Amateur vs Pro: The Importance of Asset Allocation | Erik Averill, Brandon Averill, Justin Dyer | Insights #73
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Episode Summary
In your investment portfolio, you have the choice of making the amateur move – listening to the mainstream financial pundits who want you to feel FOMO over the latest stock picking craze – or the pro move of looking at how the best in the world do what they do, which is also backed by decades of research.
We started this series a few weeks ago by focusing on overall financial structure and followed up last week with how to think about portfolio construction, and the result of that is the topic for this week – your asset allocation.
Erik, Justin and Brandon define what asset allocation is, the complexity of asset classes, and how to avoid making the amateur investment moves.
Episode Highlights
(00:30) The news you should know: US stock market doubles, Robinhood goes public, paid vaccinations, drop in poverty, how much are Olympic medals worth
(3:57) What is asset allocation? Model portfolios?
(6:35) Adding human capital into the mix
(9:23) The complexity of assets
(11:30) Amateurs vs Pros
(12:40) “It's really unfortunate, because you do have the Robinhood’s of the world, the big brokerage houses that we all know, and they're so focused on marketing and generating this activity, and playing on emotions, it's really unfortunate. Because the education out there, the buy, the sell, the Jim Cramer's, they're all trying to get you to focus on the tool, and the tool's not what's going to make you successful, the tactic. It's more about stepping back and looking at the whole.” – Brandon Averill
(14:56) “That's the whole goal here, is to make sure your assets, your overall net worth, your total net worth, is structured in a way, is built in a way to support your priorities.” – Justin Dyer
(16:01) “Am I allowing [mainstream voices] to get my emotions riled up, to use my FOMO against me, to extract dollars out of my pocket as an amateur? Or, do I want to take a step back, and do I want to look at the best in the world at what they do? Because that's who you are as an audience. You're a professional athlete, you're a founder, you're a business owner, you're a wealthy individual, who has gotten that way by being a pro.” – Erik Averill
(17:24) How are you measuring investment performance?
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+ Read the Transcript
Erik Averill (00:00):
Hey, everyone. Welcome back to AWM Insights. It's your power three, two CPWAs and a CFA. We are Erik, Brandon, and Justin. And each week we cut through the noise of what Wall Street is selling you to bring you the knowledge, skills, and the access you need to invest like a pro. And today we've got a super exciting topic called asset allocation. But before we jump into that, let's focus on what's going on in the markets.
Erik Averill (00:30):
Read this fascinating stat earlier in the week, that since the pandemic-low in March, that the United States Stock Market has doubled, and it just is mind blowing to me. I don't think there's anybody who would have been able to guess that, that's where we're at today. In other news, the exciting story of Robinhood going public. Once again, we see that the IPO market can be harsh for companies filing for their listing, and they made the news, they made history, but unfortunately it was on the negative side. So it was the worst debut for an IPO of their size, in history. And so it'd be interesting to see what ends up being the story for Robinhood, now that they're publicly traded.
Erik Averill (01:20):
Some other interesting things that we've read about in the news, just around vaccinations. President Biden is asking states to offer a $100 payments to people who go out and get the COVID shot. So obviously trying to put some incentives there. And then an interesting study of how successful some of these aid programs have been through the pandemic, which is a great thing to see is that, there's been a record 45% drop in poverty, since 2018. So at times it can kind of feel like what's working, what's not? And so to get this positive news, that it's really helping our poorest communities, is definitely something exciting to be able to see.
Erik Averill (02:04):
And then just from a sports' standpoint, we always think that this is fascinating that the Olympians that go out there and they win gold, they win silver, they win bronze, and they're doing it for their country. We love them so much that we actually tax them on those medals that they earn. And so, if you win gold, you get to pay 600 bucks, if you win silver, it's 300. And I guess if you come in third place, they at least don't make you pay any tax on that. But now-
Brandon Averill (02:34):
Let me interrupt real quick, Erik. Actually, you got it backwards there, which I think is fascinating. The medals are only worth that much. So your gold medal is only worth $600. Your silver is only worth $300, and your bronze is worth zilch. So you're actually paying tax on 600 bucks. So that's the taxable value there. The melt value on those medals, which is kind of fascinating.
