So, the next question comes from one of the live attendees and they asked, “With all of the rapidly rising real estate prices, what do you think about investing in Reeds?”
I’m going to start, but, again, Larry is an expert in all of this.
I just want to stress that we don’t try to time the markets. And I know there are a lot of questions in the chat that says we answer these the same way. It’s because we answer them the same way. It’s what we believe.
And if it doesn’t work for you, that’s okay. Go find someone who you think can time the market.
Oh, Adam, and let me know when you find that person.
So, what we’re going to do…it’s boring. It is not sexy, but all the Nobel prize-winning evidence says that it works. So, we are going to apply, again, that evidence and say, “You’re going to have a diversified portfolio because we’re the first to admit we have no idea what tomorrow brings.”
So real estate absolutely went through the roof last year, and we pared it back based on the rebalance we talked about. Guess what? It’s not doing so well this year. When it’s not doing well, that tells you have a higher expected return, but we’re not making any bets. We are sticking to the plan as boring as it sounds.
Last but not least, and this goes back to what Jim said. If you have 3% of your portfolio in real estate, that’s a fraction. If it outperforms the market, whatever that means, that’s also a fraction. It’s right of the decimal point. We really think the value add is keeping the money away from the tax man. It’s loss harvesting. It’s moving money out of your taxable estate. It’s gifting. It’s all of those things.
I am the first to tell you that the portfolio management, the allocation, whether it’s to an alt, or large cap, or small cap, will not make a difference in your lives at that individual asset-allocation level within the asset class.
That said, Adam, is there any difference in your allocation, or in your answer, if somebody has a substantial ownership in an expensive home, or maybe even two homes?
So, let’s say that one of your investors is a snowbird, and maybe they have a million-dollar house in the North, and a million-dollar house in the South. Would you treat that differently than somebody who is, say, renting, or has a more modest house and doesn’t have a lot of money in real estate?
What I would say, Jim, is we’ll look at it in terms of your goal, in terms of what you want to pass to children, unless you plan on selling that home to fund lifestyle, and then we’ll look at the probability of being able to get what you want.
Certainly, we all think you should be able to sell the home for what it’s worth, but we know that home prices cycle, nonetheless. So, we generally focus on liquid assets when we build these portfolios, recognizing someone who might have a pension might be treated differently, or somebody who has a home that they might sell.
We prefer not to try to time the market based on the sale of a home, though.
Well, that brings up another question. Sorry about that. I should let more people get in, but I’ll just do this quickly.
Two people have the identical amount of money. Client A worked for a railroad or worked for some kind of organization that doesn’t pay them Social Security. Client B has both a pension and he and his wife both are getting Social Security.
So, you have a pension and Social Security, and let’s call it a significant type of income, but the portfolios coming into you are identical. Are you going to shift your asset allocation based on the fact that one has a guaranteed income, let’s forget about the safety of the pension, but one has a guaranteed income, and one doesn’t.
And I might ask Larry the same question because he might have a different answer.
Since I did a lot of the talking in the last five minutes. I’ll let Larry start.
No. Go right ahead, Adam.
I would say if you use the caveat, don’t consider the safety of the pension, certainly we would probably change that.
But we’ve seen pensions cut in half by the government, or a company, or whomever, so I would say that certainly bakes into our analysis. But if there is a steady stream of income, maybe from an existing trust, or some other source, we absolutely would consider that into our analysis.
Go ahead, Larry.
The way I think about these things is a pension should be thought of in exactly the same way Social Security should be treated. And there are people who try to make this complex, so they’ll turn Social Security and say it’s a bond. And then you’ve got to figure out what that cash flow is worth, say it’s $20,000 a year. How much is that equivalent in a bond? And you’re going to change that every year depending upon where the interest rates are.
I think that’s way too complex. Unnecessary. The way to address it is pretty simple, is let’s say a client comes in and meets with Adam and says, “My goal is to generate $80,000 a year of spending power.”
And so, what Adam does is says, “All right, how much Social Security are you getting?” And, by the way, that’s an inflation-adjusted term. So it should go up in the future…which Social Security does.
So, if you’re getting $40,000 in Social Security, now my need to take risk is lower—it’s not $80,000 a year, I only need $40,000. Now if I had an outside pension that was considered safe, and that was giving me another $20,000 a year, now I only need to generate $20,000 a year, and a good rule of thumb used to be that you needed about 25 times your need for cash flow, so 4% safe harbor rule. 4% is one 25th, so that’s how you get the 25 times.
So, if you had $80,000 in need times 25, you need a two-million dollars in that portfolio. So, that’s our goal…to get you to a two-million-dollar portfolio. If, on the other hand, you only need $20,000, because of Social Security and your pension, now you only need a half a million-dollar portfolio. So, Adam can say, “Hey, you are already there. We’ve got half a million.” We could get by with a very safe portfolio. Maybe it should be at least 20% equities because some periods stocks do better than bonds. So, you don’t want to generally own less than 20%. We could go 20, 30, maybe 40, at the most, depending upon your other objectives, but you don’t have need to take more risks. And it’s that pension that allowed me to lower that equity allocation. Maybe if I need two million, I might have to be 60% or 70% or 80% in equities to get that goal with a high likelihood of achieving it.”
So, the simple answer is, pensions, in whatever form, or cash flow, in whatever form, that you’re getting, if they’re known, reduce your need to take risk, which means you can get by with a lower-equity allocation and can hold more safe funds.