Risk of losing money is always top of mind. But, in this podcast, Karl Eggerss discusses a few others that most investors don’t think about.
Hey, guys. Welcome to the podcast. I am Karl Eggerss, and this is Creating Richer Lives. If this is your first time, welcome. We always love to have new listeners to the podcast.
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You can also tell us what we’re doing very well, right? By the way, somebody did reach out this past week and said, “Hey, why don’t you talk about different types of risk?” We always think about risk when we’re investing our money just in terms of, “Can I lose it?,” so we are going to answer that today. We’re going to talk about different types of risks that maybe you haven’t been thinking about, and it may help you diversify a little more and may help you think about your portfolio in a slightly different manner. This show is brought to you by Covenant, Lifestyle. Legacy. Philanthropy.
For more information about Covenant, just go to creatingricherlives.com. Our telephone number is 210-526-0057. This podcast comes out every week, and of course, it’s up there forever so you can listen to that. We do all kinds of topics. We have guests.
We have a lot of good guests lined up in the next few weeks, so be on the lookout for some of those. All right. Before we do get into some of the types of risks that you may be overlooking, I wanted to give you five quick things that I saw this week, energy surged, as crude is now at its highest level since October of 2018. It’s pretty fascinating, right, to think about what oil has gone through in the last 12 to 18 months, being at a -35 or $40 a barrel, and here, it’s come full circle, over $100 per barrel move. Amazing to watch, so that was one big move this week.
Again, oil at its highest level since October of 2018. The initial jobless claims, this is something that comes out every week on Wednesdays typically, and they fell for the fifth straight week, and they’re now at a new pandemic low, so continuing to see improvement on that front, although it’s a little ironic that we have so many employers that I talked to. I talked to CEOs, business owners that are saying, “I cannot get workers,” and yet, we still have a lot of people sitting on the sidelines. In fact, we have seven and a half million less people working today than in April, 2020, and it’s not that the jobs aren’t there, they are there. It’s just people are not wanting to work because of the fact that we’ve had stimulus, we’ve had a lot of unemployment, so as that starts to roll off, let’s see what happens to the jobs picture.
We did get a May jobs report, and it was less than expected, so we’re still seeing recovery, but less than expected, so you still see interest rates kind of hanging in this lower level, and that does at least add to our thesis that interest rates may not be spiking up huge anytime soon because maybe inflation does taper off a little bit. We’ve been talking about that the last several weeks. Unemployment rate’s at 5.8%, was supposed to be 5.7%. A couple other things I saw this week, Nautilus Research did a study that shows that when you have the stock market perform as well as it has from January through May, it tends to have a pretty good year the rest of the year, so just because it’s had a good first half of the year here, we’re not even halfway through, but just because it’s had a good first five months, don’t think that all the gains are behind us. History shows that we may have more to go on the upside.
Those were a few things that I saw this week that kind of stuck out to me, but let’s jump right in our topic. I was reminded this week, I got a call from a radio listener that said, “Hey, we’re about to go into retirement,” and we were kind of worried about the election. We were worried about all kinds of the stuff through COVID, and so we’ve moved all of our retirement assets to ultra-ultraconservative, and so we talked through that and I said, “You know, your biggest risk going forward, if you keep it that way, is inflation risk,” and inflation risk is, hey, things are going to cost more, and if your money does not keep up with it, you’re going to fall further and further behind, so either you have to adjust your lifestyle and not do the things you want to do in retirement, or you’re going to have to change your allocation at some point, and so we kind of talked through that, but that risk of market risk is what they were concerned about. We’re worried about losing our money, so let’s park it over here, and that feels good. Okay, we know it’s not going to go down, but they are ignoring other risks, and I just talked about one other risk, which is inflation risk, that things continue to cost more, and so you can only be so safe.
As I’ve mentioned in the past several weeks, this is not the timeframe like we used to have, where you could invest and sit in a money market or CD and beat inflation. If you do that, you’re actually fallen behind, and it’s been that way for about 10 years, so it’s forcing people to be more productive with their money, so yes, we have market risks. That’s what most people think about when you think about risk, but you also have other types of risks, such as inflation risk. Along with that, this retired couple, they’re in their mid-60’s, one of the risks they have is longevity risk, right? How long do they live? What if they live until 105 years old?
Will their money and their portfolio and their assets last that long, so longevity risk, right? A lot of us want to live longer, but there’s a financial component to it, and it’s a risk that you could live too long, and so there’s longevity risk. We have market risk, we have inflation risk, we have longevity risk. How about liquidity risk? That’s an interesting one. I had a gentleman one time come see me, had a really nice, solid 401(k), worked for a great company.
He was a lifer. He’d been there forever, had a big, big 401(k), and he said, “Karl, my house is paid off. We’re debt-free,” and I looked at his balance sheet and I said, “That’s all great, but you’re a couple of paychecks from having some real trouble.” In other words, if he were to lose his job, he didn’t have a lot of liquidity in his life. He had his 401(k), he was not near 59 and a half, so he had taxes and penalties to think about, and he worked for the company, so he couldn’t even maybe access if … They didn’t have loan provisions on it.
