Paul Winkler: Welcome to “The Investor Coaching Show.” I’m Paul Winkler, talking about the world of money and investing.
The Indexing Approach to Investing
So one of the things I have to just be aware of because sometimes I forget this is that sometimes there are people that just aren’t really familiar with what we teach here. I guess I’ve just been hearing this conversation around the station this week and talking to people and talking to some of the guys that are on the station, Matt and Chris, and Dan — every once in a while talking to him and getting into conversations about this.
I forget how much people don’t know about stock markets and the questions that come up, I go, “Whoa, wait a minute. Maybe I need to revisit some of this stuff every once in a while.” And the thing that we think of with investing is I’ll just go and put money in my 401k and everything will just magically work out.
Markets are going to do what they do — they go up and they go down. But what we often don’t think about is how we typically approach this or how the investment managers are approaching this. Now, with an investment manager, let’s say you have a mutual fund.
Now, some of them will do an indexing approach. We’re increasingly seeing more of that, where you’re finding a fund that will just buy into an index like the S&P 500.
You got the 500 biggest companies — they’re going to put most of the money in the very, very biggest of companies.
And that will be because it’s just really easy. It’s cheap, it’s an inexpensive way of doing things.
And a lot of fun companies are marketing as cheap. And quite frankly, when it comes to a 401k and you have a fiduciary responsibility, one of the responsibilities is to keep expenses low, which is, yeah, we ought to keep expenses low.
But what happens is in order to just keep under the radar and not be accused of charging too much, sometimes they’ll just do that — they’ll just use indexes, and you’re over-weighting the very big companies because it’s less expensive to do that. And then what ends up happening is you end up with underperformance because where do we expect more returns? Smaller companies, because smaller companies can become big, and big companies, well, they’re already big, so you don’t have as much of an opportunity to grow.
And the thing is that investors end up at the end of their investing cycle, whether it be 30, 40, 50 years, and they end up with a whole lot less money than they should if they have actually not paid attention to this. And then, well, they don’t know it because they don’t know what should have happened. Older investors who want to control risk think that there’s less risk in big companies, so it doesn’t bother them.
Tactical Asset Allocation
What they don’t recognize is that the academic research shows that when you combine companies of different sizes, that’s how you can reduce the level of risk in the portfolio because they don’t move with each other. You have value companies, like in years where markets drop a lot, and I use the example of 2000 and 2001 as a really good example, value companies actually went up, but most people didn’t own them. Hardly anybody owned them because of the fact that most of what had been doing so well in the previous five years — ’95, ’96, ’97 ’98, ’99 — had been the growth companies, and those are the companies everybody was talking about.
If you just ask people, “Hey, give me a stock that you might invest in,” 9 times out of 10, they’re going to give you a growth company. And what happened with investors in downturns throughout history, and I just use that one example, but you look at a lot of downturns throughout history and you see that small companies, maybe value companies, other companies didn’t go down when the S&P 500 took a big dive or didn’t go down as much.
So what happens when we don’t own a lot of these market segments is we end up with more risk.
So with investors in 401Ks, let’s say we’re using those target date funds with index funds inside of them or the portfolios being put together by a robotic portfolio designer or whatever — robo portfolios — then what happens is we end up overly concentrated in those bigger companies and we don’t know until it hits us when the bottom falls out and then it’s too late to fix it by then.
So number one, they might be using indexing; that could be a problem. What I see quite often is that they’ll use active buying and selling of stocks inside of portfolios, and people don’t even realize it’s happening because they don’t know to look at the turnover ratios. They don’t know to look at whether tactical asset allocation is being used.
They don’t even know what to look for. And again, one of those things is that you may be not losing money but having relative losses, and it’s not until it’s too late that you figure out that that happened.
Young Investors
Well, the other thing that we see with younger investors is they may be investing in market segments that make no sense whatsoever, and they buy commodities or things that they think are investments because their friends are talking about these things as being investments, and then they’re playing the market based on emotions.
They get in when they think things look good or if they feel optimistic, and then they get scared when they think things don’t look so good.
And older investors do this too. I mean, we see this all the time.
Boy, should I be doing this right now? I hear this in the news. This is getting me nervous.
And the reality is so much of our self-talk is what drives us crazy. Oh, I think things are looking really, really bad right now, and then all of a sudden, we start to ruminate on it.
I was talking with somebody this week about the word rumination and where it comes from. It’s where we think about things. We think about them, we think about them, we think about them, and then they really, really just drive us crazy.
