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CHAPTER 4.2
PLAYING TO WIN: THE RISK/GROWTH BUCKET
The winner ain’t the one with the fastest car. It’s the one who refuses to lose.
—DALE EARNHARDT SR.
The Risk/Growth Bucket is where everybody wants to be. Why? Because it’s sexy! It’s exciting! You can get a much higher return in here—but the key word is can. You can also lose everything you’ve saved and invested. So whatever you put in your Risk/Growth Bucket, you have to be prepared to lose a portion or even all of it if you don’t have protective measures in place. How do we know this? Because everything in life, including markets, runs in cycles. There are going to be up times and down times. And anybody who invests in one particular kind of asset while it’s on a roll—be it real estate, stocks, bonds, commodities, or whatever—and thinks the party will last forever because “this time will be different” should get ready for a rude awakening. When I interviewed Jack Bogle for this book, he repeated one of his mantras: “Markets always revert to the mean.” (That means what goes up is going to come down, and vice versa.) And I’m sure Ray Dalio got your attention when he said that whatever your favorite investment might be, at some point in your life, you can count on it dropping 50% to 70% in value. While there’s unlimited potential for upside in this bucket, never forget that you could lose it all (or at least a significant portion). That’s why I call this the Risk/Growth Bucket and not the Growth/Risk Bucket, because growth is not guaranteed, but risk is!
So what investments would you put in here?
Here’s a sampling of seven main asset classes to consider:
- Equities. Another word for stocks, or ownership shares of individual companies or vehicles for owning many of them at once, like mutual funds, indexes, and exchange-traded funds (ETFs).
Exchange-traded funds (ETFs) have been called the “It” girl of the stock market, ballooning in popularity by more than 2,000% from 2001 to 2014, and holding more than $2 trillion in investments. But what exactly are they? ETFs are built like mutual funds or index funds, because they contain a diversified collection of assets, but you can trade them just like individual stocks. Most of them follow a theme (small-cap stocks, municipal bonds, gold) and/or trace an index. But with an index or mutual fund, you have to wait until the end of the trading day to buy or sell; ETFs can be traded all day long. Experts say that if you like the idea of an index fund, but you want to buy when you see the price is low and sell when the price is high during a trading session, an ETF might be for you. But that’s trading, not investing, and trying to time a market brings very intense and special risks.
But there’s another difference: when you buy shares of an ETF, you are not buying the actual stocks, bonds, commodities, or whatever else is bundled in the fund—you are buying shares in an investment fund that owns those assets. That company promises that you’ll receive the same financial outcome as if you’d owned them yourself. But don’t worry, it sounds more complicated than it is.
A lot of people like ETFs because they give you a tremendous amount of diversity at a low cost. In fact, many ETFs have lower fees than even comparable traditional index funds, and sometimes lower minimum investment requirements. And because they don’t engage in a lot of the kind of trading that produces capital gains, they can be tax efficient (although there is a move toward more actively managed ETFs coming to the market, which makes them less tax efficient).
Should you invest in ETFs? Jack Bogle, founder of Vanguard (which, incidentally, offers many ETF funds), told me he sees nothing wrong with owning broad-spectrum index ETFs, but he warns that some are too specialized for individual investors. “You can not only bet on the market,” he told me, “but on countries, on industry sectors. And you may be right and you may be wrong.” David Swensen wonders why individual investors should bother with ETFs at all. “I’m a big believer in buying and holding for the long run,” he told me. “The main reason you’d go into an ETF is to trade. And so I’m not a big fan.” 2. High-Yield Bonds. You might also know these as junk bonds, and there’s a reason they call them junk. These are bonds with the lowest safety ratings, and you get a high-yield coupon (higher rate of return than a more secure bond) only because you’re taking a big risk. For a refresher, go back and read the bond briefing at the end of the last chapter.
