Episode 522 – Are You a Do-It-Yourself Investor?

Welcome to the Your Life Your Wealth podcast with John Walker and Jason O’Meara, helping you find clarity and comfort for your life and wealth.

John Walker
Hey, welcome to the Your Life Your Wealth podcast. I’m John Walker, Regional Vice President at Mercer Advisors, joined by my good friend and colleague, CERTIFIED FINANCIAL PLANNER® and market leader, Mr. Jason O’Meara. Jay, great to see you today.

Jason O’Meara
Hey, John.

John Walker
So Jay, we’ve had a lot of questions with the families we meet with about why do they need professional help, right? We meet a lot of folks that have been very successful, DIY investors. We are challenged, right? Like, hey, what can you do that I can’t do on my own? Because these days, investors have more tools, more data, access to markets that they didn’t before. You know, there is this propensity to challenge us to say like, you know, I’ve done pretty well in the market myself. Why do I need the guidance of a professional money manager or what do you do as certified financial planners that are different, right?

And I think it’s a very, I think it’s a rational question. I think it’s a fair question, and it’s, I actually think it’s one I quite enjoy answering. On the surface it might feel very relevant, you know, real that what do you guys do that I can’t do myself these days, right? What makes a partnership with you valuable to me, a very successful do-it-yourself investor, right?

Jason O’Meara
And usually, John, when we hear that question, the first thing I ask is, well, walk me through your process. Yeah, walk me through your investment process. Walk me through what’s your stated risk tolerance. Like, you know, what are you doing that is working, right? And unfortunately, a lot of times I hear, well, I know that this XYZ stock is going to be really successful, or I think it’s going to go big, or this guy at work told me to buy this, and so I do, and it works out, and there I go, I’m successful. Where most of the time when we dig a little deeper, what we find is because people don’t invest, they gamble.

You know what I mean? Like I find a lot of times it’s a gamble. They don’t know what their entry point is, what their exit point is. They don’t know what that stock is going to do. They also don’t look at the portfolio as a whole and build out a diversified portfolio, right? They’re buying various stocks.

John Walker
Yeah. I think one of the things that we most often see is that do-it-yourself investors don’t recognize their blind spots. They don’t see the things that they’re missing out on. They don’t see, or there’s not an integrated thought process around how the portfolio is constructed. You’re right, it’s a lot around picking winners and chasing returns. And a part of it — we’ve had shows on this in the past — is around the behavioral finance situation. Right now people are driven by the fear of missing out on market trends. It’s normal, right? It’s very normal.

And it’s not to say that professional money managers always outperform do-it-yourself investors. I don’t want that to be the takeaway here. That’s not necessarily true. But what is always consistent in good planning that is dovetailed with money management is that there’s an integrated approach. There’s a disciplined approach — one that is looking not at trying to predict the future or choose the next winner, but that is really embedded in stress testing assumptions and looking at long-term market cycles and a broader historical context and not the recent past, right? Which does cloud a lot of thinking around investments.

And I think, you know, I was really excited to talk this over with you today because I actually just met with a new family that’s considering working with Mercer. And part of what they have done very, very well is that they like a low-cost indexed, simple bread-and-butter, let’s-take-the-market-returns approach. And I said, you know, that really dovetails well with our thinking here at Mercer and the way we integrate factor-based investing and how we look to the longer-term future. But what they were lacking is that they didn’t really have that anchored to any part of a traditional financial plan that incorporates their taxes, their asset allocation, their asset location, right? They didn’t have a strategy around qualified accounts or Roth conversions. They had no idea about what their withdrawal sequence was going to look like or any of those things.

And so when you look at it in terms of market performance, their portfolios have done really well. But upon analysis, we were able to show them quite a lot of other opportunities to optimize the way that they were investing that don’t really show up on a monthly statement but have material impact on your balance sheet, right, and on your family’s trajectory for wealth. And I think that’s one of the big things to underscore here — how you quantify returns is really, really important, because it’s not always what just shows up on the investment statement.

Jason O’Meara
You’re right. And one of the things that I usually point people towards is, if we look at your returns as a do-it-yourself investor, how much risk are you taking compared to, say, an institutional investor, right? And what we usually see is there’s a lot more risk associated. And by risk — again, John and I talk about this all the time — risk is defined as volatility, right? How much volatility are you exposing yourself to because of the way that you’re buying these pieces of this portfolio?

