How to Crash Proof Your Portfolio

On this episode of The Dentist Money Show, Matt, Jake, and Rabih explain why diversification is one of the most powerful tools in investing. Using historical data, they show why a globally diversified portfolio has a long history of positive long-term performance and why holding cash may be riskier than most investors realize. They highlight common misconceptions about risk and the danger of losing purchasing power over time. Tune in to understand how better education and portfolio optimization can lead to smarter long-term investing.

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Podcast Transcript

Matt: Welcome to the dentist money show where we help dentist make smart financial decisions. I’m a guy named Matt. I’m here with the What we like to call him hot take Jake Jake Elm everybody and the Lebanese legend Rabih Dimachki Hello guys. How are you? I just made it up. I literally just made it up. I Was thinking about the intro to this as I was going to grab some water and I was like, know what we need Rabih to have a

Jake: What up?

Rabih: What’s up?

Jake: I don’t think I’ve heard that before. Lebanese legend.

Matt: A nickname. We’re going to test some out Rabih along the way, but I think the Lebanese legend or the legend of Lebanon. Which do you prefer?

Rabih: My goodness. I’ll just go with whatever you think suits me. But yeah.

Matt: Okay. I’m, I’m a sucker for alliteration of any kind. So anything that’s that I’ve kind of, I’m kind of there, think something like that. So Rabih was just sharing with us. He’s fueled right now off of ⁓ ice cream and pie, ⁓ for breakfast. Yeah. I was going to say, this is the classic, was it, it was a pumpkin pie. You Speaking of hot takes Jake, ⁓ can I fill one out there? I’m not a huge fan of pumpkin pie.

Rabih: For breakfast, it’s Thanksgiving weekend. I can do whatever I want. Yes. Yeah. Some people aren’t, but I really love it.

Jake: Don’t like it either. I don’t like it. I don’t like pumpkin anything. Pumpkin, I’m not a pumpkin person.

Matt: Apple pie? Yeah, I don’t love pumpkin either. ⁓ we’re going to talk about this on the next recording after this, ⁓ two cents, but, anyway, not a, not a huge pumpkin guy. ⁓ but that’s for another day. All right. Let’s jump in today. We are talking about crash proofing your portfolio. So a couple of different things to this. this is a, ⁓ a remake, a remix as if you will, we’ve been doing this throughout the last part of this year where we’re kind of gathering. You know, we were 10 years into the show. Now we have over 700 episodes and we got this idea to kind of go back and just recycle or re remix some shows. for various reasons, the biggest one just being, ⁓ that I think this is stuff that’s worthy of repeating worthy of talking about. then also because it’s been so long, it’s been years since we’ve done, you know, these types of topics. It’s, worth talking about, has our, has our view changed on some of these things? So this fits that category of, of a remix from an old show. This was from again, years and years ago. ⁓ but the title or the topic today is talking about crashproofing your portfolio. ⁓ and so this has been pertinent for me and I think for all of us, Jake, I know you can, you have stories around this as well, but I’ve been talking to a particular dentist over the last, month or so, six weeks or so. And they’re, you know, we’re, talking about them hiring us, coming on board. And one of the things that they’re struggling with, they mentioned is they’re sitting on quite a bit of money in cash. So like over $2 million right now sitting in cash and have been sitting on cash for that amount of cash for over a year now. And we talked to him about, know, Rabih and I actually talked to this, to this fine gentleman and He just said, you know, I’m waiting for something big to happen. I’m waiting for the market to pull back. It just feels like it’s going to happen. There’s going to be a crash and I want to be ready for it. And he is not, this is not unique. think there’s, we hear this kind of, these kinds of thoughts or concerns or fears quite a bit over the years. I want to, as we jump into this, any thoughts you guys have just about that, how often you hear this and your general kind of, again, just thinking around that sentiment.

Jake: $2 million is a large number, but I would say I think this is pretty common for a lot of dental practice owners. And a lot of it can come from like we’ll get into today, maybe fear of when to get in the market or how to time that correctly, or if you can do that. I think sometimes too, it can just be from started up a practice. There’s a lot of cash that accumulates in my operating account and I just don’t really do anything with it. And before I know it, I have a few hundred thousand extra dollars in cash, right? Just sitting in operating account that I may be a little nervous about just putting a sum over that’s investing or paying off debt or things there. So two million dollars is an extreme case, I think. But I think it’s pretty common that most people we talk to are sitting on maybe more cash than they need. ⁓ And so I think this is a pretty common thing that we hit on.

Rabih: Pattern that I always see is the excuse that people use. It’s like, I’m waiting for a big crash, but it’s never opportunistic. It’s always because they’re afraid it’s going to lose money once they’re in. It’s never that they are waiting for an opportunity. This is what they tell themselves. But we have seen this over and over, especially when the market starts dipping and you reach out to these people and you tell them, well, here’s the crash you’ve been waiting for. They still wouldn’t put their money in because all they’re afraid of is losing more money and they’re

Jake: Huh.

Rabih: Excuse changes and then suddenly it will become, well, the market is going down now. Let’s wait until we see the bottom or maybe it will go back even more down. So, ⁓ sorry, I’m just not going to buy. I’m waiting for a crash because we have learned that this is just hiding something else.

Matt: That’s a really good distinction, Rabih. think that’s a re that’s actually spot on that. That is the outward definition or justification they use when in reality, they’re just afraid of, and we don’t blame them. We don’t like, this is an extreme case as Jake pointed out, but it would suck if I put in $2 million in the portfolio and then a month later saw a 30 % crash, which is possible. That is not out of the realm of possibility. Um, we’re going to talk. So I guess we’ll just say that like we have empathy for that fear. Like that is a realistic thing to be afraid of. That’s a lot of money. And even if it’s a hundred thousand dollars, even if it’s $50,000, if it’s a smaller amount of money, it’s still scary to put in a chunk of money. Uh, especially in the environment we live in nowadays, what we are getting bombarded with negative media from every single angle. Um, because now everyone with a phone is, is now able to. Give their opinion. And a lot of people give negative opinions of like the crash is coming. is so, so again, we get it. Um, so today we want to talk about this. We want to talk about crash proofing your portfolio. Uh, let’s, think that would, know, catchy title, catchy being a little bit sensationalistic there. Um, but I think the main point here being is if I, if I could summarize kind of what we mean by this is putting your focus in the right areas of things that you can control versus things you can’t.

