193 Diversify & Asset Allocation

Jason and Emilia discuss diversifying and asset allocation during your retirement years.

Below is the full transcript:


Announcer: Welcome back, America, to Sound Retirement Radio, where we bring you concepts, ideas, and strategies designed to help you achieve clarity, confidence, and freedom as you prepare for and transition through retirement. And now, here is your host, Jason Parker.

Jason: America, welcome back to another round of Sound Retirement Radio. So glad to have you tuning in this morning. Emilia Bernal, welcome back.

Emilia: Hi Jason, hi. How is everyone. Doing great today.

Jason: Doing good, doing good. Boy, it’s nice to have you back in her, Emilia.

Emilia: Yeah, thank you.

Jason: We had some people say some just really nice things about you recently, and I appreciate that encouragement. It’s the encouragement that continues to move forward, so I’ve got a word of encouragement here for us because this comes to us from second Timothy 3:12. It says, “In fact, everyone who wants to live a godly life in Christ, Jesus, will be persecuted.” How’s that for encouragement.

Emilia: Very encouraging.

Jason: Persecuted. Well, that’s not what I signed up for, but I’m reminded. There is gonna be persecution, and how we respond to that persecution is very important. I’m being challenged with that through right now, so bring me a joke, Emilia.

Emilia: Yes, I’ll make you smile.

Jason: I need to lighten up my life a little bit.

Emilia: Here we go. So I know that we’re all working on the New Year resolutions and working out, but what do you call a snowman with a six pack?

Jason: I have no idea.

Emilia: An abdominal snowman.

Jason: I like that one. Boy, we’ve been having some cold weather. We’ve been out sledding and just enjoying the winter here in the great northwest.

Emilia: So that’s a snow day joke for you in case it comes up.

Jason: Well, thank you. Yeah. So this is episode number 193. The title is Diversity an Asset Allocation. So I’m a little bit fearful that we’re gonna get into the weeds a little bit with this topic and subject, but it’s important that we talk about. So let’s get into it.

Emilia: Let’s get into it. All right, Jason. So what is the difference between diversification and asset allocation?

Jason: Yeah, and I think this is so important for people heading into retirement. I am reminded that when you’re accumulating money, so when you’re in your 20s, 30, 40s, even 50s, you don’t have to think this way, what I’m about to explain to you, the same. So this is one of the reasons I’m always explaining that when you retire, your money’s gotta work differently for you. Diversification and asset allocation, sometimes people clump those together into just one area of thinking, and I disagree with that thought process.

Jason: Diversification to me means that you decide when you’re gonna need the resources, when you’re gonna need money out of those accounts, and diversification becomes a twostep process, where first you diversify your time horizon based on when you’re gonna need the assets. So you figure out how much money you’re gonna need, when you’re gonna need it, and the money that you need in the short term you want relatively safe. Money you need in the long term, you take more risk with. So the first one is just understanding when you’re gonna need the resource. So that’s why I say if you’re 20, 30, 40 years old, you’re not gonna need the money for a long time, so we don’t have to think of it in terms of buckets, but retirement’s a different story.

Jason: Asset allocation has to do with which asset classes you’re gonna be invested in. So small cap stocks, mid caps stocks, large cap stocks, some to fixed income, whether that’s long term bonds, intermediate term bonds, short term bonds. Maybe that includes some asset allocation to commodities or real estate investment trusts or treasury inflation protected securities. So looking at asset allocation and seeing how much of our money do we have in these different asset classes? So that’s what we’re gonna dig in today really, is understanding diversification and then also asset allocation.

Emilia: Great, so before going on to my next questions, I just wanted to ask you, is this topic covered in your book as well?

Jason: It totally is. Thank you so much.

Emilia: Yeah.

Jason: Yeah, we go into depth on both asset allocation and diversification.

Emilia: Great, so I just want to remind our listeners that we still have a great deal for our listeners. If you go to Amazon and you purchase the Kindle version for 99 cents, we’re still honoring that offer of a free paperback book if you write us a review and then go to soundretirementplanning.com, let us know you made the purchase, and give us a copy of that review. We’ve gotten so many great reviews so far, and we’re sending books.

Jason: Oh man, it’s really been fun.

Emilia: I think I sent one to Poland, which was awesome, so it was really interesting to see how many people we’re reaching. So just want to remind our listeners that you still have that opportunity to go out and make that purchase and get not only the kindle version, but the paperback version signed by Jason.