When we take a look at your overall financial plan, the first thing we look at is how much risk do you need to take? What return do you need, right? And if we bring it back to that, it kind of helps you understand the purpose between each piece of that portfolio. John mentioned something around asset location, right? Not just asset allocation. Where are you holding your least tax-efficient investments? Are you holding them in a brokerage account, paying tax on it every year, or are you holding it inside of an IRA? Like, those are things that you’ve got to look one step beyond just what stock am I buying or bond am I buying, right?

And then furthermore, my favorite conversation I ever have is tax loss harvesting, right? You know, if you’re buying a big diversified portfolio, not everything’s going to be going up at the same time. Some things will be going down, and you can take advantage of those losses to offset your taxes either in this year or at a later date. And it’s something that, as an institutional investor, we can focus on, whereas I find as an individual you’re not apt to focus on that.

John Walker
Yeah, and it requires discipline, right? It requires being able to—many of the folks we meet with that do it themselves have a really hard time choosing when to buy or sell and choosing when to let go of a holding, right? And so sometimes that neutrality — it’s not an emotional decision for us as an institutional investor, right? It is dictated by a disciplined, methodical approach that says, you know, we’ve hit this. This is a good tax opportunity. Let’s sell it. We don’t have any bias towards that individual holding. We’re not drawn to it. We don’t have an emotional connection to it.

And that unemotional decision-making process allows us to take advantage of things that many folks struggle to do on their own. And not to put too fine a point on it, but that asset location conversation is so critically important. Because a lot of the folks that we get the privilege of meeting — when we can show them the delta, right, the tax alpha, what we can generate just in tax savings alone, just by doing simple things like placing the right types of assets in the right type of account classification or tax characterization — it’s really, really important. Because it’s an old adage, but it’s not what you make, it’s what you keep, right?

And so having a really successful portfolio that is costing you an arm and a leg in taxes because you’ve got lots of treasury bonds—

Jason O’Meara
Something that’s taxable, right? The interest is taxable, and you’re sitting in a high earner situation — we can make a big impact just by switching to something more tax-favored or moving those into an account that is tax-deferred.

John Walker
And it’s such an eye-opening conversation sometimes to say, hey, on paper, it looks like you’ve done really, really well, but net of taxes, how much of this were you able to actually keep? Because to be able to access this capital, you’re going to have to sell it. Very high capital gains or, as you just said, you’ve got treasuries or high-yield bonds or non-qualified dividends — they all look great on the statement when you see the return. But when you do the actual math and say, how is this actually impacting you, it reduces the net effectiveness of some of those investments, right?

And so understanding that and actually viewing it through that lens — looking at balance sheet growth instead of just the returns on the statement — it is a different perspective that we often bring. And it opens the door to a conversation around efficient investing and what we do a little bit differently. Because I think many of you know that Don Cagney is our chief investment officer. I’m fairly certain that if we had him on the show with us today — and you should definitely check out his podcast — he’d be saying something to the effect of, no one’s magically going to outperform the market on a consistent basis, right? That’s not how it works.

Very few investors can, right? The market itself is remarkably efficient. It does a great job—as we’ve seen over the last 10 to 15 years of this bull market we’ve been in—of finding a way of navigating all kinds of challenges, right? Global economic challenges, wars, crises. The market finds a way to find its growth, right. And that is a credit to the way the market operates. So trying to beat that on a consistent basis—no one’s clever enough to do that, right?

But the value we can add is inefficiency — or out-efficiency in the market, which I know is not a real word, but it’s one we use all the time — finding ways to optimize a portfolio. And it includes, Jason, things that are not really obscure strategies that people know about, but that we can put into action in a much more congruent process. Things like we just talked about — asset allocation, tax loss harvesting, and Roth conversion strategies, which are really critically important. We have a lot of folks who do them or want to do them because they think they’ll be beneficial, but it’s very, very difficult to weigh all the different variables that go into a Roth conversion, right?

Jason O’Meara
Without having the correct software to truly map out, one, a course through Roth conversions, and two, how will that affect you from a tax perspective in each year? Does that trade-off outweigh the gain, the savings in taxes later? Because with a Roth IRA you do not have a requirement of distributions. You never have to take money out of it. It can grow as long as you’re alive, plus whoever inherits it gets 10 years to take the money out as well. So your lifetime plus 10 years — is that a long enough runway to make up for the taxes that you’re going to pay today?

John Walker
There are so many trade-offs with Roth conversions that are difficult to evaluate, right? You’re so right. There is how do we look at the tax benefit, and then there are things like, OK, so what are the other trade-offs that I need to be aware of? It’s now taxable income in that year. Does that trigger higher Medicare premiums for me down the line because of IRMAA, right — income-related monthly adjustment amounts — which could potentially add hundreds of dollars in unanticipated costs if you haven’t prepared for that?

