Retirement Investment: How Can I Reduce Risk and Enhance My Return?

 

Troy Sharpe: I want to give you two investment options to choose from, investment A and investment B. Both of them returned 10% last year. Which one would you invest in? Now, hit pause on the video. I want you to go down, write your answer in the comments. This is a little exercise, I want to see what your feedback is, but then also, once we go through the video, I want you to think about what you’ve learned and what your original answer was.

For many of you, this is going to be one of the best videos I’ve done in a long time because you’re going to get insight into the financial industry, how many firms like ours run their company, and how they run it differently from us. You’re going to understand fees versus value, but also investment management versus financial planning and how in retirement, it’s really important that those two get married together. The result of that here at Oak Harvest Financial Group is our retirement success plan.

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Two Retirement Investment Scenarios

I’m going to jump right into it now, but I want you to think about the answer to the original question in the beginning of this video. I want to show it to you in graph form. Here we have investment A and investment B, both return 10%. As you can see over here on the Y-axis, we have return percentages 5, 10, 15, 20 and on the X-axis, we have risk. The farther we go out on the scale here, the riskier the investment is.

We can see both A and B returned 10%, but investment B had more risk. Another question I want to ask you, your portfolio, because this math can be done not just for individual securities, but the entirety of your portfolio, the combination of investments that you have can be whittled down to a math calculation to determine where it belongs on this graph.

The question is, do you know where your portfolio would belong? Probably not. This is, in a very simple explanation, what an investment manager does. This is an investment manager’s job. Now, you have mutual funds out there and mutual funds have a specific purpose. We can quantify the math for a specific mutual fund, but a mutual fund isn’t usually trying to end up a certain place on this spectrum. Let me give you an example.

Large-Cap Growth Fund Example

Let’s say it’s a large-cap growth fund. They’re going to primarily, if not entirely invest, probably entirely invest in large-cap growth stocks. They have to make a filing with the SEC to explain what’s going to be in that fund, and that’s all they’re going to invest in. Based on that asset class, it’s going to fall in a certain place on this spectrum, but they can’t make adjustments to that fund in order to bring down the risk level or increase the return percentage.

Large-cap growth stocks are going to fall typically somewhere over here on this graph. As we look on the chart here, almost everyone is going to want investment A. If you’re a rational investor and you have enough information, you’re going to always choose the highest potential return, expected return is what we use in the finance world, for the lowest amount of given risk. Here at Oak Harvest Financial Group, this is step one of what we call the retirement success plan.

The allocation meeting, the allocation part of the overall plan, because wherever we end up on this spectrum in regards to your portfolio is going to be fairly predictive of the type of volatility you’ll experience, the expected returns over a period of time, and of course, the maximum amount of risk. Now, when we tie this into financial planning, let’s say someone comes in and they say, “Troy, I don’t want to lose more than 10%.”

Well, that’s good information for an investment manager because we could mathematically construct a portfolio that would fall somewhere over here to where the 10% is the maximum downside. Our job as investment managers would be to try to increase it up the return access. The question is, from a retirement planning standpoint, given your income needs, your health and your longevity, your tax situation, is all this money inside IRAs and 401Ks, do you have any tax-free money? Is it outside in what we call a non-qualified account?

What’s the tax impact? Can we make adjustments that are accretive to your return potential? Meaning, can we make adjustments that give you, for that given level of risk, higher expected returns? Where are you going to get your income from? What is the tax plan? Then step 4 and step 5 of the RSP is the healthcare side of things and the estate side of things.

I’m not going to get into healthcare or estate planning for this video, but step 1 of the RSP is the allocation and it’s important to understand that investment managers are simply going to construct a portfolio to get you into your high, medium, or low-risk tolerance and then that portfolio can be mathematically quantified to fall somewhere on this spectrum.

What’s your risk capacity and willingness?

A retirement planner is going to understand that with respect to your goals, your taxes, your income needs, your longevity and tie all this together and then create a calculation or a probability that shows, given those factors with this type of portfolio, this is your expected range of success. Now, many people who come to us, they have modest spending needs and they have the ability to take more risk. We call this a higher risk capacity. If you have the ability to take more risk, the question then becomes, do you want to take that risk? We call that risk willingness. You may know it as risk tolerance.