- Real Estate. We all know real estate can have tremendous returns. You probably already know a lot about this category, but there are many ways to invest in property. You can invest in a home that you rent out for an income. You can buy property, fix it up, and then flip it in the short term. You can invest in first trust deeds. You can buy commercial real estate or an apartment. One of my favorites that I mentioned to you already is investing in senior housing, where you get both the income and the potential growth in appreciation as well. Or you can buy REITs: real estate investment trusts. These are trusts that own big chunks of commercial real estate (or mortgages) and sell shares to small investors, like mutual funds. REITs trade like stocks, and you can also buy shares of a REIT index fund, which gives you a diversity of many different REITs.
For growth, the Nobel economist Robert Shiller told me that you’re better off investing in REITs than owning your own home (which belongs in the Security Bucket, anyway). “Buying an apartment REIT sounds to me like maybe a better investment than buying your own house,” he said, “because there seems to be a tilt toward renting now.” That could change, of course. And, as with any investment, you’ve got to pause and think, “What am I betting on?” You’re betting that the price of property is going to go up over time. But there’s no guarantee, so that’s why it’s in the Risk/Growth Bucket. If it goes up, it could have a nice rate of return; if it doesn’t, you get nothing—or you could lose it all. When you buy your own home, you’re betting that the price of your home will go up. When you’re buying real estate that has income associated with it (a rental unit, an apartment building, commercial real estate, an REIT, or an index that holds these), Shiller points out you have two ways to win. You make income along the way and if the property increases in value, you also have the opportunity to make money when you sell on the appreciation.
Commodities. This category includes gold, silver, oil, coffee, cotton, and so on. Over the years, gold has been considered the ultimate safe haven for many people, a staple of their Security Bucket, and conventional wisdom said it would only go up in value during uncertain times. Then its price dropped more than 25% in 2013! Why would you invest in gold? You could keep a small amount in your portfolio that says, “In case paper money disappears, then this is a little portion of my security.” You know, if all hell breaks loose, and the government collapses under a zombie invasion, at least you’ve got some gold (or silver) coins to buy yourself a houseboat and head to sea. (On second thought, can zombies swim?) Otherwise gold probably belongs in your Risk/Growth Bucket. You’d invest in it as protection against inflation or as part of a balanced portfolio, as we will learn later on, but you have to accept the risk. So don’t kid yourself: if you buy gold, you’re betting it will go up in price. Unlike many other investments, there’s no income from this investment like you might get in stocks from dividends or from income-producing real estate or bonds. So gold could be a good risk or a bad one, but it goes in your Risk/Growth Bucket for sure. This is not an attack on gold. In fact, in the right economic season, gold is a superstar performer! That’s why in chapter 5.1, “Invincible, Unsinkable, Unconquerable: The All Seasons Strategy,” you’ll see why it can be invaluable to have a small portion of gold in your portfolio.
Currencies. Got a yen to buy some yen? Since all currency is just “paper,” currency investing is pure speculation. There are people who make a fortune in it and even more who lose a fortune. Currency trading is not for the faint of heart.
Collectibles. Art, wine, coins, automobiles, and antiques, to name a few. Once again, this asset class requires very special knowledge or a lot of time on eBay.
Structured Notes. What are these doing in both buckets? Because there are different types of structured notes. Some have 100% principal protection, and those can go in your Security Bucket, as long as the issuing bank is financially solid. Then there are other kinds of notes that give you higher potential returns, but only partial protection if the index drops. Say you buy a note with 25% protection. That means if the stock market drops up to 25%, you don’t lose a dime. If it goes down 35%, you lose 10%. But for taking more risk, you get more upside: sometimes as much as 150% of the index to which it’s tied. In other words, if the market went up 10%, you’d receive a 15% return. So there’s potential for greater gains, but there’s definitely increased risk. Remember once again, structured notes should be purchased through an RIA, who will work to strip out all excess fees and deliver them to you in the form of an even greater return.
Safety doesn’t happen by accident.
