Episode 507 – The Risk You Want vs. The Risk You Need

The content shared on Your Life, Your Wealth Network reflects the views of the host and guests of the program only, and are not necessarily the views of Cordasco Financial Network or its advisors. This media production is educational in nature and should not be construed as financial, legal, or tax advice or a solicitation or presentation of sale of any financial products or solutions. Please consult a professional prior to making any financial, tax, or legal decisions.

Welcome to the Your Life Your Wealth Network, 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. Always a pleasure to be with you. And today we’re gonna talk about why your financial advisor may want you to take more risk than you think you can handle. Why sometimes we find that advisers are pushing. For a higher growth allocation. And might feel right to you. And so before you dismiss that advice or change advisors for that matter, There’s a lot of new research that suggests that that tension between you and your comfort zone, and where your team might be pushing you, may actually work in your favor. There’s always a disparity between maybe what you think you can handle and what you may need to be successful.

And this is a conversation we have all the time with the families that we’re working with and why financial planning is so critical to this conversation as a whole. And so to help me discuss this and talk a little bit about how we address this push and pull between risk comfort and risk need is my good friend and colleague here, CERTIFIED FINANCIAL PLANNER® and market leader, Mr. Jason O’Meara. Jay, thanks for joining me today.

Jason O’Meara
Of course, John. Thanks for having me back.

John Walker: Always a pleasure, my friend, and I think, I think it’s fair to say. That When particularly In the beginning of the planning process, but frankly on an ongoing basis, particularly as the market Has volatility or swings or people feel like it’s over overweighted or overinflated or all these other things, right? We always get questions around, well, you know, it, it, they’re usually something to this effect.

Either, you know, the market’s really frothy and they say something to the effect of, Should we take some of this off the table, right? Should I be taking some of this off the table, or They’ve been advised or read an article somewhere that says when they hit a certain age, right, your favorite rules of thumb, lazy as could be, right? Well, if I take my age and I divide by the, right, no, no, no, no, you know, like all of 100…

Jason O’Meara
…minus my age is how much I how much I should have in bonds, right?

John Walker
We get these kind of things. All the time, right? And so I caught an article that basically said there’s research out there that advisors recommended stock allocations, so the, the orientation towards growth often exceed. What investors say they want, right? So, right, right, they,

Jason O’Meara
I mean, let’s call it what it is, John, right? There’s that difference between wants and needs.

John Walker
Absolutely right.

Jason O’Meara
And we’ve had this conversation around budgets, around, you know, spending money, like, you know, there’s wants and there’s needs, but when it comes to investing, there’s wants and there’s needs as well. How do we, how do we kind of bridge that and how do we help clients stay on track is really what we’re looking at.

John Walker
Yeah, and this study indicated that. Retirees with an average risk preference typically favor about 39% of their portfolio in stocks, whereas their advisors, in contrast, recommend closer to 48%. And candidly, that 9 point gap is not trivial, right? That is a, it’s a fundamental divide in how retirement investing should be approached. And so, you know. There, that push and pull, that dialogue, that understanding of This is about more than market risk for you is, is a critical conversation to be had, right? And I think that’s sometimes what’s lost in this whole.

Enterprise, right? There’s market risk, which is important, right? That’s how much. Volatility am I allowing to come into my portfolio, right? And it’s something that we really can’t, the markets, we say this to families all the time, Jason, we can’t control, right? We cannot control that, but what we can control is Building a portfolio that’s diversified enough that gives you a high probability of success for your longer term goals. So when we talk about risk, we have to reorient it to other types of risk, and I think that’s where, when we have that conversation beyond volatility and what you can stomach on a day to day basis and reorient it to what are the actual serious threats to your planned success.

Jason O’Meara
Yeah, we see that all the time. We hear kind of the same themes run through. One, you, there’s a few different types of people that we come across, right? One is that the black box thinkers, I call them, that they believe that the market is just a random number generator. They have no idea why it does what it does and how it does what it does. It’s just every day it just spits out a number, right? And so when we come across people thinking like that, they tend to be a little bit more hesitant. To invest right in, in, into the into the equity side of the market. God forbid we explain bonds. It’s even more confusing, right?

