Is your portfolio built to weather volatility and unknown elements of financial markets? Kim Parlee talks to Brad Simpson, Chief Wealth Strategist, TD Wealth, about his investment philosophy based on mitigating risks outside and inside a portfolio and understanding human behaviour around decision-making.
And you were alluding to this before. But we are seeing a shift-- that fork in the road. Tell me a bit about maybe what was the case and why that may not be the case in the future.
Yeah, sure. First and foremost, we have a whole industry built on asking that question. What's happened in the past, let's measure, let's look at that, and then invest according to it. We have gone through an extraordinary time. The last 10 years-- think about it.
10 years ago, almost to tonight, you would be sitting here, and this would all be about the market. It's just continuing to fall apart, and what are we going to do, and the world economy has come to an end. And we've implemented measures-- monetary measures-- that have never been tried before. And it was just, well, let's try it.
It's so bad. Let's just give it the medicine and then see what happens. And the net result is that, first and foremost, the outcome has been pretty good.
So far. We've drove interest rates down, which has led to multiple expansion for the S&P 500 and other global markets. And for investors, as interest rates went down, value of the bonds went up. Money leaves the bonds, goes into the stocks. It goes up.
And oh, by the way, every time you were worried about something wrong, what happened? You just said, well, that's OK, the Federal Reserve Board will fix it. So we've had absolutely no volatility. And so if you look at that and drew that and said, well, those are your major inputs-- then you throw in a nice, healthy world of free trade and this incredible digital economy-- I call it digital 2.0 or whatever you want to call it.
It's all cylinders, yeah.
Right. So you've got five things making the world absolutely work in the perfect way. And I would suggest that if you say, OK, now I'm going to build my investment strategy-- I'm not so sure-- we might have one of those as an input that works really well. But I'm not so sure you're going to have all five.
So if those are the five that stirred the drink, if you will, it's really hard to say, I'm going to move into an environment that's going to look like that. So if I'm in a different environment, then I'm going to have to do something a different way.
You talk a bit about-- and you've got a great paper talking about your philosophy on risk priority management. A few things I just wanted to draw out that stood out for me. One of them was, you talk about the approach, often, to managing money is that the concepts are old, to your point.
And there is also-- and I love this. I'm not going to steal your thunder-- a little bit. There's a machine of how you do it versus a biological being. Why do you talk about that?
Well, most of the tools that we use are 60 years old, designed by people who really wanted to be physics professors. And that didn't work out, so they took it to economics and financials. And the net result is that they created a world that was like a machine.
But the world isn't a machine. It's made up of these biological organisms, like you and I. And we make decisions.
And we adapt. And we change. And the perfect example of that is 10 years ago when the world was falling apart.
We just didn't say, oh, gee, that's too bad. No, we had a central bank in the United States step in and say, no, wait, we can make adjustments, we can try new things, we can adapt to the reality of the world that's around us.
Which is what biology does. It's evolution.
Exactly. And markets are like that. And so I think that one of our key tenets to our investment philosophy is, what needs to innovate and look forward? And so for us, that's a key tenet.
So for us, gone are the days where you can take the last 10 years of data and extrapolate forward and make your decisions. We're going to have to make decisions through the windshield.
OK, so it's evolutionary, number one. Number two, as you mentioned, there's people in it. So there's human behavior. And last time I checked, we're not completely rational.
Yeah, think about it in this way-- how difficult that is. You walk around in your day-to-day. And after a while, you'll get used to interest rates are always going down, equity markets are always going up, and it surrounds you.
You pull out a new phone, you're driving a new electric car. And boy, we're in the middle of this incredible, tactical, digital age. Well, then that leads to a conclusion, then, this is always the way it's going to be and then kicks in all these incredible biases.
So you're surrounded by that. So all of the sudden, your recency bias kicks in-- how it's always like this. And then if it's always like this, what I'm experiencing, your overconfidence bias kicks in. I can really make good decisions, because I've learned and I've lived within this.
What the result is, is that we don't really make decisions based on the world around us. We--
Our perceived world around us.
Our perceived world around us-- when we really should be making decisions about where we're going to be going to next.
The one thing that this all kind of drives towards-- and I know this is your passion-- is you talk about managing risk. And I think we've got a chart here. I'm not sure how well it's going to show on camera.
But the idea that 60-40 is the traditional-- bonds weren't risky, and equities were. And I think what you're showing here is that there's risk that is maybe more correlated than perhaps you think it is in the portfolios.
The chart on the left is the traditional stock and bond portfolio that we always see. It's neat. It's tidy. It must be diversified, because they're different colors.
We open it up with a can opener. We look at the inside. We consider the DNA.
And look at today. We're talking about stocks and bonds going down. Well, my way-- what this chart would show-- is that inside a portfolio, that you can have equity risk, you can have interest rate risk, and volatility risk, all intertwined with one another and interacting with one another.
And that's what drives portfolios-- not the surface. These pretty colors on the outside, I always say, are kind of like alchemy. And you've got to be more scientific with this and dig on the insides. And so I think one of the key things you want to do is to build a portfolio.
And instead of trying to predict what tomorrow's going to bring, I think when we're building our portfolios, we want to focus on three things. We want to manage interest rate risk. We want to manage volatility risk. And we want to manage interest rate and credit risk. And if we do those four things, boy, you're going to have a portfolio, I think, that is really well-diversified.
And also something probably super important, again, at this kind of turning point where we are right now.
Yeah, and I think that's the message for right now.
Brad, always a pleasure. Thanks so much.
Brad Simpson. He is Chief Wealth Strategist at TD Wealth.