2022 EP0423 - Planning Matters Radio - Risk And Volatility

We want you to plan for success. Welcome to Planning Matters Radio. Yes, welcome once again to Planning Matters Radio, the show where we shed some light on the personal finance issues of the day and have a little fun along the way. My name is Scott Wallace and I'm here as usual with a Ramsey approved SmartVestor Pro. He's an author of Understanding Your Investment Options and he's a fiduciary financial investment and retirement planner serving his clients throughout the great state of North Carolina. Pete and Rashad, thanks for joining us. It is always a pleasure, Scott. A lot of important information to cover, a lot of people I think reasonably concerned about the market, their money, their retirement accounts, their investments.

Let's call it what it is, their life savings that hangs in jeopardy in the balance based on what direction the market is going. It really can kind of set the mood. Are we euphoric? Are we happy?

If we see green on the charts that day, maybe so, but a lot more red to start 2022. The first quarter, you know, markets and indices fluctuated 10 to 15 percent. We're still down off of highs.

And although I'd say it's relative, you've got to really look at this in perspective of the grand scheme of things. The market is still hovering near all time highs, as it were. But because we have seen a little drawback from the peak of that all time high, I think a lot of people are worried that, hey, we're losing money because it sort of feels like a new phenomenon that the market can even go down. We've become so accustomed to it constantly moving up over the last 12, 13 years since the bottom of the Great Recession that it feels like it's new and fresh. And people, I think, are worried as a result.

Yeah, there are literally people in their early 30s who have never experienced a down market in their entire working, investing, saving life. So it makes a lot of sense that the things that you're saying. So today we're going to talk about risk and protection.

And in some ways, those things feel like opposites, but they can occur at the same time. What is risk? We hear that word gets thrown around so much.

What is it? Well, there's many different types of risk. There's risk in almost everything that we do. But when we hear about our money or our investments and risk, most often we're talking about the market base risk, the risk that the market takes a downturn, has a drawback, has a correction, enters into a recessionary period. You know, the regular economic cycles of boom and bust. We've been booming for a really long time.

Side note, a lot of it because of government intervention, support, infusions of cash and capital. But we have been seeing this upward trend in the market for really so, so long. I mean, there was a little downturn in 2015. 2018 was the last time they tried to raise interest rates.

They raised it a quarter of a basis point at the end of 2018. And as a result, the markets ended the year. The month of December was down like 18 percent. We bounced right back from that in 2019, though.

COVID hit. We had a big major downturn then, but it happened so fast. It was like most people didn't even open their statements by the time or during the time of that downturn.

By the time they did open their statements, the market was already back up. And so we really have not had investors experience what losses or what volatility in the market feels like for quite some time. And as you noted, so there are some investors out there that that it feels fresh. Other investors may have experienced this kind of risk before, but it was different last time, right, because it was 12, 13 years ago.

They're that much closer to those retirement goals. And so we don't want to suffer another round of the dot com bubble kind of losses or the Great Recession kind of losses. So this time it's a little different. But what is risk? Risk is the chance that anything goes wrong. It's the possibility or probability that things don't go our way, that there's inherent danger or damage that can be caused as a result. I mean, waking up and rolling out of bed in the morning involves some kind of risk, but we've got to measure all risk.

Right. Is the reward worth the risk? Here's the thing is that with our money, we have been taught and we have been told we have been trained that risk is a necessary part of progress. If we want reward, if we want growth, then we have to take risk. And we have to wonder where that training, where that message has come from. Right. Always pull back the curtain. Who's the man behind the curtain?

Where is that message coming from? That has been through decades of Wall Street advertising, marketing and what I will call propaganda, because Wall Street benefits when we choose to trust them and turn our money over to them. The risk isn't necessarily a requirement to make forward financial progress. If you are willing to take risk, the possibility is that you could make more rapid or larger amounts of financial progress. But risk is risk. Right. We can't base the amount of risk we're taking or the investment selection, the allocation off of the reward and the growth that we want and negate the risk factor of losing money, the possibility. I mean, and even if someone not taking action or taking action to mitigate risk can also be inherently risky.

