Welcome to The Invested Dads Podcast. Simplifying financial topics so that you can take action and make your financial situation better. Helping you to understand the current world of financial planning and investments. Here are your hosts, Josh Robb and Austin Wilson.
Austin Wilson:
All right. Hey. Hey. Hey. Welcome back to The Invested Dads Podcast, a podcast where we take you on a journey to better your financial future. I am Austin Wilson, research analyst at Hixon Zuercher Capital Management.
Josh Robb:
And I'm Josh Robb, Director of Wealth Management at Hixon Zuercher Capital Management. Austin, how can people help us with our podcast?
Austin Wilson:
We would love it if you would subscribe if you're not subscribed, so hit that plus, follow, whatever that button is on your podcast player, so you get new episodes when they drop each and every Thursday. And if you wouldn't mind going to our website and signing up for our weekly newsletter, that will also let you know when our new episodes are out as well as provide a nice little summary, where we're going to be.
Josh Robb:
And the show notes.
Austin Wilson:
Yeah, exactly. So check that out as well. So today, we are going to be talking about risk.
Josh Robb:
Yes.
Austin Wilson:
Not the board game.
Josh Robb:
No. Which is a fun game.
Austin Wilson:
That is a fun... It's a long, long game, but it's fun.
Josh Robb:
Potentially, yes.
Austin Wilson:
I think Risk got de-throned by Catan. When Settlers of Catan came out.
Josh Robb:
You think so? Yeah.
Austin Wilson:
Settlers of Catan is kind of the same strategic long game vibe, and I love me some Catan too. Good game.
Josh Robb:
I like the rolling the dice of Risk. It just adds that variation to it. Now they have a game you can play Risk on your phone and you can play against computer. So you could just do that.
Austin Wilson:
Oh, that's what you're doing all day.
Josh Robb:
And you don't have to worry about a board you have to keep and no one mess with. But you can also play with people too, so that's like the new modern version of it.
Austin Wilson:
Oh yeah, you don't even have to have friends.
Josh Robb:
Yeah, it sells randomized dice and all that.
Austin Wilson:
So today, we're talking about risk and how to know if you're taking too much or even too little risk and really, as it pertains you to your investment philosophy and your investing.
[1:55] - What Types of Risk Are There?
Josh Robb:
So first we're going to talk about what is actually risk. When we're talking about risk, what are we talking about?
Austin Wilson:
Could mean anything.
Josh Robb:
Yes. Normally when I say, "Hey, we're talking about risk," and here we're on a financial podcast, people immediately go to stocks or what we would call in our industry, volatility. The movement up and down of the stock market.
Austin Wilson:
Or really risk of downward movement is what people think.
Josh Robb:
Yes. Yeah. What's the chances of me losing money on this investment? When we'd say risk, that's what most people think of when it comes to mind. And that's really what we would call here, and we are going to use some industry terms, market risk.
Austin Wilson:
Correct.
Josh Robb:
So market risk is the decline of your investments. But there are other risks to consider, and when we're talking about risk, I'm going to encompass all these because these are all part of your overall risk tolerance. And so another one is inflation risk. And we know, as last year, 2022, there was a little bit more inflation than we've had experienced in the past.
Austin Wilson:
Less than ideal.
Josh Robb:
Yes. So I think we ended the year at 6.5% inflation, which means from January through December, because it's a 12-month number.
Austin Wilson:
For December to December, yeah.
Josh Robb:
The whole year, six and a half percent growth. Meaning if I was buying basket of goods.
Austin Wilson:
In December of 2021 versus December 2022.
Josh Robb:
6.5% higher cost for that.
Austin Wilson:
Which is down from 9.1, where it was in about June.
Josh Robb:
But that is a risk, and most people don't think about that. But inflation risk is the risk that rising prices limit your ability to purchase the same amount of goods. And so you may say, "Oh, I don't want any volatility, any movement in my investments." In doing so, you may not get much upwards growth. And then if you don't keep up with inflation, that's a risk because you won't have enough money down the road to buy the same thing.
Austin Wilson:
The risk is really purchasing power.
Josh Robb:
Yes, that's the term.
