Three Types of Risks to Consider When Investing In The Market

Segment 1 Transcript:

00:00 Danny Howes: Good morning, Vero Beach. Welcome to the Financial Pulse Radio Show. I’m your host, Danny Howes, CEO of East Coast Tax and Financial Planning. Welcome, welcome. Hope everybody’s been enjoying the weather, like I have been. It’s been amazing here on the Treasure Coast lately. A little windy, but it’s been really nice.

00:15 DH: I wanted to address the elephant in the room lately, with the stock market. We’ve seen dramatic swings this first quarter of the year. It seems like that’s the buzz in the news. And everywhere you turn, you’re hearing these things. And last week, of course, we saw a two day decline, like 1,700 points in the Dow. So a lot of people are asking, “What should we do?” It’s alarming, if you have a lot of money in the market, and you don’t have a good sound financial plan, and you’re not diversified, or maybe you just don’t know. It can be very nerve-wracking, if you’re getting close to retirement or you’re retired. And we all remember what happened in 2008. We all remember what happened with the tech bubble and terrorist attacks, back in the early 2000s. And so nobody [chuckle] wants to experience that. Everybody wants to avoid that.

01:09 DH: But on the flip side, everybody wants to get rich. Everybody wants to make money. And you look at last year, last year was phenomenal for the markets. And so there’s been just a tremendous amount of interest, in as far as people wanting to invest, and take advantage of that, with the cryptocurrencies, and tech. You just look at some of these companies that have made… The stocks have just soared. And now, it’s kind of an uncomfortable plane ride. Turbulence is back. And so, then there’s this question of, “Well, should we stay in? Should we double down? Or should we get in, or should we get out?”

01:51 DH: I wanted to talk about the three different types of risk that affect markets in general. There’s more. You could go more granular, than what I’m gonna talk about. But I just wanted to talk about big picture, the three different types of risk that really can affect markets. The first is what we’re really seeing in real time right now, and that is legislative risk. Legislative risk is basically completely unpredictable, and the reason why, is because it’s regulatory risk, it’s legislative risk, tax risk. And who makes those policies? People, Congress, the President, and so forth affect legislative risk, and that can cause a dramatic impact on the market. If you look at what happened with the Tax Reform Act, that was actually a positive thing, right? We saw the stock market just bounce incredibly up, as a result of passing that bill. Companies were excited. They gave out huge bonuses to employees, a lot of ’em.

02:52 DH: We’re a tax firm here, as well as an investment firm, so we prepare a significant amount of tax returns for individuals and businesses. And we’ve been doing a lot of analysis for people, to show them what the impact that new law is gonna be on their personal income taxes going into 2018. And it’s pretty significant. If you’re retired, you have a pension, Social Security, maybe you’re taking distributions from IRAs, maybe you got some capital gains, and interests, and so forth. We’re seeing, on average, people saving about $2,000 to $2,500 a year, going forward, as a result of the Tax Reform Act. Businesses, even more, because of the pass-through entity reduction in income that’s happened, both on S corps, and corporations, and so forth. So positive impact as a result of legislation.

03:45 DH: But most of the time, [chuckle] it’s not like that. Most of the time, it’s a negative. And we’re seeing that in real time right now. If you just look at the tariff talk and what’s happening with that, that’s affected the markets, in general, in a big way. It was interesting. I was listening to… I was watching the news and they were interviewing the previous CEO of Heinz. I can’t remember what his name is, but he was talking about, with the steel tariffs, just one penny difference. So let’s say there’s a penny difference on a can of soup. With the tariffs, if there’s an increase of cost of a can of soup, say tomato soup, one penny, that can make a dramatic difference in a company’s bottom line. Because most of us think, “Well, one penny’s not a big deal. One penny?” And then we’ve got… Well, his opinion was very interesting. And what he said was, “Well, it’s not just one penny. It’s consumer perception. Because with a lot of things, especially with canned goods, sodas, and all these different things, consumer perspective is very sensitive.”

