How to Effectively Explain our Root Reserves Investment Strategy

Most retirement portfolios start the same way.

A risk tolerance questionnaire.
A model allocation.
A 60/40 or 70/30 portfolio.

But that approach misses the most important question: how does the portfolio actually support a client’s retirement spending plan?

In this episode, James walks through the framework Root Financial uses to design retiree portfolios — and more importantly, how advisors can explain that framework in a way clients truly understand.

Instead of starting with percentages, the process begins with risk capacity. How much income must come from the portfolio? How long do bear markets historically last? And how can a portfolio be engineered to protect retirees from sequence-of-returns risk while still capturing long-term growth?

The result is the Root Reserves framework: a clearly defined “stable bucket” designed to cover several years of portfolio withdrawals while the growth portion of the portfolio remains invested in equities.

But the real lesson isn’t just about asset allocation.

It’s about communication.

Because even the best portfolio design won’t matter if clients don’t understand why it works. In this episode, James walks through the exact narrative advisors can use to explain Root Reserves to clients — from sequence-of-returns risk to the role bonds play in protecting the growth portion of the portfolio.

If you want a clearer way to connect portfolio design to retirement income planning, this episode gives you both the framework and the language to do it.

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The individual featured in this episode is a professional contact of James Conole and is not a current or former client of Root Financial Partners. This individual was not compensated for their participation, and no material conflicts of interest exist in connection with this endorsement.

Advisory services are offered through Root Financial Partners, LLC, an SEC-registered investment adviser. This content is intended for informational and educational purposes only and should not be considered personalized investment, tax, or legal advice. Viewing this content does not create an advisory relationship. We do not provide tax preparation or legal services. Always consult an investment, tax or legal professional regarding your specific situation.

The strategies, case studies, and examples discussed may not be suitable for everyone. They are hypothetical and for illustrative and educational purposes only. They do not reflect actual client results and are not guarantees of future performance. All investments involve risk, including the potential loss of principal.

Comments reflect the views of individual users and do not necessarily represent the views of Root Financial. They are not verified, may not be accurate, and should not be considered testimonials or endorsements

Participation in the Retirement Planning Academy or Early Retirement Academy does not create an advisory relationship with Root Financial. These programs are educational in nature and are not a substitute for personalized financial advice. Advisory services are offered only under a written agreement with Root Financial.