So, so the reality of it is those are the people who are probably more likely to want to take a step back, especially if they had a couple of really good years in a row, you know. Why is this going to continue? How do I know this is going to continue? How do I know I’m going to lose it all, you know, they kind of have that casino mindset where, all right, the house is going to win eventually. And the reality of it comes down to, if we look, um, you know, one of your biggest threats to your retirement is inflation. Right, if the cost of living increases every year, we know that, we see that, we get those numbers all the time, right? What are we doing to preserve your buying power? And the reality of it is equities is one of the best ways to fight against inflation.

John Walker
I mean we certainly are, this is, you know, top of mind for a lot of families right now with inflation being so much in the news and people feeling it at the grocery store and the gas pump, right? These are the, you know, I think it’s a, it’s a relevant conversation right now. It’s always a relevant conversation, but inflation, the rising costs of goods, erodes your spending power, right? And so, If you do not. orient your assets in a way that they can keep pace, right? You are spending more money of your retirement assets is an example to maintain a similar lifestyle, right? And so while it may be challenging emotionally to put your portfolio in a position that seems riskier, you might actually need it.

And when we share with families, Jason, that conversation of like, listen, which is the greater risk? Are you More afraid of running out of money. Or a little bit of an up and more, more up and down on a day to day basis than maybe you’d like, right? Like where on the risk spectrum are you, right? Which is more dangerous to your well-being? And I’ll, I mean, overwhelmingly we find people are much more concerned, right, about, well, I don’t, once I retire, I don’t want to go back to work. I don’t want to have to change my lifestyle. I don’t want to have to. Whatever, readjust because I’m worried about, I don’t want to have to worry about running out of money, right?

Jason O’Meara
And that inflation is that invisible threat, right? The problem is when the market goes down, when there’s a downturn, even if there’s a correction, 10, 15%, whatever, they see that clients see that number as real. They see it on their statement. The account just went down. They had a million dollars, now they have $850,000 and they didn’t spend any of that. And there’s that feeling of loss, right, even though it’s on paper, we can go, we can go down this stuff, we can say that that we’re blue in the face, but the reality of it is the feeling exists and it’s real.

Inflation is that one that you don’t see. Inflation is that one that sometimes maybe even prices at the grocery store stay the same, but the packaging gets smaller. It becomes almost this. I’ve had people say inflation is not real, and I was like, what do you mean by that? Yes, it is. I can prove it to you.

John Walker
Yeah, you know, it’s data. It’s math, right? And, and so that is. One of the, as you said, the silent risks, one of the other ones that people don’t think about is longevity.

Jason O’Meara
Yeah, countless times, John, we’ve heard, oh, I’m going to retire this year, so I, I no longer need to be invested. They looked at retirement as the goal, the deadline, they hit retirement, they no longer want to be invested because they don’t want to lose their $1.5 million or whatever they have, right?

John Walker
Exactly. And so now I can take risk off the table and we say, when we build out plans and we model them out to 95 or 100 years old, we also often get, well, I’m not going to live that long. Well, candidly, if we knew how long you were going to live, we wouldn’t have jobs, right?

John Walker
But candidly, right, the reality is you may not, but, but the data says you statistically have a pretty high probability these days of getting into You know 90s, into your 90s, right? And so when we show people that and we say, listen, you’re 65 years old, this money that you have worked your entire life to save now needs to help support you for the next 20 to 30 to 40 years. Sometimes for families. Some people these days are retired longer than they worked. And so when we talk about risk, it’s the risk is.

You need to make this hard earned savings last for a potentially very long time and that requires a certain amount of growth to keep pace, right? You need to be able to continue to grow your assets through retirement potentially so that you have sustainable resources. To support your lifestyle. So that, that is a different mindset than what a lot of people approach it with, which is what you share, Jason. They say, I hit the summit, now I can take all the risk off the table.

Jason O’Meara
But the reality of, of it is, John, not only that, you’re now living off of this pile, right? So now you have a depleting pile. You’re pulling money off of it, right? So we always say there’s cash flow and there’s cash pile. Cash pile is your, is your, your, your account value that you are now pulling off of to, to survive. Unless You are only taking out the amount that, you know, dividends and interest are making up, which most portfolios aren’t producing enough dividend and interest to really do that, right? There’s always some level of of uh pulling actual shares of your investments. The reality of it is we need that account to grow to backfill what you’re taking out, and in the good years we need to grow more so that when there is a down year, because the only thing I can guarantee you there will be another down year, right?