Austin Wilson:
It's purchasing power risk. So it's your dollar's ability to buy goods. And if you don't keep up with or outpace inflation, your dollar does not go as far and your purchasing power is not as strong, so inflation just eats away your money over time.
Josh Robb:
But that's an unseen risk in the sense that you don't get a monthly statement that says, "Here's that purchasing power risk that you just experienced last month." And so that's another risk to consider. Interest rate risk is what we saw last year from a positive side, is interest rates do move.
Austin Wilson:
They do.
Josh Robb:
They fluctuate. They go up and down. Last year we saw up because as interest rates were rising, you got more on your holding. So if you had a savings account, things like that, they were probably increasing the amount they were paying you.
Austin Wilson:
Unless you're holding a bond, then it was bad news.
Josh Robb:
Yeah. But their interests were going up. The new bonds issued were getting higher interest.
Austin Wilson:
New bonds, yes. The value of your current bonds at lower coupons.
Josh Robb:
That is a risk from an interest rate standpoint, is bonds in particular, their price reflects changes in interest rate.
Austin Wilson:
Correct. Stocks as well, is what happened last year, too.
Josh Robb:
Yes. And the other side of the interest rate risk is if they're raising their interest rate for savings, probably your cost of borrowing are going up as well. Just something to keep in mind. There's reinvestment risk. This is something to think about, and a bond is easiest way to think of this in that if I buy a two-year bond, $10,000 and they're going to pay me whatever the interest is, doesn't matter. My bond matures in two years, they give me back my $10,000, that's how bonds work, I loaned them the money, they give it back at the end. Two years later though, my $10,000 just comes back to inflation, probably won't buy the same thing that it did two years prior. So my reinvestment risk means that when I do get my cash back, can I use it the same as I did before? So then I want at least some sort of interest to help compensate for me missing out on the ability to use it during that timeframe. So reinvestment risk is another risk.
When we talk bonds, there's default risk. What's the chance that the person who I'm lending money to can't actually pay me back when the time comes?
Austin Wilson:
Exactly.
Josh Robb:
They go bankrupt in a sense. Liquidity risk, this is important one, is if I'm investing my money, how likely can I quickly get that back if there's an emergency? Liquidity is just another term for how quick can I get cash; how much can it turn into cash and how fast?
Austin Wilson:
And different investment vehicles have different liquidities. So obviously stocks and ETFs, some of the most liquid, even crypto to some extent, traded on exchanges in real time. So generally speaking, during market hours or whatever with stocks and ETFs anyway, you can sell at any point. Mutual funds, very similar, only one time a day though.
Josh Robb:
End of day, yeah.
Austin Wilson:
But there are certain investment vehicles, I'm thinking things with lockout periods, hedge funds, things like that.
Josh Robb:
Private equity.
Austin Wilson:
Private equity, those things, not very liquid. There are often years or something that you have to hold that for and you can't sell it in certain time periods. There are also certain things like hard assets. Hard assets can be great investments.
Josh Robb:
Yeah. Real estate.
Austin Wilson:
I think people talk about real estate, housing, stuff like that. However, not easy to offload a house in a minute.
Josh Robb:
Can't do a portion of that.
Austin Wilson:
Exactly. Yeah. Yeah. You have to liquidate the whole thing. So yeah, those are some asset classes and how liquidity is different.
Josh Robb:
Political risk. So we try not to talk too much into politics, get too partisan in that discussion, but political risk is not talking about one party over the other.
Austin Wilson:
Correct.
Josh Robb:
It's the fact that what if there's legislation or changes within what the government oversees, because they oversee most of the financial industry, minus cryptocurrencies right now, but that may be coming. What if they change something? What is the risk that what I'm doing now, there'll be a change in how it's either regulated, taxed, or even controlled? And so there's a political risk there.
Austin Wilson:
I'm going to piggyback on that one.
Josh Robb:
Yes, please.
Austin Wilson:
Geopolitical risk.
Josh Robb:
Geopolitical.
Austin Wilson:
So this is global political risk, where we've got things like Russia's invasion of Ukraine, that's geopolitical, that's causing all kinds of issues and turmoil and controversy between nations, which can lead ultimately and has in the past, and that can change all kinds of commodity prices and supply and demand issues. So that's another one that's very similar.