Jake: Have fun.

Matt: I think one of the fundamental aspects of being a good investor over the long-term is being able to define and focus on the things you can control and forget about the things that you can’t and build your portfolio around those things and build kind of understanding what risk means. So ⁓ let’s start here, Rabih and Jake. ⁓ First part being kind of why, when we talk a lot about markets always recovering and we give a lot of historical data let’s talk about first, what is a market? I think we take this term for granted. ⁓ let’s talk about this and then what the history tells us about why they’re always, why we can say like based on history, they always recover. Can we just start here, Rabih? What let’s define when we say the market, what do we actually mean?

Rabih: So the market is usually ⁓ all businesses in the economy and the place where you can interact with all businesses in the economy. So a market is a place where it’s a very democratic place where a buyer and a seller come and they agree to exchange a share or a stock or a product for a certain price. And the beauty of it is because it’s a very democratic environment, both people have to tango for a transaction to clear. This makes it a very efficient thing, which means we can trust the information we see in it, which can trust the prices that show up from there. And it’s not really a market if it’s just you and another friend. It has to be a big system and network. Think of like a farmer’s market. Think of like a fish market. I’m hungry guys. But like think of all these, I’m very hungry. Think of all these places where a lot of people congregate and they are transacting.

Matt: Clearly.

Rabih: Over many different products, that market is a very efficient system. And in that market, whether it was a stock market, a fish market, et cetera, everyone there is trying to find the best thing for themselves. If you’re an investor, you’re out there trying to get the cheapest, the best price for that stock that you are buying. Or if you’re buying a fruit, you want the best fruit in that basket type of thing. Similarly, whoever is selling you the stock or whoever is selling you the fruit, they are trying to make sure that they are there making profit and they can continue to do so. And this is a human nature. So just like everyone wakes up trying to buy the best thing for themselves or someone trying to make sure that their business is run every single day and can, as they grind, they can make a better future to themselves. This same thing generalizes to the stock market, just like any other market. And in the stock market, we’ve got businesses. And actually, stock market is made up of businesses and the businesses are made up of us. And we are waking up every single day trying to make our own lives better. But in aggregate, this makes the whole market something that is incentivized to recover, to do better, and to impact the ones around it.

Matt: Jake,: anything you want to add to that? Yeah, I love that you went there, Rabih, and we’ve talked about this before, but I think it’s worth repeating around the three places that you can invest because when you talk about the market right now, we’re talking about whether it be a farmer’s market or in this case, the stock market, there’s also the real estate market. There’s the private market, private equity, private businesses. And we’ve said this many times, but there’s again, to…

Jake: No, that’s great.

Matt: Simplify this, there are only three places that you can actually put your money, private markets, public markets, or real estate. Today we’re talking about specifically, ⁓ the stock market, but Rabih, I’m really glad you went there at the end of like, actually, what actually does a market represent? And in this case, the stock market, what it represents is millions of people waking up every single day to better their lives and access to the stock market is being able to take a long-term bet that people are going to continue to do that over time. And it doesn’t mean that every day the market goes up, there’s going to be ups and downs and things that go wrong at businesses and all that. But this is just fundamentally, I think it’s intuitive of like, why does the market always go up over time? Because we continue as a population to keep getting up and wanting to better our lives for us and our families. And you’re betting on that by investing in the stock market.

Jake: And I guess you don’t have to believe in that principle. You know, we always anchor to that point of eventually if you are buying a broad basket of stocks, a broad basket of companies, again, like you said, I like the world is going to continue to progress and grow and people are going to continue making more money if you don’t. So we think that the market is going to recover if there is times when the market does go down as a whole. It is going to recover. We don’t know when or how or when that’s going to happen. But that’s our core fundamental belief. If you don’t believe that, I guess that’s OK. But then at that point, it’s like, what’s the point of saving your money even in the first place? Like if you think we’re getting the government crashing or a zombie apocalypse or whatever there, you don’t really need to worry about your 401k balance. You can build a bunker in your basement. That’s probably a more effective use of your time and money if you don’t believe that.

Matt: My name is… yeah. Exactly. Yeah, it’s true. ⁓ with that said, I think this is actually a pertinent time to talk about whatever. So when someone says I’m, ⁓ I’m, I’m waiting for something or I I’m waiting for something big to happen, or I’m going to not invest because of X, Y, Z it’s fear, which is really, again, a good time to talk about what are they afraid of? Meaning what is the risks we’re talking about? And Rabih, you said something recently on another episode we did to talk about kind of the definitions of risk. I think this gets, again, this is a, think worthy to talk about for a few minutes of, ⁓ truly understanding what risk is and the different types of risks that are out there when it comes to investing. Cause I think people just kind of lump together risk as like this general kind of squishy term without actually taking the time to understand what that actually means. So for example, sitting in cash and not investing is actually rather risky. You’re just engaging in a different type of risk than like, let’s say the volatility of the market. ⁓ Rabih, when you talk about the market versus an individual stock, those two things inherently have different types of risks attached with them. ⁓ do you want to speak more on this Rabih and just kind of expand out on that topic of, of risk in general?

Rabih: Yes, not all risks are the same and like a feature of the market could be either considered a risk or benefit depending on who’s investing in it. So in the very simple example, if we have an investor who still has like five years and at that point their investment horizon ends, they need to get all their money back. A stock market that fluctuates up and down a lot, that is risky for them. But for someone who has a timeframe of 30, 40 years, that fluctuation up and down in the stock price doesn’t necessarily mean risks for them. What matters is that by the end of the 30 year period, they are at an upper higher level than what they started. So fluctuation does not mean trend. And in that sense, for a short term investor, fluctuation is risk for a long term investor. Fluctuation isn’t risk. But what is risk for this long term investor? The risk is permanent loss of capital or losing the purchasing power that your capital provides, AKA sitting in cash and having inflation erode your income. The same thing, and it happens, and I also want to emphasize a point that we lump different risks under one word of risk, but there are so many different risks. There’s that volatility risk, the fluctuation. is real or purchasing power risk, which is erosion of your capital. There’s…credit worthiness risk, aka if you’re lending your money to someone else, they might not pay you back, right? ⁓ There is a duration risk, which is how sensitive are you to when interest rates change, not when the price of a stock change. So there are so many different risks in the market. And when we lump them together, we kind of lose granularity. We need to know what feature of the market you’re exposed to. And depending on your situation, is that a risk for you or just something that is in there in the market you have to control for?

