The Power of Diversification, Discipline, and Staying the Course

I'm a CFA. I've had my CFA for 24 years. If anybody though they were gonna be a stock picker, it was me. I have not picked a stock in 23 years. Why? Because it's hard. It's hard, it's hard to beat the market. Welcome to The Informed Investor, the podcast that brings you research and insights to help separate the news from the noise. Well, welcome everybody to the latest episode of The Informed Investor, a show brought you by Dimensional Fund Advisors, a firm bringing financial science to the world of investing with over a trillion dollars of assets under management. I'm Jake DeKinder, and we are broadcasting from the Ritz-Carlton in Chicago where we're putting on conferences for the financial advisor community that we work with and incredibly pleased to be joined by Randy Hardy, Factor Wealth. Randy, it's great to see you. You too, my friend. It's been a long time. It's been a long time. We've known each other for a long time. It's great to be here in Chicago with you. I know. I walked four blocks to get here, so it was out of my way, out of my way. It was easy. Very, very easy. I sent you a note and I was like, hey, is this gonna be too much for you? And you're like, I got you. I'm like 10 minutes away. It was less than that. That's good. Well, yeah, it's great to see you. And one of the things that I want to discuss with you today, which ties in, I think, directly to Dimensional, I want to talk about investment philosophy. Absolutely. Because one of the things that I've noticed working with you over a number of years is you have complete clarity of investment philosophy, your view of markets, your view of the world. I guess I'll start with where does that come from? Sure, so number one, my background perhaps is different than a lot of the advisors you've talked to and perhaps have had on this podcast that have graduated through Merrill or Morgan or a big wirehouse. My background is I spent a couple years in investment banking and then I pivoted. I went to work on your side of the desk. I went to work for an asset management firm and did that for 10 years and traveled all over North America dealing with advisors and their clients. So it was baptism by fire. In 2009, I decided to leave the institutional side and went to the advisory side. And one of the things I brought with me was this conviction, was this belief system and having an investment philosophy, sticking to that investment philosophy and having ultimate clarity. One frustration perhaps that I always had in dealing with firms as I traveled across North America is I felt like many of them were agnostic and many investors are agnostic. One moment they're strategic, the next they're tactical, one moment they're stock picking, the next they're embracing evidence-based investing, they're indexing. And for me, that was never the case. I was introduced to this philosophy of market efficiency and diversification 26, 27 years ago and it stuck to my core. I believe it in my core. Yeah, and I think, we're here in Chicago. Obviously a lot of what you're talking about comes out of University of Chicago, Professor Fama, efficient markets, markets work is really the hallmark of Dimensional. I think a lot of firms that work with us as well. And it's nice to hear that clarity of what you have. What do you think it does for your clients at a high level? Well, first of all, I think when a client comes in and especially during turbulent times, they're looking for somebody to guide them and they're looking for a belief system to follow. They're nervous, they're alarmed, guide me the right way. And their motivation is it's self-serving. Will I have enough, will I make it? Will I be okay? And so they need that bedrock, that north star, if you will, to make sure they can get their investment objectives met. And so sticking to an investment philosophy, as David Booth always says, the important thing about having an investment philosophy is sticking with it in good and bad times. And frankly, having that bedrock or that north star ensures that investors capture returns that they're entitled to. Do you find that it's tough for investors to get over that hump? Because I do think a lot of people with investing are sort of taught of the smartest, the hardest working, find the manager, find the person who's got the secret sauce, can make a prediction about the future, where's the market gonna go, pick individual stocks. Do you find it's challenging for investors to get over that mental hurdle and get to your side? I would have said that to be the case probably 15, 20 years ago when this concept of indexing and market efficiency and passive investing was newer. It was so un-American to be average. Coming from a Canadian. Yeah. Coming from a Canadian, exactly. Who's also an American. So how's that for a paradox? But frankly, nowadays I don't think that's the case. It's so logical, it makes sense. And the paradox to build on that last thing is that investing today, if you shoot for the average, you'll typically be above