Brian Perry

In addition to overseeing Pure’s investment offering and platform, Brian works closely with Pure’s financial advisors, helping provide them with the tools and resources necessary to serve their clients and continue the firm’s mission of providing the highest quality financial education and planning to as many people as possible. He has been actively involved in [...]

How does Pure Financial Advisors look at investing at a fundamental level? In this video, Pure’s Executive Vice President and Director of Research, Brian Perry, CFP®, CFA®, gets back to the basics, explaining Pure’s investing philosophy and the rationale for building globally diversified investment portfolios, informed by academic research.

Free Financial Assessment


Andi: Now, please welcome your presenter, Brian Perry, CFP® and CFA®, Brian. Hello, how are you today?

Brian: I’m doing awesome, Andi. How are you?

Andi: I’m very well. Happy Spring. It’s so nice to actually start heading in the direction of not having cold weather. I mean, it is San Diego. So it’s that bad-

Brian: What are you talking about? When did we have something that wasn’t – oh you mean last Summer? We have Spring and Summer?

Andi: Well, that’s true. Yes.

Brian: We might have to toughen you up a little bit. We don’t have Winter here.

Andi: Yeah, that’s true.

Brian: So, yeah, I guess it is Spring. Spring is sprung and markets like it apparently. Markets have been going up and things are good. Right. We’re getting towards the end of COVID. Just yesterday they said, what is it? September 15th that they’re going to do away with the rest of the restrictions here in California.

Andi: Oh, wow. Really? September 15th?

Brian: Or no, excuse me, June 15th, June 15th.

Andi: I was gonna say.

Brian: Yeah, but you’re still going to have to wear a mask, so I don’t know what the difference is, but yeah.

Andi: Awesome.

Brian: So, yeah. Well, hey, we have a lot to cover. So what we’ll do is we’ll- we’ll dive into a few slides and cover some things and then from there we will open it up as we go along, Q&A. Andi, if questions come in, feel free to ping me and we’ll take it from there. So, folks, first of all, thanks for joining. Brian Perry again, Director of Research, Executive Vice President here. Good to virtually see you all and looking forward to seeing you all in person. Hopefully it won’t be too much longer, but we’ll see. We’re still keeping everybody nice and safe and masking up and limiting the people in and out of the office. But hopefully the day is coming a little bit sooner if we all get vaccinated where we can come in and see each other in person. For those of you that are near one of our office, for those of you that are a little bit further away, we still love seeing you over camera. And that’s a growing percentage of the people that we talk to.

Anyway, I want to cover a couple of things today. I wanted to make this- we do a lot of these market updates and talk about what’s going on in the world. We’ll do some of that kind of the second half of this webinar. What I wanted to do to start, though, was talk a little bit more about how we look at investing, a little bit more at a fundamental level and really kind of go back to basics, just a little bit of- just really talking about our philosophy a little bit. And so what I’ll do is I’ll start there. And again, if you have questions on any of this, let me know. And I’m always happy to join in a meeting as well. If you want to have a little bit more of a one-on-one dialogue on anything we talk about here today or anything at all, just let your advisor know. I’m always happy to jump into a meeting and have a chat with you.

How Do You Sleep at Night?

  • Where are you taking risk?
  • What’s the right asset mix for you?
  • Do you need to worry about what stocks are doing?

So for starters, it’s like, OK, let’s go to the video board here and let’s go the other way because I’m going the wrong way. What I want to do here is talk a little bit about how we think about investing and at the beginning, how we talk about- how we think about stocks and bonds. Right. And how we think about risk, because at the end of the day, there’s a saying that portfolio management is risk management and you all want to make money. You all want your portfolios to grow. But you all, I’m assuming, want to sleep at night as well. Right. And so our goal is always to take the least amount of risk possible in order to get a certain amount of return. Right. And so as a starting point, we base all of our investing off of financial planning. We are a financial planning and investment management firm. That’s why we’re always going through cash flow planning with you, to figure out what kind of return you need in order to meet your goals. From there, that suggests what portfolio mix might be appropriate for you. And then it’s like, OK, there’s lots of different choices about kinds of things to invest, so how do we determine what investment to put you in, what mix of stocks, bonds, etc.? And I’m going to walk through a simplified exercise here to show you kind of how we think about this. I’m going to give you a couple of caveats. First of all, I’m going to use round numbers here and some of the percentages that are going to come out might seem kind of commonplace or boilerplate. They’re not anybody’s mix. They’re not a recommendation or anything. They’re just round numbers because that’s the way the math works in my little example here. The second thing is that for those of you that have met me before or seen me, I actually flunked second grade handwriting, got a D minus. And so that’s with a pen and paper. I’m writing here with my finger stylus on a screen. So it’s not going to be pretty, but you’ll get the concept.

