Nebo Wealth

Investment portfolios often rely too heavily on a single risk score, overlooking other important factors like time horizon and required rate of return. This oversimplification can lead to generic and non-personalized portfolios that don't align with individual goals. The alternative approach, called the Investment Policy Process (IPP), focuses on understanding clients' needs and goals and tailoring portfolios accordingly. The IPP defines risk as not having what you need when you need it, and it prioritizes a dynamic and personalized investment strategy. It requires ongoing monitoring and adjustment, but it aims to withstand market volatility and keep long-term goals in sight. The IPP integrates financial planning with asset allocation, ensuring that investments align with specific goals. It also emphasizes the concept of maximum loss tolerance, determining the amount of loss one can afford without derailing financial plans. It's important to take ownership of one's financial journey, c Ever try buying shoes based on just your shoe size, no matter the activity? Oh, yeah. Like hiking boots for ballet class? Yeah. Sounds kind of ridiculous, right? Totally. But that's kind of what happens with a lot of investment portfolios. They rely way too heavily on just a single risk score. Yeah, it's a fascinating point. It is. You know, we always hear about risk tolerance being so important, but what about those other two pillars that the CFA Institute emphasizes, you know, time horizon and required rate of return? Yeah. They often get sidelined. Like they're just footnotes. Yeah, exactly. But today, we're diving deep into this NEBA Wealth research paper called The Perils of Outsourcing Asset Allocation to a Risk Score to see why that might actually be a problem. Yeah. The paper really challenges this oversimplification that can happen. For example, you could have two investors, one young, one nearing retirement, but they have the same risk score. Their portfolios might end up almost identical, even though their goals are completely different. So someone just starting out with decades to invest could end up with the same portfolio as someone who needs that money pretty soon. Exactly. That seems like a recipe for disaster. It kind of illustrates the big flaw in this approach. Because risk scores often don't capture the nuances of someone's needs and circumstances. Yeah. So we end up with these generic portfolios that aren't really personalized. And then to make matters worse, these risk questionnaires, they're not exactly foolproof either, are they? No, they're not. I mean... The paper dives into that too and talks about how behavioral biases can creep into those questionnaires and actually distort your true risk tolerance. Wow. So one example is anchoring bias, where you might unconsciously get fixated on irrelevant information, like your social security number, and it can influence your answers. So a number that has nothing to do with my investments could actually be shaping my portfolio. It's possible. That's a little unnerving. Yeah. It's a reminder to kind of take those questionnaire results with a grain of salt and really have a deeper conversation about your goals and your comfort level with market fluctuations. So if relying solely on a risk score isn't the answer, what does this paper propose as a better way to manage risk and build portfolios? Well, the paper introduces this alternative called the Investment Policy Process, or IPP for short. And it tries to rebalance the equation by bringing those other two pillars back into focus, time horizon, and required return. Okay. So instead of just asking, like, how much risk can you stomach, it also considers how much risk do you actually need to take to achieve your goals. Exactly. That's smart. And it starts by actually redefining risk itself. Oh, of course. So instead of just viewing risk as volatility, the IPP defines risk as not having what you need when you need it, which I think is really interesting. I like that definition. Yeah. It feels a lot more relatable in most people's lives. Absolutely. But how does this IPP actually work in practice? Like, walk us through it. It prioritizes a deep understanding of what the client's needs are and when they need them. Okay. It's like plotting a financial journey with specific milestones in mind and then uses that information to tailor a portfolio designed to reach those goals. So it's more like creating a custom-made suit than trying to squeeze everyone into the same off-the-rack garment. Exactly. You're creating a personalized investment strategy tailored to your specific needs and goals. Yes. Unlike the one-size-fits-all approach. Yeah. And risk scores. And what's even better is that it allows for dynamic adaptation. Okay. As your life changes. Okay. Maybe you get a promotion, buy a house, have a child, your portfolio can actually evolve with you. That's a huge difference compared to just relying on a