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Has Risk Changed?

Summary

We all know that you can barely get any interest, or return, on your savings account. The Fed is keeping the interest rate very low, which translates into low returns on savings and safe assets like money markets and government bonds. With so little return in the traditional fixed-income side of your portfolio, does that fundamentally change the way you should consider risk?

It used to be that you could get 4-5% interest on fairly safe investments like your savings account and money market accounts.  Therefore, to invest in more risky assets like an individual stock or the entire stock market, you would expect to get more than 5%. Seeking risk wasn’t the safe thing to do, avoiding it was. But now we’re in the opposite regime: you have to actively seek out risky investments in order to get a decent return.

It’s important to understand the associated risks of your investments. Make sure that you know what the range of future outcomes could be, and how that might affect your ability to reach your goals. Be confident with a plan on how you will proceed in any given market event.

Resources:

Photo by Loic Leray on Unsplash

Transcript

[00:00:00] Mike: Welcome to financial planning for entrepreneurs and tech professionals. I'm your host, Mike Morton certified financial planner and charter financial counselor today. Matt and I discussed the difference between risk and volatility, just because stocks go up and down doesn't necessarily mean that your portfolio is risky and that cash under your mattress.

That might be the most risk you're taking. Enjoy the show.  

[00:00:26] Matt: I Matt Robeson and I'm joined as always by Mike Morton, the guru of personal financial investing, Mike.

[00:00:34] Mike: I'm feeling really great now. Thanks Matt.  

[00:00:36] Matt: You are the group. You're the only one. Now you, run a really great business. You have a ton of clients and you focus on personal investing. You have a particular focus on entrepreneurs, high-tech professionals, but all of your advice obviously applies to just about anybody. So what are we talking about today?

What's on your mind.

[00:00:56] Mike: Today. I wanted to talk about risk taking risk, how to think about risk as it applies to portfolios and investments. And just how to view that in today's environment, because it's changed over the years, how risk is playing out and where we're putting our money and what the risks may be on those investments.

So the bottom line up front. Risk has fundamentally changed because of the Fed's policy, because we have such low interest rates these days. It used to be that you could invest your money into a savings account that savers. We're really rewarded because you could pretty easily get three, four, 5% on pretty safe, not taking too much risk in a savings account or money market accounts.

And so in order to invest in other areas, you needed to get a return more than that, more than that four or 5% in order to take that risk. And so it had to be a pretty good payoff. Now, as we know, interest rates are so low, you can get, if you're lucky, maybe 1%. And so individuals are really looking around for other investments to get more than that 1% and those investments can be quite risky.

And so that's what I wanted to talk about today that the change in environment and the risks we're taking,  

[00:02:12] Matt: It's really interesting because I guess I'd never really thought about that, but it does seem what you talk about on this show all the time and with your clients, I'm sure all the time is making the longterm plan, setting goals, deciding what you want out of your future goals. Both in terms of lifestyle and retirement, and maybe you want to buy a boat.

Maybe you want to send your kids to college, and then you build your financial approach around your goals. But if the interest rate environment, if the return you're getting on your portfolio of investments is fundamentally lower, it does reset your whole plan. You have to think differently, and maybe you need to be willing to take on more risk.

If you want to achieve the goals that you've set.

[00:02:59] Mike: Yeah, that's absolutely the case that you may have to take on more risks. You can no longer get that three, four, 5%. If that's not going to reach your goals, then that pushes you out the risk curve. You got to take on, more in stocks or equities or other investments that you hope to get that higher return that 5, 6, 7, 8% return, but understanding.

That they might be more volatile and they could go down more often than your less risky, investments. And therefore you might not reach your goals. So it's a trade off. And it's a tougher environment these days. Especially, a lot of talk is around people retiring, like you said, we want to have these goals.

The old 60, 40 portfolio we've talked about is that dead. That 60% in stocks and 40% in bonds, which was a very classic sort of retiree portfolio, is that now dead because interest rates are so low, I'm not buying that argument necessarily, but you just have to go in with eyes wide open understanding that.