Easy way to think about that is if I were to tell you that your current portfolio, now this is a $2.7 million hypothetical portfolio. If I were to tell you that the downside over the next 12 months with how that portfolio is currently constructed is close to a million dollars. Now your capacity may be fine to withstand that, meaning the amount of income you need to take out of the portfolio won’t be impacted. Your lifestyle won’t be impacted if that does happen but the question really is your risk willingness.

Are you willing to stay committed emotionally to a plan, to an investment strategy if your investment profile, or your investment portfolio and profile are such that this could potentially happen? Some of you, most of you probably are sitting there shaking your head like, “No, that’s crazy. That’s a million dollars in a year. Do you know how long, Troy, it took me to accumulate a million dollars?”

As retirement planners, our job is to understand the investment side of things. Now, this is very important. How a lot of firms like ours operate is you see an advertisement, you give a call, you go see the financial advisor. The financial advisor asks you questions about your income and your assets and your risk tolerance. Most likely they work for either a brokerage firm or an RIA, which is a registered investment advisor. They could be an insurance agent, they could be a standalone CFP practice that just does fee-only financial planning.

How firms typically charge for Investment Management

Lots of different options out there in the industry but what we see a lot is when you have the RIA, where you go and meet with the advisor, but then they don’t construct that portfolio in the house. What they do is they outsource the investment management through what’s known as an SMA or a separately managed account. You come here, you pay 1% to your advisor, but then your advisor has all these different choices of portfolio managers to do this type of calculation for the portfolio.

Then the advisor chooses the portfolio based on either the statistics or their relationship with the manager. Then they may put some of your money here, some of your money here, some of your money here. Now, this guy’s not working for free, this woman’s not working for free and these people are not working for free. They may charge 1% also they may charge 0.5, they may charge 0.75. This is where the fees versus value conversation comes in because oftentimes these additional fees are embedded in disclosures that you may not have fully read.

Now, what are these people going to do with your actual money? Because they’re getting paid a fee to actually manage the money, but if they’re putting it into mutual funds or ETFs or other type of investments that have costs, maybe you’re paying an additional 0.5%. Maybe it’s just 0.1%. Or maybe it’s an additional 1% to 2%. When we do a hidden fee analysis for prospective clients that come in to see us, oftentimes we’re uncovering this. We’ve seen before anywhere from 2% to 4% of fees. Most of those people just thought they were only paying their financial advisor this 1% fee.

Now the question is fees versus value. Is this embedded system the most valuable for people in retirement? I think not. When we created Oak Harvest Financial Group, we said, you know what? We’re not going to have all these separately managed accounts. We’re going to bring the investment department into Oak Harvest Financial Group. We’re going to do all the planning and have the investment management done by a separate group but inside the company here that are employed by Oak Harvest.

Our Investment Team

Many of you may be familiar with Chris Perras, who has his own YouTube channel as a subchannel on the Oak Harvest Financial Group channel. Chris is our Chief Investment Officer, MBA from Harvard, undergrad from Georgia Tech with a BS in electrical engineering. Highly successful career in the institutional management world. He’s managed the number one-ranked fund in the country, the number two-ranked fund over both three and five years.

You can go through his bio here on the website. It’s under investment team. Many of you may also be familiar with Charles Scavone who is our Director of Investments, also a CFA. We just did a live stream where we went into depth about the stock selection process here at Oak Harvest Financial Group but Charles, again, very successful institutional career, launched three funds with 5-star ratings from Morningstar, 4-star rating for Morningstar and another fund that he’s managed number one ranked fund in the country as well.

We’ve brought these professionals, we’ve recruited them, brought them into Oak Harvest, and made them employees to manage the assets for our clients. The value that we feel that brings to you is we can help to eliminate a lot of these hidden fees that are very prevalent within the financial industry. Make sure you understand this concept, whether you’re working with us or not. You want to make sure that for what you’re paying, not just the 1% or one and a half or 0.7 to the financial advisor, you want to know what you’re paying in total. Now, just to recap that, the investment manager is responsible for constructing a portfolio of securities.

Those individual securities all fit somewhere on this graph, but then the combination in how the historical relationships between those securities and how the different prices react to different environments, but react together, that portfolio of securities itself can also fit somewhere on this graph. What we’re trying to do from an investment management side internally is to create lower-risk portfolios with higher expected returns.

We have higher-risk portfolios, we have a lot lower-risk portfolios, but that’s what an investment manager does. Now, I recently did a video on fixed-indexed annuity. Fixed-indexed annuities are 100% safe from market risk, rates today are amazing. They have been for some time now, just to let you know because a lot of people don’t understand the value of this asset class. If we were going to plot an FIA, right now your risk is, always your risk is zero with fixed indexed annuities and your return percentages very reasonably.