static risk score. Huge difference. This level of dynamic portfolio management, it sounds complex. It is. It sounds like it would require a lot of work and ongoing monitoring. It does require more of a hands-on approach. For both the advisor and the client. For both. So it's not a set-it-and-forget-it approach. No. You're actively adjusting and optimizing as you go. That's right. While the IPP sounds promising, I am curious. Yeah. How does it address market volatility? Yeah. How does some of this need for constant adjustments increase the risk of overreacting short-term fluctuations? Well, that's where the focus on time horizon comes into play. Okay. The IPP doesn't try to predict short-term market movements. Instead, it builds a portfolio designed to withstand those inevitable ups and downs and really keep your long-term goals in sight. So it's more about having a compass to guide you through the rough seas than trying to avoid every wave. Exactly. Okay. I like that. So, as it works in practice, the paper includes this case study of a couple who's nearing retirement. Okay. They each have different goals. Oh, interesting. One partner is simply aiming to not outlive their savings, which is a common concern as we get older. Yeah. But the other partner is focused on preserving purchasing power. Okay. They want to make sure that their savings don't get eroded by inflation and that they can maintain their current lifestyle throughout retirement. That makes sense. So two people. Yeah. One couple. Yeah. But different financial aspirations for their future. Right. A single risk score wouldn't be able to capture that. No. And the complexity. Rarely would. No. So that's where the IPP shines. Exactly. By considering their individual goals, their time horizons, their risk tolerances, it can create separate, tailored portfolios to meet their specific needs. Exactly. This is starting to make a lot of sense. But doesn't this sound a lot like good old-fashioned financial planning? Yeah. Where's the revolutionary aspect of the IPP? It's true. The IPP does build upon those principles of good financial planning. Right. But what I think is innovative is how it integrates financial planning with asset allocation. Okay. So instead of creating a plan and then just slapping on a generic portfolio based on your risk tolerance, the IPP bridges that gap. Okay. And you make sure that your investments are actually working towards those specific goals that you outlined in your financial plan. So it's not just about creating a plan. Right. It's about making sure your investments are actually aligned with that plan. Exactly. It's about moving beyond the limitations of that single risk score and embracing a more nuanced and personalized approach to managing your wealth. I like it. And that's where the paper delves into some really interesting concepts. Okay. So let's talk about maximum loss tolerance. That's a term I've heard before. Yeah. But haven't fully graphed. Can you break down what maximum loss tolerance actually means? Sure. And how it fits into this IPP framework? So maximum loss tolerance is really a crucial element of the IPP and draws on the work of Harold Davinsky. Okay. Who's like a pioneer in the world of financial planning. Got it. He emphasized understanding the maximum loss that a client can tolerate financially and emotionally before it significantly impacts their plan. Okay. So it's not just about how much you're willing to lose, but how much you can actually afford to lose without derailing your financial plans. And then this tolerance gets translated into portfolio constraints. Okay. Maybe like a maximum allocation to stocks or a cap on portfolio volatility. So you're building in guardrails. They're building in guardrails. Exactly. To prevent catastrophic losses. Exactly. So it's not just about technology, guardrails for your portfolio. It's about recognizing that everyone has a breaking point and ensure them that your investments aren't designed to push you past it. But how do you figure out this maximum loss tolerance? Is there like a formula? There's no one size fits all answer. It's highly personal and subjective. The paper suggests looking at historical bear markets or financial crises as a reference point. Okay. And then you can go out in those situations and ask yourself, could I have handled those losses? Wow. You know? That's a tough question. Yeah. It's a thought experiment. Yeah. You know, simulating those worst case scenarios and seeing how you react. Right. Would you panic and sell everything? Right. Or would you stay the course? Yeah. That self-reflection can be really valuable. It's essential. Yeah. Understanding your emotional response to market volatility is just as important as understanding your financial capacity for loss. Absolutely. It's about finding that balance. This is all getting quite deep. Yeah. I'm going to bring it back to our listeners for a second. Okay. What are some key takeaways