Transcript
Paul Winkler: And welcome to the Investor Coaching Show, Paul Winkler talking about the world of money and investing.
What Makes a Good Investor?
So one of the things I want to talk about today on the show regarding investigating, you know, I find that a lot of people get their 401(k)s at work. And what they do is they believe that there is so much thought that goes into the management of a 401(k) at work. You know, that there’s so much thought that goes into the selection of investments and, and it’s, you know, so it’s a process that isn’t necessarily nearly as analytical as you might think it is. And people don’t trust their employer.
You know, I work for these people and I know these people that manage it and they seem pretty smart and they seem to know what they’re doing. And, and you know, what you’ll find is one of the things I’ll talk about today is a lot of times people think that they know actually more than they do and research is bearing that out. There’s actually an interesting study that I’ll talk about today. And it is, it’s pretty stark how people do on retirement planning tests, how the general public does. And it’s not just women, it’s men and women. It is not gender specific. It’s both, you know, cause some people think, well, you know, it’s just, just women don’t know anything about, you know, which is very sexist. Obviously there are a lot of people that, you know, I have people that come in and, and women will come in and go, my husband doesn’t care anything about this stuff, you know?
So you have it both ways, but you find actually, but a lot of times men, it’s the bravado, you know, I’ve got this type of thing and you find it actually that neither sex actually has it down is really what it gets down to. But we often think, you know, that we know more than we do and, and I’ll get into why that is. There’s a really interesting bit of research as to why that’s the case. But there was one article that I saw in the Wall Street Journal that caught my attention. It was, “The story behind the market’s hottest funds” was the title of the article.
I was fighting a lot of stuff, you know, as far as what the academic research said versus what I was seeing people do and what I was seeing the investment industry do. And quite frankly, I was kind of concerned about coming out and starting a radio show on this topic because I thought, well, you know, your scarcity mentality, kids. If I become too public about what I know, you know, all this academic research that I’ve been engaging in and people that I’ve been studying under the university of Chicago, Yale university at the time, Dartmouth university, if I become too public about this stuff, then the investment industry is going to eat my lunch because they’re way bigger than me. I’m little old Paul Winkler from Goodlettsville.
But one of the things that are found is that over the years, the industry has gotten worse. They haven’t gotten better. And what has happened is they’ve just kind of changed their stripes as to what they’re doing. They’re not doing the same dumb things that they did 20 years ago. They’ve just changed the dumb things their way and what well, what they used to do well, what they used to do all the time. And they still do to a great extent is buy individual stocks, you know, stock pick and go and figure out which companies are better than others.
And, and, you know, they would actually market time, you know, try to get in and you know, when to get in, when to get out in the market and, and there were blatant about it, that that’s what they were doing. Now, the market timing has just changed more to what’s called tactical asset allocation, and that they’re doing the same market timing. They’ve just changed the way they’re doing it. And, you know, market timing is purely cash. And I think the stock market’s going to go down, you know, cause so I’m going to stay in cash. And then when it does go down, then I’m going to buy. And then, you know, when I think the market’s gonna go down again, I’m going to sell my stocks by cash again, you know, so you go back and forth and that’s just blatant market timing. And we know that it just doesn’t work.
You know, pension studies have been done where they analyze these really well-educated, well-informed investors. And they find that not one of them increased returns as a result of their activities doing that. Now they didn’t increase the returns as a result of doing tactical asset allocation either, which is its cousin, which is, you know, I think that small companies are going to do better and next year, and you’re hearing this stuff now, right. You know, you’ve heard people say, well, you know, we’ve had a, you know, we’ve had a rotation into value and we’ve had a rotation into small and, and you know, it sounds really sophisticated. And, and the thing is, that rotation, yeah so it was two months ago.
The Industry Hasn’t Changed
So you go back and go, well, gee, you know, I think I’m going to go do this now. Well, you know, it may continue, but the reality of it is you missed a lot. If you weren’t already diversified over the past two months, if you didn’t already have, you know, follow what I’ve been talking about forever. I didn’t know when it was going to happen. Either I had a client about before I got on the show, just, you know, emailed me and said, “Hey Paul, thank you so much. And I was just laughing, going well, you know, I didn’t know when it was going to happen. I just knew that it could and would eventually happen because historically this is the way markets work. So, you know, you don’t know how to determine the timing of things, but that was what the industry and what the industry still is engaged in.
And then the third one is trying to choose investments based on past performance, you’re looking at track record, you know, has happened, you know, with which investments over the past 6 months, 12 months, 3 years, 5 years. And people will go look at 10 years and they think that that’s it, it’s an eternity 10 years. And I’m like, no, it’s not, it’s not much time at all. Actually you can have, you know, technology stocks just knock it out of the park for 10 years or you can have international stocks and knock it out of the park for 10 years. That doesn’t mean what’s going to do well, going forward and international small value stocks, you know, beat everything else for 10 years. That didn’t mean that they were going to continue and they didn’t continue.
