Proper Portfolio Construction with Stephen Tuckwood

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Proper Portfolio Construction with Stephen Tuckwood Show Notes

Two weeks ago on America’s Wealth Management Show, Modern Wealth Management Co-Founder and President Jason Gordo and Managing Directors Dean Barber and Bud Kasper told everyone to stay tuned for more exciting news. We’re thrilled that we can share that news with you today on The Guided Retirement Show. As we build our investment management team at Modern Wealth Management, we’ll be doing so with our newest team member, Director of Investments Stephen Tuckwood, at the helm.

Stephen, AKA “Tuck,” joined Dean on The Guided Retirement Show to share a little bit about his background, proper portfolio construction, investment risk, and how a good CFP® Professional that has access to a Chartered Financial Analyst can make a major difference in your portfolio.

In this podcast interview, you’ll learn:

The Background of Modern Wealth’s Director of Investments, Stephen “Tuck” Tuckwood
What Goes into Proper Portfolio Construction?
The Relationship Between a CFP® Professional and Chartered Financial Analyst
The Importance of Taking Your Emotions Out of Investing

Getting to Know Tuck

Before we get into explaining the role of a CFA and why it’s critical for a CFP® Professional to work with the CFA, let’s learn a little bit about Tuck. Tuck broke into the industry in 2008—right in the middle of The Great Recession—when he was hired by an independent RIA firm in Atlanta. He was brought on board to help navigate the firm through The Financial Crisis and assist clients with portfolio construction and management.

A few years later, the two partners at that firm decided to join United Capital, which was a larger nationwide RIA firm based, and Tuck followed suit. He was recruited to join the corporate team for United Capital in Dallas, which was charged with building out a centralized investment platform for the broader organization. That role helped Tuck realize how critical it is for a CFP® Professional to have direct access to a CFA or somebody that spends all their time focusing on the investments.

“When it comes to really interpreting what something might mean or a tactical change in a portfolio, it might not always be that obvious to everybody. I think it’s critical to have a resource of a CFA to lean upon, especially with introducing new strategies into a portfolio. What are the effects going to be on the rest of the portfolio? What are the upsides? But more importantly, what are the drawbacks? Every different investment strategy has a drawback. It’s important to recognize what that is at the onset and how the how that might interact with other positions in the portfolio. A CFA does a reasonably good job at identifying those types of things and making them reasonably clear upfront with the CFP® Professional. The CFP® Professionals then do a fantastic job of communicating that to the client in a way that they can understand.” – Stephen Tuckwood

The Detailed Analysis from CFAs

Dean does know that there are a lot of good CFP® Professionals who don’t have direct access to a CFA or team of CFAs. But we want to dig into to some of the drawbacks of a CFP® Professional not being able to work with a CFA(s).

There are also a lot of wholesalers that want to come in and talk about the programs that they’re doing. Let’s see what Tuck has to say about the deep dive analysis and due diligence that a CFA offers.

“That wholesaler will only ever come knocking on your door when they’ve just had a good run of performances. That tends to be the case quite often. It’s really moving the analysis past just past performance track record and really understanding what it is that that team of investment managers are trying to achieve and how they’re doing that. Is it sustainable and repeatable? These are the some of the things that we’re looking to really assess as we’re reviewing different investment managers in different products that we might make available to clients.” – Stephen Tuckwood

Beware of the Investment Salespeople

A younger firm that hasn’t been around as long can also offer some great investment solutions. It might not have a long track record, but its team members might have had success at a prior firm and then come together at the younger firm. So, there are those types of situations where it’s not always straightforward in terms of identifying who’s good at doing any particular task.

Meeting with them face to face is usually idea to get a feel of if they’re great investment decision makers themselves or just good storytellers that give more of a sales pitch. Those are a few things that are important to be aware of when looking at any new investment solution.

Taking the Emotions Out of Investing

One thing that Dean has always talked about is how problems can arise when someone lets fear and greed take over when making investment decisions. Taking the emotion out of investing is a critical component of proper portfolio construction, but it can be very hard for people to do. Here is how Tuck goes about taking the emotion out of making investment decisions so he can demonstrate proper portfolio construction.

