I love talking shop with colleagues from around the country and wanted to give you a peek into those conversations, so this week I invited two of my favorite Chief Investment Officers, Phil Huber and Rubin Miller.
Listen now and learn:
- Our thoughts on the biggest storylines of 2022
- How we develop return assumptions for financial planning models
- Things people misunderstand about the role of a Chief Investment Officer
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Show Notes
I love talking shop with colleagues from around the country and wanted to give followers a peek into those conversations. This week, I’m joined by two friends who both serve as Chief Investment Officers of their firms and regularly create content on their own websites.
Phil Hubert (Savant Wealth Management and bps and pieces) and Rubin Miller (Perspective Wealth Partners and Frictions & Fortunes) each bring a unique perspective to analyzing the investment landscape and coaching clients. I highly encourage you to check out both of their work.
If you enjoy our conversation, please leave a comment on YouTube or write a review on Apple Podcasts to let us know what you think.
Here are my notes from our conversation.
The Biggest Storylines of 2022 From A CIO Perspective (0:40)
We recorded this episode on January 4, and started by discussing the types of questions we expected to receive when clients opened up their quarterly statements.
Everyone Lost Money
Differences in performance are mostly by asset allocation. If the stock market has a good year, you’d expect someone with an 80/20 stock-to-bond allocation to do significantly better than someone with a 20/80 allocation. But in 2022, everyone had a bad year regardless of whether they had a conservative, moderate, or aggressive asset allocation.
The people that are likely to be most surprised (and potentially concerned) are those with a heavier tilt towards bonds. Investors with a conservative, bond-heavy asset allocation are used to an inverse relationship between stocks and bonds (when stock prices fall, bond prices rise).
The Bloomberg U.S. Aggregate Bond Index was down 13% — the worst-ever annual return for bonds, which most investors think of as the defensive or “safe” part of their portfolio. But the universe of fixed income and different types of bond categories is vast, so your experience might have varied significantly depending on how your bond portfolio was positioned.
Unlike 2008-2009 when credit risk was the driver of poor returns, this time it was duration (or interest rate sensitivity) that was the big driver of negative returns. Isolating those drivers of returns is a particularly useful concept to reinforce because the time horizon really matters.
Because bond returns have been relatively smooth since 2008-2009, this is a great time to coach clients on how bonds work as well as what it means when a bond fund has a negative year.
Stock Market Downturns
Even though the maximum drawdown in 2022 wasn’t as large as what we experienced in February/March 2020, this “more normal bear market” is almost harder to live through simply because it’s longer in duration. Days start to feel like weeks and weeks feel like months – it really starts to interfere behaviorally with our perception of time and what “long-term” actually means.
The longer a bear market lasts, the more time you allow yourself to let doubt creep in. And I’m always of the opinion that a lot of investments’ success comes down to minimizing mistakes – and some of the most common mistakes happen when you don’t maintain discipline during these downturns.
As it so happened, I had just tweeted a related market statistic just before we hit record and I think it’s useful for setting expectations going into 2023…
We haven’t had a recession yet. And maybe we will, maybe we won’t. But the Federal Reserve is setting policy in a manner to intentionally slow the economy. Plus, we’re only 12 months into a downturn, so history would suggest it’s reasonable to plan on disappointing returns for a little while longer.
Time to Go to Cash?
We’ve all had to field questions about swapping out our bond allocations for cash or shorter-term bonds, which often have higher yields at this moment in time.
It’s very intuitive for clients to look at something like the two-year yield being higher than the 10-year yield and think: “Why on Earth would I take that duration risk for less yield?” So it’s not uncommon to hear people ask if they should sell out of their existing holdings to move to cash or short-term bonds.
But imagine there is a recession or some sort of prolonged continuation of the market in stocks, then it’s possible the Federal Reserve stops raising rates and we could maybe even see a reversal in market interest rates in a manner that is more beneficial to your longer duration fixed income assets than your shorter duration bonds.