Jake: I think this is a great point when someone says I’m scared of getting in the market because I think it’s risky. Like just identifying, okay, well, let’s dig a little bit deeper. And what do you mean by that? Like, what are you scared of? Are you scared of, like you said, Rabih, a loss of capital? Like, are you just scared of losing your money that you’re going to put in? If that is the case, then maybe we can dive deeper in a bit of market education, right? There’s a lot of different ways to invest your money. ⁓ If you want to invest in individual stocks, there’s always a chance that like the hundred dollars you invest could go down to zero. If you are investing in a broad basket of stocks though, if you own a globally diversified portfolio, the market research actually tells us that over the past hundreds or so years, there’s never been a single 12 year period ever where you would have lost money. that’s just to reframe that. So it’s like over the past 100 years, if you had invested in a broad basket of stocks,

Matt: He’s battling.

Jake: There was never a 12 year period where there was a negative return, any rolling 12 year period really ever. That is not to say it’s like historically speaking, your risk of losing money in that scenario and that investment style has been zero. Obviously we can’t, if you invest for at least 12 years, we can’t predict that all the way out to the future. There’s always uncertainty in the future. Maybe that could change. So like risk of loss, if you’re in a globally diverse portfolio investing for a decent amount of time, your risk of loss is actually pretty low. Now if you say, well, The other form of risk I’m scared of is volatility. That’s just like the ups and down movements of the market. I mean, that’s fair. And then we could talk about why volatility is necessary. We can’t have ups without the downs. Typically the US stock market is up three out of every four years. So whenever you do invest your money at any point, you have about a 75 % chance over the next year that you’re going to be positive rather than negative. Anyway, I just, I really think that’s an important discussion of what are you scared of? What do mean my risk is a volatility is a loss of money. Getting granular on that, like you said, Rabih, is important.

Matt: This is why education is so important to this discussion or to, to, to being able to make good decisions around investing. And I love that you said that Jake ⁓ what are you afraid of? Like you’ve got to define when we don’t say that, like in a patronizing way, we’re saying like, actually get granular and, and, and define what is holding you back from investing. And most of the time what we have discovered, and this is why we have these conversations It is just a lack of education and nuance and understanding of like, yes, of course there’s risks and there’s a trade off you’re going to be making. But Rabih, I want to come back to something you said, cause I think it’s so, so important. The true risk when it comes to just the spreadsheets, forget real life emotions. If we’re just talking with the Lebanese legend to say, just tell me how optimized my portfolio. We’re going to make it stick. Rabih, ⁓ just optimize my portfolio. What is the only risk I should actually care about at the end of the day? Cold hearted. It’s true loss of capital, permanent loss of capital. Right? So if that’s the actual risk that we should care about more than anything on a spreadsheet, then over the next 30 years, cash is so much more risky than investing in a diversified portfolio. It’s not even close. Like that $2.1 million you mentioned earlier sitting in cash for the next 30 years. You are almost, you are guaranteeing a loss of capital over the next 20, 30 years. So just that mindset shift of understanding what trade-offs am I making? And Jake, I love that you came back to this of defining what I’m actually afraid of and get getting educated around why I’m afraid of it. And am I actually implementing a plan based around those fears or my misunderstanding it? Like really, really, really critical piece of this, ⁓ building an investment portfolio. Rabih, anything you want to add to that?

Rabih: No, I love it. And if we put as our target the permanent loss of capital as the main important one, one, we eliminate that we should not be in something like cash or bonds for the long term because that erodes. But there are other ways you can also have a permanent loss of capital, which we are going to be covering. set that as your target because you’re a long term investor and then see all the different ways that that can occur and try to avoid them. Right.

Matt: Yeah, love it.

Jake: Yeah. Speaking of loss of capital to inflation, right? I think we, don’t know if we’ve said the word inflation on here, but that’s kind of the big, the evil we’re speaking of, right? If you just hold your money in cash over time, inflation is going to roll that balance. think the math is, you know, long-term we’ve had a two to 3 % inflation rate long-term. think that’s right. Rabih, I kind of see the average per year around two to 3%. I think at 3 % your dollar, the value of your dollar gets cut in half about once every 23 years. I mean, that’s like, if you just like, whatever cheeseburger costs today, on average, that cheeseburger is going to double its price in about 23 years from today. So that’s a scary thing to get them for scared of the market. It is scary being like, man, if I just hold on to this cash, it’s not going to be worth very much in a couple of decades. That’s a scary feeling too, because we’ve worked so hard to save and like make like you go to work and you put all this time and effort into building up this money. We want to make sure it’s still going to be worth something for you when you need it down the road.

Matt: Yeah. And it feels really good in the short term. We don’t blame people. ⁓ we don’t blame people for that. And we’re going to talk here in a moment about the, the role of liquidity and cash and what, like it is an important component, to become a good investor for sure. But, you know, there’s a balance there of not holding too much. I think it’s one thing I wanted to add to this section too, before we move on is I think perspective matters as well. I love this quote from Morgan Housel. That all past declines look like opportunities and all future declines look like risks. I think that’s really important to talk about perspective. When you talk about investing that I hear, I’ve heard so many times, I’ve thought this myself, cause we’re all, you know, we’re all human of looking back and being like, man, if I would have just held onto XYZ stock or man, if I would have jumped into this when, when I had the chance, like it looked like such a great opportunity, but it’s only because of the vantage point. You’ve got to shift that mindset and look at even your future declines that are going to be coming over the next 20, 30, 40 years of your career, of your life investing life. They’re also opportunities. They just don’t feel like it because you’re in the middle of it. So anything else you guys want to add to this first part or to that quote at all? Okay. so I guess to summarize segment one of why markets always recover. The one thing we’ll just say is the open secret of investing is time. And it’s easier said than done, but you’ve got to focus on a long-term strategy. I think it’s so talking about kind of this next part. ⁓ I think it makes sense to maybe to drive home this point, compare public markets to real estate. And we’ve made this, ⁓ comparison before, but we firmly believe that the stock market overall over the long-term is a better asset class than real estate. Like we’re not shy in saying that.

