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Managing Risk In Individual Wealth Management

Katlyn Graham:  Hello, I’m Katlyn Graham, here with Rick McDonald, the president of US Advisory Group. Welcome, Rick.

Rick McDonald:  Hello, Katlyn.

Katlyn:  Hello, thanks for joining us today.

Rick: My pleasure.

Katlyn:  We’re just talking about individual wealth management. You manage money for a lot of individuals. How do you address all the risks and uncertainties that seem to abound in this economy today?

Navigating the Risk/Reward Relationship

Rick:  That’s a great question. Number one, we need to navigate the risk‑reward relationship in any time we put our money anywhere outside of our mattress, so the bank at zero percent. Risk is a fact of life.

How much are we getting paid? What are our expectations on reward for that every incremental step of risk? That’s important. The cost of living runs two or three percent, so if we’re going to grow our wealth, we need to be getting something greater than two or three percent. Capital growth in the five and six and eight percent returns are exceeding the cost of inflation, so that’s growth.

Our money needs to grow. We work hard for our money, we need to put it to work, to make, ultimately, this transition from man at work to money at work, so we can retire comfortably and live the latter 20, 30 years of our life, living off of our hard earned earnings.

We need growth, comfortably in excess of inflation, whatever that may be, two or three percent. Let’s assume that two or three percent is that bogey. We need mid single digit to low double digit teen kind of returns, with some degree of consistency, but we don’t want risk. Therein lies the challenge.

There’s always a problem. There’s always a reason not to invest money. It’s very, very difficult to run money, to manage money impassionately. We always, always, always live for seeing the trees, not the forest.

Any given time, or any given 2 year, 5 year, 10 year span, we can find reasons why it’d be crazy to invest money, because of all of the risk, all of the threats, all of the uncertainties. It goes on and on and on and always will.

The challenge is to be intelligent about it, be pragmatic about it. We don’t want to bet the farm because there are problems out there. Every once in a while, we will find large drops in the market every couple of years. Every 1 or 2 years across a 10 year decade, we’re going to find drops in the market, that’s reality.

How do we mitigate, how do we have risk management processes in putting money to work?

That’s the question that has to be asked on everyone’s mind. Whether it’s my 401Ks, whether it’s my personal accounts, whether it’s my more aggressive capital appreciation that I’m trying to get, it doesn’t matter. How do we get good returns with managing risk?

One of the biggest things we need to look at first and foremost is recognizing that the tools that most of us are using today were born 20, 30, 40 years ago. Big box mutual fund, can’t get out of its own way.

With the greatest respect to the Fidelitys and T. Rowe Prices and Vanguards of the world, it’s very, very difficult for a very, very smart portfolio manager having thousands of positions in his portfolio, or her portfolio, with multiple tens of billions of dollars in the fund, to be nimble and adroit and responsive to world events, technology changes on a whim. It’s not going to happen anymore.

The Internet changed that. Global investing changed that. The fact that Russia goes after Ukraine has a major impact on all economies around the world, and your large big box fund has a very, very hard time making any adjustment because of that. Those kind of tools don’t serve us very well going forward, and there are better tools out there. We need to embrace them.

The people that are listening out there for the first decade of this century, from 2000 to 2010, we’ve seen no growth in your 401Ks that were all chock full of big box funds, know exactly what we’re talking about. Don’t know what to do necessarily, but know what happened.

What did work? The pension funds, the large investment firms. We all hear about the Harvard endowments, the Yale endowments that were chock full of alternative investments. They did fine, so what are we missing as individuals?

We’re missing the tools. We’re missing the understanding of alternative investments, starting to look at things that are different than what worked last decade. We need to embrace things that are more responsive and have different correlation, fancy word for they don’t always move up or down with regard to the typical popular indexes. This is how we manage risk.

You also need to have a relationship with an advisor or a portfolio manager, someone to help you guide you with good information at a reasonable cost and a transparent basis, where your money is safe. We don’t want the Madoff nonsense ever again.

Your money goes into a custodian where it’s safe, where you know it’s there. You have affirmation that it’s there, confirmations that the money’s there, your relationship with your advisors is transparent. There aren’t internal things. There aren’t proprietary conflicts that there are with all these banks and wire house firms.

