Real Life Planning Podcast Episode 13: Creating a Risk-Balanced Portfolio with John Bernstein

In Episode 13, I talk to John Bernstein of Bernstein Financial Advisory about the importance of balancing the risk of your portfolio in all investment environments. Based on the institutional strategy called “risk parity,” John offers an educational overview on how portfolio construction using a risk allocation can help navigate difficult market environments. Stick around to learn how John has sustained his six-year daily exercise streak!

"Don't time the markets. It's not a strategy that works very well." - John Bernstein

This week on Real Life Planning Podcast, Cynthia and John will cover:

Takeaway Quotes:

“ Life is always going to throw curve balls at you. And the more flexible you can remain about that, the easier it is to navigate through it all.” - John Bernstein

“The idea that you can take an institutional approach to your personal portfolio, really can benefit all of us.” - Cynthia Meyer

“[Investing] is an industry that has a tendency to make things more complicated than they need to be.” - John Bernstein

Connect with John Bernstein:

• Bernstein Financial Advisory Website
• John Bernstein on LinkedIn
• John Bernstein on Facebook
• John Bernstein on Instagram

Connect with Cynthia Meyer:

• Real Life Planning Website
• Cynthia Meyer on LinkedIn
• Cynthia Meyer on Facebook
• Cynthia Meyer on Twitter
• Cynthia Meyer on Instagram
• Cynthia Meyer on Pinterest
• Email: cynthia@reallifeplanning.com  

About the Real Life Planning Podcast

Host Cynthia Meyer welcomes fascinating guests to share real life stories of how they are realizing their financial potential. Each episode explores practical, realistic steps to create results.

If you like this video podcast, consider joining Real Life Planning’s Question of the Week where CERTIFIED FINANCIAL PLANNER™ and rental property business owner Cynthia Meyer answers the most common questions about real estate financial planning direct to your inbox each week.

Transcript - Real Life Planning Podcast - Episode 13

[00:00:00] Cynthia Meyer: Hello friends. It's Cynthia Meyer with Real Life Planning, and this is the Real Life Planning podcast. And today, I have a special guest, John Bernstein from Bernstein Financial Advisory, and a member of my coaching circle or mastermind group, who is here today to talk to us about risk parity. It's an important conversation, and there are a lot of good takeaways. I hope you'll stay with us.   

[00:00:27] Cynthia Meyer: Good morning, John. How are you?  

[00:00:29] John Bernstein: Good morning, Cynthia. I'm very well. How are you?  

[00:00:32] Cynthia Meyer: Good. Thank you for being up early this morning to come on the Real Life Planning podcast and tell us a little bit about your story. What's important to know about you? 

[00:00:41] John Bernstein: Let's see; I've been in the investment business for a very long time. I don't know if I should admit that or not, but I began my career in the investment business in 1987, about nine months before the market crash occurred back in that year. And I had a very long career as a Minneapolis-based institutional investment manager. And in 2016, as my eldest- I have four kids, my eldest daughter was graduating high school, and I decided I wanted to spend a little bit more time with them as they were starting to grow up quickly. Or at least it felt like that. I left my job and spent some time with them. 

And when I started interviewing to go back to work, I had an informational interview with somebody who was like me. A father whose kids were a little bit older. He had similar work experience, and during the interview, he said to me, you ought to start your own business. That's what I did 10 years ago. 

And I went home, and I thought about it for about 24 hours. And I never really looked back after that.  

[00:01:38] Cynthia Meyer: That’s wonderful. And so now you're working with clients. You're helping your colleagues in our mastermind group. What do you focus on in your firm?  

[00:01:47] John Bernstein: I try to make investing simple. Both in the way I communicate it and in what we do. This is an industry that tends to make things more complicated than they need to be. 

I think there's a variety of reasons for that, which maybe aren't very important for us to discuss, but the reality is I think that's the case, and there's nothing about this that should be a black box. I like to say when my clients go to a cocktail party, and somebody says to them, "What's your advisor doing for you?" They can tell them. They don't have to say, "I'm not really sure, but it seems to be working," or "I'm not really sure it doesn't seem to be working." 

