Ep. 235 – The Art of a Risk-Adjusted Portfolio in Retirement

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In this Episode of the Secure Your Retirement Podcast, Radon and Murs discuss the art of building a risk-adjusted portfolio. When building a risk-adjusted portfolio, it’s important to identify your personal risk preference and choose the best model to structure your investment portfolio.

Listen in to learn the key differences between passive and active investment styles and the benefits of each in helping you reach your goals. You will also learn about the tactical and core investment strategies and how they considerably cut risk.

In this episode, find out:

• The two styles of investing – the key differences between the goals of passive and active investing.
• Understanding the tactical and core investment strategies and how they considerably cut risk.
• The elements of the moderate growth portfolio and how they reduce the effects of market volatility.
• The importance of having a conversation around risk with your financial advisor to identify where to be with risk exposure.

Tweetable Quotes:

• “Every strategy (passive and active investing) will have its years that it wins and every strategy will have its years that it loses against the other.”– Radon Stancil
• “The tactical is there to start reducing risk when we have heightened periods of volatility or deterioration in the market.”– Murs Tariq

Resources:

If you are in or nearing retirement and you want to gain clarity on what questions you should be asking, learn what the biggest retirement myths are, and identify what you can do to achieve peace of mind for your retirement, get started today by requesting our complimentary video course, Four Steps to Secure Your Retirement!

To access the course, simply visit POMWealth.net/podcast.

Here’s the full transcript:

