Emotionally Abnormal, Statistically Normal, and Healthy Cookies | Series 7.8

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Welcome to the Enjoy More 30s Family Finance

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podcast. The only podcast dedicated to making life more

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enjoyable for young families by hitting on the financial topics

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Hello, and welcome once again to the next episode

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of this Raising Your Investment Mindset series. This series

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we're trying to help you reframe how you may view the scary word

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that is investments, and therefore be able to utilize

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them in a more constructive way, a better way to reach your goals

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and make life more enjoyable. That is the point of all this.

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As always, if you like what you're hearing, please make sure

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to subscribe, follow us on Apple podcasts, wherever you may

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listen. The stars, the reviews, they help us reach many, many,

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many more young families out there that are just like you.

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Last week, we discussed how you probably don't just own "the

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market". Going through how what they talk about on TV really

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only represents the 500 largest US companies, not any bonds, not

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any foreign stocks, not small companies, not real estate, all

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those things that you would have as a part of a diversified

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portfolio. So don't get too worked up either way, because

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what they say on TV is probably not what you actually have. So

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if you haven't checked out that episode yet, definitely do that

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soon.

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Today's episode is titled Emotionally Abnormal,

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Statistically Normal and Healthy Cookies, where we're going to

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cover just how much investments can go up or down over the short

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term, and still haven't be normal from a statistical point

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of view despite, you know, honestly, it feeling very

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abnormal from an emotional point of view. The goal for today's

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episode then, so the if you can say this at the end of the

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episode, then you have succeeded statement is "I now better

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understand how much up and down is normal for investments so I'm

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better prepared to not freak out when it does." Again, "I now

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better understand how much up and down is normal for

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investments so I'm better prepared to not freak out when

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it does."

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When I was on my honeymoon, one of the things I tried was scuba

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diving. I didn't go out, you know, into the ocean but the

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hotel that we stayed at had this cool trial class included where

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you could just go into the pool to see if you wanted to expand

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it to a paid excursion. I thought I would just completely

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love it. I love the ocean. I love the sea, swimming

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underwater and not needing to come up for air and seeing all

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this cool stuff that's going on down there. That seemed like it

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would be right up my alley. I quickly found out though, that

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it is not the easiest thing to do. You don't just jump right

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into it. The equipment, it's big, it's heavy. And most of

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all, when you go under the water, you can't swim like

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normal. You know, I thought that I could just like swim around

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like I was holding my breath. And then it'd be all kind of the

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same thing just with oxygen attached to me. But you don't

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get a supply of air like you do above the water. You need to

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move slowly, breathe slowly, be more intentional with your

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movements under there. I felt like I was being suffocated like

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someone was trying to kill me under the water. So as you could

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guess I did not pursue the excursion. But what I did learn

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what normal was in this case when it came to scuba diving.

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And in speaking with very experienced divers since then,

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there is a ton of training that goes into it because

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encountering difficulties or obstacles that is normal. When

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it comes to scuba diving, there is a reason scuba diving is a

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question on a life insurance application. You need to know

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what normal is and what to do under the water when there is a

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problem ahead of time, so that you're not going to panic,

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you're not going to get emotional, and you're not going

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to quickly run out of air as a result, when you almost

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inevitably come across some kind of problem in your entire scuba

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diving career.

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When it comes to investments, it is hard to learn what normal is.

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Every movement in the market makes the evening news, right?

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They provide apparent reasoning at least for why it did what it

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did. And every time it goes down, they talk about it a

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little louder, a little louder, a little longer. And it makes it

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feel you know, abnormal. So what is normal then when it comes to

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your investments? If you're using a diversified so again,

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fancy way of saying spread out statistical or mathematical

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based portfolio, you can actually use math to say what is

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normal. You know, aka what should happen the majority of

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the time. The fancy intimidating word for this is Modern

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Portfolio Theory and it was developed by a guy named Dr.

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Harry Markowitz. And he basically just said we can use

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statistics to build an investment portfolio. Stocks,

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for example, they go up more long term than bonds, but they

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also have a lot more ups and downs in the short term. So risk

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along the way. So ups and downs are volatility, that's just a

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way of saying risk. They also have a certain amount of

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correlation, which is a fancy way of saying how they move

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compared to each other. So the majority of the time when stocks

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go down, bonds, they go up.