average, just because obviously active management's this negative sum game. It's very logical. The KISS principle applies and I think it resonates with most investors today. So if you go back to when you moved from the asset management side over to the advisor side, take me back to those first couple of years. And you've got strong conviction, but how you communicate that strong conviction, I got to believe there were maybe some conversations that you stumbled through. You're a great advisor, I'm not saying that. No, no. But you and I were talking about that, right? You're sort of learning like, I believe this deeply, how do I communicate it to people? Absolutely. And I think in terms of when you're dealing with an advisory firm or an institution, they dig really deep. And what I find in dealing with investors is they don't want the details. They just want to make sure they're gonna be okay. So rather than getting into the nitty-gritty on an investment topic, perhaps, maybe it was the outperformance of small cap over time or this factor premium that we talk about or the value that a firm like Dimensional can add just through patience in trading and not holding firm to an indexing philosophy. Clients don't care about that. Again, what do they care about is they want to like you, they want to trust you, they want to make sure you add value above and beyond just the portfolio and make sure I'm gonna be okay. One of the things that we do on this show is a lot of times we'll read some headlines here. And I grabbed a couple just because I thought they were interesting. Our team kind of scans what's going on out there. A couple sort of jumped out to me, which was the new psychology of investing, why the future of wealth creation may depend less on prediction and more on discipline. And the reason I grabbed this I think speaks to what you mentioned earlier of there has been a little bit of an evolution where people are, I think, starting to come around to this idea of outguessing the market and predicting what's gonna happen is a tough thing to do. Did you get that sense? Absolutely. And I used to, when I did my CFA, it's hard to believe I finished it 24 years ago, but obviously what was drilled into you was this concept and idea that asset allocation, number one determinant of portfolio performance. And what I've learned over the last 20 years is it's not the number one determinant of portfolio performance. The number one determinant of portfolio performance is investor behavior. And are you gonna chase returns? Are you gonna panic when markets are falling? Are you gonna chase returns at the top? And I think day to day we still deal with that with investors, but I think that headline, it should have been written 20 years ago. It could have been written 10 years ago. It's written today. And I hopefully think it will be written in the future because it should apply yesterday, today and tomorrow. But as more investors are coming around to this, and I'll take your client base of you believe it, you communicate it well, but it doesn't mean that it's always going to be easy. And one of the topics that you brought up or concepts you've always brought up to me that I love is this idea of start date bias. And that's a tough thing for investors, right? Tell us what start date bias is. Sure. Well, just to build on something you said is there's the old Warren Buffet quote he said, investing is simple, but it's not easy. So number one, realize that. But start date bias is when I sit down with a client and you talk to them about the merits of diversification and this factor-based investing approach and perhaps market efficiency and rebalancing portfolios and focusing on things you can control, perhaps they come to you with a portfolio, it's very heavy US large cap portfolio and they say, I'm all in. I want to diversify. And the moment they sign that paper, what they think is magically everything is gonna align going forward. Stocks are gonna go up, value's gonna outperform growth, the size premium's gonna show up. I'm gonna have benefits to having international diversification in a portfolio. And it's just, I invested and the market's magically gonna go up tomorrow. But as you know, just even in our client base and certainly across your broad client base, both individuals and advisory firms, there's money going in every single day. So the market can't go up every single day. You don't want it to go up every single day because it wouldn't be riskier. And I know you've talked about that in the past. And so oftentimes, client come on board and it's just education, education, education. And you want to see day-to-day volatility, week-to-week volatility because that's how you can set the stage for the first year, the first 10 years, and certainly longer than that. And that's a tough thing, right? Because as you said, you're like, look, I've got five different clients that come in January 1st, five different. I'm gonna do the exact same thing for them, but they will have different investment experiences over the short term. So you set the