The Wiser Financial Advisor: Portfolio Sanity Check #114

Today we thought it would be interesting to do a portfolio sanity check on all the turbulence and craziness of the last few years. Some of what we talk about is going to make you question or maybe reaffirm what you're already doing, which could result in some changes in how you'll manage your portfolio. We want you to really understand what’s involved in those decisions and what the outcomes end up being.
A transcript of this episode is posted and episode chapters have been created for your convenience. 

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Contact Jeremy Busch: https//www.keystonefinancial.com
Podcast Editing: Tim Leaman/info.primegen@gmail.com

Chapters

• 0:15 Episode Preview
• 0:59 How to know your portfolio is matching your expectations
• 1:55 Talking about Volitility
• 2:45 The whole idea behind an efficient portfolio
• 12:37 The art and science
• 14:00 The hardest part for people to look at
• 17:16 Summary, Contact info

Transcript

Wiser Financial Advisor – Portfolio Sanity

Hi everyone, welcome to the Wiser Financial Advisor show with Josh Nelson, where we get real, we get honest and we get clear about the financial world and your money. This is Josh Nelson, founder and CEO of Keystone Financial Services. Let the financial fun begin! 

Josh: Hi everybody, welcome to a special video version of the Wiser Financial Advisor Podcast. Today I’ve got Jeremy Bush here with me. We’re both Certified Financial Planners (CFPs) and experts in all things financial. CFP is the gold standard when it comes to the financial industry. Both of us are not only CFPs; we also have other letters after our names. But CFP are the letters you want to look for when it comes to vetting financial advisors or planners. 

Today we thought it would be interesting to do a portfolio sanity check on all the turbulence and craziness of the last few years. Some of what we talk about is going to make you question or maybe reaffirm what you're already doing, which could result in some changes in how you'll manage your portfolio. 

Volatility is turbulence—the ups and downs of financial markets. We're not talking about permanent loss of capital because you put all your money into one stock or cryptocurrency. We're talking about diversified portfolios. And the reality is that almost every investment portfolio is going to involve some volatility,  so every person has to come to grips with how much risk they can tolerate on their own. When we talk about risk and volatility, it means the higher the risk, the sharper the volatility. Sharper up sharper down, so it works in both directions. 

In fact, sometimes turbulence is required. For example, if you're trying to go to Hawaii, you're probably getting on an airplane or a ship. Either way, there's going to be turbulence/volatility, right? It doesn't matter how big of a ship or how big of an airplane, or how good the pilot is. You are going to end up with some turbulence. That's how you're gonna get to Hawaii, right? Or you can choose not to go. And that's really what we're talking about; in our world we refer to different “flavors” of portfolios, from really mild to really hot. The theory behind that is that the more risk you take, the more potential return you can get.

Jeremy: In other words, there are ways to maximize between asset classes, right? So if we have two basic asset classes of stocks and bonds, finding what combination of those is the most efficient for you. I think a lot of people don't realize that a 100% bond portfolio is actually more risky than a 20% stock 80% bond portfolio. And the reason for that is primarily diversification.

Josh: Absolutely. Now, an example of a really inefficient portfolio would be one where there's a lot of risk and no return. There would be no reason to do that, right? So the average investor is going to be saying, “OK, if I can step up the risk, that means that I should have higher odds of getting a better return.” Otherwise, there's no point. Lots of volatility to go only five miles down the road is really not worth it. 

Jeremy: We see people all the time who have a lot invested in one specific stock, maybe their company stock. That is not efficient; it adds a lot of risk.

Josh: Yeah, for sure. And sometimes company stocks can do well for a period and then they really don't. We've got lots of examples of people that worked an entire career at a company and then at the end, the company went away. There are lots of examples of brands that don't exist anymore. So that brings us to what we're really interested in talking with you about today. There's a study that Jeremy and I saw in Financial Advisor magazine earlier this year. Some of it was striking, as far as end result. So let's unpack that.

Jeremy: The basis of this study is that they took the last 50 years’ worth of actual portfolio performance starting December 31, 2022 and going all the way back 50 years. Then they averaged out those 50 years to give us a 25-year living and retirement time frame. They looked at different periods of inflation and deflation and financial crises and the dot.com crash. So they looked at 6 portfolios where everybody starts out with $1 million and then over the next 25 years of taking out distributions, where you end up and what happens.