There’s a lot of reasons why, ⁓ but we use this strategy or sorry, we use this analogy sometimes of why real estate feels better for people. and we want to just highlight, I think part of it is just the mechanism of real estate, meaning, ⁓ if something goes wrong with your house, let’s say a pipe breaks your, you like the, ability to sell your house. Like the, with the click of a button is obviously not there. So the behavioral aspect of real estate is kind of built into it where it’s the exact opposite with the stock market. So I think understanding that as well of, think the greatest asset of the stock market is also its greatest enemy, which is transparency and ability to transact. So I think also understanding that piece of it and how it interacts or how it relates to other asset classes is critical here. Any thoughts on that, or Jake?

Rabih: Yeah, because this goes, right, we defined risks as like permanent loss of capital, volatility, etc. In the volatility regime, people choose or defer to things that will stay better just because that volatility is muted. But in real world, it is still there. It’s just you’re not seeing it. The stock market has a big infrastructure where you can see trades clear every single second, even less than a second. And you are seeing a continuous Life stream of prices going back and forth. So when volatility happens, when prices tend to go up and down in the stock market, you have access to them and you see them immediately. The fact that you do not see stocks, you do not see prices of real estate fluctuate up and down does not mean that stock house prices do not move up and down. Just means that there is no system for you to see them moving up and down. And you think just because I do not see them, there is no volatility. But on the contrary. The volatility in real estate is as large as that of the stock market. Just you don’t have, you don’t see it. Right. So far we don’t have, you know, the New York stock exchange, the New York real estate exchange. You don’t, we don’t have that. And the reason you get that flexibility is by having so many transactions happening at the same second. This doesn’t happen real estate due to the nature of it.

Matt: Well, and the cost of transacting in the real estate market is so arduous. So that makes it little, just a completely different market. Jay, go ahead.

Jake: I just do have some data on like real like us housing returns. I think this is registered residential. So we’re spreading out like residential and commercial real estate here. But it’s yeah, I don’t know what the returns are intro year, but we do have some data on just like housing price returns since 1950. The housing market doesn’t have a lot of volatility. It actually you get to all the things you guys have spoken to. It’s gone down like early 1990s. We had a couple years of negative, obviously 2007 to 2011. Kind of a big negative. Besides that, we’re all green positive years. ⁓ But I want to emphasize is there is a trade off to that, right? When we talk about any type of investing risk and return are married, unfortunately, right? Like this is a key principle that everyone should understand. So just because the housing market doesn’t have a ton of volatility, what you’re giving up for maybe some more stability is that the returns are going to be less. That’s what you’re giving up. More volatility can equal a higher potential for return. I have the numbers. If we just want to look at annual returns, broken down by asset class from 1928 to 2023. Stocks had a 9.8 % return. Real estate was 4.2 % return, annual return over that time. So stocks do outperform ⁓ over time. Maybe they’re a little more volatile. Well, we know they’re more volatile into a year, but you do, there is a trade-off benefit of high returns for them.

Matt: Yeah, yeah, that’s a good point. And again, I think to Rabih’s point, I think what you’re saying, Rabih is we just don’t have the data on real estate as an example. Same thing in like the private sector, private equity. We don’t have the transparency to even under, truly probably conceptualize or define volatility within that market compared to the stock market.

Jake: We just don’t see it, yeah.

Rabih: Yep. That’s why, 100%. That’s why the numbers Jake are reading are showing, we’ve always been in the green. It barely moves. Just because we don’t have the infrastructure for it. And actually, you can make the case, I’m not saying real estate is a sector versus stock market is a sector, but I will make the case that your portfolio in real estate is more volatile than your portfolio in the stock market. And why is so? Because when you buy the stock market in the stock market, you’re just buying the stock as is.

Matt: Yeah.

Rabih: But whenever you’re buying real estate, you’re not buying the whole thing upfront. You’re taking on a margin law or a mortgage in that sense. And that mortgage is usually five, four, five times your initial investment. So any small fluctuation in the real estate just even amplifies it even more. So if we want to truly compare apples to Apple and assume that you have full access to information in both real estate market and the stock market, your real estate portfolio is actually more

Matt: Leveraged.

Rabih: Volatile than your stock market.

Jake: It’s also why it’s just hard to compare the two asset classes too, because with real estate and like you mentioned, the leverage piece is a big one. That’s hard to quantify and we can’t get data around just how much debt people took on on what property, but also just maintenance costs and repairs and upkeep and all of those things which do eat into your return on real estate, which the stock market doesn’t quite have those same expenses. So it’s really hard to compare the two in terms of just like what’s a total return number.

Matt: Yeah, it’s true. It is interesting. By the way, we are just to be clear, we’re proponents of both. We really are. And by the way, the fundamental truth is the same for both of these asset classes, which is time. Time is the ultimate magic sprinkle of ingredients here to build wealth in either one of these asset classes. Again, we’re not shy about the fact that there are advantages of the overall ⁓

Jake: Yes.

Matt: Equity markets, capital markets that we appreciate and especially for dentists, we think make it a, overall better asset class for most dentists. but, but yeah, I’m glad you said that Jake, that it’s hard to compare these two. They should both play a role in your life and on your balance sheet. So, ⁓ let’s, ⁓ let’s move on. So let’s, let’s kind of the main section here we want to talk about would be. If we’re talking again, we talked about risk. talked about, ⁓ this idea of like waiting for something, you know, waiting for this crash or being afraid of things. Let’s talk about the levers we actually can control when it comes to the, you know, your, your portfolio, right? What are the things that you should be actually focused on to, as we say, crash proof your portfolio, but it really what it comes down to is what can you control? There are certain things that you can’t. So for example, we’ll just hit the easy one. We can’t control or know day to day what’s going to happen on the markets. Like we, we don’t know. We don’t even know year to year in the short term, what’s going to happen in markets. Yeah.