expectations upfront, but how do you keep them disciplined going forward? Yeah, and just again, to build on what you said is imagine the client that came in January 1st of 2020. So it's right before COVID, equity markets are gonna disappear, they're gonna fall by 30%. And that investor opens their statement at the end of April. And they look at it, they're down 20%. And they say, just mental math, at this rate, I'm gonna be out of money in five years or five months or 15 months. It's just everything gets straight lined. And then imagine that another client walks in the door and it's July 1st of 2020 and the market has started to recover. They start investing. By the end of the year, they open their statement, they're up 20%. Same philosophy, same approach, same discipline, different timing, yet they have two different, very different perspectives. They rode through the exact period. One started right at the bottom, one perhaps started at the top. You've got to really educate those clients that certainly over a longer period of time, the differences between those philosophies and those start dates are gonna be negligible. The other concept that you talked to me a little bit about here was this idea of portfolio variance risk, which sounds a little technical. So break it down for us. When you say portfolio variance risk, why should investors care about that concept? Sure. So again, think of an investor that's used to picking the big names. So they've got the NVIDIAs, they got the Apples, they got the S&P. And so when they turn on the TV, it's easy to benchmark their portfolio to what the people are talking about. And I've said for the past 20 years is anybody can say plus or minus a thousand, what's the Dow trading at? What's the S&P trading at? And right or wrong, people benchmark their portfolios to the US large cap market. All of a sudden you layer on value, you layer on small cap, you diversify in international markets, you add some fixed income, you invest in emerging markets. Perhaps you have some real estate in the portfolio. All of a sudden your portfolio, for better or worse, I think for better, doesn't look like what everybody else is talking about. That's portfolio variance risk. And if you think back, again, just my personal experience, it was the late '90s. I left investment banking. I started sitting down with clients and I have never seen, still to this day, 27 years later, I've never seen more unhappy people in the late '90s that had a diversified portfolio. And granted, we were showing up with fantastic returns. They were doing well, capital markets were going up, but they weren't going up as much as the S&P. That variance was real. Then all of a sudden, we lived through the lost decade of 2000 to 2009 where the S&P was negative over a 10-year period and you lived through the great financial crisis. We lived through 9/11. And if you were diversified and you implemented this variance risk portfolio, you generated positive returns in that decade. And I sat down with investors and what did they say? Thank goodness I'm diversified. Thank goodness I don't look like the S&P. Thank goodness I have international. Thank goodness I have value. Thank goodness I have small. Thank goodness I have short term high quality fixed income, which weathered the storm in 2008. And then bam. Then what happened? The great financial crisis ends and all of a sudden, the US large cap market is shot back up again. And what questions are we facing? Why am I diversified? Why doesn't my portfolio look like the S&P? And it's just people have such short memories or perhaps they haven't been there because of that start date bias. Again, it's this constant reeducation that goes on with clients for sure. Do you fault investors when they come and have those conversations with you? No, not at all. Because again, with an investor, I always know where their motivation lies. An end investor client, we sit across from them all day, every day, have these calls. What are they concerned about? They're concerned about themselves, their own wellbeing. That's what they should be concerned about. We work for them. So if they bring concerns, I'm not frustrated, I'm not alarmed, I'm not shocked. I'm there to relieve their fears or questions or anxieties, but I don't fault them at all. We're here in Chicago putting on conferences for advisors. You've been through a number of those. I have. And Dan Wheeler, who started the financial advisor group here at Dimensional, I mean, really was one of the people who had more conviction and clarity than anybody you've ever met. Absolutely, absolutely. I remember seeing Dan in 2004. And so I moved to the US in 2003. I went to the old conference center in Santa Monica and Dan Wheeler gave a quote and he said, there's no such thing as people with investment problems. There's only investments with people problems. And certainly, I think study after study after study proves that is the investment return is there for the taking, we just don't take it. Investors don't take it. And so that quote has stuck with me for the past 