Investments

Things to Know Before Building Your Portfolio

July 30, 2019

Things to Know Before Building Your Portfolio with Brad Kasper

Financial Scams Targeting Seniors

Things to Know Before Building Your Portfolio Show Notes

In our previous podcast episode, Certified Financial Planners Bud Kasper, Jason Newcomer and I discussed the differences between ETFs and mutual funds to help you truly understand which product is best for your portfolio. If you haven’t listened to Part 1 yet, please click here to listen it before this episode.

Today, we continue our deep dive into this topic. You’ll learn how to decipher the differences between the many different options, the tax efficiency of both mutual funds and ETFs, and why a comprehensive financial plan is so critical to choosing the right product to meet your needs.

In this podcast interview, you’ll learn:

  • How to assess risk when looking at mutual funds – and why mutual funds can carry greater risk when they appear to deliver the same returns.
  • Why prospectuses are usually full of outdated data by the time you receive them – and the reason it’s so important to educate yourself about the funds you own.
  • How Bud talks to clients about risk – and why it’s so important to talk in terms of dollars, not percentages, to think about how you might react to a major financial loss.
  • What you need to do when adding a mutual fund or an ETF to a taxable account to calculate capital gains risk.

Inspiring Quote

    • “Even though the results could be the same, living through the experience can be quite different.”
      Bud Kasper
    • “You can’t advise someone without going through a full-blown financial plan.”
      Dean Barber

Interview Resources

Interview Transcript

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[INTRODUCTION]

[00:00:11] Dean: As always, thank you for listening to the Guided Retirement Show. I’m Dean Barber, founder and CEO of Barber Financial Group. I know there are thousands of podcasts out there. I appreciate you choosing to listen to the Guided Retirement Show. In this episode, we continue our discussion with Brad Kasper, President of LSA Portfolio Analytics, taking a deeper dive with his degree in economics, into investment theory, economic theory, and things that you really need to know and understand before you go to build your own personal portfolio.

[INTERVIEW]

[00:00:42] Dean: So, we’re back with Brad Kasper. He’s the President and Chief Financial Officer of LSA Portfolio Analytics. It is a company that is designed to provide advice for portfolio construction for over 440 advisors all across the country. They influence about $8.5 billion in assets. Brad’s a graduate of the University of Maryland with a background in economics. So, Brad, in our last episode we talked about some basics, understanding valuations, understanding where you are in your lifecycle and how that relates to risk and here on the Guided Retirement Show, we ended the last episode with me telling you so, look, if you’re going to take this trip and I consider retirement to be a long trip. It’s a long journey which I believe people really need a guide to help them through all of the different ins and outs.

And we talk about not just things that surround investments in finance and your money, but we talk about your taxes and your risk management, your estate plan, and there’s all kinds of different things you need to address. And that’s why you really need a guide, someone to help you to make all the right decisions. So, I told you I had a story about making sure that you had the right guide so that you had the right experience. Well, my mom has wanted to travel to Europe her entire life and my mom and dad divorced. My dad passed away. So, my mom is single and at the age of 70, my brothers and I decide, “Well, we’re going to give her a gift and that gift is going to be a trip to Europe.” And so, we all chip in some money and we say, “Here’s what your budget is,” and we give her some travel agents and some things that she should use, maybe here are some groups that do European trips.

[00:02:39] Dean: And so, she looks at the amount of money we give her and she says, “You know what, I could hire a travel agent, I go with the group, and I can be on for two weeks or I can do this all on my own and I can travel for a month.” So, she decides at 70 years old and you got to picture my mom. She’s 5 foot nothing, weighs maybe 105 pounds soaking wet, little lady, and she decides she’s going to book her own European vacation and she’s going to be gone for a month. Everything was wonderful in Ireland. It was amazing in Scotland. She hops on a train outside of Scotland and there was a Scottish gentleman there and he helped her with her bags and he says, “Hey, you’re headed to Leads, London. Don’t expect people to be nearly as nice to you in London as they are here in Scotland,” and she is like, “Well, I don’t know what he meant but I got off the train in London or in Leads,” and so she gets off the train. Nobody there to help her. People just kind of walking all around her.