05:02 DH: And so, if you look at a can of tomato soup, that usually, you sell for 99 cents, but now you have to sell for $1.01, the consumer looking at that looks at it in a completely different perspective, than just us saying, “Oh, it’s only a penny.” There’s actually… It’s price pressure to make a decision, of whether or not they wanna buy that product. And so the company’s reaction is, “Well, if our price threshold for the consumer is 99 cents, then we’re either gonna have to take that bite ourselves on our bottom line, or the consumer’s gonna have to pay the extra.” And the consumer has the choice. They don’t have to buy that can of soup. They can buy a generic one or do whatever to save money. So the impact of the tariff thing is very interesting, to watch people’s different reactions and responses to it. Regardless of what side of the aisle you’re on, politically speaking, it’s just very interesting.

06:05 DH: The other thing is, you look at President Trump, he’s been talking about regulating digital commerce, e-commerce, and that’s affected tech stocks in a big way already. We’ve seen a huge amount of volatility in companies like Amazon as a result. Legislative risk is very important to keep an eye on. It’s immeasurable. You can’t really price it in, until it happens. And you don’t know what’s gonna happen, until it comes out. You can’t look at a chart and say, “Historically speaking, this is what legislative risk does.” It’s completely unpredictable.

06:40 DH: The other type of risk I wanna talk about is business risk. Business risk is that risk that we’re actually seeing in the markets right now too. And that’s basically the old adage of, “Don’t have all your eggs in one basket.” And a lot of people end up with business risk on accident. Maybe you’ve worked for a Fortune 500 company and they had generous stock awards. Like Publix, here locally, they have very generous stock awards. A lot of Publix employees hold a lot of Publix stock, and what ended up happening, inadvertently, is that they end up with business risk, because so much of their wealth and their future is based upon the performance on one particular company.

07:20 DH: I’ve been seeing this a lot lately, because people get, just really enamored with particular companies, tech companies, in particular, like Tesla. Everybody wants to own Tesla, and Facebook, and Amazon. And that’s all good stuff, but you gotta be very careful, because if you go out, and you make a significant bet with a significant [chuckle] portion of your wealth, then unpredictable things happen to companies. I mean, look at Facebook. Just because there was a little privacy breach, all the sudden, billions of dollars of value of that company has been erased. You look at Amazon, just because the President goes out there and says, “Oh, we wanna start regulating that,” boom, billions of dollars erased. It’s been unbelievable to see that, but that’s business risk. You have to be careful. You have to be diversified.

08:14 DH: And when you’re talking about business risk, many people think that they’re diversified when they own mutual funds, or when they own exchange traded funds. You could have 10, 15, 20 different mutual funds, but all those mutual funds could potentially own the same type of companies, or same companies inside those mutual funds. You have to be very careful with that as well. We run a stock intersection report through Morningstar that un-bundles those mutual funds, so we can see exactly what they’re invested in. We can see if, whether or not somebody is way overweighted in one particular company, or sector of the economy, that could cause that business risk. That’s very important to consider.

08:57 DH: And then the third market risk would be systemic risk. Systemic risk is where there’s no place to hide. We saw that, 2008. We saw that in the early 2000s with the tech bubble, and terrorist attacks, and so forth. And that is just where everything is just correcting, and going down, and it’s a very uncertain, and very unsettling situation to be in. The mortgage crisis was terrible, almost a two-year decline, where it just seemed like it was never gonna come back. And that was a global situation. There was no place to hide, even globally. That’s systemic risk.

09:40 DH: So you talk about legislative risk, you talk about business risk, you talk about systemic risk. And right now, I feel like we are facing all of those things in the market right now. It doesn’t mean there’s not opportunities. It doesn’t mean that we should get out right now, but it’s something that you have to keep a very close eye on, and consider all three of the three-legged stool of risk, if you will.

10:05 DH: We’re gonna be right back. We’re gonna talk more about risk, what’s going on in the markets. I’m Danny Howes for Financial Pulse. We’ll be right back.

