EWA’s Investment Pillars- Our Approach to Portfolio Management

June 29, 2023

Director of Investments and Trading

Investment Operations and Client Service Specialist

Episode Transcript

Welcome to EWA’s Finlyt podcast. EWA is a fee -only RIA based at Pittsburgh, Pennsylvania. We hope all listeners of this podcast will benefit as we deep dive into complex financial topics that we will make simplified for you.

And we hope that this really serves as a catalyst so that you can make the best financial planning decisions for your family and also save time. Welcome everybody to this week’s Finlyt podcast. We’re joined by Jordan and Nick.

Jordan and Nick are the all -stars behind the scenes at the EWA team. They’re responsible for all portfolio management, all money movement transactions, we’ll be onboard a new client getting all the transfers, rolevours, and the million details that need to take place and for existing clients on a day -to -day basis.

They’re the ones implementing all the planning behind the scenes. So Jordan and Nick, welcome. Exciting to have you. So we’ll be here, yeah? Thank you. Absolutely. Well, today’s episode, we’re talking in detail about our investment philosophy and our investment processes.

So I figured I’ll go high level because clients are used to me going high level, but they’ve never really gone into the finite details of what actually happens behind the scenes and why we make the decisions we do.

So as I go high level, I’m going to hand it over to you guys to go over the details because you know the details the best. So first of all, Nick and I have been working together over 10 years now. There’s been so many studies that have done on investment management that essentially 94% or 95% of your results or returns are if you follow three simple principles.

And those three simple principles are asset allocation, diversification, and then just having a long term investing timeframe to letting your money go. So let’s first start with asset allocations. Asset allocation, the way I describe it to our clients is it’s the relationship between return and risk.

So essentially, we’re trying to get the highest amount of return possible, but also well giving the lowest risk possible for the portfolios. And one of the key principles is actually how we named our firm equilibrium, which is having a balance and looking at that relationship between sometimes greatest strengths can become our greatest weaknesses, like the greatest returns.

One year could wipe all that out, because $1 million if you drop 50%, you’re down to 500% with 50% back up. Recovery, you’re only at 750%. So a great return can also become a great weakness if you get the opposite of that.

So we really do a careful job in asset allocation of marrying that high risk, but also with the lowest or high returns with the lowest risk available we’re getting those returns. So Nick, walk us through what actually is asset allocation and what does our portfolio look like to address this?

Yeah, absolutely. So we’ll discuss diversification a little later, but. asset allocation and diversification while different are definitely married in some way. But to start with just let’s take a look at asset allocation.

For us it’s holding a wide array of investments across different market segments and sectors. And you’ve heard the old adage, you know, you don’t want all of your eggs in one basket. Well, for our investment strategy we’re a long -term investing strategy type of firm.

So holding a wide array of assets and really diving into asset allocation is really at the forefront of what we’re doing with our investment management. So what do I mean by different market segments and sectors?

So for us we tend to utilize seven different asset classes primarily. There’s certainly additional asset classes that could be added to the array, to the investment lineup if you will. But for us we utilize equity investing in the United States versus international equity investing is primarily where I want to start.

So for US equity investing we’re looking at large cap, mid cap, and small cap. For international equity investing we’re taking a look at international developed markets versus international emerging markets.

So to break this down a little further. For US equities large cap, mid cap, small cap, that’s talking about the market capitalization. So basically just how big is the company that you’re investing in?

What’s the outstanding shares look like? So to kind of break down some examples, and this is where asset allocation and diversification kind of start to go hand in hand and what, but a large cap company you could look at Amazon versus a mid cap company five below is a retailer that falls in mid cap right now versus a small cap company which is, we could use Yelp as an example.

I do have some of the statistics on those as well. So when you look at the market capitalizations of those companies, obviously right off the bat you look at Amazon as a large cap company currently in the S &P 500 and clearly Amazon is a lot bigger and more reputable, more well known than Five Below.

But it’s still recognizable obviously. But the market capitalization of Amazon is in the trillions versus the market capitalization of Five Below which is in our mid cap space which is more like probably in the eight to nine billion range.

So both United States corporations but one significantly bigger than the other versus then going to small cap which is a little bit of a smaller company. So really the effect of having all three large men in small cap across your portfolio is the smaller the company, it doesn’t necessarily mean it’s a guarantee but the smaller the companies.

Typically, you’ll see a little more high risk in small cap, a little bit higher of a standard deviation. So some of the boom and the bust in those smaller companies can tend to outweigh some of the more reputable, bigger blue chip companies like a Google, like an Amazon, like an Apple.

So for us to really kind of like geek out and get into some of the numbers, I took a quick look this morning and just took a look at some five -year statistics. So in the large cap space, five -year average return for Amazon, 8% with a standard deviation of 34%.

So standard deviation is really looking at the potential, like ups and the downs, how far is it going to move from the median there? So obviously a higher standard deviation, you’d be looking at potential bigger swings, bigger swings up, bigger swings down.

So if Amazon’s at like an eight and a 34, let’s move down into mid cap at five below. Now we’re looking at the five -year return, 19% did pretty well over the past five years. Standard deviation of 43.

So the standard deviation is creeping up on this one. And then let’s take a look at Yelp down in the small cap space currently in the S &P 600. And the five -year on that is negative 4% return and a standard deviation of 47.

So if you’re developing and building a portfolio, to start, we wanna make sure we have pieces of all these different asset classes across the US. And then as we get into diversification, we’ll explain further why it’s so important to not just hold Amazon and five below in the Yelp in your portfolio to really make it more of a wide array of investments.

But when we take a look at large, mid and small cap, I think it’s important to note that’s a part of our asset allocation and our strategy is we wanna make sure we hold. a lot of different companies inside of these, and this is where it mirrors into diversification.

S &P 500 over five years, 11% return, standard deviation of 14 versus just Amazon, which was 8% return, standard deviation of 34. So already. So really a third of the risk. Exactly. With the high return.