It’s important to recognize that the paper losses you’ve seen in bond portfolios are just price adjustments based on a new environment. To lock in those price losses and move everything to higher-yielding short-term fixed income or cash might not make much sense if such a rate reversal happens.
Ultimately, shortening the duration of your fixed income allocation by going to cash or purchasing T-bills in this manner is really just a form of market timing.
Most people acknowledge that they can’t time stock market movements. It’s our job to help people realize that timing interest rate movements is just as difficult.
The important thing for us as advisors is to build a portfolio that is informed by a client’s financial plan. Regardless of the market environment, your bond portfolio should have an average duration that’s shorter than your time horizon. Otherwise, you don’t have enough time to recover from temporary price fluctuations.
While none of us are proponents of making tactical moves in the portfolio, we have encouraged clients to change the way they are managing cash.
Relative to what you can earn on your bank account, a 3-month Treasury is yielding ~4.50%. So there is a HUGE opportunity cost to holding too much cash in a bank account.
Value Stocks Outperforming Growth Stocks (14:18)
Value handily outperformed growth stocks in 2022, which we all agree was nice to see because we all use portfolios that own the global market portfolio with a tilt (i.e. overweight) towards value. There is plenty of empirical evidence as well as a sound theoretical framework for the value premium existing.
Over a long enough period of time, we all expect there to be some incremental returns from a strategic overweight (i.e. tilt) to value stocks or small stocks. At the same time, we wouldn’t consider being invested 100% in small-cap value stocks because the investment experience would be so different than the overall market that it would be harder to stay the course in bad times.
If anything, the last decade or so has taught us to be humble in our expectations for these premiums because they don’t show up in a straight line every year. The growth cycle that started at the end of the Financial Crisis lasted way longer and was of much greater magnitude than anyone would have expected. So much so that it caused a lot of value investors to sort of question their beliefs around having a value tilt.
For better or for worse, your portfolio is going to behave differently than the market, so investors have to consider how different they can tolerate being from the market before behavioral biases start to creep in and cause costly mistakes at the wrong times.
In the end, we all agree that how much you tilt towards different factors is far less important than your chosen mix of stocks and bonds.
The market return is great, but it’s hard to earn if you keep making changes.
In the end, investors would be better off focusing on things they can control like inputs to their financial plan around how much they save, how much they spend, how long they work, etc.
Projecting Future Returns in Financial Planning Models (21:50)
All financial planning models require capital market assumptions, which are return, standard deviation (volatility), and correlation assumptions for various asset classes.
Financial planning outcomes are incredibly sensitive to these assumptions, so I asked Phil and Rubin to share how they think about making those assumptions.
Rubin emphasized conservatism in his response, noting that you definitely don’t want to set expectations that are wildly incorrect. He describes their process as taking “a pretty historical perspective.”
Historically the data suggests that stocks might have slightly better results when valuations are high and worse results when valuations are low, but timing valuations is really tough and you can be wrong for years.
For bonds, Rubin suggests that yield is a good proxy for expected return if you’re using market-based funds. If you use active management, though, you’re allowing a manager to drive your returns as opposed to the market driving the returns.
For both stocks and bonds, his firm reduces their market-based assumptions by a variety of factors to arrive at what he describes as a “very, very conservative” set of inputs. The nice thing about financial plans is that you’re hopefully updated every year at least to adjust for the good or bad outcomes along the way.
Phil also takes an approach that’s rooted in historical returns because most plans are multiple decades in duration. Where he makes adjustments, it is to balance the historical returns with the current state of the world in terms of inflation, interest rates, and valuations. Like Rubin, Phil also emphasizes that it’s “an exercise fraught with imprecision, but we have to do it because those plans need assumptions.”
At Plancorp, we also anchor to historical market-based assumptions but place a greater emphasis on historical real returns than nominal returns because then we don’t have to accurately forecast inflation. Where we try to bring in an additional dose of conservatism is my assuming slightly higher volatility for both global stocks and bonds than what history would suggest.
In short, all of our assumptions are rooted in historical data with adjustments made to best serve our clients’ financial plans.