Erik Averill (02:55):
Dude, they got to start making Bitcoin medals. This is -
Brandon Averill (02:59):
There you go.
Erik Averill (03:00):
Are you kidding me? $600.
Brandon Averill (03:03):
Yeah. Can you imagine being the mom of the bronze medal winner? I mean, shoot. My son's medal, daughter's medal, is only worth zero. That sucks.
Erik Averill (03:12):
Dude, that is terrible. Yeah. Go USA. I guess, go Olympic Committee. Well, anyways, let's jump into this fascinating conversation around asset allocation. And so here's the thing. This is not sexy. It is far sexier to want to talk about picking individual stocks. What's going to be next, whether it's cryptocurrency, or so much of how we talk about private equity, and venture capital on here, and the things that get us super excited. Yet, asset allocation is far more important for investors. Which is why we want to spend this session talking about it. I would just love for you guys to just jump in defining, what is asset allocation?
Justin Dyer (03:57):
I'll start. It's the next step from what we've been discussing over the last couple of weeks. Financial structure to portfolio construction, portfolio construction results in your asset allocation. The way we approach building your individual asset allocation is truly from a customized standpoint. In a simplest form, how much do you put in stocks, and how much do you put in bonds? Most investment advisors out there will have what are called model portfolios. And maybe there's five to 10 different model portfolios. And those range in exposure to stocks versus bonds, depending on how aggressive they want to be, or conservative they want to be. And that's the starting point for asset allocation. Let me just say, too, Erik, to your point that, stock picking is way sexier. You turn on CNBC, you see all these, the Fast Money, or Mad Money, whatever that show is called. They're just talking about stocks, right?
Justin Dyer (04:59):
All professional investors, whether we agree with them or not, truly at the end of the day, focus on asset allocation. And whether it's a stock of 10, or a portfolio of 10 individual stocks, highly concentrated, highly risky. Or, a portfolio of global stocks, 13,000 individual companies combined with bonds from around the world, or in the United States. That is how professional investors think about constructing a portfolio.
Justin Dyer (05:32):
And to your point, if you look at the statistics as to what really matters for your bottom line return, your blend between stocks versus bonds, or US stocks versus international stocks, is what truly matters and drives your rate of return. Whether or not you pick to invest in Apple or Amazon, today, has so little impact on your portfolio, unless that's all you're holding, clearly. But for most professional investors, those individual positions, they're diversified and weighted correctly.
Justin Dyer (06:11):
And so each one's contribution of the portfolio is minimized to an extent, or sized in the correct way. And therefore, the overall exposure to US markets versus bonds, or whatever it is you're comparing, that's truly what matters significantly more than picking individual securities, or individual positions.
Brandon Averill (06:35):
Yeah. And I'd even take that a step further, Justin. I think this is one thing that often gets missed. We've talked about it several times, but the human capital is an asset as well. So as we start to think through our asset allocation, most people don't take your human capital into consideration. Recent conversation with a venture capital investor running a fund, and so much of his life, his livelihood, his future human capital, is tied to the venture markets, to the equity markets. If you completely ignore that, you don't have the proper asset allocation for him to be able to achieve his priorities.
Brandon Averill (07:21):
Yes, it's the stocks, it's the bonds, but it's also, look at all your other assets. And so that conversation led, it was actually fascinating, was, "You know what? So much of my human capital is tied to the equity markets. I have a really good bond allocation for my essential priorities to take care of my family in the short term. But I'm actually starting to take some of those money and diversify it into farmland, into other assets that are going to be from a correlation perspective. You start to look across the total asset allocation, it's going to provide a much safer return."
Brandon Averill (07:56):
But really, and when we're talking about returns, return to his priorities, his outcomes, rather than necessarily maximizing some rate of return. So I think expanding it, it's also a fascinating discussion.
