The Power of Consistency and Commitment | AWM Insights #175
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Episode Summary
World developments frequently impact financial markets and test the resolve of investors. The fear, panic, and uncertainty these events cause are exactly what creates the concept of a “risk premium.”
The evidence is also very clear. Those who weather the storm have been rewarded over the long run. Consider the COVID outbreak, the Great Recession, and the Dot Com Bubble. These were all significant periods where markets moved, but the investors who didn’t panic and stayed in the market were rewarded for their perseverance.
Investing is not always going to be a smooth and comfortable ride, but the destination is worth it.
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Episode Highlights:
0:00 Intro
1:50 Uncertainty is unavoidable, but how can you construct your portfolio to weather the storm?
2:59 Uncertainty creates excess returns.
5:31 How hard is it to predict the future?
7:02 How market timing is a damaging strategy.
8:58 Control what you can control.
10:35 The power of diversification.
11:03 Text us!
+ Read the Transcript
Brandon Averill (00:03): Hey everybody. Welcome back to another episode of AWM Insights, Brandon and Justin here. We've been taking a little bit of a journey down the path of really trying to tie our investment portfolio to what is the bigger idea here? The bigger idea is that money is a tool and that it is here to achieve our priorities. And so how do we think about investing? How do we look at the results of investing and tie it all the way back to what a really good investment experience is?
(00:33): I think what's happening in the world right now leads us to the topic of today, which is there's a lot of news out there. There are a lot of things going on. We've got a war in Israel. We've got some negative sentiment coming out through economic indicators. The Fed is trying to deal with interest rate hike potentially, or not. And how do we get the soft landing out of all this stuff?
(01:01): We've gotten several client questions from you guys on, "Hey, I'm hearing recession's coming. What should we do? How do we deal with these types of things?" And so we thought it would be really good just to go through some key tenets to really keep in mind as we look at how do we build portfolios? What are the expectations for returns from those portfolios? But more importantly, how does all of this get back to the tool? What are the priorities that we're trying to achieve?
(01:30): So one of these big tenets, Justin, and it's really that all of this uncertainty is unavoidable. Things are going to happen and maybe talk a little bit why we have so much confidence in looking historically when things did happen that we still can have really good outcomes.
Justin Dyer (01:49): I think the answer is really part and parcel of what we've been focused on over the last few episodes. It's tying the history, the financial, the science. We talked a lot about that. I think it was the last episode, to the behavioral side. You need to be able to connect those dots and be able to pivot from one to the next.
(02:09): But uncertainty being unavoidable. What does that actually mean in the context of what I'm saying? Well, if there was an uncertainty, we wouldn't expect a positive rate of return over and above just holding good old-fashioned cash or buying a Treasury bond and investing in the debt of the US government. Or you could even step it up and go buy a corporate debt or a savings bond. Pick your quote, "safe investment". In order to expect a higher rate of return, again, you have to plan over longer periods of time. But that return largely comes from uncertainty. There's a lot of economic drivers underneath that company risk and currency risk, et cetera, et cetera, sector risk, all that nuance.
(02:53): But essentially it can boil down to the fact that hey, in order to get a favorable return on your money, again over the long term, you do need to accept that uncertainty is there. It's actually your friend if you can get to a point where you understand it. And then most importantly, your portfolio is structured in a way according to your priorities. That's something you'll hear us say time and time again. Hey, money is a tool in order to accomplish your priorities. You should build a portfolio that takes into account those priorities. But then allocates the rest of your assets in a way that can adapt to uncertainty, that is planning ahead for uncertainty and a range of outcomes. Because you can't predict the future and you can't time uncertainty, certainly.
Brandon Averill (03:39): And I am so glad you brought that up. I think, again, you guys have heard us beat this horse dead for sure. But really that uncertainty only becomes a problem if you have the wrong financial structure in place. And so it can be a big problem. And I think we hear the stories of the 2008 financial crisis or even during the global pandemic where, yeah if people had the wrong financial structure, if they had the vast majority of their savings that maybe they need in the short term allocated towards equities, long-term investments, yes. Guess what? Uncertainty is not your friend in that scenario. But for those of you that are listening, this is why we spend so much time harping on what are the priorities? What are we actually planning for?
(04:25): Because that really allows you to then turn it to the positive like you mentioned, and now it becomes an asset for us. If we're able to now be really confident about the money that we can allocate longer term, that means we get to take advantage of that uncertainty. This really turns us all the way, I think is a great lead in spot to just the futility of market timing. And how do you look at that. Maybe you're trying to read the tea leaves. I mean, how hard is this to actually do?
Justin Dyer (04:56): It's incredibly hard. I mean, you can just look at the data of professional investors. There's something I've probably referenced a couple of times called the S&P Index versus active dataset comes out every six months, SPIVA for short, look it up. Type in S-P-I-V-A, you'll find all sorts of information. And essentially it shows you it's a fool's errand. It's a silly game to play. Professionals suck at it and fail each and every year, and there's no persistence. There are some that outperform. Let me be very clear on that.