Well, it’s a cow chewing food over and over and over again. That’s where the word comes from. Chewing and chewing and chewing and chewing. It’s like we chew on our thoughts all day long and then we go and act on them because your thoughts and your actions tend to be related.
I think about something for a long period of time, then I act on it, and then all of a sudden, I make a mistake and then I go, “Oh, what have I done?” But then by then, it’s too late, right?
Well, this caught my attention because this week there was an article. Oh, man, I’m not even sure where this article showed up. I saw it because it’s one of those things that pops up in your list of things. Fortune Magazine.
Yeah, it was Fortune, now that I think about it, but it was Warren Buffett saying, “The stock market is increasingly casino-like.” He said, “And young investors need to remember this one fact of financial life to avoid this mess.”
The Dunning-Kruger Effect Versus The Real Deal
I know this is really good. Warren Buffett, CEO of Berkshire Hathaway — talk about a guy that is lauded as being a successful investor. He’s it. He’s the poster child.
He was a value investor, who basically bought companies that were in trouble, turned them around, and got on their board as directors. We like to point out that he actually cheated a little bit because he got on the board of directors. He could turn companies around because he was a very, very good business person as well.
So anyway, Warren Buffett has often talked about how he’s getting up there in age, and you look at somebody like that and you go, “There is a guy that’s been there, done that, and he got the T-shirt, maybe we ought to listen to what he has to say.”
Isn’t it so often that we don’t listen to people with wisdom and we listen to our peers? Young people, and if you’re a younger person, you listen to your friends and you go, “Wow, my friend says this.”
And you go, “He sounds so smart and he sounds so educated,” but he may not know much of anything. It’s the Dunning-Kruger effect, which is literally people that have enough knowledge to be dangerous can fool even seasoned professionals because they are so confident with their information and they’re so confident with their knowledge.
And there’s a psychological concept, a Dunning-Kruger effect that actually shows that people tend to do that. They tend to think that they’ve got it all together and then they go out and do things until they don’t have it all together and they figure out that they don’t have it together. That’s when all of a sudden everything falls apart.
Well, Warren Buffett’s one of those guys who’s been there, done that, got the T-shirt. He’s not Dunning-Kruger. He is the real deal.
He knows his stuff. What he talks about here, he was doing a little bit of a tribute to his old right-hand man, Charlie Munger, because Charlie was a hoot.
I mean, he was one of these guys who was just wisdom seeping out of every pore as well. And he had this annual shareholder letter that he did, and then people would flock to read this thing and go, “What does he have to say?”
So often what people do is they flock to this newsletter hoping that they’re going to get some stock tip or to find out what’s going to happen in the market. “I want the Oracle of Omaha to tell me what’s going to happen in the market.”
And yet, what he does time and time again is he tells you, “Don’t do that. Don’t pay attention to that.”
The Stock Market and Casinos
And so it says, the Oracle of Omaha, lauded Munger as the architect of Berkshire’s success, eulogizing the abominable no man, by discussing some of his favorite whipping posts, including the comparison of the modern stock market to a casino. Now, he’s not the only one who has done this.
For many, many years, it was like John Bogle was comparing it to these people running casinos. He would use the croupier and he said they’re playing it.
They don’t care if you win or lose, just that you keep playing. That’s the idea behind it.
And that’s how people approach investing, and they don’t recognize that that’s the way their investment advisor is approaching investing. I was looking at somebody’s ADV, which is a disclosure document from another company in town, and they must have had 20 different investment managers.
I’m like, “Oh, wait a minute. Why don’t you guys just choose one of those investment managers, because you have, inside of the investment managers, you have dozens and dozens and dozens of investments that they’re managing and they’re choosing? Why would you have 20 different managers that have different opinions about what’s going to happen in the stock market?
“Why don’t you just choose the one that’s going to be really, really good? Wouldn’t that make a lot of sense?” Yeah, I think maybe it would make a lot of sense, but that’s not necessarily how Wall Street works. You get one of those 20 investment companies that do well versus the others, and then you start marketing.
“Hey, these guys are really good. Look at the past five years. Look what they did. And you need to put your money with them because look at how smart they are.”
That’s why you have mutual fund companies with 1200, 1300, 1400 different mutual funds because one of those funds or a handful of those funds are going to really do well. And then you could say, these people are really, really skilled. That is the game that the investment industry is playing.
So he said, “They’re playing it like a casino.” He said, “For whatever reasons, markets now exhibit far more casino-like behavior than they did when I was young.”
