Investment Risk in 2023 with Garrett Waters

February 27, 2023

Investment Risk in 2023 with Garrett Waters

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Investment Risk with Garrett Waters Show Notes

Whenever Dean Barber discusses investments, it’s hard for him not to think of a famous quote from Berkshire Hathaway CEO Warren Buffett. Be fearful when others are greedy, and greedy when others are fearful. Understanding investment risk can be difficult if you let emotions like fear and greed take over at the wrong times. How do you combat the fear of missing out when it comes to investing? Dean and Anchor Capital CEO Garrett Waters will discuss exactly that and much more about investment risk in this episode of The Guided Retirement Show.

In this podcast interview, you’ll learn:

  • How to Remove the Emotion from Investing
  • Combating the Fear of Missing Out When Investing
  • How to Decide Whether to Be More Defensive or More Aggressive
  • Looking at Investment Risk First Rather Than Returns

The Concept of Managing Investment Risk within Your Portfolio

Dean and Garrett could talk for hours about the detail that goes into the construction of specific funds. But today, they’re going to highlight why it’s first important to understand the concept of investment risk and how to manage it. Having that understanding is critical to your long-term success, but it’s difficult for a lot of people to grasp that.

A Little Bit About Garrett

Before Dean and Garrett go over how to understand investment risk, let’s learn a little bit about Garrett’s background. Garrett began his career in investment management by working at JP Morgan for about five years. At JP Morgan, Garrett learned a lot about actively managing portfolios through stock picking and about risk management on positions. Garrett then went to work for Barclays Global Investors, which is now known as Blackrock. There, Garrett helped Barclays Global Investors launch their ETFs.

Through Garrett’s experience at JP Morgan and Barclays Global Investors, he began to realize that many advisors don’t have the necessary education on how risk management can play a massive role into asset allocation. Garrett has learned how modern portfolio theory that incorporates risk management can lead to much better results over time.

What Is Modern Portfolio Theory?

Modern portfolio theory essentially means that with any given level of risk, there is an optimal level of return that can be achieve through proper asset allocation. But what’s the problem with that?

“The problem is what we saw in 2022. When you need the diversification of stocks and bonds the most, it tends to fail you. As we saw in 2022, stocks and bonds suffered significant losses. And those significant losses have shook a lot of investors and their advisors from their financial plans. By incorporating investment risk management, which is what you need in times of stress with negatively-correlated assets—stocks and bonds, you increase your diversification and lower your risk. That’s why it’s so important to add it into your asset allocation.” – Garrett Waters

Different Approaches with Investment Risk

When assessing the mindset of an individual investor, you’ll see that investment risk can mean different things to different people. For some people, investment risk is simply volatility. For others, it’s the risk of truly losing something and never recovering. When you’re talking about risk management, you’re talking about reducing volatility so it can remove the emotion from the individual investors. That way, they can stay the course and achieve similar results long-term with less volatility.

“We start with the risk first. Many investors start and look at the returns first. They fall in love with return streams without realizing the risk that they must take to get those return streams. So, we feel like we need to quantify how much risk is in a security or a portfolio before we get started. We look at the risk someone is taking and basically put a buy/sell discipline around that so we have a good quantified hedge of when risk is and isn’t present. Then you invest accordingly.” – Garrett Waters

Removing the Emotion from Investing

Again, when risk is low, you want to be fully invested. And when risk is high, you want to reduce your investment risk. The problems usually arise when people become dissatisfied with that line of thinking. And the reason they’re dissatisfied is usually because they don’t understand their potential investment risk.

“People might think that the storm is blowing through, start investing again, and get hurt again by not knowing the risk. Or they wind up doing the classic investment behavior of buying at the top and selling at the bottom. That’s why if you can quantify those moments, it helps to remove the emotion of when you should be in or out of the market. It helps keep people in the market because they know they have something in their portfolio that will offset those modern portfolio risks.” – Garrett Waters

FOMO (Fear of Missing Out) Is Real

Despite the market downturn we had in 2022, there were some nice bear market rallies that occurred. Those bear market rallies are also referred to as head fakes. That alludes to what Garrett was talking about with people wanting to start investing again when thinking the bear market could be over. That market volatility has poured over into 2023.

