Ask the Adviser: Creating a Sustainable Portfolio
In this latest installment of Ask the Advisor, Chris and Bob Fitzwilson focus on how to approach creating an investment portfolio with the tenets of the Crash Course in mind.
Bob explains how he believes a prudent process starts with securing the essentials for resiliency; in other words, investing in the resources that will sustain yourself and your family regardless of how the financial markets perform. These are things like your local food supply, your homestead, your health, etc. Only after you've created a plan for procuring those should you then focus on what do with any funds left over.
Then the focus should be on your desired lifestyle. Ask yourself: How much do I need to meet my base-case needs and wishes for my family? Expectations for quality of life, travel, education, and retirement all come into play here. A financial portfolio should then be constructed to maximize the odds of providing the capital appreciation and/or income – inclusive of estimates for higher taxes and inflation in the future – to meet these goals.
The last step should be looking for returns in excess of these base-case goals. There's nothing wrong with pursuing greater wealth, but such pursuit comes with greater risk and therefore should be done separately from securing the returns you need. In Bob's experience, many of today's investors are too speculation-focused, looking for windfall returns on their funds instead of building wealth sustainably.
In this podcast, Bob also shares his personal story in overcoming a rare and deadly form of cancer. The experience informs his approach to investing, as it taught him the importance on focusing on the essentials for happiness in life and avoiding getting distracted by other temptations and fears. It's a perspective worth listening to in full.
If, after listening to this podcast, you find yourself interested in connecting with Bob and his team to learn more about their advisory services, please use the form here to do so.
Transparency note: As a result of our public endorsement of Bob's firm, Peak Prosperity has a commercial relationship with them. The details of this relationship are clearly presented in writing during the referral process – but the punchline is, our relationship does NOT result in any increased fees to those who become clients.
It should go without saying: this discussion should not be construed as individual financial advice by those listening to it. The content should be taken as informational and educational in nature only. Investment advice must be tailored to your specific personal situation (which Chris and Bob are obviously unaware of) and should be obtained directly from a financial advisor you trust. Before acting on any of the statements made in this podcast, we advise you do just that.
Click the play button below to listen to Chris' interview with Bob Fitzwilson (36m:06s):
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Ask the Adviser: Creating a Sustainable Portfolio
The following is a transcript of recorded content. Please note, these transcripts are not always perfect and may contain typos. If you notice any major mistakes, please feel free to report them by opening a Technical Support ticket under the Help menu at the top of the screen.
Chris Martenson: Welcome to another Peak Prosperity podcast. I am your host, of course, Chris Martenson. And today we are pleased to welcome back Bob Fitzwilson, founder and managing partner of the Portola Group, one of the financial advisory groups we endorse here at Peak Prosperity.
I’ve invited Bob to join us again to share his expertise on how the average investor can design a portfolio around the Three “E” forces identified in the Crash Course – something Bob is going to call, I believe, the “sustainable portfolio.” As mentioned in my prior podcast with Bob, there is a business relationship between his firm and Peak Prosperity, the details of which are clearly spelled out in the write-up accompanying this article.
So hey, Bob, I’m really interested in exploring your sustainable portfolio concept on behalf of our listeners. Thanks so much for coming back on the program.
Bob Fitzwilson: Well, thank you very much for having me back.
Chris Martenson: We really didn’t have a whole lot of time to dig into this concept of portfolios, portfolio allocation. I know you've spent a lot of time thinking about that; in particular, very interestingly, how the Three “Es” in the environment, energy, and the economy, how [through] all three of these, we might build a portfolio that’s really sustainable and durable, we might say, in this age.
So let’s start all the way at the beginning and give listeners an idea of what is your approach to portfolio allocation.
Bob Fitzwilson: Well, it actually gave me some good thoughts that I hadn’t had before. You know, I think I had mentioned the last time that I had written software that calculates how much is enough, for example, and I needed the software because it’s a hugely complicated problem.
But in thinking about it today, I broke out sustainability into two pieces. One is sustainability of lifestyle and wishes, and the other is sustainability of the portfolio. So if we take out the inflation and the rate of return components to the problem, it’s pretty simple. It’s just really adding up what your desired real lifestyle would be over your life expectancy, along with wishes. I mean, some people have wishes to make charitable contributions and gift to kids. But if we hold the inflation and the rate of return exemptions at zero, it’s really just adding up the numbers over what you consider your life expectancy, and that’s the amount of money you need.
