Which Side Are You Protecting?

by Benjamin Beck, CFP® Benjamin Beck, CFP® | March 2, 2022

On the MLB network I watched a sports documentary about Cal Ripken Jr. For those of you who aren’t baseball fans, Cal Ripken Jr. is a Hall of Fame shortstop who played his entire career for the Baltimore Orioles. He exhibited a number of Hall-of-Fame-worthy statistics, one of which was being one of only 32 players in the history of the game to accumulate over 3,000 hits in his career (3184 to be exact). You could argue that the 3000 Hit Club alone earns your place in the highest echelon of baseball greatness. That, however, is a feat that has been and will be repeated again. There is a completely different streak that Ripken is much better known for, one that any baseball expert worth his or her salt would tell you that there isn’t a snowball’s chance of being repeated…ever. You see, from 1982–1998, Cal Ripken Jr. played in 2,632 consecutive games. Let me say that again…every single game, for sixteen full seasons.

Forget about talent for a moment, forget even being good enough at your job to earn the right to play that much baseball at the highest level for nearly 16 complete 162-game seasons. More interestingly, what does it take for a human being, physically and emotionally – despite sprained ankles, broken noses, the common cold or the flu, stress at home with spouse or kids, all those daily aches and pains— to show up? Can you imagine? Despite all that, putting on the uniform every day for 2,632 consecutive games…and not “just showing up,” by the way, but day in and day out, through all the ups and downs, playing the game at the highest level.

I wonder if the Orioles reimbursed him for unused vacation days. I’m kidding. Here are a few financial stats that this story made me think about:

During the 16-season streak that Ripken played, the S&P 500 rose from 116 points to over 1000 points. With dividends reinvested, that’s an appreciation of 1,400% or adjusting for inflation, a more usable number, an annualized 14% per year…of real return. The bigger message I know is how truly mind-boggling it is what the markets can and will do for our clients if we could only let go of this obsession, this nonsense about protecting an investor’s downside.

I have to admit, every time I hear the phrase “downside protection” or “protect your downside” – as is often the case these days in financial services marketing, I get triggered. For me, the notion of protecting your downside, this idea of providing you with some sort of cushion from great loss, it’s equivalent to the “elliptical machine” of the finance industry. You know that machine at the gym, that allows you to simulate running, walking or climbing, (albeit somehow comfortably) and that is touted as a great piece of fitness equipment? Let’s face it, that piece of equipment was designed for comfort! Who are we kidding? Find an elliptical, and if it doesn’t have already have a TV screen built into it, then it’s lined up in front of a bank of TVs at your local fitness center, intended to distract you, dare I say TRICK you into thinking you’re burning a material number of calories. I know I’m going to piss off more than a few people who get their sweat on such a machine, and I have respect for anyone who gets off the couch and gets moving. But the elliptical is ultimately not the piece of equipment that’s going to give you the results you think you want. It may feel like you’re doing something, but you’re not doing much. And this is the relentless pitch of the financial industry.

I remember early in my career at Merrill Lynch I was already well into years of working with the Strategy we use to this day here at Beck Bode, I was approached by a family friend, a successful longtime executive at Lehman Brothers who had left to start a new hedge fund with a friend of his. They were looking for young, aggressive folks who could go out and sell their “products.” At this point in my career, I was curious, intrigued by what a hedge fund was all about, this mysterious unknown galaxy to which only the wealthiest of the wealthy had exclusive access. I eagerly drove my beat-up Nissan Maxima to the barrios of Wellesley, Massachusetts. After 20 minutes of hearing how much success they had had in the past, how great they were, all about their past returns, seeing their pitch deck and the usual song and dance meant to excite and motivate people, I finally got to ask the question that had been brewing in my head. “What’s your process?” I asked.

They drew me a picture, a simple graph. Along the bottom, the horizontal axis, they labeled “time,” and along the vertical axis, they labeled “returns.” Then they drew a very staggered and busy line to represent the ups and downs of the market over time, with highs and lows and highs and lows back and forth. But wait, there’s more. Then they drew two parallel, horizontal lines – one below the x-axis and one above it. “This is it,” they proudly exclaimed, going on to point out their unique skill as the ability to provide “bumpers” for the investor’s portfolio so that they wouldn’t experience the reality of the big lows of a market downturn. It struck me back then that they were purporting to provide a tremendous amount of downside protection. To me, they were simply SUPPRESSING VOLATILITY.

When I was triggered this week, it got me thinking about that meeting, and how even back then I could see what a ridiculous argument they were making. Sure, they were protecting the “downside,” but they were making sure that their clients missed out on the highs, too. They never mentioned the upside to future investors. All that was mentioned was the bit about protecting the downside.

Look, I’m not naïve. I know that fear sells, and that the financial services industry capitalizes on peoples’ fear of losing their principal. What does the industry go and do? For the majority, the fearful, it has created the equivalent of the elliptical machine at the gym, an investment vehicle that on the surface generates the illusion that you are participating in the market, except that you are only comfortably participating – you’re breaking a sweat, but not too much because they know that you can’t handle it.

