Exclusive Interview: Getting to Know Our Clients Inside and Out

Felix Kwan of Edelman Financial Engines on Volatility, Diversification, and Company Stock Plans 

Ric Edelman: I'm happy to bring on to the program one of my former colleagues at Edelman Financial Engines, Felix Kwan. He's a Certified Financial Planner and Executive Director of Financial Planning at Edelman Financial Engines. He's based in San Francisco in the Bay Area, been with EFE since 2012, ten years now, and he's got 20 years of experience overall in the financial planning and investment management field. Felix, great to see you, my friend.

Felix Kwan: Great to be here. Thank you.

Ric: So there's a lot going on in the marketplace, which is why I wanted to have you chat with us on the show. We are facing an economic environment that is brand new for an awful lot of investors. A lot of folks are looking toward retirement some very, very soon. And we're fearful, right, that the stock market is dicey. We're seeing increased volatility. There's a lot of uncertainty due to inflation and rising tax rates, the war between Russia and Ukraine, COVID is still lingering and so on. So what do you say to people who tell you that they can't afford to lose a lot of money at their age? I don't want to lose any money for my portfolio. What do you tell them?

Felix: Sure. I mean, it's definitely a lot of uncertainty out there. You know, that's the foundation of the investment management is really to begin each and every interaction, whether it's a new client referral or whether it's an existing client. We always began with the financial planning process. That way, we hope to come up with a goals-based strategy and then determine what is the best risk-adjusted rate of return that we need to solve for to achieve our client's goals.

Ric: But what about someone who says, look, the stock market's down a lot this year to date. The bond market is down double digits over the last year and a half. Inflation is continuing. Interest rates look like they're going to continue rising. And therefore, it looks like portfolio volatility may continue. And I don't want to lose money. What do you do to help them prevent further losses?

The power of diversification during these troubled times

Felix: Yeah, unfortunately, the adage is diversification. If you look at the last 3 to 6 months, you know, we've seen so much, so many large downturns, especially in the growth stocks and that's affected the broader markets. And unfortunately, you'll have markets like this where there's nowhere to hide, there's nowhere to go except for cash in a rising rate, inflationary environment. So that's why I think I go back to really that financial planning approach. It sounds really clichéd, but we always go back to the two foundational elements are the investment time horizon. If this money is not going to be used within 3 to 5 years, we need to be invested in a broadly diversified portfolio in all of these different asset classes. And then secondly, cash reserves is critical. Oftentimes, we'll set up strategies within a portfolio. Let's say a client's taking an RMD- required minimum distribution, where they're forced to take a withdrawal every year, but they also need to live off of the funds as well. We can carve out some cash reserves inside the IRA account, and that way we can at least control the timing of when we want to rebalance or liquidate securities and not be necessarily forced to sell asset classes at the very worst time when they're low.

Ric: So, are you making any recommendations or changes in the portfolios when someone says, I want to protect myself against inflation?

Felix: The question I go back to: Well, what's changed? I think you know our role as financial planners at Edelman Financial Engines is to get to know our clients inside and out. And I remember, telling clients 3 to 6 months ago that, hey, the Federal Reserve, they're changing course, right? They're going to be changing their accommodative policies. They want to start raising interest rates. They made some of these announcements last year. So, it wasn't a new thing. Right? But as even as you're talking to clients or doing reviews with clients, you're always reassessing what is their attitude towards risk? Has anything changed? Most of the time clients are like, no, no, everything's fine, nothing's really changed much. But then you get a call from somebody a month later, kind of freaking out. What's really changed? I think it's going back and really understanding, number one, what are the goals that the clients are trying to achieve? But more importantly, what concerns or what barriers to success or what's getting in their way? Oftentimes, it's not anything that's market related.

Time to rebalance your portfolio?

Ric: How often do you review of the client accounts to see if there are any changes that you need to make in the portfolio?

Felix: At Edelman Financial Engines we'll do a daily strategic review of each account to see whether or not any holdings, any mutual funds or any exchange traded funds within the account has drifted too far off its target. We can then take advantage of rebalancing.

Ric: Not every fund is always going to prove to be a great investment. So, what causes you to change a fund? What are the triggers for doing that?