Josh: So looking at it this way, with the average retirement of age 65, that portfolio gets you to about age 90, which is a long period of time, though certainly it's a lot of income and stuff that's going to happen in between.

Jeremy: It all comes down to asking, “OK, what type of portfolio do I have and how does it fit in?”  If we start with $1,000,000 going into retirement, and do the distribution rate of around 4%. The total amount you would have withdrawn in the aggressive portfolio (we're talking about 80 miles down the Interstate speed regarding your risk score), you would have taken out about $5,000,000 in distributions. That averages out to about $200,000 per year. And not only do you take out $5,000,000, but at the end of the 25 years you're actually left with $3,000,000. 

Josh: Think about that—you only started with $1,000,000 but you got $5,000,000 worth of spending. That's a lot of trips and gifts and all kinds of stuff.

Jeremy: That's a pretty nice lifestyle, yeah. That growth rate is associated with an aggressive portfolio over the last 25 years.

Josh: Yeah, but the 80 mile an hour portfolio, some people are comfortable with that in retirement, but some people aren't, right? They know themselves well enough to know that the volatility that comes with the “down years” isn't worth it to them. They're losing sleep at night or worst case scenario, they don’t understand their risk and end up bailing out right at the bottom of the market just because they can't take it anymore. They cash out right at the worst moment. 

The second portfolio in the study is the 80/20 portfolio, which  gives you overall spending over those 25 years of about four and a half million. Average annual withdrawal on that one is $176,000. Still looking pretty good, only about $25,000 less per year. That's a couple thousand dollars less per month spending. 

Jeremy: And some people might be thinking $176,000 a year is nothing to sneeze at. So over that 25 years, you spend 4.4 million, you still end up with two and a half million left over to give to the kids.

Josh: Not too shabby, but it is a couple of thousand dollars less per month of spending and effectively about $1,000,000 worth of money that somebody is not going to get. So there was a price to go to a more comfortable portfolio. And the question is, are you willing to pay that price or not in dialing up or down these different portfolios. 

Then we go to a 60/40 portfolio, which is a stereotypical balanced portfolio. In many studies, 60/40 is kind of an average. So where do we end up with this one?

Jeremy: The middle of the road average annually draws $150,000. You spend about $3.7 million over your 25 years of retirement and still end up just north of $2,000,000. Not bad, but you start seeing a turning off there.

Josh: We have a risk assessment that we have our clients take, and they can retake it as often as they want to because it shows some of these trade-offs, but when you see everything over a 25-year period, it really is striking how different the end results are, which could result in some different decisions for people, maybe even if they’ve already invested with us. They might look at this and say, “Maybe I need to look at that again; I need to make sure I'm in the right spot.”

All right. Then we flip it to the opposite of the balanced portfolio, which is 40/60—that is, 40% stocks, 60% bonds.

Jeremy: Now we're getting more in the range of the conservative investor. This time the average annual draw is about $130,000 per year, spending right about 3.2 million over 25 years. You end up with about 1.6 million when it comes down to it.

Josh: Now we are talking about millions of dollars difference in how much you were able to spend and how much you got to leave your kids, your grandkids, or whatever is gonna get your money. Maybe you'll leave it to a church or charity or somebody else. Whichever way you do it, that money is just not there. So we need to recognize the difference. 

Then when we go to a super conservative portfolio, the 20/80, we've got 100% fixed income portfolios. We didn't run out of money. So the good news is, we didn't run out. 

Jeremy: We didn't run out of money in any of these examples. A key thing to point out though, is that we were using a very usable distribution of 4%. So that is a major assumption in this study—they assume that the 4% rule (4% withdrawal rate) is lived by. The other thing to consider is lifestyle preference. How much volatility can you stomach for a particular lifestyle? Because if we look at the top number and the very bottom number, there’s a $100,000 a year difference. 

Josh: Most people could live on any of these examples. But you're probably not going to Europe and Australia if you're in the super conservative portfolio, because it's just not going to produce the income to make that happen. It might be once in the lifetime you go to Australia, but if you want to do stuff like that continually and have that lifestyle there’s a big, big difference between those incomes. So again, it all involves trade-offs.

Jeremy: And some people might look at that and say, “Well, I do not need $100,000 more a year, so why would I subject myself to that turbulence? That's the other kind of thing that figures into risk, right? How do you want to live? What is your lifestyle? What do you want retirement to look like? That can help us feed into asking, “How much risk are you comfortable with?”