—FLORIDA HIGHWAY SIGN
We’ve now covered a sample of some of the investment vehicles/assets that you might find in a diversified Risk/Growth Bucket. You may be wondering why I haven’t included some of the more daring investment vehicles of our time: call and put options, credit-default obligations (CDOs), and a whole host of exotic financial instruments available to traders these days. If you build up a lot of wealth, you may want to have your fiduciary look into some of these vehicles. But just realize that if you’re playing this game, you’re most likely no longer just an investor, you’ve become a speculator as well. It’s what’s called momentum trading, and you have to realize you can lose everything and more if you play the game wrong. And because the mantra of this book is that the road to financial freedom is through saving and investing for compounded growth, I’ll leave a discussion of these momentum assets for another day.
IT’S TIME TO GET IN THE GAME
Okay, now you know the players that belong in your allocation buckets, and you know the key to building a winning team: diversify, diversify, diversify! But there’s more. You not only have to diversify between your Security and your Risk/Growth Buckets, but within them as well. As Burton Malkiel shared with me, you should “diversify across securities, across asset classes, across markets—and across time.” That’s how you truly get a portfolio for all seasons! For example, he says you want to invest not only in both stocks and bonds but also in different types of stocks and bonds, many of them from different markets in different parts of the world. (We’ll talk about diversifying across time in chapter 4.4, “Timing Is Everything?”) And, most experts agree, the ultimate diversification tool for individual investors is the low-fee index fund, which gives you the broadest exposure to the largest numbers of securities for the lowest cost. “The best way to diversify is to own the index, because you don’t have to pay all these fees,” David Swensen told me. “And you get tax efficiency.” Meaning that if you’re investing outside of your IRA- or 401(k)-type account, you don’t get taxed for all that constant buying and selling that goes on in most mutual funds.
HAVE SOME FUN!
Of course, if you have your money machine in full gear, and you have the desire, there’s nothing wrong with setting aside a tiny percent of your Risk/Growth Bucket to pick some stocks and do some day trading. “Index your important money, then go have fun,” Burton Malkiel told me. “It’s better than going to the racetrack.” But, he said, limit yourself to 5% or less of your total assets or portfolio.
Is all of this giving you an idea of what kind of portfolio mix would be best for you? Before you decide, just remember that we all have a tendency to pile up on the investments that we think will give us our greatest victories. And everybody gets victories. You know why? Different environments reward different investments. So let’s say real estate is hot. You’ve invested in real estate, so now you’re a genius. Stock market is hot? If you have stocks, you’re a genius. Bonds are doing great? If you have bonds, once again you’re an investment master. Or maybe you just landed in the right place at the right time, right? So you don’t want to get overconfident. That’s why asset allocation is so important. What do all the smartest people in the world say? “I’m going to be wrong.” So they design their asset allocation ideally to make money in the long term even if they’re wrong in the short term.
LET’S TEST YOUR KNOWLEDGE
In the coming pages, I’ll be showing you the portfolios, or the asset allocations, designed by some of the greatest investors of all time. Let’s start with a sample from someone you’ve been hearing from throughout this book: David Swensen, Yale’s $23.9 billion–plus man, a true master of asset allocation. Would you be interested in seeing his personal portfolio recommendations? Me too! So when we sat down together in his office at Yale, I asked him the key question: “If you couldn’t leave any money to your kids, only a portfolio and a set of investment principles, what would they be?” He showed me the asset allocation that he recommends for individual investors—one he thinks will hold up against the test of time. He also recommends this portfolio for all institutions other than Yale, Stanford, Harvard, and Princeton. Why? Because these four institutions employ an army of full-time top analysts.
When I saw his list, I was amazed by how elegant and simple it was. I’ve shown you 15 types of assets to choose from; he uses only six categories, all in index funds. I was also surprised by how much weight he gave to one particular bucket. Can you guess which one? Let’s activate some of what we’ve learned thus far about the division between the Security and Risk/Growth Buckets.
Have a look at the box below and jot down where each asset class belongs. Check which ones you think belong in the Security Bucket, where you put things that are going to give you modest returns in exchange for lower risk; and then check which belong in the Risk/Growth Bucket, where there’s greater upside potential but also greater downside.