How are you going to pay the tax liability on that, right? The value of a Roth conversion is diminished if you have to sell additional assets to pay the tax on the conversion. If you’re selling the stock itself and not fully converting and getting to place those assets into the Roth, well, then you’ve significantly diminished the value of that Roth conversion, right? How long does it take to break even on the taxes that you paid? Do you have a long enough runway to make it impactful for you as the investor choosing to do that?

What assets do you convert, right? We talk a lot about opportunistic growth conversions. Like, when do you do them? Sometimes we encourage families, again, if it makes sense within their plan and it’s part of their objectives, we can accelerate Roth conversions when we have down markets, when we have pullbacks in individual stocks that they may own. Those are maybe ideal times to convert assets, right?

And so, going back to our conversation around discipline and knowing when to buy, when to sell, and taking that emotion out of it — for us, there is no emotion, right? The plan is what we’ve built together. These are your stated objectives. Our families can ultimately choose if they’d like to execute on our ideas or not. It’s their money. It’s their plan. It’s their wealth. But for us, it doesn’t matter. We don’t have any allegiance to a particular holding or anything else. It’s just the math that fits within the broader context.

And I think that is really an important consideration. It’s also important when it comes to other things that we’re thinking about, and that’s withdrawal sequences, which I know you’ve spent a lot of time talking to families about lately because it is really important when you’re in retirement — how and when and where you take income from.

Jason O’Meara
Exactly. And one of the things when you think about withdrawal strategies — I always tell people, anybody can build a portfolio, right? That’s the easy part. Just put money in the account, don’t spend it, let it grow, and you can amass a massive portfolio. But then when it comes time to distribute that portfolio, where do you start? Because that’s where you can absolutely make or break your financial plan — in this part of taking money off the pile, right?

So there was the long-standing strategy of 4%—the 4% rule—basically saying that if you have a million dollars, you can take $40,000 out of it every year and you should never run out of money. So, it’s 4% of the initial amount. And if you were to play that game out, how would you build a portfolio that reliably generates 4% — and maybe more than 4% because you want to put back what you’re taking, right? So that’s one of those portfolio design questions you need to think about: how much should I have in fixed income, how much in equities, how much should be dividend-bearing, how much should be growth-focused.

Being able to build out a portfolio that predictably and repeatedly returns similar numbers in most market iterations is super important for you. And then how do you start? Do I start taking out cash first, then maybe taxable accounts, maybe IRAs, maybe Roth IRAs? You have this litany of different types of accounts. How do you know which ones to take from? And one of the best ways to do it is for a financial planner to illustrate all of those options and determine what’s the best way to pull from these accounts.

John Walker
Absolutely, Jason, and it really is. It’s so important and, again, they’re not obscure strategies. We’re not bringing anything exotic to the table. But they are often very difficult for folks to do on their own. And what we can bring is the knowledge to spot the right opportunities, act at the right time, and take emotion and other things out of it.

I think what we’d be remiss not to talk about — something that we’ve seen a lot lately, I think as a product of this long bull run and because of the current makeup of the market itself — we have been introduced to just an inordinate amount of people lately that have concentrated stock positions, right? Some by choice, some by luck, by chance, by circumstance, by employment status. They work for a company whose stock has taken off, and now they have this overnight millionaire dynamic where so much of their wealth is held in a single position.

Intuitively, I think we all understand that that has an additional level of risk to it. But many investors have a hard time separating that risk from the reward that they’ve received from it, so they don’t really always feel any urgency to diversify that position. They’ve enjoyed how strong the returns have been, right? It seems almost counterintuitive to walk away from, right? Or the tax burden is so onerous that they don’t really know how to effectively get out of it. They feel stuck, Jason, right? They don’t know what they can do.

And another critical role we play — and have had a lot of success helping families navigate lately — is navigating these concentrated stock positions and giving them the entire menu of options that may be available to them to either diversify the position, mitigate a little bit of the risk, reduce the tax liability. We have access to tools and solutions and resources that the everyday investor doesn’t have, and that can really, really help families navigate that. Because — and Warren Buffett always says this — concentration builds wealth and diversification preserves it. Knowing how to get from step A to step B is really often challenging.

Jason O’Meara
Right. And I think — not every concentrated position is equivalent, right? So, you may be concentrated in a stock that is great today, but it’s in a dying industry. And at that point, how do we diversify from that position without causing too much of a tax gain? Or are we so bullish or bearish on the stock that we don’t care about the taxes at that point — we’d rather pay tax on the money you made and keep it in your pocket than let the market swallow you whole. So, there’s a lot to be considered.

