Have I told you the story about Tom?
It’s a story that highlights how timing combined with a little wisdom can make all the difference between retiring in style or seeing your golden years tarnish with age.
This is also a story many of you should know, as it provides valuable insights on why at certain times in life it is best for our investment portfolios to be focused on optimization as opposed to just managing a portfolio.
Tom was a long-time prospect of ours back in 1998, during the Dot Com boom.
Tom was pretty stoked at the time. A mid-level exec at one of Southern California's rapidly growing technology companies. Tom was 55 years old, had just over 500k in company stock that for the past few years seemed to only go up, a house with enough equity to feel confident that the roof above his head was secure and $1.8 million socked away in his 401(k). Not a bad place to be at age 55, right?
Tom and I met on a few occasions because Tom was looking for investment management proposals. Tom wanted to retire at age 55 and use his 401(k) to supplement his income for an indefinite period of time. Needless to say, there were many challenges to his desires that we presented to Tom to make sure he understood the nature of his decisions. Regardless of the risks and challenges that were presented to Tom about taxes, market valuations, proper long term expectations, the fact he was so damn young and healthy, and the challenges that presented when he needed the money to last longer in retirement than he did working, yadda yadda yadda….. All the precautionary tales went out the window, Tom was determined to do what Tom wanted to do, after all in Tom’s mind he had “arrived”.
Apparently, through our courtship, I did not give Tom the answers he wanted and Tom decided in 1999 to retire and roll his 401(k) to an IRA with Merrill Lynch, disappointingly not the firm I was with at the time.
Equity markets were at all-time highs and there was a euphoria happening around the dot com boom and many people were saying things like “this is a paradigm shift” and “markets will never be the same” and “because of technology this time it’s different” and all kinds of other delusionary bullshit markets and PR firms sell us on when animal spirits reach crescendo moments.
The market tides were high and because it had been a long time since investors experienced what can happen to the best-intentioned plans when the tide drops, complacency had settled in for many unassuming investors. While others, that had come late to the game were chasing the next penny stock that they hoped could turn twenty cents into million-dollar fortunes by the sheer mention of the stock in a new thing called “chat rooms” and “investor forums” on the “internet”. Ha, sounds familiar?
This was truly the case for Tom.
Fast forward to early 2002. Never being one that took “No” for a permanent answer I reached out to Tom to check-in to see how things were going with him and his relationship at ML.
Since our last conversation in 1999, the tone of markets had changed. The Nasdaq was on its way to a 70% decline with many of the “new paradigm” dot com stocks going to 0 while the SP500 and Dow Jones experienced more moderate yet painful declines of between 25 and 35% in a similar time frame. Ouch.
Tom had retired, his company stock that in 1999 seemed to always defy gravity (remember the 500k?) had hit the tarmac hard and was merely 20% of the 1999 value. Tom had also begun a monthly withdrawal from his IRA that in 1999 value seemed almost sustainable (approx 10k a month or about 6% of the $1.8 mill) but in 2002, with a value that had shrunk to $750K due to market losses and withdrawals, Tom was in a bad situation that was causing all kinds of havoc in his life.
As my luck would have it (hopefully you smell the sarcasm in this statement), Tom finally became a client. Yes, after the shit had hit the fan and we needed to save every kernel of corn we could find.
Now, Tom was ready for portfolio optimization. Better late than never I guess.
It took a few years and a lot of retraining of Tom's behaviors but we got Tom’s portfolio back on track despite being in the middle of what eventually became known as the “lost decade” of investing.
Sadly, Tom wasn’t alone in this story. That era is riddled with stories of people with too much complacency as well as too much risk at the wrong time.
Tom’s story is what emboldened us in doubling down on our emphasis on optimizing portfolios, not just managing them. Especially for individuals that find themselves in their own “Red Zone” just like Toms where they are entering a life transition that requires the use of some of your hard-earned savings.
After decades of investing in markets, I have come to the conclusion that just managing a portfolio is for the young and unassuming with decades in front of them before they need to use those funds. Optimizing on the other hand is for the savvy and discerning that understand that time is of the essence.
With markets at all-time highs and as a sense of euphoria continues to entice risky behavior in arcane investment vehicles like options and crypto, we are back to pounding the table about the importance of optimization, not just portfolio management.
It’s also interesting to note that our emphasis on optimizing seems to be en vogue and a part of many new trends in many industries.
If you haven't noticed, there is an evolution taking place in almost every industry of the economy. This evolution is part of a shift from “managing problems” or even fixing problems after they appear to harness the technology at our disposal to create efficiencies and track data that prevent breakdowns from happening in the first place.
For example in the healthcare industry, there are various sub-sectors like pharmaceuticals, medical devices, medical software, healthcare providers, telemedicine, etc. Things like inflation and government regulation may cause headwinds in certain sub-sectors like pharmaceuticals and health care providers while creating tailwinds for other sub-sectors like telemedicine, medical devices and medical software that are focused on efficiencies and reducing illness. Part of optimizing an investment portfolio is this type of research and review when deciding where to allocate funds.
While “managing” a portfolio may include owning a mutual fund or ETF that has exposure to the entire healthcare industry. Optimizing a portfolio would drill down deeper into the healthcare sector to differentiate which sub-sectors may have an advantage to future growth from those that may experience more challenges to future growth. Then based on that analysis you invest accordingly.
Managing focuses on diversification and the long term. Optimizing on the other hand focuses on efficiency within diversification with a focus on being ahead of the curve not behind it.
If we broaden our lens for this conversation and discuss how to optimize a 401(k) or retirement account while in the Red Zone, the best example may be found in a dizzying trend many unassuming 401(k) and retirement account investors are in the midst of being caught up in.
This dizzying trend that may end up making many retirement plan investors ill to their stomach is allocating or investing into Target Date Funds.
According to Wikipedia, a Target Date Fund, also known as a lifecycle, dynamic-risk, or age-based fund – is often a mutual fund designed to provide a simple investment solution through a portfolio whose asset allocation mix becomes more conservative as the target date (usually retirement) approaches.
In layman's terms, it is a very broad-based investment that has a date in the title and the closer you get to that date the investments allocation should become more conservative, the assumption is that it would move from a basket of broad-based equity indexes to fixed income as the date approaches. Sounds reasonable and sensible, right?
Possibly, however, like most things in the world of financial products the devil is in the details and history has shown these approaches have not worked well at maximizing returns. Also, keep in mind if your target date approaches at a time interest rates and inflation are rising or market tides are dropping then your well-intentioned retirement plans may become delayed.
There are countless articles we can share with you that highlight the weaknesses of target-date funds from fees, poor asset allocation as well as how they aren't the best option if you are needing to optimize and maximize the next ten years of your investment life. See below for a list of articles you can review.
How could target-date funds be public enemy number one to retirement planning?
The sheer fact that there are so many unassuming investors currently invested in target date funds. According to Morning Star, there are 1.6 trillion dollars of assets currently in target-date funds. I often wonder how many of those unassuming investors are on the path to being a Tom?
Colby McFadden Founder, Quiver Financial
Justin Singletary Director of Retirement Services, Quiver Financial
Patrick Morehead Director of Alternative Investments, Quiver Financial
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