That was an issue for him, right, was liquidity risk. He had money tied up in his house, not very liquid, and then his 401(k), not very liquid, so when you’re looking at your overall finances, it’s important, especially with investments, to look at the liquidity risk as well. There’s one thing about money markets and CDs. I was just talking about how bad they are for long-term retirement savings, but they’re great for emergencies, right? You know it’s there, you know you can tap it, but there’s a price to pay. It doesn’t pay you very much.
That’s okay for a portion of your money, so when you’re looking at your investment, how liquid are you? Right? There is a benefit of having some non-liquid investments. Private equity investments aren’t very liquid, but they tend to have a higher return in exchange for that lack of liquidity, right? That’s the price you pay.
401(k)s give you a tax deduction. In exchange, you’re not going to touch it until you’re in your 60’s or 70’s or 80’s. That is another big risk to look at, is liquidity risk. How about concentration risk? I was just talking about somebody being a lifer at a particular company.
Well, a lot of these companies may be public and you get stock given to you, and if you do, through grants or options, you may have a lot of your net worth tied up in one particular stock, but it’s more than that. I remember meeting with people back in the late ’90s, and they would come into my office and they would say … I’d say, “Let me see your portfolio,” and they’d say, “I’m really diversified,” and I would look at it, and their portfolio would have Sun Microsystems, Lucent Technologies, Cisco Systems, Oracle, WorldCom, all these technology stocks of the 1990’s, and as you zoom out, I would tell them, “You’re not really diversified. Yes, you have a lot of different stocks or a lot of different mutual funds, but at the end of the day, you’re still concentrated in technology,” and of course, here comes 2000 through 2002, which was a tech bubble that burst, and we went into a pretty significant bear market, where many of those stocks went down 60, 70, 90% in some cases, so concentration risk, and it’s really important to look through your mutual funds, look through your ETFs. Where are they leaning?
Do you have too much in emerging markets? Do you have too little in commodities? Do you have too much in technology stocks? I’m just using examples. Those are the types of things you need to look for in your overall portfolio.
Do you have too much real estate? Right? I know a lot of people have a ton of real estate. They love real estate. It does so well, can never go down.
No, it does go down. There have been risks of real estate over the years. There have been risks in the stock market. This is why we diversify, and so concentration risk is not just about one stock or one ETF, it’s also about types of assets, right? Real estate, for example.
Reinvestment risk is a really interesting, especially nowadays. You think about maybe a lot of bonds, and some of you may have bought bond funds, some of you may have bought bond exchange traded funds, but some of you may have bought individual bonds that paid you a particular coupon or an interest rate for a set amount of time. Then, what happens is, when it matures, you get that money back and you can’t go and invest in the same rate that you got back in the day. For example, something was paying you four or 5%, and lo and behold, now you come back and you get your money back, your principal back, and you want to go reinvest it and do the whole thing over again, and now you can only invest it at 2%, so you have to look at, “How much am I tied to fixed interest rates, fixed coupons versus variable ones or versus dividend stocks that can actually increase your income over time?” Right?
Reinvestment risk is something that a lot of people don’t consider, especially if you own mortgage bonds. Mortgage bonds have that, as a risk inherently in them because people refinance their homes, and when they do that, you get your principal back sooner than you thought, and you had anticipated getting all this interest, and instead, you got your principal back, which sounds great, but now you have to go reinvest it. Can you reinvest at the same rate or higher than you did in the past? Another interesting one is sequence of return risk. This is really interesting because in the last …
You think about it, in the last 20, 25 years, we’ve had some really significant bear markets or stock market sell-offs, right? You think about the dot-com bubble I just referenced. That was in the year 2000. We saw the Standard & Poor’s 500 fall roughly 50%. You fast-forward to the 2008 financial crisis, again, the stock market falls roughly about 50%.
You fast-forward even to COVID in March of 2020, and the stock market was just, in a few weeks, fell anywhere from 35 to 40% very quickly. Well, think about retiring just before that happens, so you go into retirement, you’re looking at this, everything looks good, and the stock market sells off very, very quickly. You’re not allocated properly and your returns are bad at the beginning of your retirement. That’s the sequence of return risk versus a sell-off that happens 20 years from now, and you’ve made so much money, and your portfolio’s so big that that sell-off doesn’t impact your life because you’ve already gone through a lot of your retirement, so when the sell-off happens, does have an impact. Now, having said that, again, we know there’s going to be corrections in the market.
Anywhere from 10 to 15%’s normal in any given year. We know that. The 30, 40, 50% are more rare, but they have happened. We’ve seen that. When they happen is a concern, and so part of answering that and part of dealing with that particular risk, to me, is realizing where we are in the cycle when you’re setting your allocation.
