Power Up Wealth podcast – episode 7 transcript:
Sharla Jessop 0:00
Risk comes in so many forms: some good and some bad. How do you know the difference? I’m Sharla Jessop. Today we will discuss the many phases of risk with our guest and financial planning expert Jordan Hadfield.
Welcome to the SFS Power Up Wealth podcast, where we provide impactful insight and expert opinions on timeless financial principles and timely investment topics. Preparing you to make smarter decisions with your money.
Jordan, thank you for joining us today.
Jordan Hadfield 0:48
I’m glad to be here.
Sharla Jessop 0:49
Jordan is a Certified Financial Planner and Wealth Management Consultant at Smedley Financial Services. Jordan, what did you find interesting about risk? Why did you want to write an article about balancing risk?
Jordan Hadfield 0:59
Risk management I think is one of the most important aspects of my job as a financial advisor. Risk management means different things to different people based on their situations and where they’re at in life. Most people when they think when they hear the word risk, they think of stock market risk. And stock market risk is complex. There’s different stocks carry different amount of risks. But typically speaking, when you’re talking to an investor about investment risks, the first thing that comes to their mind is stock market risk. And I think the reason for that is because the stock market risk is constantly in our face. We turn on the news, we jump online, we’re talking to our friends, and we hear about the Dow and the S&P 500 and the NASDAQ and it’s going up and it’s going down and that is stock market risk. It’s in our face all the time. And so, unfortunately, we’ve been trained to think of investment risk as stock market risk. The truth of the matter is, though, stock market risk is only one aspect, one of the several different types of risks we take in the financial industry. Some of the others just to name a few would be inflation risk, interest rate risk, credit risk, foreign investment risk, liquidity risk, for those that are retired sequence of return risk becomes very, very important. There’s also political risks and the effects that it has on the financial industry. Then you get into psychological risks, emotional risk, and recency bias, and uninformed risk. People that make decisions based on inaccurate, incomplete, or, missing information. You know, they’re uninformed about a particular topic, and that’s a risk. So all of these types of risks need to be calculated when you’re performing a risk management analysis. The reason why I think it is so important is because if you take too much risk, you can find yourself making bad decisions when things go wrong. And if you don’t take enough risk, you may be leaving a lot of returns on the table. And some of those returns may be necessary to achieve success. And so the balance of these risks are, are very, very important. Let me try and illustrate this point a little better. If I were to chart these different risks, you may think of the left side of the chart as being zero risk. And the right side of the chart is being high risk. And if that’s your perception of investment risk, and a lot of people I think have this perception, it’s very inaccurate. The truth of the matter is on the left side of the chart would be high risk, and on the right side of the chart would be high risk. There’s risks everywhere, and there are different types of risk. And so again, managing these risks balancing these risks become important. To try and further illustrate my point, let me give you let me greatly simplify the situation. Let’s take two risks and isolate them. Let’s talk about market risk / stock market risk and inflation risk. Imagine a teeter-totter. On one side of the teeter-totter, you’ve got stock market risk. On the other side of the teeter-totter, you have inflation risk. Well, if we increase the stock market risk, inflation risk will decrease. And if we decrease the stock market risk, we may be increasing inflation risk. And I think that’s a very accurate representation of risk in the marketplace. Although, again, that example might be oversimplified. But, the point is, it’s a balance. If we properly perform risk management, what ends up happening is we mitigate risks that can be mitigated, we completely remove risks that can be removed, and we balance these other risks that are important for success. The reason for risk management is so that if we have an investor regardless of what financial situation may come, he’s gonna find success. That is the purpose of risk management. If the stock market drops, he’s going to be okay. If inflation increases, he’s going to be okay. If interest rates rise, he’s going to be okay. If there’s some new laws passed and tax laws change and estate planning laws change, he’s going to be okay. Because we’ve mitigated all these different risks. That’s the purpose of risk management. And that’s why it’s so important.
Sharla Jessop 5:18
How do you balance the risks in terms of planning?