Your bonds and fixed income investments are earning a lot less than they were 20 years ago. And inflation may be, average or rising. So therefore you're losing out purchasing power. So what risks are you taking in your portfolio? And making sure you understand the.  

[00:04:15] Matt: The entire environment means that the ground might be shifting underneath your feet and you better be aware of it at the very least. Is that the way the average investor should think about the effect?

[00:04:27] Mike: yeah. You just want to understand what risks you're taking and do you need to take them? If you have part of your portfolio and you say, oh, look, I'm going to take this a risk. This bet. I think this company is going to do well, or the sector is going to do well , imagine that with that amount of money.

So whatever that means to you say, I'm going to take some part of my portfolio and be a little more risky. So think about that. If that goes up by 10 times. All right. So think about. What you might risk how much that would be in your portfolio. And it goes 10 X. Okay. So put another zero behind it. How would your life be different?

Would that really fundamentally change your future? I'd feel great. Obviously you don't put an extra zero behind that number that feels really good. But if it's not going to change your lifestyle significantly, if it's a shrug oh, I'd have a little more money, I'd be a little more comfortable.

I could do, one or two extra things or something, but it's not a big shift then maybe that's a risk not worth taking because think of the other side. Okay. So think about that same amount of money and think that it goes to zero that you lose. Would that change your outlook? Would that change how you feel?

And so is that investment worth it? So that's how you want to think about when you're taking riskier investments and now time horizons come into this and everything else, but just really understand, what you gain from that investment and what you could potentially lose from that event.  

[00:05:52] Matt: Now we've been in this fairly low interest rate environment for quite some time. And it does create a little bit of a frog in the pot of water. That's slowly rising in temperature until it's at a boil and the frog doesn't realize it's being boiled. All of us have in recent years, gotten quite used to this low interest rate environment and therefore, maybe an elevated risk profile that we're not even aware of in our investments.

Kind of being the baseline for most investors who have taken your Sage advice. Over the years, the average investor, who's, let's say looking ahead to retirement and is in a target date, retirement fund. It's 20, 21 right now. You're looking ahead to 2040 when you're going to retire and you've got a portfolio of investments and you're in an index fund.

That's basically attuned to the right degree of risk to achieve your financial goals. Bye retirement. Is it the case that degree of risk is different than you may have thought of it being because of the interest rate environment? Is there more. Risk embedded in that portfolio because it's aimed at achieving based on historic returns and projected volatility.

Is there more risk embedded in those portfolios than we even realize

[00:07:26] Mike: Yeah, that's pretty hard to answer. I initially would say probably not in the sense that when you're talking about risk, think about your time horizon as well, So in terms of the time horizon, you laid out, we're talking 20 years until I'm going to use that money. And so now the bands I said before, what if you 10 X your money or it went to.

Okay. That could be an investment in say an individual company that's pretty volatile. Like you don't really know which way it might go. It's not in a sort of a tried and true standard industry, so it could go, could we great and go 10 X or could flame out? So we understand the potential risks of that.

Same as we understand, like we've talked about before going to the casino and betting on black, you understand I'm either going to double my money or it's going to go away. I understand that when you're talking about a

[00:08:16] Matt: well, according to Wesley Snipes, you're always going to double your money if you bet on black, but go on.

[00:08:21] Mike: So in terms of a target date fund, that's massively diversified across U S international and stocks and bonds with a 20 year time horizon.

You have to look at the bands of where it might end up. So you could say, look, five, 6% a year growth plus, or minus two to 3%. So then the bands are, it's with one or two standard deviations, you might make one or 2% a year or you make 10% a year. And so it's going to end up with, over 10 years.

So understanding where it's going to at where the average might be, what the high might be in, what the low might. And seeing, are you going to reach your goals, especially based on the lows? Okay. So I don't think there's too much necessarily different embedded risks because of the interest rate environment.

Now that said what the interest rate environment is potentially doing is boosting the value of riskier assets because there's nowhere else to get that return. Okay. So if I need a 7% return to reach my goals, okay. A pension fund, a state pension fund . They know how many workers and when they're retiring and how much they're gonna have to pay out and they need a seven, eight, 9% return.