Felix: At Edelman Financial Engines, we are constantly reviewing all of the investments that are out there. We manage money inside personal accounts. They could be trust accounts, taxable accounts, IRA accounts, but also inside 401(k) plan sponsors as well. We're constantly reviewing the holdings and the options for fees, expenses, performance and asset classes. As an example, certain asset classes may work better in these types of inflationary environments. So, we'll also want to make sure that we monitor for changing financial conditions and we can adjust accordingly.

Ric: And have there been changes that you've made so far this year?

Felix: Yes, a couple of times. So, in addition to the daily strategic review, we can also do off-cycle rebalances as well, depending upon what's happening with everything that's going on, as you mentioned at the beginning, right?

Ric: Give me an example of one of the changes that you've made this year.

Felix: One of the changes that we made was the emerging market fund. We went from a more expensive fund to provide better to improve the risk-adjusted returns of the entire portfolio.

The role of target date funds within your 401(k)

Ric: And very commonly investors own target date funds. These are perhaps the most popular investment choice within 401(k) plans. What's your opinion of target date funds?

Felix: You have to really understand the methodology. They're not all created equal. What you have to do is you have to really study how all the different vendors operate. What kind of international exposure did they have? When do they start becoming more conservative? Are there some that are maybe too conservative and maybe you're not? I think these are all the things that we have to make sure that the vendors target date funds kind of fit our methodology and then the financial plan for our clients.

Ric: Do you routinely use target date funds in the portfolio?

Felix: Within the Edelman managed 401(k) accounts? We could use those as a building block. So sometimes we will use that and then build around it. The role of an advisor is to help the clients determine what's the right strategy for them.

The risk of owning too much of your own company stock

Ric: A very common occurrence is for people to own stock in the company where they work. How do you how do you fit that into their overall investment strategy?

Felix: Especially in the Bay Area. A lot of where I work in the San Francisco Bay Area, a lot of options as well. So, yeah, so oftentimes we'll see clients that are pretty lopsided in their company stock. But generally, we think if you work for the company, 15% is okay.

Ric: How often do you tell a client that they need to sell the stock or some of the stock in the company where they work?

Felix Kwan: As often as I need to.

Ric: And what's the typical reaction when you tell a client that you want them to sell some of their company stock?

Felix: The last 10 to 15 years have been phenomenal, right? The market's been up 3- 400%. Why should I sell my stock and diversify it? So again, that's our job - to get our clients to take the right action, to do the right thing, to make sure and also have that risk discussion with them. What's the risk of having that concentrated position in a drop 60%? The last couple of years they were very reluctant. Now? Not so much.

Helping investors cope with today’s volatile stock market

Ric: So, what's the overriding message you would say to somebody who's dealing with the challenges of investment strategy today, given the volatile marketplace and the uncertainties that lie ahead? What's your advice?

Felix: It really goes back to the financial planning process. And ultimately, I think it comes down to what rate of return are we trying to solve for? How are we trying to then optimize the risk? I think we ultimately have to go back to not necessarily what the headlines are telling us about inflation, we have to go back to what is our what is our client's personal inflation rate. I'll throw the question back at the client to say, well, we tracked your expenses so if inflation is 5%, 6%,7%, 8% or whatever it is, how are you personally impacted by inflation?

Ric: So, a good financial planner can help you challenge your assumptions and make sure that you're making the right decision for the right reason at the right time. That's Felix Kwan, Executive Director of Financial Planning at Edelman Financial Engines. Felix, if people wanted to reach you or your colleagues at the firm, how would they do that?

Felix Kwan: You can just reach us at EdelmanFinancialEngines.com. We'd love to hear from you and see how we can help.

Ric Edelman: Well, I think if there's one word that we can use to describe what's going on in the financial markets this year, it's volatility. And whenever we experience volatility, that means you're wondering, what do I do about it? Edelman Financial Engines is presenting a webinar on this very subject, 8 Ways to Help Stay on Track Through Volatile Markets. The webinar is April 26th. You can choose between three and 8 p.m. It's free, of course, and you'll learn four key steps that you can take and four common mistakes to avoid. I encourage you to sign up at PlanEFE.com/Ric. It's free PlanEFE.com/Ric. Thanks, Felix. Appreciate it very much.

Felix Kwan: Thank you.

Ric Edelman: Felix and I actually had a conversation for about 20 minutes. If you'd like to read, watch or listen to the entire conversation, just visit TheTruthAYF.com.