David Swensen Portfolio
Which Bucket?
Asset Class (Index Funds)
Portfolio Weight
Risk/Growth
Security
Domestic stock
20%
International stock
20%
Emerging stock markets
10%
REITs (real estate investment trusts)
20%
Long-term US Treasuries
15%
TIPS (Treasury inflation-protected securities)
15%
Let’s start with the top four. The first is a broad domestic stock index, something like the Vanguard 500 Index or the Wilshire 5000 Total Market Index. Where would you put it? Does it come with risk? Absolutely. Have you got a guaranteed return? Absolutely not. Could you lose it all? Unlikely—but it could drop significantly—and it has at times! Over the long term, US stocks certainly have a great track record. Remember how they compare to owning your own personal real estate? Equities have done well over time, but they are one of the most volatile asset classes in the short run. In the last 86 years (through 2013), the S&P lost money 24 times. So stock index funds belong in which bucket? That’s right: Risk/Growth.
How about international stocks? David Swensen puts a lot of weight in foreign stocks because of the diversity they bring to the portfolio. If there’s a slump in America, business may be booming in Europe or Asia. But not everybody agrees with David. Foreign currencies aren’t as stable as good old US greenbacks, so there’s a “currency risk” in investing in foreign stocks. And Jack Bogle, the founder of Vanguard, with 64 years of success, says that owning American companies is global. “Tony, the reality is that among the big corporations in America, none are domestic,” he told me. “They’re all over the world: McDonald’s, IBM, Microsoft, General Motors. So you own an international portfolio anyway.” Where do foreign stocks belong? I think we can agree on the Risk/Growth Bucket, no?
Emerging markets? David Swensen likes to put some money into the volatile stocks of developing nations, like Brazil, Vietnam, South Africa, and Indonesia. You can get spectacular returns, but you can also lose everything. Risk/Growth Bucket? You bet!
How about REITs? David told me he likes “real estate investment trusts that own big central business district office buildings and big regional malls and industrial buildings. They generally throw off a high-income component.” So these index funds can generate great returns, but they rise and fall with the American commercial real estate market. Which bucket? You’ve got it: Risk/Growth.
What about the last two on the list: long-term US Treasuries and TIPS? Do they offer lower returns in exchange for more safety? Spot on! So which bucket do they belong in? You’ve got it: Security.
Congratulations! You’ve just assigned six major asset classes to their proper allocation buckets, which is something 99.9% of the people you pass on the street wouldn’t be able to do! Pretty cool thing, isn’t it? But let’s dig a little deeper here to understand why David chose this mix, and why it may or may not be right for you.
First let’s look at the Security Bucket. David said he chose only US Treasury bonds “because there’s a purity there in having the full faith and credit of the US government backing them.” But why did he pick this particular combination of bond funds? Half are traditional long-term Treasury bonds, and half are inflation-protected securities.
I said to David, “You’re basically saying if I’m going to be secure, I’m going to protect myself against both inflation and deflation.”
“That’s absolutely right,” he said. “I can’t believe you saw that! A lot of people who put together bond indexes lump the two together. The Treasuries are for deflation, like we had in 2008. But if you buy regular Treasury bonds, and inflation takes off, you’re going to end up having losses in your portfolio. If you buy the TIPS, and inflation takes off, you’re going to be protected.” I want you to notice that David Swensen, like all the best, doesn’t know which is going to happen: inflation or deflation. So he plans for both scenarios. You might say as you look at this, “Well, yes, fifty percent for inflation and fifty percent for deflation. Doesn’t he just break even?” It’s not that simple, but your thinking is quality. He is using his Security Bucket investment as protection that if his equity investments or real estate go down, he’s lowering his downside by having something to offset some of those investment risks. So he’s certain to make some money in his Security Bucket. And he doesn’t lose his principal, so he’s practicing smart Security Bucket usage. He won’t lose money, but he’ll make some additional money if things inflate or deflate. A very smart approach.