Transcript

Listener Question From Jed

SPEAKER_00 0:00

Welcome back to another episode of the Root Ready Podcast. I'm your host, James Cannoll. Today we're talking about two things. Number one is how do we at Root Financial allocate retiree portfolios to stocks and bonds and how is our approach different than what I would call industry standard? But most importantly, number two is how do we explain this to clients? It doesn't matter how good the investment allocation is, it doesn't matter how good the strategy is. If you can't explain it in a clear, compelling way, you're going to miss out on some of the effectiveness. It's just not going to land with your client. Today's question comes from Jed. Jed says the following: Hey, James, thank you for the work you do in this industry. As a younger advisor who first got into the business listening to your real personal finance podcast while mowing lawns, I realize it's because of people like you going the extra mile that I get to do what I love successfully today. I still find content like yours to be the most helpful and growing technically sound in this field, even after going through all the designation programs. I can tell just by listening how passionate you are about what actually helps people, and that's inspiring to me. Thank you, Jed. My question is about determining the proper asset allocation for clients entering retirement. If I'm understanding you correctly, your framework involves looking at the client's reliance on portfolio income. For example, if a client has a$1 million portfolio and requires$40,000 annually, you might set aside a few years of living expenses in a conservative sleeve and keep the remaining amount in growth-oriented assets. Could you go deeper into how you implement this in practice? Specifically, how do you define the conservative sleeve? How many years of portfolio withdrawals or expenses is enough? How do you view bonds in the sleeve given periods like 2022, where fixed income sold off alongside equities? If we do run into a bear market and emergency reserves are being drawn from the fixed income sleeve, how do you frame that conversation with the client? Where do you personally draw the line between encouraging a client to take on more risk, if they clearly have the financial capacity to do so, and respecting their emotional bias towards safety, even when their preference doesn't have much logical support? I realize this is a lot of questions and by no means expect you to address each question individually. My goal is simply to share how I'm thinking about the process and highlight the areas where I feel less confident. Thank you, Jed. So, Jed, thank you for that. Um, some of those questions are definitely more, I would say, practice management questions or have uh probably a need for their own full episode to fully get through those. So, what I'm gonna focus on today is how do we size up how much should go into what we call root reserves, and how do we implement that and how do we most importantly explain that to a client so that they feel that their portfolio allocation is fully connected to their goals because we know it's going to be. We know how this approach is gonna add value and how it's gonna help. But what's gonna make it most impactful for a client is their ability to clearly see, for you to clearly explain to them how this is gonna support them in their retirement journey. So I think probably the best way for me to do this is to actually articulate this as if I were talking to you as the client and you as a client could hear how this was explained. And I'm not gonna say that I'm the best at doing this, but I do think there's a few core things that if you hit on will make this much more impactful, rather than just saying Mr. Client or Mrs. Client, we recommend to you a 70-30 portfolio or we recommend to you a 60-40 portfolio. Why? I don't know. Because you're retired, because you filled out a risk tolerance questionnaire, because that's how everyone else does it. No, we're getting away from that. We are getting away from the industry standards and we are designing a portfolio that's going to not only meet our clients' needs, but fit into the rest of their plan. So as I go through this, I'm going to go through this as if I'm talking to a client as we go through this process. Now, you as the advisor need to know there's two things that we're actually looking for as an advisor, two high-level things, I should say. One is risk capacity, and two is risk tolerance. This industry focuses too heavily just on risk tolerance. Slide over a piece of paper or send an online questionnaire to the client, ask them to fill it out, and based upon their responses, you're going to give them a portfolio that matches that. That is the worst way to do this. Now it's okay to use a risk tolerance questionnaire. It's okay to do that, but use that as a basis for conversation. Use it as a basis for exploring the answers that we're given. But if a client has no context and all they see is how do you react when the market does this, or which of these portfolios would you choose between? They lack the proper context to understand how this actually connects to the other goals that they have. They lack the proper context to fully understand the trade-offs. The trade-offs, not just would you prefer a portfolio that goes up in value some years, but also goes down and more, or something that does that less. That lacks full context. And so use that. But if you are relying on that as a single thing that you are doing to