Mutual Funds vs. ETFs Pt. 2

July 30, 2019

Mutual Funds vs. ETFs Pt. 2 with Bud Kasper & Jason Newcomer

Financial Scams Targeting Seniors

Mutual Funds vs. ETFs Pt. 2 Show Notes

In our previous podcast episode, CERTIFIED FINANCIAL PLANNERS® Bud Kasper, Jason Newcomer and I discussed the differences between ETFs and mutual funds to help you truly understand which product is best for your portfolio. If you haven’t listened to Part 1 yet, please click here to listen it before this episode.

Today, we continue our deep dive into this topic. You’ll learn how to decipher the differences between the many different options, the tax efficiency of both mutual funds and ETFs, and why a comprehensive financial plan is so critical to choosing the right product to meet your needs.

In this podcast interview, you’ll learn:

  • How to assess risk when looking at mutual funds – and why mutual funds can carry greater risk when they appear to deliver the same returns.
  • Why prospectuses are usually full of outdated data by the time you receive them – and the reason it’s so important to educate yourself about the funds you own.
  • How Bud talks to clients about risk – and why it’s so important to talk in terms of dollars, not percentages, to think about how you might react to a major financial loss.
  • What you need to do when adding a mutual fund or an ETF to a taxable account to calculate capital gains risk.

Inspiring Quote

    • “Even though the results could be the same, living through the experience can be quite different.”
      Bud Kasper
    • “You can’t advise someone without going through a full-blown financial plan.”
      Dean Barber

Interview Resources

Interview Transcript

Read More


Starting your route to retirement.

[00:00:09] Dean: As always, thank you for listening to The Guided Retirement Show. I’m Dean Barber, Managing Director at Modern Wealth Management. I know there are thousands of podcasts out there. I appreciate you choosing to listen to The Guided Retirement Show. In this episode we continue our discussion with Bud Kasper and Jason Newcomer, both CERTIFIED FINANCIAL PLANNERS®, Bud since 1982, Jason since 2010.

In the last episode we discussed the differences between ETFs and mutual funds. We’re going to go into some more of the differences between ETFs and mutual funds, some advantages of ones over the other in certain circumstances, all designed to get you to understand what it takes in order for you to build the right portfolio for your own personal situation. Enjoy the conversation.


[00:00:54] Dean: Back for a second episode we’ve got Bud Kasper, CERTIFIED FINANCIAL PLANNER® in the financial planning industry since 1982. Bud, welcome.

[00:01:04] Bud: Thank you. Good to be here.

[00:01:05] Dean: Jason Newcomer, CERTIFIED FINANCIAL PLANNER® in the industry since 2007. Obviously, Jason, you started here at Modern Wealth Management when you were in college studying finance full time. Starting in 2010 one of the youngest CERTIFIED FINANCIAL PLANNERS® in Kansas City when you got your CFP®.

This is really going to be a continuation of our prior episode where we talked about the differences between ETFs and mutual funds. The difference between active management and passive management, and when some things do good and when others do well and how sometimes the idea might be a blend. I started to talk a little bit about how a person would decipher all of the differences of the different investment options that are out there to make the right decisions. We talked about 401ks and the advent of putting some ETFs into 401ks. There’s more money in mutual funds today than there is in ETFs.

A couple of things that we didn’t get a chance to talk about in the last episode. We ended, Bud, with you making a comment about risk versus reward. Let me just give an example. Let’s say that I look at two equity mutual funds. Both have an average return of 8% over the last 15 years. The average person out there would assume that both of those funds, if they both are equity mutual funds and they both averaged 8% they both have the same risk parameters. How does a person analyze that, because you and I both know that’s not true?

[00:02:40] Bud: Well, all we have is history. You have to go back and take those two investment options and compare them against each other at different timeframes to see how they reacted, and then ultimately, you’ll get your average return but-

[00:02:51] Dean: Do you look year by year, day by day?

[00:02:53] Bud: Yes and yes. Not so much day by day, because normally we’re investing for the long term since the majority of our practice is based on retirement. Inside of that, the construction of the portfolio, how you allocate between the various asset classes, which is simply stocks, bonds, and cash in the simplest form. How much in each of those? As you build that out it’s going to change the risk. If I can use an example, let’s say we have zero risk at the beginning and our maximum risk level is 10. As we change these compositions between bonds, stocks and cash that risk level is going to slide around that. By the way, it’s also going to slide based upon different timeframes that you’re looking at.

