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At the Money: Using Volatility to Rebalance Portfolios · Masters in Business

• 0:00
  Speaker 1: That bank.
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  Speaker 2: Since the October twenty twenty two lows markets have had
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  Speaker 2: a great run, recovering all of their losses and then some.
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  Speaker 2: But valuations are higher and the market seems to be narrowing.
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  Speaker 2: How should long term investors respond to these conditions? I'm
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  Speaker 2: Barry Riddelts and on today's edition of At the Money,
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  Speaker 2: we're going to discuss what you should be doing with
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  Speaker 2: your portfolio to help us unpack all of this and
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  Speaker 2: what it means for your money. Let's bring in Liz
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  Speaker 2: An Saunders. She is chief investment strategist and sits on
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  Speaker 2: the Investment Policy Committee at Schwab, the investment giant that
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  Speaker 2: has over eight point five trillion dollars on its platform.
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  Speaker 2: So Liz, let's start with the basics. How should long
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  Speaker 2: term investors be thinking about their equities here?
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  Speaker 1: Well, you know, Barry Shaman, anybody that answers that question
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  Speaker 1: with any kind of precision around percent exposure, and that's
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  Speaker 1: not just on the equity side of things, but broader
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  Speaker 1: acid allocation. I could have I could have a little
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  Speaker 1: birdie from the future land on my shoulder and tell
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  Speaker 1: me with ninety nine percent precision, what equities are going
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  Speaker 1: to do? Over the next whatever period of time, what
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  Speaker 1: bonds are going to do, even what maybe real estate
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  Speaker 1: is going to do. But if I were sitting across
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  Speaker 1: from two investors, one was a twenty five year old
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  Speaker 1: investor that inherited ten million dollars from their grandparents. They
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  Speaker 1: don't need the money, they don't need to live on
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  Speaker 1: the income. They go skydiving on the weekend. They're big
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  Speaker 1: risk takers. They're not going to freak out at the
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  Speaker 1: first ten or fifteen percent drop in their portfolio. And
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  Speaker 1: the other investor is seventy five years old, has an
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  Speaker 1: st egg that they built over an extended period of time.
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  Speaker 1: They need to live on the income generated from that
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  Speaker 1: stag and they can't afford to lose any of the principle,
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  Speaker 1: So one essentially perfect the high conviction view of what
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  Speaker 1: the markets are going to do. What I would tell
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  Speaker 1: those two investors is entirely different. So it depends on
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  Speaker 1: the individual investors.
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  Speaker 2: So that raises an obvious question. You work with not
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  Speaker 2: only a lot of individual investors, but a lot of
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  Speaker 2: rias and advisors. How important is it having a personal
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  Speaker 2: financial plan to your long term financial.
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  Speaker 1: Well, absolutely essential. You can't start this process of investing
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  Speaker 1: by winging it. It's got to be based on a
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  Speaker 1: long term plan, and it's driven by the obvious things
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  Speaker 1: like time horizon. But too often people automatically connect time
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  Speaker 1: horizon to risk tolerance. I've got a long time horizon,
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  Speaker 1: therefore I can take more risk of my portfolio vice versa.
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  Speaker 1: But we often learn the hard way. Investors learn the
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  Speaker 1: hard way that there can sometimes be a very wide
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  Speaker 1: chasm between your financial risk tolerance, what you might put
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  Speaker 1: on paper, sit down with an advisor, establish that plan,
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  Speaker 1: time horizon coming into play, and your emotional risk tolerance.
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  Speaker 1: And I've known investors that should, essentially on paper have
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  Speaker 1: a long term time horizon, but if the sort of
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  Speaker 1: panic button gets hit because of a short term period
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  Speaker 1: of volatility or dropping the portfolio, then that's an example
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  Speaker 1: of learning the hard way that your emotional risk tolerance
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  Speaker 1: may not be as high as your financial rest.
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  Speaker 2: So let's talk about that a bit. Everybody seems to
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  Speaker 2: focus on let's pick this stock or this sector or
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  Speaker 2: this asset class, but really, is there anything more important
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  Speaker 2: to long term outcomes than investor behavior?
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  Speaker 1: Investor? Absolutely, it's not. Too many investors think it's what
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  Speaker 1: we know or somebody else knows or you know that matters,
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  Speaker 1: meaning about the future. What is the market going to do?
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  Speaker 1: That doesn't matter because that's impossible to know. What matters
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  Speaker 1: is what we do along the way. And I enjoy
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  Speaker 1: these conversations because we get to talk about what actually matters,
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  Speaker 1: the disciplines that arguably are maybe a little bit more
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  Speaker 1: boring to talk about when you're doing, you know, financial
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  Speaker 1: media interview. The bomb bast is what sells more, but
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  Speaker 1: it's asset allocation, strategic and at times tactical. It is
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  Speaker 1: diversification across them within acid classes. And then the most
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  Speaker 1: beautiful discipline of all is periodical rebalancing, and it forces
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  Speaker 1: investors to do what we know we're supposed to do,
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  Speaker 1: which is a version of BI low sell high, which
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  Speaker 1: is add low trim high and one left to our own.