create portfolio recommendations, you're doing your clients a disservice. So let's walk through how we would do this. And what I'm gonna do with a client right now, this sample client, is I'm purely gonna be focused on the risk capacity standpoint. I would say the risk tolerance standpoint is a separate layer that you can put on top of this, but I'm first going to approach it from a risk capacity standpoint. So let's say I'm talking to Mary. Mary just retired and she's 65 years old. Now, Mary's gonna collect Social Security at the age of 67. And at 67, she's gonna have$3,000 per month coming in from Social Security, but she wants to spend a total of$6,000 per month. And Mary has a$1 million portfolio that she can draw from to help meet her needs. So for the purpose of this conversation, I'm going to ignore taxes, just so we can explain super clearly both how do we go about determining how much to have in stocks versus bonds, as well as how do we properly communicate that. So if I'm talking to Mary, the first thing I'm saying to Mary is, Mary, as you come to me, as we are building a portfolio for you, there is one asset class or there's one type of investment that's going to grow your portfolio or give you the greatest growth potential over time, and that's equities. That's stocks. If I use the SP 500 as a simple benchmark, going back over 100 years, the SP 500 is averaged right about 10% per year. What does that mean for you, Mary? Well, if you got 10% every single year, you could simply take your million dollars, pull out$100,000 every year because that's the growth that you're going to get. Now, of course, we wouldn't actually do that because of inflation. You need to keep something in your portfolio, but you get the picture. If you got 10% every single year, put all of your money in equities. That's a great place to keep your money to get wonderful long-term returns. Unfortunately, that is not how it works. In fact, the SP 500 has never once returned exactly 10%, and only in a handful of years has it even come close. So, what do we do with that information? Well, up until now, you've probably just worried about or just been concerned about what is that return that you're getting. Are you up 30%? Are you up 5%? Are you down 20%? Yes, you care year to year, but most importantly, you care about what's been your average return as you've been investing and preparing for retirement. That is great. And that's all that really did matter. But that's completely different now. That's completely different now because there's something that's going to present itself as a big risk now that you are retired that was not previously a risk. That's something called sequence of return risk. So if I go back to the S P 500, yes, it has averaged 10% per year growth over the last hundred or so years, but it is not going to give you 10% every single year. It's going to be up 40% or it's going to be down 40%. It's going to be up 20% or it's going to be down 15%. It's going to be anywhere in between, but it's never going to consistently give you 10% year in and year out. What are the implications of that for you? Well, the implications are, Mary, what if you retire today at age 65 and next year is one of those down 40% years? So your million dollar portfolio is down 40%. And by the way, you treated it like you could just pull out 10% per year. Now I know you wouldn't do that, Mary, but just kind of go with me for the sake of conversation here so I can illustrate why we don't do that. Well, if your portfolio is down 40% and you take out 10%, you're down 50%. You have a million dollars to start, but now you're down to$500,000. Well, if the next year you take another$100,000, well, now all of a sudden that's a 20% drawdown on your portfolio and you're down to$400,000. No amount of growth is going to allow you to dig out of that hole, or it's going to take an enormous amount of growth for you to dig out of that hole. So you can start to see why don't we put all of our money here? Why don't we put all of our money in the thing that grows the most? We don't do it because we can't predict or we can't guarantee, in fact, we can guarantee the opposite, that you're not going to have consistently positive results. So this is the shift, Mary, that we need to be very mindful of. Up until now, you could fully get away with having all of your money in equities, assuming you're comfortable with it. And those ups and downs, they don't bother you because you just keep putting money in. But now, those ups and downs, it's not just a thing that's going to bother you emotionally, it's a thing that could ruin you financially. So we need to engineer a portfolio to make sure that we are protecting against those downturns while still giving you the growth potential needed to keep up with inflation over time. So the next question becomes how do we do that? How can we capture the growth of the market over time, but also insulate ourselves against the downside of the market? Well, to do that, we need to understand how the market works. No, we can't predict what exactly it's going to do going forward, but we do have a huge amount of data of how it's performed in the past. And if we look at all past major downturns, if we look at bear markets, which is defined as the stock market going down in value 20% or more from its previous all-time high, those bear markets happen on average one every four or five years or so. And when those bear markets happen, it takes, on average, about two and a half years for the market to fully recover. So