How the Economy Affects the Marketplace with Brad Kasper
How the Economy Affects the Marketplace Show Notes
When it comes to retiring, nothing matters more than building a portfolio that allows you to achieve your goals, and no one knows this better than Brad Kasper.
As the president of LSA Portfolio Analytics, Brad Kasper helps 440 financial advisors manage over $8.5 billion in assets by building better portfolios for his clients, working directly with them instead of tying into client assets. He believes in using math to create solid strategies to meet goals, and as simple as that may sound, it’s less common in the financial services industry than it should be.
Today, Brad joins the podcast to talk about how shifts in the economy and the marketplace affects retirees. You’ll learn how the rules change as you transition from accumulating to distributing your wealth, where fear of the stock market comes from, and the steps you need to take to ensure that your portfolio positions you to live the retirement you’ve always wanted.
In this podcast interview, you’ll learn:
- Why investing isn’t just about making money – and the reason the S&P 500 isn’t a predictor of success for the average investment portfolio.
- How advisors can get caught up in emotions when trying to please clients – and why chasing markets doesn’t set you up to succeed.
- Why fear stems from a lack of understanding about what you own – and how to think about changing values of stocks, homes, and other assets.
- Where Brad finds data, the analytical tools Brad uses to understand data, and how he uses this information to advise advisors.
- “The most important question, the one you have to start with, is ‘What’s your objective?’ I deal in an industry where there’s a lot of really smart people, a lot of egos […] and at the end of the day, if you didn’t ask this question, your entire premise of what you’ve built that portfolio for is wrong.”
– Brad Kasper
[00:00:09] Dean: As always, thank you for listening to the Guide Retirement Show. We know there’s thousands of podcasts out there and we appreciate you listening to ours. I’m Dean Barber, Managing Director at Modern Wealth Management. This episode we’re going to be talking with Brad Kasper. Brad is President of LSA Portfolio Analytics and Brad also has a degree in Economics and Brad’s going to be getting really technical with us on a few things as it comes to investment theory, economic theory, and what a person should be really looking for, listening to in order to understand what’s going on, not just in the economy but what’s going on in the economy affects the marketplace. I hope you enjoy this episode.
[00:00:54] Dean: Joining us, Brad Kasper. And so, Brad, President and CFO of LSA Portfolio Analytics, I’m going to have you explain a little bit more about what that is. You also do your own what you call FANN Radio, FANN as a Financial Advisor News Network and your main focus is on helping financial advisors build portfolios for their clients and that is your entire business, right?
[00:01:24] Brad: That’s correct.
[00:01:25] Dean: All right. So, you have about 440 advisors that you work with all across the country, helping them construct portfolios for their clients and your firm, LSA Portfolio Analytics, is influencing about $8.5 billion in assets.
[00:01:41] Brad: That’s correct. So, we are an institutional research firm based here in Kansas City. We work with independent advisors across the country to help with construction of portfolios on a number of platforms, mutual funds, ETFs, 401(k)s, 403bs, really anything with an investable chassis. We help advisors with how to search, how to allocate portfolios, and then most importantly, how to monitor over time and make good, important investment decisions for strategies.
[00:02:11] Dean: All right. So, how long have you been doing this now?
[00:02:13] Brad: So, we launched back in 2005, so we’re coming up on our 15-year number here.
[00:02:19] Dean: All right. So, that’s awesome. That’s quite an influence, $8.5 billion in assets under influence in 15 years. That’s a big accomplishment. Congratulations.
[00:02:28] Brad: Well, thank you, and it’s been an interesting path, to say the least. You know, when we established our business model, we acknowledged that cost is always an issue. And so, we really wanted to address our solutions in a very different way than what this industry has seen in the past. So, we actually work directly with the advisors. We don’t tie into client assets. We don’t charge additional expense ratios. It’s a unique way for advisors this time to research that I think is extremely appropriate for clients and especially if you’re focused on controlling the expense side of that equation when investing.
[00:03:01] Dean: You know, we’ll get into that expense side of thing at some point during our discussion, but I want to go and I want to start here, Brad, with your background. You went to the University of Maryland. You’ve got a degree in economics and that’s been kind of your love. You like kind of digging in and understand why things work the way that they work and the mechanics behind why investments work the way they work and how different things in the political environment or economic environment affect different types of investments. And so, talk a little bit about that whole process and not too great a detail, but give us a little bit of a flavor of what it is that you look at.