that they can start implementing today? Okay. Even if they're not ready to dive head first into the full IPP process? Yeah. That's a great question. What are some things they can do? So first, don't just blindly trust a single risk score. Okay. It's only one piece of the puzzle. You need to understand your individual needs and goals and time horizon. So it's about taking ownership of your financial journey? Yes. Not just outsourcing it to a number. Exactly. Okay. What else? Second, remember that risk isn't just about volatility. Okay. It's about achieving your goals. Uh-huh. Ask yourself, what do I need and when do I need it? Okay. Let that guide your decisions. That's a really important mindset shift. Yeah. Any other practical tips? Third, consider your maximum loss tolerance. Okay. What's a worst case scenario you can handle? Uh-huh. Make sure your portfolio is designed to withstand those potential shocks. So don't just focus on the upside potential. Right. Think about the downside risk as well. Exactly. And finally, don't be afraid to seek professional guidance. Working with a financial advisor who understands the IPP can really help you create a plan that's truly tailored to your unique circumstances. Those are some great actionable tips. Good. This has been an incredible deep dive so far. Yeah. I feel like we've just scratched the surface. We have. But we are running out of time for this segment. Okay. But don't worry. Okay. We'll be back in part two to dig even deeper into the IPP. Great. We'll be exploring some real world examples. Sounds good. And practical tips for implementing this approach. I'm looking forward to it. So stay tuned for part two of our IPP adventure. All right. See you then. Welcome back to our deep dive into the investment policy process. Thanks for having me back. One of the things that really struck me about this NEBA wealth paper is how it challenges this traditional idea of a static portfolio. Right. Like we're so used to thinking about our investments as something we set and forget. Yeah. Maybe rebalance once a year. Yeah. If we're feeling ambitious. If that. But the IPP seems to really turn that on its head. It does. Yeah. It recognizes that life is dynamic. Yeah. Markets are dynamic. Yeah. So your portfolio should be dynamic too. It should. And that's where this idea of ongoing optimization comes in. Okay. The paper talks about how their platform allows you to kind of re-optimize your portfolio. Okay. As things change. Uh-huh. Your goals change. Market conditions change. Mm-hmm. Even your risk tolerance might change. So instead of just rebalancing back to some predetermined target. Right. You're constantly making adjustments. Yeah. To stay on course. Yeah. Like adjusting your sales as the wind changes. I like that analogy. Yeah. How often are we talking about here? Are we talking about doing this daily, weekly, monthly? It's not about constant tinkering. Okay. It's about having a process in place to review and adjust your portfolio as needed. Okay. The frequency really depends on your individual circumstances. Okay. And how quickly things are changing. Either in your life or in the market. So it's more proactive approach. It is. Than the traditional buy and hold strategy. Much more proactive. But what does this re-optimization actually involve? Well. Is it just tweaking the percentages of stocks and bonds? Yeah. Or could it mean more significant shifts in your asset allocation? It can definitely involve more substantial changes. Okay. Especially as you move through different life stages. Okay. So let's take that young investor we talked about earlier. Yeah. Just starting out, their portfolio might start out really heavily weighted towards stocks. Okay. Seeking growth over the long term. Makes sense. They have time to write out the market's ups and downs. Exactly. But what happens as they get closer to retirement? Right. Would their portfolio look the same? As their time horizon shrinks and their need for stability increases, their portfolio might shift to a more conservative allocation with more emphasis on bonds and other fixed income investments. Okay. Does that make sense? It does. It's not just about their age. Right. But it's also about how their goals and risk tolerance might evolve over time as they enter retirement. Yeah. Their focus might shift again, this time towards generating income and preserving capital. Exactly. So their portfolio might then incorporate annuities or other strategies designed to provide that steady stream of income. Exactly. That's a great illustration of how the IPP can adapt to all these different chapters of your financial life. It is. But let's be realistic. Okay. This level of dynamic portfolio management sounds complex. It is. It sounds potentially expensive. It can be. Is this something that the average investor can realistically access? That's a great question. And afford it. You raise a really valid point. Yeah. In the past, this