Jordan Hadfield 5:22
We have an advantage, admittedly, because we are active managers. And I think that’s a very, very important part of risk management. A passive manager will typically do a risk evaluation, and then create an allocation in an investment portfolio, and then let it ride. The problem is risks are always changing. Constantly risks are changing, the risks that we are facing now in 2022, are very, very different than the risk we were facing in 2018 2019. And so as active managers, we’re constantly evaluating the risk in the different investments, and trying to reduce high-risk investments and move into areas that have a lot more potential based on the amount of risk we’re taking. So active management is a very, very key component to that I think. The active management side addresses the investment portion of risk management. But there’s another side of that, and that is the individual client, their goals, their needs, their particular situation. And so the other half is meeting with our clients. And we like to do so at least annually, review their situation, review their goals and what they’re trying to accomplish, determine their risk tolerance, get kind of a feel for how they’re doing with the amount of risk that they’re taking, and look for ways that we can maybe reduce some of that risk. That is also a key component to risk management.
Sharla Jessop 6:42
What risks do you worry about the most?
Jordan Hadfield 6:44
So that’s a really good question. I would say the risk that’s on my mind most frequently is the inflation risk. And that might surprise people. Maybe it doesn’t, but the clients that I worry about the most are the clients that should be taking more market risk, and they’re not out of fear. And so they have a very high inflation risk, and they don’t even realize it. That’s something that I that I’m constantly trying to educate my clients about is if we take all investments off the table, we haven’t removed all risk. In fact, in many areas, we’ve greatly increased risk. And so there’s this idea that stocks are dangerous. Stocks carry risk. We don’t like risk. We’re now retired. We need to reduce risk. Let’s sell out of stocks. This greatly increases inflation risk. And that’s a scary thing for me. To try and give you an example, let’s create a hypothetical. We’ve got a client, and let’s say he’s age 65. Let’s say he’s got an IRA of a million dollars, let’s say he’s living on $6,000 a month, and he’s got social security of $3000, so half. So $3,000 a month he’s pulling out of his IRA to fund his retirement, his living expenses. Let’s assume a reasonable rate of return of about seven and a half percent. And let’s say inflation is 3%. Okay, if this hypothetical client lives to age 95, his portfolio will be in the ballpark of $725,000. But if we were to increase inflation, by 1%, we were to change that from 3% to 4%. He actually runs out of money at age 90, 5 years sooner. And that’s a swing of over $1.5 million.
Sharla Jessop 6:57
That’s huge!
Jordan Hadfield 8:18
It is huge. So inflation over the long-term can be really, really scary. Now, for those of you listening, don’t be scared by inflation rising. We are, you know, we were talking about inflation rising last year, it was really high. We expect it to be higher than average this year, and maybe even going forward. But again, talking about risk management, higher inflation can be mitigated. There’s things that we can do to offset that risk. And that is the job of active management. Stocks are a great hedge against inflation. So if inflation is high. Stocks are a great place to be. Inflation is something I worry about for people who fear taking on a little bit of market risk.
Sharla Jessop 8:54
You know, I think that people view risk, it seems like a scary word. It’s concerning when people talk about risk, they have this idea in their head, that risk is great if you’re in the market, and they tie risk to the market has been greater. Are there different levels of risk in the market? Or is market risk? Just market risk?
Jordan Hadfield 9:09
No, there’s absolutely different levels of market risk. On a scale of 1 to 100. There are some stocks that are 100, that are very, very risky. There are other risks in the market that are very, very conservative. You know, on that same scale, they could fall in, you know, the 10 or 15 compared to 100. So you can be very, very risky, and or you could be very conservative and still take on market risk. And again, that stock market risk has a lot of benefits. To remove it entirely I think actually is the riskiest move for most people.
Sharla Jessop 9:39
I think in your article, one of the things that you talked about was recency bias, which you know, we all have biases in life, whether it’s from beliefs from experiences, or you know, what we’re taught. They’re hard to manage and get rid of, but recency bias is something that impacts almost everybody.