So how do we think about stock and bond investing? Here’s a way to think about it. Let’s pretend that there are two kinds of- that there are two kinds of stocks. There are large company stocks and there are small company stocks and you can buy either of these. And let’s pretend that hypothetically you have to choose, which has more risk. I think most of us would agree that the small company stocks probably have more risk. They’re a little bit more volatile. You would never want to buy just one small company or for that matter, just one large company. You’d want to buy a basket. The entire basket, if you go out and buy 1000 small companies, they’re not all going to go under. Right. But they’re going to be more volatile. They’re going to bounce around a little bit more and whatnot. And just to clarify, when we talk about small companies, we’re not talking about mom and pop operations. An example of a large company would be McDonald’s. An example of a small company, it would be Denny’s. So still large companies. Let’s pretend that over time you look at it and the large company stocks have gotten you 8% and the small company stocks have gotten you 10%. They aren’t the actual figures that they have gotten. But from an order of magnitude or degree, it’s about what these- these have done. Right. And let’s pretend you’ve gone through your financial planning exercise and it’s been determined that you need to get 6% from your portfolio in order to meet your financial goals. So there’s lots of different mixes you can use to get to 6%. I’m going to limit your options here for the moment and say you’ve got two choices. You can put it in these large company stocks or you can put it under the mattress, right. If you put money under the mattress, the good news is it’s not going anywhere. You’re sleeping on a bed of money. The bad news is that it’s growing at a big fat goose egg. Right. You don’t get any growth when the money is under the mattress. So if you’re going to put some of your money in stocks getting you 8% and some of it under the mattress getting zero. The question then becomes what percentage of your money would need to go in these stocks in order to for the whole amount of your portfolio to get you 6%. So here we flash back to third grade math with fractions, and it turns out that about 75%. So 3/4 of 8 is 6; 75% of your money would have to go into these large company stocks, 25% would be left to go into the mattress. That mix, that 75/25, would be expected to get you 6% over time. So you’ve met your financial goal. All right. And again, these large company stocks, not as volatile as the small company stocks. Let’s run the same exercise, though, and say, what if we bought the slightly more aggressive, higher growth but more volatile stocks, right? Well, here you’re getting 10% on those. You only need to put 60% of your money in those stocks in order to get to 6%, which leaves 40% to go under the mattress. Right. So, again, either one of these portfolios will get you to your required rate of return. The difference is that these stocks right here are a little bit more volatile. These stocks are a little bit more conservative. However, here’s the key point. I might very well want this 60/40 portfolio instead of this 75/25 portfolio in order to meet my goals. Because goal number one is don’t run out of money. Right. So you need to get 6%, either of these will do it. Goal number two is to sleep at night. I think this portfolio could be more- allow you to sleep better at night because it’s got more money under the mattress. Here’s a way of looking at that. Let’s say you’ve got $1,000,000. And again, I want to caution there’s no magic to 60/40 in the financial industry. Some of you have a 60/40 portfolio, some of you have 10% in stocks. Some of you have 100% in stocks. It varies depending on your needs. It’s customized. The only reason this is coming up 60/40 again is because the math works that way. If you are 60/40, you would have $600,000 in stocks, that’s in ST, stocks, and you would have $400,000 under the mattress, we’ll go M for mattress. Well, what does that mean? Well, let’s pretend that you have $1,000,000 now. You need 4% of it each year to live on. So you need $40,000 a year in distributions. Well, if I need $40,000 a year and I’ve got $400,000 under the mattress, I do some math and that equals 10. And you know what 10 is? In this example, 10 is the number of years of your spending that you have under the mattress. Right. So think about it this way. Somebody comes to you and says, hey, that was a crazy coronavirus collapse we had last March. Oh, man, that election season was insane. I’m worried about midterm elections. I’m worried about inflation. I’m worried about COVID. I’m worried about the- this and that. Right. You know what you say? You say, I don’t care. Talk to me in a decade because you know what? I have the next decade of my spending needs under the mattress. I don’t need to worry about what’s going to happen tomorrow, next week, next year, next month. I’ve got my decade of spending under the mattress. And so that’s how we think about combining stocks and bonds. Is that one kind of stock or one security, maybe a little bit more conservative, a little bit more aggressive than another. But we look to combine them so that a) the portfolio is expected to meet your required rate of return and b) the portfolio will have as many years of spending under the proverbial mattress as possible so that you sleep at night, that you have money to distribute to yourself to withstand market declines. Again, of course, these are hypothetical numbers, and you don’t literally put the money under the mattress that might be high quality, fixed income and the like, but again, conceptually, this is how we think about building portfolios. All right, let’s go to some slides here. I’ve got a couple of slides in here, we can start those up. And what I want to do next is just talk a little bit more about- here we go- let’s get to the- all right, there we go. So when we talk about investing in that mix of stocks and bonds, the one reason that we want to have this mix of different assets is that you sleep at night. The other is that at times different types of investments are doing better or worse. Right. And what I mean by that is that reversion to the mean is an extremely powerful influence in the financial markets.

Reversion to the Mean is Still a Thing: Market Returns Before and After November 6, 2020

So look at this chart here, what this shows is that the performance of these different sectors in the stock market during the worst of the pandemic, so from the end of 2019 until November and then from November to now. Right. So you can see that the grey at the bottom- online, retail, home improvement, IT- those sectors did phenomenally- groceries- they did great during the shelter-in-place era, right, because you couldn’t leave the house. If you can’t leave the house, you need to shop online. You might as well make your house nice with some home improvement. You still need to eat, so groceries, right. So those sectors did great. And then you can see that since then, their returns have been much more muted. Conversely, energy did awful during the collapse. So did airlines, you can’t fly. Why would an airline stock do well? Right. REITs. Real Estate Investment Trust. On the- on the retail side, you can’t go to the store. Cruises and hotels didn’t to do well. You see the losses there during that period, but then you see that there what is done the best more recently as the economies reopen. So again, that reversion to the mean that what did best last month or last quarter or last year may not do the best going forward and vice versa. Right.