if the market hits its high point, then it drops 20% or more from the high point and then gets back to that previous high point. So from peak to trough to peak again, that takes about two and a half years. Sometimes shorter, sometimes longer. Sometimes it's as long as about five years or so in very extreme cases. So what does that tell us, Mary? It tells us we need to have something that's not subject to those market ups and downs that is gonna give us the income we need to last for at least five years so that we can say, yes, the market's gonna go down. We know it's gonna go down. But do we have some dry powder? Do we have something set aside that's yes, still in your portfolio? But that's the money we can draw from. Now, the trade-off is this the money that we put there, it's not gonna grow nearly as much as your growth portfolio will over time, as stocks will grow over time. But that's not its purpose. The purpose here is to provide stability, and we will gladly trade off upside return potential for the protection that's gonna get us. Think of your portfolio as like a castle, or think of the growth portion of your portfolio like a castle. The portion that we're gonna put in bonds is almost like the moat around that castle. That castle is not very good if there's nothing to protect it. This is the thing that's gonna protect it so that your castle can keep growing and keep providing for you even as the markets go up and down in retirement. So that five years of reserves that we're gonna put into something outside the market, we're gonna call that your root reserves. That is the money that, yes, it will go up and down a little bit, but the downside on that portion of your portfolio is gonna be significantly higher than the downside on the equity portion, the stock portion of your portfolio. Okay, tracking so far. So that's what we need to have. We need to have high level, enough money in stocks and enough money in bonds. So, what does that mean? We have five years in bonds. Does that mean five times 100,000, like you said, James, because you walked through that hypothetical example of being able to spend$100,000 a year? No. What we need five years of isn't your spending, it's the portion of your spending that needs to come from your portfolio. So let's look at this deeper for you, Mary. So you want to spend$6,000 per year in retirement. We know that the first two years, and by the way, talking to you as advisors, this is where we'd actually reference back to write capital. So we're not just articulating numbers because typically these numbers are going to be ebbing and flowing or they're gonna be changing as income sources change, expenses change, tax brackets change, et cetera. So this is where I'd actually go to write capital to walk through exactly how we've modeled this out, but I'm just talking to Mary in a very basic example here. So, Mary, for you, you want to spend$6,000 per month. That's$72,000 per year. Well, for your first year of retirement, in your second year of retirement, that full$72,000 per year needs to come entirely from your portfolio. You don't have Social Security that's coming in yet. You don't have the other income source that's going to alleviate some of the pressure in your portfolio. So the full amount has to come from your 401k, from your portfolio. But what happens in year three, in year four, in year five, and beyond? Well, what happens in those years is Social Security has kicked in. And when Social Security kicks in, the amount that you are going to spend is gonna stay the same. You're gonna continue to get your$6,000 per month adjusted for inflation, of course, but the makeup of that income is going to change. Now, 3,000 of that is gonna come from Social Security, and the remaining 3,000 will come from your portfolio. So what I'm gonna do as your advisor is I'm gonna understand that, Mary, to get growth over the course of your retirement to keep up with inflation, because inflation is not gonna stop. We need as much of your portfolio as is reasonably possible in the equity portion and the growth portion of your portfolio. But we need enough such that if you retire today and we get hit with a horrible bear market today and it takes five full years to recover, I need to make sure that you're not gonna be depending upon the stock portion of your portfolio to live on as that's happening. So I'm gonna add up how much you need, not in total, but just from your portfolio for those first five years. And Mary, I already did the math. The math is about$250,000. Meaning if you had$250,000, and let's just call it bonds, you could pull out$72,000 the first year,$72,000 the second year,$36,000 the following year,$36,000 the fourth year, and$36,000 the fifth year. Yes, I know inflation is gonna be going up, but so too is the value of those bonds. So let's just call that a wash for the time being. And by doing this, what we have done is we have set you up to say that even if you're the unluckiest retiree and you retire right into a horrible bear market, we're not gonna love that, but it's not gonna force us to sell our great growth investments, our great stock investments. We've insulated you from that by having this very intentional portion in root reserves. So again, you need about$250,000 in bonds to be able to do that. So, Mary, working backwards, what that tells me is we need to allocate or we need to engineer a portfolio. It's about 75% stocks and 25% bonds for you to be best positioned to meet your retirement goals. Now I'm just saying stocks, I'm just