[00:03:37] Dean: Right, but if we’re talking about simply two equity mutual funds there’s not going to be stocks, bonds and cash. There’s going to be stocks.

[00:03:44] Bud: Right.

[00:03:45] Dean: Right? How would one carry more risk than another if they both own 100% stocks and by prospectus they mandate that they maintain 100% investment in stock? How do you get two funds that are going to have a similar performance over time, but yet you’ve got one that carries far more risk than another?

[00:04:03] Bud: Well, obviously you have different stocks. If you were dealing with large cap stocks that dominated in healthcare and the other one was dominated in financials, you’re going to have a different outcome associated with it and also a different level of risk. Jason, want to share your thoughts?

[00:04:19] Jason: Yeah. There are different metrics that we can look at to compare funds to help us… We look at the return and we might not see a difference but we look month to month- maybe not day to day but month to month- and look at how volatile were those two mutual funds. There are things like the sharp ratio of the fund that we can look at to help us to put them on an even playing field.

[00:04:40] Dean: What is the sharp ratio?

[00:04:41] Jason: It’s a way of measuring performance that also takes into account volatility.

[00:04:48] Dean: Would you want a high sharp ratio, a low sharp ratio? What’s a person’s supposed to look for? If they don’t have a degree in economics, Jason, what are they looking for?

[00:04:55] Jason: Sure. A sharp ratio. Generally, if you have a portfolio or a fund with a sharp ratio that’s positive that’s what you’re after. Even with a positive return if you have a negative sharp ratio we would say that your risk adjusted return… you probably would have been better off just holding cash and not dealing with the headache that you had to go through to get that return. Probably higher than a 1 is probably a good score.

[00:05:22] Dean: Okay. Now, Jason, you mentioned something in our prior episode about people understanding what their portfolio could do through good times and through bad times, and that they have the emotional wherewithal to stick with that investment. If you don’t understand risk and you don’t understand what that investment may do over a short period of time, does that lack of understanding lead to investors making emotional decisions?

In other words, let’s just use the example that Bud gave where you have one that was overweight financials, one that was overweight healthcare. Somebody could look at both of those things and say over the last 15 years they performed identically. Then now all of a sudden you get into a scenario where healthcare comes under attack from the government and the healthcare one isn’t doing as well as the one with financials. That person could say, “This one’s not any good anymore that holds the healthcare stuff.” They don’t even really know what it holds, quite honestly. In most cases, they have no idea what the underlying asset is. They may lose patience when in reality they need to understand what it is so they can stick with it. What’s your thoughts on that?

[00:06:29] Jason: Yeah, absolutely. There we would go back and we’d say, “Look, we know that what happened in the past isn’t necessarily going to tell us what happens in the future, but we can look at things like previous drawdowns. We can look at different sectors and see that maybe certain sectors are more volatile in recessions and bear markets than other sectors.” Just understanding that certain investments that you have, certain sectors or certain ETFs or mutual funds are going to be more volatile than others.

[00:06:56] Bud: If I were to make it even more complicated than that, then you get into things like sector rotation, which means out of the 11 sectors that are represented in the S&P 500, maybe oil’s falling out of favor as a sector. You’re going to leave that in the portfolios? The manager of the mutual fund or the basket of ETFs that has that representative you’re going to leave it in there? They’re going to leave it in in the ETF because no one’s going to move it out, but in the mutual fund they might be moving it out or altering the strategy.

[00:07:25] Dean: All right, so if I’m an individual investor and I’m looking at these two different… I’m going to stay in the mutual fund world here for just a minute. I’m looking at these two different mutual funds. Both have the average return of 8%. This is hypothetical by the way, but how do I analyze? How do I know what they own? Yes, okay, I can order a prospectus and it’s going to give me that, but by the time the prospectus is printed that data is ancient in a mutual fund. They don’t own the same things that they printed in the prospectus. How do I get it? Jason, what’s your…?

[00:08:02] Jason: One of the things that I encourage our clients to do when we first start working together with someone is to really know what you own and why you own it. Why did we put that into your portfolio? If you have a better understanding of why it’s there, when things go wrong or poorly in the market and we’re seeing negative returns and red numbers they’re going to be more slow to want to move those things out of the portfolio because they’re there for a reason. I encourage a lot of our clients to go out to free websites like, type in the ticker and then click on the portfolio holdings page. Really educate yourself about what’s in this particular fund that I own, and in what sectors is it overweight in? Is it heavy in technology or is it more in consumer staples?