Josh Robb:
And then speaking of global, currency risk.
Austin Wilson:
We saw that recently too.
Josh Robb:
We have the dollar here in the United States, it's what everybody uses, but if you're investing, you may own a foreign company that is not using the dollar or you may actually be owning foreign currency. The risk is that the amount you can get back in US dollars fluctuates as well.
Austin Wilson:
Exactly.
[8:00] - Everybody's Risk Has a Tolerance
Josh Robb:
And so maybe it's worth less in the future than what you had to exchange rate for at that point. So in general, the point of this is saying, when we are talking about risk, there's more than just the downward movement of your investments. So the overall question is, am I taking the right amount of risk? And so we're going to talk about that and how everybody's risk has a tolerance. You and I each have a different amount of risk we can tolerate, and that's for our whole life.
Austin Wilson:
Exactly.
Josh Robb:
When we associate our investment risk within just looking at that individually, we sometimes may miss that point. And so let me give you an example. If I'm a small business owner and I'm starting my new business, starting this venture off, I'm taking risk. The chances of small businesses lasting three years, there's a lot of ones that tryout and they just don't work. There's risk associated with this new venture. So in my life, I'm taking a good portion of my risk tolerance in associating with this new venture. So it may actually happen that while this is going on, my ability to tolerate my investments may be limited. It may have been two years ago, I was totally comfortable with the up and down movement of my portfolio, but now that I increased my risk in another place, all of a sudden, it's like I can't stomach this.
And as an advisor, I've been on those conversations with clients to say, "Let's work through this." But they may say, "You know what? This movement in the market is just way too much. I can't handle this." So at first I'd say, "What are you talking about? Well, you had something like this last year and you didn't even bat an eye." Well, their tolerance in their whole life has changed. There's something new, drawing more of that risk into a different area. So am I taking the right amount of risk? The answer is changes throughout your life.
Austin Wilson:
Absolutely.
Josh Robb:
Other examples of that would be, let's say your tolerance for risk may change while you have kids in college. If you're helping fund some of that college, your income's changing, so your risk to see that fluctuation may adapt.
Austin Wilson:
Or kids at home, period.
Josh Robb:
Or kids at home, new kids. There's down the road weddings. Retirement is a really good example, is there's a life event that is causing some risk to be used up that may limit your ability to tolerate elsewhere. You may think, "What's retirement have to do with risk?" Well, you're losing your income.
Austin Wilson:
Yeah, exactly.
Josh Robb:
Your paycheck goes away, and that just psychologically eats up a lot of your risk tolerance for seeing other things change, because that's one big change in your life.
So in general, when I look at this and when we talk about risk, you can't look exclusively at investments and say, "This is what I can tolerate." Because throughout your life, that will fluctuate based on everything else going on.
[10:24] - Dad Joke of the Week
Austin Wilson:
So Josh.
Josh Robb:
Yes.
Austin Wilson:
I got a dad joke of the week for you and more of a thought.
Josh Robb:
I'm ready. Thought, okay.
Austin Wilson:
I didn't know if you knew this about me, I'm a kleptomaniac.
Josh Robb:
Kleptomaniac.
Austin Wilson:
So I've now stolen 56 copies of the board game Risk from local retailers.
Josh Robb:
Oh, boy.
Austin Wilson:
56.
Josh Robb:
Oh, yeah. That's scary.
Austin Wilson:
When they eventually catch me, I'll say, "Well, life's all about taking the risks."
Josh Robb:
Taking the risks.
Austin Wilson:
I'm lying. Actually, that was a joke.
Josh Robb:
That was a joke, he has not taken.
Austin Wilson:
I've not stolen a game of Risk.
Josh Robb:
Ever.
Austin Wilson:
I've played a game of Risk.
Josh Robb:
But it was legally bought.
Austin Wilson:
I've had a win stolen from me on it, probably.
Josh Robb:
Probably.
Austin Wilson:
I'm not a kleptomaniac.
Josh Robb:
Not good. You can't use puns with kleptomaniacs because they take things... literally.
