Thoughts On Money [TOM]

Today I want to talk about portfolio design. Specifically, I want to start with the basics; the foundational concepts of how one begins to build a portfolio.

But first, let’s talk a little bit about road trips…

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It was May 10th, 1996, when Twister hit the box office, a popular action-packed thriller that was the second highest-grossing film of the year.  This fictional flick sparked the popularity of “storm chasing” across the country.

Fun Fact: Twister was the first film to be released on DVD in the US.

Some twenty-six years later and the enamor for storm chasing has not faded.  A number of travel companies even specialize in storm chasing-led-adventure tours.   Throughout tornado alley, local news outlets highlight the collateral damage caused by storm chasers.  The influx of traffic and lack of local law enforcement – distracted by the tornado at hand – leads these chasers to blow through stop signs, run red lights, and drive distracted by their various weather devices, often resulting in fatal accidents.

Rick Smith with the National Weather Service speaks out against these amateur chasers, "It is a serious situation in that anytime you have a severe storm, the storm itself is bad enough, and these storms can be very serious. It's important for people to know it's not like watching television it's not a video game. These storms can really hurt you, they can kill you, they can damage your vehicle,"

We are talking about ill-equipped amateurs seeking a thrill and relying on their limited experience and know-how to go out and "play" with tornadoes.  This is just downright foolish, no?  When it comes to weather, we call these folks storm chasers; when it comes to investing, we call these folks performance chasers.

Today we will dive into the wild world of performance chasing and the financial wreckage this common pastime can cause.

And off we go...

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I’m writing today specifically to give you permission to transact.

If you’ve met with your family and your financial advisor and you’ve collectively decided that it makes sense for your financial plan to acquire a new property - do it.

If you’ve met with your family and your financial advisor and you’ve collectively decided that it makes sense for your financial plan to sell a property you currently own - do it.

I’m seeing too much concern/anxiety out there about where real estate markets will go from here and how to best “time” one's next real estate transaction. I don’t see a lot of value in speculating or prognosticating about where your gut (or my gut) is telling us about the direction of real estate prices. My encouragement today will be on the importance of patience and how fear and greed typically cause the most damage.

Note, the focal point for me today is more on one’s primary residence or second home. There is a different type of analysis when discussing investment properties. For investment properties, we’d most likely be juxtaposing multiple opportunities and concluding which poses the optimal risk/reward outcome. The acquisition or sale of a residence - your home specifically - will have more qualitative factors that need to be weighed, assessed, and considered.

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A Practitioner's Perspective

I know I’m not the smartest guy you’ll ever meet.

And I know I don’t have a reputation or record of predicting macroeconomic events.

So why listen to what I have to say? 

Well, I have a distinctive vantage point as an advisor - as a practitioner versus an academic - who talks to investors all day long, every day.  

I know what makes investors tick.  I advise folks to make wise financial decisions, and I know what fears and concerns are currently dominating their thought life.  

Today we will discuss what I believe is the number one concern on most investors' minds, and I’ll explain why you really shouldn’t be worried.  

But first, let’s talk about Winnie The Pooh…. 

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So, you’ve decided that you are going to purchase a new vehicle and you’ve narrowed your focus down to one particular make and model. You’ve even determined the color along with all the bells and whistles you’d like on this new gem. Then, you can’t help but notice your desired automobile everywhere – on the freeway, driveways in your neighborhood, the parking garage at work, etc. It “feels” like now that you’ve concluded your target buy that there has been a dramatic increase this week in the prevalence of this particular vehicle.

You wonder… Did your neighbors go through the same process you are experiencing and just beat you to the punch at the car dealership? Is your community just one step ahead of you regarding this dramatic increase in your dream car? The answer is no. You are experiencing the Baader-Meinhof phenomenon (or frequency illusion). Your increased awareness is leading to a cognitive bias that this particular thing is more prevalent. One of those weird tricks our brains can play on us.

Let me take this one step further, what is your actual fear? That you will lose your job? That you will outlive your nest egg? Again, the answer here could be different for all of us, but peeling back the layers is important. I’ve had many conversations recently where I have seen the fear of recession paralyze individuals from being able to design and execute aspects of their financial plan. The “what-if” enemy has people absolutely frozen in their tracks. By identifying and calling out your fear specifically you can measure and address this concern in your planning.

Today, I thought it would be both appropriate and interesting to zoom in on some contrarian indicators. These are measuring sticks or alerts that may encourage us to stray from the herd.