20 plus years and it certainly guides part of what I do with clients each and every day. Even when you have the same conversation with them over and over, which again, you said you don't blame them because we're sort of wired a certain way. So you almost have to keep reinforcing that idea. Furthermore is when you talk to clients every single day, you use a quote like that to a client today and two weeks down the road you think, ah, everybody's heard it. Well, they haven't heard it. And frankly, if you tell them three years from now, we all have busy lives, short memories, and just drilling home that concept again that the investment world, it's simple, it's not easy, and there's no such thing as people with investment problems. There's only investments with people problems. We were talking a couple weeks ago on the phone and you said one of the common things that I encounter is someone calls me up or they come in and they say, I got a half million bucks. What you gonna do with it? Sure. And how does that conversation go? And again, I think back is, it's just comfort and it's belief and it's what do you feel in your core, in your guts? And so for the longest time, I felt like clients were testing me and, hey, I've got half a million dollars, what should I do with it? And what would my response be? We built an asset allocation model based on your objectives and constraints. Let's allocate it based on your target asset allocation. We're gonna diversify and that's what we're gonna do. And I felt like they were sometimes early on, like maybe he's gonna say something else, but then they'd say, that's what I thought you'd say. And so now when they say, hey, I've got some extra money to invest or how should I deploy this capital? They know the answer. We're gonna stick to our target asset mix, that north star, that ballast in a client portfolio again, it's their portfolio. It's not mine, it's not yours. It's not anybody else's. What's their asset mix? Let's deploy it according to that asset mix. It's very thoughtful and we put the money to work. So there's never any, oh, maybe we dip into structured notes. I never fall victim to that. Again, I am not agnostic. I sit here with full conviction saying that, again, everything we preach, markets work, diversification is key, risk and return are related, focus on things you can control. It permeates through every single conversation I have with clients. When you think about your time building the advisory firm, where you're at, what are some of the stories that jump out to you from client experiences? I think they kind of drive this point home of if you buy into this belief set, if you view capital markets this way, especially maybe during some choppy times, what it does for you as an investor. Sure, and there's just so many stories, right? Like that's the great part about dealing with clients is you develop these stories over time and I've certainly developed them over the last 17 years at Factor Wealth. And so there's a couple clients. I remember one client of mine, still a client to this day. She lived in Chicago, She now lives in DC. She has been my number one advocate. She's just been a huge referral source for me. And originally, she started interviewing five different investment firms in and around Chicago. And I'd met with her a couple times and I'd walked through our approach and our belief system and how we lead with planning and the core investment philosophy and all the things that certainly your listeners have heard time and time again on this podcast. And so as it was coming down to the wire, she was gonna make a decision and she called me up one day and she said, Randy, can I come by and visit your office? I said, yeah, come in. And she came in and she sits down and she said to me, Randy, I've got one question before I give you my decision. She said, why have you never asked what other advisory firms I was talking to? And I chuckled, I laughed. And I said, honestly, I said, because I don't care. I don't care. I said, it's not gonna impact how I believe we should lead with planning. We should run through a financial planning process, how we should build and construct portfolios, how we're gonna embrace financial science, how we're gonna embrace academic research, this philosophy based on logic, not on luck, the difference between investing and speculating, all these things that I believe, it doesn't change because that's what I believe. And she thought and she said, that's what I hope you'd say. And signed up right there. And again, it was this snowballing effect. One other story top of mind, it was, so I moved to Chicago in 2009 to purchase the firm that I now own. And I received a call from an investor. It was a lady, unbelievably smart, intelligent, well-read, informed investor. And she called up and she had the most unbelievable questions. And I answered them and she stopped me and she said, Randy, are you okay? Are you okay answering all these questions, giving away your secret sauce? And again, perhaps self-deprecating, I was like, of course, I have nothing