Ever wondered how your individual risk tolerance should shape your retirement investments? Justin Gaines and I, John Prover, crack the code on aligning your financial temperament with your long-term planning in our latest podcast episode. We shed light on the common misconception that your age is the sole driver for risk tolerance and provide you with an engaging exercise to help you gauge your own comfort with market swings. It's about more than just numbers; it's about understanding your personal reaction to the market's highs and lows and how this should inform the crafting of your retirement blueprint.
We also tackle the crucial task of balancing your portfolio as you sail towards your retirement horizon. Navigating through a case study, we illustrate the significance of protecting your hard-earned assets while still capturing the growth opportunities of the stock market. Justin and I guide you through creating a financial "floor," securing your essential needs before venturing into more unpredictable waters. Join us as we navigate through the strategies designed to offer stability and peace of mind, equipping you with the knowledge to manage your retirement investments proactively, no matter the weather in the financial markets.
Ever wondered how your individual risk tolerance should shape your retirement investments? Justin Gaines and I, John Prover, crack the code on aligning your financial temperament with your long-term planning in our latest podcast episode. We shed light on the common misconception that your age is the sole driver for risk tolerance and provide you with an engaging exercise to help you gauge your own comfort with market swings. It's about more than just numbers; it's about understanding your personal reaction to the market's highs and lows and how this should inform the crafting of your retirement blueprint.
We also tackle the crucial task of balancing your portfolio as you sail towards your retirement horizon. Navigating through a case study, we illustrate the significance of protecting your hard-earned assets while still capturing the growth opportunities of the stock market. Justin and I guide you through creating a financial "floor," securing your essential needs before venturing into more unpredictable waters. Join us as we navigate through the strategies designed to offer stability and peace of mind, equipping you with the knowledge to manage your retirement investments proactively, no matter the weather in the financial markets.
Welcome to the Balanced Blueprints podcast, where we discuss the optimal techniques for finances and health and then break it down to create an individualized and balanced plan. I'm your host, justin Gaines, here with my co-host, john Prover. In this episode, john and I discuss retirement accounts and asset allocations, how they should be adjusted based on your risk tolerance and your age. Thank you for listening. We hope you enjoy. We're going to talk about diversification of your retirement accounts. Thank you for listening. We hope you enjoy better when the client responds if I summarize it well.
Speaker 1:But the key part here is that whenever you're investing for retirement, you're always going to think about your risk tolerance. Everybody always asks you what's your risk tolerance? And we both know from our relationship that I have a much higher risk tolerance than you do, even though we're the same age. And that's where the risk of just because we're the same age or in the same age bracket, that doesn't mean that we have the same risk tolerance. So a lot of this blanket financial advice isn't good advice for your specific situation if it doesn't match your risk tolerance.
Speaker 1:So one of the exercises I use with my clients to very easily determine what your risk tolerance is is you'll ask yourself if I had money in the stock market and for just easy round numbers, we'll say I have $100,000 in the stock market and tomorrow it goes down 50%. So I had 100, I put 100 in. Now it's at 50. Do I want to get out of the market in that situation and say like this is not for me way too much risk? Do I let it sit there and build over time? Or do I want to buy more and put more money in in hopes that I can buy it at a discount and it'll grow faster because of that?
Speaker 1:The way you respond to that will help you in determining what your risk tolerance is. If you pick option one that you want to pull out, you have a lower risk tolerance. If you would set it there and just write it out, that's a moderate risk tolerance, and low, we would say is conservative. Middle of the road, we'd say is moderate, and low, we would say is conservative. Middle of the road, we'd say is moderate. And then if you're somebody who's like I'm gonna put more money in and hopefully I'm buying at a discount and we'll go from there, that's somebody who's a little bit more risky. So you you tend to fall in the uh, conservative to moderate category, and then I definitely fall into the risky category.
Speaker 2:Yeah, I think I've at least learned enough at this point where, like my initial thought when you said that was I gotta leave it in because if I sell I lose that. So, like that was my initial thought.
Speaker 1:So we've moved slightly towards right and that's why I said when we first met you were definitely yeah ultra-conservative. You would have invested like a seven-year-old man when we first met, but now you're falling into that moderate category.
