Episode 334: The Most Important Financial Decision You Will Make

Most investors assume the key to building wealth is picking the right stock. Melissa Joy, CFP®, says the far more important decision is how you structure your portfolio in the first place, and how much risk you choose to take on. In this solo episode, Melissa breaks down asset allocation, the mix of cash, bonds and stocks that make up an investment portfolio, in plain language, without requiring a finance degree to follow along.

Melissa walks through the fundamentals of stock and bond investing, explains the common shorthand investors use to describe their portfolios (like 60-40 or 80-20), and shares how she helps clients think through allocation decisions using broader, 15 to 20 percent notches rather than micromanaging every 5 percent. She also digs into the questions that matter most when setting your own mix: your time horizon, your investing psychology, your tax situation, and how you would actually feel if your portfolio dropped 20 to 30 percent for an extended period. The goal, she says, is not the perfect allocation. It is one that helps you stay invested through both difficult and exuberant markets.

What You'll Learn

• What asset allocation actually means, and why it matters more than picking individual stocks
• The differences between cash, bonds and stocks, and the pros and cons of each
• How to read portfolio shorthand like 60-40 or 80-20
• Why Melissa builds portfolios in 15 to 20 percent notches instead of fine-tuning by 5 percent increments
• How time horizon, investing psychology and tax considerations shape the right mix for you
• Why the first days of retirement can be the riskiest, and how allocation needs can shift over time
• How to check your current asset allocation and decide whether it needs adjusting

The previous presentation by PEARL PLANNING was intended for general information purposes only.  No portion of the presentation serves as the receipt of, or as a substitute for, personalized investment advice from PEARL PLANNING 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, be suitable for your portfolio or individual situation, or prove successful. Neither PEARL PLANNING’s investment adviser registration status, nor any amount of prior experience or success, should be construed that a certain level of results or satisfaction will be achieved if PEARL PLANNING is engaged, or continues to be engaged, to provide investment advisory services. PEARL PLANNING is neither a law firm nor accounting firm, and no portion of its services should be construed as legal or accounting advice. No portion of the video content should be construed by a client or prospective client as a guarantee that he/she will experience a certain level of results if PEARL PLANNING is engaged, or continues to be engaged, to provide investment advisory services. A copy of PEARL PLANNING’s current written disclosure Brochure discussing our advisory services and fees is available upon request or at https...

Transcript

Welcome And The Big Idea

SPEAKER_01 0:00

Welcome to the Women's Money Wisdom Podcast. I'm Melissa Joy, a certified financial planner and the founder of Pearl Planning. My goal is to help you streamline and organize your finances, navigate big money decisions with confidence, and be strategic in order to grow your wealth. As a woman, you work hard for your money, and I'm here to help you make the most of it. Now let's get into the show.

Why Process Beats Picking Stocks

SPEAKER_01 0:31

Did you know that the most important investment decision that most of you will make isn't about picking the right investment? More so, the best decisions are often how you set up your investment process and choosing what type of risk you take in investment portfolio. That's what we're going to talk about today. I want to get into the nuts and bolts of investing strategies and talk about one of the most fundamental concepts when it comes to investing. As an investment professional, I call it asset allocation. But for you, you could just consider it the mix of different types of investments, primarily stocks and bonds, and how you that can shape a portfolio. This conversation can feel very intimidating if you're not someone who studies investing all the time. And sometimes I find the conversation is kind of skipped over by a financial advisor. They just go and say, hey, here's what I'm going to give you. And in other cases, it becomes like so much of a negotiation and kind of ticky tack where there's almost too much emphasis on getting exactly the right mix. So I'm going to tell you how I think about it with the clients that I work with. And hopefully it will provide more insight for you as you consider the money that you have invested and how you should approach and think about your investment decisions over time. I think so many times people think that they need to pick the perfect stock in order to be successful. And using a time-tested, diversified, using, you know, kind of indexes and more simplified investing strategies can go a long way. And it's not all about picking, using a crystal ball to pick exactly the company that's going higher. I also think that if you pick the right mix of stocks and bonds, you can be one of the groups of people that are able to live through market declines in difficult markets. And that's really what I want for investors because that is the behavior during difficult markets, is what can really help to have sustainable growth and help you to build wealth over time. You do not need a degree in finance in order to understand this conversation. And my goal by the end of the episode will be that you could talk with other people about investment allocation decisions and even your own decisions and why you make them with more informed information.