[00:08:47] Bud: In regard to that, I think that people would generally get lost in those reports because generally all they do is give you the top 10 holdings in it, and that’s not really filling to the… If they have 300 stocks in the portfolio and you’re looking at the top 10, what’s that really telling you? Unless that represents 90% of the fund then it’s really not telling you much of anything, but at least it does give you the ability of looking at what the returns were on rolling periods. If you’re looking at “What did it do over the last three years of the rolling period, or five years, so on and so forth?” that could give you a better understanding as to what degree of highs and lows they participated in during that timeframe, and maybe you can get a little bit more comfortable with that.

Dean, you know that in the financial planning process with the programs that we use that one of the things we show is a client’s current portfolio. Then we go back to one of the worst periods in stock market history, meaning 2008, nearly part of 2009. Let’s say we see a drop of, let’s say, 35%. The question would be, and this is the way we pose it to the client, “If we had that type of a drop what would your reaction be? You would sell everything? ‘I’m okay, I’m in it for the long run’?” A lot of people will come back- and this is where the emotions tie in with this- and they’ll say, “Oh yeah, I can tolerate that.” My reply to that is, “You don’t know yourself. I’m here to tell you that you’re not going to react that way. You’re going to be semi panicked and you’re going to be looking for someone to regain or rebuild that confidence that what we’re doing is working from that regard. Or if it’s not, we better find a better solution than what you currently have.”

[00:10:30] Jason: Yeah. I’ll oftentimes, instead of use percentage terms, try and put it in dollars that are relevant to the person that we’re talking with. Say they’ve got $500,000 saved, we might say, “What would happen if you lost 40%?” They say, “Yeah, I’d probably be all right.” Then I’d say, “Okay, let me rephrase that. What if you woke up and you’ve got $300,000 instead of $500,000? Do you still feel the same way?”

[00:10:53] Bud: That’s exactly right. Human nature being what it is. Perception, right?

[00:10:57] Dean: All right. Jason, let’s go to the ETF in the same concept. We’ve identified the fact that two equity mutual fund managers may have the same average returns but the risk levels could be totally different, affecting that sharp ratio that you talked about. Is that going to be true in the indexing part of buying ETFs? In other words, if I’m looking at two different large cap blend ETFs that are designed to mirror the S&P 500 index and they both have the same average annual return over the last 15 years, am I going to see a difference in risk levels on those two things or are they going to be identical?

[00:11:32] Jason: Yeah, I think you’ll see a difference but it might not be as pronounced as it would between two active managers that are each trying to gain a foothold and outperform a benchmark. You’ll see differences in the ETF market between similar funds in the same category, but it might just be a much smaller difference.

[00:11:51] Bud: My reply to that as well is… because you were indicating that the results on a return basis were equal or near equal. That’s all well and good but we’re not looking at the downdraft. One might have a downside that it reached that was 10% and the other one might have had a downside that was 21%. Even though your results might be the same, living through the experience could be quite different.

[00:12:15] Dean: Right, but in a passive indexing ETF you’re not going to have that huge difference. You might in the mutual fund-

[00:12:23] Bud: Right.

[00:12:23] Dean: -but you’re not going to have it… That’s what Jason’s saying. You’re saying in the ETF maybe one’s down 20 and one’s down 21 because they have a slightly different style of how they’re trying to index, but you’re not going to see the vast difference in the index. Is that what you’re saying?

[00:12:34] Jason: Right. Not as pronounced as you would between two actively managed mutual funds.

[00:12:39] Dean: Okay. Something else I think we need to take into consideration before we talk about how a person would decide how to construct their individual portfolio as it pertains to somebody heading into retirement or in retirement is tax efficiency. Obviously, I did a couple of episodes with JoAnn Huber, our in-house CPA, where we talk about IRAs and Roth IRAs. We’ve got a lot more to talk about on the tax side of things.

From an investment perspective, if you own an ETF or a mutual fund and those are owned in a taxable account, whether you own that in a trust, whether it’s in a joint tenants with a right of survivorship, single ownership. However that’s titled as long as it’s taxable where dividends, interest, capital gains, et cetera are taxable on a yearly basis. Jason, explain the difference between a mutual fund and an ETF. Are there differences, and if so what are they?