Radon Stancil:	Welcome everyone to Secure Your Retirement. Murs and I are excited to talk to you today about the art of risk adjusted portfolios. So why do we need this? What’s it all about? Well, it really kind of comes down first and foremost that one of the conversations that we have with every person before we talk about how their money should be invested is their viewpoint of risk. And so today we’re going to talk about how we could design portfolios to try to match that. And again, I just want to say it upfront, this is our philosophy. We are never talking about things saying it’s the absolute right way to do it. That’s just the way we believe. This is what we think is the right way to set things up for us and our clients. And so we’ll talk it through. And the one thing that we talk about when we talk about risk is really from your approach of at what point on a downside, meaning the market’s pulling back, do you start to lose sleep at night?
	Right? So most people understand if I’m invested in the stock market, the stock market goes up, it goes down, bonds go up, bonds can go down. And if I look at this approach and say, “Well, at what point would I start to get nervous? At what point would I start to go, ‘I can’t handle this.'” So imagine that you had a million dollar portfolio, and I said to you, “How would you like it invested?” Many people would say, “Oh, you know what? Let’s be moderately conservative.” But if I said, “Okay, the moderately conservative portfolio could be down by 20 or 25%, 200 to $250,000.” Now the person says, “Wait a minute. That doesn’t make me comfortable.”
	Many people might say, “You know what? At around that 10% or $100,000 of loss, I start to get concerned and I definitely don’t want to see it down 250 to 300,000, or 25 to 30% down.” Now if you’re listening to this and go, “I’m fine with that, I understand that,” well then, okay. But most of our clients that are close to or already in retirement do not have that much threshold for having on a downside. And so what we say is let’s build a risk adjusted portfolio. Now Murs, could you just hit here for a second, the two styles of investing between active and passive?
Murs Tariq:	Yeah, sure. And so of the two styles of investing, passive management is probably one of the more common or the easier things to do in a lot of ways. 401ks promote passive investing because you’re just contributing into your account and you’re setting up what’s called an asset allocation typically, which is let’s buy a well-diversified portfolio, let’s put some money in large cap growth, mid cap, small cap, let’s get some international exposure, let’s get some commodity exposure and let’s fill up that whole pie with a bunch of different sections of what is available in the market.
	And then from time to time, you may rebalance that as it gets out of balance on a quarterly or an annual basis, but you’re not really trying to actively manage that, it’s very passive. Let’s continue to contribute to the account. We know that we are going to have some bad times in the market, but in the long run, we think the market is going to be okay, so let’s just buy a well-diversified portfolio and let that grow over time, that’s passive.
	And then active goes into the world, and there’s many, many strategies when it comes to being active. You could have active money managers that would consider themselves the best stock pickers and they just want to go find the best stocks and they want to actively move within the individual stock realm to try to outperform a certain type of benchmark. So that manager’s goal is to do better than say the S&P 500 or something like that. Oftentimes that’s going to be associated with a hedge fund. You can also have active management on the side of protecting against significant draw downs in the market. So when you have a pandemic type of scenario or a 2008 type of scenario, 2001 where the market fell significantly, that active manager could make some changes to the portfolio to go into safer places to reduce the volatility swings of that portfolio.
	So there’s clear differences. Active is really active with a goal of what do we want to try to achieve? Are we trying to get the best rate of return out there and take all the risks to get it and move around in the markets quite a bit? Or are we trying to reduce volatility? And so there’s goals there. Just like with passive, the passive goal is we don’t want to overthink, we just want to be invested. And we know that if we give it 30 years, it’s going to work out just fine.
	Now when it comes to our clientele, the phrase, “Let’s just give it 30 years, it will be just fine.” Well, if you’re working with someone that’s 55 plus approaching retirement and also they’re going to need those assets to start drawing on, sometimes that passive type of arrangement of a 30 year time horizon isn’t all that attractive anymore. While it worked very well when you’re in your 401k type of age and you were in your earlier stages, a lot of times we’re seeing this shift to where, “Hey, I want to start getting some risk mitigation or some risk adjustments in my portfolio.” So that’s the key difference between active and passive.
Radon Stancil:	And I think that one of the things that we have learned over the years is that it’s not as if passive is inferior to active, nor is active inferior to passive. And I always say this, every strategy will have its years that it wins, and every strategy will have its years that it loses, meaning it loses against the other. And so, one of the things that we have tried to construct in our portfolios is to have basically a part of the portfolio that we describe as tactical. When I say tactical means it could be risk on and risk off. And then another part of it that we call our core strategy, which means that it is always invested, but that what it is invested in can rotate throughout the year. Typically, that rotation is on a quarterly basis on that part of the portfolio.
	So now what we’ve got is we’ve got one part of the portfolio that’s a hundred percent invested all the time, but can rotate. And then we’ve got another part of the portfolio that could be 100% invested in equities and then it could go all the way to 100% to fixed income or fixed assets that are paying us just a decent rate of return but not related to the equity market. So think about where I’m at in that, I’m hedging my risk with the tactical and because I’m trying to say, “Look, the risk is high.” But then on the core strategy, what I’m saying is, “I need to always be invested even if the markets are volatile.” But I cut my risk considerably by doing those two things.
	So ultimately what we’ve tried to do is to split that up. So if you were in our growth portfolio, it’s super simple, it’s 50/50, 50% tactical, 50% core. But then as we try to get risk adjusted, we add even more layers. And so, Murs, could you walk us through what I think is our most popular portfolio, which is our moderate growth, and maybe explain why it’s the most popular.