kind of personalized, ongoing optimization was really only available to like high net worth individuals who could afford to pay those hefty fees for that level of service. Right. The private wealth management type people. Exactly. But technology is changing the game though, isn't it? It is. It is. You're talking about robo-advisors. Yeah. And these algorithm driven platforms that have become so popular. That's part of it. Yeah. But platforms like Nebo Wealth are going beyond just simple robo-advice. Okay. They're using these sophisticated algorithms and automation to make this level of portfolio management more accessible and affordable for a much wider range of investors. So technology is essentially democratizing access to personalized financial advice. It really is. But what about the role of human advisors in this increasingly tech driven world? That's a great question. Are they becoming obsolete? I don't think so. Okay. I think technology is a powerful tool, but it can't replace human judgment and expertise entirely. Right. It's not about humans versus robots. Right. It's about finding that right balance between the two. So it's more like humans and robots working together. Exactly. Okay. I like that. Yeah. So the technology can handle the heavy lifting. Yeah. Crunching the numbers. Yeah. Generating those insights. Yeah. Maybe even executing trades. Uh-huh. But it's the human advisor. Right. Who can interpret those insights. Yes. Who can interpret those insights through those really complex financial decisions. Absolutely. Especially when emotions are involved. Especially when emotions are involved. You got it. So the human advisor is still the captain of the ship. Yes. But now they have a much more sophisticated navigation system to work with. That's a great analogy. What are your thoughts? I think that's a great way to put it. Yeah. And the NEBA Wealth paper emphasizes the importance of that human element. Okay. It talks about how the platform empowers advisors to have more informed and meaningful conversations with their clients. Right. Because at the end of the day, it's about building trust and relationships. Exactly. When it comes to something as important as your financial well-being. Yes. People want to know that there's a human being they can talk to. Absolutely. Someone who understands their needs and their goals. Someone they can trust. Exactly. Yeah. Technology alone can't replicate that. No. That human connection. No. There's no assurance that comes with it. You can't. This has been a fascinating discussion so far. It has. We've explored the limitations of risk scores. We have. The power of personalized portfolio management. Yeah. And this evolving role of technology and human advisors in this new landscape. It is a new landscape. It is. And there's still more to explore. There is. In part three, we'll wrap up our examination of the IPP. Okay. We'll dive into some more specific case studies. Right. And some additional tips for applying this approach to your own financial life. Awesome. I'm excited. Me too. Stay tuned for the final chapter of our IPP adventure. Okay. Sounds good. You won't want to miss it. All right. See you then. Welcome back to the final part of our deep dive into the investment policy process. It's great to be back. We've covered a lot of ground. We have. From the pitfalls of relying solely on risk scores. Right. To all the possibilities of personalized portfolio management. It's been a lot. It's been a lot. Yeah. And I think it's time to bring these concepts to life with a real world example. I agree. Don't you? The NEBA wealth paper presents a really compelling case study. I think our listeners will find it pretty illuminating. Perfect. Let's hear it. Okay. Who are these clients? All right. So picture this. Okay. Couple. Okay. Both 60 years old. All right. Five years away from retirement. Okay. They've saved up $3.1 million. Wow. And they're already putting away another $40,000 per year. Okay. And they've determined they'll need about $190,000 annually in today's dollars to cover their expenses in retirement. Sounds like they're in a pretty enviable position. They are. But I'm guessing there's more to their story than just those impressive savings. There always is. There always is. So one partner is mainly focused on not outliving their money. That's a big one. Which is a common concern as we approach retirement. Oh yeah. So the partner wants to see their hard-earned savings disappear before their time. Absolutely not. Right. But the other partner has a different priority. Okay. Preserving purchasing power. Okay. They want to make sure that their savings don't get eroded by inflation. Right. And that they can maintain their current lifestyle throughout retirement. So two people. Yeah. One couple. One couple. But very different financial dreams for their future. Different goals. I can already see how a single risk score wouldn't be enough to address their individual