then what we can do is shift the conversation to more of qualitative questions and more of that, “Hey, what are you comfortable with? What is the risk tolerance?”
There’s a multitude of ways that we can drive that conversation. I mentioned a couple questions before where, “Hey, how would you behave if the stock market sold off, or how did you behave in 2008 or how did you behave in March of 2020? Did you sell? Did you change investments?”
I tend to think of it in a little bit more concrete terms and really think of it and find it helpful to say, “All right, hey, let’s test your portfolio now and let’s say, well, if 2008 happened, how much in dollars and cents would your account have likely dropped? Would it drop by 100 grand, 200 grand, 400 grand?” And really hone in on, “Okay, well, did you know, one, that your portfolio has that level of risk to where you could potentially drop by those dollar amounts? Then, two, all right, let’s explore how you would feel about it and how you would approach that, with the thought in mind that, hey, maybe you’re in retirement now, or maybe you have other spending goals that are out there that we need to weigh against it.”
I find that, instead of speaking in percentage drops or possibilities, when we truly look at it from a dollars and cents number, it hits a little bit home and makes it a little bit more real. We start with that quantitative approach. What’s that required return? How much would you potentially… Would the plan results be okay if you experienced a bear market? That’s your risk capacity, and then finally ending up with that emotional side and the comfortability of volatility and seeing your accounts go up and down, of course, while nobody likes seeing their account go down, but we need to explore, well, how does that fit into your overall investment strategy and retirement plan.
Walter Storholt:
All great points across the board, Tyler. Anything else we need to know about risk in this evaluation?
Tyler Emrick:
Sure. As we think about risk, I want to shift gears a little bit and look at it through the lens of portfolio construction and actual underlying investments that you’re using inside of the portfolio. I’m sure you’ve run across the term diversification before. Is that fair?
Walter Storholt:
Oh, yeah. Yep, and another one of those things, kind of like risk, where people can have different definitions or interpretations of what makes up diverse, right?
Tyler Emrick:
Oh, absolutely. You know, the whole idea here is when you take a look at your portfolio and you get down into a little bit more granular view of the nuts and bolts of the investments you’re using. When you look at that risk and exposure, if you have diversification, well, some things will act differently during different market conditions. Each investment that you’re using is put into the portfolio thoughtfully to help really smooth out your ride over a longer time horizon.
If you have less diversification, you’re likely going to be bringing in more volatility to your portfolio, so higher highs and lower lows. By having a diversified portfolio, it’s meant to, again, smooth out that ride and then, in turn, have higher expected return over the long run.
I think back to an individual that I literally just met with last week. I’d like to use him as a little bit of a case study here because, when he came in, we started talking a little bit about his portfolio and what he was using to diversify. He was very, very happy with the portfolio, in general. He actually had a very simple portfolio, where he just had two ETFs.
For those of you that don’t know what an ETF is, it’s just called an exchange-traded fund. It’s very similar to a mutual fund, if you’ve heard that term before. There are certainly slight differences, but an ETF is, simply put, it’s a vehicle where you can put your money into it, and the ETF will invest it for you, based off whatever objective that it has.
In this individual’s case, well, he had two ETFs, one that was a stock ETF and one that was a bond ETF. ETFs are good vehicles to use. They’re generally pretty low cost, and most individuals think of them as being pretty diversified.
When we got to talking, this individual was actually using an S&P 500 indexed fund or ETF for the stock exposure inside of his portfolio. Again, I’m sure most individuals have heard that term S&P 500, but it’s essentially an index of 500 U.S. companies, okay? When you think 500 companies, I think a lot of people, ding-ding-ding, would be like, okay, that’s probably pretty diversified.
Walter Storholt:
Diversified, yeah.
Tyler Emrick:
Yeah, exactly, but as with anything, you kind of peel back the onion a little bit and get into the details. This is where details matter. If you look at the S&P 500, and you hear it on the news all the time, most individuals look at that as saying, “Well, hey, that’s a good gauge for how the U.S. Stock Market is doing in aggregate. If it’s up, hey, it’s a good market. If it’s down, the market is negative.”
You go back to, say, the beginning of 2023, over the last… We’re recording here at the end of February, so that’s almost 14 months ago. The S&P 500 is up over 30%. Pretty good number, right? Well, 30% not to shabby.
Walter Storholt:
We will take 30% all day long, right?
Tyler Emrick:
Well, you got it. I mean, historically speaking, the S&P 500’s averaged somewhere around 10%, so a significant outperformance, but what a lot of individuals I don’t think understand is how that index actually works and how it reports that performance. What I mean by that is the S&P 500 index is what’s called a market cap-weighted index. Said another way, the bigger companies represent more of the performance that comes through it.
For example, about 85% of that return since January of last year has come from the top 10 biggest companies in the S&P 500. There are 490 other companies that represent a much, much smaller of that overall performance. So, I would argue that when the vast majority of your performance is coming from just a couple handfuls of companies, well, it might not be quite as diversified as what you might expect.