But I was a bit surprised that only 30% of his asset allocation goes into the Security Bucket, while 70% of his assets go into the Risk/Growth Bucket! That seemed pretty aggressive to me for some investors, so I asked David how it would work for the average investor.
“That’s a good question, Tony,” he said. “Equities are the core for portfolios that have a long time horizon. I mean, if you look at recent long periods of time—ten, twenty, fifty, one hundred years—you see that the equity returns are superior to those that you get in fixed income.” Historical data certainly back him up. Have a look at the visual below that traces the returns of stocks and bonds for periods of 100 and 200 years. It shows that US stocks have historically outperformed bonds in compounded annual returns. In fact, $1 invested in 1802 at 8.3% per annum would have grown to $8.8 million by the turn of the new millennium.
So David Swensen designed his ideal portfolio to be a wealth-generating machine that offers some stability through its tremendous diversity. And because it takes a long-term view of investing, it has the time to ride out periodic drops in the stock market.
I was curious to see how this asset allocation mix would have fared in the past: those volatile 17 years from April 1, 1997, when TIPS first became available, to March 31, 2014. It was during those years when the Standard & Poor’s index performed like a rodeo bull, yet it dropped 51%. So I had a team of financial experts test its performance against the index during those years. Guess what? The Swensen portfolio outperformed the stock market with an annual return of 7.86%! During the bear market of 2000 through 2002, when the S&P 500 dropped almost 50%, Swensen’s portfolio stayed relatively stable, with a total loss of only 4.572% over those three terrible years! Like other portfolios heavy in equities, Swensen’s took a hit in the massive crash of 2008, but it still did better than the S&P 500 by more than 6%, (losing 31% as opposed to 37%) and then bounced back. (Note: see the end of this chapter for the specific methodology to calculate the returns. Past performance does not guarantee future results.) So, ladies and gentleman, it’s safe to say that David Swensen is one of those rare unicorns who can actually beat the stock market on a consistent basis—and in this portfolio, he does it with the power of asset allocation alone! And you have access to his best advice, right here, right now. If that was all you got out of this chapter, I think you’d agree it’s been worth the time! However, the most important thing to understand is this: even though this portfolio might do better and be more stable than the general market, it is still an aggressive portfolio that takes a strong gut because few people can take a 35% loss of their lifetime savings and not buckle and sell. So is it right for you? If you’re a young person, you might be very interested in this kind of mix, because you’ve got more time to recover from any losses. If you’re getting ready to retire, this portfolio might be too risky for you.
But not to worry. I’m going to give you several other examples of portfolios in the coming pages, including that one particular allocation mix Ray Dalio shared with me that practically knocked me off my chair! It was so spectacular that I’ve devoted a whole chapter to it in the next section. But here’s a hint: its mix was much less aggressive than Swensen’s, but when we tested it over the same time frame, the Dalio portfolio had a higher average annual return and significantly less volatility—it’s a smooth ride. It may be the Holy Grail of portfolio construction, one that gives you substantial growth with the lowest ratio of risk I’ve seen!
In any moment of decision, the best thing you can do is the right thing, the next best thing is the wrong thing, and the worst thing you can do is nothing.
—THEODORE ROOSEVELT
But for now, let’s get back to the big picture and look at how you’ll decide your own basic numbers: What percentage of your assets are you going to put at risk, and what percentage are you going to secure? Before you make the choice, you have to consider three factors: • your stage in life,
• your risk tolerance, and
• your available liquidity.
First, how much time do you have ahead of you to build wealth and make mistakes with your investments along the way before you need to tap into them? If you’re younger, once again, you can be much more aggressive because you’ll have longer to recover your losses. (Although nobody wants to get in the habit of losing!) Your percentages also depend on how much access to income you have. If you earn a lot of money, you can afford to make more mistakes and still make up for it, right?
GAME SHOW TIME: WHAT ARE YOU WILLING TO RISK?
And when it comes to risk, everyone has radically different ideas about what’s tolerable. Some of us are very security driven. Remember the 6 Human Needs? Certainty is the number one need. But some of us crave Uncertainty and Variety; we love to live on the edge. You have to know your personality before you dive in here. So let’s say you’re on a game show; which of the following would you take?