Emotions Driving Investing Decisions
Buffett wrote, “Though the stock market is massively larger than it was in our earlier years, today’s active participants are neither more emotionally stable nor better taught than I was when I was in school.”
And that’s it. This is what I’ve been talking about forever here on this show.
Our emotions are driving the ship. If I feel good, I feel euphoric, I feel excited, I’m going to buy.
I’m going to go out there and I’m going to feel really confident about what I’m buying, what I’m doing. If I’m buying that cryptocurrency, I feel really confident about this. I got this.
And you hear that with people now: “I got this. You got this.” That term, that little phrase, “you got this.”
Maybe you do and maybe you don’t. But it’s the emotional stability.
Then when I’m not feeling great, that’s when I just have to quit. I can’t do this anymore. I have to pull my money. I have to go do something else.
I’m going to put it on the sidelines. I’m going to leave it in the CD for a little bit longer. I’m going to leave it in a money market. I’m going to put it over in this insurance company because they use the word “guaranteed” in their advertising.
Never mind that the insurance company, whatever calamity that you’re worried about, the insurance company may not survive it. Never mind that they’re using the word “guaranteed,” and that really makes me feel better.
Buffett’s words of caution were definitely a throwback to some of Munger’s favorite lines. Throughout his more than 75-year career, Munger argued that there were two types of people that buy shares of stock in the stock market: investors and speculators. And a lot of people, I’m just going to say, a lot of people don’t know that they’re speculating. They don’t even realize it.
It’s typically one of the first things that we do. We go, “Hey, let’s take a look at what you’re doing right now. Let’s look at how things are being managed.” And we look for signs of speculation.
And the funny thing is, people know the rules of investing. They know, don’t time the market. They know, don’t stock pick. They know that bonds are there for safety.
They know that they should diversify, but they don’t recognize what they’re not doing because they don’t know how to look for it. They don’t know what to look for. He said, “But the speculators are those who seek nothing more than a quick buck without care for the intrinsic value of what they’re buying.”
Well, Munger didn’t really like them very much. And I look back to the GameStop thing. That was the thing that I remember talking to Pamela Furr about one day.
She and I got into a conversation on the radio, and I said, “Here’s what’s going on.” And she was like, “Oh, wow.” And I said, “Yeah.”
It was no underlying look at the earnings of the company or the book value of the company or any of the fundamentals of the company. It was just, “run this baby up and chase after it.” And that worked really well for not very long until it didn’t work well and it came crumbling down.
Gambling With Investments
The thing is, he said that they love gambling. The trouble is it’s like taking heroin. And that is so true. We have this dopamine hit with drugs.
And the funny thing is the dopamine hit, it kicks up the amount in our system, and then each progressive time somebody takes a drug, it takes more and more of the heroin to get the same level of high until you have to take so much of it just to get back to feeling like a normal person. And that’s when you know you’re in trouble.
Well, you don’t know you’re in trouble when it comes to the stock market until, quite often, it’s too late and you don’t have enough years.
Because if you look back at how much the time value of money makes a difference in your accumulations, historically, you look at a person in their 20s, and they start putting away money for retirement.
A tiny, tiny, tiny, tiny fraction of what they have in retirement is due to their contributions. Most of it, if you did this right — hopefully, you’ve got it — most of it is coming from the actual gains that you got.
But if you look at the actual returns that investors get investing in the stock market, it’s so much less than what markets have delivered historically, that they end up at retirement, and most of it’s money that they put there with maybe a little gain, and you see that in the data when you look at what actual investor returns have been. And people don’t recognize that now they’re struggling in retirement because of the way they actually approached investing.
And I’m going to talk more about this in a second. There’s more. I want to continue because Buffett talked about some really interesting digging that they had done into the Securities and Exchange Commission filings, what younger investors actually did, and what they actually looked for. And I’ll do that right after this.
Keeping It Simple Versus Diversifying
So this was an article about Buffett and he was eulogizing Charlie Munger, his long-term partner at Berkshire Hathaway. Now Buffett just had so many good things that I wanted to say in here because I think you can just take a look at somebody that has been around the block, like Warren Buffett.
He has a lot of good things to say. Some of the stuff I disagree with because I think he oversimplifies a little bit, not because he doesn’t know what he’s talking about by any stretch of the imagination, but simply just because so often people need really, really super, super simple, and it can be a little bit of a disservice, especially when you don’t diversify as much as you ought to because you’re trying to keep it super, super simple.