Jason: Yeah, and that 99 cents is going away, Emilia. I want to let people know. So we wanted to do that for our listeners. We wanted to give them the best offer first, but I imagine, it’ll probably be mid-March that we plan on increasing the price significantly on the Kindle book. So if they haven’t got it yet, this is a good, it’s not gonna get better.

Emilia: Yeah, there you go. All right, so let’s jump back into our topic today. So Jason, why is it important to diversity different in retirement then during the accumulation years?

Jason: Yeah, again, time is the cure to the volatility of the stock market. The more time you have, the more risk you can afford to take, and one of the things I hear from people often is they’ll, especially as we’re doing retirement planning so they’re still working, but maybe they’re a year or two away from retirement. They’ll say, “Jason, in the last downturn in 2008, I didn’t touch anything. I didn’t change anything. I just let it ride, and boy, that was a smart thing to do, because the market recovered, like the market always recovers.” And they benefited from that.

Jason: But the difference between being retired and having that happen versus working and having that happen is when you’re working, you don’t rely on those resources. You’re not dependent on those resources, and so it’s just different. When you’re retired and you’re having to pull money out of those accounts and you see the value drop by 50%, I tell you, that does affect you differently than when you’re working and you have your greatest asset, which is your income.

Jason: So it’s the right thing to do when the market gets wobbly is to not make any changes, but in retirement, we want to make sure that people are in a position where the money that they’re pulling out is not going down in value. So that’s the big difference is again, when you are working, your money should be working harder for you in a way that represents your lifestyle at that point. When you are retired, your money should work for you to accommodate that area of your life. Emilia, so many people don’t make that change, and so we want to make sure that they’re really thinking, not just about rate of return and not just about fees, but volatility and how we accomplish those.

Emilia: Yeah. So for our listeners, Jason, just like me, I’m a visual learner. How can, and I know you’ve touched on this before, but how can people visualize diversification?

Jason: The easiest visualization I think anybody’s ever come up with is the idea of having buckets. Some people use ladders, but the idea is you have a bucket for the money that you’re gonna need for the first 0-5 years, then a second bucket that you’re gonna need in years 5-10, and then a third bucket where you’re not gonna need the money for 10+ years. So if you just think of taking the money out of your 401k and your IRA and maybe keeping it in those accounts but having it in these different buckets.

Jason: Again, I’m just always reminded, retirement is all about cash flow. It’s about making sure that your income matches up with your expenses, or even better, that your income exceeds your expenses. So we just need to know that if we’re gonna have to be pulling money out of those accounts, especially when people are retiring early, say 55, 57, we see a lot of those people these days. 59 years old, and they’re not gonna start social security until 70. That means we gotta have a bucket of money there that’s gonna be relatively secure while they’re replacing their income. Then essentially what we’re doing is we’re just buying time. So I think the easiest visualization is to think of buckets.

Emilia: Yeah, so Jason, how much should people set aside in that first bucket then, if that’s, if they’re retiring earlier, what’s your recommendation there?

Jason: It really depends on people’s comfort with risk. So obviously, I would say probably at a very minimum one year of cash reserves, so in order to know what your cash reserves are, you have to know how much your spending is and what your other income sources are. But let’s say you’re spending $5,000 a month and you have no other income sources. Well, that’s $60,000. We know that we need to have $60,000 in cash at a minimum. We also know that the market can trade sideways or down over short periods of time, so we don’t have to look very far back in history to a year like the year 2000, 2001, 2002, where the S&P 500 was at three negative years there.

Jason: So I would say if you had four years of cash on hand, you’re probably gonna be pretty comfortable. I find that if people have over saved, if they have enough resources to accommodate it, if we can go out even five years, have five years of cash that gives them the most security. But again, it’s gonna depend on just how comfortable people are with risk.

Emilia: And everybody’s different when it comes to that. So what are some good financial tools, Jason, that could be used for this first bucket?

Jason: Yeah, so again, the idea with the first bucket is we don’t want to be losing money, and so we want the money to be safe and secure and guaranteed. We’re more concerned with the return of our money in that first bucket than the return on our money. So there’s always this trade off. The more time you have, the more risk you can afford to take, the higher the return potential. The sooner you need the money, the more conservative we want it to be, the lower the return potential.

