3 Buckets of Risk

Our clients value us for our credibility, ethics, knowledge, and value system centered around our proven track record of providing low-risk and prudent money management.

As with all financial services that Mark provides his clients, he always acts as a fiduciary – putting his clients’ welfare and goals ahead of his own. He is legally and morally bound to put your needs first.

The idea of lower risk and low volatility investing, with excellent returns over time (5, 10, 15, or more years), was a radical new investment philosophy to the “buy, hold… and pray” mentality and “just take your lumps” investing “since the markets always come back.”

It took the Dow Jones Industrials (DJIA) about 25 years to “come back” after the depression. My clients don’t want to wait that long and prefer not to participate in BIG market losses fully.

Most mutual funds, low-cost index funds, ETFs, and many advisors never go to an all-cash position. Most mutual funds are actually prohibited by their prospectus from doing so, and many advisors won’t do that either – subjecting their clients to the full or bulk of the market’s tumble. 

Of course, most people should have some assets in the Principal Protected bucket, which can never suffer market losses.

Below, you’ll find an excerpt from a chapter in his Social Security Income Planning book, giving insights into how Mark helps his clients manage risk and returns.

 

Let me ask you? When your portfolio crashed in 2000-2002 and again in 2008, did your financial advisor tell you not to worry – “just hang in there — that it’s only a loss on paper”? Or did you convince yourself of that nonsense if you managed your money?

How did you feel when you opened those awful monthly or quarterly statements? The newest statement was even worse than the last one!

Well, if that is true, then did your advisor tell you that your gains in 2003-2007 and again in 2009-2013 are only “paper” ones and not to feel good about them? No, he/she basked in the glory and said – “see, I told you the markets would come back if you just hung in there” (and suffered emotionally along the way)!

Those past losses were very real, and so were the gains (unless you panicked and sold near the bottom– only to buy in again near the market record highs).

And if you will be using your savings to help fund your retirement lifestyle by taking a monthly income from them over the next 20 or 30 years, can you afford to participate in the next major market downturn?

If your accounts drop by 15%, 20%, or more, can you still take the same monthly withdrawal as before without jeopardizing your outliving your money?

It is widely known and believed in the community of Certified Financial Planners™ that investing during the “distribution” phase (taking income) is VERY different than investing while in the “accumulation” phase (saving for retirement).

However, it has been my experience, based on years of reviewing actual prospect’s portfolios, whether managed by the individual or another advisor, that they are not treated differently… as they should be.

When I meet a prospective new client on the phone, internet, or in person, one of the first things I like to do is talk about the 3 buckets of risk. More specifically, I call it the 3 buckets of risk and return, but my clients like to call it the 3 buckets of risk.

This is a very simple and easy-to-understand way for my clients to clearly decide for themselves how much risk they can live with and sleep at night during their retirement (distribution phase). The same theme would apply to the accumulation phase, too.

What I have them decide is how much of their investable assets as a percentage (excluding their home) they would like to have invested in each of 3 risk/return buckets:

1) the PRINCIPAL PROTECTED bucket,
2) the LOW-Risk bucket, and
3) the HIGHER Risk bucket.

You can see the 3 buckets above, as well as a brief summary of the bucket’s risk/return profile.   This is something that 98% of investors have never been presented with.

Let’s expand a bit on each of the brief descriptions inside each bucket. The Principal  Protected bucket is exactly as it says. This is money that will never go down in value. Many people think of CDs and 90-day Treasury bills here, and in normal times, they might provide an expected return of 3%-5% – but certainly not over the last 5-7 years.

CDs and T-bills have paid less than 1%-2% over the last few years. But there are other assets that I use that can safely and consistently provide 3%-7+% without any risk to the principal.

But it is very important to understand that your principal is losing purchasing power if this money does not earn an after-tax return equal to inflation (like CDs). So, in this sense, there could be a “loss,” — but no losses are ever shown on your monthly, quarterly, or annual account statements.

But you are “losing” in purchasing power just the same (remember that we will all have a “rising income” problem and need to be protected from inflation over time).

The Low-Risk bucket is for people who want or need a higher interest rate or return… and are willing to take some fairly predictable and reasonable risks in order to earn those higher returns over a period of time. It’s very possible, although not very typical, to lose a small percentage of your principal in a bad year; these investments are pretty dependable over time.

A diversified portfolio of these investments now generally provides average annual returns of 5%-7% over a period of 5, 10, or 15 years, with some mild fluctuations (volatility) in value during that time. During the worst of times in 2008- 2009, these investments lost no more than 4%-5% before rebounding by over 15% or more in 2009. However, in 2022, the Barclay’s Bond Index lost about -15%!

The Higher Risk bucket is exactly what it’s named. Most savers invest in stocks, mutual funds, ETFs, gold, variable annuities, IPOs, private placements, limited partnerships, etc., to earn high returns (7%-10% or more) to compensate for a much higher risk than either of the other two buckets.

Over time, in a diversified portfolio, you might get 9%-10%+ returns (historically) — although the S&P 500 returned virtually nothing during the period of 2000-2011.