[00:02:21] Cynthia Meyer: Some people just say, "Oh, I don't know. They just tell me what to do." That isn't necessarily a great recipe for success. 

[00:02:26] John Bernstein: Right. At the same time, it reminds me of the old expression: Somebody asks you the time, don't tell them how to make a watch. The truth of that is it's my job to figure out which of my clients, when they ask me the time, in fact, only want to be told what time it is, and which clients want to hear how you make a watch.  

[00:02:44] Cynthia Meyer: Do you prefer working with people that want to understand how things tick? Or for somebody who just wants to know the simple answer to the question? Okay, can I retire? Yes, or no?  

[00:02:54] John Bernstein: Not necessarily. I find all my clients at least want to hear the story. They'd like to have a basic understanding of what this strategy is at least once. Maybe once we've done that initially, at that point, they trust me and they, don't want to know the details anymore. And that's fine if that's who they are. If it's somebody that wants to discuss the how and the whys, I'm happy to do that. And it's, that can be kind of fun. 

[00:03:15] Cynthia Meyer: John, you have a very clearly defined investment strategy in your firm. Can you talk a little bit about this defined strategy that you have and how people can think about it in terms of an investing paradigm?  

[00:03:30] John Bernstein: Sure. I'd say that the basic root of it is trying to get a well-balanced diversified portfolio. There are a lot of ways to think about that. Typically, when you hear people in the industry talking about a diversified balanced portfolio, they're talking about the dollars. 

The classic example is what's called a 60% stock, and 40% bond portfolio. When somebody says that they're talking about 60% of the dollars in the portfolio being in stocks and 40% of the dollars being in bonds. One of the problems with that is that doesn't focus on risk, which is the piece of a portfolio that you really ought to be focusing on diversifying. 

In the 60-40 stock-bond portfolio, as an example, when you do that by dollars, the risk is still about 90% in stocks, in a portfolio like that. And I think most people don't realize that. And the reason for that is that stocks are about five times as risky as bonds. What we try to do is focus on the risk that each asset has and distribute the risk across all of the possible investment environments that exist in the world, which is basically four. And when you do that, you don't have to guess about when inflation is going to be difficult or when inflation is going to be a tailwind and dropping. At the same time, you don't have to worry about whether the economy is going to grow next year, or we're headed into a recession. 

You build a portfolio that can withstand all those things because the risk is equal between all of those environments.  

[00:05:01] Cynthia Meyer: That's a risk parity approach. And do you have a name for how you describe how you do it in your firm? 

[00:05:07] John Bernstein: Yeah.  the generic term for this is risk parity, which literally means equal risk between these different environments. It was developed about 20 to 30 years ago. Largely, it was developed for institutional clients. And part of the reason for that is that to make this work with true equal risk in the four different environments, you must use leverage and you have to borrow money and buy some of these investments. 

[00:05:30] Cynthia Meyer: Which the average person is not well suited to do.  

[00:05:33] John Bernstein: That's right. And because my clients are individuals, I didn't feel like that was an appropriate strategy. The generic term for what I do, I call modified risk parity.  we get that risk distributed as well as we can. It's not perfectly equal. It's not 25% in all four boxes, but it's much better than a 100% stock portfolio. And it's much better than a 60-40 stock-bond portfolio. 

[00:05:55] Cynthia Meyer: What are the four environments for those people that aren't familiar with this kind of investment research?  

[00:06:01] John Bernstein: Yeah. It's easy. It's rising growth when the economy is strong. It's falling growth when the economy is weak. Rising inflation and its falling inflation. 

If you think about those four boxes, there are two of those that stocks do well in and that's rising growth and falling inflation.  

[00:06:16] Cynthia Meyer: And where do you think we are right now?  

[00:06:17] John Bernstein: It's a great question.  

[00:06:21] Cynthia Meyer: Maybe we should just take it straight to Bloomberg, right? Yeah.  

[00:06:25] John Bernstein:  Part of the answer is you can be in more than one box at the same time. 