[00:13:43] Jason: Yeah, that’s really where the two investment vehicles really start to diverge is their tax efficiency. It has to do in large part with how shares are sold. If I own a mutual fund and I no longer want to own that fund, I want to sell my shares, I sell those shares directly back to the mutual fund company. Say it’s an S&P 500 mutual fund. I want to sell my $50,000 worth of shares. They may need to sell $50,000 worth of stock and give me the cash that they get from that stock sale. If they’re selling shares that are sold for a gain that capital gain is then distributed out amongst the shareholders. Bud and I both own the same mutual fund. I sell my shares. He doesn’t necessarily have to sell anything to get a 1099 for a capital gain at the end of the year.

[00:14:38] Dean: Because the fund itself had to sell shares of stock in order to come up with the cash to buy your shares back?

[00:14:43] Jason: That’s correct.

[00:14:44] Dean: All right, and how is that different from an ETF?

[00:14:46] Jason: Let’s say that Bud and I own the same ETF and I want to sell mine, Bud does not want to sell his. I would need to go out to an exchange and sell my shares on the secondary market. Me selling my ETF doesn’t impact Bud because I’m selling it directly to you who is a new investor-

[.00:14:46] Dean: I don’t want your shares.

[00:15:07] Jason: Yeah, well, I’ll give you a good price on it.

[00:15:09] Dean: Okay.

[00:15:11] Jason: The fund company, the ETF company didn’t have to sell anything inside of their portfolio in order for our transaction to take place, so Bud’s not hit at the end of the year.

[00:15:22] Dean: That tax efficiency makes sense, but is that another reason why your internal expenses on your ETFs can be cheaper is because they don’t have to do nearly as much on a daily basis to run that portfolio? They don’t have to worry about liquidity or anything like that.

[00:15:36] Bud: Yeah, that’s true. You do have trading costs associated with it, but the trading costs are pretty low so I wouldn’t let that influence me. The real issue that we have here, and one of the other points, Jason, once it applies to ETFs or from the dividends because if the ETF is producing qualified dividends you have an entirely different way that is taxed. That can be a very big plus from the ETF perspective.

[00:16:00] Dean: Let’s go into some detail on that.

[00:16:01] Bud: Okay, go ahead. Sure.

[00:16:04] Jason: Qualified dividends get preferential tax treatment to ordinary dividends, so you’re paying a lower tax rate on dividends generated through those funds.

[00:16:14] Dean: What’s the difference?

[00:16:16] Jason: Qualified dividends are going to be taxed at the long-term capital gains rate, which is 15%. Whereas a nonqualified dividend you’re going to be paying your ordinary income tax rate on something like that. If you’re in a high tax bracket, owning those ETFs in taxable accounts might benefit you quite a bit.

[00:16:34] Dean: Especially if your adjusted gross income, whether you’re single or married filing jointly, falls below the thresholds that are out there today under the current tax code as we produce this episode in 2019. Those qualified dividends could essentially be tax free where if it was not a qualified dividend it would be taxable.

[00:16:55] Jason: Yeah.

[00:16:56] Bud: Let’s flip this thing around though and let’s talk about one of the inefficiencies associated with mutual funds, and that is capital gain distributions. If you go in and let’s say you bought in March a mutual fund and the capital gain distribution in November was, let’s say, 4% now you’re going to get a 1099 to be able to pay the dividend tax on that. Let’s say that you didn’t get that gain though. You’re going to have to sell that fund before the actual distribution in order so that you don’t participate in a gain that you didn’t receive because of when you bought it, and so there’s a great inefficiency there.

[00:17:43] Dean: What you’re explaining is a phantom gain.

[00:17:46] Bud: Yeah. The last thing that a person wants to have is all of a sudden to buy a mutual fund and then found out that there was a 12% capital gain issued and in reality, all they got was four. They’re not going to be very happy. Therefore you have to go and liquidate prior to the distribution so that they don’t have that tax to pay on that particular distribution.

[00:18:06] Jason: There were years… remember back in 2015 with the markets down we saw this quite a bit where mutual fund share owners lost money, their funds went down in value. They didn’t sell. They did the right thing but they still got hit with 1099s for gains that were realized during that short-

[00:18:25] Dean: Let’s get into really, really simple terms. How the heck does that happen? What’s going on within the fund-?

[00:18:30] Bud: Because of the activity. That’s exactly-

[00:18:31] Dean: What’s going on within the fund-?

[00:18:33] Bud: They sold something.

[00:18:34] Dean: What’d they sell?