Segment 2 Transcription

00:00 Danny Howes: Welcome back to the Financial Pulse Radio Show. I’m your host, Danny Howes, CEO of East Coast Tax and Financial Planning. Today, we’re talking about risk. It’s the elephant in the room. Everybody’s concerned about it. The market is just extremely volatile. Some people feel like there’s a significant amount of opportunities, maybe doubled down by more. People that have been on the sidelines, maybe you wanna get back in. And there’s other people that are just scared to death, and they [chuckle] wanna get out. They don’t wanna deal with this anymore… The reminiscent of 2008, and the early 2000s, and those big crashes. Nobody wants to stub their toe in the dark again. They wanna be very careful and rightfully so.

00:39 DH: In the last segment, we talked about the three-legged stool of risk, legislative risk, which is tax risk, and regulatory things, the tariff talks, and just regulation and legislation. And it’s very unpredictable, there’s no charts to measure it. It’s just… Is what it is and depending on who’s in office. It doesn’t matter which side of the aisle you’re on. In my opinion, both parties tend to screw up markets.

01:10 DH: And you have business risk that we talked about, having all your eggs in one basket, being overweighted in a particular company, or a particular area of the economy, a sector of the economy. And we also talked about systemic risk, where it’s just basically no place to hide. It’s just, everything’s going down, correcting bear market. And right now, we’re facing all of those three risks [chuckle] in the market. I am not out there just saying, “The sky is falling.” I’m just saying that, “It’s time to pay attention.” To make sure that you understand what’s going on, what you have, how it works, and how it affects you. Understanding how much you’re weighted in a particular area of the economy, or how much you have in a particular company, being careful to understand and watch what’s going on with legislation, and also just being careful, and have a plan in place, for maybe a circumstance of systemic risk, where we do see a significant correction in bear market.

02:17 DH: All these things can negatively affect us, but here’s what my answer to all of that is. And I’ve talked about this quite a few times this first quarter on the show, but I can’t ring the bell [chuckle] loud enough, and that is making sure that you have a sound financial plan. I talk about this in my workshops, and I talk about this on the radio, in the podcasts, and so forth. Having a financial plan in place, a purposeful, written out plan, to make sure that you have success over the long term, really can ease your mind and help you make smart investment decisions, with uncertainty and the unpredictability of the stock market. The stock market is not where you start. The stock market is not what we rely on for our economic security. That should be the last place that you put your eggs in, that you really have to rely on. That’s long-term growth. It’s long-term value. It’s equity that you want to build wealth over a longer period of time.

03:26 DH: Warren Buffet has become the ‘Oracle of Investing,’ because of patience, and time, and the value that he sees in what he’s investing in. Why has he been so successful? Well, he’s been so successful, because he has the ability to wait it out. It’s, “Be greedy when others are fearful and fearful when others are greedy.” That’s a saying of his. Well, he has the ability to do that, because he has the financial margin, in order to be able to handle that. Well, each of us have to put ourselves in that same position of power, and choice, and control. And we do that by putting together a sound financial plan, an investment policy, so that when things happen, when we start to see volatility like we see, when life doesn’t go the way that we want it to go, we’ve got a plan in place to solve for.

04:31 DH: What is a financial plan? Well, I have a process called COAST that I’ve developed, and it’s just based around sound, fundamental financial planning concepts. And COAST is an acronym, it’s C-O-A-S-T, obviously, and the C stands for certainty. Certainty of income. Creating predictability in your financial life, making sure that you have enough income to cover your basic expenses, and needs, and the things that you desire to do. Certainty of income allows for an incredible amount of spontaneity. Spontaneity could be a number of things. It can be something as simple as, “Hey, look, honey, I’ve found a great deal on a cruise around the world, that we’ve always thought about doing, and it’s 50% off. We can go ahead, and take advantage of that, and pay for that, because we have certainty of income. We have a foundation, so we can be spontaneous.” It can also be spontaneous for an investment opportunity. Jumping in the stock market, making some bets, doing some things that you wanna do, and having certainty of income allows you to take a little bit more risk, if you want to. That’s the C part.