She goes out, finds a cab. She purposely booked the hotel that was about a mile from the train station. She gets in this cab, tells the cabbie where she wants to go. About 45 minutes later, she finally shows up at the hotel which was a mile from the train station. So, this cabbie took her on a really long ride and wants to charge her this huge fare for the cab ride. She argues with the cabbie, says, “No, I’m not going to pay. It’s not my fault. You took me on a ride. You got lost. Whatever happened, I don’t know, but I’m not paying that much,” and that argument ensued, and she winds up paying about half of what the cabbie wanted. She walks into the hotel and there’s a Muslim gentleman behind the counter at the hotel and she goes to check-in and the gentleman says, “Where’s your man?” and she said, “There’s no man. It’s just me,” and he tells her, “You can’t stay in this hotel unless you have a man,” and she’s like, “You got to be kidding me.” He says, “No. No women in this hotel unless they have a man.”

[00:04:42] Dean: What she didn’t realize was that she had booked a hotel in a part of England here that was majority Muslim community and it’s a place where you really don’t want to go. So, she says, “All right. Well, I need to hook up to your Wi-Fi then so that I can find another hotel to stay on.” And he tells her, “You cannot hook up to our Wi-Fi unless you pay for a night’s rate in the hotel,” and so she hands him her credit card and he says, “No. Cash only.” Well, because of the cab ride, she didn’t have enough cash to pay for it and she says, “Well, do you have an ATM?” “No, I don’t have an ATM.” “Well, where can I go to get an ATM?” All right. So, here she is 70 years old. She’s a part of London that she shouldn’t be in, okay, and so she’s really kind of stuck here.

She walks outside to go follow directions that he told her to go get to the ATM. She walks outside and it starts pouring down rain. By the time she gets to the ATM, gets the cash, she realizes that she really has now no idea where she is or how to get back to the hotel. And so, she goes to a bus stop and asked the bus, “Can you take me to this hotel?” and the bus goes, “No, we don’t go that way. If you walk up the hill this way, take a left. Go up to another hill, there’s another bus stop up there that will get you there.” Long story short, she winds up getting back to the hotel. She hooks up to Wi-Fi. She gets a new hotel booked. Walks out. Gets to another cab and the cabbie says, “Where’s your man?” and she’s like just, “I’m not talking to you. Just take me where I want to go.” And so, the reason I tell that story is because I think it’s interesting. My mom decides that she’s going to take this amazing trip. It’s going to be the trip of a lifetime.

[00:06:40] Dean: And this one incident in this trip wasn’t really her fault. I mean, she didn’t know what she didn’t know. And so, the reason why I think you and I are going to talk about today when it comes to the investment part of a person’s retirement throughout their whole retirement lifetime and the reason why I think our guided retirement system is so critical is because had she had that guide, had she had even used a trip planner or someone who knew the right areas to be in or the areas to avoid, it would’ve totally changed her experience. This is why people need professional help. This is why people need professional guidance when it comes to their underlying investments. I told you it was a great story. It’s a crazy thing, but it really sets the example here, Brad, of why I think it’s critical that people not think, “Well, if I just do this investing on my own, I can do it a little bit cheaper.”

[00:07:42] Brad: Well, don’t leave listeners hanging. Please tell us she got home safe and has recovered comfortably from the Great European Vacation. Well, I think I saw that movie once,

[00:07:51] Dean: Yeah. Well, the interesting thing was every night she would get back to the hotel that she was staying at and she’d write a long email kind of an outline of what she went through for the day. Oh my God, when she wrote that email about what happened that day, I was dying. I was just like, “You got to be kidding me.” Well, it turned out great. I mean the hotel she wound up in, the new hotel was a great hotel. It happened to be right across the street from some big event that was taking place the next day, so she got to experience some things that she never would’ve gotten to experience had that not happen. But, yeah, she made it back, but I promise you that when she took her trip to the Holy Land a couple of years later, she did with a group, with a guide.

[00:08:34] Brad: Learned her lesson.

[00:08:35] Dean: Yes, it was a little more expensive, but it actually helped her experience.

