How to Get the Highest Returns | Erik Averill, Brandon Averill | AWM Insights #13
Episode Notes
What should we be doing with our money right now? Over the last few weeks, we've covered topics that we've been asked about from our clients on real estate, private markets, and more. We've also been asked if now is a good time to consider cryptocurrency.
However, these might be the wrong questions, at least in starting the conversation. Instead, we should start with our overall money goals - what do you want your money to do for you?
The answer to this question helps us to determine an appropriate level of risk to work toward achieving the returns that would help us accomplish our money goals.
In this episode, Erik and Brandon discuss this idea and cover topics and questions like:
How do you actually define investment risk?
What is the framework for determining how much risk you can handle?
Why saying you want all the return but none of the risk does not work.
Understanding the relationship between risk and return.
Cutting out unnecessary risk.
The impact of diversification on risk.
+ Read the Transcript
Erik Averill (00:00):
Hey, everyone. Welcome back to another episode of AWM Insights. We are your co-hosts, Brandon and Erik Averill. We're excited to jump into our conversation today. Brandon, one of the things that we continue to hear which is a lot of fun conversations from our clients is asking, what should we be doing with our investments right now? What should we be doing with our money? Is this a time for opportunity? We're getting a lot of questions of what specific stock should we invest in? Should we invest in private real estate? There's been a reemergence of a conversation around cryptocurrency or gold right now. And one of the things that we try to reframe the conversation is saying, you're really asking the wrong questions because we can't give you a definitive answer. We always go back to what are the things that we can control. And specifically for us, we think the conversation about investing should actually start with the conversation around risk. Can you walk us through how we start to have those conversations and for our audience, how to define risk?
Brandon Averill (01:02):
Sure Erik. I mean, it's a great question. I think risk unfortunately is a very confusing topic because we can start to apply all these financial jargon to it, volatility is the biggest one. But really what we like to start with clients is, risk ultimately is you not achieving your goals. So, when we look at risk, there's different elements of it, right? If you set certain goals for the future, we obviously set goals for a savings rate, and then we need to determine how much risk should you take and then how much risk can you actually handle? And when we talk about risk in that sense, then it starts to reshape the potential, right? So you need to take enough "volatility risk" so that way, your assets, your investments actually earn enough in the future to support your goals. Because ultimately if you don't achieve those goals, that's the biggest risk, right? If you don't take enough risk within your investments to get to those goals. So I would say that's the biggest place that we start with clients.
Erik Averill (02:03):
And I think it's a really good point because you have to start with actually a clarification of what you want your money to do for you. What is it that you're trying to achieve? Because if you just ask the question, I want to invest in the thing that's going to give me the highest return. Well, then all of a sudden you're talking, well, should you put all your money in venture capital? Of course not. Nobody's going to think that, right? No, you're not going to tie up all your money in illiquid real estate because you have to pay for things, you have to pay for those vacations, and hopefully that college education and those types of things.
Erik Averill (02:35):
So, first and foremost, is you have to go back to clarifying what it is that you want to achieve to be able to determine how much risk return that you're going to get. That leads to the next question I have Brandon that I want you to talk about is, a lot of times there's this unrealistic expectation of like, I want all the return but none of the risk. And there's a lot of disappointment that we're already seeing, right, is just not probably understanding the relationship between return and risk. What would you say about that?
Brandon Averill (03:07):
Yeah, absolutely. I think that's a big thing right now. I mean, we've seen, obviously we've had turbulent times in the markets up to this point this year, we've also had a huge recovery. The United States stock market for instance, has done fantastic over the past, really the past decade. And so, we get clients that make statements like, well, let's just go 100% percent US stocks. But I think, again, if you don't have a plan in place and you're just going for that highest return, I think you're going to be severely disappointed because you might not need to take that amount of risk. I mean, if you're diligent with your savings, if you're diligent with your plan, maybe you don't need that type of return and that potential blow up in your portfolio.
Brandon Averill (03:53):
So, I think people really understanding their investments, understanding what they can reasonably expect going forward from their returns and then checking to make sure that there isn't any unnecessary risk. I think we often see this with people that pick individual equities, pick stocks, all you're doing there is adding additional risk to your portfolio without the additional expected return. And this leads to diversification. I think people miss the point on diversification. What that really does is, it's a practice of lowering your risk and increasing your return for that risk. And so, I think people really need to understand that.
