Creating Wealth is an in-depth conversation between Bill Taber, an experienced financial advisor, and his millennial daughter about personal finance, investing, and financial planning.
Bill Taber is President of TABER Asset Management, a Registered Investment Advisor (RIA) and fiduciary firm located in Des Moines, Iowa since 1998. For decades, Bill has provided investment management services to clients, creating wealth, building wealth, growing income, and preserving capital for each and every client. TABER offers personalized asset management, wealth management, retirement planning, financial planning, and services such as 401(k) rollovers.
His daughter, Anastasia, lives and works near Washington D.C. She enjoys discussing finances and her cats’ latest antics with her dad.
Episode 14 - What does risk tolerance mean and how important is it in forming your investment strategy? What should you keep in mind as you start to invest? How do you know when to listen to your gut feeling about an investment decision and when not to? Bill discusses at what point after the 2008-2009 financial crisis that he knew the financial markets were about to improve. Anastasia compares risk tolerance to the entertaining documentary, Class Action Park.
For questions and comments, you can email us at firstname.lastname@example.org.
Anastasia: Welcome to Creating Wealth, I’m Anastasia.
Bill: Hi, I’m Bill.
Disclaimer: The views expressed today are our own, solely for informational purposes, and it is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular investment strategy. The views are subject to change and are not intended as a forecast or guarantee of future results.
Anastasia: So Dad, what is risk tolerance?
Bill: I define it as one's willingness and ability to have an investment that you have made permanently lose some value. Novice investors usually make a mistake when they confuse an investment where a company is likely to succeed and grow over time with the short term price volatility that you see hourly and daily in that stock. Sometimes novice investors fail to stay invested in a good company, because they watch the hourly or daily price quotations of the company go up and down, and then make a decision to sell out of it. Because their internal emotional system couldn't tolerate the fluctuations. Literally they cannot stomach staying invested in the company.
Anastasia: I'm going to need a specific example of this to illustrate this, because it's kind of a heavy topic.
Bill: So say you've researched a company and you determine that it's priced at $120 a share and that is a good price to buy in at. And then, say, the very next day, the news media reports that there was some sort of issue that affected the company and the stock price fell from 120 down to 85. Novice investors sometimes have the tendency to look at that short term news and the short term volatility in that price and basically get out of it, because they're concerned that maybe not only does it go from $120 to $85, but it goes from $120 to $60, or $50, or even lower than that. And what the key is, is that they need to focus on the business merit of the company over the long run so that they will stay invested in it, regardless of what impacts the stock in the market each day.
Anastasia: Okay, so that's what I was thinking, while you were talking, if you had done a lot of research into the company, you should probably have a good idea why the price dropped? You know, if you made the decision the day before to invest in the company, then that shouldn't be a surprise, or total surprise or--
Bill: Well, yeah, in investing you really never know all the variables. But when that news comes out, and it forces the stock from $120, down to $85, you are able to determine is that really pertinent to the long term progress of the company? Or is it just a short term news thing that other investors reacted emotionally to. There's another element of this and that there are all sorts of different types of investors and speculators in investing and some will only buy a stock for a period of a day, or some only now will buy a stock for a period of an hour or two. And if the stock starts to move in the wrong direction that they want it to, then they'll get out. And if enough of them do that, that can cause the price to go up or down, and that may cause you if you're not aware of the reason that you went into it and the investment merit behind the company to get out of it. All that is tied up and understanding the difference between how good is your company, how good is your investment, and separating the price volatility action of it, because the price volatility is the thing that engages people's emotions. It really engages people's fear if a stock drops from $120 to $85, in the matter of, you know, a few minutes or even seconds.
Anastasia: And that could be just a lot of almost what you would say micro day traders.
Anastasia: Like hourly traders who might be able to cause that kind of volatility within a day. They have like an inch view of the future, but you have the 1000 yard view of the future. So you need to keep true to all of the research that you've done on the company and the reasons why you invested in it, and think of it in a long term way?
Anastasia: Okay. And then I just want to circle back to the definition of risk tolerance.