[00:03:42] Brad: Yeah. So, my wife is a therapist. She describes me as a functioning introvert, which means I probably do better in front of numbers and reading research and things along those lines than people, but I can also be personable as well as hopefully, I’ve been able to demonstrate over the last 14 years of knowing you. That said, when I started in this business. I gravitated to the investment side of it. Why? Again, there’s a lot of numbers, a lot of math that I can sink my teeth into. And what we were trying to do at the time was really establish a defined process. We weren’t trying to get cute with anything. We are simply stepping in and saying, where does the math work out to where we could build solid strategies that fit a goal? And I know that we’re going to be talking about different types of goals down here in a few minutes, but we really wanted to establish strategies that resonated for that goal purpose. And so, I leveraged my background in economics and understanding what’s happening in the markets to help influence the development of portfolios.
I leveraged my background in math because this is a business that is driven by statistics. There are so many stats that we could probably do a four-hour segment on those alone and I had a passion for it and so we started developing processes around those stats, around what’s happening in the markets to really build out what we define as meaningful strategies that we think resonate well, especially for those investors that are in retirement or pretty darn close to it.
[00:05:12] Dean: Why is it different for somebody that’s in retirement or close to it? I know the answer to that, but I want to hear from someone with a background in economics and someone who really I’ll call it geeks out on the numbers and the statistics. Why is it different in retirement or close to retirement than say somebody in their 20s or 30s?
[00:05:31] Brad: Well, I think that’s the most important question that you have to start with is what your objective. Ideal in an industry where there’s a lot of really smart people, a lot of egos engaged. Everybody’s puffing their chest talking about, “Oh, my strategy did this, my strategy did that,” and at the end of the day, that’s all great. We can take a step back and listen to it but if you didn’t ask the question of the investor for that specific strategy is what’s your goal of that strategy? And I think your entire premise of what you built that portfolio for is wrong.
[00:06:09] Dean: But so many people, Brad, they think that, well, investing is simple. The whole goal is just make money.
[00:06:14] Brad: Yeah. Go outpace the S&P 500 and 15+ years of doing this, I’ve never seen the S&P 500 be the determining factor of success within a financial plan, yet that’s what our investors seem to think our industry gauges all this by and I think that’s crazy. Now, if I’m a younger investor, maybe the S&P 500 or the risk of their S&P 500 might make sense. Why?
[00:06:40] Dean: Well, hang on a second. I got to throw something out at you here. So, let’s say that we take the peak of the market in the fall of 2007 to the trough of the market in March of 2009 where the S&P 500, an unmanaged index which you can’t really invest directly and there’s some funds account that mirror it, but that index was down by 57%. So, are you telling me that a person says, “I want to beat that loss of 57%,” so if I manage to only lose 55%, I’m a winner?
[00:07:13] Brad: Well, trust me, there’s a number of people in our industry that would define that a success if that’s what their benchmark was and if that was the goal of the investor was to simply outpace the S&P 500, I guess you could use that as a barometer of success. But let’s think about that for a minute. If I’m older in retirement or darn close to it, the disruption of 57% drawdown in your account is detrimental. You know, for me…
[00:07:41] Dean: That’d be almost impossible to recover from.
[00:07:43] Brad: Yeah. You know, the simple math that I like to use is if I were in an investment that lost 50% so I had $100,000. Now, my account’s worth $50,000 and the question I always ask of any investor is how much do I need to make on that $50,000 to get back to my $100,000?” And what do you think the answer is 8 out of 10 times?
[00:08:02] Dean: Fifty percent.
[00:08:03] Brad: A lot of loss, but that’s not the reality. So, the miracle of compounding works when you’re growing assets.
[00:08:10] Dean: When you have a positive return.
[00:08:11] Brad: When you have positive returns. When your account of $100,000 goes down to $50,000, I now have to make 100% return to get back to where I started and we use that as a gauge of this is what I want to be as an investor is just keeping pace with what the S&P 500 is doing, but it’s used time and time again through multiple market cycles. Why? Because the S&P 500 is going to post a couple of really positive years. We get in this mindset that we’re missing out on something so we start chasing those types of returns and again, I take a step back to what the previous statement was. If we don’t understand what the goal of the investor is, your strategy is rendered worthless.