I'm obviously not getting much of that from my fixed income. My bonds getting me one. So if I'm that pension fund, I have to take on more risk and hope for the higher return. So potentially supply and demand more money is going into riskier assets, boosting them. Okay. So your target date fund has done pretty well in the last few years and in the future, if the fed raises interest rates and we can get more return on that fixed income.

There's potentially wind out of the sales of riskier assets because , some people no longer need those riskier.  

[00:10:10] Matt: makes sense. And I guess I know we're going to talk about portfolios a little bit more deeply in a future show, but I guess to the extent that you have a portfolio that's really broad across the market in an index. You're essentially betting on the overall market. And I guess that amount of hedging does wash out some of that risk factor.

Are there other different types of risks that we should be aware of in this  

environment?  

[00:10:35] Mike: I think one that's, may not be obvious, , but it will be, as soon as I say it, the stock market's been going up right. For the last decade. We did have a blip if you recall, 18 months ago, we'll talk a little bit more  

about  

[00:10:46] Matt: we've all been living through the blip. There was . There was a finger snap. All of a sudden there was COVID and I don't know. I think Benedict Cumberbatch saved us, but go  

[00:10:54] Mike: That's right. That's right. So it's been going up and so your portfolio to your point, you're in that target date fund and that target date fund has been adjusted for you automatically, but if you're not, if you're in just the S and P five if you're in a total stock market fund and then maybe a total bond fund, and you want a 60, 40, we mentioned that 60, 40 classic portfolio.

If you were in that 60, 40, maybe in the last couple of years, or even this year alone, the market's up over 20% in this calendar year. So you might be sitting on 65% equities, instead of just 60%. And so it's a good time to rebalance, that automatically sells. And buys low fixed income.

Really hasn't gone anywhere this year. So you sell 5% of your portfolio and that's gone up and you buy the things that have not gone up and hopefully in a couple of years, and that changes roles. I That's the whole point of rebalancing. You might get a little bit of boost of returns by selling high and buying low.

So there's something just to be aware of that, the risk you wanted to take in your portfolio, how volatile you wanted it to be may have increased just because the markets have been going up the last.

[00:12:01] Matt: So you mentioned when we were talking a little bit about this topic beforehand, that one factor to be aware of is this question of. Who's on the other side of a trade with you. Why are they interested in making this trade? It reminds me a little bit. I know we're not supposed to. Bill Cosby is a monster.

Okay. But he did have a funny observation. Once back when he was just a comedian before he was a monster, he was telling an anecdote about seeing a sign-up at a diner, one egg, any style, a dollar 39, 2 eggs. And he stopped. A dollar 59, what's wrong with the second egg. And it begs this question of what are the motivations of the person on the other side of the transaction.

So how does that all play out as you think about risk in this kind of an environment?

[00:12:52] Mike: Yeah, so there's a couple of ways that I think about that. And I do believe that it's very good to think about who's on the other side of that trade, because it helps bring some perspective to the trade you're about to make. Okay. So if you're just rebalancing because of what we just talked about, stocks have gone up, I'm going to rebound.

No problem. It doesn't really matter. Who's on the other side of the tray, this is for your risk tolerance and how you want to try to reach your goals. If you are constantly buying into your 401k, it doesn't matter. If someone's selling, you're just, buying into the market because you got a 10, 20, 30 year time horizon.

That's great if you're trading a stock because you have a belief and they're buying it or selling it because you think it's going to go up or go down. That's a good time to think about who's on the other side of. In a bear market where things are going down, lots of people are bailing out.

Okay. They could be bailing out because they're scared that they're running out of money. They can't take the risk. So that could be an okay time to be buying, if you. can tolerate it. But when things are going up and your buying who's selling who's on the other side of that, often it might be somebody that has more information.

All right. There is there are tens of thousands of people. I like to say tens of thousands of people. Full-time 40 to 60 to 80 hours a week researching analyzing these companies, talking to them, boots on the ground tons and tons of time and energy to try to outsmart the market. Okay. I don't know if you're putting in that amount of time into, that research.

