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 [...]

Pure’s Executive Vice President and Director of Research, Brian Perry, CFP®, CFA® explains how to craft an investment strategy that takes the least amount of risk in working toward your financial goals and retirement goals. He explains the rationale for building globally diversified investment portfolios, informed by academic research, and provides a recap of the activity in the financial markets during the first quarter of 2021.

Free Financial Assessment


Andi: Now, please welcome your presenter, Mr. Brian Perry, CFP®, and CFA®. Brian, are you with me?

Brian: I am. Hey, how are you, Andi?

Andi: Very well. Good to see you today.

Brian: Yeah, same to you. Same to you. A lot going on, huh? A lot to talk about.

Andi: A lot going on. Yes. I’m sure that you’ve got plenty to talk about and a short window of time to talk about it. So I’m going to hand it over to you.

Brian: What I want to do, for starters, is basically how do you look at stocks and bonds?

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?

Right. So we want to make this educational and a lot of people don’t really even understand what they’re buying when they’re buying stocks or bonds. And really what you’re doing is you’re trying to build a portfolio designed to meet your goals. And there’s a few different ways to do it. And at the end of the day, when you’re investing, you have two goals. One is to have enough money to accomplish whatever you want to do financially; whether it’s sending somebody to college; whether it’s a wedding or something like that; or whether it’s saving for retirement, which is probably the most common one. Right. So if you’re saving for retirement, you need to accumulate enough money and invest it appropriately so that you do not run out of money. But there’s a second key component of it. And the second part is that you want to sleep at night, right? Money is just a tool. And what a lot of people do is they take on more risk than they maybe are capable of doing or more risk than they have to, and then they end up not sleeping at night. So when you take a look at stocks and bonds and how you put them together, there’s a particular way that we do it that I think makes a lot of sense. And I want to run through that. So I’m going to go do some drawing here. OK, we’re going to go to the whiteboard here, do some drawing. And when you think about stocks and bonds, there’s a couple of different things. And let’s look at this. Let’s pretend that you have a required rate of return. Remember that I said that the first goal is not to run out of money. Let’s just assume that you need 6% to not run out of money. Now, there’s no magic to the 6%, there’s no magic to any of the numbers I’m going to use, they’re just for illustrative purposes and because the math works. So you need to get 6%. Let’s also pretend that there are two kinds of stocks. There are large-company stocks and there are small company stocks. The large company stocks, over time, you expect to get you 8%. The small company stocks, you expect to get you 10%. Now, the question is, which of these do you think is riskier? And the correct answer? It’s not a trick question. Small companies. Small companies are going to have a little bit more risk than large companies. And just for context, when I say large company, think Mcdonald’s. When I say small company, think Denny’s. So Denny’s is a small company compared to the restaurant space of publicly traded companies, but it’s not a fly-by-night operation. So these stocks have a little more risk. Now, let’s pretend you’re building a portfolio when I say you can only buy the large company stocks. Those are going to get you 8%. Your other choice is you can stick the money under the mattress. And the nice part about sticking the money under the mattress is you know it’s not going anywhere. It’s going to be safe, but it’s also going to grow at zero. Right. So the question becomes, how much of your overall wealth would do you need to put in these large company stocks, if some of it’s going under the mattress, in order to achieve your required rate of return of 6%? And the answer is 3/4 or 75%. If you put 75% in large company stocks, the other 25% would go under the mattress. That mix you would expect to get you 6%. So you’ve accomplished financial goal number one. Now, let’s shift it and said, you need to buy the small company stocks, which are riskier than the large company. And as you buy these small company stocks, you’re going to put some money in them and some money under the mattress. So same question, how much of your wealth needs to go in the small company stocks? In this case, the answer is 60%. 60% of 10 is 6, the remainder or 40% goes under the mattress. So this portfolio, you also expect to meet your required rate of return. So it satisfies task number one, which is don’t run out of money. But then the question is, which of these portfolios is riskier? And here’s what I think. I think that despite the fact that the small company stocks might bounce around a little bit more and be more volatile, that this is a safer portfolio. And here’s why. Let’s just hypothetically say that you had $1,000,000, $1MM, and again, you’ll have to excuse me, my writing is pretty bad. So $1,000,000. If you are a 60/40 mix, and again, I just want to reiterate, there’s no magic to 60/40, it’s just the way the math works here. Your mix is probably going to be different. You’re 60/40. You have $600,000 in stocks. And you’d have $400,000 under the mattress. And let’s pretend, if you think of that old rule of thumb, that you can take about 4% of your money out each year without running out of money, you’re doing that. So you’re pulling $40,000 a year from this $1,000,000 portfolio. Well, if you’re pulling $40,000, and you have $400,000 dollars under the mattress and you do some math, you get 10. And you know what 10 is? 10 is the number of years of money of spending that you have under the mattress in this example before you have to worry about the stock market. And what that means is that when somebody comes to you and says, hey, I’m worried about the coronavirus, I’m worried that maybe the vaccines won’t be effective or there’ll be a new strain that they don’t fight or we’ll go back to shelter-in-place, or I’m worried because my political views are such that I don’t like the new administration or the old administration or worried about inflation or deflation. You can say, you know what, I don’t care. Because for the next 10 years I’ve got my spending under the mattress before I have to worry about what the stock market’s doing. And historically, if you have 10 years, in 10 years, the market’s going to be higher. And so when we look at building portfolios and the roles of stocks and bonds, right. Your money is not actually going under the mattress. It’s going in high quality bonds, which are the financial market equivalent of under the mattress.