Justin Dyer (08:09):
Well, it's a great point. And we always talk a lot internally about how our approach is this circular loop, if you will. And Brandon, what you just highlighted is a perfect example of that. Asset allocation in the common sense is kind of what I was alluding to in stocks versus bonds. But the way we approach it, approach working with client, and thinking about financial structure, including human capital, including things like a pension, if you may have it, or social security in some cases. Those are valuable assets to you, they have a present value today, even if you're 25 years old. And taking all of that into account, relating it to your priorities, is incredibly powerful and unique to you. Very few firms do this.
Justin Dyer (08:58):
Again, the typical way is kind of what I was saying early on is, let's put together an asset allocation, 60/40, 60% stocks, 40% bonds, 70/30, 80/20. You just kind of have these portfolios, and it's a good way of doing it. It's not custom to you, and your needs, and your priorities.
Brandon Averill (09:21):
Absolutely.
Erik Averill (09:23):
I was just going to say, something both of you guys have mentioned is that, professionals start with the asset allocation, because they're also looking at what is the evidence that leads to expected returns for given level of risk. And you guys are talking about putting together an individualized-customized portfolio, based off of trying to achieve your priorities. And something I just want to zoom back out is, I think sometimes we miss even defining what an asset is, or even an allocation. Because one of the things we see amateurs do is, they fall in love with one specific asset, and think that investing should only be done in that one. And so we see this a lot with real estate.
Erik Averill (10:11):
And even calling real estate an asset, is not singular. It's a class of different types of assets that fall within real estate. So Brandon, you said farmland, right?
Erik Averill (10:23):
And we have multifamily, and we have commercial, we have residential, single family homes. And I think it's important to draw back out and say, an allocation is different amounts of money to different type of assets. So going back to the analogy of filling up a baseball lineup of one through nine, you're not going to just go, "I'm only going to put real estate across all nine." You're not going to have just shortstops hitting one through nine, because the rest of the field would not be built out, and you are going to lose, you will not get the results, than if something like a professional would have, allocating across the nine positions to give the team the best opportunity to win.
Erik Averill (11:04):
And so just even defining what an asset is. An asset is a resource with economic value that you own or control with the expectation that it will provide a future benefit. And so I think making sure that we have definitions of not falling in love with one specific type of investment, because if you do, you will not get the results that a professional will.
Brandon Averill (11:30):
I think that's huge. And I think the one thing... Like you said, it is sexy to go in, and necessarily like, oh, I like this company, I like that. I mean, the amount of times that we see a new client come in, they've got a portfolio, and all of a sudden it's like, oh, they've gotten some venture deals, and then it's just complete disaster. There's 40 deals in there that have no purpose, really.
Brandon Averill (11:55):
You got to take a step back. And I think that's the most fascinating thing when you start to talk to professional investors, or people that have really built significant wealth. You take real estate for example, like these huge real estate families, and people that have built significant wealth, they're constantly thinking, okay, how do I take some of this money, and how do I move it out of real estate? How do I make sure that it's taking my complete asset allocation into perspective? And this is somebody that has built significant wealth in one asset class. And yet, they're recognizing that, even though I'm so skilled in building wealth here, there's still a huge importance and need to move that out.
Brandon Averill (12:40):
The same with the venture investor, that gentlemen is one of the most successful venture capitalists, probably in the history of venture capitalism. And he's talking about not doubling down on his ability to go buy or invest in another startup company. He's actually saying, "No, I understand the importance of asset allocation." And I think it's really unfortunate, because you do have the Robinhoods of the world, the big brokerage houses that we all know, and they're so focused on marketing and generating this activity, and playing on emotions, it's really unfortunate. Because the education out there, the buy, the sell, the Jim Cramer's, they're all trying to get you to focus on the tool, and the tool's not what's going to make you successful, the tactic. It's more about stepping back and looking at the whole.
