The Folly of the Risk Tolerance Discussion

Welcome to another edition of Mr. Stillman's Opus.

I'm Walter Storholt alongside John Stillman, the founder and president and guru of... I don't like the word guru. Never been a fan of that word. No, like the connotations that it has or something like that.

I don't know why, just never liked it. Guru is a very, what, like Eastern world kind of term, right? Dalai Lama sort of thing.

Yeah, you're much more of a Southern non Dalai Lama kind of thing. More of a deacon. Oh, I like the deacon. You got a new nickname. Chairman of the deacons.

Yeah, that's good. Walter Storholt here with John Stillman talking about today risk tolerance. But the way that this is going to go is John's going to actually blow this whole idea up. There in the financial world is this term risk tolerance. The financial industry kind of paints that picture, paints that conversation in a certain way.

And I know that you're not a fan of it. Well, I don't want to make it sound like it's not important at all to be part of the discussion. It is important to understand how you feel about volatility and risk and your accounts moving up and down. That's certainly something we want to factor into your overall retirement plan. Risk tolerance is what? How much risk you can emotionally kind of handle the how much volatility you can stand from an emotional standpoint?

Yeah. So if you look at your account, say, all right, well, I could have growth of 10%. Next year, within a 95% statistical probability, I could have growth of 10%, but I could have downside of 7%. Or I could have growth of 40% and downside of 28%.

How much upside do I want to try to chase understanding what the downside is? Right. Or if you look back, let's say 2008, if when 2008 happened, you saw your account cut in half, and you just shrugged your shoulders and said, well, it'll come back, then you have probably pretty high risk tolerance. Right. If you sold at the bottom, because you panicked, then you probably do not have very high risk tolerance.

That is correct. Here's the problem with the industry. So the way that this is always framed, anytime somebody asks you what your risk tolerance is, it's it's not really a planning question. It's a sales question. Interesting. Okay, so they're trying to say that again, it's not a planning question. It's not really helping them plan your retirement. It's helping them sell you sell a product or something like that.

Yeah. And so basically, if they can say, well, we've put together a plan that fits your risk tolerance, then you're more likely to be on board with it. Well, it kind of reminds me of the old Bill Cosby routine from like the 70s or 80s, where he was talking about, you know, people say that you should try drugs because it enhances your personality. Well, what if you're a jackass? And you know, that's basically his approach to that. Well, same kind of thing. We've put together a plan that reflects your risk tolerance. Well, what if your risk tolerance is illogical?

Yes, it's how you feel. I could make another Bill Cosby joke here, but I'm gonna refrain. Maybe he's not the greatest person to be quoted in this one. Especially when you talk about drugs enhancing personalities.

His old stuff is still funny. Yeah, there you go. In any event, what if you say, look, I'm a really conservative investor. And I put together a plan that reflects your risk tolerance.

Very conservative account. Well, what if we actually look at your plan, and we determine that you don't need any money until you're 78 years old, and you're currently 62? You got 16 years before you need the money. It doesn't really make sense.

What do you mean? I mean, he's gonna need money between that time frame. Well, let's say he's retiring, he's got a pension, and he's got three rental properties, and he's gonna have his Social Security, and he loaned some money to his son who's gonna be paying it back. His income needs are covered. He doesn't need the money that he has on the market for 16 years. Maybe to cover inflation 16 years from now, that's when these other sources of income are going to need to kick in. It doesn't make sense for you to be overly conservative with those dollars. Because those dollars you don't need.

Right. On the other hand, let's say, yeah, you know, I got a pretty high risk tolerance. I don't mind losing money.

I know it's going to come back. But then we look at your plan, and we say, all right, well, you're 62, you're retiring in three years, and we're going to need, you know, 250,000 of these dollars to start producing income for you. We don't want all of your money to be on that aggressive track that could get cut in half.

So it could go either way. It could be that your risk tolerance is too conservative or too aggressive for what you actually need. So my job as your advisor should not be to take your risk tolerance and put together a plan that reflects it. It should be to look at the overall picture to show you how soon or how far off into the future it is before you really need this money to become income, which then will help dictate to you what your risk tolerance should be. Does that make sense?