By building a portfolio like this, what you’re doing is you’re putting as much money in safety as you can by taking risk appropriately where it’s well rewarded, being slightly more- slightly more aggressive with your stocks in order to have more money under the mattress so that you have as many years of spending as possible before you have to worry about what the stock market’s doing. And that’s how we view stocks and bonds and the role that they play in building a portfolio. And it’s something that I would urge you guys to consider as well, because here’s the deal. The world’s not going to get any calmer. Things are not going to settle down. Between the next election and worries about inflation or deflation or the dollar or social unrest or technological upheaval, things are not going to calm down. We’re live in a crazy world. We all get bombarded with news all the time. We’re going to continue to see ups and downs in the markets just like we have. If you can have as many safe assets as possible when you transition into retirement, you’ll sleep better. Go back to the slide show.

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

So as you begin building out that portfolio, it’s important to remember that in addition to owning some stocks and some bonds, reversion to the mean is a powerful concept. And what I mean by that is that what’s done the best in the last 6 months may or may not be what does the best in the next 6 months. What’s done the worst, conversely, may not continue to do the worst. And so look at this chart. And what this chart shows is returns up from the pandemic start until November 6th of last year, which was after the election and then returned since then. And the gray is up until November, up until the election. The green is after the election. And what you see is the investments that did the best, the gray over here, online retail, home improvement, Information technology, tended to not do quite as well after November. And those that had done the worst, energy, airlines, real estate, hotels and cruises, negative performance leading into the election and then strong positive performance since then. Again, the idea is that you don’t want to just pile into the recent winners, whatever they may be, and ignore the recent losers, whatever they may be. You want to focus on fundamentals and understand that a lot of times if you pay less for something, if it’s less expensive, it’s going to be a better investment.

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

So why diversify? It’s just another way of showing this. I would urge you all to look at this closely and just tell me what the pattern is, right? If we were in person, I would say, tell me what pattern you see. And I’ll give you all a minute to think about it. And hopefully to come to the conclusion that there is no pattern, right. There’s no pattern here. And what you see across the top is each year and then you see different asset classes, stack ranked by the best to worst performer from 2006 to 2020. And there isn’t much of a pattern because what does the best in one year may not do the best the next year. Look at 2018, cash was the best performer. 2019, it is the worst performer. Right. If you look at- there’s example after example of things that do really well and then do not as well. Right. Emerging markets were the worst performer in 2008. They were the best performer in 2009 and then again by 2011, they were the worst performer. So performance shifts. And then you look at this line through the middle, the white blocks with the line drawn through. That’s a diversified portfolio. And the idea is that it’s never the best, but it’s also never the worst. And that, in a nutshell, is diversification. When you diversify, what you do is you lower your ceiling. The best way to hit a home run in the financial markets is to concentrate all of your investments in one spot. Right. But by not doing that, because that’s also the best way to lose all your money if you’re not right or if your timing is not perfect. So when you diversify, you lower the ceiling on your potential returns, but you also raise the floor and increase the odds that you get some sort of acceptable outcome. And in our experience, most people, as they save for or enter into retirement, are OK with lowering the ceiling if they can raise the floor. Because it’s that middle, those moderate returns that get people to meet their financial goals. And overconcentration may put them in a position where, if they’re right, they get higher returns, but they don’t need those higher returns to live their lifestyle. And conversely, if they’re wrong in where they’re concentrating, they wind up running out of money and not being able to live the life they want. So diversification, it’s- you know, people get tired of hearing about it. It’s like, oh, a financial advisor telling me about diversification. There’s a reason why it’s- don’t think of it as diversification. Think of it as something that increases the odds of your living the lifestyle you want across retirement. So from there, it’s like, all right, so you buy stocks and bonds, but what kinds of stocks and bonds do you buy? And then it’s like, all right, well, maybe there’s a couple of ways to do it. You could get up on the roof, get a telescope, stare at the stars to figure out what they’re telling you and then invest accordingly. You can flip a coin. You can look at charts and graphs or try to use some sort of proprietary models. There’s a lot of people trying to forecast the future and very few of them get it right again and again.

