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Step 1 of Retirement Success Plan: Investment and Portfolio Analysis

I'm giving you a choice of two Investments investment a and investment B both of them return 10 over the previous year which one would you rather have been invested [Music] oftentimes when I ask this question to a prospective client I'll get the response Troy it doesn't matter they both return 10 Give Me A or B but when it comes to retirement planning and this is why step one of the rrsp is so important the allocation meeting it's not about the return necessarily it's about how much risk did we have to take to get that return investment A and B both had a 10 percent return but this is just one outcome in an infinite set of possible outcomes remember these are two distinct Investments with different characteristics possibly different purposes so even though they return the same the question is how much risk did we take to earn this return are we being compensated enough from a reward standpoint based on the risk that we're taking so with a high degree of statistical confidence we could analyze and say investment a had a likely downside scenario of somewhere between five to fifteen percent if a different set of outcomes or circumstances occurred that's the risk profile but invest B had a possible downside of negative 20 to negative 40 percent now with that new bit of information which investment would you choose investment a or investment B all individual Investments or combination of Investments could be plotted somewhere along this chart this is what we call the efficient Frontier over here we have the return the expected return and over here we have the risk that we're taking so ideally we have Investments that are more to the left which represents lower risk and higher up the y-axis which represents higher return so if you own five different stocks that portfolio in and of itself could be plotted somewhere on this graph if you have one security let's say you're fully invested in your company stock you could plot it right here on this graph now if you have 20 or 30 or 50 different mutual funds or ETFs or individual stocks once again that set of Investments can be plotted somewhere on this graph so when we plot investment a and investment B on the graph here we can clearly see that they have a similar return profile but investment a has less risk so this makes it easier to identify as an investment that we would rather place our dollars now down here I have investment C could be a portfolio of stocks this could be maybe if you have a lot of money invested in your company stock but we clearly see that we're taking more risk without being rewarded for that risk that we're taking another way to think about this is think of your skills and the capability that you have in your current job or in your former job if you're if you're retired would you take a salary that was much much lower than Market in order to do that same job with those same responsibilities no you probably would not I know you would not that's what we're doing here with investment C essentially we are taking risk or taking on responsibilities in that example while not being compensated for it okay so think of these letters investment a investment being investment C this was the one we wanted to be in this is the one that we took a little bit more risk for the same return and over here we just don't want to be in I want to liken this to GPA grade point average because we're all pretty familiar with that either you from your schooling experience you have kids or grandkids an a investment or set of Investments kind of I put a in air quotes here that's the GPA so what we want to do with your portfolio in retirement is increase its GPA we want to reduce risk and increase expected return now that you have a good understanding of risk and return and how every set of Investments can be placed somewhere on that graph it's now important to tie that into retirement planning so the allocation determines how much income you can take how much money will be left later in life it determines how much tax you'll pay in retirement it can also impact your health care strategy or long-term care strategy and it definitely impacts your overall estate plan so those are the five steps of the RSP and this is why the allocation is so critical it's step one because it impacts everything else when you reach out to us for the first time all we do on that first visit is get to understand who you are and what's important to you we're going to gather some of the objective data under of course understand what your vision is for retirement your goals but the objective data is the current portfolio the financial statements the tax information how much we want to spend in retirement in between that first and the second visit we're going to go through an analysis to see where your portfolio falls on that Spectrum in order to understand if there's congruence between your willingness to take risk for the expected return that your portfolio can provide and where you currently are we first have to identify what is that willingness that you have to take on risk so we have to first understand your willingness to take risk so this is a pretty simple questionnaire here simply saying over the next six months you're comfortable risking this in order to make this potential return now this is what we call a symmetrical risk return profile we're essentially risking one dollar to earn one dollar but really what we're trying to identify here is what is your comfort zone on the downside because what we're going to try to do is create a portfolio that has an asymmetrical risk return profile so less risk to achieve more potential return so are you comfortable losing seven percent over the next six months in a recession or are you fine to let it stay invested and you believe long-term capital markets are going to do just fine so you're more comfortable in the short term possibly a 13 loss there's no right or wrong answer here but everyone's personal willingness to take risk is different so we have to identify that because if you have a portfolio that has too much risk that is the one thing that will absolutely be certain to blow up a long-term retirement plan if the market goes down you call us up panicking and say Troy I need to get out of the market I can't take it anymore well you most likely won't be in there for the rebound and all the planning that we've done up to that point can be significantly impacted because we were expecting the risk profile based on the conversations that we had to be structured properly and if it's not and the markets go down then we get out well all of a sudden everything is completely messed up so this is why your risk willingness is such an important concept because if we're putting a plan together we need to know that you're going to stick with it because markets will go down one other thing to point out here I like to focus on the dollar amount because percentages can be deceiving I had a client a long time ago or a prospective client come in and say Troy I'm comfortable losing about 10 percent he had two million dollars so I said okay if the market goes down and you lose 200 000 you're okay with that he said no I fire you instantly so there was a disconnect between the 10 percent and the two hundred thousand dollars so I like to talk about risk in terms of dollars because percentages seem just they don't really drill down into our willingness to take risk whereas if we focus on the dollar amount that hits home okay so this would be coming back on a second visit and we're looking at your actual portfolio and this is very similar to what we see someone maybe told us that they're they're comfortable let's say with about 50 stock but when we do the analysis what we often find is that there's more risk inside the portfolio but on top of there being more risk oftentimes it's not the most efficiently structured so we see down here we actually have bringing the GPA back a 3.1 so this means that it's not the most efficient from a risk-adjusted return standpoint means we're we're not where we want to be on that graph an annual range 3.42 so for taking this much risk we don't want to be rewarded with an annual range midpoint here of only 3.42 percent over the next six months now we also see with the potential risk and reward over the next six months there's a 95 percent probability that this portfolio to the downside could lose 16 percent over a six-month period and the upside is plus 19 so these are very very wide guard rails okay if we extrapolate that out over the course of one year we have a negative 32 percent and a plus 38 so most of our clients aren't comfortable losing potentially 38 percent in a single year so for this level of risk based on the questionnaire that we asked earlier and they come in around a 50 risk score this is not only too much risk inside the portfolio but it's really poorly constructed from an analytical standpoint and the guardrails are far too wide we're not being compensated for the risk that we're taking and that's what this GPA right here is telling us that's the analysis that we go through between the first and the second visit and that's often what we see it's not efficiently structured the portfolio possibly too much risk and oftentimes that GPA is a lower number meaning we're not being compensated with enough expected return for the risk that we're taking so in between that first and the second visit that's what our team is doing looking at your particular situation now once you become a client and we go through that allocation visit this is step one of the RSP what we're trying to do is to create a proposed portfolio that brings first and foremost the risk number in line with that questionnaire that we asked you before we're also trying to create some asymmetry in regards to the risk that we're taking in the expected Return of the set of Investments that we've put together so now what we've done is we've lowered the overall risk score of the portfolio to be more in line with the questions that we were asking in regards to that that slider that we had on the screen if you're not comfortable with potentially losing 19 percent in a six-month period we need to bring the risk score down in the portfolio so that's the first thing that we're trying to do the second thing is we're trying to create asymmetry here so you see this we're risking nine for the potential of 15.