We're in a rising growth environment now. We're also in a rising inflation environment. And by the same token, each asset doesn't necessarily belong in a single box. Sometimes they're distributed partially in several of these different environments and so that's considered when we look at the risk that each of these assets contributes to the portfolio.  

Gold performs in a rising growth environment. It also performs well in a rising inflation environment. It can also perform well in a falling growth environment. 

[00:06:57] Cynthia Meyer: That's interesting. And what about direct ownership of real estate? As you know, I work mostly with real estate investors and own many rental properties myself. Where does that fit in residential real estate? 

[00:07:08] John Bernstein: Right.  in the work that I do, I don't include that. But that is absolutely a real asset. That would be a good inflation hedge and would typically work well in a rising growth environment and a rising inflation environment.  

[00:07:21] Cynthia Meyer: That's interesting. What can the DIY investor that's listening, and again, we're not going to give people investment advice here. 

We would certainly encourage you to make your own wise and comfortable decisions in consultation with your financial advisor. What are some general principles that somebody who's interested in learning more about this? What should they be reading, thinking, and doing? 

[00:07:43] John Bernstein: A great place to start is going to the internet and Google risk parity. There are some white papers out there about this. A couple of which are written in reasonably plain English. There's one firm that kind of pioneered this idea starting back in the 1990s. If you Google it, you should find that firm it's called Bridgewater. Pretty well known. It's a highly successful firm. Its leader, a guy named Ray Dalio has... 

[00:08:07] Cynthia Meyer: He's got the best-selling book out right now, I think.  

[00:08:09] John Bernstein: Yeah. And he's had several books. Starting in the early 2000s as it became clear that this strategy worked, the rest of the investment industry adopted it. Bridgewater is a good source of information on it. There's some stuff that's come out after that, where people have made some adaptations to the strategies. Some of those have been good adaptations. Some not so much.  

[00:08:27] Cynthia Meyer: For those people who are listening who aren't as familiar with post-modern portfolio theory, for example, or how investment professionals think about constructing a portfolio of assets for a client, tell me, do I have this right, John? Basically, your budget is for risk and not for dollars. And by risk you mean volatility, right? And you mean the possibility of losing money, right? The possibility of the downside volatility because we all love the upside volatility. If we do better than expected, which is also a function of risk where we're generally happy, right?  

[00:09:01] John Bernstein: That's right. And now we've come through an incredibly unusual period in financial markets from 2009 up until the pandemic hit in March of 2020, we had the longest bull run since people have been tracking that kind of information. The 2020 market correction was so quick, that was under six months, that you could argue that until this year we were in a bull market. That's an unprecedentedly long bull market. And I think it's one of the side effects of that is people think that's normal. 

It's not normal.  

And in fact, there's an equal and maybe better chance that we could go into a period where the exact opposite of that occurs, and stocks underperform for an extended period of time. And that's what this portfolio is protecting against. 

[00:09:46] Cynthia Meyer: I think there was a McKinsey study in maybe 2016, that predicted the same thing. That real stock returns over the next 20 years would be lower on average than real stock returns in the 20 years in the rear view mirror. Now as financial planners and investment managers, we always encourage people to think about what they're doing in connection to their goals, as opposed to watching the financial theater of the markets every day. Because you could just stare at a screen and your net worth changes every second. 

What guidance would you give people in terms of their own behavior right now? If they're feeling worried or anxious. For many younger folks who are listening, they've literally other than the short period during COVID, they've never seen their portfolios go down for any sustained period of time. The first time that happens, it can wig you out, right? People may be taking more risks, meaning more appetite for possible loss than they are really, truly comfortable with.  

[00:10:47] John Bernstein: Yeah, I guess I'd start with, don't try to time the markets. Professionals in this industry spend lifetimes doing it and for the most part, are not…  

[00:10:55] Cynthia Meyer: and most can't time the market. 