“People have this fear of missing out. They think if the markets are going up and they’re fully invested that they could be missing out. They want to go all back in. But a lot of times, these bear market traps or short-term bull market runs within longer-term secular bear market can really hurt people. So, you need something in place that can mitigate that risk.” – Dean Barber

How to Decide Whether to Be More Defensive or More Aggressive

Those bear market traps can sometimes be very hard to see. It makes deciding whether to be more aggressive or to stay defensive even harder. The answer to this is to look back over long periods and quantify when risk is elevating and when it isn’t.

It’s also important to stay away from too much exposure. You do that by managing your portfolio and making sure that you don’t have all your eggs in one basket. It’s about understanding your investment risk with what you’re about to buy when there is elevated risk and quantifying it. When those risks are low, that’s what smooths out the returns in portfolios and prevents people from experiencing FOMO and chasing returns.

Looking Back at the COVID Crash of 2020

Along with looking back a little bit at 2022 to understand portfolio risk, we want to look back at 2020 as well. The COVID crash was a tell-tale sign of good investment risk management. One of the portfolios that Anchor Capital manages came to Dean’s mind when looking back on the COVID crash.

“When the market crashed in March 2020 because of COVID, I remember that Garrett had a portfolio that was down about 3%. But at the time, the broad market itself was down more than 30%. When you go to the end of 2020, the S&P 500 and Garrett’s risk-managed equity strategy were both up about 18% for that full year. So, an investor in that risk-managed strategy didn’t experience that gut-wrenching market drawdown.” – Dean Barber

The Battle of Fear and Greed

People that did experience that big market drawdown were likely more tempted to sell everything and anxiously await to get back in. That’s why it’s important to look at risk first rather than the returns. This is where the battle of fear and greed is on full display. Managing those emotions can be very difficult if you don’t understand investment risk.

The problem is that you could have the highest probability, but fear is high. People will run to cash and sit in cash because they have no knowledge of when to resume investing. So, they could miss 5%, 10%, or maybe 15%.

But then that could end up being the top. Then, people will start having that fear of missing out. They start to invest again while the market goes right back down. Suddenly, that can make people quit investing because they think they can’t stick with the risk or volatility. There’s a comfort factor when you understand investment risk and how much risk to assume. If you get the investment risk right, you’re likely to get the return right.

Looking at Cryptocurrency to Understand Portfolio Risk

Speaking of fear of missing out, let’s look at cryptocurrency as another example to understand investment risk. There are people who were boasting about how much money they were making off crypto in a day that are now complaining about their stocks and bonds.

“People didn’t understand the risks of crypto. They fell in love with the returns, developed FOMO, chased it all the way up, and now it’s crashed. Not only did it crash, but you can’t get out. They freeze you. You’re in an asset that suddenly becomes liquid and you have a different problem. You’re trying to get out and you can’t and have to suffer the whole brunt of the fall. It’s about understanding the risk of what you’re buying.” – Garrett Waters

Comparing the Hype of Crypto to the Dot-Com Bubble

In Dean’s mind, crypto was the Dot-Com bubble. Look at the technology stocks in the late 1990s that were giving strong double-digit returns for five straight years. Well, the Dot-Com Bubble then burst early in 2000 and the returns were taken away.