[00:18:35] Bud: They sold a part of their portfolio. Let’s say they had three stocks that they eliminated out of that and that entered in as a capital gain. Let’s say they also had some that they actually lost money on and they sold those. They can equal each other off or one will dominate over the other, meaning that you have a larger capital gain that you’re going to have to pay, or you might have less.


At some point in everyone’s life you have to go to school because, let’s face it, a good education is important. Just because you’re nearing retirement age or you’re already there it doesn’t mean the learning stops. One of the easiest ways to learn about retirement is at Modern Wealth Managements Education Center. There you’ll find things to read, to watch and to listen to about important retirement topics. Go to, click on the menu dropdown- it’s in the upper right-hand corner- and select ‘education center’. There you can download and read our social security checklist, watch Dean Barber’s latest video on the current state of the markets, or listen to an audio recording about tax reduction strategies and so much more. There’s no cost. Just sign up for access at It’s as simple as that. Besides, there’s no tests, no textbooks, and I promise not to move your seat even if you talk too much. There’s so much to learn about retirement. Just go to, click on the menu dropdown and select ‘education center’.

[00:20:13] Bud: I think that people would generally get lost in those reports because generally all they do is give you the top 10 holdings and that’s not really filling to the… If they have 300 stocks in the portfolio and you’re looking at the top 10, what’s that really telling you? Unless that represents 90% of the fund then it’s really not telling you much of anything.


[00:20:54] Dean: We’re back. This is The Guided Retirement Show. I’m Dean Barber. Before a person would invest in a mutual fund in a taxable account, is there a way, Jason, that they can understand what the embedded capital gain risk is within that fund?

[00:21:08] Jason: Yeah. One of the things that you need to look at when you’re considering adding a mutual fund to a taxable account or an ETF, one of the things that we look at is your turnover. That is how often are investments within that fund turned over or sold and bought. That’s kind of a way that you can estimate “In the future how tax efficient is this fund going to be in my portfolio?” Obviously if you’re talking about an IRA or a Roth IRA we’re not as concerned with turnover because we’re not paying capital gains tax.

[00:21:40] Bud: Yeah, and that’s the beauty of the ETF. The only turnover that’s going to take place is going to be with you as an individual shareholder of that ETF.

[00:21:49] Jason: Right. Yeah, that and if they make changes to the underlying index, kick a company out of the S&P 500 and add a new one and you might have a small trade.

[00:21:58] Dean: Okay. That makes sense. Let me see if I can bring it down into really simple terms. I’ll go back and use Apple stock again. Let’s say that one of these active managers bought Apple stock way back in the day when it was 10 bucks a share. Then they held onto it for years and years and years and all of a sudden it’s $200 and they’ve got all these gains in Apple stock. They’ve never sold it, but it’s made the price per share of the mutual fund push up, right?

[00:22:24] Jason: Right.

[00:22:24] Dean: Now all of a sudden they decide they don’t like Apple anymore. They want to sell off some of their positions of Apple. When they sell it within the fund it creates a capital gain. That capital gain by law has to be distributed to the shareholders, so the shareholders have to pay tax on it. Even though that mutual fund manager may have purchased that Apple stock 20 years ago and they’re selling it this year, you may have only bought the mutual fund this year. When it creates that capital gain you could be responsible for the taxes due on the capital gain of that Apple stock that you didn’t get the benefit of the growth on. That’s where that phantom gain comes from. That’s where a person really needs to understand if they’re going to own a mutual fund inside of a taxable account, why they own it there and what’s the potential.

I had a scenario a few years ago. I think it may have been back, Jason, in that 2015 year where one of my client’s mother passed away and the advisor that her mother was using suggested that she sell all of the individual stock positions that she had.

[00:23:21] Jason: Before she passed away?

[00:23:23] Dean: After she passed away to get the step up basis and diversify. To diversify this advisor placed her money 100% in a single balanced mutual fund in October of that year.

[00:23:36] Jason: In 30 days.

[00:23:37] Dean: It had an 11% capital gain distribution. At the same time the actual fund value dropped by about 10% in that period of time. She wakes up in January, she gets this 1099 in the mail that says- this was like a 1.7 million dollar account-, “You owe taxes on $180,000 worth of capital gains, but your 1.7 million’s only worth 1.5 million.” She’s like, “I’m confused. I don’t understand what’s going on.” This to me was a fault of the advisor-

[00:24:07] Bud: Sure it was.