Bill: Again, I define it as one's willingness or ability to have an investment that you've made lose value. A lot of times young investors when they first get started investing, it's theoretical, or it's in your head that you may believe that you have the ability to handle an investment dropping 50% or more of its market value. But it really isn't until you've made the investment and you've put your hard earned money into it so that your emotional system is engaged, that you'll be able to know whether or not you can actually tolerate a decline in value like that without feeling that you want to sell the investment or panic and get out of it. Because when your money's engaged in an investment as opposed to something--doing hypothetical investing, or just investing on paper--engages two basic human emotions that are key in investing. One is fear. And the second is greed. Warren Buffett, the famous famous investor--you want to be fearful when others are greedy, and you want to be greedy when others are fearful. The reality of that is not everyone is able to do it. And only by a process of actually investing, do you learn how much you can actually tolerate. So when I ask people what their risk tolerance is, I have a series of questions. But if they've never invested before, it's really just kind of in their head as to what they think they can handle.
Anastasia: It's all hypothetical.
Bill: Yeah. And then at some point along the way, through a market cycle, there's a big upturn, of course, everybody gets excited about that. And when the markets go down, then then there's kind of like, you know, fear starts to kick in. And I then learn what their true risk tolerance was. I give you an example back in 2008/2009 when the markets fell, like 50-55% in value, a lot of people stayed invested in that through that downturn. We kept saying that we have good quality companies, and they're going to come out of this. Alright, but by the end of February of 2009, which was just about a week before the absolute bottom in the market after the Dow had fallen from 14,000, down to 6,500, I got three or four phone calls from people that said, I can't take this anymore, sell everything.
Anastasia: Oh, no.
Bill: And I worked through the process of explaining there's a difference between these good quality companies and what's happening with stock prices, etc., but they just had reached their limit, they just wanted out.
Anastasia: They saw no bottom to it.
Bill: Yeah. And what occurred was, within about five days, the market bottomed and started back up. But having been in the business as long as I have, it was really key to me, that having that many people that previously had not had that type of experience had called to say, "Get me out," that it was a signal that we were pretty close to a bottom.
Anastasia: You think that that's an indicator of having a number of people say, "I can't take this anymore?"
Bill: Yeah. That speaks to basic human psychology and human behavior.
Anastasia: Well, that's comforting, you know, for the next inevitable downturn.
Bill: When you have that pit in your stomach, you know you're probably pretty close to bottom. (Laughs)
Anastasia: It's like if you're on a roller coaster and it's completely dark, like it's a tube, a tube roller coaster, it's completely dark inside, and you don't know when you're going to hit bottom. You think it'll just keep going forever.
Bill: The French have a term for this, it's called "anomie." And it basically means, "Where's the bottom? Where's the bottom? Where's the bottom?" and people can be basically screaming that and some of them might just, you know, chicken with their head cut off, basically decide just to get out at that point. When a lot of that noise is going on, that's usually a sign that things are going to turn around. There's a commonly accepted idea with markets that when maybe either eight out of 10 or more people are really optimistic about the markets going up, they tend to start down. And on the flip side, when only two out of 10 people are optimistic, or put another way, when eight out of 10 are pessimistic and think is going to go further down, then it tends to go back up. And what that refers to is something called sentiment or emotion. And that's something that our company tracks on a regular basis. So we can tell what the overriding emotion in the markets is. And contrary to what you think is common sense, when people are depressed about the markets, the markets generally are the most attractive. And when people are skeptical, they're still attractive. When people are optimistic, then you need to start being cautious. And then when they start to get euphoric, then you need to get out and run the other direction. And that's true about every bubble that's ever occurred in the markets, whether they're stock or gold or silver. When people start to get euphoric, and they start to think, you know, I'm gonna get into this because it's a sure thing, and it's gonna keep going up forever, then that's another sign that you need to be very cautious.
Anastasia: I mean, I could give the example of my friend who invested in Bitcoin.
Anastasia: At the top of its value. And I just kept telling that friend, "Don't do it. Don't do it. Everyone's excited about it, don't do it." There's a reason they're excited about it. And that means that it is now completely overvalued and is also what you were saying about it too. You were advising not to invest in Bitcoin at that time, and you were right.
Bill: What was the price of it? Was it over $10,000? Maybe it was even $20,000.
Anastasia: Yeah, I just know that it soared and then it crashed. (Laughs) And it still has not recovered to that point that it was at. I think it was 2018--I can't remember. Does risk tolerance change as people invest as they get older?
Bill: Well my experience has been that most people generally have a setpoint. That doesn't change much from that setpoint over time. They invest their money over a period of time, and they learn what they can or can't tolerate. But some people are able to handle uncertainty better than others. I think those that have a high need for certainty generally have a lower tolerance for risk. And they tend to gravitate towards investments that have little or no price volatility. Those types of investments would be things like insurance company products, like fixed annuities, bank savings accounts, certificates of deposits, the U.S. Treasury notes, or city or state municipal bonds.