Exactly. So that is starting to kind of blend into diversification a little bit, but the point being, as we move down through our allocation, US equities into international, so develop markets, you could take a look at the European nations versus emerging markets more of, I always like to say BRIC, BRIC, Brazil, Russia, India, China, these are more like low income, less developed, nations that are trying to make their way into being more modern, more industrial, more of a higher standard of living.

Certainly there’s plenty going on in China, but that’s kind of the definition of an emerging market. So we want to make sure we have pieces across our portfolio and all of these different areas. And the overall goal of asset allocation is to mitigate overall risk.

And for a firm like ours with a long -term investment strategy, that’s key, that’s paramount. That’s at the very forefront of what we’re trying to provide. So let’s talk, like, thank you for all that detailed background.

So before we hand it over to Jordan to talk about diversification, let’s talk about, I want to make this episode as accessible as possible. So obviously our clients have had many conversations about this.

They’re following our quarterly videos. Some of them have been with us for 10 years. But just for, you know, in general public, like, what I found initially with clients, we’re talking about asset allocation is we’ll go in for a review and then they’ll wonder, you know, why are we invested in this loser?

Because they’re looking at what happened last year. Maybe large -cap did phenomenal and emerging markets did great. So just naturally, I want to bring up the whole purpose of asset allocation is not to pick winners every year because that’s impossible.

And there’s no one in history that’s been able to do that. It’s to mitigate risk and it’s allowing everyone to be in all -weather portfolio. Because if you asset allocate properly, you can be in the market indefinitely in the future with a low amount of risk.

Because that asset allocation, we look at the last 15 years, I believe, and we’ll put this in the show notes. But the average returns, if you allocated the seven asset classes that you mentioned, and let’s just say it’s like an 80% equity between the large -mid, small international emerging market and then 20% fixed income, the, I believe, the return was right between seven to 8% over the last 15 years.

But the risk to that, the standard deviation was less than 10%. So it’s like everything you just quoted like Amazon, if you look at the risk, the return was 8, the standard deviation was like 32, is that right?

So basically you’re taking four units of risk for one unit of return. But what we’re describing asset allocation is it makes it almost a one to one. So it decreases and it allows you to not worry about what’s going on in the market.

And the short term, because my favorite quote is, the stock market transfers wealth from inpatient investors to patient investors over the long term. And asset allocation is the best methodology to ensure if you’re a patient investor to do so safely, securely, and historically for that to have been a consistent result that you would have received over the last 100 years.

So how would you respond? I don’t know, every year of 2021, why were we invested in emerging markets? That’s a loser, why did you put me in that? How would you respond to that? from a portfolio management perspective.

I know how I have to, how would you respond to that if a client asks? So that did lead actually just naturally into a little bit of a segue and I have some of the notes on kind of a sample, you know, 100% equity portfolio.

I did leave out in the asset allocation, fixed income and cash are the other two currently in our seven asset classes. So our equity exposure with fixed income and cash exposure as well. But so taking a look at, I ran the numbers for, again, these are five year numbers, but a sample, 100% equity portfolio.

If we broke that down and said, 55% waiting into large cap, 10% in the mid cap, 5% in the small cap, and then let’s say 22% developed markets versus 8% emerging markets. The five year numbers on that came out to be roughly 5 .5% return and a little under 20 standard deviation was 19 standard deviation.

So already like Matt was saying, the standard deviations cut in half easily and that’s just looking at a five year segment. I’m sure as you start to stretch this out, 10, 15, 20 years, those numbers will change even more so.

But so why are we doing, why are we constructing the portfolio? Why are we holding emerging markets? When emerging markets is down 40%. For us, it really comes back to emotion and it comes back to our long -term investment strategy.

So if you take a look at, I know a lot of advisors and I know I’ve seen it plenty, we like to call it the quilt chart, like a quilt asset allocation chart, bunch of different boxes, bunch of colors. And it takes a look at each asset class and how they’ve performed rolling over the past 10, 15, 20 years.

And what’s so interesting when you look at that piece from a visual perspective is the different colors, the different boxes representing the asset classes. It legitimately looks like a quilt. It just bounces around.

There’s really no direct Framework there that seems like it makes sense. So one one year will have Emerging markets down 40% and then the very next year it could be the highest performing asset class and it could be up 20 30 40% so for us About having that long -term investment strategy.

It’s about mitigating overall risk. So We don’t claim that we have the ability to pick the individual stocks to pick the winners Any better than anybody else So we want to make sure we’re holding a wide array of everything of all the different asset classes to ensure that we’re protecting some of the downside but also participating in the upside of those asset classes and Using that quilt piece as an example again The only trend line that actually really exists when you look at it is looking at a balanced well diversified portfolio That’s hitting all of the asset classes.

And just as you would expect, it kind of hovers, bounces up and down right in the middle of that piece. So it’s never the highest performing, and it’s never the lowest performing. But by nature, that’s exactly what we’re looking for.

We want to make sure we have those winners when they’re experiencing their wins. We’re also going to have some of the losers when it tends to be down. But overall, we want to make sure we have a well -asset allocated portfolio to achieve that.

Remove the emotion and for the long term, be on track. That’s so important. I’m trying to pull up this chart here. We’ll see if I can full put it on the screen when we, for everyone to see, to reference what you were just describing that, Nick.

But so something interesting, we actually recorded a video on this, but if you look at the standard deviation of a stock investment over short term, it’s very high. Because everything you quoted, large cap, mid cap, small cap.

When you look at it over like a 30 year period, the risk of investing in stocks is actually less than the risk of investing in bonds. And you’d think naturally bonds are safe. Well, interest rates fluctuations can affect the bond returns, but stock prices over 10, 20, 30 year periods, historically have always gone up, making the standard deviation very low.

So the easiest description I would give a client is, why am I in all this stuff? Some stuff’s doing great every year. Some stuff, every year, you’re gonna have a loser. Why am I doing this? Well, our belief system here is your investment portfolio should help you live a life by design.

And not everything you do in life has a 10, 20, or 30 year timeframe. Sometimes there is, your kids are gonna go to college. There’s an emergency that happens. And sometimes you need to pull unexpectedly from an account.