“It’s perhaps the most difficult thing to do because it is such an emotional event to be managing other people’s money. But it is critical. That’s where we see most errors being made. And frankly, I think one of the biggest benefits of having a financial advisor as opposed to managing your own money is that it does help to do that. The CFAs on staff can then take that responsibility away from the advisor as well.” – Stephen Tuckwood

Tuck says that some of the behavioral characteristics are the hardest things to overcome because the easy decision is often the wrong one in either times of despair, times of trouble, or market bottoms. The easiest thing to do is to de-risk the portfolio when you’ve just had a large drawdown.

It’s the same thing with de-risking a portfolio on the upside. When things are going so well, people want to be part of that market appreciation to take money off the table.

“The easy thing is to let things ride. Controlling emotions and trying to carve that out of the investment decision making process is critical for long-term success.” – Stephen Tuckwood

What’s Going on in the Markets?

Let’s also take a minute to review what’s going on in the markets. In the first quarter of 2023, we saw a nice rebound in the NASDAQ, the S&P 500, and the Dow Jones Industrial Average. The Dow Jones Industrial Average was really the star performer last year with not losing as much as some of the other indexes.

“A lot of people have the fear of missing out. They look at what happened in the first quarter and are asking if the bear market is over. Is this now the beginning of the next bull market? And of course, nobody knows the answer to that until it’s behind us.” – Dean Barber

Wednesday served as proof that it’s not behind us yet. That’s when Federal Reserve Chairman Jerome Powell announced another 0.25% increase of the Fed funds rate. That marks the 10th straight FOMC meeting with a rate hike. So, is most of the turmoil in the markets over and we’re just about in the clear? And has the Fed gone too far or did they do as well as expected with getting us through this?

Those are difficult questions, for sure. A lot of the trouble has passed in some markets, but the potential is there for it to reignite in a few others. But Dean and Tuck both think 2022 is an exception. And it’s not because there was a drawdown in the equity market. We’ve had quite a few of those and they should be expected. It’s quite a risky asset to be in public equities.

Are Bonds a Place for Safety Again After an Abnormal Year in 2022?

But in common portfolio construction, fixed income and treasuries in particular have been the ballast of the portfolio during difficult times. With the rate hikes that we’ve experienced and how they really shot up in 2022, the fixed income side of the portfolio took almost as big of a hit as the public equity side. That made for a very tough year with anyone who had a 60-40 portfolio.

“I think that’s what made last year particularly hard on everybody. I think that’s now changed in that duration, which is the sensitivity of the price of fixed income to interest rates, is now becoming our friend again in a portfolio. We had that almost reset year in 2022 where it didn’t act the way it has historically. It was painful for any diversified portfolio.” – Stephen Tuckwood

We could expect additional rate hikes this year. But it’s not likely that we’re going to have another year of unprecedented rate hikes that we had in 2022. That means that fixed income has become a potentially safer place to park money again.

What About Equities?

There was also a big drawdown on the equity side in 2022. But it’s always hard to predict what might be going on there. Two of the biggest drivers that Tuck looks at in terms of equity market performance are financial conditions—specifically the rate of change of financial conditions—and the rate of change of earnings growth.

“A lot of things factor into those two broad metrics, but those are the real two things that move the needle. A big component of financial conditions is the Federal Reserve and what they’re doing either with their balance sheet or the federal funds rate. That doesn’t look like it’s going to be helpful over the next year or so. I don’t predict that there are going to be rate cuts this year like some of the market is predicting.” – Stephen Tuckwood

The Impact of the Banking Crisis

We also have the regional bank crisis that we’re working through right now. That’s not great for financial conditions in terms of lenders tightening lending standards across the board and shoring up their own balance sheets. That’s not particularly accommodative to risk assets.

Challenges for the S&P 500

You have those two things and then earnings per share on the S&P 500 looks to be challenged this year. There are forecasts already out for next year and it looks to be turning. That might be a little bit more resilient than expectations, which will help put a little bit of a floor into the market.

