Mark Riepe: Welcome to Financial Decoder. And on practically every episode, I think at some point the word "risk" pops up. And so we thought, let's devote an entire episode just to talk about risk. And we've got Kasey McCurdy—he's chief portfolio strategist for Schwab Wealth Advisory—to tell us a lot more about risk as a financial concept. So Kasey, welcome to the show.
Kasey McCurdy: Happy to be here.
Mark Riepe: So Kasey, when most investors hear the word "risk," what are they thinking about? What does that mean to them? And I guess more importantly, what are they missing?
Kasey McCurdy: I assume it's probably not the game from the '90s. But risk in the investment sense tends to be thinking the stock market is going to go down, and I'm about to lose a lot of money. What we try to help our clients at Schwab Wealth Advisory understand is that we want to think much beyond just the investments themselves and as more focused on the individuals. So what I think people tend to miss is that they're not thinking about themselves enough. And it is your goals. It is your preferences. It's all things that matter for your life that are the risks that we want to try to emphasize. The investments are always going to do what they do. And we want to try to acknowledge that, but we always want to try to bring it back to the person themselves.
Mark Riepe: So risk is about a lot more than price swings. Flesh that out a little bit. Give me some details. What are some of those risks that people are missing?
Kasey McCurdy: It's a long list. I like to try to remember that risks are everywhere. For us, when we're thinking about building out a financial plan, the first one is always going to be what we call shortfall risk. You know, the fact that you're not going to have enough money to live the life that you want to live. Spending is going to show up. You're not able to afford those expenses. The second is one that I think most are familiar with more recently, which is inflation risk. We've dealt with a bout of that over the last five years, and it doesn't seem to be going away just quite yet. But that is something that you need to be conscious of—keeping up with purchasing power. The third is what I would refer to as liquidity risk. We've seen a lot of folks lean into investments that are not always as liquid as some of our historical public investments are, and that may have some liquidity concerns about not being able to access your capital. There's about five more that I would consider, but I think broadly speaking, we're always trying to help our investors think beyond just, is the market going down? That's not the only risk. It can be a lot of factors that, extend beyond just the portfolio.
Mark Riepe: So one of the reasons we created this episode is because we thought there was a pretty good case to be made that people have more difficulty thinking and processing risk than maybe they do on the return side. So one, do you agree with that? And secondly, if so, what do you think is driving that?
Kasey McCurdy: I think when it comes to investments, folks tend to think mostly about the returns. What is the return of my investment? What is it relative to the index? The risk side, I hope, is helping them bring it back to their own situation. And what we're trying to help people think about is there are so many different factors that are out there. Your life is the one that we're focusing on first. And for each individual, there are a lot of things that tend to be beyond just the financial space. The one that I'll call out, and you and I have talked about before, is around behavior. And oftentimes it's the risk of making decisions that could be a negative for your financial outcomes. And so that may be because you see some headline or some event, and you want to react to it, or it may just be something that's more comfortable and safe. I often get clients that are very comfortable in cash, as one example. And the challenge with that goes back to things like the shortfall risk or inflation risk. You can't quite keep up with purchasing power. You can't quite keep up with long-term spending. And I'll say one of the challenges that we have recently, which sounds like an odd challenge, but it's longevity. And it's the idea of outliving the investments that you have. So I'm often trying to tell people the risks are important. It sounds very vague and nebulous, but it is the part that is about your own financial plan, not just what did my, you know, stock return relative to the S&P 500®.
Mark Riepe: I think this is the second time you've been on the show. And I think the first time you were on, you were talking about the difference between risk tolerance and risk capacity. So could you talk a little bit more about that?
Kasey McCurdy: I think this is something that tends to show up with the conversations that we have with our advisors, where we want to understand two components. So there's risk tolerance—that is the behavioral side of the house. There's also risk capacity—that is the financial side. And so you can think capacity is often math. The tolerance is your own personal ability to handle market dynamics. And so I like to think of capacity as setting the limits. That's the threshold that we can, you know, extend to, and then tolerance tends to be something that brings it back into what you can sustain. And so we always want both because we're all human, and we're not able to invest like machines. But there needs to be an understanding of what can your plan feasibly accept and what can you feasibly accept. That's the combination of the two.
Mark Riepe: I think another thing people like is low-risk strategies. And so as I was thinking back to your original list from the first question, is there really such a thing as a low-risk strategy? Or is what is really going on that you're just kind of trading off one risk for another?