“A lot of people don’t realize it, but in the Tech Bubble, more than 75% of the money that was invested in technology stocks came in the last quarter of 1999. So, most people didn’t experience any of the gains in those technology stocks. But FOMO finally took over, so they jumped in. Subsequently, three years later, 75% of the value of the NASDAQ had disappeared.” – Dean Barber

So, you can hopefully see how crypto and the Dot-Com Bubble were very similar in terms of investment risk. When you dive deep into seeing what happened with the Dot-Com Bubble, there were no earnings. There were basically just people trying to sell other people some things on a website, but they had no revenue or earnings. It was a similar story with crypto. There’s nothing behind it except a buyer and a seller. That’s why you need to understand what the risks are when you’re investing, especially because certain assets can move quickly.

Avoid Being in a Constant State of Recovery

Again, people that lose their money in situations like that end up scrambling with figuring out how to regain it. They’re in a constant state of recovery just to get back to even. People love the compound return aspect on the way up and hate giving it all back.

“We try to minimize any type of givebacks so that the money is always in a positive state of growth. That’s our goal.” – Garrett Waters

And that doesn’t mean that you can manage risk in such a way where there’s never a drawdown or never any losses. You want to try to minimize those losses. Be opportunistic when there’s good opportunity and be defensive when there are storm clouds on the horizon.

Understanding portfolio risk is the number one thing that Garrett and many other financial professionals strive to do. Garrett wishes that understanding portfolio risk was everyone’s top priority, but again, fear of missing out is a powerful emotion.

“It’s very hard when you go to a cocktail party and hear your neighbor talking about his account being up 75%. Then you think, ‘Oh. I should be up 75%.’ But you don’t know how much risk they’re taking to get that return.”– Garrett Waters

The Power of the Financial Plan

That’s why the power of the financial plan is so important and why we fit into asset allocations so well. It’s to basically say that you can take more risks in the portfolio when you add risk management strategies. It allows you to follow your modern portfolio theory portfolio because risk can be high. But when you add investment risk management to your asset allocation, it allows you to stay focused on your plan and meeting your financial goals.

A lot of people want to try to manage investment risk through asset allocation. When you measure the volatility or the drawdown of risk-managed equity models, you’re going to have a drawdown factor that’s going to look a lot more like a 60-40 portfolio or even a 50-50 or 40-60 portfolio. But when you start to compare the returns over a long period to your models compared to a 60-40, 50-50, or 40-60 portfolio, there’s no comparison.

“When you have that portfolio risk management to your portfolio, it gives you permission to be a little bit more aggressive of your portfolio. That way, you can enhance your long-term performance.” – Dean Barber

Assessing the Performance of the Markets in Recent Years

Following the Great Recession up until 2022 (aside from the onset of COVID), we’ve been lucky to have quantitative easing pumping in that drove the markets up. But we’re seeing the opposite now. It’s a much more challenging environment for investors to navigate.

Whenever the economy looked like it was going to be shaky during that time of quantitative easing, the Federal Reserve would save the day. The Fed would buy assets and pump the system full of money.

“There was this mindset that the Federal Reserve just removed all the risk from the market. Now, we have this ugly inflationary period that the Federal Reserve now knows is far more dangerous than any recession. They have a mandate now to bring inflation back down to their core inflation rate of 2%. In doing that, they’ll potentially lead us into a recession. But they don’t care. The backstop of the Federal Reserve is gone. That’s why I think there’s more portfolio risk today than what we’ve experienced over the past decade.” – Dean Barber

From Quantitative Easing to Quantitative Tightening

Banks were freezing and shutting down during the Great Recession. In 2008, the Fed started the quantitative easing experiment. The Fed had to liquify the system and pumped it full of free to low-cost money. It created an incredible run in the markets with low volatility.

But as soon as the Fed announced that they transition from quantitative easing to quantitative tightening in November 2021, the markets consistently dripped down until December 2022. And they’re still tightening. We wish we had a crystal ball, but we don’t know how things are going to end up. We could be dealing with this mess for decades to unwind the issues created from quantitative easing.