And asset allocation allows you to never take a loss, historically, because you can pull from a sector every year, historically, not guaranteed in the future, but historically, that’s not down. And so asset allocation not only allows you to, participate in the stock market indefinitely regardless of short -term noise that’s going on But it also allows you how to portfolio Is supporting your life by design because whatever it’s throwing at you We don’t have to worry about taking a loss if we’re asset allocated if we’re making sector bets and putting everything in a large cap Yeah, there’s me some years where if you need to take money You’re guaranteeing that you’re gonna take a loss because it’s down.

So that’s asset allocation Again, just to be clear It’s not where we’re gonna try to get the absolute best rate of returns It’s where we’re going to put a financial plan in place So your portfolio supporting your life by design and you always have a place to pull your money When you need it if you need it and not have to worry about any losses taking place So Nick anything to finalize before we hand it to Jordan On from we’re gonna go from principle number one of asset allocation principal number two diversification anything to wrap to both Not not too much I would say really just Our firm philosophy with this is really, we’re not deviating from asset allocation.

We will always have these different asset classes in our portfolio. Obviously, some of the underlying holdings may and will change over time, but to remain firm to this theory, like we will continue to invest in these areas, even when we do experience significant downturns in certain asset classes.

So we’re gonna go into detail about this, but some investors are gonna wonder, why can’t I just do this myself? You just said, you just quoted 50% large cap, 10% mid cap, and a lot of investors could do that, but one thing I wanna point out is when things go up and when things go down, it’s important to calibrate that.

So we’re gonna talk about rebalancing to make sure that risk -reward relationship is always not in place upfront, but ongoing. We’re also gonna talk about tactical asset allocation, like right now, specifically the DWA.

We moved a significant amount away from real estate investment trust, because of COVID and a lot of people are still working from home, and lease rates are gonna come up, and some buildings are gonna be at less than half capacity.

So we’ll talk about that, and having a captain steer your plane and avoid unnecessary turbulence and unnecessary crashes is important. So that’s one reason why you’d want a team to do your asset allocation for you versus you doing it.

And then I think personally, the worst advice in the world is to go put your money in a life cycle fund. So a life cycle fund basically picks your age, and it says, okay, you’re gonna be risky now, less risky as you go.

But when it comes to need the money, the asset allocation, if you’re in a index fund that’s like a 2050, a life cycle fund, and you have these asset classes purchased, and you suddenly need 100 ,000 out of there, they’re going to sell across the board in those fund shares, and they’re gonna be selling large cap, mid cap, small cap.

So if you’re in 2022, and we wanna pull from one sector that’s not getting hit, you’re forcing losses out of that entire portfolio if you’re in a life cycle fund. It seems like simple again. I don’t need to pay someone to do this.

Well, it’s not that simple, and it can lead to a lot of really bad results, unless you really know what you’re doing. So one of the reasons why we don’t recommend life cycle funds, which do achieve asset allocation is the whole purpose of asset allocation is when you need it, you’re able to get it without losses.

So OK, so with that being said, I love the analogy of a football team. Asset allocation, you have your quarterback, your wide receivers, your running back, your offense, your defense. You’ve got all these positions.

An investment policy statement can’t stop there, though, because technically we could have a portfolio that checks the box of asset allocation by saying, we’re going to invest in Amazon for a large cap.

And now our large cap is done. We’re going to invest in, what was the mid cap example? I used 5 Below for this. 5 Below, boom. Now our mid cap. That’s our wide receiver. Great, check mark. Well, what if they get hurt?

Then we’re really in trouble. So that brings us to the end of this video. directly piggybacking off asset allocation, it’s having those different baskets. What we put in those baskets, is it one company, or is it multiple companies?

That brings us to the concept of what diversification is. So Jordan, hand it over to the expert, tell us, talk to us about what is diversification and why is it important? Yeah, so with diversification, we have mutual funds and ETFs that hold from a range of 100 to 200 companies.

And with us, we like to do between 25 to 100 companies. 25 companies removes 80% of the diversification risk, and 100 removes 90%. Anything above 100 really doesn’t further reduce the risk, but going back to Matt’s analogy, like your quarterbacks hurt, you need a backup.

So we wanna have those companies as a backup. And we also believe with diversification, we believe in passive investing. So mutual funds are active. So they have these hidden internal expenses to pay their managers in their hire, whereas ETFs are passive, and they have a lower expense to pay their managers.

So we are between 0 .2 to 0 .3%. We like to keep it on the lower end. So we’re holding more ETFs in comparison to mutual funds. And then over half the industry, their expenses are between 0 .65%. So double.

We’re less than half, which is important for investors, because do you know offhand how many mutual funds outperform the market itself? I know it’s very few. Yeah, very few, like less than half of the mutual funds, or actually, I think it’s 80.

It’s less than 20% for large capital. So studies show that 80 to 90% of active mutual fund managers, they… do not outperform the indexes net of their fees. That’s crazy. So there’s this whole push of like, so I guess it’s really important as an investor to figure out what are you hiring an advisor to do?

And so obviously asset allocation is important, diversification, but the other thing is really just keep my fees as low as possible, right? Because if we’re so focused on those two principles, and those two principles are gonna drive 94% of our results along with like the timeframe of what we’re investing, why pay extra fees to do that through a mutual fund?

Yeah, and like the mutual fund managers, their goal is to outperform the market. We’re just trying to invest with the market because we’re not trying to market time. Well, short, I mean, short and simple.

So diversification is so important, and there’s so many examples out there. There’s apples, there’s the Amazons, but then there’s also the Enron’s and other examples of everyone was so high in that, then suddenly, So diversification is going to, you know, I love the like a pencil analogy.

So just to piggyback off everything you said, Jordan, so if you have the examples of like Amazon’s our large cap, well, if that’s one pencil, we can snap in half. And everyone’s gonna say, nothing’s happened to Amazon.

I agree, but you never know. You wrap 100 pencils together in a rubber band that represents all of our large cap holdings. It’s impossible to break. I’ve actually done that in a meeting for just to show the analogy.