How Academic Research Can Inform Your Investing

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

If you want, instead you can use academic research because academics have gone out, modeled security returns across the decades and said, what does better and worse? And that tends to make more sense. Right? Maybe you build a globally diversified portfolio that learns from academic research. And what I want to do now, again, is go to the drawing board. I’m going to draw some quadrants here. And across the top, these are large companies. And across the bottom, these are small companies. And the data that they have goes back to 1929, that’s as far back as the data goes. So let’s pretend that you took $100 back in 1929, and you invested it in all the large companies. Basically, that would be the equivalent of the S&P 500. It wasn’t around back then, but pretend that it’s the equivalent. So you’re buying all of these companies. If you put that money in, you put it in and immediately the stock market collapsed, you went into the Great Depression, World War II, Korea, Vietnam, stagflation, presidents were assassinated or shot. You had political upheaval, all kinds of things, the financial crisis, coronavirus. But if you put that $100 in there and you stuck with it for thick and thin, and in this case, too, if you had a really long life expectancy. Right. But that $100 would have actually grown into about $600,000, so $100 into $600,000. That’s pretty darn good. That right there’s the power of compound interest and why you stay invested even when the world seems crazy. But what if instead of the small companies you went out and bought all the large or- excuse me- instead of the large companies, you went out and bought all the small companies? And here again, I’m not talking about fly-by-night, a taco stand. These are still big companies. These are the 3000 or 4000 biggest companies in the US. They’re just not as big as Apple or Google. Well, if instead of buying all the big companies, you bought all the small companies and you put that same $100 to work. Some of them went out of business, some of them merged, some of them did really well. But you just kind of stayed invested, rebalanced that small company allocation. Turns out that today you’d have about $2,700,000. So about 4 times as much as by investing in the large companies. So by that, you can conclude that small companies over time have done better than large companies. Now, let’s assume that over here you’ve got growth companies. So these are companies that are expanding very rapidly, but you pay a lot for that growth. Maybe that’s your Tesla or your Amazon or something like that- fast-growing technology of the future. But you pay for what you’re getting. Over here, you have what are known as value companies. These are maybe a more boring industry. Maybe it’s energy, maybe it’s something that’s not as exciting. Maybe the company’s beaten down a little bit, but you don’t pay as much for it. Let’s see, which of these do you think would have done better over time? And a lot of people will pick the growth because they’re the technology of tomorrow, the ones that are expanding. But it turns out that value companies have actually done better. And so if you had put that $100 instead of all the large value, all the large companies, you put it just in the large value, instead of $600,000, if you just invest it up here, you’d have about $1,300,000. So twice as much by investing in large value as by investing in all the large, right. So we can conclude from that, that value over time has done better than growth. So if value does better and small companies do better, what do you think happens if you buy small value? Well, if instead of buying large companies you bought small value companies, you would have about $7,800,000 today, right? I mean, we could do a survey probably with Andi and have you all decide, would you rather have $600,000 or $7,800,000? I think I know the answer. And you know, anybody that guesses $600,000, that’s probably not the right answer, right? $7,800,000 instead of $600,000 by investing in small- small value companies and- The reason I’m bringing that up is simply this. Is- If you look at the average portfolio that I see when it comes in the door, it looks something like this. These numbers may not round to 100%, but you’ll get the idea, right. They have 24% here. 33% here. 17% here. 3%, 4%, 6%, 5%, 2% and 1% or something like that. Right. So they’re very heavily concentrated up here in these large growth companies and sometimes that’s the place to be. But they’re very underweight down here. And so the idea is that it may make sense to migrate southwest and get some more smaller and more value-oriented companies for a variety of reasons. One of them is simply that sometimes these companies do better, sometimes they do worse. Right. It just depends on the environment that you’re in. Sometimes smaller, more value-oriented companies may not do as well. Right. And that’s where you live off the growth from your big company. Right. So you get a little bit more diversification. Over time you also get higher returns. And also small companies are less likely to get interference from the government. Right. They’re not getting called up to Capitol Hill like some of the big tech companies for anti- anti-competitive practices and stuff like that. So sometimes they fly under the radar. Also, trees don’t grow to the sky. Apple’s a great company, but how much can it grow? I don’t know. Starbucks, everybody drinks Starbucks, but there’s already one on every corner. Versus a big solid company, but not quite everywhere yet. Has more room to expand. So one takeaway might be that you can figure out what your required rate of return is, then build a portfolio with as much money under the proverbial mattress as possible while still meeting that required rate of return. Then the way to do that is by focusing on securities with higher expected returns and decades of academic research as well as logic, say, smaller, more value-oriented securities. There are other factors as well. I don’t have time to go into, more profitable companies. Companies that are moving in a certain direction continue to move in that direction. That’s known as momentum. So you use academic research to figure out what securities to own, to then build a portfolio that’ll get you where you want to go, but with the least amount of risk possible. And that’s a strategy that who knows, year to year, but across time, even when the environment is volatile, tends to be successful. And so with that, let’s go back to some slides.

The Value Premium

Here’s- I just talked about how value companies have done better over time. These are rolling 5-year periods, going back to 1932. And any time that you see blue, that’s a time when value companies were doing better than growth companies. Any time you see red, it’s a time when growth companies were doing better than value companies. And so a couple of main takeaways from this is that, first of all, there’s a lot more blue than red, which speaks to the fact that value has done better over time. The second is that there’s a lot of red here in the last 10 years or so. So it means that in the last 10 years, mostly growth has done better than value, particularly since the financial crisis. As you flash forward on here to a shorter time horizon, value companies have actually done pretty well in the last 6 months, but for a while their large-growth companies were doing much better. So the idea is that the value premium exists. It’s been successful over time, but not all the time. So one of the number one rules of investing is that you need to pick an investment philosophy and investment strategy, but then you need to stick with it, whatever it is, through thick and thin.

The Size Premium

This is the size premium, so small versus large, any time- in blue here to the right, that’s a time when small companies were doing better, anything to the left as a time when large companies were doing better. Again, this story is consistent, is that small companies have done better more often, but certainly not all the time. There are times when large companies do better.

Factor Performance

The other thing is that lately, like in 2019, big companies did better. The first half of 2020, big companies did better than the last half of 2020, small companies did phenomenal. They were up like 50% in 6 months. So again, you need to find a strategy that works with you. But one of the keys to successful investing is taking emotion out of it. And I don’t know about you guys, but personally, having a solid foundation of 100 years of academic research as well as a heck of a lot of logic behind it, helps me feel confident that even if the strategy is not working at any given moment, it’s going to make sense over time and that makes it easier to stick with. Let’s go to the outlook for markets in a post-Covid world, because there are a couple of things that I certainly want to touch on. And before I dive into that, Andi, do we have any questions?


Andi: We do have a number of questions, so let’s start at the top. While you were talking about stocks and bonds, Mary wanted to know, “Are you recommending that in retirement we draw from the mattress money first?”