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So like for my kids that Avery and Noah are very highly

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correlated, anything that he does know within also wants to

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do, there's a high degree of correlation there. They want to

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do the same thing. Whereas stocks and bonds have a negative

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correlation. When stocks go up, bonds tend to go down. He then

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broke it down into all these different segments, or what they

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call asset classes. So small companies would be a segment an

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asset class, large companies would be a segment an asset

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class, foreign companies, real estate, US bonds, foreign bonds,

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so you can go out to 20 different little segments or

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asset classes, and each one of these different boxes,

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statistically moves a little bit different. Their long term

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return is a little different. Their ups and downs in the short

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term are a little different. How they move compared to the other

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boxes is a little bit different. But with all this information,

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he could now mathematically mix together what should produce the

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most return for the level of risk someone was willing to

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take, which is fantastic, right?

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So you know how people are always trying to make healthy

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food that also tastes great, you know, new, no fat, no

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preservative, no sugar, all organic cookies, which always

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tastes like garbage, of course. But they are basically trying to

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maximize the return, so in this case, the return is the

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enjoyment of eating the cookie, that pleasure is the return,

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while taking on the least amount of risk. So in this case, the

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least amount of unhealthy ingredients. We want the most

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delicious flavor with the least amount of unhealthy ingredients.

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So the same kind of thing is true here. If someone is a

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moderate risk tolerance, we want to try and get the most return

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for that level of risk that they are willing to take. So let's

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just say a portfolio that's mixed together has a 10% long

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term expected return. That's what the math says. And a risk

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number, which is called standard deviation, of 12%. Now this

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second number you may have seen on sheets before, and it's the

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number that normally gets ignored. Because you know,

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"what's standard deviation, why do I care, I want to look at the

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return." But this second piece is actually what allows us to

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determine what normal is. Normal means that in any one year, the

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range of possible returns that should happen the majority of

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the time should be anywhere from positive 22% in this example. So

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10% long term return plus the 12%, standard deviation, and

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negative 2%. So 10% positive return minus the 12% standard

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deviation. So basically, two out of every three years should fall

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within this range, meaning falling outside of this range

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once every three years is also normal. So that range is two out

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of three years, it should happen one out of three years, it does

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not happen, right? That would be normal. Now, if you extend this

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out to two standard deviations, so we do 10 plus 24, and 10

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minus 24. Now this range, which is positive 34% and negative

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14%, this is what should happen 95% of the time statistically.

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Again, this is what normal is so nine and a half out of 10 years,

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it should fall within this range.

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So when you get to a year with this portfolio goes down 12%,

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you could say that is actually normal. This should happen once

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roughly out of every 10 to 11 years. Now do you want your

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account to go down 12%? Of course not. Nobody wants that.

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But if we look at what normal is ahead of time, then we can be

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better prepared to cope with those downs emotionally, when

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they do eventually happen. We don't want to freak out

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underwater like the scuba diver and run out of air. And as the

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time period gets shorter, that range of possible returns

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increases. So the range for what can happen in any one month is

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much more than what can happen over say a 15 year period of

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time. If we go all the way back to 1970 and we look at that

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period of time from 1970 to today, March of 2022, the

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largest single monthly decline in the market was over 21%. It

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went down over 21% in just one month. The worst 15 year period,

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though ever over that same time period was positive 3.7%.

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So circling back around to that goal statement for today, you

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could see how much how important the time element is and how

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important is to feel like I understand now what normal is.

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So that goal statement is "I now better understand how much up

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and down is normal for investments, whether that be

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short term or long term, so I'm better prepared to not freak

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out" when it does, then if you can say that you have succeeded

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in the goal for today.

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Thanks, as always, for tuning in today and join us for next

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week's episode called Advice Should Trump Fees, The 3% Study

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where we're going to review in my opinion, how advice should be

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viewed compared to the fees for that advice and what studies

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have supported in our growingly you know, fee focused society.

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Overall, if you are able to implement what we covered today,

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fantastic. You're better off than you were before. You can

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focus more on enjoying life. If you are wanting help though with

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these things, have questions you want help in clarifying all you

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have to do is head on over to our website. EnjoyMore30s.com,

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EnjoyMore30s.com. Click on that Ask Joe and you can click

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connect with me excuse me, then. You can also connect with me

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directly if it's easier through my wealth management firm New

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Horizons Wealth Management at nhwmllc.com. Until next week,

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thanks for joining me today and I look forward to connecting

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with you again soon.

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The conversations on this show are

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Joe's opinions and provided for general information purposes

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only. They do not constitute accounting, legal, tax, or other

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professional advice for your specific situation. You should

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always seek appropriate advice from a financial advisor,

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accountant, lawyer, or other professional before acting upon

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any content or information found here first. Joe is affiliated

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with New Horizons Wealth Management LLC, a branch office

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of TFS Securities, Inc., and TFS Advisory Services an SEC

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Registered Investment Advisor Member FINRA/SIPC.