We want to make sure that we’ve built enough cushion to be able to, you know, insulate you from now saying, oh, my account’s, you know, at a million is now down to 850, and I have to take out my, you know, 567 $10,000 a month. How do I build this account up so that we are not causing more pain in these down, down markets, right? So, one of the ways to do that is, as John mentioned, maybe taking a bigger bite out of the market than what you expected. Again, on all this, by the way, if you’re listening, all this is within reason, right, within reason, based on your financial plan. Again, John always says purpose drives strategy. So the reality of it comes down to without a strong plan, how do you know that you’re taking too much or too little risk?

John Walker
And I think that’s really it. When we build out plans for families, Jason, and when, when planning is how you begin this conversation. And it’s oriented on, all right, what are your cash flow needs going to be? What are you spending on an annualized basis? What sources of income do you have to support that pension, Social Security, whatever goes into the pot, and we put it all together and we say, OK, that means we are going to need to get returns of X to make your plan sustainable, right? I’m just going to make a number up. We need 5% annualized returns to make your plan successful. We need 8%. Whatever that number is that makes the plan successful a majority of the time, right?

We do Monte Carlo simulations. We model it against all kinds of market volatility, and we say if you were to average this type of return, would your plan weather all of these potential variables? And if that’s the genesis of how you start building a portfolio, instead of letting risk drive the conversation, risk tolerance, risk, you know, your preference around risk, we have to orient it around risk capacity, which is the objective measure of how much you need to take so that your plan is successful. It’s about math and facts and not your feelings, right? When you talk about risk preference, That’s so subjective. It’s shaped by who you are as a person, what your experience has been in the markets, what your family’s experience has been in the markets, you know, and, and candidly, it shifts wildly for people through their lifetime, right? Sometimes we see that, you know, we call it FOMO, right?

That fear of missing out. When the market’s doing well, people are all of a sudden ready to take a lot more risk than they were because they want to participate. They don’t want to miss out on what everybody else is getting. Even though 2 years ago they wanted all their money in cash and bonds, right? And so that separating those two and orienting it to the plan that says you need to take this level of risk to be successful, that’s where we start on the dial. We can turn it up or down depending when it’s predicated on a plan and not just how you feel.

It, it really can help, you know, families understand. You need to take this level of risk to be successful. That may not be where you thought you would be, but let’s show you why. You know, a 70/30 makes more sense right now than the 50/50 that you thought you wanted to be that you were more comfortable with, because that market risk is outweighed by the risk. of not reaching the outcomes that you want, right? It’s moving beyond that stock and bond investing framework and saying it’s less about the portfolio allocation and more about What do you need to be successful, right? When we shift the shift the dialogue to a different target, I think we have a much more successful conversation around, and I think that’s why we find and the data shows that advisors are having to, because of these things, the risks of longevity and risks of inflation, that we are moving more families perhaps out of their comfort zone with growth because they need it. There’s a framework that we use. To help Families get to a good spot on this where we can resolve their capacity and tolerance versus what they need.

Jason O’Meara
Exactly, exactly. So that’s the big one, right? We, you know, what they want versus what they need, uh, and it can go either way. I mean, we’re talking here about, hey, maybe you need to have more equities, but maybe there’s some people who have actually won the race, and maybe we’re sitting there saying, hey, you don’t need to take on this much risk. We can lower that, we can lower it back.

John Walker
I’m so glad you brought that up because we do actually get to have that conversation sometimes too, right. We’ve been talking a lot about pushing folks out of their comfort zone, but sometimes we get the pleasure of saying, hey, if you don’t want to take as much risk as you’re taking right now, you don’t have to anymore. Like, you’ll be totally fine even if you get, which is actually really fun and why I love, you know, when we meet a lot of new families.

They’ve been trained to evaluate advisers by performance, and we get asked all the time, Well, what’s your average performance? And we get to say, you know, people think we’re trying to avoid the question, but we say, I have no idea. Like that’s not how we do things around here.

Jason O’Meara
Everybody has their own portfolio, and I can’t answer that.

John Walker
It’s accurate, right, because we have families that you’d be like, you’d say, well, that return doesn’t seem to be that aggressive or even You know, that doesn’t meet the S&P and we said, you’re completely right because that’s not what we’re trying to do for them and it’s not what they want. It’s not what they need. They’re quite comfortable de-risking and getting the type of returns they’re getting because that’s what we set out to accomplish together. So that, that’s right, separating the preference from the capacity and finding, you know, what do you actually need and what do you actually want and where.