Jordan Hadfield 9:54
Yeah. So you asked earlier, what are some of the risks you fear most and I answered inflation. Recency bias would be a second. And the third would be an emotional risk. Recency bias is the idea that what’s happening now is going to continue. I was just having this conversation yesterday with a colleague. He was talking about charts and how if you’re looking at a chart that’s rising, your instinctually, without even thinking about it, you expect that chart to continue to go up. And if you’re looking at a chart that’s going down, it brings a negative feeling just subconsciously, and you expect that chart to continue to go down. The truth of the matter is, the chances of them flipping are just as high as them continuing as they’ve as they have been. And that’s recency bias. And that’s something that we all struggle within all aspects of our lives. A real-world example of that in the investment world would be the S&P 500. Over the last 10 years, large-cap US stocks have been the place to invest. But that doesn’t mean that’s going to be the best sector of the market in the next 10 years. It’s very possible that the S&P underperforms and internationals outperform, right. And so the recency bias would be the S&P has been great. I’m going to continue in the S&P 500. That’s what I’m going to invest my money in.
Sharla Jessop 11:05
That’s a great case for diversification. With respect to risk management, but do you think it’s most important for investors to understand
Jordan Hadfield 11:11
So I think the teeter-totter example I gave earlier is really important. That is something that I wish every investor understood is it’s a balance of risk and removing some risk adds others. Another important aspect, I think of risks that I think investors need to understand is the emotional side. We’re emotional beings, we’re emotional creatures. And even the most rational among us often rely on emotions to make decisions, gut feelings, and intuitions. These are emotional things. And when things get scary in the market, too often, we rely on those emotions to make our decisions for us. And an emotion is an investor’s worst enemy. And recognizing that, I think is very, very important. You know, when we hear the word risk, most of us think of, we get kind of a bad taste in our mouth. We think of risk carries kind of a negative connotation to it. And in the world of investing, risk is actually a very, very good thing. Where there’s no risk, there’s no reward. We see the market drop, and clients often will get emotional, they’ll feel uh oh, my accounts are down. This is a scary thing. But if risk management has been performed properly, and the client’s portfolio is suitable for them for their needs and their goals, a downturn in the market shouldn’t be a scary thing. In fact, it can be an opportunity to make money, right? You know, I say investment managers like the volatility in the market to some degree, because it’s that volatility that creates opportunities. And so it’s taking the right level of risk, that that becomes important. If that’s done properly, through continual active management, and risk analysis, no investor should have heartburn, you know. And they should be able to survive any economic situation that comes forward.
Sharla Jessop 12:59
Jordan, I love that aspect. I love the idea that risk is a positive. It’s not always negative. It’s scary, but we can manage it. It can be balanced and it can be positive.
Jordan Hadfield 13:08
Yeah, absolutely. Risk is a great thing. And, you know, it’s the returns we get in the market are our reward for tolerating the volatility in the market for taking that risk.
Sharla Jessop 13:20
Well said. Jordan, thank you so much for joining us.
Jordan Hadfield 13:22
Yeah, thank you.
Shane Thomas 13:28
Thank you for joining the Power Up Wealth podcast. Smedley Financial is located at 102 S 200 E Ste 100 in Salt Lake City, UT 84111. Call us today at 800-748-4788. You can also find us on the web at Smedleyfinancial.com, Facebook, Instagram, Twitter, and LinkedIn.
The views expressed are Smedley Financials and should not be construed directly or indirectly, as an offer to buy or sell any securities or services mentioned herein. Investing is subject to risks including loss of principal invested. Past performance is not a guarantee of future results. No strategy can assure a profit nor protect against loss. Please note that individual situations can vary. Therefore, the information should only be relied upon when coordinated with individual professional advice. Securities offered through Securities America. Inc., Member FlNRA/SIPC. Roger M. Smedley, Sharla J. Jessop, James R. Derrick, Shane P. Thomas, Mikal B. Aune, Jordan R. Hadfield, Lorayne B. Taylor, Registered Representatives. Investment Advisor Representatives of Smedley Financial Services, Inc.®. Advisory services offered through Smedley Financial Services, Inc.® Smedley Financial Services, Inc.®, and Securities America, Inc. are separate entities.