Brian: It’s a great question. The answer is, it depends. Now, the mattress example is one that I use a lot, that people seem to kind of understand the concept. It’s obviously- it’s conceptual. It doesn’t work exactly like that. So you don’t put the money under the mattress, right? You put it in bonds or whatever, something more safe. Numbers are again or their degree of magnitude is correct, but they’re not exact. Not necessarily. So what you want to do is you want to basically remember the number one rule of finance, which is sell high and buy low. Right. So what you do in retirement is you sell what’s done the best lately. Right. And so while conceptually you might get more peace of mind from knowing that if the world comes to an end or the stock market collapses, you can live off the mattress money. The reality is that what you probably do is think of 2020. The first half of the year, maybe you’re living off of the mattress money because the stock markets fell by 1/3. The second half of the year, the market recovered and made new highs. Maybe at that point, you’re living off of the stock money to trim that amount, to bring it back into balance. So rebalancing the portfolio is very important. And in general, you want to live off of whatever done the best lately while knowing psychologically that having that money under the mattress is there, that if the stock market falls and doesn’t recover for an extended period of time, you can go to the well and live off of the mattress money.

Andi: Next question is from Ajay. He says, “What is the optimal allocation for small value versus growth if you are risk-prone?

Brian: Yeah, the answer is, I mean, so theoretically, and there’s no guarantees in anything, right, there’s a heck of a lot of logic that says that small companies should do better than large. Right. You’re taking on a little bit more risk. They have more room to expand and stuff. Same thing with value companies. There’s logic to that, right? There’s also a lot of research. There’s no guarantee that in the future they’re going to do better. But you have to stake your hat on something, right? Theoretically, if you were an endowment and you had an unlimited time horizon, you would put- you could put all your money in small value, put 100% of it there, and that would get you the maximum returns, right. Now, I would never recommend that somebody do that, because if it turns out that the world has changed and that those don’t do the best, you would be in trouble. You still want to diversify. The amount that you’re going to put down there is going to vary for everyone. You probably still want the most money in large companies, but relative to the average of 1% or 2%, maybe it’s 5%, maybe it’s 10%, in those small value companies, enough to move the needle. And basically, the way I think of it is you’re preparing a meal. This is like the salt and pepper, right? You don’t want to just empty up the salt shaker and dump the whole thing on your food. It would taste terrible. But sometimes if you’re eating bland food, adding a little bit of spice is going to make things better.

Andi: Next question is from Rikki. “Does size and value have similar expected risk-adjusted premium internationally? How about emerging markets?

Brian: Yes and yes. It’s a really good question. So the reason that we’re believers in those premiums is because they’ve been applicable across a wide swath. So, you know, if something has only been statistically valid for the last year or two or just in one country or just in one sector, it’s not as convincing. Right. But when you look at small in value, they’ve been around for decades and they’ve- they’ve been valid. They’ve worked for big- for different kinds of industries. Right. Whether it’s telecom or energy or whatever. Right. They’ve also worked around the world. So in both international markets and emerging markets, small in value companies have tended to do better. To be honest, the only exception, and I don’t know why this is, is Japan. It hasn’t worked in Japan, but that’s really the only country around the world where that’s not the case.

Andi: Dorothy says, “I’ve always been told that low expense ratios are key. It seems like small company stocks have higher expense ratios.

Brian: It’s- so the first part of that question, 100%. When you build a portfolio, one of the things within your control is fees and most of the time, paying more fees for an investment product doesn’t make it a better performer necessarily. So you want to- you don’t need to minimize fees because what you really want to focus on is value. And here I’m not talking about in the stock sense, I’m talking about in that you’re getting something for what you’re paying. So it’s OK to pay some management fees, but you need to be getting a fair deal in return. Yes, in a vacuum, small companies can be more expensive than large companies. But in today’s environment where you can buy index funds or institutional funds, you can still get very low prices, where maybe a large company fund is 3 or 4 basis points. Maybe the small company is 10 basis points, which would be 1/10 of 1%. So a little bit more than large, but still very low.

Andi: April says, “Should I exchange or reduce my bond portfolio to money market to avoid risk of potential increasing interest rates?

Brian: Not necessarily. And that actually segues really well into what I’m going to cover from here. So let’s take a pause on the questions, go to slides. And that’s a really good foreshadowing question. I’m about to talk about inflation and interest rates.

Andi: Perfect.

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. So right on cue, we launch into the national debt. For those of you that have been paying attention, the national debt has grown quite a bit. We used to have a pretty high debt coming out of World War II, paid it off and stayed pretty low until the financial crisis where it jumped. And then it’s been climbing, particularly recently. I get the question all the time, like basically, is the economy going to blow up, or the financial markets going to blow up because of the national debt? My answer is no. I don’t believe so. Ultimately, it becomes an issue, but it’s not an imminent threat. It’s denominated in dollars. So we can always print more money to pay it back. The way you get out of a debt is a couple. One is that you can default on it and I don’t believe we’re going to default. The second is that you can grow your way out of it. So if the economy were to grow tremendously fast, that would be a way. The more likely ways I think we get out of it is you can either raise taxes or you can inflate your way out. So by inflation, you could let inflation run a little bit higher. You pay back the debt with less valuable dollars or you tax your way out, you generate more revenue to pay it back. Right now, it seems a little bit like taxes are going higher and we’re adding debt. So we’re basically raising revenues, but we’re not- we’re not cutting or keeping our spending static. At some point, the deficit will become an issue. But because the US dollar is still the world’s reserve currency, because the debt’s all denominated in US dollars, because we’re viewed as kind of the cleanest shirt on- on the block sort of thing or a dirty hamper, it seems unlikely in the short term the deficit is going to be a major issue, but it is something to keep an eye on. And probably will have longer term implications, including I mentioned inflation. Right.