[00:08:54] Dean: So, in your role as President and CFO of LSA Portfolio Analytics where you are helping 440 independent financial advisors around the country construct portfolios for their clients, is part of your job then to help that advisor understand these realities or does the advisor in all cases, understand it or are there cases where the advisor gets caught up in that emotion too and says, “Well, if I’m not keeping pace with a particular index, my client’s going to fire me.”
[00:09:26] Brad: Yeah. So, majority of my conversations are direct with financial advisor’s account across the country and one of the things that I pride ourselves on is we’ve always taken kind of this educational approach to the way that we talk about how we build strategies, why we believe they’re relevant. And so, yeah, we’re constantly having conversation with financial advisors so that they have the language to be able to communicate through different market cycles, the importance of focusing on what the strategy was built to do to hit a specific goal or target. And so, I think as soon as you start to deviate away from that educational process, you’ve rendered yourself to the markets and you’re at a whim just chasing wherever the markets happen to be blowing at that point in time.
[00:10:12] Dean: Yeah, I know. It’s been really interesting. Since the advent of the ETF or the index-type funds that are designed to track or mirror an index, people tend to look at that, “I should be doing this. That’s what I should be doing,” but the reality is you start to talk a little bit ago about this whole concept of how it’s different when you approach retirement or it’s different when you’re in retirement and the whole purpose of the Guided Retirement Show here is to really help people understand why things and rules change as you approach retirement and as you enter into retirement. So, we got off on a little bit of a sidebar there but bring us back to why the focus for your group is geared so much around that person, that pre-retirement, retirement age range.
[00:11:07] Brad: So, let’s take ourselves back to the initial phase that investors go through, the accumulation phase. You get out of college. You start working, you build your family, you try to save as much as you can, because why? There’s a goal down the road that you’ve established enough wealth that you can take a step back and live off of that wealth without working for the rest of your life.
[00:11:28] Dean: They call it financial independence.
[00:11:30] Brad: Financial independence. So, in accumulation phase, one of the topics that I think this industry leans on quite heavily is the idea that you have time on your side which means if you want to go get the best returns out there, the industry is going to paint this picture of go be 100% in equities or something that’s ultra-aggressive, something like the S&P 500. And if you happen to be subject to a period like 2000, 2001, and 2002 where the S&P dropped in a very similar fashion, what we saw again in the Great Recession of 2007 through 2009 that you have time on your side to recover those losses. So, in accumulation phase, they’re really leaning on time as your friend. And to be candid with you, after doing this for so many years, I think there’s some truth to that.
If you can stomach being down some of those 50% drawdowns that the S&P has yielded then, yes, that research, the data suggest that over time you’ll be able to recoup that and provide greater growth. Why? Because more often than not, we’re in a growth pattern within the US equity markets. But here’s where it gets difficult is at some point, you’re going to transition out of this accumulation phase into distribution phase and that’s a whole new that’s opening a Pandora’s box at that point because what disrupts investors in distribution phase is the lack of time. And so, if I’m overexposed to those equity exposures that we’ve been taught to utilize and my 401(k) just go get the growth, growth, growth for 30+ years, if I follow that same example and all the sudden my account that has appreciated to $1 million as an example dropped to $500,000 in 2007 through 2009, I think that might have an impact on what you can draw out of that over the lifetime of your retirement days and that’s meaningful.
[00:13:34] Dean: And so, your idea then in the investing just before retirement, say 5 to 10 years out or in retirement is there has to be some sort of protection mechanism or some sort of offset for those equity positions. You’re not saying time the market or something like that. You’re just saying build a portfolio that can take you through different cycles and then understand the likely outcome of that type of a portfolio through all market cycles. Is that what you’re saying?
[00:14:07] Brad: It is, but I want to take a step back first, because even in accumulation phase, we still believe in the power of diversity, and we think that you can still be aggressive investor and get equities, but you can spread that risk of equities between domestic and international. You can look at emerging markets, you can look at other sectors that might help diversify the return patterns over time to give you an experience where you’re still not trying to avoid the big participation and the massive drawdowns. We’ll talk more about why we think protect first and promote growth second is always the most important way to think about investing. But as I start to get older, that portfolio, that diversified strategy needs to continue to morph into something that is it continues to focus more on that preservation of principal side of the equation than the growth side because again it’s the disruption late in retirement that can blow up a financial plan very quickly.