Another way for us to think about this is there is an S&P 500 equal-weighted index. That is the exact same 500 companies, but this index actually has an equal representation of performance across all 500 companies. We go back over the same time period, January of 2023, so 14 months ago, that index is up just under 15%, so it is half the performance of the S&P 500. I think you can see how that performance has very much been driven by 10 very large companies that represent or that are entangled in that 500, in the S&P 500. Now-
Walter Storholt:
That’s why there’s so much focus on those big companies, and when you watch the investment news channels, and they always talk about the big… They all seem to have a different definition, but the Big Three or the Big Five, or the think stocks, or just-
Tyler Emrick:
Yes. I’m-
Walter Storholt:
These days, just what’s Nvidia doing?
Tyler Emrick:
Nvidia. Yeah, what is Nvidia doing? Yeah, the last one I heard was the Magnificent Seven, right? The big seven tech companies.
Walter Storholt:
Yeah.
Tyler Emrick:
There was a nice article that I ran into last month that was comparing the Magnificent Seven, or these big companies that represent the S&P 500 and have driven a lot of the performance over the last 14 months and comparing them to the Nifty 50s. I don’t know, Walt. I’m going pretty far back on you. You heard of the Nifty 50?
Walter Storholt:
Nifty 50. You might have one on me here. Nifty 50, okay.
Tyler Emrick:
Okay, yeah. That’s, you go back to the ’70s. The Nifty 50 were 50 stocks that, in the early ’70s, really benefited from a bull market. They were termed the set it and forget about it, never sell stocks, so everyone thought they were essentially too big to fail.
Walter Storholt:
How many of those are still around these days?
Tyler Emrick:
Yeah, very, very few. It didn’t even take this long. By the mid-70s, they went through a bear market, and that group lost a significant amount. This article was referencing those and trying to draw similarities to what we’re experiencing here. Any time that we go through a period where a select number of companies, in this case very large companies, do significantly well, you’ve really got to ask yourself and say, “Hey, how do I want to participate in that, and is that adding or am I being appropriately diversified if I have a big concentration of my performance coming from a couple handfuls of stock?”
Walt, there might be a few listeners out there, where actually they’re just saying, “Well, why do we want to be diversified? Why wouldn’t we just want to jump on this bandwagon? Most indexed investors, they’re putting money in their S&P 500. They are. Why should we take a more diversified approach?”
I think, to answer that, you’ve just got to expand your time horizon a little bit more. If we go back over the last 20 years and compare the S&P 500 index versus that equal-weighted S&P 500 index we spoke of, the equal-weighted index has outperformed it on a year-in and year-out basis by about a half a percent per year.
If we expand our time horizon out a little further, for the last 30 years, and the equal weighted has outperformed by even more than that on a per-year basis. That diversification really shines when you expand out your time horizon. For most retirees, you’re going to have a long, happy, healthy retirement, we hope, so your time horizon could be 20, 25, 30 years. Us getting caught up into some of these short-term trends, we just really need to be mindful of.
Now, when I go back to that individual that I had met with, and we’d had that conversation because again, his stock exposure was just in that one ETF, the S&P 500 Index Fund. The other thing there that we need to be mindful of is those are just U.S. companies. He had no other market exposure, no international, no emerging markets, and so on and so forth. You think about that from an overall portfolio construction standpoint, and the risk that’s inherent there, we don’t have to go back too far in history to 1999 to 2009, where we call that the lost decade in U.S. large cap stocks where, on average, the S&P 500 had negative annualized return.
You know, Walt, I don’t know about you, but I couldn’t imagine being so concentrated in just seven companies giving me most of my performance, but then, hey, if I look at it, I’m just in the U.S., and I don’t have any diversification, and then we run up on another decade where U.S. does not outperform like we’ve seen in the more recent history. You’re really kind of giving yourself a concentrated portfolio there, and not taking that diversified approach, which has, over time, proven to be the winner.
Walter Storholt:
Yeah. Two comments. One, this is from an older article, so it may have changed since then, but this is from 2019, so only a couple years ago; 22 of the Nifty 50 companies were still members of the S&P 500.
Tyler Emrick:
That half of them.
Walter Storholt:
More than half had dropped away from the S&P.
Tyler Emrick:
That’s sad.
Walter Storholt:
A few more than that still existed, but they don’t trade on the S&P anymore.
Tyler Emrick:
Okay.
Walter Storholt:
So, there you go. Second comment, back to just what you were laying out for us there. It sounds to me just like we really… Most investors, I’m imagining a lot of people that you meet with in the office, one of the big things you’ve got to do is just recalibrate this whole conversation and the viewpoint of what diversification means. People need to kind of just drop their preconceived notions of diversification and really redefine that, especially as they approach retirement.
Tyler Emrick:
Yeah, I would agree. I mean, and most importantly, it’s just having an understanding and an awareness that that’s how your portfolio is, so that way you can make decisions that put you in the best path going forward.
This isn’t just a one-time deal, Walt. I mean, I think the last thing we’ll hit on here, as we’re wrapping up the pod, is basically saying, hey, when you look at your portfolio, it’s not a one-time thing. That ongoing management is extremely important.