This is over a six month period so we extrapolate that out over 12 months it's minus 18 for plus 30. that's asymmetry when it comes to the risk return profile additionally we've increased the GPA of the portfolio so the maximum according to the software is a 4.3 so this means we're being properly compensated for the risk that we're taking the expected return is the proper compensation for that risk now anything can happen Marcus can go up or down but what we've done is we've created an efficient portfolio that when markets are up or when markets are down our potential returns are in line with our willingness to take risks but also when we've tied this into your income plan tax plan and the rest of the RSP it's all creating a much more congruent financial planning experience also the expense ratio over here I don't know if you noticed before but we had an expense ratio in the mutual funds and that current portfolio in the proposed portfolio we've eliminated those fees so in summary here during the first visit we get to know where your willingness to take risk is in between the first and the second visit we're going through and doing an analysis of your current portfolio identifying the risk score see if there's any disconnect between your willingness to take risk in the actual risk inside your portfolio but then also looking at the potential return what is the GPA what is the expected return what is the Symmetry between these two once you become a client and we go through the allocation meeting here's where we look at the proposed portfolio where we get the risk number of the portfolio in a line with an alignment with your willingness to take risks try to increase the asymmetry between the risk and the potential return increase the GPA of the portfolio and increase the expected return now all of this is a shortened version of what the actual allocation visit looks like but it hopefully conveys how important this step is because it not only determines the amount of risk or the potential downside you could see to your values in retirement it also of course contributes to the potential return which then dominoes into your income for retirement the taxes the health care plan and also the estate strategy so step one allocation extremely critical when it comes to the retirement success plan this is why we do it first [Music] thank you

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