Anastasia: Okay, so you're saying that it can change over time?
Bill: What I'm saying is that going back to the previous discussion, people may think that they're more tolerant towards risk, initially, but then they actually have the actual experience and they find out that they're not. And so that's one way where their understanding of their risk tolerance can change.
Anastasia: Does anyone ever realize that they have more of a stomach for risk than they previously thought?
Bill: I've rarely seen that happen. It's almost always the other direction.
Anastasia: Everyone's optimistic about how much they could handle and (laughs)
Bill: Some of it is interesting from the standpoint of, is it genetic? Is that their brain makeup? Is it behaviors or experiences that they've had? You know, what is it that causes people to choose one type of profession over another? I think, typically, people that are business owners, that are entrepreneurs, have the ability to accept a certain amount of risk involved in things. Others that may, as I mentioned, have a high need for certainty, don't, and it can be reflected in a person's choice of employer. Perhaps those that prefer to work in government, due to the fact that the government offers a traditional pension plan to them at retirement, tend to have a lower tolerance for risk. But again, I think it comes back to how much uncertainty can you live with? In the investing process, you'll never know everything there is to know about investment. So once you've done a certain amount of analysis, you have to say, "Okay, this is the one thing or the one or two things that I think is going to be key to this thing working or not," and then you need to make a decision based off of that. But for people that can't make a decision, because they don't know everything, and they keep researching and researching, then they typically don't get invested. Or if they do they're extremely uncomfortable about it. Does that make sense?
Anastasia: Yeah, it reminds me of One Up on Wall Street by Peter Lynch. He talks about the concept of a ten-bagger. You might be lucky enough to invest in a stock that increases 10 times in value or more, but most of the stocks that you pick are going to do okay, and some of them are going to not do okay.
Bill: Mhm. That's probably an understatement.
Anastasia: Even if you research the company as much as you can, and you have a good idea that or good feeling, good idea, whatever it is logic or emotion that this stock is promising, you still kind of have to give it up to the universe. You know, I've invested I put my money into the stock, but who knows what will actually happen? And just be able to be comforted knowing that, and hopefully, a few of the stocks that you picked actually do really well, and they make up for the losses on the other ones you chose that did not do well. So that's what that reminds me of.
Bill: Yeah, that's interesting.
Anastasia: Let's see. I feel like I know the answer to this. But would you ever advise someone if someone has a low risk tolerance, but they want to have a higher risk tolerance? Would you ever advise them against picking riskier investments?
Bill: Well, yes, because and that's part of the responsibility of being a fiduciary professional in this business is that if, in your determination, the client that you're working with does not have a high tolerance for risk, it's your responsibility not to put them in any investments that are high risk--high risk or high volatility--because if they've told you that upfront, and turns out that you put them in something different than that, to see if they can tolerate it, then they have grounds to to come back against you and sue you or take you to arbitration or basically say this investment was not suitable for me because I told them that I couldn't tolerate it and they put me in it anyway.
Anastasia: Okay. You've never run into anyone who asked for riskier investments, even though they obviously couldn't handle it.
Bill: No, and that's part of the reason why we in 40 years of business have never been sued. We've never had an arbitration. We've never had a formal complaint about what we've done. Well, we have had a number of conversations with clients that said, this investment went down in value. I didn't know that it was going to do. We go back and explain to them that we went through a process of a questionnaire asking what their tolerance for risk was in a number of different ways. And reminding them of basic communication concerning companies can fall 50% or more in value, and if you're not able to accept that, then you really shouldn't be in it. And so we have had several conversations where we had to remind them we had that “risk tolerance” conversation, and they go, "Oh, okay." But in the heat of the investment falling in price, and then being upset with us as an advisor, we had to remind them of that.
Anastasia: Yeah. So we kind of touched on this, but how do you know when to listen to your gut feeling and when not to?
Bill: Personally, I've learned to analyze opportunities, and then allow at least sleeping on the idea overnight before acting on it. It gives my subconscious mind time to work on the idea and I usually get a fresh perspective upon waking up the next morning. So that's how I do it. Plus, the process of delaying a decision for a brief period of time I found keeps me from potentially diving into something that appears to be really exciting on the surface.
Anastasia: Like Bitcoin.