It’s impossible to break. And then you put it 50 and a mid cap and 20, it still those bundles together are impossible to break. So again, it’s not, we may be missing because one company could shoot up and if we put it all or put our company that one company, but again, that’s just too much risk when our clients are trying to achieve financial independence and have their money work for them, not a life that’s dependent on maybe the money goes up, maybe it doesn’t.

And then, you know, they’re essentially a servant to their money versus the money being a servant to them. So how to flip that relationship? Because most people are in that bad relationship with money is to make sure your money’s supporting you and asset allocation diversification by far the two most important principles to follow.

So thank you. Anything to wrap up before we move on to? No, it’s just, yeah, like how you said, it’s just very important to fill all the buckets, large cap, mid cap, small cap, the international emerging and developed.

You just want to have your backups. No question. Nick, anything to add before we go into, you know, timeframe, the long term investing and some of the studies that we’ve analyzed? Yeah. So really to tie a bow on it, asset allocation diversification, two different things, but they go hand in hand for us.

You could have a portfolio that’s constructed that’s asset allocated very well, but the lack of diversification is going to obviously cause problems, as Matt and Jordan have both said. So tying into our portfolio and our strategy, the reason I took a look at individual stocks, Amazon versus the S &P 500.

We want to ensure that we have proper asset allocation and proper diversification, holding the S &P 500, holding the S &P 600, S &P 400 in the form of these passive investments, in the form of the ETFs in our portfolio.

It’s ensuring just that, that we’re holding hundreds of companies inside of each asset class, as opposed to just, let’s just invest in Amazon, let’s just invest in five below. So there is definitely a marriage there that you want to ensure the allocation is set up properly, but you also have very strong diversification.

And the ETFs are cheaper than the mutual funds, the passive investments, cheaper than the active investment. And again, we’re doing that because we’re trying to remove the emotion, long -term investing.

And we’re not trying to beat the market, we’re trying to invest with the market. Why pay a higher fee when, on average, most of those active managers, They’re trying to beat the market and they’re not doing so successfully.

So that’s kind of where we’re at. That’s our wheelhouse with our portfolio construction. And tune in. So for the sake of today’s podcast, not going into too, too much detail, but every single quarter, Jordan and Nick are going to be talking about the decision making behind asset allocation and diversification because this does.

So our principles are stay asset allocated, stay diversified, stay in the market. We’re going to talk about staying in the market in a second. How we do that and how we navigate the shift in our partnership, you know, for example, with Fidelity’s research team, the asset allocation decisions, what we wait into large cap, what we wait in the mid cap, what we wait into real estate investment trust, for example, that’s going to change based upon the type of cycle we’re in in the economy.

And if we’re in a expanding economy, certain companies are going to perform better historically. If we’re in a contracting economy, you know, talks about recession, defensive plays are going to be more important where people need to eat, people need us, you know, energy, people are going to need healthcare, for example.

So there’s certain companies that will be much more protected if we are in those kind of recession era versus a growth era. So we can do those things, the tactical side of this and follow our asset allocation diversification.

We’re staying in the market, but what type of companies we’re investing in, that’s going to be highly dependent and ongoing and change. And that is something we address every quarter on our court EWA quarterly updates.

So if you’re interested, tune in every quarter. Those go, you know, basically 15 to 20 days after the quarter ends. Those will be released from January 15th, about April 15th, July 15th, and then October 15th.

So that brings us to the third principle, which is long -term investing. So there’s a study done by a research firm called Dow Bar and that the research shows. that basically over 20 year periods, and individual investors, they don’t just leave their money in.

They put it in when they feel good, they take it out when it’s like, oh, the world’s ending. So an example of this will be like, during COVID, the market dropped 34% during 2022, the market dropped. During, there was the Brexit that happened overseas.

Even the US economy dropped double digits. So when this happens, it’s impossible at a time twice. So the studies have shown over 20 year rolling periods, you can expect over 100 years, nearly 100 years, SB500 is average above 9%, if you reinvest dividends.

And so over the 20 year period is typically 7 or 8%, but the study shows is it analyzes individual investors that are investing in the indexes, and they typically get half of the return. When literally if you put a dollar in, and you let it rise for 20 years, you’re getting that compounded rate of return, or you’re probably doubling your money at least two, maybe even three times in some periods, but the average investor isn’t even doubling their money once over the 20 year periods, because they get scared.

And when you time the market, you have to time right and sell high and you have to get back in, hope that you’re out when it’s dropping and then get back in before it’s fully recovered. But typically what happens is people will pull it, it drops, they feel really good, but then it goes way past up where they pulled it out and now they’re just lost, the opportunity cost big, big time.

So I’d love to hear from both of you, just as far as from market timing, why is it important? Obviously the study that I just described is so important, but just from what you’ve seen behind the scenes, why is it so important?

Yeah, I feel like with investors, the hardest thing is that some clients, they just get very emotional, which is understandable. When the market’s dropping, you’re worried, it’s your money, it’s your retirement, your college savings, it’s very important to you and you’ve worked for it.

But when you’re doing it based off emotions, you are gonna be selling out in missing opportunities. And then whenever you’re, oh, the market’s going up, you’re gonna be buying high, getting a bit greedy, and you’re gonna be buying it when it’s more expensive.

So we always just wanna buy when it’s low, it’s always nice buying something when it’s discounted on sale and then you’re gonna get that nice increase, that recovery of a down market. When you go to the store, you like to buy things on sale, everybody looks for sales.

And so many times the emotional response to investing is the exact opposite. You panic when everything’s on sale and you buy when everything’s going great. So you’re buying top prices and you’re selling when everything’s actually at a discount.

But to tie it in the Matt’s discussion with the study, I mean, that’s one of the many reasons, but a primary reason. reason that you do hire a financial advisor because it’s really easy to sit back and say, I will remain steadfast.

I will remain firm over the long term. But all it takes is one crack, just one. And you can legitimately destroy years of investing by getting scared, seeing returns on paper. These aren’t realized yet.

Negative 30, negative 40%, and then realizing, oh my gosh, panic button, let’s pull out. And once you do that, that’s it. And I like that return just went from here to here to here to here. Each time you make one of those poor decisions.

