Fix It Friday Ep. 16 - The Shocking Truth About Safety & Risk: Why The Wealth Management Industry’s Conventional Wisdom Could Destroy Your Wealth

• Volatility measures price fluctuations, not the long-term risk of investments.
• Mistaking short-term market noise for risk leads to poor long-term decisions.
• Bonds and “safe” low-volatility strategies can erode purchasing power over time.
• Awareness of behavioral biases helps investors make rational decisions during market swings.

Disclaimer: [00:00:00] The following podcast by Fusion Family Wealth, LLC Fusion is intended for general information purposes only. No portion of the podcast serves as the receipt of or is a substitute for personalized investment advice from Fusion or any other investment professional of your choosing. Please see additional important disclosure at the end of this podcast.

A copy of Fusion's current written disclosure brochure discussing our advisory [00:00:15] services and fees is available upon request or at www.fusionfamilywealth.com. 

Jonathan Blau: Thanks for tuning into another episode of The Crazy Wealthy Podcast. Fix it Friday edition. Today I'm gonna talk about two things. First is. I'm gonna distill a [00:00:30] counterintuitive way to think about risk returns and volatility.

And the second thing I'm gonna do is explain how reframing risk, return, and volatility. The way I'm gonna describe is gonna help you to become better decision makers in real life [00:00:45] when it relates to money and uncertainty, and when they collide together, those two things.

Voiceover: Welcome to The Crazy Wealthy Podcast with your host, Jonathan Blau. Whether you're [00:01:00] just starting out or are an experienced investor, join Jonathan as he seeks to illuminate and demystify the complexities of making consistently rational financial decisions under conditions of uncertainty. He'll chat with [00:01:15] professionals from the advice world, entrepreneurs, executives, and more to share fresh perspectives on making sound decisions that maximize your wealth.

And now here's your host. 

Jonathan Blau: First thing I want [00:01:30] to talk about is defining volatility. A lot of people. Think volatility means straight down in a hurry, and it doesn't mean anything like that. Volatility is simply the rate and the magnitude of price movements in either direction, up or down. [00:01:45] Uh, in the short term, it's daily zigs and zags in the prices in this case of, uh, of investments in general.

And today I'm gonna be talking about investments in stocks in particular. So this is not the same thing as risk [00:02:00] in the long run. And it's not a direct measure of the quality or the durability of the underlying businesses that we own as stockholders of corporations. Volatility tells us how bouncy the [00:02:15] price is, not how solid the underlying business fundamentals are, and it's important to always keep those two things in our minds separated so that we can become better investors.

A short term drop [00:02:30] in prices. It does not mean that a business is failing. It awfully sim. It simply often reflects the current mood of the marketplace, which, which can be reacting to anything from current events, to politics, to real [00:02:45] problems like COVID, for example. 

And all of a sudden, from February 20 to March 20, when the economy globally started shutting down the prices of great companies, the [00:03:00] s and p 500, uh, companies declined by 34% in one month. So most rational people, if they ask themselves a question, do I really believe that the long-term and during values of companies like Apple Computer and [00:03:15] Merck, the drug maker or Nike, have disappeared of, of course not.

These were just temporary declines. In the prices of the stocks of those companies. And ironically, when the prices of the stocks is declining, the value of the [00:03:30] companies becomes increasing directly in proportion to how much the stock price is declining. In other words, if we're paying a lower and lower price to own, uh, a percentage of these companies, we are getting more and more value as we pay lower prices.

[00:03:45] So, so the irony of, of how we. Process volatility is that it's actually, uh, not, not our foe, but often our friend for many reasons, So if volatility is not [00:04:00] the same thing as risk in the long run, why do we often treat it? Or why do investors often treat it as it is?

Because it's tangible. We can see it, we can measure it, we can feel it in our guts when the market moves, it causes us to mistake [00:04:15] the noise for the signal, and often we abandon our plans in response to mistaking the noise for the signal. What I call the noise is anything from, uh, pandemics recessions.

Fair markets,, [00:04:30] Democrats or Republicans, whichever the person is, is pro or con, uh, wars, peace, inflation going up, interest rates going up, et cetera, that's all noise. What the signal is always that causes long-term prices to increase is [00:04:45] earnings and earnings of great businesses continue to grow. Uh, for the last hundred years, they've grown dramatically and continue to do so.