to hide. This is my belief system and it's not gonna change. And so she ended up coming in. The funny thing was, is I originally thought she was a competitor. I thought she was an advisor that was fishing on the merits of passive investing and everything that we preach. Again, she has become a huge advocate for me, client still to this day. And I thought she was an advisor. But again, it speaks to my belief system. Clients feel it, and again, they want to be guided. They want to follow along in the shadow of that belief system, and I happily oblige. It's kind of a guiding light, a north star through really any market condition, any economic condition, any geopolitical event. It sort of gives you clarity of, here's the plan and we're just gonna go execute the plan. Absolutely. And it's the old Mike Tyson saying, what is it? Everybody has a plan until they get punched in the mouth. And so it's almost during those choppy periods, and certainly there's a lot of them. Is it every year or two? It's the crisis du jour, and that falling back on that written plan, that written investment policy statement, that target asset allocation customized to them, that's how to achieve the average, which as I said earlier, the paradox in the investment industry because of fees and in DALBAR studies and people chasing performance, average is not average in our industry. Average just happens to be above average. That ties in actually to another headline that I had here, which I thought was interesting was, you can beat the stock market by avoiding the worst days, but you won't. Market timing is so appealing. Get out before the market falls and get in right before it rallies. And I mean, people have tried it for decades, study after study after study, after study shows it detracts from portfolio performance. It sounds great, you just can't do it. It is absolutely impossible and you've got to be right twice. What I say to people when they want to market time, if perhaps AI valuations are frothy, there's tension in the Middle East, whatever the topic du jour is. And I say, okay, so you're scared today? Yeah, I'm scared. I said, if you get out today and you go to cash or you're rolling treasury bills, what do you want to have happen? You want Armageddon. You want markets to plummet. You want anarchy. And so you want a 50% downturn. And I said, but if that happens, do you think you're gonna be ready to hop back in? If you're scared today, you're gonna be terrified then. And so these stories, again, that I've seen through time where somebody gets out and then they never can get back in, and the regret and the lost money in terms of getting back in, I mean, that ruins financial plans. It really does, talking about that financial plan, you thought about it in an interesting way when we were prepping for this where you said, look, when you develop a plan, you got enough sort of assumptions that you have to incorporate into the plan, what's gonna happen with interest rates, what's gonna happen with tax rates, what's gonna happen with the investment piece of it, right? And there's the future, it's just life. And then you almost put this air term at the end, and when you market time or you take a traditional active approach or you really just magnify that air term. And it's hard to build a plan around it. I think it's impossible. And so a bunch of planners in my office, we run financial plans for clients every single week. And what is a financial plan? It's a series of inputs. It's inputs of everything that you talked about. It's inputs around income, expenses, assets, liabilities. And the biggest input is expected investment return and volatility. And so with some degree of certainty, you can build in some metrics around expected returns, perhaps discounted to what we've seen over the last hundred years and volatility in client portfolios. But if you are trying to time the market, which might lead to outsized plus or minus returns, more likely minus, or active management where volatility is certainly gonna fluctuate dramatically. For example, if you're using these small esoteric active ETFs that are basically actively managed mutual funds, up 40% today, down 40% tomorrow, that is just gonna lead to such a huge disparity and diversion of expected outcomes using Monte Carlo. I don't know how anybody can plan for that. I don't know as an advisor how you can reconcile that because you're just introducing these huge dispersion variables and I think it's crazy. You were mentioning sort of these esoteric ETFs. How do you handle the product explosion that we've seen? Because from when you started, I mean, look, this industry's always had products and a lot of them weren't designed with the end investor in mind. But you definitely have seen an explosion of products and anybody can access almost anything. How do you handle that? Tune out the noise, I tune out the noise. And everybody knows the stats. I think there's more ETFs and mutual funds than there's individual securities that they're buying. And so the market is sliced and diced a million different ways