And that one emotional decision can wreck a lot of the wealth that you’ve been creating over 10, 20, 30 years. So let’s go through a couple of examples. And I think it’s really tough. It’s not normal, unfortunately, right now to stay in the market and stay disciplined.

It’s normal, it’s like reacting. News outlets, social media, they get paid, if they have your attention. Because then other companies pay them to have ads on their platform, right? News channels, same thing.

The more viewers they have, the more they can charge their ads. So they will do anything to get you to watch your stuff. And studies have shown, sensationalized news, is much more viewed than actual normal news of life that’s happening.

If we say, look at this kind act that just happened. Like one of our interns, there was an IT guy here and he needed a jump start. He went out and helped him with the cables and stuff like that. That would never make the news because a good Samaritan act, it would be if he crashed and someone got hurt, that would make the news.

But so I think it’s important to remember that in investing, is that everything’s sensationalized. And so a lot of companies, social media outlets want you to be reactive. And the best thing to do is just to stay proactively in the market and to take advantage of those downturns.

I just wanna go through a couple of examples. So first, I think just from a mindset perspective. So a lot of people love physical assets. So Nick, if you had, let’s just say you hypothetically had a house that was worth $300 ,000.

And Jordan, let’s say you had an investment portfolio that was worth $300 ,000. And Nick, you don’t have a place to log in. You could look on Zillow or whatever. But if you tried to sell your house that day and no one bought it, does that mean your house is worth $0?

It’s still worth, maybe it’s dropped a little bit, but it’s still generally probably around, or if you keep it long enough, it’s gonna be. Unfortunately, Jordan, if you logged in and during COVID, it dropped a third.

So if you logged in and you’re 300, you saw 200, it’s actually, you’re seeing 200 and you say, I lost 100 ,000. What’s the same concept? If you sell that day, yeah, you’re going to accept that loss. But if you keep it in there at just on paper and no loss or no, or gain is not a loss, it’s not a gain until you realize it.

But unfortunately with investments, it’s so available. You can see it daily. You can get so many opinions about what it is daily. So that’s where I think stock market investing can be dangerous is if you become too reactive.

You got to stay in. You got to stay out. OK, you got to stay diversified. So let’s go through an example. So if you have $100 ,000 and you put $1 ,000 a month in for 30 years and get a 7% compounded annual rate of return, which would be expected if you’re asset allocating diversified, your ending balance, you’d have invested a total of $460 ,000.

30 years later, you’d have over $2 ,000 ,000 and $38 ,000. So just over $2 million. If you are part of this study and you’re not asset allocating, you’re not diversifying, you’re saying, I want to invest in the S &P 500.

I want to beat the S &P 500 index. And because of that, Your money gets half and half, then you start becoming reactive, and the study shows that the average investor in the S &P 500 gets 4%. Even though the index is average 9%, they only get 4%.

So if you’re that same person, $100 ,000 upfront, 1 ,000 a month over 30 years at 4%, guess where you’re at after 30 years? From 9% to 4 %? Well, I just said 7%. So 100 ,000, 1 ,000 a month over 30 years was just over $2 million.

If you have the same amount of money, so if Jordan put in 100 ,000 to 1 ,000 a month 30 years later, 7%, she now has $2 million after being investing a total of $460 ,000. So Nick, I hate to pick on you, but you’re the, I’m going to go big in the S &P 500.

1 .1? You’re almost exact. It’s $1 million and $27 ,000. So you got half of what Jordan did, essentially. And that could have been just one or two poor moves over that period. Just be it. Even just one.

That’s crazy. So yeah, it would be great to look at, maybe I get eight, and now you have two and a half versus one, but the studies have shown most investors will not stay disciplined if they have that much risk and see that many halves temporary losses.

So, okay, so that’s long -term investing. So let’s move into what we call the bonus principle. And this is purely for tax efficiency. So I love the analogy again, of football. We have our quarterbacks.

We’re in Pittsburgh, so Kenny Pickett, everyone’s excited about being the face of the franchise, the stealer. So Jordan, if I said, we have Kenny Pickett on our team, and I said, I want him on the defensive line.

I want him to be a nose tackle. He’d probably look at me like, I’m crazy, right? I met him, and he’s like a skinny, athletic dude, but he’s not going to do well on the defensive line. He’s going to do well as a quarterback, right?

So thinking about your investments, where you store your different investments are so important for that same reason, just from a tax perspective. He’s going to do well. as a quarterback, he’s not going to do well on the defensive line.

Same thing when it comes to your investment accounts. Walk us through the importance of asset location. I’d love to hear from both of you, but give us a high level. Yes. So first we have our Roth IRA.

The money you put in is after tax. Now this account has some benefits. It grows tax -free. When you take the money out, it’s tax -free, assuming that you’re over the age of 59 and a half, and you’ve had the account for over five years.

So all the distributions, again, they’re tax -free. There’s no required minimum distributions. And then this account can just accrue, and then whenever you pass, it can go to your beneficiaries. Now they will have to take distributions from the account, but again, it’s tax -free.

And in this account, we want to hold all high growth equities because, again, it’s not going to get taxed. So you might as well get that high return in this account. And then our other account is going to be our pre -tax.

And this is where if you’re going to hold any fixed income, you’re going to hold it in this account. For this account, similar to the Roth where the growth is not taxed, but you put your money in tax -free when you take it out, it’s taxed.

And then this will be taxed at your ordinary income rate. So the required minimum distributions for this account starts at the age of 72. And then there’s still money in the account whenever you pass, goes to your beneficiary, and they will have to take the required minimum distributions, so they will face the taxes.

But you don’t want to, if you’re going to have any fixed income, it’s going to be in this account. And then it’s just be, it’s very important to be diversified and have the proper asset allocation. So if you do have to take money out of the account, you won’t, you don’t want to touch the equities.

So you can reduce your sequence of returns risk by having multiple buckets and not having to touch your equities. You can just let them go, because whenever you’re touching your equities in a down market, that can really just take a hit on your overall return.