Uh, and the reason they do that is. CEOs, executives of public companies have a fiduciary [00:05:00] responsibility to maximize shareholder value. So when they're faced with crises, they respond to the crises rationally. They may reduce the workforce, they may pay down debt, uh, but they're certainly, one of the things they're not gonna do is continue with any activities [00:05:15] that they see continuing to lose money.

Are they gonna, bandon and jettison those activities right away. That's their fiduciary duty and they come out of the crises stronger and more profitable ultimately. So short-term horizons [00:05:30] tempt us to confuse what fluctuates with what matters. And Naim to leave put it best. He said, when we focus on short-term volatility, we are observing the variability, the up and down [00:05:45] movements temporarily in the portfolio.

Its zigs and its zigs. But not the returns. We are not observing the returns. We confuse the zigs and zigs and prices with the actual growth story of the business and the investment in the [00:06:00] business long term. So the industry siren call the, the big, uh, wall Street firms in general, but the financial advice industry, siren call, tempts us to seek out safety in principle protection, protecting if we have a [00:06:15] million dollars, that's what we need to do is protect that principle and not just from disappearing.

From even fluctuating. So their goal is to lure us with the promise of what they call smooth returns or. Limited volatility, limited up and down. They [00:06:30] sell us safety rather as the absence of volatility. They pitch products called principle protected and low volatility. There's a critical misalignment here to explore.

If you mistake volatility for [00:06:45] risk, you may opt. Or into strategies that lower expected long run returns and actually pay for advice that causes an ever even accelerates running out of money. So let's explore how this happens [00:07:00] and how should we, uh, redefine or reframe risk, return and volatility. So instead of thinking about risk as volatility and instead of defining risk and safety in terms of the need to protect our.

[00:07:15] Principle, the million dollars from temporarily fluctuating instead of being concerned with the number of dollars changing from time to time in the portfolio due to market corrections and things of that nature, redefine risk and safety, not in terms of [00:07:30] protecting principle from fluctuating. But from protecting, purchasing power from disappearing.

So while the whole world is is, is taught to worry about fluctuation in the number of dollars they're given strategies, for [00:07:45] example, bonds to go into the portfolio to. To solve the wrong problem, which is volatility. I call that the illusory risk, and when we put more bonds in the portfolio to solve an imaginary problem, volatility, we actually are feeding the real problem, [00:08:00] which is the disappearance of our purchasing power.

So, for example, every million dollars that I put today in a bond to reduce movement temporarily in the portfolio from time to time, every million dollars for the next 10 years, 20 years, 30 years, I keep [00:08:15] rolling the proceeds when that bond matures into a new bond. At the end of 30 years, I can still only have the same million dollars, but at the end of 30 years, I need almost 3 million to buy what a million bought.

What happened along the way is I was forced to unwind the million dollar [00:08:30] principle, uh, and ran out of money because nothing was protecting my money against the 3% increase in the cost of living every year. Bonds were actually if the, if, if inflation is the disease of money. Bonds are the carrier of the [00:08:45] disease, not the cure of it, because they freeze your money in the face of a 3% plus compound annual grinding away at its value, which is what we call inflation.

So why, why do we actually behave, um, [00:09:00] in such a way? That we react to this volatility as if it's going to destroy us if we don't control it. So there's a few actually behaviors that I wanna share with you. One is it's a cultural behavior. We actually process [00:09:15] most economic and financial inputs in a way that's called.

Counter-cyclically. What it means is the demand for goods and services is counter to the price of them. So if the price of something goes up and is increasing rapidly, we're [00:09:30] actually gonna, uh, try to shun it, replace it with something whose price is not going up as rapidly. Or simply delay the purchase until prices come back into more reasonable, um, prices that we can accept.

And conversely, if, [00:09:45] if the prices of goods and services that, that we want are declining, the demand is counter, it's increasing. We love a sale, right? It's, it's, it's, that's how human nature works. But what's fascinating is that we respond, count, [00:10:00] counter cyclically to every economic and financial input except one.

And that's the price of investments, particularly the price of stocks. When the price of stocks is high and rising as it was during the dotcom bubble in the late nineties. Human nature thinks [00:10:15] somehow that the risk of buying these stocks at higher prices is lower than the risk of having bought them at lower prices.

They also think that the future return, if we pay higher prices for these companies, is somehow be greater than if we paid [00:10:30] lower prices, uh, years earlier. Conversely, when, when, when great companies go on sale, when the stock prices are declining, so we're buying more and more shares for less and less money.

Human nature thinks the risk of buying these companies at lower [00:10:45] prices has increased and is increasing, and that the future return on the companies that we're investing in at lower prices, buying more shares for less money, somehow will be a lesser return than if we paid higher prices. And what I always teach, everybody who, who [00:11:00] interviews us to help them with their money is.