Jason: Then there’s also issues of liquidity, but things like money market accounts, high yield savings accounts, laddering bank CDs, certificates of deposits, so maybe we can earn a higher interest rate. Using something like a single premium immediate annuity with a five year payout. An annuity contract is where you give an insurance company money and then they guarantee to pay you a certain amount of income every month. A fixed, deferred annuity contract, something that’s truly safe, secure, and guaranteed is the kind of vehicle that we’re looking for, whether we’re using some kind of insurance product or some kind of equity product or some kind of savings product. We’re just looking for something where you don’t have to worry about losing money in the short term.

Jason: I’ll tell you what does not qualify, Emilia. Sometimes people think of treasury bonds as being safe, and maybe if you’re gonna keep those to bills and notes where they have a very short maturity that would work, but treasury bonds going out ten years with treasuries and a rising interest rate environment. While treasuries are certainly considered secure, one of the more secure vehicles when held to maturity, if we only have three years to work with and you’re buying ten year intermediate term bonds, that does not work as well, because you have interest rate work, especially in a rising interest rate environment.

Jason: So again, just thinking of principle preservation. We want to be in a position where we’re not gonna lose money based on market fluctuations, and a market fluctuation today could be something like rising interest rates.

Emilia: Gosh, very important. So I want to take a quick little minute to also let our listeners know that you have another webinar coming up on Wednesday, February 20 at 5:30 PM. So you’ll be covering this information and a lot more and the same stuff and from your book too, so go get the book if you get a chance before the webinar, and you’ll have a lot of great tools there in front of you.

Jason: On February 20, Wednesday. Yeah, and that is so good for people that are visual learners like me that we can show them slides, and I’m gonna prove to them why focusing on the wrong thing could really get you into trouble. I will tell you, this is not gonna be popular. I’m gonna say this right now, it’s not popular. That is people focus too much on their fees and the rate of return and they’re not focusing almost at all on standard deviation or volatility. It’s not just the rate of return that you earn, but it’s how you achieve that return that’s so important, and I’ve got a couple of slides that really highlight that.

Jason: If they have not joined us for a webinar, I think they really need to get. I mean, fees and returns are important, don’t get me wrong, but how you achieve those returns is even more important. It could be the difference between having enough money to last the rest of your life versus running out of money. If you don’t believe me, join us on the webinar and I’m gonna prove it to them.

Emilia: Yeah. I’ve seen those slides, and I’ve seen people’s faces when they’re just like, wow. It makes a difference.

Jason: Yeah, you could have the exact same rate of return, but when you’re taking withdrawals out of portfolio, the standard deviation, the volatility matters a lot more.

Emilia: It does.

Jason: Yeah.

Emilia: Great. All right, so onto our next portion of today’s topic, Jason. Let’s talk about asset allocation. What are the different asset classes people should consider for their portfolio?

Jason: Yeah, so once we’ve diversified your money across time, determine how much risk we’re gonna take in each bucket, then we have to diversify across asset classes. The question becomes, well, why do we do this and how do we do it? There’s really two ways that I like to teach. Both of these are in my book, but what I call strategic asset allocation and tactical money management. Strategic asset allocation is based on modern portfolio theory. It’s based on the efficient market hypothesis. It’s based on the centers for research on securities process. It’s based on all of this academic research that’s been done that says that 90% of returns come from being in the right asset class at the right time, not necessarily from manager selection or from trying to be the best stock picker or timing of the market.

Jason: So strategic asset allocation says that we need to be broadly diversified across asset classes and sectors, and then what we do is rebalance the portfolio to maintain that asset allocation. Again, depending on your risk tolerance and depending on our time before we need that asset is gonna determine how much risk we can afford to take. Now, it is important, I think, when we’re thinking in terms of strategic asset allocation, we want to keep our fees as low as possible. At my firm, we like to recommend the use of exchange traded funds, ETFs, because I found that they provide some of the lowest fees. They give us broad diversification across asset classes and sectors and we can diversify across the entire globe. They’re liquid, so they give us the ability to rebalance easily without having to worry about fund minimums like mutual funds often have. For taxable accounts, they can be more tax efficient than actively traded mutual funds.

Jason: So I think ETFs are a good tool for helping people create that broad diversification. But then, Emilia, we can really get into the weeds with asset allocation when we can talk, again, about large caps, small cap, mid cap stocks. Then we could talk about intermediate term, long term, short term bonds. We can talk about some alternative asset classes, things like real estate investment, trusts, or commodities. You can make a case for all of these different asset classes, but what we do is we have a large pool of data based on how these asset classes have performed historically, and there have been some indicators that show that there are these trends, these things that continue, that persist over time.