[11:05] -How Do You Know If You're Taking the Right Amount of Risk?
So now we've defined what risk is, and we've talked about how your overall risk tolerance is not just associated with investments, but the changes in your life and what's going on. How do you know if you're taking too much risk, or in other words, the right amount of risk? Because there is an option too, I'm not taking enough risk or I have the tolerance for more risk.
So first couple things you should know, then you and I will kind of debate through or walk through this. How do I know if I'm doing the right amount of risk? Well, you need to know what your goals are.
Austin Wilson:
Goals are very important.
Josh Robb:
What's my time horizon? What am I trying to achieve? And historically, how I'm invested right now, what has that gotten me? Ups and downs, what have historically been the experience of how I'm investing?
Austin Wilson:
Yeah, it's good to get your mind around both historical returns and historical volatility, both.
Josh Robb:
Yes.
Austin Wilson:
Because they go hand in hand.
Josh Robb:
Because you can't say, "Am I taking too much risk," if you don't know what that risk risk is.
Austin Wilson:
Exactly.
Josh Robb:
If you wait until you experience it, then it's a little too late to know.
Austin Wilson:
It's a little too late.
Josh Robb:
And there's no guarantee going forward, but historical returns and historical volatility can at least give you a framework.
Austin Wilson:
Absolutely.
Josh Robb:
And there's a lot of software out there that can help you with that, because it would be probably tiresome to go backwards and look at whatever your portfolio is, whether it's 60% stocks, 70% stocks, whatever you do to say, "Hey, would've those drawdowns been?"
Austin Wilson:
Yeah.
Josh Robb:
Yeah. That's a lot of work, so there's a lot of software out there. If you have an advisor, I'm sure they can definitely help you understand that. But when you're not in line with your risk tolerance, you need to first, step back and say, "Okay, I'm invested in this way for a reason. What was my original reason?"
Austin Wilson:
Yeah. It could have been guidance from someone based on the information at that point in time. Maybe things have changed, maybe they haven't.
Josh Robb:
And that's the thing is, if nothing's changed since that one, then why am I feeling different now? That's the question you got to ask. Review your goals. Did one of my goals change? Because that could adjust why you're in or out of alignment with your risk. Then once you determine, did my time horizon change, did my goals change? Why did I choose this to begin with? And it could have been something along the lines of, at this point in my life that was the only options I had, but now I have more options. Maybe you had a 401k, here's your 15 choices, but now there's more. Those type of things.
So then the question becomes, "Okay, if I'm out of tolerance, I've reviewed the reasons why I started there and what I need, well, what are my options?" Because sometimes, you have to very clearly understand the ramifications of making changes. Let's say it's a taxable investment account. If I'm all of a sudden making a bunch of changes, I may be creating a tax liability for me. Is the end result, what I'm going to get worth that cost? So you always have to take that in mind. So as we think about it, Austin, first question I have for you.
[13:50] - Do Investors Normally Take Too Much or Too Little Risk?
Austin Wilson:
Okay.
Josh Robb:
I got a couple questions, didn't write them down. I want to surprise you.
Austin Wilson:
No, this is good.
Josh Robb:
First question. Do you think you find more people that are over their risk tolerance or under?
Austin Wilson:
I would say I hear of more people who think they have a higher risk tolerance than they actually do. And these are the people that take these questionnaires or whatever and you assess that, hey, you're able to handle these drawdowns and be able to sleep at night. And then it happens and they can't. It's easy to say that you're comfortable with something if you don't live through it with real money. So on paper, it doesn't really hurt that bad to have a 50% drawdown because it's not your dollar, but even a 10% drawdown on real dollars is a real pain.
Josh Robb:
And you're optimistic that, "Hey, you know what? I can do this. I'll stick with it."
Austin Wilson:
Yeah. I mean, I think that people overestimate their risk tolerance, which really gets them in trouble when actual volatility happens, and everyone thinks they have a high risk tolerance when you're in a bull market.
Josh Robb:
Yes. It's the fear of missing out.
Austin Wilson:
It's FOMO. So I think that that is a risk. So you had a couple other questions?
Josh Robb:
Yeah. And I'll follow up with that to say, you look at the data and you see that.