Index Funds and ETFs
You just don’t know when the streak is going to end. So, so when I get to talking about how investors used to love story stocks, and that’s what he’s talking about, you know, companies that have a story behind them, wow, this company is really, really good. They have great products. They have things that they’re doing really, really well. And he says, now what they love is ETFs. People are falling in love with index funds and ETFs. And they’re thinking, wow, this is really great. It’s really low cost. And they go on and, and they see these commercials about really, really cheap ETFs. And they see articles in magazines and publications about how cheap they are. And I’ve been talking about this for quite a while. You know, you’re not necessarily catching the whole story guys.
And I love it that he’s done an article saying exactly that with data. Now it says a story stock is driven by not only earnings or assets, but by a simple alluring narrative, a dynamic new boss, you know, dazzling technology or customers going gaga for its products. Wow. This is a really great car. It’s a great battery. I love the technology in this.
ETF is an exchange traded fund that invests not in the entire market or a single sector, but in a concept or a trend. And you know, these, these to me, these ETFs are an issue, but there’s way more to the story here. How come a story ETFs, they’re talking about ETFs that are investing in specific areas of the marketer or stories or something that maybe is really exciting, like cloud computing or, or alternative energy, or maybe, you know, there’s, you know, government’s funds now as this is really a hot thing right now is, is what’s going on. But yeah, here’s the thing.
Yeah. This is way more in-depth than this. If you look at total market funds that are, and to invest in the entire market, and this is what you see in 401(k) this is, it goes back to that. You know, you think that your employer really has everything down and you may not necessarily know that the employer doesn’t have everything down and they don’t have the best investment choices. And the reason is they don’t necessarily have to because a lot, you know, all these different employers out there, if they’re all similar, their safety numbers, it’s like, I use the example. If you’re going down I-65 and you’re going 70 miles per hour, and you’re, you’re getting these cars whizzing by you going 80 miles per hour.
And you sit in there calling your 75 and you’re going, Oh, I’m going the speed limit here. What is what gives? But you have so many of them going faster than you, 5 miles, 10 miles per hour, faster than you and the likelihood of them getting pulled over somewhere near slim or none, because they’re all doing it. There’s safety in numbers. Everybody’s doing it to an extent. And you know, the reality of it is, is that you’re, you’re not going to pull everybody over, but you know, you know, I’ve heard funny stories of that happening where, you know, one person gets pulled over and, and you know, it’s like everybody who’s doing it. Well, you know what, it’s your lucky day. I got you. But you know, in reality, what we, what do we normally say, not that, right?
So if we look at this and we say, okay, so what’s going on with these total market funds, which are very, very, you see them all the time in 401(k)s now, like Vanguard is targeting retirement plans. That’s all they are is just total market funds, their total international total us total bond market. And you go, well, what is going on there while they’re waiting for it based on the size of companies, we call it cap weighting. You’ve probably heard me talk about that before. If you’ve heard this show before. So they overweight the bigger companies, you know? So if you have a two stock index, just to give you a simple example, it only has a mutual fund or an ETF with only two stocks. Let’s say, let’s keep this really simple. And one is a $3 billion company.
One’s a $1 billion company. One is 3 times the size of the other one. They’re going to put 3 times as much money in the fund or in the company stock. That is 3 times bigger because that’s the way it works. That’s cap weighting, capitalization weighting. Now, if you look at the S&P 500 and you go, well, what’s going on there right now? Well, there’s a story. And this story is called Covid, you know, last year, if you look at the S&P last year, it was up 18 and it was 18, some odd percent, just a little bit over 18% last year. But if you take out, you know, Facebook, Apple, Netflix, Google, Amazon, and Microsoft, and just six companies, it’s only up 3% and you go, well, wait a minute.
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Don’t Base Investing Decisions on “Good” Past Performance
Now there’s a story right there, but you wouldn’t call that a story ETF where he wouldn’t have called that a story ETF. I would, I would say, there’s a story right there. And this story is COVID drove those companies, which were more technology-oriented companies to benefit during last year’s environment. And you look at that and go, well, people get really, really bad when you buy these technologies or, you know, cloud computing or 3D printing or whatever these companies do. And, you know, you think, well, you know, yeah, that’s bad. I shouldn’t do that. But if you look at just the general market, you’re seeing the same thing going on. People don’t realize how much risk they actually have.
It’s significant. These funds kind of crossed industries, trying to capitalize on ideas like alternative energy cloud computing, 3D printing. Like I was talking about others, buy stocks that could benefit more. As people work from home, you know, demand, gender or racial diversity, or lavish money on their pets or something like that. And you know, you see these, see these things out there, assets, and these funds have grown on average 45% annually for the past three years, 45% per year. Over the past three years, he says, that’s, that’s just staggering. In the fourth quarter of 2020 alone, thematic ETF assets shot up 78%.