Jake: Even like five years to five years, I think, can be pretty unpredictable. As much as we’re getting like decade to decade, we have a pretty good sense of where things are going to stand.

Matt: Yeah, which I’m glad we went here for a second. think inherently is why, I think this really speaks to why investing is so freaking hard because it is so opposite of how our brains work and how the real world works, right? Because Jake, if I asked you, what are you doing tomorrow? You’re gonna know, pretty much. You’re gonna know, within a pretty precise plan of like, know how my day is gonna go tomorrow. Of course there’s things you can’t control tomorrow, but you know, like, here’s how my day is going to go within a, again, a pretty tight range. Same with you, Rabih. You’re probably going to get and ice cream for breakfast. Like who knows? ⁓ but like, you know what you’re going to do tomorrow. I bet if you’ve, said, what are you going to be doing next Tuesday? You’re probably going to know if I said, what are you going to be doing 30 years from now on this exact date, but 30 years from now, you have no idea. The stock market is the exact opposite. We have no idea what it’s doing tomorrow.

But we have a pretty clear view of what it’s going to be doing in 30 years or give you a, least a pretty tight range of returns. So it is exact opposite of how our brains work. ⁓ but only if you employ or have a poll on these levers, we want to talk about right now. So, ⁓ lever number one, you’re going to know it. It’s the foundation of everything we talk about when it comes to things you can control. ⁓ when it comes to managing risk and that is diversification. So Rabih,: let’s get you in here. Let’s talk about diversification. What does it actually mean and what risks does it actually help mitigate?

Rabih: Yes. And people think diversification is just to like be optimize your investments, but it is more than that. It is actually to crash proof your portfolio because you don’t have to lose all your money and like invest in something and have it drop a hundred percent for you to actually crash your portfolio and lose it. It’s as simple as losing 70 or 80 % because this is like one of the fundamental laws, slash truths in the math of finance, just like gravity is there. The harder the loss, the larger the loss, the harder it is to recover from it. Losing 10 % of your portfolio would require 10 % to make it back. Losing 20 % on your portfolio requires 25 to make it back. Losing 50 % of your portfolio requires 100 % to make it back. And losing like 80 % of your portfolio would probably require like 270 % to make it back.

So if the market is giving you 10 % on average a year, how many years do you need to recover or to go up 270 % while it only took you a couple of months to drop 80? And how do you put yourself in that situation when you lose 80? You are only invested in one stock and that’s one stock drops by 80. So when we say you need to diversify, you’re trying to eliminate those very harsh scenarios that make it impossible to recover from. So what does diversification mean in that sense? Well, instead of really putting my eggs in one basket and banking on only this one stock not dropping by 80%, I’m going to buy multiple of these stocks. But I’m not just going to buy identical stocks that are in the same industry, that they cater for the same customers, that they have the same products, because they share same risks. I’m going to be buying a basket of these stocks that have different risks or they interact in different markets or they serve different clients and because each one of them has you know its own rules of the business that or economics of the industry that they’re in those risks do not coincide in time at the same time so one could experience a drawdown in the first year while the second is actually doing better think of like covid when you know Everyone was hurting except like tech stocks because we all moved to zoom and then healthcare because we all were waiting on a vaccine everything else was oil Yep, or or oil oil really suffered in ⁓ kovat, but that did not happen ⁓ Later on so the fact that you can cherry pick and you know We should be grateful for that cherry pick different companies that will react differently to different market swings allows us to

Matt: My NFTs freaking killed it during COVID. Yeah.

Rabih: On the aggregate level, when we look at the whole portfolio, aka the sum of all these stocks combined, our portfolio does not experience the same magnitude of drawdowns as every single individual of them. So in a nutshell, diversification is really one of these cases where the whole is really greater than the sum of the parts, because the way those parts interact with each other actually put you at a better position. And in a diversified portfolio, yes. your portfolio could still drop 30, 40, 50 percent, but you’re not going to drop 80, 90, 70 percent, which…

Jake: And there’s still, if you’re investing in individual companies, there’s no guarantee they’re going to make it back. think, you know, sometimes we fall into this trap of, this one big tech stock went down 40 or 50%. And I’m just going to keep holding onto it because I hope that it’s going to reach all time highs again. There’s no guarantee of that. Again, a lot of companies just never make it back. When you are investing in a broad swath of companies, that’s mirroring what the global economy is doing. We have a pretty, again, like we talked about before, we are now just betting on that the Global economy is going to keep turning on and will make it back to a point. There’s no guarantee with that. Individual stocks, it’s a pretty good guarantee when you’re diversified across different sectors.

Matt: Yeah, that’s a really good distinction to make that we, we firmly believe markets markets as a whole will always recover. doesn’t mean in the global market doesn’t mean individual companies within. Well, there’s countless stories of companies that have not recovered companies that felt like they were Teflon. They had track decades of track record, you know, of, of returns that then just were gone. That that happens all the time over. over decades and generations of, of markets. So that’s a really good distinction to make. I, again, I think there’s this theme of like distinction between what the market is, what risk is. I’ve, I’ve said, I’ve told this story before, but I think it’s, worthy of mentioning again, that I grew up being told the stock market was a scam. My whole life, my dad’s a big real estate guy forever. He told me the stock market was a scam. And it wasn’t until I got older.

And kind of realized, just educated myself and then got into this industry and started to kind of, again, understand more and more of what was going on. finally talked to my dad years and years later. And I said, dad, you’ve always told me the stock market’s a scam. I’ve never asked you like where that came from. ⁓ and it come to find out my dad had taken a flyer back in the day in his early career on a handful of penny stocks. And he extrapolated and they obviously all went under nothing came of it. And then he, he, he extrapolated that out to, the stock market as a whole is a scam. And I think, I think about this when we talk about the massive difference of. Like we say investing in the stock market that could someone could take that and be like, yeah, I bought XYZ stock and it went to zero. So I’m never touching the market again versus I have a globally diversified portfolio of equities that I’m holding for the next 30 years. It’s the same thing that you’re investing in, but it is massively different outcomes with how you approach it.

