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Has Risk Changed?
Episode 3321st September 2021 • Financial Planning for Entrepreneurs and Tech Professionals • Mike Morton, ChFC®
00:00:00 00:19:17

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We all know that you can barely get any interest, or return, on your savings account. The Fed is keeping the interest rate very low, which translates into low returns on savings and safe assets like money markets and government bonds. With so little return in the traditional fixed-income side of your portfolio, does that fundamentally change the way you should consider risk?

It used to be that you could get 4-5% interest on fairly safe investments like your savings account and money market accounts. Therefore, to invest in more risky assets like an individual stock or the entire stock market, you would expect to get more than 5%. Seeking risk wasn’t the safe thing to do, avoiding it was. But now we’re in the opposite regime: you have to actively seek out risky investments in order to get a decent return.

It’s important to understand the associated risks of your investments. Make sure that you know what the range of future outcomes could be, and how that might affect your ability to reach your goals. Be confident with a plan on how you will proceed in any given market event.

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Transcripts

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That might be the most risk you're taking. Enjoy the show. 


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[00:00:34] Mike: I'm feeling really great now. Thanks Matt. 


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What's on your mind. 


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So the bottom line up front. Risk has fundamentally changed because of the Fed's policy, because we have such low interest rates these days. It used to be that you could invest your money into a savings account that savers. We're really rewarded because you could pretty easily get three, four, 5% on pretty safe, not taking too much risk in a savings account or money market accounts. 


And so in order to invest in other areas, you needed to get a return more than that, more than that four or 5% in order to take that risk. And so it had to be a pretty good payoff. Now, as we know, interest rates are so low, you can get, if you're lucky, maybe 1%. And so individuals are really looking around for other investments to get more than that 1% and those investments can be quite risky. 


And so that's what I wanted to talk about today that the change in environment and the risks we're taking, 


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Maybe you want to send your kids to college, and then you build your financial approach around your goals. But if the interest rate environment, if the return you're getting on your portfolio of investments is fundamentally lower, it does reset your whole plan. You have to think differently, and maybe you need to be willing to take on more risk. 


If you want to achieve the goals that you've set. 


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That they might be more volatile and they could go down more often than your less risky, investments. And therefore you might not reach your goals. So it's a trade off. And it's a tougher environment these days. Especially, a lot of talk is around people retiring, like you said, we want to have these goals. 


The old 60, 40 portfolio we've talked about is that dead. That 60% in stocks and 40% in bonds, which was a very classic sort of retiree portfolio, is that now dead because interest rates are so low, I'm not buying that argument necessarily, but you just have to go in with eyes wide open understanding that. 


Your bonds and fixed income investments are earning a lot less than they were 20 years ago. And inflation may be, average or rising. So therefore you're losing out purchasing power. So what risks are you taking in your portfolio? And making sure you understand the. 


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[00:04:27] Mike: yeah. You just want to understand what risks you're taking and do you need to take them? If you have part of your portfolio and you say, oh, look, I'm going to take this a risk. This bet. I think this company is going to do well, or the sector is going to do well , imagine that with that amount of money. 


So whatever that means to you say, I'm going to take some part of my portfolio and be a little more risky. So think about that. If that goes up by 10 times. All right. So think about. What you might risk how much that would be in your portfolio. And it goes 10 X. Okay. So put another zero behind it. How would your life be different? 


Would that really fundamentally change your future? I'd feel great. Obviously you don't put an extra zero behind that number that feels really good. But if it's not going to change your lifestyle significantly, if it's a shrug oh, I'd have a little more money, I'd be a little more comfortable. 


I could do, one or two extra things or something, but it's not a big shift then maybe that's a risk not worth taking because think of the other side. Okay. So think about that same amount of money and think that it goes to zero that you lose. Would that change your outlook? Would that change how you feel? 


And so is that investment worth it? So that's how you want to think about when you're taking riskier investments and now time horizons come into this and everything else, but just really understand, what you gain from that investment and what you could potentially lose from that event. 


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Kind of being the baseline for most investors who have taken your Sage advice. Over the years, the average investor, who's, let's say looking ahead to retirement and is in a target date, retirement fund. It's 20, 21 right now. You're looking ahead to 2040 when you're going to retire and you've got a portfolio of investments and you're in an index fund. 


That's basically attuned to the right degree of risk to achieve your financial goals. Bye retirement. Is it the case that degree of risk is different than you may have thought of it being because of the interest rate environment? Is there more. Risk embedded in that portfolio because it's aimed at achieving based on historic returns and projected volatility. 


Is there more risk embedded in those portfolios than we even realize 


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Okay. That could be an investment in say an individual company that's pretty volatile. Like you don't really know which way it might go. It's not in a sort of a tried and true standard industry, so it could go, could we great and go 10 X or could flame out? So we understand the potential risks of that. 


Same as we understand, like we've talked about before going to the casino and betting on black, you understand I'm either going to double my money or it's going to go away. I understand that when you're talking about a 


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[00:08:21] Mike: So in terms of a target date fund, that's massively diversified across U S international and stocks and bonds with a 20 year time horizon. 


You have to look at the bands of where it might end up. So you could say, look, five, 6% a year growth plus, or minus two to 3%. So then the bands are, it's with one or two standard deviations, you might make one or 2% a year or you make 10% a year. And so it's going to end up with, over 10 years. 


So understanding where it's going to at where the average might be, what the high might be in, what the low might. And seeing, are you going to reach your goals, especially based on the lows? Okay. So I don't think there's too much necessarily different embedded risks because of the interest rate environment. 