“In summary, I just don’t think the two major drivers of potential surprises on the upside are going to be there in the equity market. It’s really a case of what can hurt us on the way down, what can impact things to give us a big drawdown. We just never know what those will be. We could have had the same conversation about a year ago prior to Russia invading Ukraine. There’s just no way to predict a lot of these exogenous effects that can come. But all we can do is be thoughtful in how we think about things and where should we be positioned in risk in the portfolio.” – Stephen Tuckwood

Rate of Change of Corporate Earnings

We briefly touched on the rate of change of a few different things. One that we want to elaborate a little bit more on is the rate of change of corporate earnings. There’s been a deceleration in the rate of change on corporate earnings, which is very concerning.

“We’re starting to see some of the effects of the rate hikes impact the consumer. They’re saving a lot less and starting to borrow on credit a little bit more. The retail sales numbers are kind of messy right now because of the trailing periods. During the COVID lockdown, everybody was buying things. Post-lockdown, everybody was buying experiences. Some of this year over year look through on some of the retail numbers can be a little murky. Generally, I think it’s fair to say that earnings per share growth expectations is trending lower.” – Stephen Tuckwood

There’s always the potential for a surprise and a turn in that. The equity market often bottoms out well ahead of a turn in EPS growth. It’s tricky to get timing anywhere near correct on that just because the equity market can be so forward looking. And a lot of these companies are making adjustments now. You’ll see a lot of headlines of a lot of cost cutting in terms of employees getting laid off across the board. Companies are trying to shore up their margins.

Some of the input costs are starting to come down as inflation is starting to wane. They’ve got that as a potential factor to assist on EPS, so it’s a bit of a mixed bag.

Are We Going to See a Recession in 2023?

As we continue to discuss proper portfolio construction, we need to bring up a dirty word that no one wants to talk about but needs to be talked about. That word is recession. There are a lot of people that are saying that there is going to be a recession. There are others that are saying that there’s not going to be a recession.

We have the most steeply inverted yield curve that Dean has seen in his 37 years in the industry. Inverted yield curves are typically a precursor to a recession. When we couple that with the fact that any interest rate hike that the Federal Reserve does takes months to reach its way into the economy. We’re not really feeling the effects of those rate hikes yet.

“We haven’t felt the four very significant 0.75% hikes that the Fed did throughout the summer last year yet in the economy. The question is, has the Fed gone too far fighting inflation? Have they gone so far that they’re going to push the economy into recession?” – Dean Barber

What Are the Metrics of a Recession?

That’s definitely on the table as a potential outcome. What we can definitively say is that the Fed was late to the game initially on the rate hikes. The transitory conversation lasted far too long, which led to the Fed getting behind the eight ball.

“Have they pushed it too far or will they if they raise the rate even further? It’s hard to say. It doesn’t feel like a recession is imminent in terms of the traditional metrics. If you look at the unemployment rate, it’s still quite low. Job openings are still high despite all these broader layoffs. Whether we enter a technical recession this year or not, I don’t know. I’d call it a technical thing if it happened. The equity market and the economy aren’t always aligned. One is not a signal of another. They can get quite divorced from each other. I think that might be the case here. The most important thing to focus on is earnings growth and the ability of companies to adjust in a more difficult market.” – Stephen Tuckwood

The Components for Proper Portfolio Construction

As we begin to wrap up this article on proper portfolio construction, we want to get Stephen’s thoughts on the critical components for building a solid portfolio. His first pillar of proper portfolio construction is focusing on costs.

“We can’t predict future returns, but what we do know is if we pay more for the same product, we’ll have our returns be lower than the next person who paid less. Wherever we can, we try to squeeze out implementation costs. You can do that in a few ways. The simple way would be to choose a more favorable share class within a mutual fund or even choosing an ETF versus a managed product if the manager of a mutual fund is not being particularly active and it looks and feels more like an index fund. You can essentially trim some savings there.” – Stephen Tuckwood

Tuck also notes that going direct instead of having a mutual fund wrapper or an ETF wrapper around your portfolio holdings can often reduce some costs involved.

Asset Allocation Matters

Tuck’s second component of proper portfolio construction is to be open to where you’re filling different asset class line items.

“You want to be diversified in terms of having a multi asset portfolio. In other words, some large cap stocks, a few small cap stocks, and some fixed income of various types. The best implementation for those might come from different places.” – Stephen Tuckwood

So, don’t limit yourself to one fund company to serve all those line items. Source the globe for who does one thing particularly well versus others. Then, bring those into to implement for that particular line item.