Justin Dyer (13:31):
Yeah. And I just want to kind of underscore what you were talking about, Brandon, with the real estate families, or individuals, the venture capitalist. Let's connect the dots here. That is their human capital. They understand it, they're applying their human capital to generate wealth in a specific area. Same, a lot of our clients do that within professional sports, or venture capital, or just starting businesses.
Justin Dyer (13:58):
And then they realize, to your point that, A, maybe this isn't going to last forever. B, there's still a lot of risk on the table through holding all of my net worth in a single asset, going back to Erik's definition there. Let's harvest the financial value from that asset, which is represented in the form of human capital, and diversify it. Let's build an asset allocation that then speaks to your priorities. Because all that concentrated wealth in a single asset, likely does not speak to your priorities. Those are all unique to each and every individual. In 99% of cases, it probably does not support your priorities very well. And so your priorities are therefore at risk, which is how we really approach and weight our relationships. That's the whole goal here, is to make sure your assets, your overall net worth, your total net worth, is structured in a way, is built in a way to support your priorities.
Erik Averill (15:04):
And I think we can learn a lot. We talked about the endowment model, the pension model, on last week's podcast that, there's a reason when you look at the late David Swensen's work at the Yale Endowment, of the different asset allocation. What ended up separating them was maybe the access to the alternatives that they had. But when you looked throughout the entire portfolio, it wasn't all in just one bucket. And so, I think this is where you take a step back as an investor, an audience, and you have to go, wait a second. Am I being formed and shaped by marketing in the media? Whether it's Robinhood, or CNBC, or Fox Business news, or Twitter, or David Portnoy, or whoever it is, of going, Am I allowing them to get my emotions riled up, to use my FOMO against me, to extract dollars out of my pocket as an amateur?
Erik Averill (16:05):
Or, do I want to take a step back, and do I want to look at the best in the world at what they do? Because that's who you are as an audience. You're a professional athlete, you're a founder, you're a business owner, you're a wealthy individual, who has gotten that way by being a pro.
Erik Averill (16:19):
And I think that, that's where we sit here and goes, "Hey, we want to make sure that you're capturing these returns that you deserve. And here's just the truth. Asset allocation is responsible for 90% of your returns. So some questions if you just ask yourself is, do I even know what different asset classes are? If I looked in my total portfolio, do I have different asset classes? Most individuals probably can't answer that. And that's okay. That's why you have professionals. That's why you have CFAs and CPWAs, that can help you along your investment journey, to make sure that you're capturing the returns that you deserve.
Erik Averill (16:58):
And a few other questions that I just encourage you as the listener to think through when you're investing is, what are your investment filters? Brandon and Justin have talked at length of saying, there's a purpose to this portfolio. It's a means to an end to achieving your priorities. So your individual investment filters should be completely different, than your teammates, or your coworkers, or your neighbor down the street.
Erik Averill (17:24):
And then the question is, how are you even measuring your investment performance? This is an interesting thing is, I think we get caught up in buying individual equities, or allocating to real estate or something, because the initial thing is like, well, I think it's going to make a lot of money. I think the return is going to be there. Yet, are you actually measuring your investment returns?
Erik Averill (17:47):
At the end of the year, have you figured out, did you make a good decision, and against what benchmark? I think we learned a lot during this bull market run. Last year, everybody thought they were a great investor from an absolute return standpoint. I'm making 30%, I'm making 40%. Well, in reality, the market's doubled twice since the pandemic. So if your absolute return is 40%, yet the benchmarks earn 50%, you're a bad investor.
Erik Averill (18:17):
And so I think these are the things that we just want to pull out the media and the marketing, and protect you from that, to say, "Hey, there's evidence. It's been this way for a very long time. Now it's very difficult to implement, but if you stay disciplined, you hire the right team. You're going to find success." And so make sure you head over to awminsights.com. Once again, there is a resource called, The 10 Key Principles to Investing Like a Pro, that if you have not downloaded that, we highly encourage you to do that. Once again, awminsights.com. And until next time, own your wealth, make an impact, and always be a pro.