and some of them are, I call them very, very gimmicky. And so what do we do? I tune out the noise. I stick to building blocks in client portfolios. Oftentimes, do I read about them? Sure. You got to stay up on it. Stay up on it. But do I implement them in client portfolios? No, I don't. And back to, there's nothing wrong with speculating. If you want to take some money and speculate in a crypto ETF, for example, or anything else that exists, by the way, the new flavor changes every single day. It was meme stocks and then crypto, and then it was gold and silver, and now it's AI. Who knows what it's gonna be next? Go and go crazy with that. But what are we tasked with is building core solid institutional portfolios for clients, and I tune out the rest. And one thing I can say, and I look clients in the eye all the time, I'm a CFA, I've had my CFA for 24 years. If anybody thought they were gonna be a stock picker, it was me. I have not picked a stock in 23 years. Why? Because it's hard. It's hard. It's hard to beat the market. And there's a ton of research out there, and I'm sure you've talked about it on the podcast, like Hendrik Bessembinder.. He talks about how most stocks underperform treasury bills over time, and it's these very few outliers that lead to these outsized gains. And so what stock pickers or active managers often talk about is, well, we're gonna find those. And I say, I think that's the wrong question or wrong attempt. Instead, what I say is, the only guarantee that you're gonna own those outside return producing securities is to buy the entire market. So I don't pick stocks. I've never picked stocks. I don't time the market. I rebalance my portfolio. I keep my costs low. I rebalance where possible. I do the exact same thing that we preach for clients. And again, just in terms of the belief system, when you can look across from a client and say, I'm doing exactly the same thing as you, we're in this together, up or down, clients want that. They believe that, right? And I think that will help them weather the storms back to something we talked about earlier. It's not the investment return, it's the investor return, and there's a huge gap between them. My job is to make sure they get that investment return. I love that conviction. Yeah. Absolutely love it, I got one headline I want to close here with that I thought was kind of interesting. Why high-net-worth clients need to rethink time, health and wealth. And I think that's a big part of what you're trying to do for your clients. And I think a lot of advisors are trying to do is broaden the conversation beyond achieving the highest rate of return, because it's not about that, is it? No, it's not. And furthermore, highest rate of return, I think the more important variable, especially if clients are living off their portfolio is reducing volatility. How do you do that through diversification, layer on fixed income? So that's number one. Number two is, I listen to a lot of podcasts like yours, and I consume a lot of books as I travel to and from the office every day. And I heard somebody say one time is that what's the number one goal of an advisor is to help clients get independence and purpose. And so in talking with clients, once when a client is past that financial freedom part of their life and they're not gonna run through money, we start to have this discussion around you either got to consume more or perhaps you should start giving it to your kids or your grandkids. A couple sayings that I say to clients quite often, number one is it's better to give with warm hands than cold ones. Do you want to see your children and grandchildren enjoy the fruits of your labor, your wealth while you're alive and you get to see them enjoy it or when you're gone? And what do most people say, while I'm alive. I love to help them today. How can I make that happen? That's number one. Number two, I push clients a lot on, and I chuckle about it, but I always say, if you don't fly first class, your kids will. I mean, every time they book a flight, it's go spend your money, go enjoy life, back to independence and purpose. What's the purpose you have for this wealth? And that, as much as anything else, once when you've solved the investment equation, which Dimensional has done a great job of doing, our job as an advisor is to help guide people through the planning path, and certainly independence, purpose, and the quote that you talked about, that sort of hits the nail on the head. Well, Randy, thanks for being on the program. Love the insights, and I really mean this. I mean, I love the conviction. You and I met over 15 years ago. I remember walking into your office the first time, and I was like, this guy's got complete focus on what matters. It's Doogie Howser. I look like Doogie Howser. Randy, it's great to see you. Thanks for being on the program. Thanks everybody for tuning into The Informed Investor. And just a side note, David Booth's book, Stay Calm, is out for sale, so make sure you get out there and check out that book. Everybody have a great rest of the day.