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  Speaker 3: Devices low trim high ad low trim high.
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  Speaker 1: So I almost the reason why I have that sort
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  Speaker 1: of nuance change to that is by low sell high.
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  Speaker 3: Almost infers market time.
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  Speaker 1: Get in, get out, And I always say that neither
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  Speaker 1: get in or get out is an investing strategy. All
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  Speaker 1: that is is gambling on two moments in time.
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  Speaker 3: And you have to get them both to get them
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  Speaker 3: both dead right.
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  Speaker 1: And I don't know any investor that has become a
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  Speaker 1: successful investor that's done it with all or nothing, Get in,
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  Speaker 1: get out investing. It is always a discipline process over time.
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  Speaker 1: It should never be about any moment in time.
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  Speaker 2: So we've been in the cycle where the FED started
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  Speaker 2: raising rates and markets became much more volatile. Now everybody's
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  Speaker 2: expecting rates to go down. What do you say to
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  Speaker 2: clients who are hanging on every utterance of Jerome pal
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  Speaker 2: and trying to adapt their portfolio in anticipation.
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  Speaker 3: What the FED does.
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  Speaker 1: Well to use the word adapt expectations have adapted to
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  Speaker 1: the reality of the data that has come in. Not
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  Speaker 1: to mention the pushback that Powell and others have shared,
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  Speaker 1: and even before the hotter than expected CPI report and
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  Speaker 1: hotter than expected jobs report, that the combination of those
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  Speaker 1: brought the FED to the point of Powell at the
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  Speaker 1: press conference at the January FMC meeting saying, it's not
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  Speaker 1: going to be March. But even in advance of that,
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  Speaker 1: we felt the market had gotten over At SKIS with
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  Speaker 1: not only a March start, but as many as six
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  Speaker 1: rate cuts this year. The data just did not support
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  Speaker 1: you know that old adage. Berry, I'm sure you know
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  Speaker 1: what of the FED typically takes the escalator up and
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  Speaker 1: the elevator down. They clearly took the elevator up this time.
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  Speaker 1: I think their inclination is to take the escalator down.
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  Speaker 3: Huh.
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  Speaker 2: Very interesting. So you deal with a lot of different
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  Speaker 2: types of clients. When people approach you and say, I'm
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  Speaker 2: concerned about this newsflow about Ukraine, about Gaza, about the
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  Speaker 2: presidential election, about the FED. Do any of those things
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  Speaker 2: matter to a portfolio over the long term or is
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  Speaker 2: this just short term noise? How do you advise those folks.
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  Speaker 1: Well, things like geopolitics tend to have a short term impact.
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  Speaker 1: They can be a volatility driver, but unless they turn
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  Speaker 1: into something truly protracted that works, it's way through. You know,
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  Speaker 1: commodity price channels like oil or food on a consistent basis,
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  Speaker 1: they tend to be short lived impacts. The same thing
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  Speaker 1: with elections and outcomes of elections. You tend to get
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  Speaker 1: some volatility things that can happen within the market at
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  Speaker 1: the sector level, but for the most part, you've got
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  Speaker 1: to be really disciplined around that strategic acid allocation and
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  Speaker 1: try to kind of keep the noise out of the picture.
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  Speaker 1: The market is almost always extremely sentiment driven. I think
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  Speaker 1: probably the best descriptor of a full market cycle came
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  Speaker 1: from the late great Sir John Templeton around bull markets
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  Speaker 1: are born, and its despair and the grown skepticism mature
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  Speaker 1: and optimism die in euphoria. I think that's such a
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  Speaker 1: perfect descriptor of a full market cycle. And what's maybe
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  Speaker 1: perfect about it is there's not a single word in
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  Speaker 1: that that has anything to do with the stuff we
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  Speaker 1: focus on at a day to day basis, earnings and
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  Speaker 1: valuation and economic data reports. It's all about psychology.
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  Speaker 2: So in order to stay on the right side of psychology.
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  Speaker 2: Given how relentless the newsflow is, we're constantly getting economic
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  Speaker 2: reports that are constantly fed people out speaking earnings, you know,
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  Speaker 2: we're just wrapping up earning season. How should investors contextualize
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  Speaker 2: that fire hose of information and what should it mean
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  Speaker 2: to their buy or sell decisions?
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  Speaker 1: Well, to the extent, some of this stuff does drive volatility.