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On a few different occasions, over the last handful of weeks, I’ve had the pleasure of filling in for David Bahnsen on The DC Today. The format and style of these [The DC Today] writings are a lot different than what I am accustomed to. The focus is much more on current events, tidbits of all things markets, and politics happening around the world today.

When asked to fill in, I was reluctant at first. If I am being honest, I was a little overwhelmed by the task, but in hindsight, I can say that I really enjoyed the opportunity. I also gained even more respect for David Bahnsen – if that is possible, based on my already high regard – knowing that he produces this content plus much, much more, day in and day out. In the end, I did find it enjoyable/fulfilling to help people cut through all the noise of the everyday news cycle and to package everything in an easy-to-digest recap of the day.

This experience also made me meditate on the idea of how one goes about converting these tidbits of current events into application on the financial planning side. Yes, I know that not every news feed that comes across your desk will be or should be actionable, but I also know that if digested correctly, these small bits of information can be additive to your overall foundation of knowledge. And it is through this foundation that you derive your financial decisions and plans.

Today, I thought it would be fun to hopscotch through David’s common DC Today headers and discuss how these current events can be viewed, assessed, and applied. The intent, as is often here on TOM, is to teach you how to think and to give you a sneak peek into the paradigm of a financial planner.

So, off we go…

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I love good questions.

The type of questions that stop you in your tracks and really make you think.

Not a cornering question nor combative one, but an inquisitive one that is birthed from the inquirer’s true curiosity. For me, this is how I learn – pulling on a particular topic thread to get a deeper understanding of the nuance.

Sean Latimer is my most frequent co-host on the Thoughts On Money Podcast, a dear friend of mine, and a colleague here at The Bahnsen Group. Sean asked me on a recent podcast one of those GREAT questions that I am referring to. We were discussing the recent rise in interest rates and its impact on the stock and bond market. Sean asked me if the higher yields on bonds have changed my perspective on Expense Based Planning (EBP). EBP is a term I coined for my approach to portfolio design. You can find more on the topic here: The Madness of Methods.

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Today I’d like to discuss interest rates, which have been a hot topic in markets. I want us all to understand both the basics of interest rates and how interrelated interest rates are to the markets at large. To me, Rube Goldberg’s art expresses both the complexity and chain reaction nature of interest rates, as well as the simple results/outcomes they produce. A home purchaser might see their mortgage rate as a simple cost function that determines their monthly payment (simple), but they might also now consider the impact that the Federal Reserve has on how that risk (their mortgage) was actually priced (complex).

So, I invite you to join me on this journey through the wild world of interest rates.

… and so, without further ado …

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In the language of computers, you have a binary system made up entirely of zeros and ones. It took me a long time to realize that the language of financial planning is not binary. For a perfectionist, it is very hard to break out of the mode of complete optimization and maximization. As I’ve matured as a planner, I’ve learned how incredibly important the qualitative factors, the psychology, and the investor’s preferences are to the equation.

Today, I’d like to dig into three examples of where we often get stuck thinking through financial decisions in a binary fashion – this or that. I’ll introduce the power of “hybrid” options and hopefully encourage you to expand your perspective when it comes to financial decision-making.

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Last week I talked about one of our family traditions growing up – watching Jeopardy together. One of our other favorite pass times was and is, playing cribbage.

Whenever we’d have friends over we’d teach them how to play so they could join in the fun. Cribbage isn’t go-fish, but it also isn’t bridge. All that to say, you could easily teach the basics of the game in 10 minutes. We always started with the key numbers you have to know if you are playing cribbage – 15 and 31. The game has lots of rules and nuance, but if you’re teaching a new play, you need to make sure they know the importance and relevance of 15 and 31.

The rules of personal finance unfortunately cannot be taught and learned in 10 minutes. This is a craft that can be studied over a lifetime and perhaps never fully mastered. Just like cribbage though, I believe personal finance has some standout numbers and I’d like to discuss those today.

Here’s an important differentiator though – cribbage is just a game. No matter how competitive, emotional, and animated you get about this game, it’s still just a game. Personal finance deals with your money, the money you toiled and sweat to acquire and accumulate. Your money and your financial plan are not a game. The seriousness and weight financial decisions and plans carry make this a very emotional endeavor.

What I intend to elaborate on in today’s discussion is how these three key numbers help to build hope, security, and perspective; important emotional components to fuel a successful financial life.

So, without further ado…

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