Why Diversify? Asset Class Performance by Year, 2006-2020

And if you want more proof of that, look at this chart. And this is a really popular chart in the financial markets. And so as we look at this, what I would say is that as on this chart, you’ve got a stack ranking of all the different asset classes. And can we make this bigger, please? It’s a little bit hard for me to see on my end. I’m not as young as I once was and my eyes are having trouble making this out.

Andi: This is the biggest I’ve got for you, Brian.

Brian: This is the biggest- Oh, no. Here it comes. It’s- there it is. That’s a little bit better. Cool. So these are the different years, 2006 through 2020. And then stack ranked are the different asset classes from you know best performing to worst each month. And my old eyes are struggling to read this. Your eyes are probably struggling to read it too, no matter how young you are. But what I would say is, can you tell me what pattern you see? And then I would pause and wait, and it’s a trick question because there is no pattern. The reality is that in any given year, what did best may do best again. It may be worst, it may do somewhere in between. The different sectors, different asset classes, their performance tends to be random from worst to first and everything in between. And then what- you look where that line is going through, that’s a diversified portfolio thrown on here. And what you see is that it’s never the best, but it’s also never the worst. And that’s another key fundamental. The way that we think about this, right, is when we suggest that a client diversifies, we know that the best way to get the maximum possible returns- and maybe not the best way- but the way to get the maximum possible returns is to take all your money and put it in one investment. Put all your chips on black for a way of saying it, right? However, that also brings the most risk, right. So as you diversify, you reduce the possibility of hitting a home run, you lower your ceiling. But what you also do is you raise your floor. You raise the range of possible outcomes. Right. And for most of you and for most of our clients, as they look at retirement, having those middle returns, not having to get 20% or something like that, but removing the possibility of owning the worst performing asset class only is very acceptable. Right. So we’re trying to get that that middle when it comes to portfolios, which is really what diversification does. It lowers the ceiling, but it raises the floor. And for most people, saving for or entering into retirement, that’s a pretty good place to be.

How Academic Research Informs Pure’s Investing

  • Building a globally diversified portfolio
  • Learning from academic research
  • Controlling what you can control

All right, let’s talk a little bit about academic research, so when you talk about investing, there are really three different ways to look at it. Three or four, right? So you can go out and you can try and predict what the future holds. You can say, hey, you know, I’m going to read this report and that report and look at this indicator and that indicator and then try to speculate on what’s going to happen. That may or may be possible to do. Some people are successful for a period of time, but it’s really, really hard to do. And a lot of times it’s expensive to try. And what happens in most cases is that somebody is right for a period of time. They build a track record, they accumulate a reputation, maybe accumulate some followers or some assets, and then it tails off from there. So the second way to do it is that you can index, you can just go out and try to replicate the universe. And that’s part of what we do. And then the third part of what we do is that we build around it. We hold factor-based funds that overweight parts of the market that, according to academic research, have tended to do better. So looking not to buy a single best security, but rather the best kind of security. And in order for one of these things to make sense to us, there are like 300-odd factors that academics have found. It needs to have a long track record. Right. If it’s just worked last year, the last couple of years, it could be a product of its environment. It’s worked for 50 years. Well, then that starts to tell you something. If only works on, let’s say, utility companies, maybe that’s not as meaningful if it works on all kinds of companies, and if it works not just in the United States but abroad. Right. And then so we want these long, persistent track records across a variety of places, we also want there to be logic. It needs to make sense to us. Right. And so when we look at that, we boil it down to 3, 4 or 5 factors that we think makes sense. And I want to talk about a couple of them.

Large vs. Small, Value vs. Growth Investments

  • The Value Premium
  • The Size Premium
  • Factor Performance: small-cap, mid-cap, large-cap, value, blend and growth, 10 year annualized and year-to-date