Jake: There’s an infinite ways to invest, Like there are so literally infinite ways to kind of invest in the stock market. And I think that’s an awesome distinction of we needed to kind of define what that means investing in the stock market for you. And what was your past experience? Were you investing in just a couple of penny stocks? Were you buying and holding? There’s huge differences between how people go about it. But whenever we talk about it to friends, like you said, matter just in general, we’re like, oh yeah, the stock market screwed me here or did this year. And we’re not getting into the details of what actually was your strategy. What did you do in the stock?

Matt: Yep. Yep. ⁓ Rabih, let’s get you last word on this in regards to diversification risk, all these, ⁓ what other final thoughts do you have on this segment here? This part of this lever.

Rabih: Okay, first I have a disclaimer. was doing math while you guys were chatting. You need 260. Yeah, this is very me. For you to you need 233%, 260 % to make your money back. That’s if it drops by 70%, not 80%. My bad. If it drops by 80%, you need 400. So it’s even worse. Just dig a deeper hole for yourself. So with that diversification and what really what you guys like what you’re saying, just buying stocks does not mean you are diversified.

Matt: What? Doesn’t sound like you. Woo! Whoa.

Rabih: And there are metrics to look at it. A lot of academic studies have done, and it’s actually one of those unanswered questions on finance. like, what is the proper mix of stocks for you to be the most diversified? This is what we call the allocation problem. Like, what is the best optimal way to allocate your portfolio across different stocks, et cetera? But what we have noticed, and it’s not recent. It’s been like 30 years, but we kind of knew that this has been the most efficient way to allocate has been to follow the market portfolio. And that’s why we think, indexing has made this big boom in the world. It is good. is out of all those options available out there, just following the index as a whole is a more efficient allocation. Anything beyond that requires a little bit more of nuance or how we trade. It’s not about allocation, but how you manage the portfolio where you improve on indexing. But just as an allocation perspective, the index does well. And why is that? Like, why is it that if I choose to invest in the stocks in an allocation that is equivalent to their market size, I’m having the most efficient diversified portfolio because not all portfolios are diversified this certain way. And this takes us back to, know, ground zero when we started. Markets are efficient and it’s a very good system that we can trust the price. And those information that we’re getting from the market tells us that the reason, I don’t know, the Magnificent 7 are the largest allocated companies in your portfolio is because they provide the largest amount of value and you should have a bigger allocation to them because they contribute more than others in terms of progressing the returns in the market. So… just to like tie down the ideas like, yes, diversification is important. How do we do it? Well, don’t look further than the market. Listen to what the market tells you. It’s very efficient. You can trust the prices and follow the allocation it provides.

Matt: Love it. Love it. And, and, and we’ve talked about this before, but this is why we hear when people say, Oh, I only S and P 500. I’m good. Like this set it and forget it strategy. Um, you know, that’s better than day trading. Like you said, Jake, there’s an infinite number of ways to invest in the market.

Jake: Or it’s better than maybe just holding Apple or one or two companies. You’re more diversified. There’s levels of diversification here.

Matt: Yeah, totally. You’re more. Yes. Yes. But it would not, we would argue it’s not multiple. It’s not optimally diversified. So a lot more that goes into it to be properly diversified. So lever one, diversification, huge part of, of crash proofing a portfolio. think we hit that number two would be having a proper runway of liquidity. So we, started this whole thing off with a story around someone sitting on way too much cash. It was pretty, it’s obviously an extreme example, but we see it. And I think there’s an understated risk here of dentists who hold way too much cash. However, cash does play a role when used with intention and having enough of a runway, ⁓ to give you a margin of safety in order to be able to withstand the inevitable volatility that will come even with a diversified portfolio. So, so cash plays a critical role. ⁓ I, we always say this, there’s basically there’s, are two reasons to hold cash emergency fund, both at home and in the business. And then a upcoming, ⁓ definable short-term investment and or expense that you can define again in timeframe and scope. So those are really the only two reasons. A reason to hold cash is not to wait for something to happen as they, as, as we said, but again, you should have that cash. It absolutely plays a role and can make you a better investor by having that emergency fund in place and having that runway to be able to again, withstand those, ups and downs. So there’s a huge emotional benefit there. ⁓ what are your guys’ thoughts on the second lever to again, quote unquote crash proof of portfolio, having enough runway on cash.

Jake: Yeah, cash is huge. We can maybe get into the details a little bit of how much cash you want to have on hand. You know, if you read a personal finance textbooks, they’ll tell you to have anywhere between three to six months of living expenses in cash. Matt, I think you’re in our document, you put six to 12 months in cash. ⁓ I think 12 months is a tad, I think it’s a lot. But again, this is personal preference too. Personal finance is personal.

Matt: Probably the extreme. Yeah.

Jake: If having like a certain amount of cash helps you sleep better at night, by all means do that, right? This depends on your personality. You know what’s happening in your life being anywhere, you know, three to six months, I think of personal expenses and like a personal savings account is great to high yield savings accounts. Awesome for that money. And then as we’ve talked about one and half to three months overhead expenses in the practice is a pretty good cash amount there. Anything beyond that.

Matt: Yeah. ⁓

Jake: Again, we can talk about saving for an upcoming purchase if we can have it there, but you really want to try and be utilizing your money, investing it, paying down debt, doing something with it on top of those cash levels. Yep.

Matt: Putting it to work. Yep, I agree. Rabih?

Rabih: Yeah, Jake said cash is huge. I thought he was going to say cash is king because this is the sentence we’re very used to. But cash is really king. just I’ll address it from an investment perspective. But behaviorally, it’s very important. Like the only way you can withstand seeing your portfolio going up and down by, you know, big magnitudes, if you know that, ⁓ I have cash that’s going to cover me for three, six, 12 months, whatever number you decide on.

Matt: That would have been the way to go.

Rabih: This gives you some leeway and try to make the volatility of the portfolio ⁓ a problem in six months or in three months when the portfolio, when the cash buffer depletes rather than it becoming an immediate problem that the portfolio is being too volatile and you panicking around it. Yep.