Speaker 1:And it's one of those things that, as you learn things, you will move into what I call your more appropriate risk tolerance. Appropriate risk tolerance Because another portion of your risk tolerance and why I say appropriate is most financial advisors will keep you within a certain range of your risk tolerance. And that's because a 20-something invests differently than a 50-something. Who invests differently than a 70 or 80-something? And the reason that is is because of time horizon. The amount of time that they have before retirement is longer or shorter, potentially to the point where it's even zero, and so when they need that money and what the time horizon is for each dollar in their account is on that range. And the reason that range is important is most retirement accounts are invested into the stock market.
Speaker 1:The stock market is the number one area that people go to and invest in. But, as we know, the stock market goes up, goes down, goes sideways. It's very volatile. It changes every single day, it's at a different value, it's constantly moving, and so you'll hear people say, oh, you know you should invest in the stock market because it always goes up. Now, the reason that they can get away with saying that is because, if you look at generally speaking, if you look at any time period, what I would say is you look at any 20-year time period, the stock market has increased in value. Now, if you look at shorter time periods, the market market has increased in value. Now, if you look at shorter time periods, the market may have decreased in value. And that is why time horizon matters is because if you are trying to time the market, you don't know if it's going to go up, down or sideways. And if you do, give me a call because we need to talk, that's fair. Give me a call because we need to talk.
Speaker 1:That's fair, because you would be the wealthiest person out there, because you'd be. You know shorting stocks in the down market and buying everything up and going from there and your upside potential would just be massive. But nobody has that crystal ball, nobody has the ability to do that. They usually call that insider trading, which is illegal, which does happen, it does happen. But don't give me a call if you're that insider trading which is illegal, which does happen, it does happen, but don't give me a call if you're doing insider trading, because I don't want anything to do with that.
Speaker 1:But if we look at averages, that's really the only thing we can do is we can look at 80, 100 years of stock market history. Let's look at averages. So we'll talk in terms of bear and bull markets. Today, bear markets are when the market's going down, bear markets are when the market's going down, bull market is when the market's going up, and so your average bear market lasts 1.3 years, so that's 16 months. Your average bull market lasts 6.6 years, so you know six and a half, a little over six and a half years. Now, what that means is that, and that's why, because of those time differences, that's why, over time, the market has just continued to increase Right, and I believe during those bear markets it's about a 38% decline on average, but during the bull markets it's like a 336% increase incline. Now, part of that's because you know, if you looked at year over year so that's the total during those time periods If you looked at year over year, what the rates of return are, while one's's positive, one's negative they're probably going to be a lot closer in values, and that's because one's over 1.3 years and one's over 6.6 right.
Speaker 1:So when you're looking at your time horizon, if you're going into retirement, you want to avoid a bear market as much as possible, because if you have a million dollars and it goes down, we'll round up and say it's 40% decrease. So a million dollars and it goes down by 40%, that's $600,000. Now to get back to the full million you need an almost 80% return to recover from that, 80% return to recover from that. So really the question becomes in a bear market, how long does it take to get back to even? And on average it's 19 to 24 months, so around two years, just under to at two years, which means from the start of a bear market to break even the point at which it goes down. So so you started here. The point at which it goes down and to get back to where you were is anywhere from two to three years okay and that's that's time that you didn't make any money.
Speaker 1:You just, you know you lost money and then came back to even, and that's if you don't touch it yeah so with my clients we look at allocation mixes.
Speaker 2:And every financial advisor. This is not just a me thing.
Speaker 1:Every financial advisor is going to look at allocation percentages how much of your investments should you have in the market and volatile asset allocations and how much should you have in fixed assets or retirement assets that aren't going to be able to have these bear and bull market fluctuations? Typically, those fixed assets, as we call them, will have guarantees or set interest rates that are either FDIC insured or they're backed by insurance companies. It might be bonds, municipal or privately held bonds but things that have set interest rates. You know what you're going to make Now. It's going to be a lot less than what you could make on an up market, but it's also a lot more than you could make on a down market.