Kasey McCurdy: 100%. That is exactly the case. I think you can have a low-risk strategy if you tell me exactly what the risk is you're trying to address. But the challenge with that is that you are not thinking about all of the other risks that you're taking on by choosing that path. Again, cash tends to be the one that I hear the most. It just becomes something that is very comfortable. I'll tell you a personal situation. I have a family member that recently had an inheritance. She's taking her inheritance now in cash. And the question immediately was, should I just put this into a savings account and hold on to it? And immediately it goes, well, it feels very safe. It's something that I can see. I know what the value is going to be. It's not going to change. And while that is true in the account itself, it may not be the fact that you're keeping up with all of the other risks, meaning you're not keeping up with purchasing power from the inflation risk. You're also not keeping up with the growth of investments, or if you were to invest in longer-term assets. And so I think the low-risk portfolio tends to be more behavioral in nature. It tends to be something that fits for somebody's life. It doesn't tend to be something that fits for a long-term financial plan. And so we're trying to help clients oftentimes think beyond just, "I want this to be the exact same dollar amount tomorrow." There are some other things that we got to bring into that conversation.
Mark Riepe: That's a great example. Can you, let's see, reverse that maybe and think about the person who's willing to take on a lot of investment risk because they're trying to generate a high expected return over time to feed their retirement liabilities. What's wrong with that?
Kasey McCurdy: Well, I think the idea is that anytime you're on the edges, there tend to be some risks associated with that. The way that you set it up, I often will talk to clients about what we call the spectrum. This is the investing spectrum. So cash being on one side; the other one I've named FOMO—fear of missing out. This is the idea that I want to chase all of those growth-oriented ideas. I hear my neighbor or my mate on the golf course that is doing very well in certain investments, and I need to chase that. So I think the challenge with going too far onto that side of the spectrum is that you run other risks, meaning you're maybe too concentrated as you lean into certain investment ideas.
A lot of times people have concentration in individual stocks that can come from just a preference because you may know a company. It can also happen because you have employer stock where you are granted those positions. You also can just see concentration happen as you lean into, let's say, growth as one individual idea. Around right now, artificial intelligence—AI is certainly a very big factor that folks have a lot of exposure to in their portfolios. And hopefully they recognize that. Sometimes they're not always aware of what risks we're actually taking. But the challenge oftentimes is that you lean too far into trying to follow those growth-oriented ideas and you run the risk in the short term.
One of the ideas that you think about in financial planning is what we call sequence risk, and the idea that if you are entering into, let's say, retirement and you have a very sharp downturn in the market, and you're heavily leaning into growth or risky investments, that may be a time when you need to spend and you have a smaller pool of capital to pull from. And that can really offset a lot of planning that we have for the longer term. So I think there are always challenges whenever you're on either side of the spectrum. So we're trying to help people move back to whatever that optimal mix of investments may be.
Mark Riepe: The sequence-of-returns risk is really important because you've got this pool of money you're going to be living on in retirement. You have a down market, and you're pulling money out right in the midst of that down market. It's like this double whammy on the size of your portfolio. So I think that's something that people don't appreciate it. While I was trying to get prepped for this, I looked up this statistic because you mentioned concentrated positions: 60%. And this has been a consistent number around a lot of different types of surveys—financial literacy surveys. Sixty percent of people get the question right: What is riskier, a single company or a single business, or a portfolio of stocks and a portfolio of businesses?
Kasey McCurdy: We've got to get those numbers up. Yeah.
Mark Riepe: I think that's a big deal.
Kasey McCurdy: I like that we're on the positive side of 50-50, but I think that we should, you know, make sure people understand what they're, you know, taking on when it comes to risk in their portfolios.
Mark Riepe: We are in such a news-driven society. Information is everywhere. We all got apps, you know, pinging us all day long. I think my phone over there has gone off three times during this, screwing up this recording. How do you decide what risks are worth paying attention to versus risks that you just kind of hear about? And we've all got a limited amount of time to spend on things. Some things you've just got to push aside. It's probably not relevant to me.
Kasey McCurdy: I try to help people think through this systematically. The challenge that I have, particularly when it comes to headlines or the pings we get from apps, is that those interjections in your life are designed to be very emotional. I will often say that the news and social media, they're there to get your heart rate and your blood pressure higher. I'm trying to help people lower their blood pressure wherever we can. And the reason for that, and the way that we do it, is by first asking the question of how does this impact me, and how does it impact my financial life? And so first, let's think: What is the headline telling you about your own portfolio? The second, let's try to put at least some thought into what is the probability of said risk actually occurring. What tends to happen—and this is just a behavioral bias—is that because it's very familiar and memorable, you put more weight on the likelihood of that happening. And so the probability becomes a much higher number than it really is in reality. And so the second piece is the probability.