A lot of that has to do with the actual stock. One thing, John — you’d mention this — I do hear it a lot, “I’m in this concentrated position and look how good I’ve done. There was no risk. Look how good it worked out.” It’s a very outcome-biased look at it. It was, there was no risk because it worked. It’s like hitting on 20 in blackjack. You have 20 and you take a hit and you get an Ace. You look like a genius, and the reality is, no — you should never hit on 20. You got lucky. So, when I look at some of these concentrated positions, I look at it and say, acknowledge the luck, and let’s figure out a way to get you to a point where it’s real and it’s in your pocket and it can’t be swallowed back up.

John Walker
Yeah, I mean, that’s the evaluation, right? A lot of folks we meet with are looking at it saying, but look at the upside, right? It’s outperformed the market every year for the last 10 years. And I want to go back to what you said earlier — but at what risk, right? And do you need that at this stage, right? If you’ve won the race, maybe it’s time to stop running.

Jason O’Meara
Like I said, John — the only team throwing Hail Mary’s are the ones that are behind.

John Walker
Exactly. And so, understanding, what’s the trade-off here? Can you absorb a severe loss? Does your plan sustain itself if that position is cut in half in value? What does your financial plan look like then, right? And so there’s the risk-reward equation, and it’s very difficult to do unless you have it as part of a more complete picture—unless it incorporates the plan and all the other objectives you have. So, thinking less in terms of market returns, but in plan success and in reaching the outcomes that you want in a reliable, predictable way.

There’s not a right or wrong answer here, but sometimes when we show folks that all their hopes and dreams for their family and their finances can come true at a certain level of return that might seem modest, it allows us the privilege of saying, so, now that we know that, now that we know that your plan will work — and I’ll make a number up — at 5% annual returns, you may not need to be taking as much risk as you’re currently taking. And we see that a lot. And that risk — once you realize it — makes it a little less comfortable to know that, oh hey, if this thing does fall apart, I’m in a totally different economic environment than I was when it was at its highest. So how do you square that circle?

I think we’ll leave it with this, Jason. The other big thing that I think we provide, and that good financial professionals do, is hardly a dictation. It’s not an ultimatum. It’s a collaboration. And I think that’s why we can work so well with do-it-yourself investors who have had success and who do value the knowledge that we bring to the table — to collaborate together to make a custom portfolio that fits their needs, their plan, and where they are a part of the decision-making process but have the support of a team who’s making more informed decisions, less emotional ones.

Jason O’Meara
Exactly. Making decisions with data, not emotions.

John Walker
Having that collaborative approach — working together with an actual plan and outcomes that are defined — can really, really allow for do-it-yourself investors to work really well with institutional investors like our team.

So, I think I’ll leave you with this: a detailed financial plan really becomes the lens through which institutional investors look at every decision. Things like Roth conversions, asset location, how to handle concentrated positions, sequences of withdrawals over long periods of time—they all work together. They compound, they interact, they evolve. And managing them well requires a lot of attention, and one that not all folks have time to do on their own.

The other thing that’s important is we focus much more on managing wealth well and not just doing well in the market. Those two things are not always the same thing, right? And they can make a huge difference to your family’s overall bottom line. And so, Jason, I think it’s been a privilege to have this conversation with you. I think it’s a really important one, and it’s one of the most fun things we get to do for the families that we work with. Jason O’Meara, CERTIFIED FINANCIAL PLANNER™ and market leader, thanks for joining me as always.

Jason O’Meara
Of course, thank you.

John Walker
And so if you’ve heard what Jason and I talked about, and if you’re having trouble navigating it, have questions, want to see the difference between the way you do it and how other teams might approach a similar portfolio, we’re always here to help. Love to take your questions. You can email us anytime at jwalker@merceradvisors.com or jomeara@merceradvisors.com, and Jason and I would be happy to answer your questions.

On behalf of Jason O’Meara, I’m John Walker, Regional Vice President at Mercer Advisors. Thanks so much for listening to the Your Life and Wealth podcast. We’ll see you next time.

Announcer: If you’re interested in learning more about applying the principles we discussed to your personal financial circumstances, please visit merceradvisors.com.

This presentation by Mercer Global Advisors Incorporated, also known as Mercer Advisors, was intended for general information purposes only. No portion of the presentation serves as the receipt of or as a substitute for personalized investment advice from Mercer Advisors. All expressions of opinion reflect the judgment of the speaker as of the date of recording and are subject to change.