Speaker 1:So you're trying to protect that because you've worked all these years, from your 20s until your 50s, we'll say you've worked all these years you've had maybe 10%, 20% in fixed assets, 80% in the market, some people even 100% in the market, but now you're sitting at $1.5, $2 million, $1 million. You do not want to go from a million down to 600,000 because you know you're just cut. Now you have three years, essentially based on averages. You'll have an average of three years to be able to get back to even, which is not a good setup. Not a good setup Even if you're, you know, low risk, medium risk, high risk.
Speaker 1:Even if you're a risky person, 10 years before retirement, a 40% dip you may not have the ability to buy in enough, or just the stress of that situation is less than ideal. Yeah, and ultimately, what we're doing is when you adjust the allocation from a 10% to 20% allocation to, in your peak retirement years you'll have 100% allocation. Years you'll have 100 allocation. But as you're increasing that amount, that amount is being adjusted as you get older in order to lock in returns, so that you lock in a portion of your retirement plan, because we know that that money has got a guaranteed interest rate. It's not going to go down. We can we guarantee that it might only keep pace with inflation, but we've guaranteed that portion of it.
Speaker 1:So you know, like with this client that I'm working with, they're in that 10 to 15 years from retirement, depending on if they want to retire at, you know, 65 or 70. And so we're looking at adjusting a portion of their accounts into these fixed accounts because they have enough. If they retired today they wouldn't have enough money to get through retirement.
Speaker 1:But if they retired in 10 years with the same dollar amount that they have now. They would be slightly underfunded. But if we get that fixed asset rate of return on their accounts they would be funded completely and have no issues retiring.
Speaker 1:So with that situation, they don't need to get those market rate of returns on all of their money because they're pretty much golden in their set Right and so if we run some quick numbers, we'll say that they have 1.2. So if their current market value is 1.2 million and the market turns bare, say in December because we're still in a pretty good bull market right now from going up a pretty good bull market right now from going up, say it turns bear after the election in December, right around Christmas time, it goes bear. If that were to happen, end of 2024, they'd be at 1.2.
Speaker 2:We're saying they'd be at 1.2.
Speaker 1:They'd probably be a little bit above that, but we don't know what rate of return they would get from now until then. So we just say they're at 1.2, December 24. By April of 26, if we're looking at averages, that 1.2 will have gone down to 745,000. And it wouldn't get back to 1.2 until January of 2028. So that would mean from December 24 to January 28, a three-year time gap. You would not have made any money, you would just stay completely flat. Now the opposite is but what about a bull market? I could have been up during all those years. Yes, absolutely. But what I always say to my clients is you could, but could you retire at $745,000 in investment accounts?
Speaker 1:In this individual situation, it would be very, very tough to do and fully fund the retirement accounts, and in most people's situations it would be very, very tough to do and fund their retirement accounts. And so what I've proposed with this client is that we move 75% of this into a fixed account but still leave a quarter of it in the market. Now if we did that, what do the numbers look like? So we still have 1.2 in December, but it would only drop down to 1.1 by April of 2026. So instead of losing $355, 5 000, we'd only lose 100 000 and then, at the same time period, where they normally would have broke even and they would have been back to 1.2 in january of 28, they'd be up to 1.35. That's in a down market.
Speaker 1:In an up market, that's in a down market. In an up market, they still would have, since we're using a 75% number of that 1.2, this I didn't put in the email, so let me just quick calculate this. So they still have $300,000 that is in the stock market that they're able to get ready to return on, and so they're still going to get their you know, 3%, 4% on their fixed asset not taxed. Some of their retirement accounts still growing tax deferred. That's still going to increase steadily. And so in a bull market, say it doesn't go, bear it maintains bull, they're still going to get those massive rate of return on the 300,000.
Speaker 1:And so now their 1.2 might go to 1.4, 1.5 by that 2028 number, but they're still in a down market, they're not impacted, and an up market they're only positively impacted and that's only because of asset allocation. They can still be as risky as they're being now in that 300 000 that's still in the market, but by by adjusting your asset allocation because of their age and because they're 10 years away from retirement, adjusting that asset allocation and just taking 75 out of the market, leaving 25 in.