Jordan, real quick, two really important things you said there. So the Roth, you want to have the high growth stuff, which would be the equities, because not only tax efficiency, but you mentioned the sequence of return risk.

So Roth IRA has no required distribution. So even if the Roth’s going down, it’s irrelevant, because you can always, you don’t have to touch it. You’re 75 and you can just let it ride. But in that qualified account, you said with RMD starting, I think with the Secure Act, these may get pushed back a couple years, the 2 .0 or so every year, once you reach that age, you have to take it.

And if not, there’s a big, there’s a 50% penalty, right? So that fixed income becomes important for retiree for two reasons that you mentioned. reiterating, one is it’s going to get taxed. And typically fixed income doesn’t have a lower return.

So why share the high returns with the government? Stick that in the Roth. And then secondly, that has a lower standard of aviation than the short term. Bonds do. So we can fulfill those requirement of distributions with a steady kind of investment that we’re not worrying about equity markets going up and down.

So it’s not just taxes. I said taxes, but it’s such an important thing I want to reiterate. It’s taxes and also back to that philosophy of your money supporting your life by design. Because when the plan’s live, it’s much more dangerous going down the mountain than up the mountain so if someone’s in distribution, an asset location what you just described achieves most of those things.

I think that’s super important. Yeah, because whenever you’re going up the mountain, you’re investing, you’re not at retirement, you’re going to have those up and downs, but you’re still going to get to the top of the mountain.

And then it gets very important when you’re at retirement coming down the mountain where you’re taking your money from, when you’re taking it out. Absolutely. So the third time account we see is typically a taxable account.

So what would we want in a taxable account? Yeah, so for the taxable account, this we’d want to invest in once we’re maxing out all of our retirement accounts. So we prefer to invest equities in this account to get that growth.

You put your money in, and then whenever you take it out, assuming you’re holding it for a long term period, it’ll get taxed at a capital gains rate. So you’re getting taxed on the growth in the account.

Which is typically almost half. Yeah. For someone in the highest tax bracket, and they stick a bond, like a corporate bond, paying interest every year, that interest gets added to their adjusted gross income, and it gets taxed at their rate.

So someone’s in the top rate, 37%, over a third of the returns immediately going to taxes, versus if you have, like you mentioned Amazon stock, and that taxable account, you don’t have to sell it until you want to.

And then there’s no taxes while it’s growing. When you sell it, if you’re in that top income bracket, you’re going to pay 23 .8% on a federal level. So whatever the math is, 13 .2% less in taxes, but one time versus every single year of the government taking part of that interest, which can really get in the way of returns.

I think there’s been some statistics. Do you know any statistics on what the tax drag is? Is it about 1% a year if you have a corporate bond versus a growth stock? Truthfully not offhand. But yeah, I mean, it’s important to note that you are getting taxed along the way with this.

So it does make a lot of sense to take a look at what you’re putting into this taxable account. Because it is kicking off capital gains and dividend distributions. You’re going to see it on your 1099, as well as when you go to sell in the future, hopefully at a gain at the capital gains tax rate.

But now I don’t have some of those stats, I guess, right offhand, but certainly is a drag there. Yeah, I mean, I think it’s over 1% because I’ve seen, you know, here’s if you can defer taxes, here’s if you have to pay them every year.

And it’s, It’s a huge difference. So, well let’s go right in. So we recently implemented this thing called Direct Index. And actually the first episode of this podcast, we go into really detail about it.

Just wanna hear from your perspective, Nick, implementing Direct Indexing behind the scenes and then how, you know, this isn’t, a lot of people think, oh, your picking stock’s not at all. We’re just doing everything we just talked about in this episode, asset allocation, diversification, long -term investing, but we’re doing it more tax -efficiently, we’re doing it by removing the manager.

So just give us a high -level overview of Direct Indexing and the experience it’s been for you with this technology behind the scenes managing this for all of our clients. Definitely. Typically for me, you know, being such a talker, it’s hard to be short -winded, I’m always long -winded, but for me, taking a look at Direct Indexing, it’s, we’ve already talked about our asset allocation, investing in ETFs, investing in the index.

Let’s unwind what an S &P 500 ETF would look like, and let’s hold some of the constituents. tying into our diversification, let’s hold maybe 200 companies that are currently in the S &P 500. And what this is allowing us to do is we create a target allocation of benchmark that we want all of these underlying holdings in each asset class to get as close as humanly possible to that benchmark.

That’s called tracking error. So for us, we want to take this S &P 500, unwind it, purchase hundreds of the underlying holdings with the full goal of being, we’re investing in a solid benchmark, a well -constructed benchmark.

So why would we do this? When you take a look at 2011 through, let’s say, 2019, we were on a huge bull run. If you held the S &P 500, you would have zero opportunities, most likely to sell out at a loss at any point in time because it was just up.

Now if you took that S &P 500 and held 200 of the underlying holdings, the chances of having some of those losers inside of that portfolio are pretty high. So if the S &P 500 is up 30%, you might have five or 10 holdings that were down 10, 20%.

So through the direct indexing initiative, we’re still following all of our principles. We’re not trying to market time or individual security selection because we want to invest towards this target benchmark allocation.

But now it gives us the ability and the flexibility to pick those losers, target those losers, realize some of those losses, and not get out of the market, instantly get right back in the market without causing a wash sale and realizing some of those losses.

The purpose of this being we talked about capital gains in the taxable space. As we realize these losses, we can utilize those indefinitely against future gains. So 3 ,000 off of your income, any each and every year moving forward.

But if you realize 100 ,000 of losses this year, you’re instantly back in the market. 20 years from now, if you realized 100 ,000 gains and that’s still sitting there, you can wipe that out. So it’s really increasing a lot of tax alpha on your portfolio by engaging in this direct indexing initiative, and it’s not trying to market time or select individual securities.

It absolutely goes in line with our philosophy and our portfolio construction. So let’s just say, let’s pick on me and Jordan for a second. So let’s say I put $100 ,000 in the S &P 500, and it grows to $400 ,000 over 20 years.