And you know, what they’re looking at is going to all be based on the IRS and what’s going on, you know, what should we be investing in? Now? He says, one reason is performance. And he’s talking about a fund that had good performance. And I would submit no, that’s not one reason. It is the reason. Now, if you look, imagine, and I’ll give you an example, just so you can see why I say that. Imagine that you had a fund that invested in space travel, and we thought that space travel was the future. Let’s say, Oh, that’s yeah, that’s going to be, everybody’s going to be flying in the moon and back. And they’re going to be going around the earth and checking out what it looks like from way up there. And, and, and so on and so forth.
If you looked at this mutual fonder, this ETF and saw that it lost 50% over the last year, my bet is that you would put nothing in it. So I would submit that performance, recent performance is the only thing that really people are looking at. And then they go, Oh yeah, it’s, this is a really hot industry. And then what they do is they look at the performance and they go, why did this perform so well? Oh, it was in 3D printing. Oh yeah, yeah. That’s, that is the future. And then they invest in it. So that’s, that’s the emotion and the instincts of people playing out in the investing process. So in 2020, the investors stuck at home trends hit home. He says, people now understand themes like cloud computing, collaborative software in ways they may not have appreciated before blah, blah, blah.
All of a sudden, you know, it’s like we’re here. And it was like, invest in what you know, now that right there, I think is one of the worst pieces of advice that I hear consistently. You know, they, they talked about, well, that came from Warren buffet. That was his advice, invest in what you know, but you gotta realize he would buy companies that he knew, and he would help them fix things is a whole different story. When Warren was involved, he’d get in there and he, and he would go, well, what’s wrong with this company? I know this industry, like the back of my hand, Oh, these guys are in, in value or they’re distressed is what he would do.
And the reality is that the funds that are really popular, these ETFs are anything but distressed. They’re not valued in the least way. Fact cloud computing. I just pulled up, you know, the, a big fund that does cloud computing, investing in ETF and wisdom tree, you know, the, the historic average PE ratio price that you pay for every dollar of earnings in the S&P 500 is $16. This thing is selling for $115.
The PTB, which is, you know, the price book for the S$P 500 is like 2.4 historically. And that’s a bit high. Now. It’s like a little bit over three, but this thing is 12.2. You talk about, you know, just nothing, something that’s not selling Frank out of a bargain by any stretch of the imagination. So he says investing in only a slice of the market instead of the entire market lowers your diversification raises your risk management fee is, can be at least 10 times higher than ETFs that track the market as a whole. But I’ve already talked about why markets funds that track the market as a whole. Aren’t just another story that’s similar. So I’ll skip that for now. If the theme feels intuitively to you, he says, chances are millions of other investors are finding it appealing as well, making the fund’s underlying holdings more expensive.
As I just pointed out, this is finally a new study by several finance experts. Professors find that on average, such ETFs hold only about one quarter as many stocks as broad-based funds. Looking at more than a thousand ETFs of all types between 1993 and 2019 researchers found that thematic funds underperformed the overall stock market by 0.5% per month adjusted risk. So you look at returns adjusted for risk, you know, so I don’t want to take, I don’t want to take risks that I’m not getting paid for is really what we’re talking about here. From an academic standpoint, I don’t want to go invest in something that is risky with no additional expected return.
Individual Stocks Assume Lots of Risk
That’s the problem with investing in individual stocks. You’re taking lots of risks, but there’s no additional expected return for holding single companies. That company doesn’t want to pay you any more to use your money. And they have to, that’s the reality of things, you know, so if I buy the stock in and go, wow, you know, I really like this company, realize your expected rate of return is no greater than the broad market, because that company in the lower pay you anymore to use your money. But anyway, so if we look at this and we say, Oh, 0.5%, Oh, that’s nothing 0.5%. That’s per month. If you take these numbers and you say, well, what does that really mean? Well, if you put $10,000 and you’ve got a 30-year time horizon, that $10,000, if you had a 1% return per month would be about $360,000.
But if you lop off a half percent per month, now you’re down to $50,000 or $60,000. So basically one sixth, the amount of money, one sixth, the amount of money, well done, really, really great. And you go, wow, that is a huge difference while people believe, you know, they get into these things. And they really think that this is a great story. And it’s going to give me more return because of what this company is likely to do. Nothing could be further from the truth. The reality is we have just basically seen a move from making mistakes, stock picking market timing, and using past performance to a different type of market timing, and really engaging in something that’s very similar to stock picking is picking industries, entire industries instead of individual stocks and doing it based on past performance.
If you see any changes there, please tell me what they are. Cause I don’t see any difference in what we have. You have done forever, same mistakes, different days.
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