[00:24:08] Dean: -for placing that much money in that type of an account when clearly we as advisors have the data to see what the embedded gains are, what the potential capital gains exposure is. If we knew that that capital gains exposure was there we wouldn’t have bought that fund in the first place.

[00:24:23] Jason: That’s right. Our responsibility is to contact each of those funds and find out what their capital gain and dividend schedule looks like. Once we have that then we need to recheck it to see the exact date that’s going to have, because you want to be able to sell that prior to that distribution date.

[00:24:40] Dean: All right. You think that, “Okay, I can handle this on my own. I can do this stuff on my own.” I promise you, the things that Bud and Jason and myself have been talking about here on The Guided Retirement Show are not normal things that you think about when you’re trying to pick your investments. I know what you do. Let’s say you’re looking at your 401k. You’re going to look in the rearview mirror and you’re going to say, “How have these things performed over the last several years? I’m going to pick this one because it’s done the best.” You’re ignoring risk, you’re ignoring allocation, you’re ignoring having good diversification and you’re blindly picking. Or you’re talking to a friend or a neighbor or a golf buddy or something and they’re talking to you about a fund or an investment that they own and that’s done so well, so you just go out and buy it. Very little research is put into most of the people that are trying to do this on their own because they really don’t… The tools are there and it’s available, but the amount of data you have to sift through to build that portfolio the right way is daunting.

[00:25:44] Bud: Yeah. I’d say this is where experience comes in, understanding what those factors are that they can change the outcome for the clients. Therefore all that has to be weighed very carefully to make sure you’re making the right decision.

[00:25:56] Dean: All right. Jason, I’m going to turn to you on this. I want to get into high level basics of if you’re going to help a person create the right portfolio, where do you start? What do you have to do in order to help that person create the right portfolio? If somebody comes to you and said, “Jason, I got a million dollars,” or “I got $500,000,” how would you invest it?

[00:26:22] Jason: Yeah. I think that step one, in my mind it’s important, it’s critical to tie the money and how it’s invested directly to specific financial goals. Not necessarily in all cases do you need a full-blown financial plan, but you do have to have some idea in mind of what is this money going to be used for in the future? Why have you saved it and set it aside? Is it going to be used in 2 years or 10 years or 30 years? Once we establish that timeframe of when are you going to need that money or in 20 years, 30 years, 10 years how much income do you need off of this pool of money, those conversations help to dictate, along with someone’s risk tolerance, what should our allocation be between stocks and bonds?

[00:27:14] Bud: I think the other way of looking at that is what are the distributions that are necessary for our person when they’re in retirement? Let’s say that they had a distribution need of 4%. I always tell people, “If this is our actual need, this is exactly what we’re going to pull out every year to sustain your standard of living then that becomes our bogey.” In other words, we have to have an underlying investment that can make 4% just to do what? Keep the portfolio exactly at the same level it was at the beginning of the relationship.

[00:27:45] Dean: If that’s the goal. If they want to pass that money down. If they want to spend it all during retirement that’s another… I’ve had people say that “I want to give my last dollar to the doctor on the last day and tell him thanks for trying.” Some people don’t want to leave this huge legacy behind and-

[00:28:02] Bud: Yeah, but 90% of the people want to be able to sustain what they have at the beginning. That isn’t realistic necessarily and in some cases it’s worked out just fine.

[00:28:12] Dean: To go back to what you were talking about, Jason, let’s specifically direct somebody that’s heading into retirement. I don’t think you can advise somebody on investing for retirement without going through a full-blown financial plan.

[00:28:26] Jason: I agree.

[00:28:27] Bud: Absolutely.

[00:28:27] Dean: If you’re younger, no, maybe not. “Okay, so I want to fund my kid’s college.” “All right. Where do you want to send your kid to college? Here’s about how much we think you need to be saving. Here’s some ideas on how to put that together.” When you’re talking about somebody heading into retirement and they’ve earned and accumulated everything they’re going to have we better know what those spending patterns are going to be over time. We better have stress tested for long term care expenses. We better have stress tested for a premature death and a lot of the social security checks going away. We have to identify through that financial planning process what we call the personal retirement index. What does your money need to do for you as far as a rate of return over time? How much volatility can that portfolio handle to be able to safely generate the income that you need? Only then can you really dictate what that portfolio should look like.