[00:15:00] Dean: Okay. But I don’t think it’s just that. So, I’ve been a financial advisor now for 32 years. I’ve known you for almost 15 years and I think you do a fabulous job of what you do, but I think that there’s a lot more what I’ll call behavioral finance psychology of the individual investor that really is the problem here and not just the strategy itself because you can look at different strategies and you can have one strategy that say is let’s call it a moderate growth strategy where you might have a 70% equity exposure and a 30% fixed income exposure and you can then compare that to a strategy that is just the opposite, 70% fixed income, 30% growth or equity positions. Run that through a financial planning program and you can see that the probability on the end of the plan of that person being able to do what they want to do is really the same with the 70% equities or the 70% fixed income.
It’s opposite, right? So, you can make it work both ways. However, what I would argue, Brad, and what I want you to talk about here is that the portfolio that 70% equities can have more substantial losses than the portfolio that 70% fixed income and even though knowing intuitively and from mathematical-based decision and knowing all the statistics and all the facts that, hey, that drawdown and that 70% portfolio, yes, it hurts but it’s not going to impact your ability to do all the stuff you want to do. You can say that the somebody but the reality is how they feel when it comes to the losses that they experience won’t allow them to actually carry that through the other side, and I think that’s where the real danger comes in is that people they’ll bail, right?
[00:17:00] Dean: They just say, “I can’t take the pain anymore,” so they jump out and then they’d have no plan for reentry and so those losses become permanent and I think that’s the most devastating peace. And so, to me, that’s where the investing in retirement is so different it’s the psychology of it more than it is the underlying mask. I can look at those two strategies and say, “Hey, either one of these things is going to work. You’re going to be successful,” and we look at statistics and we look at time and we look at backtesting and we look at taking you through the great recession, the ‘87 market crash, the 2001 dot-com bubble, the financial crisis in Russia when they had the Russian bond crisis. I mean, we can go back into the energy crisis. We can test all these different time frames and say, “Look, you know what, yeah, you had some losses but just give it time. It’s going to be okay.” But psychologically, I think people have a real problem with that.
[00:17:48] Brad: Yeah. You’re having a full discussion around what we spent a lot of time on which is behavioral finance, how do we respond to the way that our investments are behaving. And to your point, this can be a double-edged sword. So, let’s go back into our 2008 as an example. If I’m in that accumulation phase because I sat across from a financial advisor that said, “You have time on your side. You can do this. Just be a little bit more aggressive. Go participate in the markets,” and then all of a sudden I get halfway through 2008 and I watched my account lose 20%, 30%, and then all of a sudden what I do? I throw my arms up in the air and say, “I give up. I can’t take this anymore.”
[00:18:29] Dean: Right? Because they don’t know where the end is.
[00:18:31] Brad: Yeah. So, what emotion are we drawing on there, right? When we think of that big pullback, we’re talking about fear. And in this case, when that capitulation happens, I typically see investors go to very secure assets, their CD rates, the money markets, that short-term fixed income, “I don’t care what it is. Just get me the heck out of the way of the equity markets.” Well, what ends up happening, they stomach a lot of the losses you had just mentioned and then they’re sitting on the sidelines when that dead cat bounce happens in March of 2019 and the markets roll back 20 some odd percent in a single year and that disrupts this overall return profile so…
[00:19:10] Dean: You said 2019. You meant 2009.
[00:19:12] Brad: 2009. Thank you. So, let’s go back to your original premise here. If I’m in a 70/30 or 30/70, the ability for those to work for your financial plan is it requires the investor to have the mindset and the ability to live through those market cycles to avoid those fear trades, to also avoid what we’re seeing a lot of right now. Markets are at very lofty levels here now in 2019 and we’re seeing people at the tail end really chasing that return. Because why? Now, you’re talking about the greed side of the equation, this fear of missing out on returns. And where is it coming from? Maybe you’re playing golf and somebody in your force talked about this tremendous stock portfolio that’s up 20 some odd percent, whatever it happens to be. We start to feel that we’re missing out on that, but again, all of this is great conversation but what does that circle back to is the original thing that we talked about.
If I don’t understand what my goal is as an investor, then I can’t make the appropriate decisions from an investment strategy, from an allocation, maybe or my ability to tolerate the up and down market participation in different types of market movements.