Jason O’Meara
Do those two meet, but you really can’t to that determine what you need though, we need to be specific, right? We need to evaluate how does it, how does, how does a super aggressive portfolio work inside your plan? How does a super conservative portfolio work inside your plan, and then some blend in the middle, right? When we’re dealing with those kind of investment questions, you know, it, we can’t be vague, you know what I mean? You can’t be vague. You’ve got to know what you’re investing in and why. You know, and, and that’s another thing like, you know, every, every, everywhere you go has a different methodology around investing and, and you have to find a methodology that fits your needs, you know. Some people are super passive, some people are super active, some people want a bunch of private stuff, and you know what I mean, it’s a matter of us kind of finding which one of those tools. Work best for your situation,

John Walker
Yep, and then test it.

Jason O’Meara
Right? That’s the important thing, right.

John Walker
Using, using Monte Carlo simulations, using all the capabilities we have from a planning perspective and test what, what is the likely outcome, right? We can’t guarantee future performance, right? We can’t tell you what the future holds, but we can make our best efforts to test the data, see if it’s going to, how it might work out, give you that spread, right? These are the potential likely outcomes from this is the median likely outcome. This is the best case scenario. Here’s the worst case scenario, and where are you comfortable, right? What do we need to do to be comfortable after you do all that, right?

Jason O’Meara
The most important thing we can do after that. is to test again every year, right? We monitor, we make sure that there’s no, that we’re, I, I, I always tell clients the same thing, or families the same thing. We’re going to watch this every year and we’re going to see problems a decade before they arrive and we’ll have plenty of time to make small adjustments now to avoid having to make massive adjustments later.

John Walker
We use sort of that the GPS analogy a lot, Jason, right? Like just, you know, you know this from, from your own personal experience outside of the investment space, right? If you start walking and you turn to the a little too far to the right and start on that angle, in the beginning, you’re not too far off the path. But give it, you know, an hour of walking, and now you’ve somehow deviated a mile from where you’re supposed to be. And this is a similar type construct, right?

Hey, these little reorientations, these little testings, these looking in 3 to 5 year windows instead of 30-year windows and making sure that we are on track for where you want to be and constantly. Testing it constantly, having this conversation, letting this tension be a good healthy thing, right? When you’re panicking because the market’s really volatile, going back to the plan and saying, yep, I know this is scary right now because the market did X, Y, and Z, but that is a small window, right? Let’s look at the big picture and that is really sort of how we planned for this. That’s the big one, right.

Jason O’Meara
If you can, if you can sit there and say, oh, we’ve planned for this, we knew these things were going to happen and it’s gonna be OK. And let me show you where we did that and what it looks like for you.

John Walker
Exactly, exactly, so you know, ultimately, Jason, the goal isn’t to find the perfect allocation, right. There isn’t one, but it’s just Coming up with the plan and the, the investment structure that balances the math. With something that fits with your Comfort and can be sustainable. That’s the nuance of what we do and where working with a good planner and a partner can really help because it’s really, really challenging to, to find this on your own and to separate the emotion from the data. Jason O’Meara, a CERTIFIED FINANCIAL PLANNER® and market leader here at Mercer Advisors, thank you so much for joining me, which, you know, for a conversation I think is really important and the 11 we, we have quite a bit around.

Jason O’Meara
Yeah, exactly. Not a problem, man. Thanks for having me back.

John Walker
And so if you have questions about what Jason and I talked about, if you’re really struggling with this push and pull between what you may need and what you may feel, we’re always here to help. Give us a call anytime at 215-558-3500. That’s 215-558-3500, or you can email me at jwalker@merceradvisors.com. That’s jwalker@merceradvisors.com.

And as always, if you’d like to learn more about how we actually construct portfolios and how our investment team thinks about the market, I highly encourage you to listen to our Market Perspectives podcast with our Chief Investment Officer, Mr. Don Calcagni, which you can find at merceradvisors.com under the podcast tab. I’m John Walker, Regional Vice President of Mercer Advisors. Thanks so much for listening to the Your Life Your Wealth podcast. Have a great week.

If you’re interested in learning more about applying the principles we discussed to your personal financial circumstances, please visit Cordasco Financial Network at CFNplan.com.