Here, though, is what David Mallach would call in Dancing with the Analysts, “the undeniable truth” with respect to equities versus fixed income instruments. On average, over a long period of time, the equity markets conservatively will produce or have produced equal to or more than roughly 7% in real returns (net of inflation). That's a fact. Fixed income instruments, on the other hand, over the same period of time, have produced just about 3% in real returns. And this is the point that is irrefutable: investors who show up every day, riding out those temporary declines in the equity markets, inevitably solidify increased wealth over time.

Part of the training program at Merrill Lynch obviously was to go out and meet with Mr. and Mrs. Client, build a relationship with them, and engage them in an investment discussion. But when it came to recommending investments, we would take the information back, plug in all the quantitative data about the prospects or clients’ lives (including data about goals and objectives) into a piece of software that would spit back a breakdown of mutual funds that were to be recommended to them. Even to the youngest clients I had at the time, this software would recommend they hold 10-15% or more of their portfolio in fixed income funds. And, of course, every fund would be presented with its historical performance, which was amazing. I mean, it created literally “60/40” stock vs. bond portfolios that were seemingly outperforming most equity indices, at nearly half the standard deviation for “risk.” (You know that word risk…we love to use…the most misunderstood word in the financial advisor dictionary). A normal person couldn’t make an argument against using these funds, because look at how incredibly they had performed over the past five or ten years! How could this be…if not for hindsight being a perfect 20/20? Oh, wait never mind! In that very same fund solution snapshot proposal, which is what it was called, that showed how beautifully this mix of funds had performed, was another phrase (in much smaller font, mind you), that stated, “Past performance is not indicative of future results.”

I thought then and I still think so…was this all we could provide as financial advisors? Is this all we can provide? Was this the level of our sophistication? I remember thinking: “What does this do for the client?” Wasn’t our main priority, our purpose, above all else, to help them achieve a successful retirement and legacy for their children. To not run out of money. And we were to do this somehow by attempting to avoid a significant amount of volatility, over a normal 30 years or more? So…when it comes to investing in retirement, “volatility BAD…safety and certainty, is good?” Am I understanding that correctly? Unbelievable.

Come to think of it, can you think of a time that the word “volatility” has been used in a positive sentence? In 2018, from approximately sometime in October to just about Christmas Eve, the markets fell close to 20%. You’d consider that pretty volatile, right? At the time, I think it was Trump and China and the whole deal around tariffs and trade that was reported to be driving market behavior. Then, from Christmas Eve on, and through most of 2019, the markets were up in the range of 36-39% from that low point. Now did anyone mention volatility when it was all roses and things were up? Did people speak about the tremendous volatility in the middle of 2019? No, they did not.

Here's the truth. Historically speaking, every year, on average, the market falls about 14%. Now that’s an average, but you get my point. Every five to seven years we will experience a decline into the bear market territory. Again, it’s an average, but historically speaking your equity portfolio will give back somewhere around 30-35%. Worse, certainly. Less frequent, sure. But nonetheless, and this is incredibly misunderstood, but so imperative to understand…these fluctuations are TEMPORARY. Bear markets are TEMPORARY.

David Mallach did a presentation for me and Jim at our Merrill Lynch office in Boston back in 2010. We had about 100 or so invited guests, prospective clients. David opened his presentation the way he typically has, with a brief history of his career, and how he has been through eight bear markets in his career, since the early ’70s. During this presentation, he turned his focus to me, sitting in the front row. He pointed at me and said, “Now Ben, he has only been through one bear market so far, and look at how much hair he has lost already!” After the laughter in the room subsided, he went on to say, “Ten years from now, I expect Ben will be completely bald, but so long as you follow his advice, I predict the value of your portfolios will be close to double from where they stand today.” Truth be told, he was wrong on both accounts. I still have some hair, and portfolios that our clients have held on to since then are closer to triple their value, after inflation.

We have a real problem in our industry with regard to what we're saying to investors about what volatility actually is. I'll take that a step further. What's not being said is how incredibly important volatility is for your future. There’s only one asset class that can truly help our clients achieve their objectives. At an average real rate of return of 3%, it ain’t bonds. There exists no galaxy where bonds make sense. Not for the 65-year-old retiree who needs a minimum of 4% withdrawals to outpace inflation for a three-decade-long retirement, and certainly not for any younger investor accumulating money for retirement.

David Mallach’s message and my message is crystal clear.

Our job as advisors has nothing to do with protecting our clients against volatility. It is not about beating a benchmark, nor is it about avoiding downturns. It is distinctly about coaching our clients to make sure they show up each and every day for that ball game. No, not just putting on the uniform, or simply going through motions. but starting and finishing every game and committing to play at a high level. Inevitably, there will be bumps and bruises each year. There will be sprained ankles, a cold. Many times we won’t feel up to playing. Once every six years or so, a Nor’easter’ will hit our portfolio and no matter how emotional our clients get about adjusting that lineup card, it is imperative that we tell them to “lace ‘em up and stay on the field.” There’s no hiding in the dugout. We certainly won’t let them retreat to the clubhouse.

Here’s the deal. The greatest power that we have as advisors is our ability to lead. We are our client’s coaches. When we show strength and integrity in our convictions, our clients will follow. And as they stay in the game, they will, in time, reach levels of wealth for their families that they never thought possible.

Ben Beck is Managing Partner & Chief Investment Officer at Beck Bode, a deliberately different wealth management firm with a unique view on investing, business and life.

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