• $1,000 in cash
• A 50% chance at winning $5,000
• A 25% chance at winning $10,000
• A 5% chance at winning $100,000
Here’s another: you have just finished saving for a once-in-a-lifetime vacation. Three weeks before you plan to leave, you lose your job. Would you: • cancel the vacation;
• take a much more modest vacation;
• go as scheduled, reasoning that you need the time to prepare for a job search; or
• extend your vacation, because this might be your last chance to go first class?
Rutgers University has developed a twenty-question, five-minute online quiz (http://njaes.rutgers.edu/money/riskquiz) that can help you identify where you fit on the risk-tolerance scale. But the real answer is in your gut.
For the past 30 years, I’ve been putting on my Wealth Mastery seminars, where I’ve worked with people from more than 100 countries to transform their financial lives by putting them in a total-immersion four-day wealth-mastery process. In it, I like to play a little game with them called “the money pass.” From the stage, I tell the audience to “trade money” with one another. That’s all I say. There’s usually a few moments of silent confusion, and then they start trading. Some people pull out a dollar, some take out a twenty, some people a hundred. You can guess what happens. People are moving around, they’re looking at one another, they decide how to exchange. Some negotiate, some give away all their money, and some take another person’s $100 bill and give them $1. You can imagine the astonished look on that individual’s face. After three or four minutes of this type of trading, I say, “Okay, grab a seat.” And I move on to the next subject.
Invariably, some guy will shout, “Hey! I want my hundred dollars back!”
I’ll say, “Who said it was your hundred?” And he says, “Well, we’re playing a game.” And I say, “Yeah. What made you think the game was over?” Usually I get a confused look as the person sits down, still frustrated over the lost $100. Eventually they get the insight: their perception of their risk tolerance and the reality are in different universes. This guy thinks he has a high tolerance for risk, but he can get pissed off over the loss of $100. It always amazes me. Imagine if you were to lose $10,000, $100,000, or $500,000. That’s what aggressive investors can lose in a relatively short period of time. People don’t know their true tolerance for risk until they’ve had a real-life experience taking a significant loss.
I’ve taken God-awful losses—multimillion-dollar hits at a stage in my life when I didn’t have that much to lose, when the losses equaled more than all that I owned. Those gut checks will wake you up! But the numbers don’t matter. You can get thrown by losing $100 or $1,000. The pain of losing far exceeds the joy of winning. And that’s why it’s great to have something like the All Seasons portfolio in your investment arsenal, because, through asset allocation alone, you can significantly reduce the risk of sizeable losses.
Just as science shows us that we’re hardwired to hate losing, it also shows that humans are not good at assessing our potential to win. Sometimes after you’ve made a few successful investments, you start thinking, “Hey, I’m good at this; I can do anything!” It’s just human nature to think you can beat the system. It’s what psychologists call motivational bias. Most of us think we’re better than we really are at predicting patterns and luckier than we really are when there’s a jackpot at stake. What else can explain why so many people play the lottery?! A famous 1981 study at Stockholm University found that 93% of US drivers think their skills are above average. There’s even a name for this phenomenon: “the Lake Wobegon Effect,” referring to author Garrison Keillor’s mythical town where “all the children are above average.” Hey, who doesn’t think they’re above average! But when it comes to money, delusions that you’re better than everybody else can kill you.
If you’re a man, you’re guilty of this bias by biochemistry. Testosterone equals overconfidence. Study after study show that women tend to be better investors because they don’t overestimate their abilities to anticipate the future accurately. Sometimes confidence works against you. Just watch little boys. “I’m Superman! I’m going to fly! Watch me jump off this roof!” Suffice it to say, if you’re a woman reading this book, you have a built-in advantage!