Speaker 1:They've now secured their downside risk and now have the ability to continue to make upside if they'd like yeah, yeah, for me that's a great middle ground.
Speaker 2:I mean again, as we talked about the beginning, switching more into a moderate middle ground type uh response. That's just best of both worlds of where I'm no, I'm secure'm secure and that still gives me some. You know, I won't kick myself of like, oh, I pulled everything out, but if it does go down I'll be glad I secured some. And I mean, but I imagine some people it really stuck on that number of well. If I, if it is an up market and I don't you know put any in fixed well instead of 1.5, I could be at2 million. But you know, it's like at your age and it just comes into, I guess, greed of like, how it's not like greedy in a sense, that you want to take from others. But how much do you need to make when you know like you're all set? So why do you need more than you need?
Speaker 1:Right, and that, and ultimately not understanding risk tolerance and not understanding these numbers is what drives people to not play with their asset allocation properly. They're thinking, yeah, but my upside potential is this? My upside potential? Ok, but the problem is, is that if you take, in my opinion, the 10 years before and the 10 years after retirement are your most important years, because it's where you can lock up and guarantee that you know how retirement's going to go and make sure that you have that security, like we potentially will do for this client. Or you play the gamble game and we're talking averages here. So if the average is 6.6 for an up, 1.3 for a down and 2 to get back to level, say that it runs that cycle. It's 6.6 up 2. Typically it would go up, down and then flat. You know, back to flat and then back up again. So say it's 6.6 years down, 1.3. So now we're at 7.9 and then takes another two years to get back up. So there's your nine years.
Speaker 1:your nine years is the cycle yeah and so that's why I'm saying you're 10 there, you're 10 before, you're 10 after. The most important because? Because most retirement accounts, if you only in that 20-year period, if you only have two bear markets, your retirement accounts generally will be okay, because the amount of increase that you had prior to the decrease and then back to even doing that twice still puts your accounts well above where you need to be at for retirement, assuming that 10 years before retirement you were at a position where a healthy, conservative rate of return would have funded your retirement. If that is your scenario, two down markets the numbers show don't negatively impact your retirement. Three down markets, though, can reduce your retirement income by 20 to 40 percent. That's huge, and that's your income for all of retirement can be reduced by 20 to 40 percent, which, for some people, could be the difference between being able to retire and not being able to retire.
Speaker 1:Okay, we have enough here. Let's adjust our allocation to 75-25 and you have an up market your allocation, naturally, because your investments in the market are going to outpace what you had allocated. Proper financial planning would suggest that you should then take out of your 300,000 that grew. You should take a portion of that to rebalance your account to a 75-25 split.
Speaker 2:Yeah, that makes sense.
Speaker 1:But what I would tell a client that is very risk-tolerant is we did the calculation and we know that 75% of the old account balance was sufficient Right. You don't need to move this amount over. You should, If we're following, maximizing your retirement, maximizing your guaranteed income in retirement we should reallocate. However, if you want to play it more risky, in my opinion that is when you play it more risky.
Speaker 2:Yeah.
Speaker 1:When you've already balanced the account, you already know that you're going to be okay in retirement. There's an opportunity here to potentially be better off. There's also an opportunity to because we've already guaranteed our level. There's not really an opportunity here where if we take on more risk, it's going to negatively impact us.
Speaker 1:It's only going to negatively impact us from the new level of high that we're putting at risk. We've already secured our floor. Putting at risk, we've already secured our floor. And so if we then go to a 60-40 split, it's not as much of a concern, because the 60%, while it's a lower percentage, it's a lower percentage of a larger pie is still the amount of money that we need in order to guarantee the retirement.
Speaker 2:It's funny because I feel like this concept and I'll probably fumble through this, but this concept is understood if, say, someone is younger and they have a lot of debt and they haven't paid off their debt and they're like, oh okay, well, I can't afford to buy I shouldn't say not everyone, but I can't afford to buy a brand new car. But it's like we get into, it's like my basic needs aren't covered yet, so I shouldn't spend extra than I need to Like Maybe I should buy a used car, and as I'm saying this, I know a lot of people don't do that. Actually, they get leases and overspend. But point being is, I feel like it's easier to understand in that scenario than like oh, in retirement I have this collection of money. I just have so much right now in general, even though I can't touch it. It's like the same philosophies I should secure my basic needs and then, yeah, play with any money you want. If I lose all of that, I have my basic needs covered and it kind of sucks, but I'm okay.