Jake: Yeah, ideally when you’re investing money, it’s money that you are not going to need for a while, right? So when you’re like, when it goes down or whatever happens in that portfolio, you can be like, I don’t really care what it does because I don’t need it right now. That’s ideal scenario.

Matt: And hopefully you’re adding to it on a regular basis too. So the down, you know, when it pulls back, that’s actually a good thing to be able to buy lower.

Rabih: The other side of the coin about liquidity, because we talked about personal liquidity here, but there’s also investment liquidity, is that when a crash happens and it’s obviously that investing at this point is buying stocks at a discount, it’s very cheap, it’s the value play, it’s the opportunity to purchase, well, you don’t want to be in investments that are illiquid. You want to be in investments that are liquid, AKA not real estate in this example of the podcast that we’ve been discussing, but more into stocks because then you can funnel money from the ones that kind of maintain the value, their value and invest them in the ones that lost. So cash is very important because just like it gives you the flexibility to withstand behaviorally the volatility, it also gives you the flexibility to capitalize on market opportunities. And this is the true one. This is where the true saying of I’m waiting for a crash applies. Not when you’re sitting in cash. It’s when you’re invested, but you’re invested in stuff that continuously provide you that liquidity.

Matt: Yeah, it’s really good. Jake, any other thoughts?

Jake: The only in practice doing like saving up some cash for an opportunity in the market, Ravi could be, well, if I’m waiting for like, let’s say I just had some cash in 2023, beginning of 2023, and I was waiting to deploy this into the market and I’m still holding onto that cash today. I dismissed out on three years of incredible returns and it would have been as far better if I would have got that money in the market rather than waiting for a crash from opportunity to get in. There’s always the risk of if I’m waiting for an opportunity, that opportunity will actually just pass you by you’re not in.

Matt: Yeah, as an individual investor out there, let’s just be candid about this. Any dentist I hear that says I’m waiting for an opportunity, it’s what Rabih said earlier. That is a telltale sign that they’re just afraid to invest, which again, we don’t blame them. But if I ask one more question of what are you waiting for? Meaning what factors or things are you waiting for looking at ⁓ to know when it’s time to jump in? They’re very rarely going to be able to answer that. That’s different than a professional money manager like Rabih truly, who he and I have had these conversations and customizing portfolios for clients in certain situations. Rabih might hold away, hold something to the side for that in certain situations, but it’s a completely different situation from a full-time dentist out there doing it to your point, Jake, what naturally will happen is they’re just going to sit on cash for way too long. Rabih,: any final thoughts on that?

Rabih: Yeah, yeah, I think I miss I don’t know if I misspoke, but you guys, I agree with all what you’re saying. What I was saying from the liquidity perspective is like the liquidity of the asset class you’re in. Like you could be in real estate, right? And then the market crashes. Good luck selling out of that real estate to put it into the S &P 500. It’s not going to happen. Even that’s the second phase ⁓ side of liquidity. You want to be in liquid asset classes to be able to properly capture dips in the market or

Jake: Mm-hmm.

Matt: ⁓ yeah, yeah, yeah.

Rabih: Actually capitalize on that opportunity.

Matt: Okay. okay. love that you clarified that Rabih, what we’re going to is the last lever here of crash proofing a portfolio, is having a rules-based rebalancing and a strategic rebalancing strategies. And I think that’s what you’re alluding to here. So can you, let’s have you jump into this piece of being again, rules-based and strategic when it comes to rebalancing a portfolio.

Rabih: Yes, 100 % because once you’ve figured out that yes, all the assets that I’ve invested in are all liquid and I can move money from one to another at opportune time, you could choose to wait for a crash to do it, which is the simple example we’ve been going out there. But is it the most optimal way? There are more levels to this and more nuances. And with time, because and looking at your portfolio as a snapshot in time does not give you the big picture. You have to look at it as, you know, a drift, as a series, as an evolution. And what we notice is that with time, this allocation that you chose at the beginning of your investment horizon is going to drift away. some will be winners and some will be losers. But those losers are still diversified portfolio. It just means that they still need time to go up. So why not? optimize at that level and rebalance. And what rebalance means is that once you have chosen an allocation of diversified units in your portfolio or diversified asset classes in your portfolio that in the long run will ⁓ reward you, ⁓ why not choose to take money out of the winners, put them into the losers or vice versa bring the losers back up to a proper allocation that one defines your risk and two optimizes your portfolio on the long

Matt: Yeah, that’s great. Jake, anything you want to add to that? I, the only thing I’ll say is, would you go through this Rabih? It’s there’s just so much to this. And I, and, this is where I get a little bit. I’m irritated. It’s not the right word. really isn’t, but I, I kind of want to like jump on whenever someone talks about and simplifies this down to like active versus passive. like, that is such a, like a simplified way to put it. And it’s not just those two categories because what we’re talking about is a very active process. But if someone asked me, do you believe in active management? I’d be like, well, no, not in this way that you’re asking it. Like we don’t believe exactly. We exactly, we don’t believe in stock picking and momentum trading and saying like we’re going to pick, but cause dentist asked us this.

Jake: Not in the stock picking sense that you’re asking me this,

Matt: But do I believe in an active, proactive and systematic process of which is active in order to optimize a portfolio and maximize returns over the long-term? Absolutely, I do. But it’s, we’ve now kind of like this reductive kind of like simplified, are you a passive investor or an active investor? It kind of drives me nuts. Cause I’m like, that’s not, that’s not an accurate way to define it. Rabih,: is that fair?

Rabih: Yeah, 100%, 100%. It’s…

Jake: It’s an active management of your passive long held portfolio, which is kind of an interesting thing. Yeah.

Matt: Yeah, yeah.

Rabih: Yeah. And honestly, passive versus active are just the packaging or the rephrasing that the investment industry uses to, you know, communicate with retail clients. in the real, like behind the curtains, like what is happening? What does passive mean? It means that you are buying and holding and ⁓ you are believing that the price in the market is the one that is the true value because the market is efficient.

Matt: Yes, to sell something, yeah, yeah.