If you put all your money in a mattress over a long enough time frame, inflation will make your money go down by effect. Correct? Absolutely.

Right. Again, yes, different types of risk. So there's interest rate risk, there's duration risk, there's legislative risk, there's sector risk, there's all kinds of different, there's specific company risk.

If you are invested in one particular company, let's take like a shopping mall staple, like a consumer retail, JC Penney's or Belk's or something like that. The retail sector still was going very strong, but JC Penney's didn't put the dot com after their catalog and become Amazon. Right. So their particular company was suffering and losing value while the retail sector as a whole was still very strong. We could take several other examples. Blockbuster Video, the entertainment sector, still going very strong.

Sure. That company specifically did not keep up with times. And so that company had specific company risk where the sector still was doing very well. Now, sectors can have their own subset of risk. Health care, energy, oil and gas, financial sector, consumer staples, commodities, all of these things behave differently and they're cyclical. And so there are parts of the economy, for instance, like the commodities that actually held their value relative to the broader markets in 2007, 2008, the Great Recession. But the financial industry, the financial sector, which had the mortgage backed securities that sort of were the dominoes that fell and led to the collapse of the financial industries. The Bear Stearns, the Lehman Brothers.

Right. That sector didn't do very well. And then you've got economic cyclical kind of risk where the entire economy is suffering. We are just in a recessionary period.

And right now, I think that's what people are worried about. As we have seen the supply chain woes continue from Covid and then from the Russia Ukraine conflicts, as we have seen prices rise, inflationary pressures and the government's response, their weapon to try to keep inflation under control is to raise interest rates. Well, interest rates rising does not have positive implications for a lot of the different sectors in the financial markets. The bond market in particular is likely to lose value as interest rates rise. And we hear a lot about the stock market, but the bond market is actually four to five times the size of the stock market.

It's just generally not as exciting. But I think this year in particular, as rates are rising, you're going to hear a whole lot more about fixed income losing value, about bonds and bond funds losing value, about the bond market having more volatility than we are accustomed to seeing. And then as interest rates rise, refinances are going to slow down, people continuing to move into larger and larger and larger homes simply because they could afford to on the same payment because interest rates kept going down.

That's going to slow down. And then all of the ancillary factors that go into people moving and filling homes with new furniture, many different angles that are impacted by the transitory nature of people moving around in large numbers. When relocations, when refinances, when buying bigger and bigger homes slows down, it's going to have ripple effects on other aspects of the economy. And we are probably going to see some continued volatility throughout the year because the Fed has now raised rates twice. Their stance at the beginning of the year was they planned on doing it six times in 2022 and two more times in 2023.

They said they were going to be more aggressive on the front side of this. So I think that we're going to continue to see some ups and downs in the market. And people need to be aware that that is part of the investment experience. Downturns in the market, fluctuation and volatility are not something that is new or novel or unusual.

In fact, the stability that we have seen over the last 12 years, the lack of volatility, that has been something that has been a bit of an anomaly where we have not seen this level of volatility. Well, there's Peter Rochon's take on kind of the overall conditions. If you want to talk with him specifically about your situation, you can. You can call him at 919-300-5886.

That's 919-300-5886 or just go to his website, www.RochonPlanning.com. Peter, many people, some investors, certain type of investor, wait for these periods of volatility and take advantage of them because that is where perhaps more risk begets more reward. How much risk should the average person be taking?

Well, so you're correct that there are certain investors that are positioned for these types of instances for volatility. Let no opportunity in crisis go unrecognized or there's always opportunity in crisis. I think something... Right. Don't let a good crisis go to waste. There you go. Thank you. Yes. And there's another one.

It's even more gruesome. But when there's blood in the streets, there's money in real estate is another saying that I've heard that kind of is the same line of thinking. But only if you are prepared and positioned correctly and can afford and stomach some amount of losses. But when I am onboarding a client, I am tasked with part of my responsibility and part of my process is trying to help them determined and understand their risk tolerance.