I go to sell that. I haven’t tax law, starvacidology, so let it ride. I now have a gain of $300 ,000. And if I’m in the top tax bracket, 20, what do you say, 25% of that’s going to get wiped out. So I now owe the government $75 ,000 of my 400.

My end result’s only 325. Jordan forgets the index, but buys $5 ,000. I think it’s like 125 to 200 companies that represent that index within the technology to make the tracking error. She has you managing the money through the direct indexing.

Amazon drops the technology saying, okay, we can purchase Apple and keep the tracking error within 2%. Great. So she gets the same result of return -wise, so 100 ,000 goes to 400 ,000. She goes to unwind the portfolio and sell it.

All of those little moves you made along the way now offset her gain, so she’s not going to owe $75 ,000 in taxes. She’s going to owe a lot less, potentially zero if there was enough tax loss to harvest an opportunity, or potentially just a drastic reduction in.

So to reiterate everything you said so clearly, Nick, this is not replacing asset allocation. It’s not replacing diversification. It’s doing everything that we stick to our investment principles, but it’s just creating tax efficiency that’s usually just available in Roth’s or forwarder’s case, and now we’re most high net worth clients have their money because it’s limited to what you can put in these other avenues like a 401k Roth.

Most high net worth people have the majority of their wealth in a taxable account, and it’s making that as tax efficient as possible while achieving the same result that they would have otherwise. So I love using the analogy of a surgeon with robotic arms.

So if you were to tell me, oh, you’re going to go get surgery from a robot, I’d be like, no, no, no, don’t touch me. But if you’re going to say, hey, this surgeon is a well -known, renowned surgeon, isn’t it going to do it?

And he’s going to use robotic arms because guess what? We can make the angles. His hand can’t reach in these angles to get, but with the robotic arms, he’s still guiding you. So that’s powerful, and that’s what direct indexing is with the technology.

It’s you two, actually human, the human mind, looking through and making the decisions, but the technology, because if you didn’t have the technology, you have to do spreadsheet after spreadsheet, figure out standard deviations, risk, and every single trade would just create hours of work.

Well, now the technology we’re allowed to look at the entire portfolio, and within a couple of minutes make those decisions. So we’re able to look at every client’s. portfolio is really on a weekly basis, which is an amazing thought process.

Because just a couple years ago, this just didn’t exist. And you needed like $10 million to do what’s called a separate managed account for someone to do this, and you’d pay the 2% fee. But this is just like there’s been a disruption in most industries.

I think this is one of the biggest disruptions that’s happened to our industry. And we’re fully taking advantage of it for our clients. Just pretty cool. Okay, so let’s go into, we’re going to finish up with dollar cost averaging and rebalancing.

So let’s just say, so Jordan talked to us about the importance of dollar cost averaging. Just for our current clients that are giving us money on a monthly basis. So Nick, I want to turn it to you because over the last 10 years, I’m sure you’ve seen many of our clients say, hey, I’ve got half a million.

I’ve got a million dollars of cash. I’m nervous about putting it all in the market right now. So I want to talk about how we address that. But first, let’s just talk about the blocking and tackling going with the football analogy.

Sorry, Jordan. We like football, so. How do we do you talk to us about our process of dollar cost averaging and the importance of that beforehand to Nick. Yeah. So dollar cost averaging is the clients they want to put in maybe like a thousand couple hundred any range of amount of money in on a weekly or monthly basis.

Now the benefit of this is not just dumping all of your cash in and maybe buying at the top of the market. You’re hoping that you can reduce your cost per share avoiding poor market timing and potentially like again buying at the top of the market with all your money.

And then this also just allows the clients to get into a good investment monthly savings just creates discipline for the clients which will help them be good when they’re with their retirement they’re just saving money periodically.

So it just gives good benefits with getting into the market trying to potentially buy lower but then just establishing good savings savings habits. Yeah this is like dollar cost averaging to me I think is like there’s an epidemic with people think that media net worth in America is like under three hundred thousand dollars and people just dollar cost average a little bit.

They’d be everyone be millionaires by the time they’re 65 they just take you know a couple hundred bucks a month or you know whatever it is at a young age. So to me this is preventative medicine. This is like you work out you eat well and in investment sense you dollar cost average and you’re going to avoid all the market noise because you’re going to get highs you’re going to get lows but you’re going to remove a lot of risk and like mentally be able to stay with with the game plan the whole time.

Unfortunately a lot of people like medicine in America people go to see doctors once it’s already too late and you know as a financial advisor it’s much easier to have a financial plan before it’s too late.

Once it’s too late credit card debt it’s a health problem you can’t work anymore. It’s typically too late. So these are just the dollar cost averaging along with these investment principles is it’s preventative medicine.

from a financial planning standpoint. So Nick, we’re giving you the tough one. So a client comes to us and has a million, existing client has a couple million dollars investor already. They have a great business year, or maybe a doctor has a big bonus, they give us a million dollars in cash.

And they’re like, I want to invest this, but for a reason, one, two, three, this, this, and this, I don’t feel safe going in right now. What’s our game plan of how we, so to first talk about what is typically best to do, and then what’s our philosophy of the WA to address that?

How do we get it in the market? Yeah, it’s really just about discipline and systematic savings. So clearly we don’t know in the day to day is the market going up, is it going down? As Jordan mentioned, we are looking to try to reduce the average cost per share.

So if somebody is giving a large infusion of cash, there may be a little scared to dump it all on the market. Well, we agree. Let’s create that systematic approach. We don’t want to potentially throw all of the money in right now and buy at a super, super high point.

I mean, maybe we’d be buying fully at the low point and it just continues to go up from here. That’s not for us to determine, obviously, but for us, it’s let’s create that systematic approach. And if somebody has a large infusion of cash potentially over the next three to six months, let’s invest that into the market in segments, weekly, monthly.

Let’s take little bites, but with the overall goal of let’s get it into the market, but let’s, as you mentioned, Matt, participate in some of the ups and the downs there. Let’s not buy all in at one particular segment or price.