(05:26): But picking from that group that outperforms in hindsight as to who's going to outperform the next year, it just is nearly impossible. The group that outperforms one year does not usually end up in the group that outperforms the following year. So not only does the data say it's foolish, to your point around uncertainty being incredibly damaging if you're not structured, if your portfolio and your investment's not structured properly, market timing is even worse, you could say.
(05:53): There's another study that Morningstar referenced recently. I'm totally drawing a blank on who actually published it. It could have been Morningstar. But basically it looks at flows from retail investors as a proxy for getting into and out of markets. And it still happens time and time again that people do try and time the market because I don't want to be completely flippant about it. Emotions matter. And if you're not working with a professional, it's very easy to just sell out when things get a little bit shaky.
(06:24): But what this study shows you is that active versus passive, yes, it doesn't make sense to market time. But then from an individual stock picker standpoint, you generally underperform. But if you are moving in and out of markets completely, you are typically doing so based on emotion and costing yourself 50, 60, 70% of what you should have earned elsewhere.
(06:49): And it is incredibly damaging if you rinse and repeat and you play this game, "Oh, I'm going to sell out when markets are low and then buy back in when I'm comfortable. And headlines are great." And so you do really need to take a step back. Understand the behavioral side. Again, this is all this very virtuous cycle. Understand the behavioral side, ask yourself, be reflective, work with professionals like everyone here on this podcast is. And go back to the science. What does it actually say and then bring it back to your priorities. Is your portfolio structured in a thoughtful way that is there to support what you want to accomplish in life? That whole process can really get you to those healthier outcomes.
Brandon Averill (07:28): And I think the real good gut check here is I think even taking a little trip down memory lane to an extent. But if I gave you the crystal ball with a hundred percent certainty and told you these things are going to happen, there's going to be a global pandemic. Russia was going to invade Ukraine, inflation's going to spike, and people have recession fears. Oh, and then we're going to throw a war in Israel on top of that. How would you be invested in what you expect a return would be? I think you'd have to be insane to sit here and go, "Oh, I think things are going to be really rosy." But really what happened? We have the benefit of hindsight of looking, this is why it's so hard. All those negative things are happening. Yet if you look at the Russell 3000 Index, which is a broad market-based capitalization, weighted index of public US companies, north of 10% annualized return during that period.
Justin Dyer (08:24): So above average, right?
Brandon Averill (08:25): Yeah, it's above average. It's just an incredibly difficult thing to do. What we would rather do is focus our attention on those things we can control, like you've hit on having money allocated in the proper financial structure. And then allow yourself, yes, that uncertainty that exists through all those events, guess what? You get to be allocated to them. You get to take the benefit of them. And sometimes it is, what? Two steps forward and one step back like we've seen over the past couple of years.
Justin Dyer (08:51): And I love that statement. Two steps forward, one step back. There's another great one that markets climb a wall of worry. I mean, to predict the future, there are going to be some other crazy headlines that really shock the world and potentially shock the market short term. We're not recording this podcast today to say the market is going to tank. There are certainly some events out there that have changed the general feel and narrative. And we're not trying to downplay those. It's really hitting on, "Hey, let's acknowledge that. Let's go back to these behavioral tips and tricks we've talked about. Let's go back to what history tells us. What the science around investing tells us, and then review the plan."
(09:36): Okay, is it well put together? Does this accommodate the things that are truly important to me? Does it give me a high level of likelihood to meet those things? And the answer for the vast majority of our clients are, yes, it does. That is how we approach our relationships with you all. It's how we structure portfolios to be as confident as we can and to give you that understanding and comfort and staying power.
Brandon Averill (09:57): And I think the last tenet, and you guys have heard us say this, but they say, we got to say it, what? 21 times for it to sink in. I think we're probably at 2,100. But diversification's your buddy. At the end of the day, it's really making sure that you have a very thoughtful, diversified approach. It's going to smooth out your investment experience. It's going to allow you to weather some of this behavioral storm and help you to get ultimately to the returns that you need to achieve your priorities.
Justin Dyer (10:26): Yeah, 100%. It's so-called one free lunch that you can have investing and you should never go without it.
Brandon Averill (10:33): So a good way to think about this is that when the unexpected happens, when we have these big global events, when it seems like if you're looking in your account every single day-
Justin Dyer (10:46): You should have.
Brandon Averill (10:46): ... and it seems like the account's always going down, you have a reminder, a 49% chance that it's probably going to be negative and 51% positive over a one-day period. So extend yourself out, give your sanity a little bit of a break there.
(10:59): But when this unexpected happenings happens, it's natural to want to do something. And I would encourage you, pick up the phone, call us. That's part of our job is to help you work through these types of things and hopefully keep you really on the path to that long-term financial experience that you deserve. And we'll help you to achieve those priorities. So hopefully this is helpful.
(11:22): Shoot us a text. We'd love to hear future topics and hear if this is helpful. But 714-504-7689. And until next time, own your wealth, make an impact, and always be a pro.