Asset Allocation Defined With Three Buckets

SPEAKER_01 3:12

So to begin with, let's talk about what is asset allocation. I want to keep this simple. Asset allocation is simply how you divide the money that you are going to invest across different types of investments. And sometimes we call different types of investments asset classes. You can think of it in terms of a pie chart, and some of the slices of the pie would include cash. So that's something that you can use to fund paychecks if you're in retirement. It's also a safety net or could kind of substitute for emergency reserves. Then you have bonds, which are loans to different entities that are kind of packaged in an investment vehicle that you get paid a dividend to or paid interest to lend your money set by prevailing interest rates. And then stocks are investors are aligned with companies in order to grow over time based on the profitability of the companies and the growth in their earnings over time. There's also other subsets of investments. There's private investments as well as alternative investments, and sometimes those can be interchangeable. But we're going to stick with the big threes cash and most importantly bonds and stocks in this conversation. I'll mention, I always think about investments from the less risky to the more risky. And so I'll often or almost always start by discussing cash and then bonds and then stocks, because that's a representation of day-to-day, month-to-month both risk as well as opportunity. They kind of go in that order from less risky to more risky. So when we're thinking about how to invest, some people may choose to only have cash or things that are very close to cash. We often call those cash equivalents. Some people may choose to only have bonds or mostly have bonds. And other people may choose to have almost only stocks. There are proponents for each of these types of strategies. But for most of my clients and most of the people I work with, they have some combination of all three and may also include other alternative investments. And by having different types of investments, this variety helps to keep a balanced investing diet. It gives you opportunity to make money in different types of markets, and it also helps to prepare in some cases for a rainy day. But the bigger, you know, kind of focus when it comes to investing is on in the fundamental conversation is between stocks and bonds.

How Stocks Actually Create Returns

SPEAKER_01 6:14

So when you own a stock, you own a part of a company. And as that company makes money, has profits, and its price changes, hopefully going up, you participate in those ups and downs as an owner of stocks. And nowadays, many people end up not just purchasing the stock of a single company, but either through mutual funds or exchange-traded funds, they will instead purchase groups of stocks. And they might be indexed investors where they have stocks similar to common indexes like the SP 500 for larger companies or the Russell 2000 for smaller US companies, or a commonly referenced index for international companies is MSCI. And so in all of these types of investments, you're expecting more growth over time. That growth has typically two primary components. One component is the change in the price, which can be attributed to how the financial world perceives that company. The other component is a dividend. And so that is typically paid quarterly for the companies that pay dividends. Not every company pays a dividend. But when you add up the change in price, up or down, plus the dividend, which could be anywhere from zero to a certain percentage of the company's value, let's say zero to two percent, if you're thinking about US-based stocks, when you add up that change of price plus the dividend, you get the return of the stock investment. Many people are under the impression that the dividend paycheck is kind of all of the returns of the stocks. And it's really important to note that the change in price matters as well. And of course, the stock change in price can go both up and down. In about seven or eight out of ten years, on average, stock prices tend to go up. You have more consistent probability of how stocks will behave when you bundle them together in groups like indexes. It's less consistent company to company, which is one of the reasons that professionals like myself like to recommend that you invest in more diversified kind of bundled things like exchange traded funds instead of just picking, you know, the companies that you're familiar with, um, where many of those companies may have, you know, kind of a different batting average year to year versus indexes as a whole. So some of the pros of um stock investing are that you have high potential return. Um, also, stock investments tend to be considered a good hedge against inflation. They offer better protection for the purchasing power of your dollar over longer periods of time, um, at least hypothetically, no guarantees versus um more um bond investments and certainly cash. Um, and stocks tend to be a great, especially in the United States historically, have been a great wealth creator over time. But you also have to live with when you invest in stocks, um, periods of underperformance or the ability, um, uncertainty of losing money during um certain periods of time. And um, things bounce around and are more volatile than typically than bond investments.