Bill: Yeah, I mean, you could get an idea from a friend and get really excited about it and just want to jump right into it. And it's generally good to put a little bit of time between that. It's important to consider an opportunity from multiple angles, or multiple perspectives.
Anastasia: What do you mean by that?
Bill: Well, just to take a look to analyze and look at the pros and the cons--
Anastasia: But from like, what perspectives? Are you talking, like, industry perspectives, owners of the company? What are you talking about?
Bill: All of those things
Bill: Yeah. I think when you say the words listening to your gut, to me, what that means is that you allow your subconscious mind to be heard. Because psychology has studied this for decades and decades--there's a conscious and an unconscious or a conscious and subconscious mind. And the subconscious mind really has a whole lot more depth to it than the conscious mind does. And so from the standpoint of weighing the pros and cons of something, and then just giving it time to just kind of ruminate, or giving it time to germinate, so to speak, then you can generally come up with a better decision.
Anastasia: I mean, that's something you can apply to a lot of things.
Bill: Oh, yeah.
Anastasia: That's how I would make any major decision would be to sleep on it, to consider it from multiple angles, asking multiple people what they think of it. I typically like to do a pro/con list. I don't know if that's something you would do with choosing an individual stock?
Bill: Yeah, I think in the early going that I would have come up with a pro/con list. But now that I've been doing it as long as I have, the pro/con list is in my head.
Bill: And I can know what are the key elements that have to be in place for me to want to put my money into something.
Bill: This is the aside that I kind of wanted to go into and see if this takes us anywhere. But you know, sometimes young adults get started with investing, because they hear that because they're young, and they have a long time to accumulate money for retirement that they can take bigger risks. You want to make investments in things that you understand, or that your fiduciary advisor understands. We talked about the idea of Warren Buffett of “staying within your circle of competence”. You want to invest only when you determine that the potential rewards outweigh the potential risks. And, that you can assess the probability of success to be greater than 50-50 and preferably well above that. 70-30, 80-20 is great. 90-10 rarely occurs and is never going to be 100-0, because as we mentioned, you're never going to know all the factors that are involved with a company. In the process of doing this, it's important to understand the difference between investing and speculating, or investing and gambling. Speculating is when you risk potentially all of your money. You employ a strategy that's like going for broke, or “double or nothing”. A good example is casino gambling. You know, first of all, the odds of winning are stacked in favor of the house, not you. I've always been fascinated by an advertising sign that I saw on the side of a local bus that was promoting a local casino, saying we pay out 94 cents on every dollar that you wage. Is that a game where you would have a high probability of winning?
Anastasia: You have a high probability of losing six cents on every dollar. (Laughs)
Bill: (Laughs) Yeah. But for people that like to do that type of gambling, I think it's fine. It has entertainment value for some people. And the best approach is simply say, "Okay, I'm going to go to the casino with a certain amount of money. And I lose all that money, I'm done." Which is not what the casino wants to see. They want to see you double down at that point to try to get your money back. But that's a loser’s game. Investing in common stocks should be a business enterprise, where you can assess the quality of the company to determine the quality of their management, their ability to continue growing their profits, their track record in paying dividends to shareholders. It's just very important to know the difference between investing and gambling and to focus on a long term approach towards building wealth that takes advantage of the concept of compound interest and compounded earnings.
Anastasia: Yeah, I agree with that.
Bill: So when we talk about that long-term compounding curve, where if all it takes is you continuing to put money into things that grow and continue to give it time to grow, that is a far greater influence on your ability to build wealth than simply saying, "Okay, I've got several thousand dollars. I'm going to go into this speculation that could maybe quadruple my money in a short period of time, or potentially, fall in value, and become worthless." So young people that stay towards that longer term, slow growth compounding process do far better over time. It's important to continue to do intelligent investing as opposed to speculating.