That’s a dozen years with nearly 0% growth (excluding 2%-2.5% dividends) with tremendous volatility (with significant and scary losses along the way). If you were taking distributions, it would be very difficult ever to recover fully. Even buying and holding in this bucket can be very scary.

During 2011, a year in which the S&P 500 index price began at 1258 and ended the year at the same price of 1258 (but earning some 2.1% in dividends that year), there was huge volatility – big price swings. In that calendar year alone, there were 13 periods when the index price went up or down by 7% or more! Thirteen times! That is a lot of volatility to withstand – especially while drawing a monthly income.

During 2000-2002, the market dropped by about 50%. In the calendar year 2008, the market (S&P 500 index) fell some -37% — however, from peak to trough in 2008 to 2009, the index fell by -51% (cut in half).

When you are in the accumulation phase, you have time to recover from (ride out) these market drops. However, many people panic and sell near the bottom, only to buy back in again near the top once they forget the earlier financial pain. That’s called selling low and buying high. But when you are taking distributions, that is completely another thing altogether.

So, the first thing my new clients do is tell me how much of their assets (as a percentage) they want in each risk bucket. How much will allow them to sleep at night… no matter what is going on in the economy or the markets? There is no right or wrong answer. The only answer that matters is the one that gives you peace of mind and helps you attain your goals.

Often, the husband has one set of percentages in mind, while the wife has a different set she feels most comfortable with (usually more conservative). Then it’s just a matter of making a compromise they can both easily live with.

Getting the right mix (for YOU) of percentages of your assets in the right buckets is the first step in the investment process. This is an easy step for you to complete – go with your gut feeling on what you would feel comfortable with – no matter what’s happening now or can or will happen in the future in the stock, bond, real estate, or commodities markets. What mix will allow you to sleep at night?

But this is the strangest part. Most people’s “desired” percentages in their risk buckets are NOTHING like how their portfolios are actually invested. How can anyone let this happen? It’s crazy!

When I do portfolio reviews for new potential clients, I find that nearly 90% of the time, the percentages they say they WANT in each of their 3 buckets… is absolutely nowhere near what they actually HAVE.

It’s hardly ever even close! Either their current financial advisor isn’t asking the right questions or paying little attention to their answers and feelings. That’s a recipe for emotional pain and financial loss.

The next step in the retirement planning process is to find the lowest risk (lowest volatility) investments for each bucket to provide the anticipated returns over time so you can comfortably attain your goals. That’s where a professional can add great value, experience, and access to special low-risk or even guaranteed investments.

(For example, my clients get access to an excellent safe/secure bucket investment that simply “kills” a CD). This way, the investor’s aversion to risk and financial returns will be better combined to reach their retirement objectives… and sleep at night.  It doesn’t have to be difficult to attain your goals. If you could get the same return with lower risk, wouldn’t you do so?

Again, the question is how much of your investable assets should be invested in each bucket to help you reach your financial goals… while allowing you to sleep at night in virtually any market conditions?

Sometimes, one must take on a bit more risk to reach their income or savings goals at the expense of their complete peace of mind — due to needing to “catch up,” “make up” for a low past savings rate, or to overcome a past history of poor investing.

However, investors should carefully consider taking much more risk than they need to in order to attain their financial goals and objectives.

As one moves closer to retirement (and even throughout their retirement), these risk/reward preferences (buckets) will likely change over time, and their choices of investments should then mirror those changes.

Why not take a few minutes and write down how you would allocate your own buckets? If you have a spouse, each of you should do this and compare them. This is important to talk about.

For a FREE, no-obligation analysis of the risk profile of your current portfolio, don’t hesitate to get in touch with me. I will provide an easy-to-understand and verifiable analysis of your portfolio.  We’ll look at it in terms of the 3 risk buckets as well as the 3 tax buckets (described in my book, too) and see where you are and if there is room for improvement.

Here’s a chart of the S&P 500 from 1993 through April 30, 2023. Click on the image for a clearer view!

 

 

 

Investment Advisory Services are offered through Retirement Wealth Advisors, Inc. (RWA), a Registered Investment Advisor. Mark J. Orr and RWA are not affiliated. Investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.

This information is designed to provide general information on the subjects covered; it is not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market, or recommend any tax plan or arrangement. Please note that Mark J Orr and its affiliates do not give legal or tax advice. You are encouraged to consult your tax advisor or attorney.

Life insurance and annuity guarantees rely on the issuing insurer’s financial strength and claims-paying ability. Any comments regarding safe and secure investments and guaranteed income streams refer only to fixed insurance products. They do not refer in any way to securities or investment advisory products. Fixed Insurance and Annuity product guarantees are subject to the claims‐paying ability of the issuing company and are not offered by Retirement Wealth Advisors, Inc. All life insurance and annuity products are sold separately through Mark J. ORR, CFP, RICP. PROACTIVE Tax Planning services are also offered separately through PROACTIVE Tax Planning, LLC.