It does. I was saying, if I'm understanding you correctly, that it doesn't matter how I even feel about risk in these situations. It doesn't even matter because it's going to be what you need. I may hate risk, but I may need it if it's some money that I don't need for 20 years. You have to kind of convince me that, look, I know that you don't want to take a bunch of risk and we won't with the short term money, but with the long term money, hey, you've got to do it.

That's a pretty good summary of the issue. So when does it matter, my opinions on risk? Well, in a lot of cases, let's say we need to get from point A to point B and we could do that in a very conservative fashion or a risky fashion. At the end of the day, we'll go with whatever makes you feel good, whatever you're most comfortable with in getting from point A to point B. But if the conservative route is not going to get you from point A to point B, I can't just say, well, you're a conservative investor, so we're going to invest everything conservatively. It fits your risk tolerance. The plan doesn't work, by the way, but it fits your emotional feelings.

So all is well. That doesn't work. Basically, risk tolerance is important, but your risk tolerance should be based on an understanding of the bigger picture. Usually, once you understand the big picture, that's going to dictate your risk tolerance.

Most people don't approach it that way, though. It's just like, I don't like risk or I don't mind it. Okay, so here's an annuity where you don't have to take any risk. That's the sales part of it, right?

Or you love risk? Great. Let's put all your money in these mutual funds and then the brokers making, you know, whatever commissions off of those financial products. That's a sales question. If you have a plan, that's a sales pitch. Exactly. And so it makes you feel like you've gotten this customized plan that's been tailored around your needs and your wants. Because it has been.

Tailored around your wants, not your needs. Exactly. Yes. So you can see why I get frustrated by this whole risk tolerance conversation and just the way that it's framed. Wow.

This is a drops mic and walks away kind of podcast. Is it? Yeah. This was enlightening. It's on one hand, I'm glad the conversation is being had with people that, you know, most people, I would say that walk into my office, understand the concept of risk tolerance. But it just really hasn't been thought through thoroughly enough in most cases. And if I'm going to somebody else's office who's kind of teaching me this is the right way to view it.

Oh, yeah, whatever you feel, that's what will match. That would make sense in my mind if I was uneducated. But this is a different kind of education where you're kind of learning a little bit different way to look at it.

This is a great example in real life of what this looks like. So had somebody who was within their 401k, they had, you know how a lot of companies will have financial engines or one of those companies come in to help you manage your 401k. So you pay a small fee to let's say financial engines to rebalance within your 401k for you to keep on track with your risk tolerance. Right.

Okay. So in this case, we said, look, all right, you have about $2 million. And I don't know, 750,000 of it is in your 401k. You've got 400,000 in this IRA, a couple hundred thousand in this Roth over here. So we're looking at the entire plan and we're saying, this is what we need the money in your 401k to do. This is what we need the money in your IRA to do. This is what we need the money in your Roth to do.

And all these pieces are fitting together. Well, then he goes back based on the allocations I've given him for his 401k, because basically he had his 401k too aggressively invested relative to what we needed to do based on all these other pieces in his plan. Right. And so when he goes to financial engines and says, all right, well, I want to reallocate to this, they say, oh, no, no, no, no, that's way too conservative. It doesn't fit your risk tolerance. They're not looking at his IRA, some of the other things. They're looking at $750,000 out of his $2 million portfolio. They're not seeing the big picture and they're telling him that's too conservative.

Well, it's not when you consider that we're going more aggressive with some of these other pieces. Wow. I'm left speechless. This has been one of your better and more educational enlightening podcasts, I think.

I'm not sure if I'm excited to hear that or not. I feel like we've been accomplishing nothing for the previous months. When you told me we were talking about risk tolerance, I honestly was going to be bored and probably checking my phone the whole time we were having this discussion, but I haven't even looked at it once. This has been really engaging. Explains why you haven't been returning my text messages for the last 10 minutes.

Just a slow text or two. That's really helpful. Thank you, John. I appreciate it. Always a pleasure.

Risk tolerance. Really good kind of behind the scenes look at how that discussion should go and way too many times it doesn't go that way. Very, very enlightening. Thanks as always, John. Thanks for tuning in and we'll talk to you next time on Mr. Stillman's Opus. Another masterpiece next time.