Inflation: Cost of Living Increase Since WWII

So if you look at this chart, this is inflation ever since World War II, it’s the cost of living increase. You can see a pretty gradual trend higher. However, although it looks pretty gradual, the reality is, is that life is about 13 times more expensive than it was after World War II. After World War II, that maybe to go to the movies was $1. Now it’s $12 or $13. However, that being said, when it comes to inflation, it’s not something that I spent a lot of time worrying about it going back to the 1970s. And that’s another question we get a lot is, what if we go back to double digit inflation? Right. A lot of people remember that, especially if you’re of an age where when you bought your first home, got your first job, got your first credit card, inflation was running at 10%, 12%. That’s a historical aberration. The 100 year average for inflation is 3.7%. If you look at the last 30 years, it’s more like 3%, maybe 2.5%.

Inflation Has Been Muted

So inflation has been muted for a long time. My personal view is that inflation will go a little bit higher, but not to double digit levels. but I could certainly, if we’re running at 1.5% to 2% now, see it going to 3% or 4%, at some point maybe even 5%. The way you protect against that is a couple things. One is when you look at your future cash flow and you do your financial planning and you’re like, hey, how much are you going to have coming in? And how much are you going to be spending? Do you have enough money? Include inflation in there. Right. So bump up the rate of inflation a little bit in your plan to stress test it to make sure you have enough money to live the lifestyle you want in retirement, even if inflation runs higher. The other thing is look at what kind of investments you have. Stocks historically have done OK when inflation rises, at least over the longer term. International stocks, well, if you have inflation, what that means is the dollar is falling in value. Right. In general, that’s a positive for holders of international stocks. So maybe have some of that. And then when it comes to bonds, be mindful of what kind of bonds you have. Right.

So as you look at these, these are different Treasury yields and this looks at a few different periods in the last decade. So this is 2013 at the top. This is August of last Summer at the bottom, and this is as of the end of last month, right. And what you can see is that we hit record low levels here at the height of the coronavirus shutdown. And now we’re right back in the middle of the range, really, that we’ve been in for the last 10 years. And that feels about right. I think that at .05% on the 10-year Treasury that was artificially suppressed by the fact that we’re sheltering in place in the economy was essentially closed. The longer-run range for the last decade has been somewhere between that .05% and about 3.25% on the 10-year Treasury. Right now we’re in the middle of that, and I think this is the range we’ll stay in. OK, so the question to cycle back to the question of, should you move the money to a money market? I don’t think so necessarily, because you’re not getting any return. Look at down here is short term rates. They’re at zero. Right? You want to at least keep pace with inflation, with your bonds. But notice this. Notice that- let me see if I can work the mouse here- All right, so notice that when you look at this chart, if I can draw on it, this part in here. If you look at that line, and I’m sorry, that’s ugly drawing, but if you look at that line, you’ll notice that it’s steeper here than it is further out. And what that means is that you’re getting more compensation for every unit of risk you take. And what I mean by that is that if you look at here, right, the difference between investing for 20 years or 30 years in the bond market isn’t much, but you’re taking on 10 more years of risk. The difference for investing from, let’s say I don’t know, 3 years to 5 years is more like 35 basis point. So you’re only taking two more years of risk and you’re getting a lot more return. What that means is the steeper this curve is, the more extra return you’re getting for every unit of risk you’re taking, which is a really long-winded bond geek’s way of saying that what you want to do is you want to generally invest in short and intermediate-term bonds. Call it an average maturity of 3 years, 4 years, 5 years, 6 years, something like that. You get most of the return, but with a fraction of the risk. So if you buy a 30-year bond and interest rates go up 1%, you’re going to lose about 20% of the value in your portfolio. If, on the other hand, you have a 3 or 4-year bond, you’re going to lose about 3% of the value of your bond portfolio. So you should concentrate your bond holdings not in cash, but also not out in the 30-year space, but more in the intermediate space. Call it the 2 to 10-year range, to get the maximum amount of return while still minimizing the risk that you’re taking. Also, when it comes to bonds, there’s a lot going on in this chart, but the concept will come through. This is basically correlation of the S&P 500. So how closely does something move in conjunction with the S&P? No need to memorize every number on here or whatever. But what I want to focus on is as you move left, so everything over in here where my mouse is, it means that this type of bond doesn’t really move in conjunction with the S&P. And that’s what you want. You want things that zig when something else zags. That’s how you get diversification. So if you’re buying Treasury bonds, if you’re buying foreign bonds, Germany, Japan, you’re buying mortgage-backed securities, there’s not that much correlation between the way they operate and what happens with the S&P. And that’s good. That helps you diversify. If, on the other hand, you’re buying high yield bonds, convertible bonds, emerging market bonds, there’s a very high correlation between how they move and what happens with the S&P. So what happens with high yield bonds a lot of times is that if the stock market drops 20%, maybe they drop 8% or something. They move in the same direction. You don’t get the same diversification. What does that mean? That means that with your bonds, most of your bonds should be higher quality. I already mentioned shorter-term, high-quality bonds. You may, depending on your goals, your risk tolerance, how long your investment horizon is, you may still sprinkle in some of these more aggressive types of bonds we call that ‘plus’. So it’s just bonds slogan. Usually, you talk about these are core bonds and these are plus, which means that you’re adding yield, but you’re also adding some risk. So if you use these, you should use them selectively. We tend to if we use these- these make up about a 5th of the overall bond allocation. So the vast majority of the bond allocation, more than 3/4, is in the high quality bonds. And for people that we think it makes sense for that want to take on a little more risk to get more return, they selectively add in a little bit of this. So just make sure that your bonds are actually doing what you want, which is diversifying away your stock risk. I also want to talk- I’m just going to flash back a couple of slides here, people are really worried about inflation. And again, like I mentioned before, inflation is a little bit like the boogeyman. And what I mean by that is often feared, never seen, right? Most of us in the last 3 or 4 decades haven’t necessarily experienced inflation, but we still worry about it. And we also worry about what’s going to happen to financial markets with inflation. So I want to look at this chart.