Right, and so if you look back in history and the data goes back to about 1929 or so, and you can divide the market really into a couple of different quadrants here that I’m going to do, I’m going to jump at the top here, put large companies. And at the bottom, I’m going to put small, just going to abbreviate. Over here on the left-hand side trying to put value. So these are companies that are a little bit less expensive. They may not be growing as fast. Maybe in a stodgy industry, but you don’t pay as much for it. And then over here on the right-hand side, I’m going to put growth. And these are companies that are rapidly expanding. But you pay a lot for that growth. Think your Amazons, your Teslas, or something like that. Right. And if you look- if you- the data goes back to 1929 and if back then you had $1000 and you put it to work, here’s what would happen. If you bought all the big companies, and so you don’t try to pick the winner, the loser, you just buy all the big companies. You would have about $600,000 today. Right. Which is really good. That’s a tremendous rate of growth. OK?. But over time, it turns out that value companies have done better than growth companies, right? And that makes sense. When you look at value companies think about it in a real estate example. If you’re looking at two different apartment buildings and they’re very similar in most regards, have a lot of the same characteristics, both will rent for, let’s say, $1000 a month and one is selling for $500,000 or one selling for $400,000. Well, all else being equal, you’re going to get better returns from the one that’s $400,000. Right. So what we do is- it makes sense that value companies should do better. And when you look at the math, if you put that same amount of money into just the large value rather than all the large companies, you’d actually have about $1,300,000. So about twice as much money. So over time, value has done better than growth. Again, not all the time, but over time. So then it’s like, all right, well, what about large vs small? Well, on the previous- when I was drawing a few moments ago, I talked about how over time smaller companies have had a little bit higher returns. And it turns out that if you measure it and if instead of buying all the large companies, you buy all the small companies, you’d have more money. And that makes sense too. Right. There’s more room for, let’s say, I don’t know, for Denny’s to grow as opposed to McDonald’s. Right. There’s a McDonald’s on every corner. There’s a lot of Denny’s, but there’s not one on every corner yet. It’s a little bit easier. Trees don’t grow to the sky. So if you look at the smaller companies, instead of $600,000, you’d have about $2,700,000. So about 4 times as much. So now we can say that small outperforms large, right? Well, if small outperforms large and value outperforms growth, what do you think happens if we combine those two and we focus on small value? Well, as you might imagine, it turns out pretty well. If you focus on small value, you’d actually have about $7,800,000. And it’s about 13 times as much. And again, this is over time, and it’s not every time, but this is one of the reasons why we spread positions around and we lean portfolios in the direction of small and value companies is because the evidence is really compelling and so is the logic. The returns are higher, plus you get more diversification. There are times when small value is doing great. There are times when mid-sized companies are doing well and there are times when large growth companies are doing well. 2018, 2019 was a time when large value companies were doing well, particularly large tech, small value was struggling. Since then, things have changed. Right. And so what we want is we want to have some holdings in each of these positions, because when it comes time to generate income, what’s the number one rule in finance? It’s sell high, buy low. Well, when you’re retired, if you need money, whether it’s because you need to live on it or because a required minimum distribution is coming out, you no longer have a choice about whether or not to sell. You need to put money in your pocket. Right. So what we do is by having diversification, you need to sell something. You can choose what to sell. Large growth is doing well, sell that. Small value is doing well, sell that. Midsize companies are doing well, sell that. You can get back to selling high and buying low. We think that makes a ton of sense. Like I said, let’s go back to the slides here for a few minutes. I want to look at like I said, over time, these companies have done better, smaller, more value, but not all the time.

And so as you look at it, this is the value premium. So this looks at rolling 5 year periods, going back to the early 1930s through 2019. When it’s blue, that means that value is outperforming growth. When it’s red, it means that growth is outperforming value. And I would point out a couple of things. One is there’s a lot more blue than red. It makes sense, right. We just talked about it. The other is that the last 5 or 10 years have not been a very good time for value. Right. Growth has tended to outperform over most of the 5 year periods more recently, which, as you can see, is historically unusual but not unprecedented. When we look at growth companies.

When we look at small versus large, right, the size premium, everything to the right, everything in blue is a year in which small companies outperformed large companies. Everything in the light gray is when large companies outperform small. Right. And what you can see is the dark blue sell highlighted 2019, which is when this goes through, was a year in which large companies outperformed small. But you can see that there’s a lot more years in which small outperformed large, including more recently, small companies have been on fire over the last 6 or 9 months. But again, these things vary, here’s a more recent. So the top left-hand column and again, there’s a lot of numbers on here, looks at the 10 year performance. And what you can see is that large value companies did OK, up about 11%. Small value did OK, up about 10%. But large growth beat them all up about 16%. So in the last 10 years, you would be better off with all your money up in the large growth, but you’d still done pretty well in some of these other spots. Now, look at year-to-date. So this is over the last 3 months or so, you can see that large growth companies are up a little bit under 1%. Mid-sized growth companies are actually down 0.6%. But now look at the value in the small companies, right. Large value is up 11%. Small value is up 21% so far this year. So significant outperformance by small in value over the last 3 months or so, maybe even the last 6 or 9 months, which is great. Right? The portfolio is again there a little bit tilted in that direction. We like to see that. It doesn’t mean it’s going to continue. We don’t know necessarily what the future holds. We just know that it makes sense to spread these things around. All right, that’s a little bit about how we think about investing kind of at a fundamental level. I want to switch gears and talk a little bit about the outlook for stocks going forward. But before I do, Andi, do we have any questions?


Andi: We do have a couple of questions. And as a reminder, if you do have questions, as Brian is going through this presentation, you’ll see chat on the right-hand side of your screen. If you’re on a desktop computer, just go ahead and enter your questions there. So our first question comes from Roland. “Please address whether we should front-load tax recognition this year in anticipation of higher taxes next year.”