How much risk can you stomach? And part of that process is a series of questions, kind of hypotheticals that I go through. One of them being, you know, if we hypothetically were to invest one hundred thousand dollars and then we come back one year and we review the progress of this account. And let's just say, let's pretend that the market is down 30 or 40 or 50 percent. How much of that hundred thousand dollars are you comfortable having lost?

Right. And there's kind of some range of options there. And I go through a little bit of a follow up question.

Well, if you had the potential to gain this much more, would you be comfortable with the possibility of losing this much more? And we try to hone in on where that risk level is. Another one of those questions is that the market has experienced several different types of downturns like sharp short term downturns or more prolonged periods of downturn. If the market was down 25 percent in two days, what's your reaction? If the market's down one third of its value, down 33 percent over a three month period, what's your reaction?

And there's a spectrum of answers. Do you move everything to cash? Do you move things to more conservative investments? Do you wait and see? Do you move to more aggressive investments or do you add more money during those periods of decline?

And based off of those answers, you know, we have follow up discussions. There's no right answer per se. But if we look at fundamentals for successful long term investment, there are right or answers. There's answers that if we have a plan in place, if we are comfortable taking the risk in the first place, we should be better positioned to not panic and lock in losses during downturns, but rather be positioned proactively to take advantage of those downturns. Because if you can move to more aggressive strategies during the bottom of a market or add more money as prices are on sale, then long term you should have more potential benefit and you don't necessarily have to take more risk along the way. So the question of how much risk should we take?

That's a very individual kind of question. There's rules of thumb. You know, as you get closer to retirement, you should likely be taking less risk. As a 30 year old investor, you know, you can sort of swing for the fences and shoot for the stars. But as a 60 year old investor kind of on the verge of beginning to make withdrawals and use your money, then you really shouldn't be taking nearly as much risk. Also, your wealth level, like the net worth, the amount that you have invested is another aspect that needs to go into that equation. If you've got two hundred thousand dollars as far as your net worth, you probably shouldn't be risking all of it or more than is appropriate to achieve certain goals.

But if you've got two million dollars, 20 million dollars, maybe, you know, at that point in time, we could be a little bit more risky. A lot of these old Wall Street rules of thumb, by the way, and in fact, the modern portfolio theory and the asset allocation model, all of these kind of rules were incepted when Main Street American individuals weren't really Wall Street investors. That didn't happen until the inception of the 401k and ERISA that Main Street Americans became Wall Street investors. Those kind of rules of thumb and the old traditional rules were really set up for institutional investing.

Pension funds, ultra wealthy individuals, corporations that were investing their money were the ones that were to follow these rules and they somehow were transposed onto us as individuals when us as individuals really can't afford to, in most cases, take the same kind of risk as institutional investors or ultra wealthy investors who were the traditional Wall Street investors before the inception of the 401k. So, again, you know, if we're kind of looking in general how much risk we should take, A, it is individual, B, it changes over the course of our life, our life cycle. We could take a general rule of thumb. The rule of 100 says whatever your age is, that's the percentage of your portfolio roughly that should be safe. 100 minus your age is the percentage of your portfolio roughly that should be at risk. But, again, that's not hard and fast. That is not a strict rule. That is a very generalized rule of thumb and maybe a starting point for that conversation.

And it's really different for each and every individual based on their situation. 919-300-5886 is the number to talk to Peter Rochon directly about your personal financial situation. It's interesting and one of the smartest that you said a lot of smart stuff. One of the smartest things that you said is that you have follow up conversations. That's why it's so important to have a relationship with a financial planner that not only knows your financial situation, the dollars and cents, but knows you. Because I would imagine that all the conversations you have, there's the amount of risk that someone thinks they can stomach. And then after working with them a while, it's the amount of risk they can actually stomach, right? Yeah.

And we're trying to, as best as possible, set that up on the front end, right? And be prepared for that and discuss expectations for return and time horizon and willingness to accept losses and fluctuations along the way so that we can be properly positioned. But everybody is a risky investor when the market's heading up. It's not until the market starts to go down that we really find out what somebody's true risk tolerance is. Because somebody who has said, oh, yeah, I'm a pretty moderately aggressive or aggressive investor, and then the market loses 10 to 15 percent and they're worried and panicked about it.