saying bonds to use those as high-level categories. Within the bond allocation, within the root reserves, we're gonna have a very intentional bond ladder. A very, very short-term, very, very high quality, the safest possible bonds in one fund that would give you the money you need in that year one. Then something that's maybe a little bit longer duration, then a little bit longer duration, then a little bit longer duration to ladder that out. Now, going back to talking to advisors here, read your client. If your client's pretty savvy, it might make some sense to go into the details here of how that bond ladder approach is going to work out and why it benefits them. If your client isn't or doesn't care to know this, just keep it very high level of growth bucket and stable bucket, growth bucket and root reserves, and that should fully get the point across. But going back to talking to Mary, so Mary, that's what your bond portfolio is gonna look like. There's actually gonna be different funds within that bond portfolio that give us the freedom and the flexibility to even be intentional within your root reserve allocation of where money is gonna come from. Now, same goes for your stocks. Within your stock allocation, we're not just gonna dump all this into the S P 500. We're gonna have a very intentional and diversified allocation to many different types of stocks. Because once again, just because stocks are going up doesn't mean all stocks are going up. You might have small companies performing better than large companies. You might have growth companies performing better than value companies, you might have emerging market companies performing better than domestic companies. Whatever's performing best, we need to ensure that we have it and we will have it. That's why we're gonna split your stock portfolio up into these various different funds. So it's not even just blindly pulling from the growth bucket, it's pulling from the best performer within the growth bucket. So, Mary, that's how we're gonna allocate your portfolio today. And by the way, this is gonna change. I can just tell you, fast forward two years, you're now collecting Social Security, your portfolio has actually grown a little bit. What's happened is you have a bigger portfolio base. I'm just making this as an assumption to illustrate a point here, and you have a lesser need from your portfolio. What does that mean in practice? Well, in practice, it means that we no longer need a full 25% to your root reserve allocation. We can, assuming the market's done well and you haven't had to draw down your root reserve allocation, we can start to fold some of that back into your growth allocation, depending upon what your needs and your goals are at that time. So this is just an example of how your allocation might be dynamic and it might shift throughout your retirement years, as opposed to you walking into my office, filling out a risk tolerance questionnaire that you have no idea how to answer, and then me slapping you with a 60-40 portfolio because that's what most retirees do. That's not the approach that's going to get you from where you are to where you want to be to accomplish the goals that you shared with me. This approach, one that's based very intentionally, both on science and research of how do markets actually work, how long do downturns work, what's the right allocation to have optionality when it comes to drawing down your portfolio, combined with your specific financial planning needs, your specific cash flow needs, as we understand fully where income is gonna come from between Social Security, between portfolio, between any other income sources you might have. So, Mary, the final thing I want to tell you here before we wrap up and start to implement this portfolio for you is some things are still gonna be the same, but some things are gonna be different. So, what's gonna be the same? Markets are absolutely still gonna go up and go down. Let's not assume that just because we had this conversation, we know how markets work, that that's in any way gonna change the actual behavior of markets. That's number one. Number two, with that, your portfolio will absolutely keep going up and going down, maybe not to the same extremes as the S P 500 or an all-equity portfolio, but it absolutely still will. And I want to tell you that ahead of time. Don't be caught off guard when you see this portfolio drop 20%, 30% in some really bad years in the market. However, here's what's not gonna be the same. What's not gonna be the same is we're no longer gonna treat your portfolio as one thing that's all going up or all going down. You might see your statement and think, okay, this is just one value. My million dollars turned to 1.3 million, or my million dollars turned to 700,000. That's all you're gonna see. But what's gonna be different on my end is I'm gonna see how the different components of your portfolio are performing. Let's use that example. If your portfolio is down to$700,000, I'm not seeing one portfolio down to$700,000. I'm seeing a growth allocation that if your overall portfolio is down 30, man, your growth allocation, Mary, it might be down 40%, 45%. But sitting right next to your growth allocation is your root reserves allocation. And that's doing exactly what we need it to do. Now it might be down a little bit, it might be stable, it might actually be up a little bit. There's no way to predict with perfect certainty. But it's not gonna be down to the same extent, and that's where we're gonna draw your income