The one thing we all adamantly agree on is that financial planning isn’t a one-time exercise. Instead, it’s a dynamic process that should be updated at least annually.
The process of making return assumptions is inherently flawed and there’s no perfect way to do it. But by regularly updating the inputs of the plan you can control, you improve the usefulness of such modeling.
A recurring theme from this portion of the discussion was the negative implications of overshooting or undershooting our return assumptions.
Underestimated returns mean that clients may not get to enjoy their capital as much as they should.
Overestimated returns increase the likelihood of financial distress at some point in life.
Other mistakes and pet peeves we discuss include:
- Misunderstanding how returns are made up of expected returns and unexpected returns.
- Predicting how any given asset class will perform in the next 12 months
- The use of the word “optimize” as in, “we’re going to optimize this portfolio for XYZ”
- Using expected returns when utilizing active management
- Year-end playbooks and annual market outlooks
What People Misunderstand About Our Role as CIO (36:59)
There’s a difference between investments and investing. Investing is an exercise, but people probably assume our attention is predominantly focused on the former, which is selecting investments or building asset allocations. And while that’s certainly something we all do, a bigger part of our job is helping curate a successful investment experience for the clients that work with us.
The three of us could quibble about what the best portfolio construction looks like, but the best portfolio for someone is the one they can stick with. And investments can be very hard to stick with, especially for someone without the deep understanding of market theory and history that we do.
That’s why the three of us spend so much time on education and communication to support advisors of our respective firms, but also to support our clients and how they navigate long-term investing.
In short, the role of CIO is just as much (if not more) about the experience of investing as it is about the investments themselves. I’ll admit that we review a lot of funds throughout the course of a year, but people often think our job is to say “yes” to all of those investment opportunities whereas our job is usually to say “no” to new things that aren’t really going to help.
Or as Phil puts it: “you’re acting as a bouncer and keeping out most things.”
Using a Financial Advisor (41:20)
I told Phil and Rubin that my 2022 reader and listener survey showed that the number one reason people haven’t hired an advisor is the cost, so asked Phil and Rubin for their thoughts.
To Phil, he believes there is a really small subset of people that are truly able to do it on their own, but the question he has for those people is…
How much time do you really want to be spending on all of this stuff?
If you do an inventory of all the different things you need to do – not just once, but on an ongoing basis across your entire financial picture – he would argue that most people don’t have the experience, energy, or interest in doing all those things well.
Understand that you’re paying for more than building and maintaining a portfolio. Once you really look at a checklist of all the things you need to be doing on an ongoing basis, you may eventually realize that you’d rather spend your time doing things you enjoy. And while it’s not an inexpensive relationship, the value is far in excess of the cost.
Rubin looks at it from a slightly different angle in that he thinks people may not have the time, energy, or disinterest. It shouldn’t be exciting to engineer your finances and your investments properly. In his mind, people that are overly passionate about running their own money are likely the ones that tinker too much.
Rubin notes that Phil mentioned how he is the bouncer, keeping things out of the party, but a lot of do-it-yourself investors get excited by the party. And the more you tinker with your investments, the worse off outcomes become.
From my own perspective, if you’re the do-it-yourself investor, most of my experience is that you don’t really know how you’re performing. And that can be okay, but I don’t think they realize how big the mistakes they’re making add up to be over time. And one of the biggest value adds on the investment side is the avoidance of errors – all it takes is avoiding one big mistake to pay for a lifetime of advisor fees.
See EP.24: Do It Yourself or Hire an Advisor?
Now, in reality, our firms are also doing financial planning. There’s tax planning, there’s estate planning, there’s capital allocation questions… there are all these different things that are really bundled up into an advisory fee.
Resources
- Phil Hubert at Savant Wealth Management and bps and pieces
- Rubin Miller at Perspective Wealth Partners and Frictions & Fortunes
- How bonds work
- See EP.62 for empirical evidence and a sound theoretical framework for the value premium existing
- See EP.24: Do It Yourself or Hire an Advisor?
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Long-term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence.
Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.
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