Well, that's not truly a moderately aggressive to aggressive investor. If that has you worried, then we really need to back up, kind of regroup and assess that risk tolerance. You know, I view it that there's maybe five criteria there, five categories for how risky somebody is or risk adverse somebody is. There's ultra conservative, not willing to accept any losses whatsoever.

There is conservative to moderately conservative. I sort of group that in one, willing to accept a very, very small incremental amount of losses. But really, any dollars evaporating and disappearing without them having withdrawn it does raise concerns. And in the red zone of retirement, really, I don't think that you should be positioned to where you have the potential to lose any more than about five to 10 percent of your portfolio value or your net worth, or at least the dollars that are going to be responsible for generating income for you within the next five years or so. And that's really how I try to set up the portfolio is to time optimize it, even if we are maybe a more aggressive type of investor. Well, we don't want to be aggressive with all the money. We want some money that is safe and absolutely liquid, some bank money, some money that is responsible for generating income if we're going to have that need in the short term. And then maybe we could be, once we've got those first two buckets in place, more aggressive with the long term growth money that we're not planning on using for 10 years or more. But so ultra conservative, conservative, moderate, aggressive is willing to take on the risk of the market and then speculative is really willing to accept even greater losses than the market.

I don't have many of those kind of clients, but anywhere in the spectrum of conservative to aggressive, we try to match up portfolios that meet that individual client's acceptance of risk and then monitor them along the way to make sure that we are honed in on that and do at least an annual review of progress to continue to make sure that the portfolio allocations are in alignment with the risk tolerance. And if we've seen a couple of jitters in the market, if we've seen some downturns, we talk those through and say, hey, this is a reality of the market. It does happen. It has happened. It will happen again. How comfortable are we with the reflection of those losses being shown in the portfolio? You know, we're shooting for gains and growth here.

We'd like to see that happen consistently every year, but that's just not a realistic expectation. Over time, we should see gains and growth because the market not only has always come back, it has always surpassed previous highs. It has gone up over time, not every time, right? There are times when the market is down and we need to be prepared for those down times when we set up the initial allocation so that it does not come as a shock and so that it does not disrupt the plan. Because during those down times, if we are properly positioned, we can actually take advantage of them. There are several ways that we can take advantage of downturns in the market, actually. So that would be maybe the upside of risk is that you can take advantage of downturns in the market. Now, there's also downsides to risk, of course, and I guess there's a bunch of ways to look at it.

I'm going to present two scenarios to you, and I think we both heard them both. The market's going up, so conditions are good, and it's going to keep going up. Or the market's going up, then we're due for a downturn. Both of those things can be true, right? Absolutely.

They can be true simultaneously. We can be enjoying the upswing, but we also, again, need to be aware and cognizant of the reality that the market will, at some point, turn around and have a downturn. And we're really overdue. We have not seen a regular kind of economic cycle in quite some time. And going back to a previous comment, a lot of that has been due to the fact that the government and the Fed's new approach to economic volatility and speed bumps is to throw money at it. I mean, you know, during the midst of COVID, they were sending checks to the mailbox of every American.

That was not only bipartisanly supported, which is a rarity, but widely popular with the American public. And as a result, we bounced back from that COVID downturn in miraculous times. So that's probably the new go-to play in the playbook is, oh, economic troubles and hardships.

Throw money at it. Just send money out to the American public. But if you remember, the last time around, the Great Recession, there was equal stimulus in the form of quantitative easing. There were several different rounds of quantitative easing, and there was stimulus thrown out. Except it wasn't thrown out to the American public. It was thrown out to the banks and the financial institutions, not so wildly popular.

So it was a similar approach. Economic trouble. Throw money at it. And it dug us out of it. We recovered from the Great Recession, just like we recovered from COVID. But they did alter the play a little bit and pivoted from throwing money at the financial institutions to, well, how about we just send money out back to the American public? The problem is that, you know, that money comes from somewhere and it comes from a couple of different places.