When the markets are going up and up and up, investors can be mesmerized by their returns. Everybody’s seduced by the possibility of growth, thinking it’s the probability of growth. That’s where they get into trouble. As a result, they pour the majority or all of their money into investments that fit into the Risk/Growth Bucket—not just 70% but sometimes 80%, 90%, or 100%. Some even borrow money to make investments that they believe are going to go up forever, until they don’t. And because of poor asset allocation, with too much of their money riding on one horse, they lose it all or even end up in debt. And the reason people get screwed is that by the time they hear that the stock market (or gold, or the real estate market, or commodities, or any other type of investment) is a great place to go, very often the bubble is just about to end. So you need to put in place a system to make sure you don’t get seduced into putting too much of your money in any one market or asset class or too much in your Risk/Growth Bucket.
All of this may sound pretty basic, especially to sophisticated investors who feel like they’ve got everything covered. But sometimes it’s high-level investors whose strings of successes send them veering off course. They forget the fundamentals.
Naturally, there will always be investors who can’t listen to reason, whose “irrational exuberance” runs away with them. They talk themselves into believing the biggest myth of investing: “This time will be different.” I know dozens of these stories, all with unhappy endings. Take Jonathan, a friend who made a fortune in business (and whose real name will remain anonymous for his privacy) and then liquidated everything to invest in the booming Las Vegas real estate market. He had some early wins, so he doubled down and borrowed like crazy to keep building condos. Every time Jonathan came to my financial programs, he heard about the importance of putting some of your wins into your Security Bucket and not putting all your eggs into any one basket no matter how compelling the returns might be today. Jonathan gave credit to me and my Business Mastery programs for the more than 1,000% increase in his business that made all these investments possible. He made more than $150 million selling his company. But he didn’t listen when it came to taking money off the table and putting it in the Security Bucket, and, boy, did he pay a price. Today he acknowledges that he let his ego get in the way of his eardrums. He wanted to be a billionaire, and he knew he was on target to become one. But then, do you remember what happened when the real estate market in Las Vegas collapsed? How far did housing prices go down? How about 61% between 2007 and 2012. Jonathan didn’t just lose everything—he lost a half billion dollars more than he had.
I sincerely hope all this is sinking in. If there’s anything you should take away from this chapter, it’s this: putting all of your money in the Risk/Growth Bucket is the kiss of death. It’s why many experts estimate that 95% of investors lose money over virtually any decade. Typically they ride the wave up (in real estate, stocks, gold), and when the wave disappears, they sink like a rock, and they’re pounded by financial losses during the inevitable crash.
Some people just won’t listen to advice. They have to learn the hard way, if at all. But to avoid those kinds of painful lessons, and to help you decide which options are right for you, I have to remind you that a conflict-free, independent investment manager can be the right choice. Notice how professional athletes, men and women at the top of their sport, always have coaches to keep them at peak performance? Why is that? Because a coach will notice when their game is off, and can help them make small adjustments that can result in huge payoffs. The same thing applies to your finances. Great fiduciary advisors will keep you on course when you’re starting to act like a teenager and chasing returns. They can talk you off the ledge when you’re about to make a fateful investment decision.
PICK A NUMBER, ANY NUMBER . . .
Okay, the moment of reckoning has arrived! Say you’ve still got that $10,000 bonus in your hand (or you’ve accumulated $100,000, $200,000, $500,000, or $1 million or more), and you’ve decided to invest it all. Knowing what you know so far, how would you divide it up? What’s your new philosophy of investing? What percentage of your money are you going to keep growing in a secure environment and what percentage are you willing to risk for potentially greater growth?
You’ve probably heard that old rule of thumb (or what Jack Bogle calls a “crude method”): invest your age in bonds. In other words, subtract your age from 100, and that would be the percentage you should keep in stocks. So if you were 40 years old, 60% should go to equities in your Risk/Growth Bucket and 40% in your Security Bucket as bonds. At age 60, the ratio should be 40% stocks and 60% bonds. But those ratios are out of whack with today’s reality. The volatility of both stocks and bonds has increased, and people live a lot longer.