So we have the sophisticated technology but for the average person, they can certainly begin the process by just making those calculations. So if I’m going to spend two hundred thousand dollars over the rest of my life and my life expectancy is ten years, I know how much money I have to squirrel away or have coming in.
It gets a little more complicated when you talk about rates of return and also, particularly, inflation. What we use in our model – and have for 32 years – is three to five percent, and I think we touched on that in the first interview. So three to five percent is the real rate of return to sustain the real value of the lifestyle. So if I had a hundred million dollars and I needed two hundred thousand, then sustaining the real value of my portfolio is not an issue and I probably don’t need to worry about rate of return and inflation unless it’s runaway inflation. But if I want to maintain the total value, I’ve got to factor those in, too.
Chris Martenson: Right. So this lifestyle and wishes – that sounded easy enough, right? There are some numbers, but then you have all these moving pieces that have to be accounted for. So in the portfolio, I guess you’re saying the first decision here is, what are your goals, where are you trying to get to, where are you today? That sounds pretty classic.
Of these moving pieces you mentioned before, there are a lot of them, right? We’ve got the two you mentioned – rate of return plus inflation, so one a gain, one eating into our potential real returns. And then what else? Taxes?
Bob Fitzwilson: Yes.
Chris Martenson: You know, I guess lots of other complexities in people’s lives depend on relatives they might have or circumstances or different holdings, so lots of pieces there. You got some insights; you felt you had to develop a program to sort of manage all those pieces. I understand.
Bob Fitzwilson: Yeah, and the three to five percent is after tax and inflation, because nobody knows what inflation’s going to be and nobody knows what taxes are going to be. So it’s really a sort of a leap of faith that there will be some real rate of return out there.
Chris Martenson: Especially these days. Do you think that’s realistic?
Bob Fitzwilson: We know that, in our view at least, inflation’s going to go way up and we know that taxes are going to go way up. I mean, it wouldn’t surprise me to see taxes double in a very short period of time. And that’s not just income taxes; that’s across the board. Because governments are broke – our main office is in California – and you know, the State government’s broke, a lot of the cities are going bankrupt, and the classic way for them to gain revenues is through property taxes. So I suspect that those are going to be going up, too.
The reason why I broke it up is that I think people get confused about sustaining the nominal and even the real value of their portfolio without thinking about it relating to them personally and their family. Because if you really have – you know, I’m taking silly numbers – but let’s say you do have a hundred million and you need two hundred thousand, you shouldn’t focus your time, probably, on maintaining or increasing the real value of it unless that’s your avocation. You should focus on nailing down the family and the lifestyle issues and just making sure you don’t – you can go down to two hundred thousand, but –
So one is really a portfolio question. I find most people that I talk to are focused on the portfolio side, and I try to get them to focus on the life issues and their family issues.
Chris Martenson: Meaning not just in the future, but today, as well?
Bob Fitzwilson: Yeah, because you know, I’ve always been somewhat of an existentialist about this money stuff. You know, there is an end to it. And so it’s not that we just live forever and accumulate forever. So with all the TV and the Internet and data coming in, and opinions, people, I think, get defocused too much to the portfolio issues instead of really saying okay, I’ve got a family or I’m an individual. What are my needs? What do I have to sustain and for how long? And that should be their base case first.
Chris Martenson: Sure. I, as well, over here at Peak Prosperity, am very interested in having people understand that. Some of the best investments that exist right now are in yourself, your homestead, your current living situation. And that we always have – I always have – an eye towards the idea that I’m not socking away money so that I can enjoy myself in the future. I’m going to enjoy myself today, first and foremost, and in the future, too, I hope. So making sure that my own existential approach is really lined up, making sure for me, I really care that I'm living well and in accordance with my beliefs and principals today, and tomorrow, too, if I can afford it. So, is that –
Bob Fitzwilson: Completely agree.
Chris Martenson: – part of what you're thinking about there?