A, they collect it in taxes or B, they create it. And more than 20 percent of the dollars that are currently in circulation have been created since the onset of COVID, which means that the dollars that were in existence before COVID have been watered down in value by about 25 percent. So we're seeing this 7 percent or 8 percent inflation that is advertised, and I worry that just based on the math of holding the value but increasing the dollar supply in circulation, we're really only seeing so far maybe, maybe about half of the inflation that is rightfully due, that we would expect to see when the money supply is increased like that. So again, you know, I think that there are some answers that the government has come up with, some approaches to economic headwinds and challenges. But yeah, there's an upside, there's a downside to everything, including in our personal investments taking risk. Now, I mentioned there were a couple ways to take advantages of downturns. One, put more money in, you know, investing in a downturn as long as we don't stop our progress. Like if we've got our paycheck that's taking care of our standard of living and we have been participating in a 401k, I've heard some people say, oh, well, the market's down, I'm going to stop contributions to my 401k. No, don't do that.

That's absolutely the worst thing that you can do. Keep contributing because you're buying some of the cheapest shares that you're going to buy over your lifetime during that downturn. Rebalancing during a downturn is a fantastic opportunity to, again, kind of shift just the existing dollars that are in your portfolio, but take advantage of those lower prices. And then we also have the opportunity for doing some tax damage control, some tax planning proactively. I'd rather have $100,000 in my account, but let's say that that's a traditional tax deferred IRA.

At some point in time, taxes are due on that. So if the market has taken a downturn and my $100,000 becomes $80,000 or $75,000, yes, of course, I'd rather have the $100,000, but I'd rather pay tax on the $75,000. So Roth conversions are another great opportunity if you're properly positioned that you can take advantage of during market downturns. And then everybody really should take the opportunity to really take a step back and reassess their risk tolerance. The market has come a long way, but the market has changed and evolved. Economic conditions have changed and evolved, and our own life situation changes and evolves over time. So we probably do not have the same risk tolerance that we had five years ago or ten years ago. Those have changed, and we need to make sure that our plan reflects that.

Mr. Arshad is the expert here, but if I could impart one thing to you, speak to a financial advisor. That's kind of the summary of this whole thing because they're tuned in, especially when times are hard or difficult or volatile. It's easy to turn off the news. It's easy to kind of tune out because it's hard to hear these things. And someone, a professional financial advisor like Peter Rochon, his job is to not tune out.

It's maybe tune in even a little harder when things are volatile. And only take risks you can afford. Carefully examine your willingness, work with a financial advisor, and examine your ability to incur losses and maintain your lifestyle.

It's your life, it's your money, and you have people that depend on you. And it's just a wonderful thing to have someone in your corner like Peter Rochon. And if you want him in your corner, give him a call, 919-300-5886, or go to his website, www.richonplanning.com.

Peter, any final thoughts today as we wrap up? Well, as we have gone through the first quarter of 2022, we've seen this volatility. We've talked to a number of new proactive savers, investors, those that are interested in making sure that their money is working for them. And we've done a lot of those optimized retirement plans. It's a great tool, ladies and gentlemen, and it's done through the appointment process through a conversation. But it looks at a high level, at your comprehensive plan, it looks at the income, the investments, the taxes, health care, legacy.

Make sure all of those things, plus the subcategories that fall underneath them, are addressed. That you know where you stand, you know what your approach to the various risks that we may face are. Really sheds a lot of light on your situation, and that is a complementary service.

It's not an overly complicated 1,000-page binder, it's about 10 to 13 pages. But it really will shed a lot of light on your situation. And make sure that your assets are aligned with your goals, your objectives, your risk tolerance, and what you expect your money to be doing for you into the future. Well, thanks so much for the good advice. We all appreciate it, all the listeners appreciate it as well. If you want to talk to Peter Rishon himself, 919-300-5886, or go to www.richonplanning.com, richonplanning.com. And Peter, thanks so much for your help. Always a pleasure, Scott, we appreciate the conversation and the time. Thank you for being here and hosting the program. Ladies and gentlemen, look forward to speaking with you soon, or hopefully you tune in again next week to more Planning Matters Radio.

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