Josh: And that's where the art and the science comes into this. Sometimes, we put on our psychology caps, because a lot of it does come down to psychology. And the thing that blows all of this up, is if you bail out when times are tough. Any of these portfolios can go down for a while. These rates of return in the study were what an investor would have gotten over that period of time, true. But that's for the person who didn't try to time the market, and didn't get scared and sell when things went down. They also didn't get greedy and do stupid things when the market was really high and going up. In other words, market timing does not work consistently. We've never seen a study that has shown that can be done, not even by the most successful investors. 

No one can consistently time the market. That’s why it’s important to recognize that emotional component is key. You will need to hang in there when times are tough, hang in there when you have a bad year like last year. Pretty much all of these portfolios would have been down last year, no matter what flavor of salsa your portfolio was, from mild to hot. It wouldn't have mattered because everything was down. Stocks, bonds, real estate, everything had negative numbers.

Jeremy: That is a really good point about the need to stay invested and know that you have a long term plan. Another interesting thing about this is that you're looking at a 25-year retirement. I think the hardest part for people to look at is beyond the short term, especially when you're living in a market like we had in 2022. It takes a savvy investor to sit back and look at a negative return in 2022 and say, “I’ve got a long term plan, I'm all right, we're going to make it through.” That's why we had to help quite a few people through 2022. But how many people look five years out ? Obviously as CFP's we're planning 30, 40, 50 years in advance for a lot of people. We're in the habit of this, it’s our job.

Josh: Absolutely. A big mistake would be to think, “Well, the best result would have been that hot sauce, that 100% equity portfolio. Why shouldn't I put all my money there?” Well, for some people, that's appropriate and they’ll sleep like a baby at night. But you’ve got to recognize the emotional component of what you really can tolerate, because when you're in a terrible year and we've had them right from the initial crisis in the early 2000s, where that 100% equity portfolio would have been down by over half. I mean, that $1,000,000 would have been worth $500,000 for a while. That’s when some people say, “No, I couldn't live with that.” 

That person, somewhere along the way, would have called Josh or Jeremy up and said, “Get me out,” which negates the entire thing here. In such a case, you wouldn't have come back to see that the markets have actually done very well. None of our clients did that, of course, but how sad for people that bailed out when the market was down 20 and 30% last year. They never got to come back to fight another day when the market has done so well coming up this year.

Jeremy: They would have missed out on six of the best months to start a year, pretty much ever.

Josh:  I want to reiterate that people shouldn’t think, “You guys are saying I should take a lot of risk and have the most aggressive portfolio.” Some of you may be comfortable with that. It's not an age thing by the way. We've got clients that are quite old but have very high risk tolerance; the market volatility does not bother them a bit and they don't even think about who the president is with regard to their portfolio or what's going on in the world. 

Jeremy: And we have young clients who are just the opposite, do not want to take that much risk, can't stomach it. And you know what? That's fine. They have a long time frame to use. They don't have to take that much risk in order to get where they're going.

Josh: Yeah. So make sure you've thought through this. We have a risk tool and risk assessment, and we have lots of conversations when people come on board, but that doesn't mean it's a one-time conversation. It's something to reassess over time. You want to make sure that you're not taking too much risk, or you'll bail out when the market goes down. You also want to make sure you're not taking too little risk. We want you to really understand what’s involved in those decisions and what the outcomes end up being. 

We're here to be a caring advisor, somebody that you trust that has a lot of experience along with book knowledge. We've seen a lot of things that work and a lot of things that don't work for people. We can't guarantee anything but we've got a great team, so we are here to serve you. We do thank you for those of you who are our clients. As always, thank you so much for trusting us and for sending your friends and family and coworkers to us. That's nearly 100% of how we grow—through people sending their friends to us when they need help.  You can contact us at josh@keystonefinancial.com or   jeremy@keystonefinancial.com . Our website is www.keystonefinancial.com.   

Have a great week, and God bless. 

The opinions voiced on the Wiser Financial Advisor show with host Josh Nelson are for general information only, and are not intended to provide specific advice or recommendations for any individual. To determine what may be appropriate for you, consult your attorney, accountant, financial or tax advisor prior to investing. Investment advisory services offered through Keystone Financial Services, an SEC registered investment advisor.