Speaker 1:The hardest part for most of my clients when they're younger is that they don't understand how the market operates and they don't understand how to get into the market. But then if they've gotten into the market and they're closer to retirement years, they've seen how the market's done over the last 30 years and they try to say and it's confirmation bias they look at the market and they say it's done this much over this time period. Why would I get out of this? It's done so well for me.
Speaker 1:Yeah, it makes sense that's the same argument, though we'll use the car analogy. So you've had, you bought a car brand new, you've taken really good care of it and you've kept it for 10 years and it's treated you really well, and you have an opportunity to buy another car at a really great price. Say it's the say it's an identical car, identical make model. It's just it's the say it's an identical car, identical make, model, it's just upgraded 10 years, but it's the identical quality, identical vehicle. It would be the equivalent of saying I don't want to get rid of this car because it's taken me and my kids to all the sports games, to all the dance recitals, to all these great things. Why would I get rid of this car? I have so many memories with it. It's done so for me, but we know with the car that if I hold on to this, eventually it's going to break down.
Speaker 2:Right.
Speaker 1:The same is true in the stock market. Eventually, the market is going to correct Always. If you look at historical 6.6 years up, 1.3 years down. And so what we don't want to do is we don't want to try to time the market. And that doesn't matter what your age is. You should never be trying to time the market.
Speaker 1:If you're trying to time the market. Everybody who tries to time the market loses money. You want to talk to a day trader and you have a day trader who's trying to get you into day trading. All day trading is trying to time the market. All you have to ask a day trader to get them to be very upset with you and not know how to respond and just blow up and just be very upset is ask them what their compounded annual growth rate over the last three years is and ask them what their compound annual growth rate over the last five years is. There is not a single day trader in the world who has performed consistently over time not not one. Because you can't time the market if you could, you would be a gazillionaire.
Speaker 2:Yeah, well, I think that's a perfect analogy because even even say the car doesn't break down, but you decide to keep it and you get hit by another car. I mean, that's what covid was, you know, it's like there's even outside variables that like right.
Speaker 1:You have no control over it. So my argument with the allocation piece is keep the car. It has a bunch of memories. Keep the car.
Speaker 1:Maybe it's a collector car and it's got value so, and you know, maybe it's not a collector car, it's just one that you have a lot of emotional attachment to put it in the garage, drive it a little bit, keep it around, but have something else that's going to guarantee you safety, transport ability to get from point A to point B, ability to get to your medical appointments, something that is reliable and, you know, has a minimal chance, if any, of breaking down.
Speaker 2:Just sell everything and buy a crotch racket.
Speaker 1:You can do that with your 20s. You can buy a crotch racket with your 20s. That's true If you end up losing a leg, you have the ability at that time period to learn how to walk again.
Speaker 2:I know.
Speaker 1:With an amputated leg. You don't have that ability at that time period to learn how to walk again. I know, you know, with an amputated leg, yeah, you don't have that ability when you're 50, 60. It's not that you don't have the ability, it's going to be much more difficult, it's going to be much harder. The same philosophies are true in your retirement accounts.
Speaker 2:So my only other question I guess I have is I know we kind of talked about that nine year window and and I know we're not supposed to time the market, but could you make more or less risky situations based off? I mean, if on averages it's nine years, couldn't you see like bigger cycles, so not like short timings but longer time?
Speaker 1:so that's that's why we want to start and that's why I say so I say a 10-year window before and after, so a 20-year window, but 10 years before, 10 years after. And the reason being is that we do want to do that, in my opinion. In my opinion, you want to look 10 years before your retirement. We want to look at how much of the account you have and what the market's doing and where we think the market's going to do, and we have that conversation with the client. What does the client think is going to happen with the market? And then, based on what they think is going to happen with the market, that's how we determine. Is it a 60% allocation to fixed assets?
Speaker 2:or is it an?