from. So what's gonna be different is as you're seeing the portfolio go up and down, you're not gonna need to worry about where do I pull income from? Is this sequence of return risk that everyone's talking about, is that happening to me right now? What's gonna be different is because we engineered this ahead of time for you, you can keep traveling, you can keep spending, you can keep living your life in your retirement years, even as the market is falling, because we have this intentional allocation for you. Now, there may be a need to adjust, whether it's spending or your portfolio, we'll have that conversation with you. So you don't have to worry about is this something I should be doing? We're all over it. But that's the way we're gonna design your portfolio, and this is how your portfolio isn't just a standalone asset, it's something that's deeply connected to your financial strategy, to your cash flow strategy, to everything else you want to do in your retirement years. So that's how I'd frame the conversation to Mary. I'm putting my financial advisor hat back on. Now, Jed, you mentioned a whole bunch of questions, and a whole bunch of those questions are really good questions. Here's what I'd encourage you to do, though. Even right now, I'm tempted to go into some of those other questions and have them or have a discussion about them right now. But when your client is coming to you, even if those questions you ask me are all points that you want to go through, split it up. Make sure that one meeting ideally is focused on one core theme. And my core theme with marrying this meeting would be exactly what we're talking about. Now, I might be thinking, okay, this is the right allocation, but going back to Jed's other question, he asked, where do you personally draw the line between encouraging a client to take on more risk, if they clearly have the financial capacity to do so, and respecting their emotional bias towards safety, even when their preference doesn't have much logical support. Now, I can say that totally ties in to this conversation I just had with Mary. But let the main thing be the main thing with Mary, at least for this conversation. Have the conversation. You might even know, hey, there's three or four or five follow-up things I want to talk about with Mary because of this. Don't overwhelm, though. Do not put too much on a client at one time. This is how meetings start going really long. This is how the things that you say that you've planned for, you've prepped, they start to be lost on a client because you're trying to cram too much into one single meeting. Someone once told me, this is maybe unrelated, but it for whatever reason is connecting with me as we're talking about this, that when you record a movie and you go to see a movie in theaters or you watch on Netflix, it might be two hours. But there are dozens of hours of film and footage. It's actually being captured. And so when the producer or the director or whoever's in charge of all this is capturing all this, they're capturing a massive amount of footage. And as they're walking through that or they're viewing through that, working through all that, every single scene that doesn't directly tie back to the core message or the core theme of the storyline, it gets ruthlessly cut. And I got to imagine that can be very hard for a director, very hard for a producer, very hard for whoever's actually calling those shots, because they see how good that scene is. They see how helpful that scene can be. They see how cool that scene was, but they got to relentlessly cut, cut, cut, take those many, many, many hours of footage recorded and translate that into a two-hour film. Take that same principle to the way you approach meetings with clients. Jed has some really good questions here. And I'm not even assuming that Jed wants to go over every single one of these things with every client in every meeting. But think about this. What's the movie I'm trying to tell? What's the story I'm trying to tell here? How can I connect this? And all these other really great things, all these other really great questions. I absolutely want to tell the client that. But should that maybe be another movie? Let them see the first movie first before the sequel comes out, before the next part of the conversation comes up, so that they can see it, they can hear it, they can fully absorb it before you start to take this into a different direction. So maybe I should have cut that portion out of this podcast. Who knows? But that felt like something relevant to say that as you're delivering this message to clients, and this isn't just about investments, this is about all messages you want to deliver to clients. Try to keep it super simple and fully focused on what is the single most important takeaway I want my client to walk away with. It's a lot of extra work for you because it's actually easier just to brain dump everything and say, I checked the box, I went over everything. The harder part is understanding how do you most effectively deliver this message. And sometimes that's understanding what not to say, or at least when to move different parts of the conversation into different meetings. So that is it for today's episode. Thank you everyone for listening. If you're enjoying this podcast and you haven't done so already, would really, really appreciate it if you left a review on Apple Podcasts, on Spotify. Subscribe on YouTube if you don't already. It's the Root Ready Podcast. But thank you for listening, and I'll see you next time.