Bob Fitzwilson: Yeah, yeah, because just in my career, it's gone from Value Line and Ben Graham to futures and options and puts and calls, and Forex and all this stuff, and so people are getting wrapped up in what they see, instead of it coming back to themselves and their family. For example, I had a question this week about paying down their mortgage. And this person was getting a distribution from an investment. And I said that's not a bad idea, because if you are paying five or six percent on your mortgage, that is a certain five or six percent cost versus let's say an uncertain eight to ten percent. You can argue about whether that is out of line, which it probably is, but paying down your mortgage is like making a great investment. And it also aids in the sustainability, because the last thing you want to do is to stock up your apartment, your house, your farm, or whatever and have the property tax man, the sheriff, come and take it all away from you.
Chris Martenson: Oh, absolutely, absolutely. So what do you mean then by what's a sustainable portfolio?
Bob Fitzwilson: Well, again, I'd start first with what do I need to do to sustain the base case, my lifestyle and wishes for my family. And then you go up the ladder, and you're talking about sustaining the nominal value, and then the after-tax and inflation value. There is virtually no income anymore. So to generate 3-5% returns, longer term, you're going to have to be in some form of equity, and I would include real estate and private companies and businesses in general. So if the goal is the whole tuna, not only the lifestyle, but also the value of the portfolio, you're going to have to be in some form of equities. And I find a lot of people have been investing in “adjectives”, they're in small cap and big cap and all of this stuff, but they really don't know what they own.
And the master investors throughout my lifetime and all the ones I've read about were people that identified businesses that had great long-term prospects, and then they tried to hold onto it for as long as they can. People are disparaging buy-and-hold, and yet if you look at the Forbes 400, or whatever the number is now, virtually all of those people were people that bought and held, whether it was a private company or a public company. So, I think people need to – and we touched on this a little bit – people need to go back to investing instead of speculating. Because if you're on the speculative side, you're going to lose, because you're planning against people with huge money, computers, billions-of-a-second strategies and it is really destructive. So, I think to sustain your portfolio, you have to find the businesses – and there are plenty of them around the world – that are doing old-fashioned things: growing sales, earnings, things like that, providing a good product, not damaging the environment.
Chris Martenson: You know, it's interesting that there are so many parts about stocks and investing in stocks, or speculating in stocks, that seems to run counter to almost all of our other experiences in life. You know, it is one of the – stocks are one of the few things you can find that the more expensive they get, the more people want them. And the cheaper they get, the less they want them.
Bob Fitzwilson: Right.
Chris Martenson: And that's an oddity, but when you say people are investing in “adjectives” – big cap, small cap and all that – it is almost as if I looked at my graduating high school class, I would never just say well, I put my money on all of the people in homeroom number eight; that is where I decided to put my money, over there in the small cap world. I would personally never just think about giving money equally out to an entire collection of people if I knew them. I would say no, no, I think this person [or that one] has a much better chance of doing something awesome in terms of building a productive business or being careful and clever with this money.
And the same was true when I was learning investing from my grandfather; every single investment was a real moment for him. He would tear apart the financial statements. If he didn't know the people in the company, he would try and call people who knew them. He wanted to find out, did they know what they were doing, could they value stuff – standard, fundamental analysis. And so, in your mind, then a sustainable portfolio is cognizant of the idea that there are still values to be had out there. That is a truism that is just as true today, perhaps, as it was back in Graham and Dodd's day, or maybe forever. That there will be some relative winners and losers, and you don't want to just sort of cast your money blindly across that landscape. Is that getting to the heart of it somewhat?
Bob Fitzwilson: Yeah, absolutely. You know, for me, the environment is more of what you don't want to invest in. I mean, the people who are harming the environment, doing bad things. And so the one that always been sort of the poster child for me is tobacco. And it is a great business, and most people own a piece of the tobacco industry, they just don't know it. It is done through their retirement plans. But for me, I don't care what the economics are, it is just doing something that I don't like. That's just me. And then on the positive side, you have people like Whole Foods that are trying to promote local farmers and pesticide-free, things like that.
So, it is kind of those two things, the things that you don't want to encourage and the people that you do. The rest of it is about opportunity. And energy, as much of a problem energy is, if you flip your thinking, it is a huge opportunity. And everybody has different views about which form of energy. But we know that the cost of energy is going up, and so if I were just starting in business, that would be a kid-in-a-candy-store time, because it is a huge amount of money and there are going to be great fortunes made in solving those issues.