[00:29:19] Jason: Right. The stakes really couldn’t be any higher when you’re talking about retirement planning. The sooner you can start planning for that, the better. There’s really not any time period where you’re saying, “I’m too far out from retirement to start worrying about that.” We need to start talking about things like when are you going to retire? How much income, as Bud you were talking about with distributions from the portfolio, how much income do you need your portfolio to generate? We can’t ignore someone’s risk tolerance. We could come up with the best portfolio for them for their financial plan, but if they’re not able to stomach a drawdown that goes hand-in-hand with that portfolio they’re not going to stick with it.

[00:29:57] Bud: We’ve also stated in a number of cases… By the way, you just tripped my memory with that PRR.

[00:30:03] Jason: Yeah.

[00:30:03] Bud: It was personal retirement risk. We came up with that several years ago just in the thinking that we were using in the financial planning process at that particular time. I think that the necessity from all of what we’ve gathered in terms of what our return need is is why take any more risk than is necessary to make your plan successful?

[00:30:26] Dean: I think that that’s where the difference between fear and greed really come in, and that’s where the psychology of the investor really comes into play.

[00:30:35] Bud: Wouldn’t you say there’s also those particular times when it’s a little bit more favorable to take a little more risk in times when you want to reduce the risk?

[00:30:41] Dean: There’s no question about that. I think that there are different cycles when you can clearly see, man, it’s… I grew up out in western Kansas. If you haven’t been to western Kansas, just go to Wyoming and it’s about the same thing. You can see for miles and miles and miles, and no trees and flat roads. You can see that you’ve got a long horizon here where you’ve got some safety where you can go a little bit faster. You can step on the gas a little more and take a little bit more risk. Then all of a sudden you’re going to run into some congestion. There’s going to be some troubles ahead. We want to back off on that risk a little bit and we want to understand that your investment needs to be fluid in order to be able to navigate through some of the difficult times.

[00:31:22] Bud: I tell clients all the time this isn’t brain surgery. If we get into a difficult period of time, if a recession happens or whatever case may be, we know what parts of your portfolio are going to hurt you the most in terms of downside participation. The obvious answer is to go in to reduce or remove that risk to whatever extent is necessary to make the client comfortable and to still stay on track to achieve the results of the plan.

[00:31:50] Dean: Jason, let’s go back to your risk tolerance deal because I have a different theory on risk tolerance. Let me give you my theory. Let’s say that you’re getting ready to go in to have some dental surgery done. Before the doctor comes in and administers the Novacaine he says, “Jason, before we do the Novacaine we’re going to give you a pain tolerance test here. We’re going to figure out how much pain you’re willing to tolerate, and then we’re only going to give you enough Novacaine so that you actually experience that maximum amount of pain possible.” You wouldn’t go to that dentist, would you?

[00:32:31] Jason: No, I’m walking out the door and leaving.

[00:32:35] Dean: I think the risk tolerance questionnaire does a good job of letting us understand what kind of risk a person is comfortable with. But I think so many times in our industry the risk tolerance questionnaire is misused in saying, “If this is the amount of risk you’re comfortable with, let’s go for it. Let’s take that amount of risk.” The reality is by doing the financial plan that you talked about you can actually say, “You may be comfortable taking that much risk but you really don’t need to.” Or you may have to break the news to them and say, “I know you’re not comfortable taking this much risk, so what that means is you’re going to have to work another five years because you haven’t saved enough money to be as conservative with your portfolio as what you’re comfortable with.” Those are important discussions to have prior to that portfolio construction. I think sometimes that that risk tolerance questionnaire might lead a person, if they’re not dealing with a real financial planner, in the wrong direction.

[00:33:28] Jason: Absolutely. The risk tolerance questionnaire, in my mind, is just part of the equation. We have to marry that with the financial plan. I think in many times the financial plan is probably the more important driver of what someone’s allocation should be as opposed to the risk tolerance questionnaire. As you mentioned, you may have a financial plan where a 60-40 (60% stock, 40% bond) portfolio gives you the optimal chances of achieving your goals, but you’re only comfortable in a 20% stock portfolio, so we’ve got a disconnect there. It’s just going to lead to a discussion. Like you said, there’s going to be tradeoffs. If you don’t want to take that level of risk we’re not going to be able to spend as much maybe, or you’re going to have to work a little bit longer.

[00:34:10] Dean: Right, so where are you comfortable? Are you comfortable spending less or are you comfortable working a little bit longer? Or can you get comfortable with a little bit more volatility in the portfolio?