Brian: Yeah, that’s a good question. I mean, so our view is that taxes are going higher at some point, right. If not this year then at some point. It’s possible. I mean, I think it’s worth considering. And again, everybody’s situation, Roland, is going to be a little bit different. So you’d want to kind of look at where you’re at right now from a tax perspective, where you might be in the future if taxes do go higher. We know for a fact taxes are scheduled to go higher after 2025 the way the law is currently written. There’s been a whole lot of talk in Washington about raising taxes and frankly, about the deficit where it is. And we’ll talk a little more about that in a minute. Taxes almost have to go higher. So, yeah, it could make some sense. Again, it depends on your individual situation, but I think it’s worth the conversation with your adviser for sure.

Andi: And the next question is from John. “When the government lifts the moratorium on foreclosures, will we see a real estate crash?”

Brian: That’s a good question, I don’t know the answer to that. You know, I’m not- I know real estate and I own some rentals, but I’m not an expert. I tend to think not. I mean, I don’t know that- the idea would be that they’re not going to undo the moratorium until such time as COVID is mostly done. It seems like the economy is doing pretty well – unemployment’s fallen a bunch. I’m sure there’ll be pockets. So if, you know, if it’s real estate in an area where, let’s say, the main employer shut down or went out of business because of COVID. Yeah, in that scenario, you could see some suffering in the local real estate market. But all real estate’s local. I don’t see why necessarily that one move would- would cause a rampage in real estate.

Andi: And then we have a follow-up question from Don, who wants to know, “What does Roland mean by front-loading tax recognition?”

Brian: Yeah, so. Well, I’m going to say what I- my understanding of what Roland means. I don’t want to speak for Roland. I don’t think that’s fair. But my understanding of the question is that basically, let’s say that you had an opportunity either to do a Roth conversion, which is going to cause some taxes in the near term in order to save you taxes down the road, or potentially you had something in a taxable account where you had some capital gains that you need to recognize at some point and you could recognize them sooner rather than later. My understanding, the question would be that all else being equal, I mean, a lot of people like to kick the can down the road with taxes as long as possible. But if you think taxes are going higher, maybe it makes sense to realize capital gains or to do a bigger Roth conversion this year while you have certainty around that the tax level, as opposed to waiting till next year and beyond, where a) the tax rate is a little bit more unknown and b) it could be higher. And for a lot of people, it could make sense to- I think it makes sense for almost everybody to at least look at that possibility and see whether there are moves you should make today, while for the moment at least, you know what the tax rates are.

Andi: All right. And that is all the questions we have at the moment. If you have questions, enter them into the chat.

The Outlook for Markets in a Post-COVID World

  • The National Debt: Federal net debt (accumulated deficits) as a percent of GDP, 1940-2030 forecast

Brian: Cool. Thanks, Andi. Well, let’s take a look and you know, it’s funny, the question came about higher taxes and this and that and their moratorium because I want to shift gears and talk about a few more topical things, including the idea of what’s going on in the world and the national debt. We get this question periodically. This chart looks at the national debt going back to 1940 through- it’s projected out to 2030. This is as a percentage of GDP. And you can see back in World War II, we had a huge spike in the debt from 40% of GDP, up to about 100- a little over 100%. And then we paid it off gradually and it kind of flattened. And then starting with the financial crisis, it did nothing but go up, up, up. First after the financial crisis and then kind of flattened out a little bit. And now it’s gone up a tremendous amount. And there’s a lot of concern. Right. We’re at 107% of GDP. Is that something to worry about? What I would say is a couple of things. One is I don’t think in the near term it’s a significant issue for financial markets. Right. Markets can generally only focus on one or two things at a time. And most things aren’t an issue until there’s kind of like- what’s that Malcolm Gladwell book- a tipping point or whatever, where there gets to be enough people worried or focused on something and then it becomes a thing. And I don’t think we’re there yet with the national debt. So I don’t think it’s going to cause markets to fall or anything in the near term. Longer-term, it needs to be paid back. Right. Or at least moderated. And the ways that you reduce a debt, you grow your way out of it, which is the best way the economy grows more, which gradually reduces the debt. You could default. I don’t think we’re in a default on the debt. You can inflate your way out. You have a little bit higher inflation. Or you can tax your way out. Right. And that’s one of the questions circling back to Roland and stuff. That’s one of the reasons taxes could go higher. a) there are things that the administration wants to bring into place that would need revenue to pay for and so they want to raise taxes and b) over time in order to reduce the deficit, you need revenue. And one way to get that is from higher taxes. The other is from inflation. Right. And so if you look at inflation, things have gone up over time.


  • Cost of living increase since World War II
  • Inflation has been muted since the 1981 recession
  • Market returns and inflation