05:39 DH: The O is for on-demand cash. That’s liquidity. That’s for the ‘if’ and ‘whens’ of things happening in life. That’s the air conditioners going out, that’s tires on the car, you name it. It’s just for those unexpected, yet expected events in life. That’s C-O. So you got certainty of income, foundation of your financial plan. You’ve got liquidity for on-demand cash.

06:01 DH: And then the A stands for asset protection. That is for protecting each other, if you’re married, you have a spouse, but it’s planning for the inevitable. When you look at the statistics now, 50% of us are gonna need some sort of long-term care, for example. But it’s amazing, because only about 10% of us have long-term care insurance or coverage, because traditional long-term care insurance is usually just too expensive. But that doesn’t mean you don’t need to plan for that. Because if it’s a 50% shot that you’re gonna need it, you need to protect your assets from being wasted away, as a result of the expense, enormous expense that can be with long-term care, so planning for that. There’s more ways to plan for that, than just buying traditional long-term care insurance. If you’re older, and you just know you can’t afford it, or even if you could, you wouldn’t, because it’s just so darn expensive, and the rates continue to go up, and so forth, but planning for that expense. Right now, in the state of Florida, for skilled nursing facility full-time, it’s literally almost $100,000 a year. It doesn’t take a rocket scientist to see how much that could dwindle somebody’s wealth, even if you’ve got some. So protecting each other.

07:18 DH: Premature death is another thing to plan on. If we lose a spouse and you’re retired, you can see a significant downturn in income, just by losing Social Security, ’cause you only get to keep the higher of the two. It could put you at vulnerability. If you’re still working, you own a business, having key man insurance, if you have a really rockstar employee that really helps the bottom line. Or having disability, making sure that you have enough disability coverage or business overhead expense coverage, in case something were to happen, to protect you and your family. That’s asset protection. Protecting your assets from those things that happen in life.

07:58 DH: And then you look at strategic growth. So you’ve got certainty of income, that’s the C. The O is on-demand cash liquidity. The A is asset protection, protecting each other. And then we go to strategic growth. Because once you have all those elements in place, where you have predictability with your income, and your expenses are taken care of, you have liquidity for that emergency fund that Dave Ramsey talks about, that rainy day fund, and you have asset protection to protect each other for those events that could really destroy a lot of wealth, then you could look at growth.

08:32 DH: And it’s amazing, the freedom that I watch people have and experience, when they’ve taken care of all those other things. Then they’re not so scared of the stock market. Then they’re not so scared of the investments they wanna take, if they want to take any type of risk. Or they’re not scared to spend money. I can’t tell you how many people I’ve sat down with initially, and they’re just scared to death. They have a significant amount of money [chuckle] that they’ve worked so hard for, decades and decades, to accumulate. But they’re scared to death to spend money, ’cause they don’t know much money they can spend. But when you’ve taken care of all those other elements of your life, making sure there’s enough guaranteed income, making sure that you’re protected in case something happens, making sure that you’re liquid, that allows for an incredible amount of spontaneity to go and do what you wanna do. Whether it’s investing, taking risk, or whether it’s enhancing your lifestyle, and going and do the things that you always dreamt of, and checking off those bucket lists.

09:28 DH: And, of course, you always have to take taxation into consideration. Because you should never make investment decisions, income decisions, without knowing the tax ramifications first.

09:37 DH: Well, as always, we’re running out of time. I’m Danny Howes, CEO of East Coast Tax and Financial Planning. If you haven’t had your taxes prepared, if you’re a business owner, or a family, and you want to take advantage of our tax service, give us a call: 772-774-7970. If you want an analysis done on your investments, to see what kinda risks that you might be unknowingly or unnecessarily taking, go to eastcoasttaxandfinancial.com. You can register for an appointment there or call our office: 774-7970. Make sure you protect that money, folks. But most importantly, make sure you know who and what you’re protecting it from. I’m Danny Howes, every single Thursday, 11:30 AM, right here on WAXE Radio. We’ll talk to you next week.