Murs Tariq:	So moderate growth is going to have an equity element to it, just like Radon was talking about. And there’s already that equity element of the strategic core and our tactical, there’s already some risk adjusting that’s already happening. So for example, if we walk into a period of high volatility or we see deterioration in the market, like Radon said, the core is going to stay invested. And because on one side of the coin, we don’t want to try to outthink the markets. There’s plenty of data that says if you just stay invested, things will be okay over time, we fully agree with that. But the tactic is there to start reducing risk when we do have heightened periods of volatility or deterioration in the market. And so that is where we have the beginning of risk adjustment in the portfolio.
	So we’ve got a great market, just for example, you’ve got a great market, things start to fall apart. We’re all invested at one point, but then things start to fall apart. The tactical sleeve will start to reduce equity exposure and increased fixed asset exposure like government, treasuries, and obligations and things that are much less volatile for a period of time, not forever. They’ll go right back in when we get the green light. But then if we have someone that can’t handle even that amount of risk, we start to risk adjusting even further. And now we add in our next element. And a lot of you may be thinking, “Well, now it’s time to add in bonds because that’s just traditional thinking when it comes to portfolio construction. You could do equities first and then you add in bonds to reduce the risk.” Well, we actually take it in a different direction first, we go equities first, and if there’s not enough risk controls there, then instead of adding in bonds, we add in an alternative to bonds, which is called a structured note.
	Now, we’ve done a whole podcast on what a structured note is. The high level there is that it is an instrument that we buy from the bank because of our purchasing power with our clients. We can go to a bank and say, “We have a large amount of money that we would like to purchase a structured note from you.” We get to structure what the parameters of that note is and we say, “Here’s what we want.” And then we go shopping with all the major banks like JP Morgan, Chase, UBS, any large bank you can think of. We’re talking to them and saying, “What rate can you give us on that note?” And today, because of where interest rates are, we’re seeing notes in the realm of say, seven to 11% annualized so much better than a CD rate, much better than a money market rate.
	Is it no risk? No, there is a low risk to it just like with the bond side of the world as well. But what that does now is we have… I’ll give you some specific percentages now to help you understand what we’re looking at. Our moderate growth portfolio, the way it’s designed is 38% of it is going to be in the core sleeve, which is always invested, rotating based off of where we think the opportunity is in the equity market. Then we have our tactical sleeve also 38%. And that can go, like Radon said, risk on if everything’s great, we’re equity heavy, risk off if things start to deteriorate. So that’s one of our risk adjusters, 38% there. And then with the structured notes, we go up to 24% there.
	So now you’ve got even more of an element of balancing out volatility from the equity side because the structured notes will have some equity exposure, but they are really not tracking the stock market in general. So they reduce volatility. They bring in a coupon or interest into the account, typically on a monthly basis. And so they make the portfolio a lot smoother when we do have some of the ups and downs in the markets like we’re seeing today in 2023.
Radon Stancil:	And just to kind of walk you through what this looks like, every time we are now trying to say if we need to go even lower risk, now we have to bring it up to another notch where we’re going to again, reduce even more equity exposure and bring in some fixed income type instruments, bond like ETFs most of the time. So if you look at our moderately conservative, you’ve got now lower equity exposure, 30% core, 30% tactical, 24% is still over in the bank notes, but now we add 16% to fixed income. You see how now we’ve got 40% between fixed income and the bank notes that are not correlated to the stock market. And then if we want to go to our most conservative model, you’ve got 20% core, 20% tactical, still 24% bank notes. So the theme here is growth, moderate growth, moderately conservative and conservative, all hold 24% bank notes.
	But what changes now is that now 36% is going to the fixed income. So you see how that now even risks adjusted even more. So now, if I’ve got a client who says, “Hey, you know what? I don’t really think I want to have much on the downside, and I understand that I might not have as much on the upside, but I really want to have a good risk adjusted portfolio.” We’re able to really give them wherever they want to go in that area. So the whole goal here is to say, “Hey, look, I want to be able to grow the money, but I don’t want to have 100% risk of say the S&P 500. The S&P 500 by the way, max drawdown on the S&P 500, if you go look at it over the last 30 years is 58%.
	That’s my max drawdown from a top to a bottom. So if I had a million dollars, I’d be down $580,000. Now, maybe one day when you were younger and you were still funding, you might go, “While that was not fun, I am okay with it because I know I still had time. But if I am closer to retirement, I don’t want to see a 58% drawdown. And so I want to reduce those drawdown exposures.” And that max drawdown is really kind of based on your viewpoint of risk. So what you would do if you said, “Well, I don’t know which one of these models I should be in,” you would obviously have a conversation around risk. We have a specific process that we do that, we take you through a conversation, takes about 15 to 20 minutes, and it helps you to easily identify where you would be at when it comes to risk exposure.
	So if you’re listening to this and you’re thinking, “Hey, I’m just curious, what’s my risk profile?” You can go to the website, pomwealth.net, go to the top right-hand corner, click on schedule call. That will then put you on the calendar. Myself or Murs will get in touch with you and we’ll walk you through how that process works, and explain it to you in detail. Because we really want to make sure that you understand risk, understand your personal risk. Sometimes people put that on age, it is not based on age. That’s a rule of thumb. You want to know what your personal risk preference is and then live by that because that’s the way you’re going to be the happiest. That’s the way you’re going to have the best peace of mind. So we hope this is giving you a little bit of insight on how to structure portfolios and gives you a little bit of insight about how we do it. If you have questions, please reach out to us. But we hope you have a great week. We’ll talk to you again next Monday.