The third is trying to put some idea together of how you could address the risk. Let's say that you come up with, yes, this is a really likely outcome. Now let's try to think about what is the exposure in your portfolio that you could change. And once you have figured out what that change is, the last piece is to say, what are the other points that I'm missing? What other risks am I taking on by making that change in the portfolio? And I think that's the problem that a lot of people will miss.
And the example I will give is often around the concept of addressing concentration. And so folks will want to try to lean away from, let's say, a market-cap index because recently we know more than 30% is in the Magnificent Seven stocks. You have a lot of concentration in large technology-driven companies. How do I lean away from that? And while there are ways to do that, understand that that's not eliminating all the risk. It is addressing one, but is it introducing other concerns as well? Meaning you may not be able to keep up with those companies if they continue to do well. And there are other things that I think are just important to keep in mind.
So it's first, let's think about what is the actual concern. Let's think about what is the exposure in my portfolio. Let's address the probability. And then hopefully you can try to think through beyond just what is the headline risk, but more, what's the other risk that I'm trying to not take?
Mark Riepe: Well, and I think any financial advisor would just love for their clients to come in and say, "Should I worry about this? Should I worry about this? Should I worry about this?" I think they'd all love to have that conversation.
Kasey McCurdy: Yes. I think that's mostly our job. I think that's actually the primary responsibility of an advisor. I think being able to talk through all of those headlines, social media—what we like to call ignoring the noise—because I'll share this with you as well. I think this is something that I talk about with our clients often. I usually open my client events or presentations with this. I'll ask clients, who's currently uneasy about markets? Everybody raises their hand. And then I'll ask, who was uneasy about markets, let's say, earlier this year? If you go back to March when we had the war in Iran start, were you uneasy at that point? And everybody raised their hand. And I love to ask the follow-up question of who believes in buying low and selling high? And everybody raises their hand.
The point of that sequence is to make sure that folks understand that, no matter what, you have a concern for uncertainty at all points in the market. Because if you go back to March, prices were 20% lower than where they were today. That didn't give you the confidence that you should be investing right now. And so uncertainty is part of it. The noise is part of it. We always need to think beyond that. Again, I'm going to keep harping on this. It's coming back to the person and what are their financial needs.
Mark Riepe: So final question. Let's imagine somebody's listened to this, they've watched this video, they're going to go, you know, see how this applies to them. What are the two or three steps, concrete steps or questions, they should get answered first?
Kasey McCurdy: First, know what you own. So let's first address what is currently in your portfolio. And then second, understand what you own and what you need to own. So meaning, I own this today. What is the gap between where I'm at and where I need to go? And I think that part is where the advisor, I believe, comes into play. And they're going to talk with you about all of the different things in your life. That is the full financial plan. They're going to go through the details to make sure they understand exactly what are your needs for cash flow, what are your needs for liquidity? What is your tolerance for risk? What are you capable of withstanding from a financial perspective?
All of that goes into: Here we are today. These are the positions. Again, the conversation today tends to be around things like concentrated positions or, on the other side of the spectrum, those sitting in cash. And we're going to try to think about what are the changes that need to happen to get you back to that middle, optimal portfolio again, trying to always think through the risks associated with those trade-offs.
Mark Riepe: That's right. And those risks change. I mean, those are questions you should be asking yourself on a regular basis, right?
Kasey McCurdy: I think so. I ask myself a lot of questions, so I hope others do too.
Mark Riepe: All right. Kasey McCurdy is chief portfolio strategist for Schwab Wealth Advisory. Investing is always that balance between risk and return. Kasey, thanks for clearing up at least half of that particular equation.
Kasey McCurdy: Thanks, Mark.
Mark Riepe: Kasey always has some great insights. Even better, you can put them into practice right away. If you'd like to learn more about risk in your financial life, you can find a lot of resources on Schwab.com. I want to highlight a couple, and don't worry, we'll link to all of them in the show notes. One is "Ways to Help Reduce Risk in Your Portfolio." It dives into more detail about risk management, and while Kasey covered it, the article will give you some more to think about. There's also a great one called "Seven Investing Principles" that explains Schwab's investment philosophy, and mitigating risk is a big part of that. And there are several more listed in the show notes.
With that, we come to the end of another Financial Decoder episode. If you'd like to learn more from me, you can follow me on my LinkedIn page or on X at MarkRiepe—that's M-A-R-K-R-I-E-P-E. As always, we'd appreciate it if you'd give us a rating or review on Apple Podcasts or comment on the show if you listen to it on Spotify. We always like new listeners, so if you have a friend or two who might like the show, please tell them about us and how they can follow us for free in their favorite podcasting app. For important disclosures, see the show notes at Schwab.com/FinancialDecoder.