[00:08:38] Brad: Yeah. I think the same can be said for investing. There’s times in market cycles where it seems like we can step into this investment universe and do anything that the experts out there are doing. We can pick stocks and have success. We can figure out how to diversify a portfolio and the reality is there’s a lot of great research. There’s a lot of things that you can do on your own, but the question that always pops in my mind is what happens when the unknown pops up. How do you react to it? And I think it’s often I’m going to say it’s more of an overreaction that takes place than how they react and that’s what I often see as some of the biggest pitfalls of individual investors. They have this vision just like your mom did. I’m going on this European trip. I had this vision of what I want this to be. Something disrupts that vision. How do you respond to it? And it’s often that response that I think derails a lot of investors as they try to do it on their own.

[00:09:40] Dean: Well, I agree with you, and so we talked in our last episode about how people can quantify what risk they have in the underlying investments. We spent an awful lot of time talking about how does a person value a company. We compared it to how you value real estate, but there’s been some pretty smart mathematicians out there, some Nobel Prize winners, modern portfolio theory Harry Markowitz, and the Gaussian mathematics model and some others. I want you to explain a little bit about what high level, what do these mathematicians do. How did they come up with their theories and have any of them said, “Mine’s always right,” or have they said, “Mine has room for errors?” What’s the story here?

[00:10:30] Brad: So, let’s take a step back first since it goes back to what I’m hoping every investor got from the first segment that we did and that is when we’re investing, we have to start with what’s our goal and once I understand what that goal is, that helps me understand what type of statistics are more meaningful to me. As an example, if my primary goal of investing I’ve worked really hard, raised $10 million. I live off of $100,000 a year. That’s what I need to exist in and maintain the likelihood that I’ve established for myself and my family throughout retirement. Well, $10 million, what’s your biggest disruptor to that financial plan? And it’s the unknown to the downside.

So, in this example, this is an investor that needs to be primarily focused on the preservation of principal. They’ve done it. The only thing that can goof that investor up is if all of a sudden, they invested in a cycle where they captured way too much drawdown. So, if that’s where my mind goes, I need to be more defensive in this portfolio. I need to be looking at statistics that help me understand the behavior of my strategy in different types of market cycles, and more specifically, in this instance, how does it behave in a down market movement.

[00:11:47] Dean: Because that’s really people’s biggest fear is if they get caught in a down market cycle, especially close to retirement or in retirement that is going to ruin everything that they wanted to do.

[00:11:57] Brad: Yeah. That’s right. And so, let’s go through a little bit of history here. For the longest amount of time, this industry has used predominantly what’s called Modern Portfolio Theory. MPT is what we reference it as and this is the business of acronyms that will make everybody’s heads spin.

[00:12:15] Dean: Not quite as many acronyms as the government.

[00:12:17] Brad: Yeah. That’s true. So, MPT, what did MPT give us? It gave us the ability to step in and see over longer periods of time how did investment do in averaging returns. What was the standard deviation of that portfolio?

[00:12:30] Dean: What is standard deviation?

[00:12:31] Brad: It’s a measurement of risk. Okay. So, if I had an investment that had a 7% average in return, and let’s say a 7% standard deviation, what that tells me is 95% of the time I’m going to see a return pattern that translates to either positive 14% or 0%. If we want to take that to standard deviations out…

[00:12:56] Dean: So, you would deviate seven from the seven.

[00:13:02] Brad: That’s right.

[00:13:02] Dean: Either plus or minus. That’s where you get your 0 to 14.

[00:13:04] Brad: That’s right. So, I have an average return and this is what all MPT was built around is looking at these averages and understanding as much data that we can derive from it, the betas, which measures volatility, the alphas, which measures risk-adjusted for the amount excess return adjusted for risk within a portfolio. All of these are meaningful statistics but what should I stay focused on? If I’m a defensive investor, okay, and I find an investment that has a really nice average annual return, let’s take the S&P 500 over the last 10 years, which has been very much a beta rally type of return pattern and I say, “Gosh, I want that average return of the S&P 500,” but it carries a high standard deviation. Again, go back to my initial onset here was if loss is what I’m trying to avoid, I don’t necessarily need to see the averaging return in this research. I need to understand the risk. What is the max exposure to the downside that this investment is bringing to the equation here? So, I would stay focused on more statistics like standard deviations.

[00:14:13] Dean: And so, is that what modern portfolio theory did or was modern portfolio theory more designed around the combination of different asset classes within a portfolio?