Bond Basics Plus Hidden Risks

SPEAKER_01 9:50

So now switching to bond investments, you are essentially lending money. So let's think about the um the biggest part of the bond market in the United States is government lending. So you have treasury notes, um, government um debt or mortgages. Um, and if you're a bond investor, you say, hey, I'll give you the money to do the work that you need to do, and we'll agree to be paid an interest rate based on how much risk is involved in the borrowing, the prevailing um interest rates in the market, and a variety of different considerations. And so bonds, um, you have considerably more stability than stocks, but that also lowers the return potential. So it's more of a burden in the hand. Um, this tends to be more stable, um, although not without risks. Um, income is a the primary component of your investing returns is income. Although typically with bonds, the prices can change over time. So if interest rates go up and you just bought a bond the day before that has a yield that is lower than where um interest rates are today, the price of the bond may go down. And so there's there's still can be changes in pricing that are incorporated into your bond returns. But a lot of the performance has to do with the yield from when you purchase those bonds. Some of the cons are bonds don't protect as much when it comes to protecting from inflation risk, especially because when interest rate or when inflation goes higher, one of the ways to combat that is to increase interest rates. Um, um, you need to pay attention to the creditworthiness of whatever entity you're lending to. That could be companies, there's also private credit or investments borrowing with private companies, as well as with spiraling debt and deficits. Even government debt is not 100% assured to always be a creditworthy borrower. So often, and for most people, a combination of two the two of these will be the biggest component of your investment portfolio.

Common Stock Bond Mixes Explained

SPEAKER_01 12:12

And um then you start to talk about a nomenclature or naming convention that has two numbers paired with each other with a dash across it. So, you know, I'm 100% stocks or I'm 6040, um, 60% stocks and 40% bonds. That is kind of a naming convention that we use in the investing world to talk about how you set up your investment portfolios. Um thinking about when you get those two numbers combined, that's not a year in the future. That is something that you would be thinking about how much your risk you're taking on, what percentage. Usually whatever is mentioned first is the percent stock, and whatever is mentioned second is the percent bonds. And I mentioned 6040 as an example because that is a very common mix of stocks and bonds that is recommended or used for retirees. It kind of became a standard in the 80s and 90s. Um, and even today, I use a little bit of a departure from it, but something very similar. Many of my clients that are retired and they want more moderate risk, they don't want to take on as much risk, may be invested in about two-thirds stocks and one-third bond or 6535. Now, I'll tell you, any of these examples that I'm mentioning in the conversation today are not recommendations for how you should invest your money in particular. They're just examples for you know the type of portfolios that people may have. I've always found that if you kind of slice things by 5% increments, which can be very common, um, there's a lot of like kind of micromanage-y decisions being made, and it becomes um more difficult to make kind of the the most important decision. So, in working with clients, I try to keep the investment allocation decisions kind of branched out in a 15 to 20% apart from each other. So my portfolios are built to be either 100% stock, um, but diversification amongst um big and small companies, both in the US as well as around the world, and including alternative investments. Then I have models or portfolios that are about 80% stocks and 20% bonds. So one notch um more conservative because you're introducing bonds to the portfolio. That's your 80-20 portfolio. And then I bounce all the way across to 6535. So that two-third, one-third that I mentioned, and then again another 15% notch to 50-50, and then one that is 30% stocks and 70% bonds. And that go, and then one that is like almost all cash and very short-term bonds, taking almost no risk in the short term in terms of change of prices. But what you do when trading off with that is it becomes very difficult for those types of portfolios to keep up with inflation and certainly tends to be hampered from growing ahead of inflation or kind of building wealth more than what you have acquired already. Um, so these are just some examples of investment portfolios.