At the moment you take money out of a bank, the moment you take money out of your mattress, the money has incrementally more risk. You need to manage that risk. You need to manage the volatility of the markets you’re going to invest in. You’ve got to manage the risk of the environment, who’s holding the money, who’s advice you’re getting and how you’re paying for that advice. And you need to put the money to work intelligently. You need to watch it.

I tell people all the time, Katlyn, no one will ever be more responsible to your money than you. You can hire a wonderful adviser. You could hire us. You are still the number one person in charge of and most responsible to your money.

Have good communications. Meet and talk to your adviser, but have a plan. Have a plan that you understand that’s articulated by your adviser or yourself, if you’re doing it yourself, and have some metrics to help you understand what are you doing? Are you on track?

And make sure there’s risk mitigation in your plan. Make sure you’ve got strategies that adjust to changing market events, that adjust to changing world events, that adjust to changing health issues and personal issues ‑ having a baby, buying a new home, retiring, educating your children. All of these different life events, they’re far more predictable than what Rush is going to do next year, than what the fed is going to do for policy on interest rates.

But all of these have to be factored in on some kind of a process that’s managed, that’s mitigated. And the tools that you invest in, whether the ETFs, the EINs, a myriad of different tools that have come out in the last decade that are giving you an opportunity to have lower costs, more effectiveness, more adroitness, more responsiveness in the markets, are very, very important to understand and use and use properly.

This is the responsibility of most individuals. Work with an adviser but do not delegate 100 percent of the responsibility to that person. That’s not a reasonable thing to do.

Top Tips for Managing Risk

Katlyn:  It sounds like one of your top tips for managing risk is have a plan. What are some of your other top tips for individuals who are trying to manage the risk?

Rick:  You’ve got to have a good plan. You’ve got to have a good team, whether it’s your adviser, yourself, your family members. Whoever your team is, make sure they know what they’re doing.

As self-serving as it is, it is harder than ever to manage money yourself. Technology, tools, the changes, the responsiveness, all of these things are working against you as an individual.

Larger institutions are making money. Smaller individuals are not. You need to be somewhere in between and you need to do that by harnessing, on a fully transparent basis, advice on a fair cost so you’re making money, not them. Or, frankly, both are making money but doing it properly. That’s number two.

And number three, understand the tools, the vehicles to use. No one ever got better in this investment industry as they got bigger. Bigger is not better. Too small, that may have its own issues. Overly large makes yourself cumbersome. It makes it harder.

Your best ideas as a portfolio manager are diluted as you get larger because you cannot put all your money in your best ideas. I’m a portfolio manager. I’ve been a portfolio manager. I might have a fund large enough that I’ve got 1,800 stocks in it. I’ve got ten great ideas.

I’m limited to have much I can put into one of those individual companies, but it doesn’t even matter. If I bought all of it, which I can’t, I wouldn’t be able to utilize the resources of the whole entire fund in those ten stocks.

I’d have to say, “OK, those are my ten best ideas. What are my 30 best ideas after those, and 50 after that, and 100 after that,” and so on and so forth.

What happens is I’m no longer picking stocks. At best, I’m picking industries, sector bets. That’s not what we want. That’s not what we’re paying a portfolio manager for at Big Box Mutual Fund. Once upon a time, we were paying them to pick stocks. Now they’re industry or sector best.

Use ETFs doing that. That’s what ETFs do. They’ll buy a basket of stocks representing to give an index or industry at a fraction of the cost. If you can manage a basket-full of ETFs adroitly and be in and out and change with some degree of discipline, you probably have the structure to make a lot more money for a lot less cost.

It doesn’t mean the manager is smarter or not, but you have a structure that might be more suited for managing risk and, eventually, over time, have a better outcome.

So number one, have a plan. Know what you have, what you’re doing. Be on top of what you’re doing and stay on top of what you’re doing.

Number two, build a good team. Find a good advisor, transparent, good custodian, good communication with everyone on the team.

And number three, utilize the kind of tools that have been built over the last 5 or 10 years that are more appropriate for managing risk volatility, market changes, communication changes. The Internet has changed the world, and we’re still dealing with things that were built in 1970. That’s a problem.

Katlyn:  It sounds like you’re on the cutting edge, though. You’ve got figured out how it’s working, so I’m sure people appreciate that advice. Thank you so much, Rick.

Rick: It’s always a pleasure, thank you.

Photo credit: Daquella manera / Foter / Creative Commons Attribution 2.0 Generic (CC BY 2.0)

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