[00:14:24] Brad: Modern portfolio theory is really just a mathematical way of calculating risk in different types of risk statistics within any type of investment that’s out there. And so, let me give you another example here and this is deviating slightly for just a second but bear with me. A lot of people what I see that do it themselves they take every investment that they want to review and they compare it to what?

[00:14:48] Dean: The S&P.

[00:14:50] Brad: The S&P 500. We try to establish in that first episode that the S&P 500 has zero relevance on retirement success.

[00:14:59] Dean: It’s not a relevant benchmark, really.

[00:15:01] Brad: It’s not. It’s an all-equity stock portfolio.

[00:15:05] Dean: We really try to think of it as your own. You should establish your own benchmark and the only way you can establish that own benchmark is to share with your financial planner what it is that you’re trying to accomplish over your life, what your spending needs are, what your goals are, what your legacy goals are, and what resources you have and then that financial advisor should then try to develop that portfolio because that’s going to identify what we call your retirement index. So, the index, your personal retirement index, what does your money need to do in order for you to do everything you want? That’s really the only index I think people should be measuring against.

[00:15:42] Brad: I couldn’t agree more. And so, let’s go back to what that initial statement is, is if I’m trying to build a well-diversified portfolio, yet I’m grabbing all these wonderful statistics that were developed through modern portfolio theory to understand how much return, how much risk, how much volatility, and how much excess return over time. The first question is relative to what. So, we have to understand the benchmark of the investment that we’re comparing it against and then, two, I have to understand how to combine these various investments and asset classes appropriately. That is probably one of the most challenging tasks of I think most of the do-it-yourself investors that I find out there and why? So, let’s go into a primary example of where this happens time and time again. Most of the listeners of this will have some type of a 401(k) that they invest in, right?

[00:16:35] Dean: Sure.

[00:16:35] Brad: And if I look under the hood of that 401(k) that has a menu of investment options that are available to them and all of a sudden, so we’ve been trained. The industry has trained us to think that diversity matters and a lot of times we equate diversity to just holding multiple positions or different names. Well, if all those names you see this over and over again in 401(k) area are in the same asset class but I’m carrying three of them, am I really getting the diversity? Do I understand the difference of the types of investments that I’m trying to pair together appropriately within a portfolio? And so, my best example is, I’ll give you an example, I saw a 401(k). There were six US equity stock types of funds inside of it. Five of the six were all large-cap stocks. Three of the six were all large-cap blendstocks that looked just like the S&P 500.

And so, if I’m the investor stepping in here and I just use the simple premise of saying, “Hey, diversification makes sense. Don’t put all your eggs in one basket,” and I buy those three large-cap blend S&P 500-like funds.

[00:17:46] Dean: It’s really like you have one position.

[00:17:48] Brad: Do I have anything that’s providing a level of protection?

[00:17:51] Dean: No.

[00:17:52] Brad: So, I could screen each one of those positions for alpha-beta standard deviation and potentially come to the conclusion that, yes, these are all strong investments. What I wasn’t able to do was put those three positions together in a combined portfolio and understand that collectively, I don’t have a differentiator so I’m experiencing every bit of that exposure to the downside. And I get that that’s probably a complicated analogy to try to utilize here for some listeners, but it’s a mistake that I see time and time again. Multiple names do not equate diversification. Diversification and the tools that we utilize combines multiple asset classes and then it starts to establish an understanding of in a market movement, how did these players perform together.

[00:18:42] Dean: So, let’s use an example here, Brad. Let’s say that you had Apple was one of your players. We’ll use individual companies so people can relate to that a little bit easier. I think Apple is one of your companies. You got Amazon as another company and then you got Microsoft. Well, if that’s your diversification, you’re 100% technology, large-cap technology companies, right?

[00:19:07] Brad: That’s right.

[00:19:08] Dean: Now, if I were to bring in a Bank of America, a Procter & Gamble, something along those lines, those are larger value-based companies, different business models, different growth engines, different things that are going to make those companies work versus an Apple and Amazon and a Microsoft. So, if you owned the three tech companies and then you owned the Bank of America and the Procter & Gamble and maybe another large bank, you now get some value entities and those six stocks three of them are going to act the same as the others as themselves and another three can act differently. You got some differentiation there.

[00:19:48] Brad: Yeah. I think that’s a perfect example. And if you want to do it even simpler, we could step into a scenario where let’s use Kansas City Chiefs. We just drafted Patrick Mahomes a couple of years ago. Patrick Mahomes…

[00:20:00] Dean: What a stud.