[00:10:56] John Bernstein: Right. they're not successful at that. Yeah. There are enough people doing it. There's somebody that always in fact does it in each environment. But they got lucky. The same people don't repeat that. There was a woman that called the 1987 stock market crash way back then. And she was all over the financial news for several years after that because she was viewed as being this guru, but she never made another call like that again. There are lots of examples of that in this industry. It's the old axiom, better to be lucky than smart.  don't time the markets. It's not a strategy that works very well. And that's what the Better Balance portfolio tries to do. Instead of trying to guess when we're going to shift from falling growth to rising growth or falling inflation to rising inflation, we distribute the risk as evenly as possible between all those possible scenarios and expect that the portfolio will hit singles all the time instead of reaching for the fences and trying to time one of those shifts between one of those scenarios.  

[00:11:58] Cynthia Meyer: Yeah. I think that's interesting to me as an investment philosophy, as somebody who has their CFA charter and is by no means an investment expert. There are lots of people much smarter than me in this area. The idea that you can take an institutional approach to your personal portfolio really can benefit all of us. You're not just investing in something because you saw it on CNBC.  

[00:12:20] John Bernstein: Exactly. And this is a simple concept, but its execution is a little bit more complicated. That's where my expertise comes in. One of the things I try to do is do this in a way that is cost-efficient and tax-efficient as possible.  

[00:12:35] Cynthia Meyer: Always helpful like tax optimization.  

 getting back to what people can do now in this environment. We're not trying to give you all investment advice where we're trying to talk about foundational principles for how to think about being an investor. Is there anything else that you would say to people listening right now? You said don't time the market, right? Anything else that we should be thinking about? 

[00:12:59] John Bernstein: Yeah. I think that the number one piece of advice, I'm always struck by the financial press. I think it doesn't always serve the public well. What commonly happens when we get into volatile markets like this is articles come out about what you should be doing in your portfolio to protect from whatever it is that's going on in the market. 

[00:13:19] Cynthia Meyer: Yeah. Inflation or taxes or stock market crash or whatever, yeah. Even though we're not in a crash, We are in a falling market.  

[00:13:29] John Bernstein: The problem is that by the time those articles come out, it's too late, right? The move has occurred or at least a significant portion of that move has occurred. 

The idea is that after we've had four months of strong inflation, you're going to now try to position your portfolio to protect against inflation. You've missed it. That time has passed.  my point is that the best thing to do is to sit down with a professional who can help you and think about your portfolio for the long term. 

What your own goals are? Not what you think the market's going to do next year or five years, but what are your financial goals? What are your life goals and how do you construct your portfolio to match those? As an example, if you think you're going to be buying a house in five years, and there's a portion of your portfolio that you might need to access for a down payment, that's money that probably needs to be invested differently than money that's been there for 30 years.  

[00:14:22] Cynthia Meyer: Take a lower risk strategy with that money.  

[00:14:25] John Bernstein:  when you find your dream house, you're not selling stocks at their lows because you really have that money for the down payment. Instead, that money was put into something that's safer. As you just said less volatile.  that you can take that money out and not feel bad that you've made a bad investment decision in doing so.  

[00:14:43] Cynthia Meyer: I'm talking to a lot of folks who have some relatively short to intermediate-term goals that are worrying about loss of purchasing power. Where normally you might leave something sitting in cash, for example, and then weigh the pros and cons of, is it a cash-only strategy? Is it cap a capital preservation strategy? There's a lot of discussion in the financial community at large about what folks should be doing in that right now. And I don't know that we're necessarily going to get into that, but people are thinking about it.  

[00:15:10] John Bernstein: For sure. Yes. There is one, I just mentioned briefly, there is one asset that we use in the Better Balance portfolio that would lend itself well to that. And that's U.S. Government inflation index bonds.  

[00:15:20] Cynthia Meyer:  Can I change the subject to something that I'm guessing most people don't know about you, which is that you have a very long exercise streak? This says a lot of important things about you on your website. There's this cool video montage of you doing a gazillion different kinds of exercises. 

Talk to us about that. How long is your streak? What made you start doing it? How have you been able to keep it going?  