Market Returns and Inflation

And if you look since 1988 and I get the question sometimes, why doesn’t it go back to the ’70s? It’s just data availability. For some of these asset classes, the data only goes back to 1988. But you see 4 different scenarios. Inflation is high and going higher; inflation is high, but falling; inflation is low and going higher, and inflation is low and falling. And that one scenario has been 10 times, 6 times, 4 times, 13 times. So a variety of different scenarios. And what you notice is that these are the returns of different asset classes. There are almost all positive. When inflation is high and rising, everything does OK. When inflation is high and falling, historically, everything’s done OK. When inflation is low and going higher, everything is done OK. When inflation is low and falling, everything except commodities is done OK. So the reality is, is that as long as inflation is somewhat moderate, most things do all right. Now, again, if you go to 12% inflation, that’s a whole different game. But I don’t think we’re going there. If you get inflation gradually moving from 1.5% to 3.5%, 4% or 5%, I don’t think that is necessarily a death nail for the financial markets. You just want to invest accordingly. Stress-test your financial plan, look at your portfolio, make sure it’s well-positioned for that. I think this is the environment we’re in right now, probably as low inflation that’s moving higher. And you can see that historically most asset classes have done OK in that scenario.

Market Drops: The Norm Not the Exception

All right, I want to talk a little bit about stocks, right, and when it comes to the stock market, there’s, again, a lot of stuff on this chart. But it’s the concept. This is going back for the last 40 years and looking at how the stock market did. That’s the gray bar. So you can see that in this year here, in 1980, you’re up 26%. So far, in 2021, you’re up 6%. This is the S&P 500. Last year, the S&P was up about 16%. You can see there some years that it was down, the early ‘80s, down 10%. Here’s a gray bar back in the dotcom bust, down 10%, down 13%, down 23%, the financial crisis. So the gray bar is how the stock market, measured by the S&P did that year. Look at the red dots, though. You’ll see they’re all negative. And what they show is the market’s low for the year. In other words, in a year like- let’s look at a year that we were down, so 2008, the stock market, S&P closed down 38%, but at one point it was down 49%. Look at a year like 2017. At one point the stock market was up 29%, but it also declined 7%. What this demonstrates is that even though in most years you get a pretty significant decline in the market. Most years, the market also closes higher about 70%, 75% of the time.

S&P 500 – 5 Years as of 4/26/2021

The reason I’m pointing this out is that we’ve had a really, really good run since last Spring. So for 12, 13 months now. I don’t have a crystal ball. I’m not projecting or predicting any kind of decline. But at some point we’ll see another market fall, another correction. It’s important not to get spooked by those. Remember that it’s normal. For those of you that grew up someplace besides Southern California, you’ll know that every year Winter comes. You know that at some point it’s going to snow. You prepare accordingly, but you don’t let it rule your life. You know that at some point you come out the other side and Spring comes. It’s the same with financial markets. At some point we’ll have a decline, but inevitably we recover from that. This is why it’s important to make sure your portfolio is properly allocated so that you have assets to live off of and so that you can sleep at night during these periodic market declines. The ones where you fall briefly and then recover pretty quickly aren’t so bad. But remember the early 2000s down double digits on the S&P 3 years in a row. You need to be properly positioned to recover from that.

Investors Are Their Own Worst Enemy

The reason I bring that up is that most investors are, frankly, their own worst enemy. This looks at the average performance of a bunch of different asset classes in the last 20 years. Real estate, high yield bonds, small company, emerging market. You got a couple of diversified portfolios here, 60/40, 40/60, and everybody’s OK. Hey, what should I invest in? What’s the best asset class? What mix should I be? And then you look, here’s the average investor, it almost doesn’t matter. Almost anything would have done better than the average investor did. And the reason that the average investor did worse than almost every single asset class is because they’re selling low and buying high. They’re jumping in on the latest fad just when it’s overpriced. And then they’re getting out during the maximum point of pain because they just can’t take it anymore. So you need to set your finances up in order to protect yourself from your emotions. Human beings are not wired to be successful investors. You need to have protocols in place, an investment policy statement, a financial plan. Maybe you have friends or family you check in with. Maybe you have a financial adviser, but you need to do things to protect yourself from your emotions, because in a lot of cases, people are their own worst enemy. Let me pause there and take additional questions, Andi.


Andi: OK, the next question. Again, if you do have questions from what you’ve heard so far, just type them into the chat and Brian will be able to answer them for you right now. Richard says, “What should we be watching on Biden’s tax increases, e.g., capital gains taxes?