So I think it's always, so I always think it's just good to recognize that and just say, okay, and then I'm not.

saying don't pull the trigger. I'm just saying, understand, who might be on the other side of that trade? The other point that I do want to make on the other side of the trade is lots of people are in different situations.

And that I think is a lot of it. Hey, I'm going to be retiring soon. I need to, slowly sell out of my riskier things and buy less risky things. So they're just selling out of that. It's demographics might drive a lot of the buying and selling as well.  

[00:14:55] Matt: right. Buyer beware. When it comes to risk, maybe there's a reason that your counterparty wants to sell or buy. Maybe there's not, maybe it's, not that big a factor. Of course we've been talking about the Fed's monetary policy in terms of the effect on risk taking right now. Are there other factors or is it really just all about interest rates?

[00:15:17] Mike: No, in terms of risk, there's always a lot of different factors. One that I wanted to highlight is that we're all feeling pretty good about. The markets. Okay. Not saying about other parts of what's going  

[00:15:29] Matt: yeah. Depending on when our listeners are encountering this, I'm not sure. Maybe we won't feel good about the alien invasion that's coming or whatever calamities about to befall us, but when it comes to the market, we're feeling  

good.  

[00:15:40] Mike: That's a really good point, Matt is that we never know what's coming next. And we're recording this, at the start of September here, the Delta variant is, starting to skyrocket lots of personal stories about that, that you've been hearing. And , I could easily foresee two different directions.

One market keeps chugging along. It's up about 20% this year could end 30% higher by the end of the year. I could definitely see that happening too. I can see a good.

dropping 30% over the next two or three. We have experienced with that 18 months ago. That's exactly what happened. So would you be surprised in either of those two directions that neither of those would surprise me at all?  

[00:16:14] Matt: nothing surprises me anymore, including I thought you were about to promise that the alien invasion was coming a moment. It goes, that would not surprise me given the last year and a half.

[00:16:23] Mike: Yeah. So that's just, first of all, that's just good to understand. Okay. You have to be prepared. For each of those situations, what are you going to do? You could do nothing. That's fine. Okay. I'm not saying you have to do anything, but just being understand that either of those situations could happen. But right now you asked the market, are there other risks?

We're all feeling good because the market's just been going up and up 56 all time highs since a year and a half.

ago, it's up 22% this year. Nothing can go wrong. All the sectors are on fire. Everything's gone up. Everybody's made money in the market. Everybody's feeling good. So people are buying, so just be aware that's that's a risk, understand your own feelings around that.

And that's the other thing, just to understand that, how did you feel, last March of 2020, you were terrified,  

[00:17:09] Matt: Depends on the day.

[00:17:12] Mike: but you were terrified in everybody because everybody was terrified. And I remember the news and it was. Not to not markets, but just the news was terrible.

The markets were tanking. Everything was just going badly. And I remember the day that it turned around, the markets turned around, the news was terrible. Literally you were terrified. I didn't know what was coming next. It was all on the. And we've forgotten all about that, which we do as humans, which is great that we can quickly move on, but just really, it's good to understand that based on what I said before, you never know what's coming next, so you really want to be.  

[00:17:43] Matt: And as you've pointed out on the show before, it, sometimes the biggest risk is not taking one because it's all about achieving your goals. So this. Call for being timid. It's a call for recognizing that, we have this inherent human foible of we're like the John Starks of the New York Knicks in the early nineties, we forgot that we just missed our last 27 shots.

We're confident. We're about to hit. Our next one. I hope that we're all about to hit our next big shot in the market. Mike Morton and not suffer an alien invasion, who knows. Maybe there'll be friendly aliens, but I doubt that they'll have such Sage market wisdom as you have Mike Morton financial advice.

Thanks so much for  

[00:18:28] Mike: Yeah. Thanks, Matt. Thanks for joining us on financial planning for entrepreneurs. If you like, what you heard, please subscribe to and rate the podcast on Apple iTunes, Google play Spotify, or wherever you get your podcasts. You can connect with me on linkedin or mortonfinancialadvice.com. I'd love to get your feedback. If you have a comment or question, please email me at financialplanningpod@gmail.com. Until next time thanks for tuning in