And so the cost of living since World War II has increased. Right. This chart looks at the consumer price index since World War II. And what you see is it’s going up gradually, but it is going up and over that amount of time. It’s about a 13 x increase. So if it used to cost you $1 to go to the movies, let’s say back in the 1940s, now it’s $13. Right. So things have gotten more expensive over time. And there’s lots of debate over whether the Consumer Price Index or any other inflation measure is accurate, whether it understates inflation or whether it captures somebody’s particular cost of living. I’m going to set aside those debates. It’s not designed to represent any one person and we can all debate how accurate it is or isn’t. But I will say that in most environments, the more CPI is rising, the more inflation generally is going up, because it is a measure of at least in one way, of the cost of living. And recently it’s been relatively muted, although again, over time, potentially a higher deficit could lead to higher inflation. But what you see here is going back to the early 1970s. You see the big spike in the 70s into the 80s and then moderation and relatively consistent inflation for the better part of the last 30 years honestly, south of, let’s say, 5%, 4%, 5%. You know, and the one thing I would say with inflation is it’s a little bit like the bogeyman. It’s often feared but seldom seen. Very few people have actually experienced significant levels of inflation in the last three or four decades. But many people do remember the 1970s and double-digit inflation and how much of an impact that had on the economy. And there’s a behavioral finance bias in finance called anchoring. And what happens is that if you become accustomed to something like, let’s say, 12% inflation, that becomes kind of quote-unquote “normal”, and then you’re always comparing everything to that. So if inflation is lower, you’re waiting for it to go back to those levels or you’re worried that it’s going to go back to those levels. My personal view, and again, this is speculation, is that I don’t think inflation is going back to double digits. I could see it going higher over the years. If you think out over the next 5, 10 years, I could see it running higher than it has been. But I don’t think it’s going back to those apocalyptic levels. I’ll also say this is one of the things that we focus on in the portfolios is, and in your planning, is how to protect against this. Right. And there are a few ways. One is that when you look at it, it’s like, OK, let’s talk about inflation. We run inflation in financial plans at 3.7%. That’s the 100-year average. But it’s higher than it is right now. Right now, inflation is closer to 2%. So we build in a margin of error that if cost of living increases more than expected, there’s a measure of protection for still making it to and through retirement without running out of money. And then the big concern is what happens to financial markets if inflation increases and there’s a ton of numbers on this chart. But what I would say is if you look at it, you see 4 different quadrants. The top left is high and rising inflation. So inflation’s pretty high and it’s going higher. The top right is inflation is high, but it’s falling. The bottom left is inflation’s low, but going higher. And then the bottom right is inflation is low and heading lower. Right. So for different environments, the one in the top left has happened 10 times. This goes back to the 1980s. The one on the bottom left has happened 4 times, the one in the top right 6 times and the one in the bottom right, 13 times. So consider the sample size. But what you see is that in any of these scenarios, most of these different asset classes have done OK. In fact, the only real environment is if you have low inflation and then it falls further, commodities tend to have produced negative returns. Other than that, you see that everything in here has had positive returns across different inflation environments for the last 30 years. And I think that’s important to keep in mind.

Portfolio Construction and Diversification

  • US, International, Bonds, Real Estate, Natural Resources

The other thing I would say is simply this, and I’ll go back to the drawing board, is that when you look at our portfolios, we know that inflation is one of the things that you need to protect against. And so we work on doing that. And so there really are several different broad categories of investments in the portfolio. And I’m going to call them US stocks. International stocks. Bonds. Let’s call it real estate and then NR for natural resources. Well, when we look at this, most good companies have some measure of purchasing power and most companies have done OK during inflationary environments. And what I mean by this is if tomorrow we wake up and inflation goes from 2% to 10%, everything is going to do poorly. But if inflation gradually rises over time, you know, if Apple increases their – their next iPhone by $10 or Verizon increases your bill by $3 a month, you’re probably not going to discontinue the service. Right. So we think stocks in the US provide some measure of protection against rising inflation. Then there are international stocks. Well, one of the things, I mean the definition of inflation is that money is becoming less valuable. Well, if the dollar is becoming less valuable, that means that foreign currencies are becoming more valuable. When the dollar declines against foreign currencies, it is a positive for US citizens, US investors, that own international stocks. So if inflation increases slightly, all else being equal, it would be good for international stocks. We think there’s some protection there. Natural resources tend to go up when inflation rises. Real estate, good real estate can raise rent some. So there’s at least a little bit of protection there. You can renegotiate the lease and whatnot. So then that leaves bonds, right? Most of the portfolio has some protection against potentially higher inflation. Bonds are a little bit different, right? Bonds, if you lend somebody money for 10 years, assuming it doesn’t default, the big risk is that the dollars you get back aren’t as valuable. Right. However, you can mitigate that somewhat by owning relatively short-term bonds. And that’s something that we do. We’re not lending money for the most part for 30 years, we’re lending it for 3 years, 2 years, 5 years, so that by the time inflation and the purchasing power decreases, the dollars have already come back to you or those dollars can be reinvested at potentially higher interest rates. So we think that by focusing on what kind of bonds we own, gives some protection against rising inflation there. The other thing is that inflation could go up, but inflation could also fall. Right. And so if these parts of the portfolio are for rising inflation, the bonds give you protection against falling inflation. And getting back to the diversification, the goal of building a portfolio isn’t to pick the single best investment. It’s to pick a variety of investments, some of which do good in different environments, so that no matter what happens tomorrow, next week, next year, you’re going to be OK. Can we go back to the slide, please? One of the things that sometimes accompanies higher inflation is higher interest rates, and so when we look at the interest rates here, you’ll see the gray area is interest rates going back to 2011. That’s the range. Starting in the left-hand corner is short-term rates and then moving out to longer-term rates. And what you see is three different lines. 2013 is gray. 2020, last Summer, is purple. And then the blue is as of a few days ago. Right. And what you see is that in all three of those environments, short-term interest rates were close to zero. But there were great differences among the longer-term interest rates.