Jason: For example, it’s one of the things that is called a small cap premium. So what we’ve seen is that there has been a trend where small cap stocks have outperformed large cap stocks over a long period of time. There’s also been a trend that shows value outperforms growth except for the last ten years, where growth has outperformed value. So what we’re looking for is the academic research that says, how do we structure a portfolio to create the asset allocation based on these segments, when we’re gonna need the money? Then rebalancing the portfolio is such a key to this, because when you rebalance a portfolio, what it forces you to do, and this is really counterintuitive. It forces you to sell some of your winners and buy more of your losers.

Jason: Let me say that again, because people are gonna say, huh? It forces you to sell your winners, sell the positions that have done well and buy more of the positions that have done poorly, and you think, why in the world would I ever want to do that? Because what most people want to do is they want to hold onto their winners and sell their losers. What we say is, well, if you believe that the market’s efficient, that no one asset class ever dominates year after year after year and there’s all kinds of, I mean, we can link to some of this research in the show notes.

Jason: But people will see that that, historically, has been the case. While, something like small cap value may be a strong performer this year, next year, it could be treasury inflation protected securities. So instead of trying to outguess the market, if we know that 90% of the returns just come from being in the market, then what we do is we try to create a portfolio that’s gonna give you the proper risk based on the time horizon that you’re gonna need those assets. So that’s strategic asset allocation.

Jason: The second part of this, and this is where I was worried we were gonna get into the weeds is what I call tactical money management. Let me talk for a minute about why I’m getting into the weeds. I made the mistake of reading one of the reviews about our podcast. I know I shouldn’t do this. This is that persecution I was talking about. It’s funny, we get all these really great, positive reviews. People coming and writing about the book, and then there’s one negative review. It was like, I just dwell on this, and I dwell and I dwell and I dwell and I think, man how can we be better? So part of what negative reviews do for me is they do make me think, okay, well, how can we be better? But the other thing I do is sometimes I overcorrect and I think, oh, I gotta give people more of this technical data because they’re engineer minded people. I have to kind of get in the weeds with them, and I know that’s a mistake too.

Jason: So this is a little bit of a course correction because I made the mistake of reading a negative review. Now, I will say that there’s that saying, and I wish it was more true, but it says, “In your 20s, you’re worried about what other people think of you. In your 40s, you don’t care what other people think about you, and then by the time you’re in your 60s, you realize nobody was ever thinking about you in the first place, because they’re all thinking about themselves.” So fortunately for me, I’m in my 40s, and I like to think that I don’t care what other people think about me at this phase of my life, but obviously I still let some of this stuff weigh on me.

Jason: So okay, back to tactical money management. Got that off my chest. Tactical money management is the art of investing, and for as many articles that you will find if you Google “strategic asset allocation”, if you look for some of the research that’s been done on this subject, you’ll find a lot of people that disagree with it. So that’s why we talk about tactical money management, the art of investing. Nobody’s won the Nobel Prize in Economics for tactical money management, but what it says is there are times when it makes more sense to move to cash or to a defensive position than just to ride the market all the way up and all the way back down again.

Jason: So again, depending on people’s comfort level with risk, some people like to include a tactical piece in their portfolio. Some people like to be 100% strategic. I think it’s important from an advisor’s perspective that we want to help people create a plan that they want, that there’s some disadvantages to tactical money management. So you’re gonna have typically a higher fee structure and there’s gonna be more trading costs, and there could be more taxes associated with that. So you say, “Well geeze, Jason, when I look at the fees and I look at the trading costs, do I really want to have that tactical piece?” That’s why I think it’s so important that people join us for the webinar, because when they understand that it’s not just the rate of return, it’s not just the low fee structure, but it’s how you achieve those returns. It’s the variation of the returns around the mean. It’s the standard deviation that really is so important in a portfolio where we’re withdrawing money out of an account that people really need to understand that. It’s not just about rates of return and fees, and that’s where everybody’s hung up today.

Emilia: Gosh, yes. So just reminding our listeners, that webinar that Jason’s speaking about is gonna be Wednesday, February 20 at 5:30 PM, and you can go to soundretirementplanning.com today to register for that webinar. So do we have time for a couple more questions?