As far as the economy in general, the old wisdom is just as valid today as it always was. I mean, Peter Lynch certainly is one of the top five investors in history. And he was real straightforward. He said just go to the shopping mall and see what people are buying. And so, probably the strongest message I could transmit to people is get away from the “adjectives”, get away from the speculation, just use your head and read about what companies are doing good things and try to find those and invest in them. And it doesn't have to be just public companies. It can be private companies, if you have access to that, or start a private business.
Chris Martenson: Right, so we are investing in things that we believe in, obviously, and understand, hopefully, and that there are lots of opportunities out there. And one opportunity is – I know a lot of people struggle with this first sort of bifurcation – I'm going to put some money in Holding X and Holding Y. Holding X might be their actual stock portfolio. Holding Y, let's call this their homestead, themselves, their own residence, or what have you. How would you coach somebody or counsel somebody to go about figuring out how much to invest on a percentage basis here versus there?
Bob Fitzwilson: Well, you know, you've helped to guide me in reverse of what I was thinking when I started this journey. In the beginning, you are thinking about your money, and how do I sustain that, and again, it could be sustaining my lifestyle, or it could be sustaining and growing the nominal value. But after I learned about your findings, I realized that what you have to sustain first is yourself and your family. And so I would start first with that. And whether you are living in an apartment, or you have a ranch or whatever, it is really looking around yourself and saying what is it that I rely on? I've done this for three years. I say what is it I assume I have, whether it's food or energy, or gas, or what have you, telephone? And then say what would I do if I didn't have that?
And so, to me, that is the ultimate in sustainability. And it is really the core of what people should be doing. The money part of it is really the end of the process, where you have something left over after taking care of these life issues. And then you can build a portfolio that will – going back to what we first opened up with, it is really a continuum from sustainability. At the bottom of the continuum is my life. And at the top of my continuum is that I want to have unlimited money. And so everybody can pick and choose where they want to be on that timeline. But that is on top of taking care of your health, and your food, and safety, and things like that.
Chris Martenson: Yeah, oh, absolutely, and there are extraordinary and very good and very tangible returns that come out of that. One is there are financial returns that we can easily catalog, so my utility bill used to be this much; now it's only that much. And I can see the return I'm getting off of whatever improvements I made to make that happen.
And then some things we can do are just what I call adoption versus adaption. Adopting is that we are going to take on some new technology or some new process. Adapting is just sort of changing our behaviors a little bit in the face of things. And it turns out there are some very simple adaptions that don't really take that much out of our lives or require that huge of a change, which can make very big differences. If we have had children, we have all attempted to get them to turn off lights after they leave a room, and things like that, simple adaption strategies.
Now, you're out there in California and I see premium gasoline maybe in your neck of the woods is encroaching on $5 a gallon. Are you noticing, is this creating any detectable waves for people out there yet, in terms of saying hmm, here are some clues that I might have to start organizing my life a little bit differently?
Bob Fitzwilson: Well, I know it's generating a great deal of hostility, because that is probably the one thing, you know, because if you increase taxes, the impact falls on different people. But if you increase the cost of gas and it hits everybody, and it hits your entire budget, your ability to go out to dinner and all that stuff. So, yeah, and it came virtually overnight. But I think it is a good shot across the bow for everybody that this is what can happen, and it probably will happen. And so people – I've forgotten the word you just used, but people need to change their behavior. And so, it is certainly impacting my company and me. People are driving less and telling people that if you can work at home and get your job done, you should do that. And so financially, in the short term, it is not a good thing for people, but I think in the long term, it's just giving them the glimpse of what the future holds.
Chris Martenson: Absolutely, and that wakeup call, speaking of wakeup calls, we just had an earthquake a couple of nights ago that I felt. And so I think now I've felt more in the past year than Adam has, and that is kind of weird, because he is up in Northern California, too. And it is clearly an idea of – what it raised for me was this idea that things just – what I've been saying, it's a great wakeup call that sometimes the unexpected things do happen.