Uh, reality isn't just different than what human nature thinks. It's opposed to it, it's the opposite. Higher prices for stocks or anything else means lesser returns than if we paid lower prices. [00:11:15] Lower prices being paid for stocks means higher returns and less risk. And, and, and that's the first behavioral flaw that influences our reaction.

To volatility. The second thing is called loss aversion bias. We actually [00:11:30] dislike the pain of a loss. Feel the pain of a loss two to two and a half times more than we feel. The pleasure of an equivalent gain is pleasurable, and so human nature seeks not to maximize long-term. Best returns or [00:11:45] best interest.

It seeks to minimize the chance of short-term loss 'cause that's what's most painful to us. And in seeking to do that, we seek out investments that minimize short-term loss, cash bonds, those are the same things that minimize the [00:12:00] ability to overcome the ravages of inflation and to grow our money. So that's loss aversion bias.

The third thing is related to it at a certain level of loss. You know, the, the part of our brain that, that deals with, fight or flight, the reptilian brain called [00:12:15] the amygdala, the, the organs, two little walnuts shaped organs at the base of our brain. They still process fear the same way they did 50,000 years ago when our primary threats were physical, not dealing with the vagaries of the, of the financial markets.

[00:12:30] Right. And it's never developed to modern times to allow us to do that. It actually. We are programmed to do the opposite of what's needed to deal with the capital market. So for example, when there's a bear in the woods. Uh, going to kill our ancestors. This was a [00:12:45] phenomenal thing. The loss aversion bias.

It said just, and the amygdala shooting off the signal. Just run. That's it. You don't think about it. Well, today the, the problem is the amygdala doesn't distinguish between a bear in the woods of permanent threat of death. And a bear [00:13:00] market a decline of 20% or more in the the prices of the companies we own, which is a temporary, temporary threat.

It doesn't distinguish between the two. It shoots off the sell signal, get outta the way of danger without thinking. And as soon as the markets, what I [00:13:15] found go down. More than 20 or 25%. Something gets triggered where the ability for a human being to distinguish between temporary decline and permanent loss is so blurred that they can no longer distinguish, and that's when [00:13:30] they're gone.

That's when they abandon the portfolio. So in summary, how do we deal with the issue? Of mistaking, um, volatility, uh, for something that's meaningful as it relates to being able to succeed [00:13:45] in our long-term objectives. Meaning why do we think, how do we fight the thought that I need to control volatility, succeed?

It's actually not true at all. What we need to do is understand that there are two types of, uh, money. There's wealth whose [00:14:00] natural function is to accrete and to grow over time. And there's the other kind of money, money that runs out. Most advisors, or I shouldn't say many advisors in the industry that I've met are actually money that runs out managers because [00:14:15] they're foisting on the clients.

The idea that bonds are gonna protect you from volatility, and when they're giving those bonds, what they're doing is they're ensuring that what. Extra money is in bonds for the illusory. Risk of volatility [00:14:30] is killing the value of every dollar, every day, and every year to the tune of at least 3%. So what we need to do is just reframe investments that lead to the protection and growth of our purchasing power are [00:14:45] safe, real assets companies.

By virtue of stock ownership, those are safe investments that lead to the freezing and even destruction of our purchasing power. Those are risky bonds and other investments like annuities that freeze our [00:15:00] purchasing power in the face of inflation, uh, are are risky. Now think about what I just said.

Counter-cultural counterintuitive. Stocks are safe, bonds are risky. I'll leave you with that thought, and uh, thanks again for tuning into another episode of Fix [00:15:15] It Friday.

Voiceover: Thank you for tuning into another episode of the Crazy Wealthy Podcast. For more insights, resources. And to sign up for our newsletter, visit Crazy wealthy podcast.com. [00:15:30] Until then, stay crazy wealthy.

Disclaimer: The previous podcast by Fusion Family Wealth, LLC Fusion was intended for general information purposes only. No portion of the podcast serves as the receipt of or is a substitute for [00:15:45] personalized investment advice from Fusion or any other investment professional of your choosing. Different types of investments involve varying degrees of risk, and it should not be assumed that future performance of any specific investment or investment strategy or any non-investment related or planning services, discussion or content will be profitable.

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To provide investment advisory services, a copy of Fusion's current written disclosure brochure discussing our advisory services and fees is available upon request or at www.fusionfamilywealth.com.