[00:20:32] Dean: Okay. Let’s take a quick break. This is the Guided Retirement Show. I’m Dean Barber. We’ll be right back.
[00:20:37] Female: Thank you for joining us on the Guided Retirement Show with Dean Barber. We hope you are enjoying our show. If you’d like more information on what Dean is discussing on this episode, make sure to visit us at GuidedRetirementShow.com/10 and then make sure to subscribe so you can stay up to date with our latest episodes. Know of someone who could benefit from learning more about their retirement? Go ahead, share us with a friend. That’s the GuidedRetirementShow.com/10.
[00:21:11] Dean: Are you telling me that a person says, “I want to beat that loss of 57%,” so if I managed to only lose 55%, I’m a winner?
[00:21:20] Brad: Well, trust me there’s a number of people in our industry that would define that as a success. If that was the goal of the investor was to simply outpace the S&P 500, I guess, you can use that as a barometer of success, but if I’m older, in retirement, or darn close to it, the disruption of 57% drawdown in your account is detrimental.
[00:21:50] Dean: We’re back. This is the Guided Retirement Show. I’m Dean Barber. So, to get back to what we were talking about, so let’s help our listeners here and let’s talk about realities that are present when it comes to investing because this whole fear side of things, Brad, I believe stems from a lack of understanding of what people own. So, if we broke it down into a simple company, let’s use a company that everybody would recognize. Procter & Gamble would be a perfect example. What does Procter & Gamble do? They sell and produce and manufacture household products, soap, shampoo, on and on. They had a Folgers coffee. So, all these different things.
So, if Procter & Gamble stock drops by 50%, does that mean that all the sudden Procter & Gamble is only selling 50% as much as what they were the year before, the week before, the day before? Does it mean that their earnings are off by 50%? Did they lose 50% of their clientele? Did they lose 50% of their workforce? What really happened and why in the heck would a stock like Procter & Gamble go down by 50%? I’m just using that one company as an example because I think people can relate. So, from an economic standpoint, explain why that can happen and because if people don’t understand why that can happen then that’s where their fear of this thing is never going to end and all of a sudden, I’m going to wind up with nothing comes in.
[00:23:36] Brad: That’s right. So, take a step back as an investor. If we’re going to step into some type of an investment, we have to understand what that investment vehicle looks like. In this case, we’re talking about stock that gets issued on some of the broad exchanges out there and when I purchased that stock, I’m buying it at a price that the market is deeming as fair value and we’re hoping, we’re buying that stock with the thought that over time we think that there’s going to be growth within that Corporation, and then you go through a market cycle where economic data impacts them to some degree. Maybe it impacts their bottom line so they can’t generate as much revenue so what ends up happening, these corporations will introduce on a quarterly basis earnings reports and those earnings reports simply go out to everybody and it’s a bill of health, how am I doing? How’s the company doing?
And when I look at pockets like ‘08 where you saw a number of companies down over 50%, it’s not that all the sudden overnight their workforce was cut in half or that all of a sudden they’re not selling as they’re selling 50% less of their goods or products. But there’s an impact that’s happening from an economic perspective that is driving the consumer, us, we’re the ones buying the shampoo, we’re the ones buying the household products, and that pattern starts to change and it impacts the bottom line, the revenue side of their equation.
[00:24:57] Dean: So, what causes the stock price to drop so much? Is it a buy-side, a sell-side bias? Is it more people want to sell them, want to buy? What’s the root cause here?
[00:25:07] Brad: Market sentiment. I mean, you have to be able to translate economic data, translate earnings, and come up with the idea that says, “Here’s where the markets are deeming as fair value.” And as an investor, we either ride through that and say, “I think Procter & Gamble has the ability to recover on the backside of that. I see the strength. This is just mispricing of the markets,” or you sit there and say, “No. I want nothing to do with that. I see the writing on the wall. I see the pain points.” But we’re talking about a single stock. There are so many different investments that we can step into.
[00:25:41] Dean: So, can we relate this to our listeners? Let’s relate it to the real estate market because I think that’s something that everybody can really get a grip on is real estate and let’s just talk about homeownership as an example. So, in 2000 and let’s see, it was the Fair Housing Act, which I believe was put into place in the late 90s that basically encouraged banks and lending institutions to pretty much loan money to everybody. So, it became very simple to get a home loan, there was this mad rush, and you had new home sales, existing home sales, all just going through the roof, therefore, you had this massive rush of buyers so it was a sellers’ market. People were able to ask the premium for their house. They were seeing the prices of their house go up by 10%, 12%, 15% a year depending upon the area of the United States you live in.