Austin Wilson:
The dad?
Josh Robb:
The data.
Austin Wilson:
Oh.
Josh Robb:
The dads are probably somewhat, for sure. When you look at the average investor...
Austin Wilson:
Is it data or data?
Josh Robb:
Well, it depends on if it's a capital at the beginning of the sentence.
Austin Wilson:
Okay. I've always wondered, sorry to interrupt.
Josh Robb:
Data. It's data. Data is the guy from Star Trek.
Austin Wilson:
Never seen it.
Josh Robb:
Okay.
Austin Wilson:
Live long and prosper.
Josh Robb:
The data shows that when you look at returns in the market versus what the average investor gets is lower.
Austin Wilson:
The investor underperforms, yeah.
Josh Robb:
And part of that has to do with performance chasing and then selling when the volatility shows up.
Austin Wilson:
Exactly.
[15:28] - Are We More Tolerant to Risk Overtime?
Josh Robb:
Because they have a hard time tolerance. So I agree with what you said. The other question I have for you is, when it comes to tolerance and taking too much risk or not, do you find that over time, people get more tolerant of risk or less tolerant?
Austin Wilson:
In a lot of ways, I think if they've had a healthy investing experience, they've understood and stuck with the plan for the long term, they should actually probably have a higher risk tolerance the further along in their investing career that they get, because they've understood what volatility looks like and that things bounce back and what it really looks like to just stick to it. I don't think that most people have healthy experiences for most of their investing time, so I don't think that that's always the case. And people tend to get really fearful nearing and into retirement, even well into retirement when they actually probably have a higher risk allotment that they could use than they are, because their money doesn't need to last as long, theoretically. So I think that you should have a higher risk tolerance because you should understand more, but I don't think that's always the case. What about you?
Josh Robb:
Yeah, I think over time, their understanding and education increases their ability to better allocate the risk. I think everybody still has a limited budget, if you want to call it that, of risk, but their ability to say what investments do takes less of my risk budget because I understand it. So I would agree with you that over time, if they have a healthy understanding and education of investing, that just uses up less and less. They may not need to take more risk, but the amount of tolerance they have for it is reduced.
Austin Wilson:
I also think when you're looking at making changes, because things do change, your goals can change, maybe your risk tolerance does change, something like that.
[16:57] - How To Adjust & Manage Your Risk Tolerance
Austin Wilson:
There are a number of ways to do that, and I think we should talk about that as well. And number one, yeah, you can adjust your asset allocation. So there's no harm in that, it just happens over time and it's part of a lot of plans to adjust that over time. If you need to reach a different goal or a different time horizon, higher returns, you can, generally speaking, lift your allocation to equities and reduce your allocation, your fixed income. Vice versa as well. Maybe you don't need the return or want the return or want the risk, you can increase your bond allocation, your fixed income allocation, decrease your equity, you're going to decrease your return potential over time, and so that's one way to do it as well.
But I think another lever that people sometimes don't think about is simple things like work another year, wait another year on retirement or two years or five years, or whatever that looks like, and then you can keep doing what you're doing and keep within your risk tolerance of the stock bond allocation you have. You don't need to change it. And that's one option, could easily adjust things like add more money in or plan on spending less.
Josh Robb:
And what you're talking about there, all those pieces are, if my tolerance for risk doesn't get me what I need to meet my goals. So instead of adjusting my risk, I adjust my goals.
Austin Wilson:
You adjust the goals. Move the goal post.
Josh Robb:
I adjust how long I'm working, how much I'm saving or what I'm spending. There's not a bad thing with that, because when you're setting goals, goals can be moved. And in fact, a lot of goals will change over your time as things happen in your life. So you're right, if your tolerance for risk is not enough to get you historically what you need to meet those goals, it's hard to say, "I'm going to force myself to be tolerant of this new higher amount." Chances are you're not going to be able to.
Austin Wilson:
Exactly. Change the goals.
Josh Robb:
So then you are forced to look at your goals and reevaluate which are the most important to me, which ones am I more willing to adjust?
Austin Wilson:
Exactly.
Josh Robb:
Yeah, you're right.