And I know that in your planning software, which I would like to talk about a little more, there are a lot of what-ifs in there. You mentioned to get a sustainable portfolio, there are few big moving pieces you can nail down pretty easily. But it turns out there is a lot of complexity that can get baked into things, including the unknown, the unexpected. We didn't expect gas to shoot up to $5 gallon. We didn't expect this earthquake the other night. Hey, that is life. These things do happen. So how do you help people plan for the unknowns?
Bob Fitzwilson: Well, the software took me about four years to do, because there are so many variables, so many unknowns. But basically, what it is does, is it takes all of the various aspects of a person or family and we put that into the software. And then it organizes itself by topic. So there is the traditional balance sheet and cash flow. But the question that almost everybody wants to know is do I have enough money? And so the software makes it easy to address these issues. It is kind of like having an architect draft up a set of plans.
And so we like to believe that it gives the person control and, first of all, clarity about where they are. And most people have no clarity. They just get a brokerage statement and there are all of these “adjectives” and they have no idea where they really stand. And so, one of the benefits of the software is it gives them clarity about all of these life issues and then [they are in] control. Because, you know, the standard financial advisor is going to use rules of thumb. But I tell people that whatever path we choose is going to be about you and not about me. And so I like to believe that with this software, it gives people control so they can make informed judgments about the impact of their decisions. And then, because it is very granular, you can literally change how much you spend on gas, and it will tell you how it affects your ability to retire 30 years from now. So it is a very powerful tool.
Chris Martenson: What are the kinds of things that sort of pop up as maybe learnings or surprising findings for people when you run this process?
Bob Fitzwilson: Well, the most interesting recently has been that people are out spending their money. You know, the 90s, particularly in the Silicon Valley, were pretty heady, and people made a lot of money. But they retired; for a long time the big contest was to see who could retire at the earliest age. And so what happened is a lot of people did that. And what I'm finding is a lot of people either have outgrown their money are getting close. And one of the reasons I created the software in the first place was for a person that did that. It was a great deal of money to start, but then a horrendous expense level. And so I wanted a way to show them the impact of their choices. But despite that, they continue to run it down to zero.
And what I am finding lately, certainly in Silicon Valley, is that even people that had a lot of money are – and maybe because they haven't had software like this to help them make better choices – they are running out of money. And a lot of people have viewed their home equity as their safety valve, and we know that has been under fire. And so, particularly for the people who are in the 65-and-up age range, they are hitting a brick wall and being forced to look at their home equity as a source of liquidity, which they didn't want to do.
So at least with the software and the process, we can at least help people get the clarity. And then ultimately their choices are about them.
Chris Martenson: So if I sat down with you, or we did this over the – is this something we could do over the phone? I haven't been through the planning process, so I'm just wondering what's entailed. Just walk me through the process.
Bob Fitzwilson: Yeah, the beauty of it is that it really needs three pieces of information: a name, a birth date, and one asset or liability. So think of it as sort of this cloud that as you put in data, it pops up insights, you know, like what is my net worth? How much do I spend? When can I retire? And the beauty of it is that you can start with just those three pieces of information, but as you put more and more information into it, the insights get better and better. And once you get all of the information in, and it's accurate, then the insights are superb. And so it's sort of like having a financial dashboard. And even if you're 20 years old, it tells you, so if your goal is to retire when you're 30, it will tell you what you have to do.
You know, when Google went public, there were unhappy holders of the stock, because the stockbroker who had the initial shot at providing the advice addressed it as a stock. So, Google, at 200, they perhaps correctly argued that it was ahead of itself, and so they sold it. But what you should do is start with the architecting and the lifestyle issues. And so, for example, if again, picking silly numbers, if my expenses were a million dollars a month and I had ten million, if you looked at the ten million in Google, you would want to tell people to sell and diversify. But if you looked at my lifestyle, you would know that I had to stay in there and speculate.
So I think modeling it this way gives people clarity about when to sell their stock, when to sell their business, when to sell their venue, you know, what sort of price you need. Can I make gifts to charity? How much can I give to charity?
One of the things that I sort of wanted to bring up is, as you know, I had a nearly deadly bout with cancer, and despite being the closet existentialist, when you are facing the end, it clarifies things. And so one of the things it taught me is that there is an end. And so you want to be proactive. You want to have a great life and do proactive planning, but you just never know. I was 57 at the time. So it has given me a greater emphasis with people to really address these issues and say okay, how do you want to play out what your life expectancy is, and what do you want to have happen? And that is different than what's Google going to do? or what is your rate of return? So it is very much addressing the family issues. And having the cancer really brought that to the forefront.