Brian: Yeah, that’s a good- if we have time and I don’t know if we will. I do have a slide in here on taxes. I don’t think we’ll get there. Yeah. So there’s a lot of talk about higher taxes. Among other things, Biden has proposed a top capital gains rate of basically if you make more than $1,000,000 instead of the capital gains rate, it would be ordinary income, in conjunction with his proposal to raise the current top ordinary income tax bracket from 37% to 39.6%. So basically right now, the top cap gains rate is 20%. You add in 3.8% for the Affordable Care Act surcharge, basically, 24%. If you live in California and you’re in the top bracket, California cap gains are taxed as ordinary income. That’s another 13%. You’re at basically 37%. Under Biden’s proposal, if you do that same math, your top tax rate, if you’re in California, would be closer to 60%. If you live in a no-tax state, you’d still be at 44%. So obviously, it’s a pretty significant proposal. If that were to come to pass, my guess is it would actually prompt some volatility in the stock market. That’d be a pretty big hit for some people. However, keep in mind that it’s not going to hit everybody. If you own money in a IRA or something like that, it’s not going to impact you because you can sell without taxes. If you own money in a Roth account, it’s not going to impact you because you don’t pay taxes. It’s only a non-retirement accounts that it would impact you. Only if you make more than $1,000,000. Also, institutions and institutions own most of the securities in America. It wouldn’t necessarily apply to them. So we’d basically be talking about high net worth, high income individuals. The people I think would actually penalize the most would be, let’s say, somebody that started a pool cleaning business 20 years ago and makes $100,000 a year doing it. And now the business is worth $1,500,000 and they sell it. And that’s their kind of event where they’re going to walk away and retire. Under the law as it’s currently proposed or currently being talked about, they would qualify as a quote/unquote, “millionaire”. But I think most people would say that person is probably not a millionaire. They’re just sort of an average person that is now, that’s their whole retirement that they’re going to one time sale. So but we’ll see. There’s a lot of talk around, potentially compromises. So that was the initial proposal in order to get it through Congress. We’ll see. I’ve heard talk of maybe it’s 28%, some speculation there. So we’ll see what happens. It definitely bears monitoring.

Andi: Next question comes from Brandon. Actually, we’ve got a couple of questions about studies, research. They want to know more about the academic research. Brandon says, “Are there any studies that show the longest period that a 60/40 portfolio has outperformed a 100/0 portfolio? I hate bonds, but I realize in a down market they add protection. But ultimately, doesn’t the 100/0 portfolio historically eventually make up for what was saved by being conservative?

Brian: Yeah, I mean, absolutely. If you own all- I mean, first of all, in the long run, we’re all dead, right. So do we want to take the time frame out long enough? It doesn’t matter at all. And the whole planet will be gone in 7,000,000,000 years. But if you have a long enough investment time horizon, yes, the stocks are going to outperform bonds. The question is, when do you need the money? Right. It’s not about age and this and that. It’s when do you need the money? And how much time is the stock market going to take to recover? The two longest time periods during which the market has recovered, so is from the Great Depression. So from 1929, the stock market measured by the Dow took until 1954 to make a new high. So what is that, 25 years. From 1969 until 1982, the stock market was flat. So those are pretty long periods during which an all stock portfolio would have lagged at 60/40. Remembering back- I’m cuffing these numbers a little bit- but back in 2009 during the worst of the sell-off, if you had run a- I remember using charts that showed that for the last 20 years, basically a bond portfolio had outperformed a stock portfolio and that was a 20 year period, call it, from the 1980s through 2008. So there are very long periods where you’d be worse off, just all in stocks. But if your time horizon is long enough, stocks are going to get you higher returns. I understand a lot of people hate bonds. You just want to keep in mind what the money’s for when you need it, as a general rule of thumb, if you need money within 5 years, it probably shouldn’t be in the stock market because there are plenty of examples during which it hasn’t done as well or had been down over 5 years. I’ll also add on this makes my answer a little bit longer. Keep in mind that the stock market’s a broad place, right? So a lot of times you get fixated on the Dow Jones or the S&P, just the biggest stocks. I spent all that time talking about small company stocks. There’s also international stocks. There’s probably 15,000 stocks in the world that you could trade or buy. Focusing on a narrow subset of large company stocks can be the way to failure. So from 2000 to 2010, the S&P 500 actually posted negative returns for that decade. So if you retired during that time frame and just had the S&P, you did pretty poorly, but if you also had small company stocks, they did well. Small company value stocks did phenomenally. Emerging market stocks shot the lights out and went up like 300% or 400% in that time period. So there were a lot of other kinds of stocks that did well. So, you know, I think that there’s two pieces there. One is depending on when you need the money, some level of diversification, maybe into bonds, maybe necessary, even if you don’t like it. And then additionally, it’s breaking the stock allocation itself into additional components beyond just the Dow or the S&P.

Andi: Rikki has another question. “Is there research on the best definition of value and small that gets the best premium, maybe DFA’s definition or Vanguard’s or Advantus’?

Brian: Yeah. So every company defines it a little bit differently. I don’t know that there’s one right or wrong answer. It’s just going to depend on the time. And you’re really talking shades of gray. It’s like the old 80/20 rule. If you use, let’s say, PE ratio or price-to-book or book-to-price to define value. They’re all going to give you a little bit different performance over different periods of time. I think the key is probably at the higher level is how many stocks or bonds do you hold? Within the stocks, how much large? how much is small? And then I don’t know the research off the top of my head. There are different ways to measure that will perform differently in different periods. But to be honest, you’re getting diminishing returns by going down that far. Most of the benefits are going to come from splitting it up at higher levels.

Andi: Joule says, “If I liquidated my equity mutual funds and it’s still in cash, do I still get the tax loss even if I leave the money in cash and don’t buy another mutual fund?

Brian: Yes, so, yeah, if you had- if you lost money on the sale of the mutual fund. Yes. Then you’ve got- that’s the moment. It’s the sale, the moment of sale at which you realize the tax loss. Anything you do afterwards is whatever. The only way you would not be able to use that tax loss is if you buy back into the same security or fund within 30 days, then that violates the IRS’ wash sale rule and it would disallow the loss.

Andi: And then on a completely different topic, we’ve got Ray, who says, “If I loan some money to a relative, what is the minimum interest I can charge? And if I want to forgive the interest, how do I do that?