Speaker 1:80% allocation to fixed assets. If we think we're going into tumultuous times and the market's going to be crazy we're going 80 tumultuous times and the market's going to be crazy we're going 80% fixed assets. But if we think we're at the beginning of some really good years here and the market's going to do great, I think for the next three to five years go with a 60% allocation and then that way you have more in the market but we've still guaranteed 60% of our retirement.
Speaker 2:So you're not timing it in a sense of day-to-day, month-to-month and I'm dumping all my funds in it. You're timing it in a sense of what stage is it in and I have to allocate some, so what percentage?
Speaker 1:And it comes down to, and the percentage mindset is, it's a risk management technique. Yeah, you want to look at. With what degree of certainty do you think the market's going to go up?
Speaker 1:And then how much do you think it's going to go up? Because this is what financial advisors are doing with their own money is we sit here and we go? Ok, in the next year do I think the market's going to go up, down or sideways? And then you apply a percentage to it because we don't know for certain. So, like right now, I would say you know, between now and the end of the year, I think the market will go up and I think I have a 70 degree. You know 70% certainty of that. And then I'd say you know, maybe there's a 20% certainty of it being flat and there's a 10% certainty of it going down, and then assign values to that Percentage. You know, I think you know up is 10%, flat's obviously a 0%, and then down, you know, if it goes down, maybe it'll go down, we'll say 10%. That makes it really easy. You can then multiply those percentages and see what you anticipate the market to be. 70% times 10 is a 7%, 0, and then 10% at 1.
Speaker 1:So you think that on average, based on your calculations, you're saying the market's going to go up 6% based on your degrees of certainty of certainty. Based on your degrees of certainty, you can then look at asset allocation percentages into those accounts to see how that projects over time. That's very high level and you want to have a financial advisor walk you through those conversations if you're going to have them. But that's why I want to catch you 10 years before retirement, because if I catch you 10 years before retirement, if you're at 100% in the market and you're 10 years before retirement, we're going to make some sort of change. Maybe it's a 50-50 split, maybe it's a 40-60 split. We're going to move something into fixed assets. But the question becomes what percentage? And that's going to be dictated based on what we think the market's going to do over a long period of time. We're never trying to time the market over a short period of time. We're doing it over a long period of time and we're still putting a degree of certainty of it's not going to work out how I think it's going to and then allocating cards out because realistically that you're doing the same thing with even a 75-25 split.
Speaker 1:You're still saying, ultimately, at that point in time we're concerned about down markets, but we're still saying the market has a higher percentage on average to go up than it does to go down, so let's leave some money in there. But if it goes down it's not going to greatly impact us, but it has the potential to impact us positively. If it goes up, right. And then if the market goes down, we leave it in there and we allow it to self-correct. But if it goes up, we reallocate and we take some of those earnings and move it into the fixed asset and we just harvest that.
Speaker 1:We just harvest the fixed asset earnings over and then allow it to keep going and because we have a long time horizon, if it goes down it's no concern because on average it's going to go down for 1.3 years and back up in two years. So in three-year timeframe three to three and a half year timeframe we'll be able to get back to ground zero Because we have 75% of the money over here. We can take distributions of income, retirement out of the 75 percent and allow that money to have three years to get back to even. But if we have everything in the market and the market goes down 10, we're not going to get back to even in three years because we have to continue to take retirement draws out of that, which is compounding our decrease in value.
Speaker 2:Yeah.
Speaker 1:So it allows us. We're buying time horizon by doing an asset allocation into fixed assets.
Speaker 2:Yeah, that seems like a great strategy, great middle ground because you can adjust based on risk tolerance.
Speaker 1:Right, and that's why it's. You know this is. Asset allocation is the number one most important topic as you build your retirement accounts. Funding them in the initial stages is the number one, most important thing. Number two, once you've number one, once you've actually started investing, is your allocation percentages.
Speaker 2:Sweet, anything else.
Speaker 1:That's the basics on asset allocation I think.
Speaker 2:Thanks for listening to our podcast.
Speaker 1:We hope this helps you on your balance freedom journey.
Speaker 2:Please share your thoughts in the comments section below.
Speaker 1:Until next time, stay balanced.