Anastasia: Yeah, that's interesting that you suggest to investors starting out not to force themselves to pick riskier investments, because they know they have the decades to see it out, and to recoup their losses, so to speak, if it were to go down. It just sounds like it really needs to be based on what their risk tolerance is. They won't really know what their risk tolerance is until they invest, they enter a downturn, and how they react to that. So yeah, that all makes sense. So I watched this crazy documentary on HBO Max last night, called Class Action Park. It's about this waterpark in the 1980s, that was started by this guy, Eugene Mulvihill. They called him Gordon Gekko before Gordon Gekko was a movie character, but he was an investor who was like Leonardo DiCaprio in Wolf of Wall Street. He got people to invest in penny stocks, you know, it's kind of worthless companies from which he could get paid high commissions and make a lot of money from it. So, he gets pushed out of the business. So then he goes and starts this waterpark very close to New York City. This guy's a very jovial guy, likes to have fun, and he also hates rules. He hates laws, and he hates regulations, and he hates rules. And so he'll just come up with an idea that he wants to do a vertical loop of a waterslide. They make it and then send test dummies down it and the test dummies are losing, like, limbs and heads. (Laughs) And then he convinces his teenage employees, "If you go down this, I'll give you $100 at the end." And so the teenage employees go down and some of them pass out. They find out some people going down it, start getting lacerations. They don't know why until they open up the tube and find out that earlier people had lost teeth. And the teeth had embedded in the ride.
Bill: Oh man.
Anastasia: Yeah. Finally--they did all this without engineers--they brought in this Navy engineer who told them, "There's two places on Earth that you can experience this many levels of G's. One of them is in a fighter plane jet. The other one is on this ride."
Anastasia: So they made this documentary about this waterpark that created these really dangerous rides. And teenagers in New Jersey just loved it! That was only a thing in the 1980s. Because once the 1990s rolled around, people just weren't really interested. The parents became less laissez faire about their children and how they were spending their time. I think also people died at this waterpark. So I think it just eventually it all came to a head. So I guess you could say that's the definition of a risky investment. (Laughs)
Bill: (Laughs) All or nothing. Was there any notification or any warnings that were put out to these kids in the form of a sign or something at the beginning of the ride or any disclaimers or waivers that they had to sign before they went on it? Probably not because it wound up being an in class action, right?
Anastasia: Well, yeah, he was definitely sued a lot. But then he would use his lawyers to fight them. He only lost 7% of the cases. He won 93%. The 7% of cases he lost, the U.S. Marshals would actually need to come and collect the money from him because he wouldn't--
Bill: He wouldn't pay.
Anastasia: --pay them. They did have warnings. One of the rides that actually killed one person--it hurt a lot of people--was this ride that you just slid down a mountain. Supposedly the thing you're on--the slide you're on--has a break, but most of them were not working. There were signs telling you when to slow, but drunk teenagers don't always follow signs. So what happened is people would just kind of shoot off the edge of it when going on turns and then there were a bunch of rocks around the ride. They didn't bother to remove the rocks. So this one teenager actually died because his head hit a rock. But at the top of the ride they had just pictures of all of the injuries that people sustained on that ride to be like, "Don't be stupid." But again, you know they're being egged on by other teenagers. They're not going to make the wisest of decisions, because they also feel invincible, right?
Bill: Sure. Well, it's an interesting story and in the analogy to the investment businesses is that if you're working with a fiduciary advisor professional, it's their responsibility to tell you what can go wrong ahead of time. And then have you say, "Yes, I'm willing to accept that or I'm not willing to accept it." Because if you don't get that buy in from the client after you've explained what the risks are, then you shouldn't make the investment. And if you go ahead and do it anyway, you're subject to being sued just like that guy was.
Anastasia: That's great. You're making the analogy of like shooting off the side of the ride.
Bill: Yeah, there's a number of different really high risk things to do in the financial markets. I've learned from experience which ones to avoid. For anyone else that wants to go ahead and do those types of things, it's kind of a caveat emptor. Let the buyer beware.
Anastasia: You know what you're getting into. It's exactly what happened in the documentary. One of the people being interviewed, who's actually he was on The Office. He was the funniest guy in this. He had the best commentary. But he said that before he left for the park, his parents told him, "Be safe, make good choices." (Laughs) Because they knew what they were sending their kid to.
Bill: And what did he do?
Anastasia: Well, he stayed alive.
Anastasia: He said he did get injured but--(laughs)
Bill: (Laughs) Ah, youth. Invincible.
Anastasia: Yes. (Laughs) Alright well, I think that was a lovely end to the episode. So that's all I had.
Bill: Yep. Thanks.
Anastasia: Thanks, Dad.
Anastasia: Thank you for listening to Creating Wealth! If you liked our podcast, please subscribe and consider recommending it to your friends or leaving us a review on your podcast app. We would love to discuss your questions. You can email them to us at email@example.com. You can also find full transcripts of every episode on taberasset.com. That’s Taber with an “e” not an “o.” Thank you for joining us on the path to financial abundance. We’ll see you next time!