It’s not just about, “Okay, you need to earn X return,” so we’re going to set the portfolio and forget it. It’s also about having the ability to get more aggressive or being more conservative early on at appropriate time. For example, when stocks are very, very expensive and the market has already had a huge run, that may not be the time to go to your full equity allocation. You may wait and say, “I’m going to carve out 10 or 15%, that I have the ability to get more aggressive when we have pullbacks,” and if you stay disciplined to do that, you can take out some of that sequence of return risk, because again, what you’re trying to do is leave some powder dry to take advantage of dips, as opposed to putting it all in at one time into the stock market only to see a correction happen or a big drop at a bad time for you personally, so there is some finesse in building a portfolio and how to manage a portfolio rather than just setting it and forgetting it like the old rotisserie chicken infomercial. What’s interesting is, and these are just a few …
There’s literally tons of risks, and I think it’s interesting to think about them because most people do focus in on one or two, and there’s a lot of risks. Now, how do we deal with each one of those? I think as opposed to dealing with each and every one of those individually, diversification takes care of a lot of those. It’s just, “How do you diversify?” I’ve seen over the years, many people diversify in an incorrect manner.
In other words, they may say, “The more mutual funds I own, the more diversified I am.” That’s not necessarily true. I think, and you go back 50, 60, 70, 100 years, sometimes it’s not just about stocks and bonds, right? Most people in this country own some portion of stocks and some portion of bonds, and there have been times where both of those asset classes didn’t do very well, so what do you do? Well, you may have commodities.
You may have a strategy that takes advantage of volatility. You may have something that takes advantage of shorting the market at times. You may have a momentum fund. You may have a value fund. You diversify against currency risk, which is another one, by owning international, so it’s not specifically trying to address each one of these individually.
I think by having a comprehensive portfolio, you can address a lot of this by simply diversifying, but doing it in a real diversified manner. Again, to me, sometimes I see portfolios and they say they’re diversified, but it’s not just about the number of securities, it’s about, “How do those things move relative to each other?” That’s really important. In fact, I will even go on to say, sometimes when you talk about gold or you talk about even cryptocurrency, the idea behind those isn’t always that they’re going to make the most money. It’s that they may have a different path than what your stocks and bonds and real estate is doing, and because there’s a different path, it smooths out the return, it smooths out the sequence of return risk, right?
Maybe the stock market’s overvalued, but maybe the bond market’s not, or maybe the commodities aren’t, or maybe cryptocurrencies aren’t. That takes out some of that risk. Inflation risk is taken out by diversifying, right? Diversifying also helps with longevity risk. Diversifying helps with, “What if you have the interest rate risk of not having enough income coming in?”
Well, diversifying helps to do that as well. You may have a bond ladder in there, so simply diversifying the right way, which is a little easier said than done is the solution to a lot of these risks. Now, again, hear me out, diversifying does not mean you own five mutual funds in your 401(k), and now you’re diversified. If you go back to 2008, if you go back to March of 2020, if you go back to even the dot-com bubble to a lesser extent, a lot of mutual funds, a lot of ETFs, a lot of stocks moved in the same direction, so while you may have owned five or six mutual funds in your 401(k), if you recall, they all were going down. That means you weren’t diversified.
To properly diversify, you’re probably going to have some things that are underperforming at times, and you have to be okay with that. If you’re constantly chasing what’s working now, you are a momentum trader. That is what you are, and if you want to do that, that’s fine, but that’s not what I’m preaching here. I’m talking about real diversification where, yes, you have some things that aren’t doing very well, and I’ll give you an example. You coming into 2020, everything’s looking okay, and then COVID breaks out, and very few things did well.
If you recall, the bond market was falling, the stock market was falling, commodities were falling. It was a tough time, but hedges were working very well. In other words, things that benefited from either A, volatility or B, benefited from the market falling, or cash did well. Cash can be a diversifier. Money market, CDs can be a diversifier.
They have their negatives, but they have a part in a overall portfolio, so I think if you simply diversify, you solve a lot of these problems, and I constantly see people that think they’re diversified, but they’re really not, and the test is, “What did the portfolios do during these different times over the last 15, 20 years?” You can look and say, “How was I invested and how did it do during that time?,” and that helps. Look through some of that. If you want help for us to do an analysis on your portfolio, let us know. Somebody gave me a portfolio the other day.
It was a fairly large one, and we looked at it, and it had, about 90% of it was stock, so that person was okay taking that type of risk. That wasn’t the issue, but when we drill in to the types of ETFs, to the types of mutual funds and the specific companies they owned, they owned all three, you could see where some exposures were once we did our analysis. We had our analysts do some analysis on this, and what we found was they didn’t have near enough international exposure, they didn’t have near enough hard assets or commodities exposure to protect against inflation, and it’s hard to see that if you’re just looking at all those securities individually, but once you put them all together and really do kind of a see-through and look under the hood, then you can see that exposure, so if you need help with that, reach out to us. We can help you do that. Creatingricherlives.com or just give us a call, 210-526-0057.
We’ll be happy to take a look here at Covenant. We got a large group of advisors and analysts to do this every single day. I hope that was helpful, and if you have something you want to hear about in future podcast, just shoot me an email to Karl.Eggerss@Covenantmfo.com. That is my email address, and we’ll take it under advisement, how’s that, but a lot of times, we do address some of these comments and some of these questions you guys have and things you want to hear on a podcast, so thank you for the feedback. Appreciate it.
You guys have a great weekend. We’ll see you back here next week on Creating Richer Lives, the podcast.
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