“People’s eyes have been on interest rates and inflation, whereas our eyes at Anchor Capital have been on the quantitative tightening. That’s the opposite of liquidity and low-cost money that the Fed was providing. They’re tightening up conditions instead of loosening them, so you’re getting less liquidity in the system. That means risks are getting elevated.” – Garrett Waters

Inflation Is Going Down, But Risk Is Going Up

That’s a hard concept for people to understand because everyone is looking for inflation to go down. But what you’re also seeing is the level of risk is going up as inflation numbers are coming down. It’s a challenging environment.

“I think that people are going to react in a way that isn’t normal. What’s happening is the experiment of quantitative easing is being turned off. How does it end? It’s never ended before, so now we’re going to see if we can still stick the landing as it ends. It’s a very complicated situation.” – Garrett Waters

Staying on Course

This is one of many reasons why we’re committed to helping people stay on course by being knowledgeable about portfolio risk. We want people to know that there is a portion of their portfolio that helps you mitigate volatility and not kill long-term results.

If you look at a lot of the market neutral strategies, there might not be much volatility. But the returns aren’t much either. What’s the point in that? You need to be working with a financial professional who has a track record of mitigating investment risk without destroying returns.

“That’s why we do it across the three big asset classes that we find in investor portfolios. We find domestic equity, global equity, and domestic fixed income. Because as you can see from last year, there’s risk in all of that. You need to understand where the risks are elevated and where they’re low across the big asset allocations in your portfolio. The more you add to the risk management—at least with Anchor Capital’s risk management—the better your risk-adjusted returns become. And the better your outcome becomes.” – Garrett Waters

Incorporating Investment Risk Management in Your Plan

That’s what allows you to stay on target with your plan so that you’re not deviating and reacting. It eliminates the emotion by understanding your potential investment risk. We want to help you with incorporating risk management into your financial plan.

First, that means you need to have a plan. We can help you with that as well. We’re giving you access to the same financial planning tool that our CFP® Professionals use with our clients. And you can use it from the comfort of your own home at no cost or obligation. Just click the “Start Planning” button below to begin building your plan today.

Portfolio Risk


Having a Plan in Place That Helps You Achieve Your Goals

Everything begins with the financial plan and outlining your goals. That’s been Dean’s philosophy during his 35-plus years in the industry.

“It’s been my objective to understand what a person wants their future to look like and create a plan to do that. Then, I want to figure out the investment strategy that allows them to do that with the least amount of risk possible. You need to know that risk is always present.” – Dean Barber

Unfortunately, market conditions like we had in 2022 are going to happen. And there’s no guarantee that they won’t happen in back-to-back years. A lot of people have been thinking that the risk is over and the storm from 2022 has blown through. They think it’s time to reload and start to take risks. But you need to understand that risk you’re taking. That’s why risk management exists and why it needs to be part of your overall plan.

Let Us Know If You Have Questions About Investment Risk

Along with using our financial planning tool, you’re more than welcome to reach out to us with your questions about investment risk. You can schedule a 20-minute “ask anything” session or complimentary consultation with one of our CFP® Professionals. We can meet with you in person, by phone, or virtually.

“Hopefully, everyone has their eyes open to understand that there are effective ways to manage risk. You can’t eliminate it. You can’t eliminate volatility in anything unless you’re in a bank account. But then you have the risk of inflation outpacing your performance. There’s no such thing as the perfect investment. But there is such thing as the perfect plan and perfect asset allocation for every investor.” – Dean Barber

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Portfolio Risk in 2023 | Watch Guide

Introduction: 00:00
Meet Garrett: 01:28
Modern Portfolio Theory:
Understanding Investment Risk:
Risk First, Not Return: 06:33
How to Mitigate Risk:
Looking Back at 2020:
Why You Look at Risk First:
Comparing Cypto and the Tech Bubble:
There Will Always Be a Level of Risk:
Managing Risk Through Asset Allocation:
The Markets, Inflation, and Recession Risk:
What Happens Without Quantitative Easing?:
Staying on Target:

Resources Mentioned in this Podcast

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.