So what should it be for you? Would you like to be more aggressive with your risk, like David Swensen? With a 30% security and 70% risk? That would mean putting 30% of your $10,000 windfall—$3,000—in Security and 70%—or $7,000—into your Risk/Growth Bucket. (If you had $1 million, you would be putting $300,000 in Security and $700,000 in Risk/Growth.) Can you really afford that kind of split? Do you have enough cash? Do you have enough time? Are you young enough? Or do you need to be a little bit more conservative, like most pensions are, at 60/40? Or is 50/50 right for you? Are you close enough to retirement that you’d want to have 80% in a secure place, and only 20% in riskier investments? What matters is not what most people do. What matters is what will meet both your financial and emotional needs.
I know, it’s such a personal choice, and even the brightest stars in finance sometimes have to think long and hard about what’s right for them and their families. When I interviewed J.P. Morgan’s Mary Callahan Erdoes, I asked her, “What criteria would you use in building an asset allocation? And if you have to build one for your kids, what would that look like?” “I have three daughters,” she told me. “They’re three different ages. They have three different skill sets, and those are going to change over time, and I’m not going to know what they are. One might spend more money than another. One may want to work in an environment where she can earn a lot of money. Another may be more philanthropic in nature. One may have something that happens to her in life, a health issue. One may get married, one may not; one may have children, one may not. Every single permutation will vary over time, which is why even if I started all of them the first day they were born and set out an asset allocation, it would have to change.
“And that has to change based on their risk profile, because over time, you can’t have someone in a perfect asset allocation unless it’s perfect for them. And if, at the end of the day, someone comes to me and says, ‘All I want is Treasury bills to sleep well at night,’ that may be the best answer for them.” I said to her, “Because it’s about meeting their emotional needs, right? It’s not about the money in the end.”
“Exactly, Tony,” she said. “Because if I cause more stress by taking half that portfolio and putting it in a stock market, but that leads to a deterioration of the happiness in their lives—why am I doing that?” “What is the purpose of investing?” I asked. “Isn’t it about making sure that we have that economic freedom for ourselves and for our families?” “That’s right, to be able to do the things you want to do,” she said. “But not at the expense of the stress, the strains, and the discomfort that goes along with a bad market environment.” So what’s the lesson here from one of the best financial minds in the world? What’s more important even than building wealth is doing it in a way that will give you peace of mind.
So what will it be? Write down your numbers and make them real! Are those percentages a comfortable fit? Walk around in them. Live in them. Own them! Because those percentages are the key to your peace of mind as well as your financial future.
Done?
Okay! You’ve just made the most important investment decision of your life. And once you know what your percentage is, you don’t want to alter it until you enter a new stage of life, or your circumstances change dramatically. You’ve got to stick with it and keep the portfolio in balance. I’ll show you how later in this section.
Are you still concerned about making the right choice? Just remember, you’ve got a fiduciary to help you. And you don’t need tens of thousands, hundreds of thousands, or millions of dollars to get started—you could get started with next to nothing for free with today’s online services.
By the way, I’m not done with you yet! There are ways to increase your returns within these buckets, and we’re going to get to that.
Now that you understand these principles, and you’ve made this decision about how much you want to put in your Risk Bucket versus your Security Bucket, let me tell you the best news of all: after interviewing 50 of the most successful investors in the world, the smartest financial minds, I’ve uncovered the ways in which you can get Growth-like returns with Security Bucket protections. The most important piece of advice every investor I talked to echoed was, “Don’t lose money!” But for many investors, that means having to settle for mediocre returns in the Security Bucket. In just a couple of chapters, I’m going to share with you how to have the upside without the downside. How to have significant growth without significant risk. I know it sounds crazy, but it’s real, and it’s exciting.
As hard as we’ve worked here, I’m happy to tell you that the next chapter is easy and pure pleasure. Now I’m going to reveal a third bucket that we haven’t talked about yet, but you’re going to love it because it’s fun, inspiring, and can give you a greater quality of life today, not decades in the future. Let’s discover what’s going to go in your Dream Bucket.
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