Absolutely. So half a million dollars comes in and so we typically have this rule where it’s like, okay, we’re going to get it within three months. We’re going to dollar cost average, but we also very proactive during those three months.

So talk to us about that. If we see a 10% drop in one segment, what are we doing and then how are we adjusting the remainder of the three months after? Absolutely. So I mean, a part of like a discipline systematic approach, you never want to engage fully in market timing, but this is one very easy area to track utilizing our technology and say that client gives that million dollars and we’re systematically putting it into the market weekly over the next three months, monthly over the next six months.

All of a sudden, emerging markets is down 15%, 20%. This is a great opportunity to fill out that asset class while we’re buying at an extreme discount. So we’re not actively only investing our cash when the market’s down.

We’re creating that systematic savings, that disciplined approach, but we can have our finger on the pulse. And if we do see an asset class, the investment in our portfolio that we’re targeting, all of a sudden drops, we do want to fill out that investment.

fast track that money in the market. And that’s something that’s, yes, technically it is market timing, but it’s more of a controlled market timing for us. We’re not just looking at the market on day -by -day basis and saying, only buy when it’s low, when we’re dollar cost averaging.

So yeah, absolutely. So to reiterate, we never believe in market timing once money is invested. For money that’s not currently invested, best to typically get it in as quickly as possible, studies show, but to respect the human nature of the mind and if the market goes down to take advantage of, we have this three -month typical recommendation where the money will go in on a weekly basis over three months.

However, like your example of emerging markets, if that’s 10% of the portfolio construction, so 10% of a million is 100 grand, The rule is if it drops more than, if any asset class drops more than 10%, that 100 ,000 is immediately going to fulfill that, that day.

Emerging markets over the remainder of the three months no longer gets purchased. That part of the portfolio is done. And then the dollar cost average and continues in the other six asset classes, right?

So at 10% a greater drop and immediately gets filled, otherwise we’re going to dollar cost average on a weekly basis until the full million dollars invested in over those three months. And so this is what we view as a marriage between, because if the cash, if otherwise, if there’s no good strategy and the cash doesn’t say invested, that’s going to really hurt.

Because then that money’s in a rhoda with inflation. It’s not going to enter the long -term investment plan where really true wealth is created. But having this we’ve found is a good marriage between getting the plan done and also doing it as safely as possible.

And there’s tons of studies say just invest it all at once or, you know, wait for a drop. But waiting for a drop and there’s a great blog we wrote on this exact subject, breaking this down. So we’ll reference that in the show notes as well.

And Nick, thanks for giving us the high level. So we mentioned the quarterly videos. I want to end with this. So in the quarterly videos, we address asset allocation, diversification, long -term investing, and how we’re doing that.

But in those quarterly videos, we talked about the tactical. So we basically, okay, we have this football team. Here’s the makeup. The quarterly we address how we’re changing the lineups or how we’re changing the game plan.

So talk to us about how we do that. You know, every quarter we’re looking at, you know, rebalancing, for example. What are you looking for? And how does that technically happen behind the scenes? Yeah, definitely.

I’ll jump on that one. So we are taking a look at rebalancing a little differently, depending on whether it’s a taxable account, non -qualified account versus our qualified assets. But on a quarterly basis, we will do our research.

We will take a look at the portfolio and potentially make some moves, if and when that happens. We’re not changing the foundational part, the asset allocation. We’re changing the constituents. We’re changing what we’re investing in.

So on a quarterly basis, if we decide to make those moves, we’ll take a look first at the qualified accounts. So when we were talking about asset location, we’ll take a look at here’s our framework, here’s the overall level of risk for this client.

Maybe they’re 90% equity exposure, 10% fixed income and aggressive investor. And we have our asset location, we have our bonds, our 10% in our IRA, and we have all equities in our Roth. So we’ll then look to make the change, incorporate the new investment, pull out the other investment, and we will dynamically rebalance this on a quarterly basis based on whatever that target allocation looks like.

So if it’s a 90 -10 in this example, we’ll pull that out if it’s an equity that we’re looking to replace. Maybe we don’t even touch the IRA. Maybe we’re just pulling some equity exposure out of the Roth and seamlessly plugging it in, and then we’re going to rebalance back to the target.

So this is something on a quarterly basis we’re looking at in our qualified accounts. For non -qualified, it kind of comes into the direct indexing versus a non -direct indexing strategy. So we will look for tax loss harvesting opportunities to rebalance those.

But for clients and for investors that have systematic savings in place, it gives us a great opportunity to kind of rebalance as you go by filling the assets, filling the holdings that are experiencing the largest loss on paper.

So that’s why last year some of our clients maybe saw a lot of additional infusion of their monthly investments into the emerging market space. That was getting whacked. So we were proactively buying low and maintaining that disciplined approach.

So it kind of does depend on the type of accounts, the taxation of those accounts with how we’re rebalancing and investing. But on a quarterly basis, we will look to incorporate a lot of our moves in our qualified accounts in that nature.

Well, greatly appreciate the hard work you guys put in on a daily basis. And for making yourselves publicly here available on the podcast, I know a lot of interchange you have sometimes on the phone and emails with clients.

But I think it’ll be really helpful to put a face to the name for both of you. You’re literally how EWA exists is through the back end work that happens behind the scenes, not just the conversations with clients.

It’s actual implementation behind the scenes. Thank you from myself and the EWA team. And I’m sure from our clients as well for putting in the hard work. And thanks for joining today. Before we close up, I want to encourage, if you haven’t, we notice out of all the plays that we get across the platforms, there’s about half of you.

that are not subscribed. So we’d encourage you if you Apple, Spotify, YouTube, if you find this helpful and want to get updates every week, we put a new podcast, please hit the follow or the subscribe button.

And then also, if you find this helpful, it’ll help for you to rate our podcast as well. And we look forward to catching you next week. Thanks for tuning in to our podcast. Hopefully you found this helpful.

Really hope this is as beneficial and impactful to as many people across the nation as possible. So hit the follow button. Make sure to rate the podcast and please share with any friends or family members that would also find this beneficial.

Thank you very much.

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