There are a few things that I’ll just rattle off here to keep in mind, but I’d spoke earlier about required rate of return and what rate of return your plan needs to be successful and accomplish your goals. Well, one thing that doesn’t take into consideration is that sequencing of returns and that understanding that, if you do have very poor market performance early on in retirement, when you’re drawing money from your portfolio, there is inherent risk there, and quite a bit more in outside risk, as well, depending on how your portfolio is actually allocated and where you’re actually pulling that money from inside the portfolio to get the money you need to spend and live your life and so on and so forth.
We call that sequence of return risk, and that is something we talk about on a day-in and day-out basis with the families, where we’re starting and going through that retirement plan and developing that financial plan and that cash flow distribution planning to understand, hey, where is your money going to come from? How are we going to get it? What investments, specifically, are we going to pull from if we were to experience a market downturn?
Then, to build off of that a little bit, we don’t want to forget about the importance of rebalancing that portfolio. I keep going back to that individual that I had met with. We had talked about his, maybe he had a little bit of a diversification problem there with the stocks that he was using in that one ETF, but also another thing to consider is, well, his fund was up almost 30%, his stock ETF, and he had not gone in and rebalanced it.
If you look back at the risk that he had started 2023 risk at, and then what his risk of where his portfolio is now, that’s a big difference, right? When you have parts of your portfolio that have major run-ups like that, you need to make sure that you’re peeling off those returns and diversifying. That way, if we were to go off a cliff, and the stock market were to have a substantial fall, you’re not going to fall disproportionately. So, rebalancing and that ongoing management is extremely, extremely important, from a risk management standpoint, to ensure that your portfolio does not get too risky.
It can go the other way, too, Walt. I mean, you look back on March of 2020 when COVID came, and the stock market dropped by about 30% in one month, if you’re not managing that, and you don’t go in and rebalance the portfolio, when it had its snap back, and the portfolio snapped back very quickly during that time period… It only took about a few months to get back up to where it was, but if you didn’t go in and rebalance through that, you’re not going to come back nearly as fast as what you had dropped. Rebalancing is a huge tool, from a risk management standpoint.
Then, the final thing I’ll say, as we’re looking at risk from this portfolio lens, is once you have your required return, once you have your risk capacity from a plan standpoint, and then you think you have an idea on diversification, and you’ve done all this work reallocating the portfolio, I think the next step is to certainly be thoughtful of future return expectations and how the relative performance of stocks and bonds and the outlook that we’ve had, right?
I mean, you come up on the last 14 months. You had the S&P 500 up 30%. The equal-weighted one up 15. Stocks have potentially gotten pretty expensive. The question is are you using that information to make sure that you’re adequately diversified and being thoughtful on, well, how much should I have in stocks and how much should I have in bonds? We can’t time the market, but we certainly can be thoughtful on how we have our allocation and the market environment that we’re in.
Walter Storholt:
All great points, and I really appreciate your perspective on this, Tyler. Thanks for walking us through these really important considerations from risk to rebalancing and diversification, and kind of the three big buzzwords that came out of today’s episode, along with your attempt to trigger the egghead alert, I think, when you were-
Tyler Emrick:
I stayed away.
Walter Storholt:
Dropping in some… But, I felt like you couldn’t help it, because these ETFs and mutual funds sometimes have really long names, right?
Tyler Emrick:
Sure, they do. They do.
Walter Storholt:
The S&P 500 equal-weighted index, ETF. Call your grandma. See if she can help you out, and something-something financial plan. Just some long string.
Tyler Emrick:
Yes. It can feel that way sometimes, yeah.
Walter Storholt:
Yes, yeah. The SPDR, this, this, and that, and then the acronym stands for 18 other words.
Tyler Emrick:
Mm-hmm.
Walter Storholt:
I’m not going to hold you accountable for what those are called, but no, great points across the board. Really appreciate it. If you have questions about anything that you heard today, you want to actually find out, perhaps, what kind of investor are you? Are you a conservative or aggressive investor, and is that aligned with what you should be for where you are in life and what your retirement plans and goals are? Do you have a good grasp on how diversified your portfolio is? Are you operating with a great definition of diversification? These are the kinds of questions that Tyler Emrick, Kevin Kroskey, and the great team at True Wealth Design are going to help you walk through, discover, and learn about on the way to putting together a successful financial and retirement plan.
If you’d like to set up a time to meet with Kevin and Tyler and the team, all you have to do is go to truewealthdesign.com. Click the “Are we right for you?” button to schedule your 15-minute call. Again, all you have to do is go to truewealthdesign.com or you can call, if you prefer that method, 855-TWD-PLAN, 855-TWD-PLAN. You can find all that contact information in the description of today’s show, as well.
Well, thank you for all the help, Tyler. Appreciate it. We’ll look forward to talking to you again in a couple of weeks.
Tyler Emrick:
Yeah, had a great time.
Walter Storholt:
All right, enjoy yourself. Go find an Applebee’s for the girls.
Tyler Emrick:
Will do.
Walter Storholt:
Take care of yourself. Thanks for listening, everybody. We’ll see you next time on Retire Smarter.
Announcer:
Information provided is for informational purposes only and does not constitute investment, tax, or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.