And then all of a sudden, we had this financial crisis. It was a lending crisis. There was too much money loaned to people that shouldn’t have borrowed it. They started defaulting on their loans. They’re all the derivatives and credit default swaps and things that are way too complicated to talk about here, but then all of a sudden somebody woke up a year later and they said, “Well, that house that I purchased in Florida for $500,000 is now being appraised for $250,000.” So, in that particular example, you could either say that the $250,000 isn’t really reflective of what that house is worth, or that individual really overpaid for that house. So, that same concept applies to stocks, right? If you paid $100 for a Procter & Gamble stock and all the sudden you wake up a year later and it’s worth $50, is 50 really the reflective price or did you overpay at 100? So, it’s understanding how companies are valued, how real estate is valued, and understanding where you are in an economic cycle before you make the decision to invest and for what period of time are you going to invest.
[00:27:48] Brad: Well, I think that real estate is a fantastic example. We can get our minds wrapped around it. If I were going to be buying a home in that timeframe, guess what, the end of 2008, early 2009 when all these appraisals on the homes were very cheap from a market perspective created a tremendous buying opportunity.
[00:28:09] Dean: Well, we see it now in hindsight, but we didn’t know. We didn’t know was this the end? Am I going to pay 250 with this thing and all of a sudden, I’m going to wake up in a year and it’s going to be $125,000? Where’s the bottom? And there’s where the fear comes in, Brad.
[00:28:22] Brad: It is, and this is an industry that we’re always taught about buying low and selling high but the way that our emotions operate is it tends to yield the opposite effect. So, for people that had the foresight to step in the 2008 and 2009 and look at these properties and say, “Listen, over the next five years, 10 years, the valuation on that property is exponentially higher.” They took advantage of buying low, but the problem to your point is when you’re in the midst of a financial crisis and you’re seeing your house, your stock position, that’s just getting crushed, when you execute on that fear trade and you release or you get rid of that specific investment, you just realize that loss. And so, you’re making a statement that says, “That loss today is good for me because I think there’s greater loss around the corner,” and that’s often not the case, right?
I mean, how many times have we seen too many people migrate away from really solid positions, really good company names because we just happen to go through a cycle that created so much fear that they couldn’t stomach anymore the loss. The balance sheets are probably still fairly healthy of a lot of these names. The long-term outlook on some of these companies are probably very healthy. Use Apple as an example. I mean, gosh, Apple stock sat there for over a decade and didn’t do anything and then all of a sudden, it’s not that the company was rendered worthless. It just it didn’t have a good captain behind the ship. And so, once you got the captain navigating the ship, look at what Apple stock has done for investors over the last 20 years. So, it’s understanding that valuations matter in any type of investment that you step into.
[00:30:10] Dean: Okay. Let’s take a quick break. This is the Guided Retirement Show, I’m Dean Barber. We’ll be right back.
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[00:31:36] Brad: You know, this is an industry that we’re always taught about buying low and selling high but the way that our emotions operate is it tends to yield the opposite effect.
[00:32:00] Dean: Welcome back to our program. I’m Dean Barber. So, what should a person look at? If they’re going to buy, if they’re going to invest, do I look at price-to-earnings and if I’m using price-to-earnings do I use Shiller’s CAPE Ratio when I look at the price-to-earnings? Do I look at a price-to-book? Do I look at Tobin’s Q ratio? I mean, there’s all kinds of – if you want to look at how you value a company today, there’s a half a dozen really popular valuation methods that can be used and the question is what should an investor be looking at when they’re thinking of investing?
[00:32:40] Brad: So, I think there’s two sides to that response. One, there are so many different stats out there that investors can step into to help them make a valuation decision with how they’re buying an individual stock. Let me be candid, I’m not a stock picker. I’ve seen a number of different methods work with a number of different strategists or analysts that are out there.