[00:20:01] Brad: Yeah. Probably one of the best quarterbacks in the league, and hopefully, he stays that way over the next couple of years. But if the Kansas City Chiefs were to draft an entire team of Patrick Mahomes, how good is our team going to be? Are you telling me that he’s the best positional player for every defensive position that we need to stop some of these great offenses? And it’s the same thing with investing. You talked about investing in technology types of names and, yes, net over time, again, this circles back to your goals. If you want that type of exposure, you can handle that type of risk that comes with a growth category, the technology space, then over time, you’ve been rewarded with pretty decent returns. But what did you have to stomach? If you thought 50+ percent drawdowns in 2000, 2001, 2002 or 2008 were bad for the S&P 500 going to the technology category, especially in the late 90s going into 2000s.

[00:20:55] Dean: Yeah. 80% drawdown.

[00:20:56] Brad: 80% drawdowns. And so, again this comes back to if I’m that $10 million investor that we started with and my biggest disruption is to the downside, yet I carry five different large-cap technology names that are cut from a similar cloth of Apple and I go through a 2000, 2001, 2002 timeframe, my worst-case scenario just happened because now my $10 million off 80%…

[00:21:23] Dean: 2 million.

[00:21:24] Brad: $2 million.

[00:21:25] Dean: That’s a disrupter.

[00:21:26] Brad: Now, $100,000 distribution a month for the rest of your life comes into question.

[00:21:30] Dean: So, how does modern portfolio theory help a person understand that and how does the individual capture that modern portfolio theory? And I guess, is it even relevant?

[00:21:43] Brad: I think, first of all, as a student of research, I think any research is relevant, but you have to break this down into two different themes here because you’re talking about examining a massive universe. I mean, in the mutual fund space as an example, there’s over 30,000 mutual funds that are readily available and a lot of these open architecture custodial platforms. How do I as an investor identify 10, 15 names that are most meaningful for me? So, MPT plays a huge role in helping me start with a big list and dwindle it down to a smaller list of the types of investments and the types of statistics that are appropriate for a solution that I might…

[00:22:24] Dean: Right, but you’ve got a degree in economics. You’re in the weeds in this stuff every single day. How in the world can an individual investor that says I’m going to do this on my own, how do they understand this? Because I think the biggest problem with the person trying to do their investing on their own is a lot like my mom, you know, taking that trip to Europe. You don’t know what you don’t know, and you don’t know what risk you really hold that can really derail your entire retirement.

[00:22:55] Brad: Now, see, going back, even if you did have the tool to be able to dwindle that name down, you saw the second phase of that, right? You saw you have to blend those together to make a meaningful portfolio. And so, I would argue that for the average investor out there, there are a number of hurdles that are challenging for them to be able to properly vet the names they’re using and properly vet how to pair them together. That’s what we spent day in and day out doing. That’s our wheelhouse and we use a number of different systems, the Zephyrs of the world, the MPIs, white charts, you name it. The Morningstars, Lippers, the original Thomsons, these are all software systems that we tie into to access data so that we can dissect these names 100 different ways and compare them from the individual investment level all the way down to the fund level.

[00:23:45] Dean: Which is why you have 440 independent advisors around the country that subscribe to your research and your portfolio construction influencing over $8.3 billion or $8.5 billion in assets.

[00:24:01] Brad: Well, not only that. We have multiple analysts, right? I mean, this is a full-time job and what I think a lot of people have come to the conclusion of is are there simple strategies that I can step into? And the answer is yes. Am I really getting the max out at that? I don’t see it. The ability to do what we do on an ongoing basis I find a ton of value and I think a lot of investors would as well because the ability to do this on your own is extremely challenging.

[00:24:35] Dean: Okay. Let’s take a quick break. This is the Guided Retirement Show. I’m Dean Barber. We’ll be right back.

[ANNOUNCEMENT]

[00:24:41] Female: Thank you for joining us on the Guided Retirement Show with Dean Barber. We hope you are enjoying our show. If you’d like more information on what Dean is discussing on this episode, make sure to visit us at GuidedRetirementShow.com/11 and then make sure to subscribe so you can stay up to date with our latest episodes. Know of someone who could benefit from learning more about their retirement? Go ahead, share us with a friend. That’s the GuidedRetirementShow.com/11.