Picking A Mix That You Can Hold

SPEAKER_01 15:33

Some interesting considerations when you get to that point where you're making the decisions are how soon are you going to need this money? Um, and you know, for money that's gonna be set aside likely for retirement 20, 30, 40 years away, being more aggressive may make more sense. Um, but also another consideration is just your investing psychology. Um, if you are just up at night, unable to sleep, um, feeling high, high anxiety when the economy and the stock market are in disruption and going down, um, then I 100% want to understand that about you and make a recommendation for a less aggressive portfolio. Um because the number one thing that I think is kind of a killer of overall wealth building and investment returns over time is how you react during difficult markets. It's also how you react during exuberant markets when everybody is kind of making money on silly investments, um, making sure that you don't take on too much risk at that time, but also that you don't bail on your investing strategy when the market is testing you. And so all of these, um your time horizon, your circumstances, your experience investing, um, as well as your investor and behavioral psychology, are important considerations for a professional like myself to advise you or for you to consider if you're DIYing your investing strategy. And you may be doing this with the assistance of a variety of things, including your retirement plan providers, if you're employed. Um, so more and more people are having conversations about how to invest with AI, um, as well as in um conversations with investing professionals. So we go through, you know, kind of here's some mixes of stocks and bonds that may make sense. I've described how I kind of think of things. I just don't like to slice it every 5% because you really don't get that much difference if you choose, you know, 8020 versus 8515. I like to make that big rock decision by making fewer choices and kind of narrowing it down to, hey, these two seem like they may be a fit. But keep in mind that for me, a successful investor has a high, high batting average of staying invested. That's how actually I measure my own success as an advisor with people, is how what percentage of my clients maintain their investing strategy through difficult markets. And of course, that is accompanied by a lot of proactive conversation and communication from me to my client base. Um, but also if people choose to change how they're invested, avoiding going kind of to all cash or completely to all cash, um, if they can just go one notch more conservative, that's preserving a lot more potential for returns than bailing on the entire investing strategy, which what's typically happens when this is the result for people is that they don't end up getting back invested and they've kind of materially changed how they approach their investment portfolios from there. Um, so there are all sorts of elements of risk that you may consider when you're making your investment allocation decisions. How you personally feel about risk, what the needs are of your investing

Retirement Risk And Staying Rich

SPEAKER_01 19:05

plan. I often tell people that the allocation for someone working on getting rich or really building wealth aggressively can be different than the right strategy for someone who wants to stay rich and maintain the wealth that they've already built. Um, I often find that the first days of retirement are sometimes the riskiest for people. And the academic research bears this out. You have the most number of years to make your money work for you, and it's a huge transition when you start to switch from your employment or self-employment being your paychecks to using your portfolio as a paycheck. So it feels very insecure as well, and you're not used to relying on your portfolio for investing. Um, so that's a period of time where I encourage people to consider whether you need actually need to get um a little bit, take a little bit of a foot off the gas relative to actually surprisingly later in life as well as when you're accumulating investments versus young investors who really sometimes their most valuable asset is their earning power, and they um maybe have a higher capacity for taking on risk and be more comfortable being more aggressive over time. You also need to be concerned about um paying taxes. There can be risk for strategies where you change things a lot, um, where there's a tax cost along the way. Um, it's also difficult if you have become super concentrated in one particular stock. Maybe you got an inheritance of um some stock that was really important to your family, or you're being compensated because you're employed by a company that has equity compensation, like restricted stock units or incentivized stock options. And so managing for that type of risk is also something that I want to consider in investment allocation decisions. Let's say someone's been getting paid in company stock and hasn't sold it, so that stock is built up and been very successful. We may choose to take less risk in the rest of the portfolio because um there's so much risk in the in in a good way in the concentrated stock position that also has a high tax bill for you to make different moves. So, some questions I'd like you to think about if you're investing like a professional like me. What is this money for? Is the money that you have I have, for example, for retirement is at least a decade, if not likely more away, versus my kids are going to college the first one the year after next. So that money may need to be more conservative. And in fact, my kids' college funds have a different asset allocation than my retirement funds, which are more aggressive. Um, if you're saving for a big ticket item like a vacation home, an upgrade to a house, um, you're planning to leave a legacy for kids, those may have different. Allocations, the money that you're planning to need or want to use sooner may need to be more moderate. And if you have a Roth IRA you're not planning to touch throughout retirement and really want to leave it to kids or grandkids, that might be an account that is appropriate to be much more aggressive than your common portfolio. When I'm looking at the right mix of stocks and bonds, I'm also talking about more specifically that time horizon. And the one thing I think people get often wrong amongst others is that they think of the day they retire as a finish line when really it's a starting line to what we hope would be two to three decade long, if not more, period of time where you're going to use money. So that's another question. Another question to ask yourself, especially right now, because markets have been so strong for so long, is with the amount of money that I have today, what would I feel like if the market were in my portfolio were to drop by 20 or 30% for an extended period of time? The last significant downturn we had was in 2022, but it was really contained in about a year time period. So it wasn't like a two or three year malaise. But in the 2000s, between 2000 and 2010, there were two multi-year periods where most people's portfolios were down for a considerable period of time, more than a year. And how would you feel? It might feel entirely different the last time there were an extended downturn when maybe you only had $50 or $100,000 to invest. You were just starting your retirement portfolio versus today, where perhaps you've accumulated a million dollars or more, and a 20% downturn is equivalent to $200,000 lower for that million dollar investor. And so asking yourself how you would feel using dollar terms can be really helpful in assessing whether you're comfortable right now. If you're someone who has a pension or a new a stream of income through an annuity or a lot of income from Social Security or passive income like rental income, then you may be more confident in taking more risks with your portfolio because you'll have to rely on the portfolio for less of the periodic income. And then, of course, being retired versus working can be another important consideration. And then having cash on hand for emergency reserves can really empower you to take more aggressive action in your portfolio. I think I've mentioned in the podcast before that sometimes people come to me and they're like kind of shamefaced saying, Oh, I've got a lot of cash on hand, you're not going to like that. And in fact, having adequate emergency reserves and growing that over time as your life and lifestyle change is music to most financial planners' ears. And I love the concept of really being careful with your emergency reserves to empower you to take more risk with the rest of your balance sheet.