Now that said what the interest rate environment is potentially doing is boosting the value of riskier assets because there's nowhere else to get that return. Okay. So if I need a 7% return to reach my goals, okay. A pension fund, a state pension fund . They know how many workers and when they're retiring and how much they're gonna have to pay out and they need a seven, eight, 9% return. 


I'm obviously not getting much of that from my fixed income. My bonds getting me one. So if I'm that pension fund, I have to take on more risk and hope for the higher return. So potentially supply and demand more money is going into riskier assets, boosting them. Okay. So your target date fund has done pretty well in the last few years and in the future, if the fed raises interest rates and we can get more return on that fixed income. 


There's potentially wind out of the sales of riskier assets because , some people no longer need those riskier. 


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Are there other different types of risks that we should be aware of in this 


environment? 


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about 


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[00:10:54] Mike: That's right. That's right. So it's been going up and so your portfolio to your point, you're in that target date fund and that target date fund has been adjusted for you automatically, but if you're not, if you're in just the S and P five if you're in a total stock market fund and then maybe a total bond fund, and you want a 60, 40, we mentioned that 60, 40 classic portfolio. 


If you were in that 60, 40, maybe in the last couple of years, or even this year alone, the market's up over 20% in this calendar year. So you might be sitting on 65% equities, instead of just 60%. And so it's a good time to rebalance, that automatically sells. And buys low fixed income. 


Really hasn't gone anywhere this year. So you sell 5% of your portfolio and that's gone up and you buy the things that have not gone up and hopefully in a couple of years, and that changes roles. I That's the whole point of rebalancing. You might get a little bit of boost of returns by selling high and buying low. 


So there's something just to be aware of that, the risk you wanted to take in your portfolio, how volatile you wanted it to be may have increased just because the markets have been going up the last. 


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Okay. But he did have a funny observation. Once back when he was just a comedian before he was a monster, he was telling an anecdote about seeing a sign-up at a diner, one egg, any style, a dollar 39, 2 eggs. And he stopped. A dollar 59, what's wrong with the second egg. And it begs this question of what are the motivations of the person on the other side of the transaction. 


So how does that all play out as you think about risk in this kind of an environment? 


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No problem. It doesn't really matter. Who's on the other side of the tray, this is for your risk tolerance and how you want to try to reach your goals. If you are constantly buying into your 401k, it doesn't matter. If someone's selling, you're just, buying into the market because you got a 10, 20, 30 year time horizon. 


That's great if you're trading a stock because you have a belief and they're buying it or selling it because you think it's going to go up or go down. That's a good time to think about who's on the other side of. In a bear market where things are going down, lots of people are bailing out. 


Okay. They could be bailing out because they're scared that they're running out of money. They can't take the risk. So that could be an okay time to be buying, if you. can tolerate it. But when things are going up and your buying who's selling who's on the other side of that, often it might be somebody that has more information. 


All right. There is there are tens of thousands of people. I like to say tens of thousands of people. Full-time 40 to 60 to 80 hours a week researching analyzing these companies, talking to them, boots on the ground tons and tons of time and energy to try to outsmart the market. Okay. I don't know if you're putting in that amount of time into, that research. 


So I think it's always, so I always think it's just good to recognize that and just say, okay, and then I'm not. 


saying don't pull the trigger. I'm just saying, understand, who might be on the other side of that trade? The other point that I do want to make on the other side of the trade is lots of people are in different situations. 


And that I think is a lot of it. Hey, I'm going to be retiring soon. I need to, slowly sell out of my riskier things and buy less risky things. So they're just selling out of that. It's demographics might drive a lot of the buying and selling as well. 


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[00:15:17] Mike: No, in terms of risk, there's always a lot of different factors. One that I wanted to highlight is that we're all feeling pretty good about. The markets. Okay. Not saying about other parts of what's going 


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good. 


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One market keeps chugging along. It's up about 20% this year could end 30% higher by the end of the year. I could definitely see that happening too. I can see a good. 


dropping 30% over the next two or three. We have experienced with that 18 months ago. That's exactly what happened. So would you be surprised in either of those two directions that neither of those would surprise me at all? 


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[00:16:23] Mike: Yeah. So that's just, first of all, that's just good to understand. Okay. You have to be prepared. For each of those situations, what are you going to do? You could do nothing. That's fine. Okay. I'm not saying you have to do anything, but just being understand that either of those situations could happen. But right now you asked the market, are there other risks? 


We're all feeling good because the market's just been going up and up 56 all time highs since a year and a half. 


ago, it's up 22% this year. Nothing can go wrong. All the sectors are on fire. Everything's gone up. Everybody's made money in the market. Everybody's feeling good. So people are buying, so just be aware that's that's a risk, understand your own feelings around that. 


w did you feel, last March of:

[00:17:09] Matt: Depends on the day. 


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The markets were tanking. Everything was just going badly. And I remember the day that it turned around, the markets turned around, the news was terrible. Literally you were terrified. I didn't know what was coming next. It was all on the. And we've forgotten all about that, which we do as humans, which is great that we can quickly move on, but just really, it's good to understand that based on what I said before, you never know what's coming next, so you really want to be. 


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We're confident. We're about to hit. Our next one. I hope that we're all about to hit our next big shot in the market. Mike Morton and not suffer an alien invasion, who knows. Maybe there'll be friendly aliens, but I doubt that they'll have such Sage market wisdom as you have Mike Morton financial advice. 


Thanks so much for 


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