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  Speaker 1: Use that volatility to your advantage. A lot of rebalancing
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  Speaker 1: strategies are calendar based, and it's forced to be calendar
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  Speaker 1: based in a situation like mutual funds that do their
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  Speaker 1: rebalancing at the last week of every quarter, but for
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  Speaker 1: many individual investors, they're not constrained by those rules. And
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  Speaker 1: one of the shifts in a more volatile environment where
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  Speaker 1: you've got such a fire hose of news and data
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  Speaker 1: coming out you and that can cost short term volatility
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  Speaker 1: is to consider portfolio based rebalancing as opposed to race rebalancing.
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  Speaker 1: Let your portfolio tell you when it's time to, you know,
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  Speaker 1: add low and trim high.
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  Speaker 2: So in other words, it's not like every September first,
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  Speaker 2: it's hey, if the markets are down twenty twenty five percent,
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  Speaker 2: good time to rebalance. You're adding low and your trimmings.
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  Speaker 1: And that's within asset classes too, whether it's something that
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  Speaker 1: happens at the sector level or you know, magnificent seven
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  Speaker 1: type action. And that's just a better way to stay
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  Speaker 1: in gear as opposed to trying to absorb all this
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  Speaker 1: information and trying to trade around it to the benefit
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  Speaker 1: of your performance.
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  Speaker 3: That's that's a fool's Errand.
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  Speaker 2: What do we do in a year like twenty twenty two,
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  Speaker 2: which admittedly was a forty year run since the last
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  Speaker 2: time both stocks and bonds were down double digits how
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  Speaker 2: do you rebalance or is that just one of those
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  Speaker 2: years where hey, it's literally a forty year flood and
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  Speaker 2: you just got to ride it out.
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  Speaker 1: Yeah. I mean, it's obviously been a tough couple of
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  Speaker 1: years in terms of the relationship between stocks and bonds,
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  Speaker 1: and we do think that we are in the midst
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  Speaker 1: of a secular shift. For much of the Great Moderation Era,
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  Speaker 1: which essentially represents the period from the mid to late
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  Speaker 1: nineties up until the early years of the pandemic, you
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  Speaker 1: had a positive correlation between bond yields and stock prices
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  Speaker 1: because that was a disinflationary era for the most part.
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  Speaker 1: So as an example, when yields were going up in
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  Speaker 1: that era, it was usually not because inflation was picking up.
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  Speaker 1: It was because growth was improving. Stronger growth without commensurer
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  Speaker 1: at higher inflation, that's nirvana for equities.
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  Speaker 3: But if you go back to the thirty years prior.
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  Speaker 1: To the Great Moderation I've been calling it the Temperamental Era,
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  Speaker 1: from the mid sixties to the mid nineties, that relationship
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  Speaker 1: was almost the entire period. The complete opposite of that,
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  Speaker 1: you had that inverse relationship because bond yields, as an example,
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  Speaker 1: when they were moving up in that era, it was
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  Speaker 1: often because inflation was sort of rearing its ugly head again.
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  Speaker 1: Now that's a very different backdrop, but it's not without opportunity.
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  Speaker 1: In some cases, it may be you benefit by taking
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  Speaker 1: more of an active approach, both on the equity side
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  Speaker 1: of things and on the fixed income side of things.
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  Speaker 1: The other thing to remember is that there's the price
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  Speaker 1: component on the bond side of things, but there's also
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  Speaker 1: the fact that you are going to get your yield
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  Speaker 1: and your principle if you hold to maturity. So for
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  Speaker 1: many individual investors, much like we say, be really careful
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  Speaker 1: about trying to trade short term on the equity side
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  Speaker 1: of things, the same thing camply on the fixed income
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  Speaker 1: side of things, but it's a different backdrop than what
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  Speaker 1: a lot of people are used to.
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  Speaker 2: So to sum up, there's a lot of noise. There's news,
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  Speaker 2: there's fed pronouncements, there's earnings, there's economic data, all of
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  Speaker 2: which creates volatility, and that volatility creates an opportunity to
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  Speaker 2: rebalance advantageously when markets are down and you're off of
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  Speaker 2: your original allocation. If you're seventy thirty has become a
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  Speaker 2: six because stocks have sold out off. That's the opportunity
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  Speaker 2: to trim a little bit on the bond side, a
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  Speaker 2: little bit on the equity side, and now you're back
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  Speaker 2: to your original allocation. Same thing when markets run up
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  Speaker 2: a lot and your seventy thirty becomes an eighty twenty.
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  Speaker 2: It doesn't just have to be a calendar based allocation.
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  Speaker 2: You could be opportunistic based on what markets provide. I'm
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  Speaker 2: Barry Ridults, you're listening to Bloomberg's At the Money