Austin Wilson:
So what other thoughts on risk do you have?
Josh Robb:
In general, a year like last year in 2022, when we saw...
Austin Wilson:
Was a risk filled year.
Josh Robb:
... a downward market in the stock market as well as the bond market, there was a lot of volatility. It really brings to light, people who were overexposed to risk or had a higher risk than they really could tolerate. And you'll see then at that point, there'll be a lot of adjustments. And unfortunately, that means you're making adjustments probably at the worst time.
Austin Wilson:
At the wrong time, yeah.
Josh Robb:
And that's where again, that timing comes in is, you want to get it right in the beginning because you don't want to make those adjustments when everything's down. And so that's where planning comes in, having a good advisor to say, "Let's make sure we're set up so that we're not needing to make those course corrections right at the worst time." When you're making goal adjustments, timing doesn't matter on that. If you say, "I'm working an extra year," when you make that decision, it isn't that big of a deal.
So I think the biggest deal is after looking at last year, how did I stomach that volatility? How did I feel? Was I comfortable? No one likes to lose money, right? That's the thing. It's not saying that I get excited every time I look at my portfolio and it's down, it's when I see that, what is my reaction? Everybody's going to be upset, no one's going to like it, but what does that cause me to do? Am I staying up at night? Am I waking up in the middle of the night because I'm worried? That could be a problem. And so at that point, I need to evaluate, "What do I need to do now and what do I need to do in the future when things look a little better?" Maybe I can postpone some of that decision making and make it at a more opportune time.
Austin Wilson:
I also think that something that's not thought of very much is opportunity cost.
Josh Robb:
Yes.
Austin Wilson:
Opportunity cost is a risk, and I think that especially as a young investor, thinking you have a lower risk tolerance than you really "should," can be risky. So the less exposure to, essentially equities, is what we're going to say, the more exposure you'd have to things like cash or a fixed income, the more returns you're taking off the table for the long term that have time to compound. And I truly think that if more people were educated, and I hope that our country works towards doing better about this over time, but I truly think that if more people are educated well at how market dynamics work over long timeframes, you should theoretically have very high equity allocations forever. As high as you can tolerate, theoretically forever almost, because stick with it and it's going to come back, because that's the way it works. But most people don't understand that so they're scared. And they think they don't really understand what's going to happen, so they think that they can't take the risk when they definitely have the time horizon to take the risk.
So I would say that the hidden risk is opportunity cost because if you're 22 years old, saving in your 401k, I don't know your financial situation, this is not a recommendation, but you don't need bonds.
Josh Robb:
Yeah.
Austin Wilson:
Probably.
Josh Robb:
Yeah. If you're not planning and touching that money, historically, stocks are the asset class that best not only keeps up with inflation, but outpaces, so you're right. All I have to say, risk tolerance is important.
Austin Wilson:
It's important. Yeah, absolutely.
Josh Robb:
Understanding where you fit with that is very important. Make sure you talk with your financial advisor about how you're invested and if it matches what your tolerance is. And if you don't have one, make sure you reach out to us, [email protected]. Love to talk to you.
Austin Wilson:
Or check out the Invest With Us tab on our website.
Josh Robb:
Yeah.
Austin Wilson:
So until next week, until next Thursday, don't take on too much risk, but take enough.
Josh Robb:
Yes.
Austin Wilson:
And we'll talk to you later.
Josh Robb:
All right, bye.
Austin Wilson:
Bye.
Thank you for listening to The Invested Dads Podcast. This episode has ended, but your journey towards a better financial future doesn't have to. Head over to theinvesteddads.com to access all the links and resources mentioned in today's show. If you enjoyed this episode and we had a positive impact on your life, leave us a review. Click subscribe and don't miss the next episode.
Josh Robb and Austin Wilson work for Hixon Zuercher Capital Management. All opinions expressed by Josh, Austin, or any podcast guest are solely their own opinions and do not reflect the opinions of Hixon Zuercher Capital Management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Hixon Zuercher Capital Management may maintain positions in the securities discussed in this podcast. There is no guarantee that the statements, opinions, or forecast provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principle. There is no assurance that any investment plan or strategy will be successful.