[00:34:19] Bud: Well the risk tolerance opens up the conversation, and that’s the way we work through the entire planning process. That’s good from that perspective. We have something that we can work with that is semi-tangible, meaning we can show you results of prior portfolios over different periods of time. See, here we are back focusing on portfolios instead of talking about the bigger picture, which is the income stream and the stability of that income stream as well. As you and I have said many times on the radio show, many times the investments are just the fuel for the car.

[00:34:54] Dean: That could be a whole other episode of The Guided Retirement Show where we could talk about creating sustainable income in retirement. How do you create that sustainable income? Do you look at different pieces of your portfolio and say, “Let’s have a piece that’s going to drive income for the first five years that’s super stable, super safe, and then we can have a piece of our portfolio that we can invest like we’re 30 again. That’s going to be the money that we’re not going to touch for a couple of decades or something”? That’s a discussion that needs to be had. It’s a discussion that our listeners need to understand and need to hear. I’m not going to say all the time that’s an appropriate approach. A total return approach really accomplishes the same thing long-term. From a psychological perspective though it’s not the same experience for the end investor, right?

[00:35:51] Bud: Right. If you take as an example 2008, the market was down 38½%. You’re asking yourself the question, “Darn it, I’ve lost that money. How much return do I have to have to get back to where I was?” The answer to that is 58%. Now you’re asking yourself another question that is, “When’s the last time I made 58% in 1 year? How about 5 years or 6 years from that perspective?”

I think people need to see that because we get… Everybody’s going to enter into this market at specific periods of time to their own lifetime clock, if you will. That creates an examination of the sequence of returns. The sequence of returns is just a matter of, what if you got 20% in the first year and the next year you get 10% and then the next three years you got -2%? These different sequences is what we test the portfolio as far to see if the outcome at the end is really what we’re desiring.

[00:36:46] Dean: We’ve got a lot of great information on investing here. I want to tie it back to one thing before we end this particular program and set up the stage for what I want to do with you guys next. Jason, you talked about the financial plan and the creation of that financial plan. I think most people have a lack of a thorough understanding of what’s involved in a financial plan. You’ve met with a lot of people, Bud, you’ve met with more because you’ve been in the business a while longer, but don’t you think a lot of people think that a financial plan is an investment strategy?

[00:37:19] Bud: Yes, I do.

[00:37:19] Jason: Absolutely. Yeah.

[00:37:21] Dean: All right, so let me draw a big picture here. You need to go back and listen to all the episodes of The Guided Retirement Show: the tax piece, the estate planning piece. It all ties together the risk management piece.

[00:37:31] Bud: The four pillars.

[00:37:32] Dean: Yeah, it’s the four pillars of a well-crafted plan. If in discovering through the financial planning process we see that somebody needs $6,000 a month to support their lifestyle, the question from a financial planning standpoint is not “What rate of return do I need to get on my money to generate that $6,000 a month?” That’s not the first question. The first question is “How do I get the money out of the different accounts I have with the least amount of tax as possible so that I can reduce the ultimate withdrawal and reduce the hit on the portfolio?”

We’ve got to make sure that you understand as the individual investor… and if you’re trying to do this on your own you’ve got to be able to do it in an effective manner where you know which accounts to take from first, second, third and so on so that you’re reducing that tax burden. Any reduction in that tax burden is really the same thing as a boost in the overall return because it’s just money that you don’t need to spend because you’re not sending it off to Uncle Sam.

[00:38:34] Jason: Right. Yeah, totally agree.

[00:38:36] Dean: All right, a couple of great CERTIFIED FINANCIAL PLANNERS® here on The Guided Retirement Show. Guys, thanks for being here. I will look forward to the next episode where we’ll dive into some more detail on creating this sustainable income stream and how a person approaches that in retirement.

[00:38:52] Jason: Perfect. Thank you for having us.

[00:38:54] Bud: [crosstalk 00:38:54]. Thank you.

[00:38:54] Dean: You bet. I’m Dean Barber, Managing Director at Modern Wealth Management. I appreciate you joining us for this episode of The Guided Retirement Show. You can find links to this episode’s show notes and giveaways all in the show description. You can also visit us Don’t forget, hit subscribe to this podcast. Share it with your friends. Everybody needs a guide in the complexities that surround your retirement, and that’s why we’re here on The Guided Retirement Show.


Investment advisory service is offered through Modern Wealth Management, an SEC-registered investment advisor.

Let's Get in Touch

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.