Jason: Yeah, let’s get done.

Emilia: All right, so Jason, do you think there’s enough emphasis put on volatility?

Jason: No. Again, this is one area that I just really, really, really, really hope to underscore and circle and highlight and get people thinking differently about their money in retirement. One of the most challenging things people ever understand is that whatever money you have now has to last for the rest of your life, because you’re hopefully not working anymore, or at least not earning a paycheck. You’re probably still gonna be working. We experience that a lot. People are busier than ever in retirement. They’re just not getting paid for all of what they’re doing.

Jason: But yeah, the sequence of those returns, Emilia, become so important in a retirement withdrawal strategy. It is the volatility that matters. It is the standard deviation. Of course, we need to know, and there’s a difference between what rate of return you want to earn and what rate of return you need to earn. I’ll never forget, years ago, a gentleman came in and he had over saved for retirement. We found that if he just earned a 2% rate of return on his money, he was gonna be okay for the rest of his life. How comforting is it to know that you could buy a bank CD, put all of your money in this thing earning 2%, and be okay forever?

Jason: Whereas what if we find that you have to have, in order to make the numbers work, you have to get 10%? Boy, that’s really stretching it. You might want to consider becoming an Uber driver or walking your dog, starting a dog walking service at Rover so you have some kind of cash flow coming in, because that is not a realistic expectation. If you’re building your portfolio and retirement around an assumption that you have to get 10% per year and you think that that’s gonna work and it doesn’t, you could end up really flat in that kind of situation.

Jason: The other thing, when it comes to this whole retirement planning and rates of return equation, Emilia, is that people, everybody thinks they’re gonna live to 100. You see a research report that says, hey, 20% of people live to age 92, and everybody thinks, oh, well that’s gonna be me. Wow, man, I can’t think, we work with a lot of retirees, and I just see not very many people actually making it into their 90s from my limited perspective. Now, I do believe people are eating well and exercising and medicine and science and technology’s getting better, and so there is a possibility that they could live a really long time, but what if they only do live to life expectancy? What if they’re 65 and life expectancy’s 82 and that’s how long they make it?

Jason: My friend Dean, his mom lived to be age 102, and Dean was in incredible health. We thought he was gonna live to be older than his mom, and he ended up dying at age 79, because when cancer sneaks up on you, it limits your time very quickly. So I think having a realistic expectation for what that time period needs to be for the money to last is really an important thing to think about, and it’s one area that a lot of people are kind of, some people are afraid of dying. They’re afraid of death. They don’t want to address that subject.

Jason: The other issue, Emilia, is that people, they think they’re gonna be spending the same amount of money when they’re 92 as they did when they were 65. That’s just an unrealistic expectation. When you’re 92, I hope that you’re still out on the cruise ships dancing and doing back flips into the pool, but there’s a good possibility-

Emilia: I’ve seen a video of a 90 year old gymnast. It was pretty awesome.

Jason: Well, that is awesome.

Emilia: But it was a very, very rare, I don’t think I’ve seen it anywhere else.

Jason: But it may not be the case. You may just, we know a lot of people in their late 80s where they just kind of want to stay a little bit closer to home, and they don’t travel as much and they don’t eat as much. When they go out to dinner and it’s two of them, they buy one meal and they split it two ways, because they just, and then they bring home leftovers because it’s too much food for them. So just understanding that this whole thing with retirement doesn’t have to be that we’re inflating expenses into forever.

Emilia: All right, so do we have time for one last question or?

Jason: Unfortunately, no, we’re out of time, but just remind our listeners, they can get the book on Amazon Kindle for 99 cents, and we’ve got a webinar coming up. Until next week. Thanks, Emilia.

Emilia: Thank you.

Announcer:Information and opinions expressed here are believed to be accurate and complete, for general information only, and should not be construed as specific tax, legal, or financial advice for any individual, and does not constitute a solicitation for any securities or insurance products. Please consult with your financial professional before taking action on anything discussed in this program. Parker Financial, its representatives, or its affiliates have no liability for investment decisions or other actions taken or made by you based on the information provided in this program. All insurance related discussions are subject to the claims paying ability of the company.

Announcer: Investing involves risk. Jason Parker is the President of Parker Financial, an independent, fee based wealth management firm located at 9057 Washington Avenue Northwest, Silverdale, Washington. For additional information, call 1-800-514-5046 or visit us online at soundretirementplanning.com.