Brandon Averill (04:32):
I think another good example is real estate. We hear this a lot, Hey, I'm going to go buy this property. I'm going to rent it out. I'm going to make $1000 a year, covering all my costs is fantastic investment, but they don't think about the risk part of that equation, right? They don't think about the liquidity, if something happens and they need that money, they can't get it out. They got to put the house on the market, they got to hire a real estate agent, they got to sell it if it's a market. And then, beyond that there's a whole host of other risks, right? To owning that property as opposed to potentially you have a better risk reward set up in something that you could get your money out of. So, I think, those are two really good examples of you just really need to understand what your expected return is for the level of risk that you're willing to take.
Erik Averill (05:20):
You make a great point there. And it makes me just want to make the point to our audience, and our clients know this, right? We aren't in love with any specific investment type, right? Venture capital over real estate or real estate over public markets, is one of the nice things for us as being an independent registered investment advisor and a fiduciary, we have an open architecture thing. We have no incentive to recommend one type of investment over the other. So there's truly this unbiased recommendation when we talk about investments is, we just want to make sure that you as an investor is actually capturing the returns that you deserve without taking any additional risk.
Erik Averill (05:59):
And I think this is where education is so important is because, a lot of this is academically evidence based research that says diversification works, right? These are the returns. Here are the historic risks with them. So where does it fit with you trying to achieve your goals? And it's why we work so hard to talk about asset allocation, how much money in each specific asset class, both in the public and in the private markets, because when you add them all together, it's going to produce a certain expected return for the level of risk. And this is where it is so customizable and personal to every single client. There's just no algorithm or template that you can shove everybody into. Like a lot of advisors, they have certain models that they try and push everybody into, it doesn't work because risk is specific. Can you talk about the importance of asset allocation and what happens when you deviate from that?
Brandon Averill (06:54):
Yeah, sure. I mean, asset allocations, deviating from that and not understanding what you're going to get in return can blow up your entire plan. So even the most conservative "investor" right? You don't want to take any risk. You don't want to potentially have your money go up and down. So, let's just say you sat in cash, 100% cash as your asset allocation. There's probably a high likelihood that you're not going to achieve your goals. And that's the ultimate risk, right? And so, I think you have to look at it all the way across the spectrum, and then you have to get the right asset allocation right. So, back to that example of somebody wanting to invest wholly in 100% US stocks, and they think that's great, through a lot of time periods they're achieving great returns.
Brandon Averill (07:43):
And then we go through a tough spot and there they can't stomach it. They can't stick with that asset allocation, therein lies a whole other risk, right? The risk that you're in the wrong asset allocation, you end up selling out at the wrong moment. You end up with, what's probably the most devastating part of risk, right? Permanent loss of capital. So, risk isn't simply volatility. It's not just a financial number. It's a conversation, really all tying back to, what is the risk that I need to take to make sure that I get the return to achieve my goals? And am I able to live with that type of risk and stick with that kind of asset allocation?
Erik Averill (08:25):
Very helpful. In summary, I think why I love this conversation is, this comes down to the fact that a lot of this is just taking the time to invest in your own education, to really treat your money in a professional manner. Right? We talk a lot about this in the athlete community or in the venture world. The is, it's taking ownership, it's taking control to say, you know what? I don't have to be naive and turn over everything without understanding what's going on. We're also not telling you have to go get an Ivy league education on this stuff. Right? But what we've learned is, if there's an unwillingness to learn something just because you don't want to learn everything, unfortunately, you're going to leave yourself open to salespeople trying to take advantage of you. So, we think so much of this is educating yourself on just what risk is, so that you can have a successful investment experience.
Erik Averill (09:23):
Ultimately winning whatever game you've defined is winning based off of your goals. And so, I mean, we're seeing this right now in major league baseball, right? There's a lot of disagreement between the players and the owners over what's going on. And we ended up writing an article about this the other day, of just taking a step back to educate yourself on really what we're talking about. Like what is ownership? And so, well, we spend a lot of time talking about risk today, on next week's podcast we're going to actually dive into understanding what is ownership? What is equity? And why there is a higher expected return with ownership, really comes back to risk. And so, audience, thanks again for you guys' attention. We love all the feedback that you guys have been giving to us. We'd love to hear from you if there's a topic you want us to cover or to dive more into. And until next time, stay humble, stay hungry and always be a pro.
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