Check Your Allocation And Rebalance

SPEAKER_01 25:10

So, as you're thinking about this, um, a couple things to know. One is with tools available like logging into your retirement accounts and looking at your portfolios with reports that your financial advisor gives you, you should be able to see pretty straightforward what your mix of stocks and bonds is. And that would be a great exercise to determine, hey, what's my current asset allocation? And then using some of this conversation as well as you know, resources that you have with the professionals you work with, think about whether your asset allocation needs to be adjusted. Maybe you intentionally set up something five years ago, but if you just left it to its own devices, you might have a lot more stocks than you thought you should when you started, because stocks have had such higher returns over the last five years relative to bonds. And you may have more risk in your portfolio than you thought you needed. And if you have kind of emerging goals that need to be addressed, whether it's the kids' college or a home improvement or upgrade, consider kind of slicing out that part of your portfolio if it's earmarked and already set aside, and making sure if you need to adjust that piece or that part of your investment portfolio, that you're making the appropriate adjustments that you think you'll need.

How To Get Help And Closing

SPEAKER_01 26:30

And as always, if you have any questions when it comes to your investment allocation or overall wealth decisions, please don't hesitate to reach out. I am always happy to answer questions as well as have a conversation if you think it makes sense to have a professional look at your own circumstances and situation. And with that, um I thank you for joining me again this week. We'll talk to you in another week.

SPEAKER_00 27:09

Thank you for listening to the Women's Money Wisdom Podcast. If you found value in this episode, the best way that you can support the podcast is to forward an episode to a friend or leave a review. Go to proplan.com and the podcast link to get all the resources and links mentioned. This presentation by Pro Planning is intended for general information purposes only. No portion of this presentation serves as a receipt of or a substitute for personal investment advice from Pro Planning or any other investment professional of your choosing. Copies of Pro Planning's current rent and disclosure brochure and from CRS discussing our advisory services and fees are available upon request or on our website platform at Pearlplan.com. The information that we share is meant to educate and inspire, not serve as personalized financial advice. Everyone's situation is unique, so be sure to consult with your own financial professional for guidance that fits your life. And just so you know, the opinions shared in this podcast are Melissa's own and those of our guests. They don't necessarily represent any organizations with which Melissa is affiliated. For more important disclosures, please go to our webpage at proplan.com.