[00:33:00] Dean: Right. But you understand overpriced and underpriced. So, let me take it back to the real estate as an example. If that house in Florida that I gave an example on a few minutes ago, you paid $500,000 for but the appraisal said it’s only worth 250, why would you pay 500 for it? So, I’m trying to establish how does a person determine what’s the real value of what they’re purchasing. You and I today if I’m going to go out and buy a piece of real estate, the first thing I’m going to do is I’m going to get an appraisal and say, “What’s it worth?” and I’m just going to be compared to other properties around of similar type, similar size, similar age, etcetera. We want to know is it appraising for what I’m buying it for? That’s our valuation metric on real estate. It’s simple to understand. What’s my valuation metric on the market?
And with so many people just throwing money into their 401(k)s and let’s face it, what they’ve done in creating this situation where many people have to opt-out of enrolling in their 401(k) and they have this automatic enrollment and it’s throwing them into these we’ll call lifestyle lifecycle funds or target-date funds or things like that, there is no possible way that the average person can understand what in the world are they buying and what’s the valuation of what they’re paying for today and is it really fair?
[00:34:26] Brad: Yeah. It’s a great question. So, let me answer this very simply. I think balance sheets matters so a price-to-book equation makes a whole lot more sense to me. Why? Because it gets back to the fundamentals of any business model that’s out there. At the end of the day, if you are going back to your home real estate analogy here, if I were buying a home, but balance sheet was I’m spending a whole lot more on a monthly basis than I’m bringing in, I don’t have the capacity to step in and buy that home. It doesn’t matter what the valuation is at that point in time. We’ll translate that over to the stock side of things. If a company is shelling out so much money and maybe they’re targeting growth, maybe they’re targeting something, therefore, expansion, it doesn’t matter. If they’re shelling out more money than they’re bringing in, at the end of the day, I’d say that’s a pretty tough equation to get your mind wrapped around that. The price of that company has the ability to grow unless these investments really pay off. So, your risk starts to jump up quite a bit there. And when you take a step back and think about target dates or the lifecycle funds, it’s extremely challenging for any investor to step in and say, “Am I getting this at a good price?”
[00:35:33] Dean: But I think the whole concept there and really the premise behind those target-date funds is to do what you said early on in this podcast, which was, as you age, you should get more defensive. Well, I think a lot of people believe that if I just use this target-date fund, this target retirement date fund, well, that’s automatically what’s going to happen. Yeah. We saw people, Brad, in the ‘08 financial crisis, the great recession that owned a target date fund of 2010 that took a 37% to a 40% loss. Well, I’m sorry. If I’m two years out from retirement and this thing has enough exposed that I can lose 35% to 40%, that didn’t really reduce the risk like I thought it was going to. I think a lot of people got hammered by that and for me, as a financial advisor, I think what in the world were they really doing inside there and how did that happen and even more importantly, how does the individual investor identify that potential and be able to do something to protect themselves?
[00:36:40] Brad: So, yeah, first of all, I think the general premise of what target dates were released for were incredible because it addressed the two things that we talked about earlier. I have a goal of retiring in 30 years. I have a 30-year time horizon. Each year I want to get more and more conservative as I get along. So, the general thesis of what they put together there was phenomenal. Now, the problem is on the execution side of it. Do we really understand what we’re owning as we’re getting more conservative the closer that we got? And I think your 2010 example of the target date funds’ performance through the ‘08 timeframe is prime. Here are people, investors that are two years away from retirement and experiencing a 30 some odd percent drawdown within their portfolio. Well, gosh, if I’m investing in a target date, I would think that I’m fairly conservative if I only have two years left on this slow of migration out of kind of that equity to fix or that more aggressive, more conservative.
And the reality of all of this is when you peel back the onion of some of these products that are out there. What you find is you are overexposed or maybe had greater risk that were associated because you are overextended maybe equities domestic, international. Maybe in your fixed-income side of things, you were too focused because there’s so many different opportunities that would exist there and I think that was detrimental to a lot of investors and kind of puts them really tarnished a lot of the target date funds.
[00:38:12] Dean: All right. So, how do we find this data? What analytical tools do you use to understand what’s in there? So, because what you’re doing really is you’re advising advisors and you’re the guy that you say is more comfortable with math than you are with people. Give me a computer and give me the numbers, the crunch, and I’m there. You’re the functioning introvert that your therapist wife says. So, you’re in there in the numbers. What are you looking at and where do you get your information?