Focusing on Risk

And that brings us to Tuck’s third component of proper portfolio construction, which is to be very focused on risk. Focus on where your bets are being placed and be cognizant of that.

“It’s not always obvious where they are. Understand that some of the risk is what we call covariance in CFA terminology. It’s the way that one position might interact with another. You can’t just look in isolation in terms of amount of risk to the portfolio from each position.” – Stephen Tuckwood

Making Adjustments to Maintain Proper Portfolio Construction

Being a Chartered Financial Analyst requires Tuck to have his head on a swivel with what’s going on with various market trends. Sometimes he needs to nimble and quickly make adjustments within portfolios. And during other market cycles, he doesn’t need to be so active with making adjustments but still keeps a close eye on things.

“Being nimble is a tool to have in your back pocket. There are some years when the equity market and fixed income market are just riding higher and higher. You take your hands off the steering wheel and let them take over. In more turbulent markets, there can be these pockets of opportunity that that arise that you might not have in the portfolio over the longer term.” – Stephen Tuckwood

That made Tuck think back to when oil essentially went negative at some point during the pandemic. Commodities might not have been a core asset class that you were invested in prior to that and you might not want to be into it longer term, but something like that can just an opportunity that becomes a real nice addition to the portfolio for a period of time.

“The ability to be nimble is a tool. But over the long term, it’s about getting broad exposures to risk assets and equity and fixed income asset classes. They do a lot of the work for the portfolio, but nimbleness would be an additive piece of the pie there.” – Stephen Tuckwood

Looking Forward to Tuck’s Contributions at Modern Wealth

We hope that you’ve found what Tuck has shared to be insightful as you think about your proper portfolio construction. He’s excited to use his expertise to help Modern Wealth Management clients build confidence that they’re doing the right things with their money, attain freedom from financial stress, and gain more time to spend doing the things that they love. Tuck also hopes that people who are preparing for retirement and aren’t Modern Wealth clients can see the value that the investment management team will add to the firm for our clients.

“We’re super excited to have Tuck as part of the Modern Wealth Management team and building out and improving on the investment platform that we already have available. We look forward to delivering better solutions to our clients.” – Dean Barber

Dean is also planning to bring Tuck back on to The Guided Retirement Show to discuss direct indexing. It’s something that’s very compelling in our industry that many people aren’t aware of. Again, we hope that you’ve learned a little bit about proper portfolio construction from what we’ve shared with you. We also want to remind you that investments are just one component of the overall financial plan. If you don’t have a financial plan, that’s where you need to start. And we can help get you started.

Building a Comprehensive Financial Plan

It’s critical to build a plan that’s unique to you. The plan that your neighbor, co-worker, or family member built might be similar in some aspects, but no one will have the exact same goals that you have for retirement. Our financial planning tool will allow you to incorporate your goals for retirement and show you that proper portfolio construction is just one part of a financial plan. You also have taxes, risk management, and estate planning as pillars of a financial plan. You can begin building your financial plan from the comfort of your own home by clicking the “Start Planning” button below.

START PLANNING

Proper portfolio construction is complex in of itself. Adding in the other components of a financial plan just adds to the complexity, but each component is critical. If you have any questions while you’re using our financial planning tool or about what Tuck shared, we’re more than happy to walk through those with you during a 20-minute “ask anything” session or complimentary consultation with one of our CFP® Professionals. We can meet with you in person, virtually, or by phone depending on what works best for you.

Proper Portfolio Construction with Stephen Tuckwood | Watch Guide

Introduction: 00:00
Meet “Tuck”: 01:45
CFA® & CFP® Working Together: 03:15
Removing Emotions from Investing: 07:13
Tuck’s Thoughts on Market Turmoil & Fed Rate Hikes: 09:12
Rate of Change on Corporate Earnings: 15:43
Recession Risk & the Inverted Yield Curve: 17:44
Critical Components to a Solid Portfolio: 20:55
Conclusion: 25:52

Resources Mentioned in This Podcast

Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management, LLC, an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management, LLC, 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.