Higher Inflation Can Equal Higher Interest Rates

  • US Treasury yields since 2011
  • Diversifying with bonds: the correlation of fixed income vs. the S&P 500

And what I would highlight is that if you look in the last, I don’t know what is that- about 6 months or so, 9 months- the 10 year Treasury here has gone from .5% to about 1.75%. So that’s a pretty big increase in the 10 year Treasury. Again, that’s one of the reasons that we focus on shorter-term bonds. The bonds haven’t done as well lately simply because of that. Rising interest rates generally lead to declining bond prices in the short term. In the long term, the best thing that can happen is rising interest rates. As a bond investor, one of the things you want is income. Income goes up when interest rates go up. So when interest rates go up, you get a raise. It may take a little bit to realize that raise, but it’s like somebody promised you a raise down the road. So we view of rising interest rates as a positive for investors. One of the other reasons that you buy bonds is because they provide diversification, but it depends on what kind of bond you own and the environment. But oftentimes, if you look here, there are different kinds of bonds and then the correlation to the S&P 500. So that means if the S&P goes up, if stocks go up, does the bond go up? Does it go down? Or does it just not matter? Right? And what you see is that in the bottom left-hand corner there, US Treasuries and then some of the foreign bonds and some of the high-quality bonds basically have very little correlation with stocks or sometimes even negative. What that means is that if stocks fall, maybe the bonds go up, maybe they go sideways, maybe they go down. There’s no relationship. That’s what you want when you build a diversified portfolio. As you move towards the top right-hand corner, you’re getting more correlation. So what you see as you move into high yield bonds and emerging market bonds and stuff like that, is that they tend to move more similar to stocks. So if stocks go up, maybe they go up, but if stocks fall, they fall. The reason I bring that up is for some of you, we own some of those higher-yielding bonds. They can be an important component of a portfolio. We call it a plus sleeve. Right. That’s a slice of the bond portfolio that gets you a higher return. But with it comes a decrease in diversification and a little bit more volatility. Right. So it’s like everything else in life, there are pros and cons and it’s about implementing it if it’s appropriate, correctly. But important to remember that the more investment grade, shorter-term bonds tend to give you better diversification, then more higher-yielding bonds vis a vis your stocks. All right.

Market Drops Are the Norm, Not the Exception

  • S&P 500 intra-year declines vs. calendar year returns

Markets have done pretty darn good here in the last 12 months. Before that, some of you may remember last March, last February into March was not a very good time for the markets. Some of you maybe wiped that from your memory. It was not fun. It was the sharpest decline probably in history and the swiftest. Markets, fell 30%, 40% in the course of a month when the economy shut down. Right. That was exceptional. That was one of the biggest declines in history. But sharp market declines are not unusual. Right. In fact, if you look at this chart, this is the last- what is it going back to 1980- and gray bar is the year ending performance. And you can see that in 75% of the years, stocks finished up on the year. The red dot represents the lowest point of the year. So the decline from peak to trough. And what you see is there are these gray bars and then below it are all these red dots, because during almost every year, markets suffer a relatively sharp decline, even in good years. I mean, look at- let’s pick an example here. If you look-look back to- what do we got here- a couple of years ago, you’re up 29% on the S&P 500, but at one point it fell 7%. Right, a couple of years before that, you finished up 10%, but during the year you fell 11%. So not at all unusual to have a good year, but that during that year you suffer a sharp decline. The reason I’m pointing this out is a couple fold. One is stocks have had a good run. So at some point they’ll correct and then they’ll go back up again. Right. That’s perfectly normal. The second is because the difference between where those gray bars are and the red dots represents profits that investors that panic and sell are not getting. People that move to cash or dive out of the market at those red dots and then don’t get back in are experiencing performance that correlates with those negative red returns as opposed to the great positive returns. And that, frankly, is the difference between a successful retirement or meeting your financial goals and not meeting your financial goals. And if you look at it, here’s another way of looking at that.

Investors Are Their Own Worst Enemy

  • 20 year annualized returns by asset class 1999-2019
  • Annualized S&P 500 Index returns during presidential terms, 1929-2019

So this looks at the last 20 years and the title says it all ‘Investors Are Their Own Worst Enemy’. These are different investment asset classes in the last 20 years, real estate, high yield bonds, small companies, S&P, so on. And what you can see is all the way they’re doing better, only than commodities and cash is the average investor. Right. So people spend a lot of time talking about should they be in stocks and bonds and real estate? Should they be in big companies or small? How much international should they have? The reality is almost any portfolio somebody had bought and stuck with, would have done better than the average investor. That performance gap is again behavioral, where people are their own worst enemy. They pick one approach and then when it doesn’t work right away, they switch to a new approach. They panic at the wrong moment and get out or they get overly aggressive, a little bit greedy maybe, and get in at the- take on more risk at the wrong moment. And so really, the way that we think about it is that Pure Financial, and your financial adviser, their job is to take you from what the average investor gets to what a diversified portfolio gets. Right. With the idea being that that diversified portfolio is what you need to get through retirement. And the goal there then is to help you along, to help you avoid making those mistakes that caused the average individual to get significantly less than almost any portfolio mix would get. Speaking of emotions and almost wrapping up here, and then we’ll open it up to some more Q&A.