Chris Martenson: Yeah, I imagine it did. How long ago was that now?
Bob Fitzwilson: It started in '06, I think. Yeah, late '05, but you know, I probably survived more out of ignorance than anything else. I just, you know, it just wasn't going to happen, but it was a very swift and deadly form of cancer. And so, you go from being, you know, this person who is identified by your family and your assets and your business, and a lot of stuff. And within 30 days, it's over.
Chris Martenson: Hmm, yeah, yeah.
Bob Fitzwilson: So, you know, obviously and fortunately, it wasn't over, but I got the message.
Chris Martenson: Oh, and a profound message. And I think we are all receiving a version of that message, which is saying that we are on an unsustainable course, and so there is a change coming. And it turns out, I think, with the positive side of something like a bout with cancer, or a scare with cancer, or any sort of big life event like that, is that it gives you the opportunity to step back and go hey, what is really important? And it turns out often that nose to the grindstone, the things we occupy ourselves with – I know this is true for me – are not always the most important things. And this is a great time for people to really line up where they are in life, where they want to be, where the world is headed, what their own actions are, where their investments are lined up, given the things we know. And my hypothesis is that this is an extraordinary time to be alive.
There’s lots we can do. There are a lot of opportunities, and there are some major pitfalls. The biggest pitfalls tend to be the oldest ones in the book. You can read about these. I know you are a student of history. I was in your office, I saw all of the books, a really impressive collection going back to several thousand years B.C., I believe.
And the oldest pitfall of them all is that what we think we know turns out not to be true. It is the hubris of empire. It is thinking that whatever we have built for ourselves is permanent. It is that idea of permanence that we have constructed is both inviolable and unchanging. And guess what, it always changes. So here we are, and we have, I think, some really obvious signs coming from all over the economic landscape, the energy field, the environment as well. All three are telling us the same thing, which is time to really understand what is happening, and be as proactive as you can be, given the uncertainties involved.
And so with all of that, is there anything else that we can talk about around how you would – I know in our first interview, in case somebody listening now didn't listen to that, you talked about how you believe there are big trends in play and that these offer great opportunities to position money for whatever might be coming. And you felt those were in technology. It was in energy, and water, and what else did you have?
Bob Fitzwilson: Food.
Chris Martenson: Yep.
Bob Fitzwilson: And I guess my central message is that there is too much handicapping about how the financial crisis and the fiscal cliff are going to work out. Ultimately, it is interesting, and we are all supposed to think about that. But ultimately, it comes down to you as a person or you as a family. And so what you need to do is batten down the hatches and think about sustainability issues at a personal level and try and build a sustainable investment portfolio. And then get out there and every day just take advantage of all of these opportunities that are coming our way.
Chris Martenson: That's it: Invest in yourself; find what the ways that you can invest in either reducing a mortgage that has a rate of interest that is higher than anything you could conceivably earn in a risk-free basis on the outside world. Invest in infrastructure improvements that will lower your food and energy bill, maybe even give you better-quality food at the same time it is costing you less, these sorts of things. And then, money left over. Now you have to really think about all of these other opportunities that are out there. And there are a lot of them, there are a lot of them.
You've been doing reasonably well in these past few months in the investments and – well, let me get your sense on this. Going forward, how do you feel about where we are in the markets and how you can control for whatever risks might be out there?
Bob Fitzwilson: So I see two timeframes. One timeframe is that, you know, things are set up for chaos. There are too many people that think they are in control of everything. They view life as a machine with a lever, and it just doesn't work that way. And so, as investors, we have identified who did it, how we got here, what is the history, what is the allocation. But for the next six months, it is really just paying very close attention and trying to be flexible. On a longer-term basis, it is not only taking advantage of the opportunity, but also the changes that you've identified. So, if Peak Oil is in our future, we know prices are going up.
I just saw a chart yesterday of the drilling rig count in Saudi Arabia, and it was straight up, but the production was doing a button-up to the down side. And so the fellow that sent me the chart, I said that looks like d
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