[00:25:17] Dean: Had she had even used a trip planner or someone who knew the right areas to be in or the areas to avoid, it would’ve totally changed her experience. This is why people need professional help. This is why people need professional guidance when it comes to their underlying investments.

[INTERVIEW]

[00:26:04] Dean: Welcome back to our program. I’m Dean Barber. Look, you’re going to hear it everywhere. You can be passive. All you got to do is go out and buy a couple of index funds, put 60% of your money in the S&P 500, put 40% of your money in the bond ag and just let it go. Just don’t even think about it. Don’t open your statements, don’t look at it. Over time everything is going to be just fine.

[00:26:26] Brad: And you’ll get what? Average. Okay. And so, if you’re looking to separate yourself from average then that’s where I think some of the additional analysis helps out. And more importantly, again, a 60/40 it still circles back to the original premise. If that 60/40 portfolio creates a lag when the S&P 500 is screaming up and the optics of the average investor out there is saying, “I am missing out and it’s going to cause you to capitulate,” that’s a problem. Again, you didn’t start with, “What is my goal? What is my portfolio built to do?” If that 60/40 all of a sudden in a down market has you overexposed to greater drawdown than what you expected in a down market movement, again, what happens, that fear trade kicks in, you capitulate at the wrong times. And so, for some, that might be the solution but only if you start with what was my original goal and are you comfortable with being the average of the markets?

We pride ourselves on our ability and our ongoing efforts to try to provide performance above the averages or at least compete with the averages over time. That’s the value add. Investing is really the art of getting compensated for the value that you can bring to the table. And so, if you’re really doing the screens and constructing solid portfolios, then I think that there’s a value proposition that exists there and that’s the name of investments.

[00:27:55] Dean: So, then is that what an investor should measure a relationship with their financial advisor on?

[00:28:03] Brad: Not solely. So, I think there’s two segments there. If the advisor is solely positioning themselves as the investment professional and they haven’t done a full financial plan then absolutely. Walk in. I mean, this is what you’re paying them for, right? Advisors are going to charge some type of a fee associated with it and if I’m going to step in and position myself as the investment-only professional, then absolutely. I think that that should be held to their standard.

[00:28:32] Dean: But, Brad, I think that sometimes different styles of investing can go through cycles where they may not appear as good as others where for short period of time that value may not be able to be demonstrated. Let me give a perfect example. We’ve been in a period where since the end of the great recession had you just had large-company stocks, specifically, large-company technology stocks, you would have just killed every single active manager out there. Every single manager that’s purporting to be able to do what you’re talking about in that period, those active managers they wouldn’t have been able to provide any alpha as you call it, or any outperformance.

Now, is their risk different? Absolutely. But in a market where everything is moving up and you got these massive forces pushing certain sectors so far out of the realm of what is reality, I think it’s easy for an investor to step back and judge in a short period of time that you’re not doing what you should do and I don’t think that’s fair because we talked about early on in our very first episode that we did that when you’re building a portfolio for retirement, it’s a portfolio that’s designed for the rest your life. This is a 20-, a 25-, a 30-year cycle and, yes, that portfolio that you’re designing is what’s designed to give you the highest probability of being able to achieve all of your objectives over time, but there’s going to be pockets of time where that may not look good. And so, I don’t think it’s fair that the investor judges an economic cycle that doesn’t necessarily allow that strategy to look as good as another strategy over a short period of time.

[00:30:33] Brad: Yeah. So, my quick response is I agree wholeheartedly but you’re talking about an advisor that is approaching this as a planner first.

[00:30:44] Dean: And I don’t think you can invest without a plan. That’s my theory.

[00:30:47] Brad: So, the first camp that we just…

[00:30:49] Dean: Well, you can. I just don’t think you can do it effectively.

[00:30:51] Brad: Well, it used to be the primary focus. In the late 80s through the 90s it was my investments can outperform your investments. That was the primary role of what financial advisors were doing to try to gain assets. Well, step in today’s world. What really resonates and what makes the most difference is a financial plan and so I am separating the actual…

[00:31:14] Dean: Enter our guided retirement system. That’s why we have it.