Rabih: And active, what it actually means is that you’re transacting every once in a while to correct or because you think the price in the market is wrong, right? So the active versus passive is not about ⁓ what’s your investment strategy or picking the right stock, et cetera. In backstage, all it means is like, do you believe that the price the market is providing you is the most accurate, efficient one or you don’t? If you don’t, then you should have the truth, you should hold the truth. The market doesn’t hold the truth. Then you’re an active investor. It’s more of a philosophical shift or a split between the two. It does not really translate to, it’s an active strategy versus a passive strategy. No, it’s a philosophy towards it. So would I say it’s a passive philosophy? Yes, I believe that the markets are the true source of accurate information and prices, not my own brain who thinks something should be valued at a certain point. You start from there. You take out the flashy words and the political words in the investment world, and you get down to the root of the things.

Matt: Yeah, yeah. One way we put this is if someone asks us our philosophy of dentists advisors is we have a passive philosophy to your point, Rabih, but we have active implementation of that philosophy over time.

Jake: And there.

Rabih: 100%. And sorry, Jake, and if you want to remove, you know, the titles from it, a passive philosophy means we believe that the market has the true source of information, the prices reflect the truth. And the act of implementation is we’re not vacationing. We are looking at the portfolio every single day. We are tweaking around rules. We are making sure that our risks are in control and we’re running a tight ship. But we believe that the prices in the market are the accurate ones. This is what passive philosophy active implementation means.

Matt: Yeah, go ahead, Jake.

Jake: I, Rabih was just really eloquent there and I don’t like going after that. ⁓ I was just going to say, and there can always with most things in personal finance, there could be room for both things. I are like, we can have a broad systematic approach, long term investing. could also maybe pick some individual stocks. So that’s something you’re interested in. You can have a bit of an active portion of your portfolio and a more passive systematic approach. There’s room for all of these things, right? As, we’re doing this on an individual basis.

Matt: Yeah. Yeah, that’s great. okay. Well, to wrap this up guys, ⁓ I think the last piece of this we’ve already kind of alluded to, but I think it’s, bears repeating as we summarize this of just, we’ve covered the three kind of levers of, of crash proofing a portfolio that’s diversification. ⁓ that is, having the proper liquidity runway and then also having a strategic, ⁓ proactive rules based approach to rebalancing. And then fundamentally this comes down to time in the market, as we alluded to at the beginning, ⁓ is that is the open secret of investing. And then the one thing I’ll mention here too, is we talked about at the beginning of ⁓ Jake, love that you said this. I want to come back to it as you have to truly define what you’re afraid of. What are the risks you’re, you’re trying to work around. And when it comes to anything like this, you have to choose.

You have to choose a risk. There is no riskless anything. Progress does not come without any level of pain and some level of pain and growing your wealth does not come without some level of risk. You have to choose it though. So it’s either taking volatility now in the short term in order to, even with a properly diversified portfolio, there’s still the pain of volatility and the risk of volatility, but the payout over the long run. Um, is, going to be a lot more wealth. And I’ll say this too. It’s hard. Like we’re talking 10, 20, 30 years where this is not lost on us. trying to quote unquote, sell somebody on long-term investing, it is not easy. It is not easy to, stay in your seat when things get scary. Um, but again, we firmly believe in time in the market versus timing the market. So anything on that last part here. For, from you guys on, on, on really any of this, ⁓ anything we’ve talked about any other final words of wisdom Jake, Rabih.

Rabih: Yeah, I honestly I honestly think that one podcast is not enough for this stuff. There’s a lot that goes into the details, but there are, you know, fundamental knobs that you have to play around to make sure you’re doing well in the long run, which is do not sit out there and lose money and bleed slowly without you knowing and do not do something stupid in the market that makes you lose all your money. So this is literally the whole podcast here, which is not enough. It’s just like, do not lose money. And those are only one of the few ways for you not to lose money. Right.

Matt: Yeah. Jake, go ahead.

Jake: Think my final thought would be something we touched on earlier, which is I think when we talk about the stock market, whether sometimes it can be a podcast or you hear something on the news or a Tik Tok video or talking with your friends and we talk about it in such broad terms like the market did this today, the market did that. My friend put some money in the market and made X amount of money or he lost X amount of money, whatever it may be. And I think we just do ourselves a disservice when if you just like look under the hood a little bit to those like broad terms there. so many variations and variables and different ways to invest and look at the stock market. And we just talk about everything in such broad terms. And I think that produces some misconceptions about what the stock market is. How should you invest? What does that look like? That my recommendation would be like any investment discussion you get into in the future, just try and dig a little bit deeper if you can, or get some more education. ⁓ The devil really isn’t the details when it comes to investing in the stock market.

Matt: Yeah. Well, to that point too, Jake, mean, I don’t think it’s, it’s interesting. It’s like an interesting paradox. It’s never been easier to access markets, but it’s never been harder to be disciplined in them. I think that’s, think that’s true because we, we live in an age of tick tock and 10 second clips with hot takes and opinions of like, this is what you should do. And it’s never been easier for people to sell you crap that you don’t need courses or whatever.

Jake: Yeah.

Matt: So again, we’ve never had more access to information, but on the other side, it’s never been harder to actually wade through that noise and actually like be disciplined. So, I think it’s a, ⁓ again, this is why we say like, have empathy. This is really hard. This is really hard. ⁓ okay, guys, thanks for being here. If you’re still listening, you’re one of the cool ones. ⁓ if you are listening to this and you’re thinking, ⁓ you know, I need help with this. I’ve been sitting on cash forever. And I need to talk to someone about it. needed to lay down on the couch and have a therapy session with Rabih. We’re here. We are here for you. ⁓ we, we would love to help you with your portfolio or anything to do in your financial life. This is what we do every single day. You can go to dentistadvisors.com click on the book free consultation button, and we would love to hear your story. Love to talk to you and see how we can help. for now, everyone, thanks for listening. Jake, thanks for being here. Rabih, thanks for being here until next time. Take care. Bye bye.

Keywords: diversification, investment, risk management, financial education, portfolio optimization, capital loss, market research, crash proof.

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