A lot of emotion around the presidential election and elections in general. Obviously, there’s a new administration. Some of you probably love it. Some of you probably hate it. I’m not here to take sides one way or another. Just here to point out that I’ve shown this slide before, that going back to 1929, nearly every residential term has seen positive market recurrence. There’s a lot of red on there are a lot of blue on there. It hasn’t really seemed to matter as far as which color, which party is going to be better for the financial markets. That’s not terribly surprising, right. I mean a) markets tend to go up over time. So you would expect most presidents to see the market increase and b) while the president does have control, there’s a lot of other things going on. Right. The last president, I mean everybody, whatever the response to something is, but you can’t control there being a virus and an economic shutdown and stuff like that. Hurricane Katrina in 2005 obviously set markets off, stuff like that. There’s the Federal Reserve that has a huge impact on the economy. There’s Congress, there’s the decision-making of businesses. There’s the global economy. So the president, the administration in power is obviously important, but they’re not omnipotent. They don’t necessarily single-handedly control the direction of the economy or the direction of the stock market. And finally, I will end with this slide, and this is my- this is always to end on a little bit of a depressing note, there’s a ton of numbers on this. I’m just going to wave the mouse over if you focus. Over here in the left, this is the US national debt. As of about a month ago, right? $27,000,000,000,960. So when you calculate your net worth statement, we’re not including it, but debt per citizen, each and every one of you on this webinar owes $84,000 back on our debt. Right. And then when you look at the revenue per citizen, it’s more like $10,000, over here. So just picture a business, right? If the business owes $86,000 and has $10,000 coming in, that math doesn’t work. Right. And that’s why we talk about higher taxes. That’s why we spend so much time doing tax planning. That’s why we run inflation at slightly higher level. That’s why we encourage most or many clients to make sure that they get at least some sort of meaningful return from their portfolio over time is because at some point it seems like taxes have to go higher. Maybe inflation has to creep a little bit higher because the only way to satisfy the debt that we’ve accumulated as a society and that’s continuing to increase. With that, let me pause again Andi, and see what questions there are.


Andi: At the moment, we only have one more question. And so as a reminder, if you do have questions about anything that you’ve heard today in the webinar, just go ahead and enter it into the chat. And so Don had another question. He said “If Biden gets his infrastructure bill passed, is there a way for us to take advantage of that in some way, for example, buying construction stocks or materials?”

Brian: Yeah, that’s a tough one. Right. So the idea is that they want to spend a lot of money on infrastructure, you know? Yes and no. I mean, so those- those are already held, right? I mean, so we already hold in the natural resources section a bunch of constructio-oriented stocks, materials-type stocks. So those already in the portfolio. It’s not clear yet who the winners and losers are going to be because just because you’re going to spend money, it’s going to happen over the course of years and decades. A lot of it is going to be driven not by the federal government, but by state governments. A lot of it may be with new technologies. So it’s not as simple, I don’t think is identifying one or two companies that will be winners. But we do have exposure to that in the natural resources slice of our portfolio, as well as, frankly, in the US, stock slice has plenty of materials and construction companies in there. I personally want to say, hey, let’s go out and find like three big construction stocks and buy them, because I don’t think it’s going to be that immediate of an impact as far as from the bill passing to when their revenues start to increase. And the other thing is, keep in mind, it’s not like we’re the only ones talking about this, right. Markets are forward-looking. So it’s not like all of a sudden a bill is going to be announcing, people are going to like, oh, wow, there’s going to be infrastructure, right. People know that. It’s priced in. So what will matter is how that evolves over time for each individual company, how many projects they actually win. Right. Do they win the bid? And then if they win the bid, how profitable is it? Do they come in under cost and stuff? So it’s not as simple as just running out and buying the stocks just because the announcement came out.

Andi: All right. And that’s all the questions we have.

Brian: Cool. Well, it looks like that’s all the questions we have. We’ve gone on 45 minutes, which I think is a good time for a- for a webinar. Again, thanks all for attending. If there’s questions you didn’t get answered either, send them in, let your advisor know. Happy to get back you on them. Again, looking forward to the time where we can all take off our masks. But for now, it’s- it’s fun doing these things via a webinar. Hopefully, you got some good information out of this about kind of how we think about the portfolio construction process, how we incorporate academic research into our process. Then just a few thoughts on what’s going on in the world. Times are good right now. They won’t always be good. I don’t want to be the Debbie Downer. Right. When things were bad last Spring, Joe and I were doing a lot of these talking about how, hey, things will get better. Now I’m out here saying, hey, things are good. They’ll get probably at some point a little bit worse and then they’ll get better again. Right. If you ask me what the market’s going to do tomorrow or next month, I’m gonna say it’s going to go up and it’s going to go down. Right. That’s what markets do. That’s why we have a diversified portfolio designed to meet your required rate of return. Not every day, every week, every year, but across time. So with that, we’ll- we’ll hit pause and thank you all. And everybody stay healthy and safe out there. Take care.

Andi: Thank you, Brian. Have a great day.

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