[00:31:17] Brad: So, I’m separating the financial planners that are going to establish a goal with an investor and then we’re going to benchmark that appropriately. And so, to your point of the S&P 500, if I’m stepping into somebody that’s just purely focused on the investment side and I set an expectation of outperformance, then yes, you better be able to outperform. But if I’m working with that investor, the benchmark that I’m comparing it against should be one of the first conversations that I have because I can’t tell you how many calls we take on that says, “Brad, this moderate growth portfolio is not outpacing the S&P 500 in your five-year window, in your eight-year window.” Well, of course, it’s not. Bonds haven’t outperformed the S&P 500.

[00:32:01] Dean: Moderate growth isn’t 100% stock.

[00:32:02] Brad: Internationals haven’t outpaced large-cap growth names or large-cap blend names over the last five to eight years but they’re still relevant. Why? Because it goes back to the statistical conversation that we had earlier. Each one of those positions operate the ebb and flow slightly different from each other which means when we get these market moves, we don’t have the same types of participation. And so, does performance matter? It absolutely does, but it should be benchmarked appropriately and I think the conversation is that you brought up is always putting the thought that the S&P 500 was that mark of outperformance and if an investor comes in with that as a general premise, we didn’t do a good enough job of educating them on what the expectation is. Go to your 60/40. A 60/40 didn’t outpace the S&P 500 so it’s…

[00:32:54] Dean: Well, you could argue that, that a 60/40 portfolio outpaced the S&P 500 from January 2000 to January 2005, it sure did.

[00:33:03] Brad: Absolutely it did and why did that happen?

[00:33:05] Dean: Because the S&P 500 pure by itself got its butt kicked and you lost 47% of your money and so you are barely back to even.

[00:33:12] Brad: Right. We went through that’s called the last decade. 10 years of 0% growth on the S&P 500 while the bonds were the catalyst that was operating differently. This is the ebb and flow conversation.

[00:33:22] Dean: Right. But you get into these long cycles and then somebody’s going to pick out on CNBC or something else. They’re going to pick out a date. They’re going to say, “Well, from the market woe of March 9, 2009,” okay, if you are a genius and you had all your money in cash and you stuck everything in the market on March 9, 2009 maybe that’s your benchmark, but the reality is you probably had money invested in 2007, 2008. Let’s look at what did that 100% stock portfolio do from January 2007 to say January 2012 versus the 60/40. In that instance, the 60/40 outperformed but then we get into these periods of time where the markets are up, up, up, up, up and then all of a sudden this whole greed thing sits in with investors and they say, “Well, my 60/40 portfolio is not keeping up or my balance portfolio is not keeping up. Why can’t I keep up?” Well, if you want to keep up, you’re also going to keep up when the market falls and so that’s where I wanted to go back this whole modern portfolio theory, understand these risks.

And this whole idea that people can identify or say the probability of a return over any period of point in time using these formulas tells you what you could expect, but everybody ignores the downside. They don’t think about it and they focus on the subsite because they think that that’s what’s going to make them happy.

[00:34:42] Brad: So, there’s two topics that popped in my mind and obviously the further we go, the more my head starts spinning with things that I think are relevant for all investors to understand. One, if we go back to that analogy or that example where if I started my clock from the bottom right in 2009 and look forward that I would expect it to look pretty rosy. But man, anybody can cherry-pick. What good does that do? It doesn’t tell me what happened in worst-case scenarios.

[00:35:08] Dean: And who would’ve had the courage on March 9, 2009, to dump 100% of their money into the stock market?

[00:35:14] Brad: Oh, goodness. Nobody would’ve.

[00:35:16] Dean: I mean, that’s the whole point. So, the way that the financial media spins this stuff is maddening because that then sets an expectation for the investor that that’s what you should’ve done.

[00:35:28] Brad: Right. I agree. And so, let’s use the media here as an example. I remember it. March 2012, CNBC I’m watching and all of a sudden that starts flashing yellow or orange whatever bright color they could pull up for the day and why? What happened in March 2012? We hit new high watermarks on the S&P 500 and the Dow Jones industrial average. And so, I take a step back and here’s everybody excited. We hit new highs. What did that really translate into?

[00:35:59] Dean: We got back to where we were five years before.