[00:15:42] John Bernstein: Yeah, it's been an interesting experience for me. I was an early adopter of Peloton before everybody heard all about it and they had controversial commercials and all that stuff. 

I bought one of the bikes back in 2014 and they had a Facebook group, and I joined that group. There was a subgroup that came out of that, and the goal of the group was to exercise for a hundred days in a row. And I joined that group and decided to do that. At that time, when I was considering whether to do it, I thought, "I wonder if this is really a smart idea?" I have a personal trainer that I use. I talked to him about it. I'm a guy in my fifties and I thought, if you do the same thing over and over every single day, and don't give your body rest, that's a good recipe for repetitive use injury.  I talked to him about it and he said, "If you're careful about how you do that, and you have enough different activities that you do, you can always have some part of your body resting. You're not going full speed every single day." And so that's what I did. It forced me to expand the types of exercise that I do. I picked up boxing back in 2016 when I joined this group. And I still do that today, along with a few other things. If you think about exercise, generally, there are three big categories, aerobics, strength, and flexibility. My activities expand across all three of those things. If I ride the bike one day, the next day, maybe I do an upper body strength workout. I always like to mention that, because this isn't something that's overly obsessive, where it's detrimental to my health and my body. 

[00:17:09] Cynthia Meyer: Heavy cardio every single day without rest.  

[00:17:11] John Bernstein: Exactly. I think we tend to do that with things like exercise and challenges. For the sake of the challenge. Which here and there, that's fine to do that kind of thing. But the truth is usually those types of things aren't great for your body. Those kinds of extreme challenges.  anyway, I joined this group, and about 50 days into it, I realized that this was becoming pretty easy. It was starting to become a habit. Not much different than waking up each morning and brushing my teeth. I wondered whether I could… 

[00:17:41] Cynthia Meyer: We are having coffee. 

[00:17:42] John Bernstein: Yeah. Cheers to that. I wondered whether I could go for a full year. And so that was the next goal. And here we are approaching six and a half years now. This streak started in March of 2016 and it's still going. And it's funny. People are often very impressed by it. At this point, it doesn't feel impressive to me because like I said, it's become second nature. 

It's as if somebody was impressed that I wake up every morning and brush my teeth. It's just something I do.  

[00:18:09] Cynthia Meyer: It's part of who you are. It's like how John Bernstein is in the world.  

[00:18:13] John Bernstein: Yeah. And what I stumbled on with this, and I don't think it would necessarily work for everybody, but I think there's a lot of people that would work for is that we all have behavioral stuff that we tend to avoid. We don't like doing whether it's exercise or saving money, whatever it is. If you create a streak... 

[00:18:30] Cynthia Meyer: Filing, I hate filing. Yeah. 

[00:18:33] John Bernstein: There you go. if you create a streak like this, it can help motivate you to do the things in life that you don't necessarily want to do when you wake up every day. Now, when I wake up in the morning, the question for me is," Am I going to work out today or am I going to break a six and a half year streak of working out every day?"  

[00:18:52] Cynthia Meyer: What is the best piece of advice that you've ever received? 

[00:18:55] John Bernstein: I think I would say that stay flexible.  

[00:18:57] Cynthia Meyer: Both in your investing philosophy and in your exercise program?  

[00:19:02] John Bernstein: Professional life. Personal life. Life is always going to throw curve balls at you. And the more flexible you can remain about that, the easier it is to navigate through it all. 

[00:19:11] Cynthia Meyer: Ah, that is wise. That is wise. Thank you very much for joining me this morning on the Real Life Planning podcast. Where can people find you online?  

[00:19:21] John Bernstein: Thank you. It's been a pleasure to be here. The website for Bernstein financial advisory is Bernstein finance, all one word dot com.  

[00:19:29] Cynthia Meyer: Okay. Are you on social? Any particular social platforms that you like to use? 

[00:19:33] John Bernstein: I am. You can find me on LinkedIn, Facebook, and Instagram.  

[00:19:37] Cynthia Meyer: Excellent. All right. Wow. Cheers. Thank you.  

[00:19:42] John Bernstein: Cheers. Thank you. 

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