Portfolio management begins and ends with a well-defined investment philosophy. Many strategies that have worked so well for the past thirty years are less likely to be as effective going forward. Brad Simpson, Chief Wealth Strategist, TD Wealth, discusses how to bring investing into the digital era and why “humanomics” or individual investor biases matter. TD Wealth’s Risk Priority Management Philosophy is available here.
And according to my guest, he's done just that, but for your investments. Joining me to explain his risk priority management philosophy is Brad Simpson from TD Wealth. Thanks for being here.
Thanks for having me.
I want to kick things off today, before we get into your investment philosophy, and talk about what you call your "digital map" for investors. How does that work?
Well, think about it. One of the reasons why maps have grown and changed what they're able to do is that in the old days, you'd get this kind of flat map. And then you'd kind of try to figure it out. But it really wouldn't tell you anything.
And the world in itself, if you look at what a map is, is the world is this open, complex system. It's always changing. It's evolving. It's moving. It's live. It's real.
We've really managed to, all of a sudden, start doing that with our mapping. And so I think when you open up your phone, and you turn it on, and you've hit Map, this beautiful blue dot comes out. And this blue dot really creates where you are, and then starts making suggestions where you're going to go, and how you're going to get there. And as you're going there, it's actually now getting to the point where it actually understands what your wants and needs are, and the way that you're looking for.
And money management is a lot like that. A lot of the tools that we use are 50 and 60 years old, and they're like a flat map. And with us, we look at the world in a very different way. And we created this idea, which is called Risk Priority Management, which is our philosophy, which says that in many ways, markets are alive, and that when we're managing that we have to look at the participants and the markets themselves, define where the individual is and where the markets are, and then think about how are we going to traverse that terrain, much like that map.
You mentioned the way things were done, let's say 50 or 60 years ago, and the tools there. And what I find really interesting is every time you talk to investors, people say, but how was it done in the past, as they venture off into their investments. But I had a light bulb moment when you said, would you use a map from 20 years ago? Because things are different today. Explain how that relates to investments.
That is my favorite-- that's my favorite sawhorse. And it is the question that we get, especially where I work every day, where we do a lot of portfolio reviews and suggestions where people, how they should be investing. The number one question I always get is, how was it done in the past? And if I could define that down even a little more, it's how was this done in the last 10 years?
And I guess how it pertains to money management is that if the terrain's changing, and you go back in the terrain you just went through, and you go, well, that's what I'm going to superimpose or extrapolate forward, and suggest that again, it doesn't work very well. So an instance that-- I would say a great one to look at-- is that one of my big beliefs right now and how we're allocating capital is we're seeing we're in this big environmental shift. We're going from one world to another.
So imagine if you took yourself back to 1980. And that's the last time, I would argue, that we've seen a really significant, almost 180-degree shift in the markets. So imagine you're a person at that time.
Let's take you, for example. Let's say you're back then. You're the age you are now, but it's 1980.
You're driving along, and you're driving this big, gas-guzzling car. And you have to fill it up with gas. So you pull in a gas station.
There's a line-up. There's an oil shortage. And you're in the middle of a world where inflation is making the value of assets go down every single day. Interest rates are going up to slow down that inflation.
And you are driving along thinking about all this. And we might turn on the radio, and you listen to a Bruce Springsteen song. It's 1980, "The River" comes out, and that whole album is about blue-collar people losing their jobs.
You drive to go see your investment advisor. And they sit down with you, and go, what I think from here, based on what you're looking for, is I think you need to build a portfolio made up of Treasury bills, bonds, and stocks.
The traditional portfolio.
The traditional portfolio, right. And then you ask them, hey, how was it done in the past? Well, they show you. And then, well, we'll go take a look at this chart here. Before inflation, it returned, over a 20-year period, 5.4%. After inflation, 0.3%-- no return.
Then they say, well, I think you should do this. I think the environment's going to change going forward. Well, I'm not going to do that, because everybody knows you have to take the immediate data that you just had, and extrapolate it forward, and invest based on that.
If you look at the rate of return if you did do it following 1980, and you did that for the next 20 years, then the portfolio did spectacularly well-- over 7% after inflation or 11% with inflation. That's a pretty spectacular return. And that in itself is so important when you're looking at investing, is that not necessarily the immediate thing you went through is going to be what's going to happen next.
History might not repeat itself.
No, well, it might not repeat itself from where the immediate you just went through. But it's really hard to get your head around, because we have a whole investment industry set up to actually suggest, no, no, no, take what you've done for the last five, 10 years, and then just do that again. And that's happening every day.
So how do-- and I know this might be a loaded question-- how do we look at investing in this new world?
Well, I think one of the things you have to look at is first, consider that what we have gone through is a pretty incredible period. And one of the things that made it a pretty incredible period is that if you wanted to come up with a period that worked really well for 10 years for a traditional portfolio, we just went through it. A traditional portfolio does really, really well when interest rates are going down. It drives the value of the bonds up. And as that money leaves the bonds, that flows into the stock market. And we just purposefully spent a whole decade doing little other than that.
So if you look at it on a-- if you ask yourself, well, is that going to continue? Our whole-- when I first started here two and a half years ago, I walked in the door, and I said, our starting point is that we're in a complete environmental shift, and that this one key driver of returns is going to change. And so if that is the case, we need to start thinking about how we're going to invest in a different way.
Now, I know you've written a pretty extensive document on your risk priority management philosophy. So I just want to close things up, because I know people have a lot of questions. So we're going to include the link to the document in the description of this video, where they can read it from end to end.
What would you leave people with your last takeaway?
I think that my last takeaway was this-- is that I think investment success comes from being really clear about how you think. And it's not about the things you purchase. It's how you go about doing that.
And I think if you can come to terms with that, I think the first one is that I think this notion that we really believe strongly in is it's not necessarily economics, but it's humanomics. And that is this mixture of the cold, hard facts, but also understanding that when you have the cold, hard facts, there's also the biases that we're going to have.
How we behave.
How we behave. So the example that I gave you about the person going back and wanting to invest in 1980, one of the first reasons why the reluctance to invest that way was there is a recency bias. Everything I just experienced as I was going through the terrain suggests, boy, that portfolio won't work very well.
Then you go through that. There's an overconfidence bias as well, because you go, I really understand this, because I've been living in this environment. So if you look at it, and based on those two areas, if you can kind of fuse the economic fact with the human side of it, and have a consistent way of thinking, and making decisions, and being clear on how you do that, I think that's where the success comes from.
We wrote a whole document about this that is a framework for that, called Risk Priority Management. And I'd really invite you to read that. And I think that it's a tremendous start.
Thanks very much, Brad.