Brian: I don’t know the answer to that. It probably depends on how official the loan is, if it’s within the family and stuff. The only part of that that I actually know is that if you’re loaning and truly considering it a loan to somebody, the person for whom the interest or the loan is forgiven, that’s a taxable event for them.

Andi: That’s all the questions I have at the moment. If you have more questions, type them into the chat now while you still have a chance.

Brian: Well, yeah. And as- I want to cover just a couple more slides, we’re coming up close to the end of the hour. So what I want to do, too, is just remind you all do something with this information, right? If you’re wondering, hey, how many large company stocks are in your portfolio, even if you have a bunch of funds, when you look under the hood, how much large or small do you have? How much value versus growth? Do you have anything that’s going to do OK if inflation rises? if taxes come? How are you positioned from a tax perspective?

Do something with this information, do more research, talk to your financial advisor, or if you want to come see us for a free financial assessment. Right. Andi’ll put up an offer. We usually charge a couple hundred dollars an hour to meet with people, to meet with one of the CERTIFIED FINANCIAL PLANNER™s here. For people that come to these webinars, we waive that fee and we spend a few hours with you, basically diving in to give you some thoughts on your cash flow, whether or not you have enough to retire, when you should take Social Security or pensions. We take a look through your taxes to give you thoughts on if there are any strategies to save money in taxes, today or in the future. We’ll have our CPAs in house take a look at that, take a snapshot of your investment portfolio, talk to you about the risk you’re taking and how you’re allocated. There’s no risk, there’s no obligation, no cost or anything. Like I said, we usually charge a couple hundred bucks an hour. For people that come to these webinars, and especially, you know, it’s been a tough time over the last year. I mean, markets have recovered and stuff. But just psychologically, for a lot of people, life has been tough. We’ve got things are going well. We want to be able to help you out. If you want that free financial assessment, go ahead and click on it. You can meet with one of our CERTIFIED FINANCIAL PLANNER™s here. We’re fiduciaries. We don’t sell products. We don’t try to put somebody into something with a high commission. It’s just unbiased advice, no cost. We’ll give you some thoughts. But if you don’t want to do the financial assessment, do something with this information. Otherwise, you’re not really getting full value out of the hour here. There’s just a couple more slides I’m going to cover if we can go back to slide show. Cool. All right, so I’m going to skip over this if I can get the mouse to work there. All right, so what I want to do is this is-

Annualized Returns During Presidential Terms

Two things, one is there’s a lot of talk about Biden and I’ve used the slide before, if any of you have seen any of my presentations before, but I think it’s important to look at. This is the S&P for the last, what is that, 90 years under different president. Red is Republican, blue is Democrat. And what you see is anything to the right is a positive return during that president’s term in office. Anything to the left is negative. What you see as an awful lot of positive returns, regardless of whether Republican or Democrat is in Congress. I’m going to be apolitical here and have no opinion. There are some people that think that if a Republicans in office, it’s awful. There are some people that think if a Democrat is in office or it’s Biden, that’s awful. Whatever your views are, just keep in mind that if you’re betting against the stock market, you’re basically fighting a rising tide. Over time, markets tend to go higher as companies generate more profits, make more goods and services that people like. And frankly, just as standards of living increase, regardless of who’s in office and stock markets have generally done OK under blue or red administrations.

Where Do You Think Taxes Are Heading? US Debt Clock

The other thing I want to point out is this US debt clock that I often pull up and there’s a ton of numbers on here, but what I want to point out is over here, the US national debt at $28,000,000,000,000 dollars. And then the debt per taxpayer at $224,000 per- per person. And then the revenue per citizen, that’s how much basically revenue, how much tax the average citizen is paying is about $10,000. You know, if you take 224 and divide it by 10, you see that that math doesn’t work. That’s not a good balance sheet. Ultimately, this here is why I think that inflation could go a little bit higher, but also why taxes are likely to go higher.

Tax Diversification

And so, again, one thing that a lot of people miss when they’re managing their finances is they don’t pay attention to taxes. They forget that taxes matter. And so you want to make sure that you’ve got some diversification among different kinds of accounts, whether those are IRAs and 401(k)s, whether those are non-retirement accounts or whether those are Roth accounts, having diversification among those will allow you to navigate future potential tax increases. A lot of people think from common wisdom they’re going to be a lower tax bracket in retirement. For many folks that I’ve met that you’ve saved, that have a pension or Social Security, it’s not the case. They’re going to be in a similar or higher tax bracket in retirement. So building out some tax diversification is probably something you want to start to consider potentially, given the tone of the country seems to be going towards higher taxes.

So you take a look at this, dive into it on your own or again, if you want to do the free financial assessment, this is something we’ll go through with you. Take a look at how your assets are currently positioned, what tax bracket you’re in today, what tax bracket you might be in in the future, and what steps, importantly, what steps you can take in order to get more tax diversification and minimize your future taxes. So, again, click on the free assessment if that’s something that you’re interested in. We’ll be happy to give it for you, no obligation, no cost, meet with one of the CERTIFIED FINANCIAL PLANNER™s.  We’ll give you thoughts on your taxes, your investments, your cash flow. That’s all the time we have today, folks. Thanks for attending. Hope you got something out of this. Any questions that didn’t get answered? Shoot them to Andi and we’ll be happy to get back to you on that. And everybody have a great day.

Andi: Awesome. Thank you very much, Brian. And also, just so that everybody knows, I’m going to enter a link there so that you can fill out an evaluation and let us know what you thought of this webinar so that we can make sure to make them better for you in the future. Thank you all so much for joining us. We do appreciate it. And we hope that you will join us for the next one. Have a great day.

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