I’ve done videos on this, a lot of information out there, but somewhere between this 5% to 10% range is a reasonable assumption for longer-term returns with some of the higher rates. Now, that’s not guaranteed, but they’re tied to the market with no risk to your principal. We have a lot of videos on them out there, just want to throw that out there because when we start to consider FIAs as an asset class, as part of an overall retirement plan combined with stocks and bonds and possibly other investments like real estate. What we can do is statistically lower the risk of an overall portfolio while not sacrificing too much of a return.

We’ve done videos on there and because I’m going through this risk-return spectrum, I thought that was a very valuable piece of information to add in what role the FIA plays in a comprehensive investment strategy, especially for somebody approaching retirement or in retirement. You have a fixed income, which I also want to show here. This is the 20-year treasury bond ETF. The ticker is TLT. I have it over a five-year period, just want to show you the volatility of bonds. It was trading at almost 170, right around 170, this is back in July of 2020.

If we own this, now, it’s trading at 104. It’s roughly a 50% decline in value, so when someone tells you that bonds are safe, these are government bonds over a 20-year period. If we held them for 20 years, we’re going to get that money back, but if you bought it here, you’re probably down 40%, 50%. You’re not feeling like it’s too safe. It doesn’t mean the bonds can’t play a role in a portfolio, but just understand the risks and the interim and how they play a part in your overall investment allocation.

A lot about investment management, all that is just step one of the retirement success plan process, but we have several other steps and it’s all about you and your goals. This is where the income planning, the tax planning, healthcare, and estate planning start to progress. The RSP is not just a deliverable, something that we have as a plan, but it’s also a timeline for implementation of these different steps.

I’m just going to get into the high-level here, how this plays a role as part of your overall ability or willingness to take risk. Let’s say someone comes in, this is their current portfolio. It has a risk of 985,000 on the potential downside as far as dollars that could be lost in a great recession. We start to ask questions, so we ask the husband, what is your risk tolerance, your willingness to stay invested? He comes and he says, “You know what? I’m pretty comfortable with this. It’s 884,000, I’m not really batting an eye too much there. I may start to get concerned, but I’m not jumping out of windows.” Okay, excellent information.

Now, we ask Julie, and Julie says, “No, are you crazy? If my portfolio loses that much money, I’m firing you and I’m probably divorcing my husband.” Her risk score is way down here. It’s a 33 and she’s only comfortable losing around 99,000. We have to have a conversation of how much risk do we want to take as a family. Now, we can’t have that discussion and have it be an effective discussion without respect given to how much income do we need, how long do we expect to live, the tax situation, all of these things that are part of a retirement plan.

In this particular hypothetical example, we’re going to settle somewhere around about a 50% risk score. Now the question becomes, with this portfolio, can we meet our goals? Now, this is where the big, blue button comes in. Based on everything we’ve covered so far, the question is, with that new level of risk or with your old level of risk, with the income, the taxes, all of that, the adjustments that we’ve made on a probability basis, how long will the money last?

Conclusion

Big takeaways here. Investment managers are doing that investment analysis and portfolio construction. A lot of times when you go see a firm, we call these accumulation phase advisors, that is their specialty. They’re going to recommend multiple different managers to manage your money. To me, and I think to you, which should be really, really important, is all of that is fine, and it does need to be done. If it’s not done with respect to your income and all the other steps that are needed in retirement, it’s empty, it’s not the complete picture. That’s what’s different between a retirement planner and an investment advisor.

Now, we are investment advisors, that’s our license, but we don’t just focus on investments. We have an in-house investment team, but we focus on retirement planning. Our belief is when you marry those two together, you can increase your probability of success. Also, we tend to find that you sleep a little bit better at night because you know the investment plan is tied into the income plan, to the tax plan, and of course, the healthcare and the estate side of things. That’s the retirement success plan.

I hope this video was informative and helpful for you. I mention in the video about the fixed indexed annuity earlier. If you want to check that out as an asset class to understand how it can impact the overall risk versus return profile in an investment portfolio, click on this video right here. You’ll learn a lot.

Do you need a Retirement Success Plan that goes beyond allocating funds to truly fit your needs? We can help you create a retirement life plan customized for your retirement vision and legacy. Call us at (877) 404-0177 or click here to fill out this form for a free consultation.