[00:38:44] Brad: Well, there’s so many tools. I mean, I’ve often argued that over the last 10 years the accessed information is just incredible and almost to a detriment because a lot of times we let that information drive decisions that are impacting our day-to-day investing and I don’t think that that’s the best response to the way that you digest information. But there’s simple tools out there. Heck, people can go to Yahoo Finance and grab a quote on almost any stock name that’s out there.
[00:39:11] Dean: Yeah, but the quote’s not going to do anything especially on target-date funds. It’s going to tell me what the price is that day but that’s meaningless. What does it own?
[00:39:17] Brad: So, where do I go a step further? Well, Morningstar has some access points that I can go in there and get some high-level information. But if you really want to look underneath that hood, you start to have to pay money for these systems. At LSA, it’s almost embarrassing how many different systems that we utilize because we’re constantly in search of new information. We use firms like Zephyr which is a tremendous data feed and it allows us to dive down into information and statistics that are more relevant when you’re starting to construct portfolios because we’re talking about very simple a single stock or a single asset class like real estate.
And what I hope investors get out of this or listeners get out of this program is there’s a lot more to just saying, “Hey, I need these couple names and I’m going to head out there and do well.” We think about the universe of always bring back to how we diversify appropriately. Now, Zephyr does a tremendous job of helping from an allocation perspective and deep dive into investments like ETFs or mutual funds and active managers and that’s a whole another conversation of active versus passive, but it allows us to screen to that universe and grab statistics that you’re just not going to find in a lot of the open platform.
[00:40:29] Dean: All right. So, the idea here if you haven’t picked up on it yet is what Brad really saying is you got to know what you’re doing. You got to know what you’re buying. Don’t go into something blindly. Make sure that as you’re approaching retirement, you’re consciously reducing your risk. Make sure that you understand what exposure you have to risk, know how to measure it, know what to expect. Make sure that your emotions are in check. And if you can follow those fundamental things then you have a lot better chance of success. Brad, I want to do another podcast with you and in this next podcast, I really want to address the different theories around risk in a portfolio or in an individual security or a fund. We’ll discuss modern portfolio theory and Nobel prize-winning formula put out by Harry Myron Markowitz.
There’s another one that you referenced, Gaussian mathematics, and then there’s this other one that’s called a fat tail analysis, which typically only large institutional investors will pay any attention to. All these things are designed to help the investor understand the probability of outcomes over certain periods of time with their underlying investment and, what’s the potential risk and potential loss over any period of time. You think you want to get into that on another podcast?
[00:42:04] Brad: I think it’d be extremely meaningful for people to know that the depth of research of what’s available out there, and the impact that it can have in terms of portfolio construction in a way that you think about investing. We took very broad brushstrokes in this segment. We’re identifying a single position or a stock and we’re trying to say here are ways of looking at a single investment but the average investor that carries 10, 15 different types of positions, different types of asset classes. You’re talking about a very detailed type of portfolio solution that requires I would say some very strong know-how with research and data. And I think some of the math that you had referenced I would love to talk about it even though it’s deep in the weeds, but it’s always fun for me.
[00:42:52] Dean: Well, we’ll get into more and we’ll try to bring it down to the level where the individual investor can understand it. Before we finish the show, I want to remind everybody that the Guided Retirement Show is all about you being able to live your one best financial life. Really take that trip into retirement and think of that as the longest vacation you’re ever going to take. Imagine you’re going to spend a month in Europe. What are you going to do? Just go over there and wander around the streets. Yeah. you can get there on your own. Yeah. You can rent a car, do whatever but wouldn’t it be better if you hired a guide, somebody that actually been there done that and could show you all the places where you need to go and see and places you should avoid? I got a great story about my mom traveling over to Europe by herself that I might pick up on in our next episode here. But the point is that you really shouldn’t even have the discussion about the underlying investments until you had the discussion with your financial planner about what your journey is going to look like.
And that’s what we’re talking about here on the Guided Retirement Show. We’ll get Brad Kasper back on here another segment and we’ll talk about some of these mathematics. We look forward to having you all join us for that. Thanks, Brad.
[00:44:03] Brad: Thank you.
[00:44:04] Dean: Find links to this episode show notes and giveaways in the show description or visit us at GuidedRetirementShow.com/10 and don’t forget to subscribe and get notified when we release our next episode.
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Investment advisory services offered through Modern Wealth Management, Inc., an SEC Registered Investment Adviser.
The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.