needs. You're exactly right. Right. And that's where the IPP comes in. That's where it shines. It goes beyond that generic risk assessment. Okay. And it considers their unique goals. Yeah. Their time horizons. Their risk tolerances. Uh-huh. To create these separate tailored portfolios for each of them. Okay. I'm intrigued. How would the IPP actually tackle this challenge? Where do you even begin? First, we need to understand their risk tolerance. Okay. But not in that traditional way. Okay. The IPP really focuses on maximum loss tolerance. Okay. How much can they afford to lose without jeopardizing their long-term financial security? So it's a much more practical and personalized assessment. It is. Than just asking, on a scale of one to ten, how much risk are you comfortable with? So it's a much better question. It's a much better question. Yeah. So in this case, let's say the couple determines that they could withstand a 20% loss. Okay. Before it really started causing them significant stress. Okay. This information then becomes a critical constraint. It does. As we build their portfolio. It does. That's right. So we're setting a safety net. Yeah. Making sure that their investments don't take on more risk than they can handle. Exactly. Now, for the partner who's concerned about not outliving their money, the IPP would figure out what's the minimum return needed to achieve that goal, right? And it turns out, it's a 2.5% return. Yeah. After factoring in taxes, fees, and inflation. So their portfolio would prioritize stability and capital preservation. Exactly. To make sure that it generates at least that 2.5% return. At least that much. Yeah. But for the other partner. Yeah. Who's focused on preserving that purchasing power. Right. They're gonna need a higher return. And if they are. Right. They would need a portfolio targeting a 4% real return. Okay. Which accounts for inflation. Okay. So two distinct portfolios. Two very distinct portfolios. Each designed to meet each partner's unique needs. That's the beauty of it. But wouldn't managing two separate portfolios. Yeah. Add a lot of complexity? It's a valid concern. So they're financialized. It is. But technology can help to streamline this process. Okay. And that's why Nebo Wealth can actually manage these separate portfolios within a unified framework. Okay. Taking their shared goals and resources into account. So it's not like they're suddenly living in two separate financial worlds. No. Not at all. The IPP can still provide that holistic view. Yeah. Of their finances. Exactly. While addressing your individual needs. That's the goal. Okay. I like that. Yeah. And the beauty of this approach. Yeah. Is that their portfolios can evolve over time. It absolutely can. Right. As they get closer to retirement, their risk tolerance might change. Sure. Their spending needs might adjust. Right. The market's going to fluctuate. It is. It always does. Yeah. So the IPP allows for these ongoing adjustments and optimizations. To keep their portfolios aligned with their changing circumstances. Exactly. That's where the true value of the IPP lies. I think so. It's a dynamic and adaptable process. It is. It's a framework that can guide your investment decisions. Yeah. It's an entire financial journey. Absolutely. This case study really brings the IPP to life. I think so too. And highlights its practical benefits. It does. I imagine some listeners are probably wondering where they should start. Yeah. Especially if this all feels a bit overwhelming. Understandably so. Right. It can feel that way. Yeah. But remember, the IPP is a journey. Okay. It's not a destination. Okay. You don't need all the answers right away. Right. You start by asking yourself those fundamental questions. Okay. What are my goals? Yeah. What am I willing to risk to achieve them? So it's about taking that first step. Yes. Clarifying your goals. Yes. Maybe seeking guidance from a financial advisor. That's always a good idea. Who really understands the nuances of the IPP. If you can find one, yeah. Yeah. And don't be afraid to embrace the process. Exactly. Financial planning is an ongoing journey. It is. It is. Learning, adapting, and making informed decisions. It is. To create a more secure and fulfilling financial future. Well said. This deep dive into the investment policy process has been so insightful. It has been a good one. It has. Yeah. I hope our listeners feel empowered to take control of their financial destiny. Me too. Remember, the IPP is just one tool. It is. In your financial toolbox. Yeah. The most important thing is to find an approach that resonates with you. Yeah. One that you can stick with. And that you can stick with over the long-term. Exactly. Wise words. Thank you. Well, we've reached the end of our deep dive. We have. Thanks for joining us on this journey. It's been fun. Of financial discovery. Yeah. Until next time, keep those brains buzzing. Yes. And those portfolios thriving.