[00:36:01] Brad: Five years ago. Five years of 0% growth and I think that’s what is often missed by investors. We get blinded by these optics. I want to talk about another point. Time matters in investing and we’re using examples of the S&P 500 over a five-year or 10-year window where US equity large-caps have just dominated and done a tremendous job. But you tell me, when you started in this business, what was the definition of long-term for you?

[00:36:32] Dean: Well, that’s been 32 years ago. You know, five to ten years was a long term at that point in time.

[00:36:39] Brad: Yeah. So, I think this is what is changing dramatically. If I really think about long-term, I’m looking at 25 to 30 years.

[00:36:48] Dean: Right. And that’s my perspective today, obviously, especially since I tell people not just get to but through retirement. It is a 25 or a 30-year timeframe.

[00:36:56] Brad: That’s right. I mean, we’re living longer. The expectancy in that retirement timeframe has expanded so I want to understand the characteristics and strategies as long-term as I can possibly do. But today, I think most investors view this in a one-year or a three-year. It’s the old Eddie Murphy’s stand up, “What have you done for me lately, Eddie?” type of conversation and that is actually maddening. Because again in the example that you just gave, we referenced the last decade. Well, that’s still within this 19-year window, right? And man, did that outperformance, did that protection of bonds make a difference between 2000 and 2010? Absolutely, it did.

[00:37:37] Dean: You were a total winner with a balanced portfolio and a more conservative investment from January 2000 to 2010. There’s no question.

[00:37:45] Brad: Right.

[00:37:45] Dean: Right? And yet that same strategy from January 2010 to today, you’re going to look at your advisor and say you’re an idiot because you didn’t keep up with the market, but that’s not fair.

[00:37:59] Brad: It’s not fair, but what did we miss out in that conversation was educating properly that said, here’s the benchmark of what’s meaningful to that investor. Again, we can run data statistics, everything, until we’re blue in the face. We can share with you great cryptocurrency ideas. We can do the cannabis name that constantly pops up in conversation now and it’s all speculation. Again, what is your primary objective? If we don’t establish that, everything else to me ends up being irrelevant.

[00:38:33] Dean: All right. So, this has been fascinating once again today. We’re going to continue to bring Brad Kasper. He is President, CEO of LSA Portfolio Analytics, also has his own FANN radio, the financial advisor news network. He’s going to be starting his own podcast here soon. His primary focus is educating financial advisors. You know, Brad, what we’ve done in these last two podcasts here I think give a basic framework for the investor to start to think about things in a broader scope, understanding that their expectations need to be in line with how their portfolio is designed, understanding how you can measure risk. We didn’t really get a chance in this podcast to go into this whole fat tail analysis or the probability of returns over time. I think that’s another entirely different podcast which we’ll bring out in season two of the Guided Retirement Show, but I would look forward to having that conversation.

[00:39:37] Brad: Well, I’ll just tease it with this. The evolution of math has changed dramatically in this industry over the last few years and when you start to see the big institutional players really drive all their risk models off of this type of a process, it begs the question why isn’t it finding its way to the retail side of things?

[00:39:57] Dean: And the retail side of things is down with the individual investors.

[00:39:59] Brad: Individual investors and that’s what I look forward to talking more about.

[CLOSING]

[00:40:03] Dean: Well, we’ll get that done but, as always, I want to remind everybody so when you start thinking about investing as part of your overall retirement plan, remember that you should never have a discussion about investment strategy, investment theory, investment process, any of that. That’s all the very last part of the discussion with the true financial planner who is actually doing the planning work first, because before that a financial planner can recommend the type of investment strategy that you should have, they have to understand everything about your life and what you want your life to look like. That’s why we created the guide retirement system. That’s why we’re doing the Guided Retirement Show to help make sure that your experience in retirement is better than my mother’s experience was in that first day in London on her European vacation. Brad, thanks so much for being here.

[00:40:54] Brad: Thanks for having me.

[00:40:55] Dean: Find links to this episode show notes and giveaways in the show description or visit us GuidedRetirementShow.com/11 and don’t forget to subscribe and get notified when we release our next episode.

[END]

Investment advisory service is offered through Barber Financial Group, an SEC-registered investment advisor.

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Investment advisory services offered through Barber Financial Group, Inc., an SEC Registered Investment Adviser.

The views expressed represent the opinion of Barber Financial Group an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Barber Financial Group does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.