What’s Your Number?

Dan Wiener: Hello. This is Dan Wiener, chairman of Adviser Investments, with another Adviser You Can Talk To Podcast. I’m here with Jeff DeMaso, Adviser Investments’ director of research, and we’ve been talking over the past few weeks about a topic that seems to come up from time to time and we thought was particularly relevant, given the stock market’s decline in October. Jeff and I were talking about the question of what’s your number? Not your retirement number, but the number or the size of the loss in your portfolio that can keep you up at night. Right, Jeff?

Jeff DeMaso: Yeah, that’s right, and I guess the very first thing that should be said is if you are staying up at night because of your portfolio declines, you’re probably taking on too much risk and that’s the number one sign that you need to revisit how your portfolio’s positioned.

Dan Wiener: We often talk about volatility. You know, volatility goes two ways, right? I mean there’s volatility to the upside; there’s volatility to the downside. But when investors talk about their number, in fact, not the retirement number but how much money are you actually losing in your portfolio when the stock market’s going down? If you start with a million-dollar portfolio, for instance, in October, that seven-percent decline, that was $70,000. That left you with closer to $900,000 in your portfolio than the million you started out with, right?

Jeff DeMaso: That’s right and you could take it a step further and try and run through some more examples just to think about when you’re looking at your portfolio before it drops. We’ve done some research that says that in the average year, the S&P 500 drops 14 percent during that year so a 14–percent decline on that million-dollar portfolio, that means you’re down a $140,000 and you’re left with a portfolio of $860,000.

Jeff DeMaso: Bear market, that draw a line in the sand’s drawing at 20 percent, again on that million-dollar portfolio, that’s a loss of $200,000 so you’re down to $800,000 in your portfolio. We found that when you have a bear market, the average decline is actually 35 percent so that’s a $350,000 loss and your portfolio would be at $650,000.

Dan Wiener: That’s more than a third of my money disappearing in a bear market, right?

Jeff DeMaso: It is, but you say, “disappeared”: It really only becomes a permanent loss if you sell and lock in those declines. We know over time that the market tends to rebound and go up over time. But at the same time, as I said, use these as expectations. If those declines sound too much for you, then you need to think about reducing risk, buying bonds or cash.

Dan Wiener: You know it has often been said that people tend to focus on the percentages when assets are going up and they focus on dollar amounts when they’re going down. Why do you think that is?

Jeff DeMaso: Well, I think the first thing is that loss aversion is a really strong emotion. Loss aversion is the idea that we feel pain or the decline in our portfolio twice as much as we do when we see those gains.

Dan Wiener: And then you look at those dollar amounts and, you know, October’s seven-percent decline on my million-dollar portfolio, that’s $70,000. Retirees, in particular, who aren’t earning income, they can be thinking of these dollar amounts in terms of other units, right? $70,000 might be a year’s rent. It might be the equivalent of two or three cars. It could be many year’s worth of golf club dues. You know, we tend to see a number, I think a lot of investors, or people in general, see a number, and equate it with something they’re familiar with in their life.

Jeff DeMaso: They do and particularly now that we’ve been 10 years into a bull market and your portfolio is probably much bigger today than it was eight, nine, 10 years ago, those losses, those declines are going to translate into even bigger numbers; so for some people that’s going to be an emotional problem. You know, 10 years ago maybe your portfolio was a million dollars, a 20-percent decline is a $200,000 drop. Maybe today, your portfolio is five million where a 20-percent decline means you’re down a million dollars—portfolio just dropped a million dollars. That can be really tough to see.

Dan Wiener: But that $200,000 decline that looks so big when you had a million dollars, I mean that would be a four-percent loss today on a five million-dollar portfolio.

Jeff DeMaso: Absolutely, and you could also spin this around and look at it the other way. Maybe your portfolio is bigger today than it was and that gives you a bigger cushion. Maybe you’re sitting there and saying, “whoa, I still have four million dollars. That’s pretty good.”

Dan Wiener: Right, even after a 20-percent decline or the other way to put it, is after a million-dollar decline, you still have four million dollars.

Jeff DeMaso: Yeah, and look, at the end of the day, if a number or loss is keeping you up at night, you do have to respect that and think about that when you’re building your portfolio. But rather than focus on the number, we try and focus on your broader financial planning questions: What are your needs?  What are your goals? How do those compare to your income and your overall portfolio? A key point here is that it’s an ongoing conversation. It’s not a one-and-done, “This is my number and that’s what it’s going to be forever.” Things evolve as you go through life.

Dan Wiener: And the markets do, too. I mean that’s why it’s very important, I think, to both understand how numbers and percentages change over time, but also I think you made the point, when we were discussing this earlier that maybe it’s best if you don’t focus on that number too much.

Jeff DeMaso: Absolutely, I’m not a fan of really having a number, whether it’s a number that you’ve got to retire at or the number on the decline. We do try and think in percentages—your portfolio holistically, your goals holistically—and declines always feel scary in the moment but in the past each decline has been an opportunity so we try and focus on that going forward as well.

Dan Wiener: And I think the point here that you’ve made about financial planning being an ongoing conversation about where you’re at, where your spending is at, where your savings and investing are at, that’s really important. That’s really the bottom line, isn’t it?

Jeff DeMaso: It is.

Dan Wiener: Jeff DeMaso, Adviser Investments’ director of research. Thanks for taking the time today. I’m Dan Wiener, chairman of Adviser Investments. Thank you for taking time today to listen to another of our Adviser You Can Talk To podcasts.