When I talk about investing, I cringe sometimes because I have to say, “Hey, look, when we invest, we might own large growth companies, and then we’re going to look, how do we do that?” Well, investing in the large US S&P 500 — it might be something like that. It’s simple.
But if we’re looking at large value, well, you might have to be looking at not just a value index fund, but you might also be looking at a fund that buys value stocks but doesn’t actively manage.
They don’t stock pick. So the turnover ratio is low.
Then you have to look for companies that are the lowest price to book — lowest 20% — and then make sure that you actually screen for profitability factor. And then you want a small cap fund. The small company stocks don’t need to be capitalization weight, and you have to be really conscious of not having capitalization weighting of the portfolio.
And then internationally, you want to make sure you’re dealing with developed markets, and then with emerging markets, you’re looking for markets with less than four market makers, and it gets complicated, and you go, “Oh, Calgon, take me away.” It’s a lot easier to say, just buy an index fund.
That’s why a Warren Buffet might do something like that, even though he would know that you want to diversify more than that and there are things that you can do to help protect yourself as an investor because you can go 20 years. I mean, we’ve seen it. We just saw a recent 12-year period where there was no return for the S&P 500, and that can be very dangerous as well.
Checking the SEC Filings
But he’s talking here about active management, which is what often people do as the approach that they take to investing their money. And he, like Munger, just feels that people — modern investors — have become too entranced by speculative investing.
He says that they do that rather than digging into the Securities Exchange Commission filings. It happens with too many investors, particularly young investors, when you look at filings for the Securities and Exchange Commission. Like we as an investment firm have to file ADVs with the SEC because we’re a registered investment advisor.
And what we do in our ADV is we specifically state that we do not actively stock pick market time. We believe that markets are efficient. We’re not going to engage in those processes.
And where do we get information? We’re not going to get it from newsletters on tactical asset allocation. We’re not going to get newsletters on bottom-up investing or top-down investing. We’re not going to be looking for information on options and doing anything involving options or those types of contracts.
What we actually stated in there is our philosophy, and it’s going to be based on the prudent investor rule and so on and so forth.
So there’s a lot of information the Securities Exchange Commission has on investment advisors that people never even look at.
I mean, most people say, “Hey, have you checked out their ADV?” And they’re going, “What’s an ADV?” They don’t even know what it is.
And the reality of it is that is there to protect you as an investor. These firms have to put out this information because if they don’t put this information out there, then you have no idea what you’re investing in. And the problem that you run into is that people don’t actually look into it and they think somebody else has done the legwork for them.
“Oh, they’re a really big investment firm. They can’t be doing anything wrong.” No, they can be doing lots of stuff wrong, but just disclosing it. I mean, that is the reality.
I’ve talked to regulators before. They’ve told me that is the reality. It’s a free country. We let people do what they want to do in running their businesses.
We want to protect the investor. But it is buyer beware. I’m telling you. That is what the deal is.
This is Warren Buffett basically saying the same thing here. They don’t even check the Securities and Exchange Commission filings.
The Greater Fool Theory
He said, “Too many investors, particularly young investors, are simply buying stocks that are trendy, hoping someone else will pay more for them in a few months, days, or even hours down the line.”
And that is exactly what I told Pamela that one day she and I were talking. I said, “It’s the Greater Fool theory,” is how I put it.
They’re hoping somebody’s going to pay a little bit higher price for whatever it is.
In that particular case, it was GameStop, and they’re hoping that they’ll pay a higher price than they did, and that’s where returns come from.
Well, that works until it doesn’t. I used the example when I was talking to her. She was hosting the show one day, and she and I got into a conversation about it.
It was the idea of the tulip bulb craze where people kept progressively paying a higher and higher price for tulip bulbs in Holland. And at some point, somebody looked and said, “I’m not paying that much for a tulip bulb.” And then all of a sudden, the game’s up, it’s over.
And that’s exactly what Buffett was saying here. He said, “What or who does Buffett blame for this rising casino-like behavior in the markets? Well, the democratization and gamification of trading is certainly not helping.”
As the billionaire put it, “The casino now resides in many homes and daily temps, the occupants.” That is so right.
Have you ever looked at these stock picking websites, these places where you can go and do trading? Bells and whistles, going off to TV programs. I mean, look at the TV programs on stock picking, bells and buzzers and running around and hitting things and lights flashing all over the place. What is the difference between that and a casino? I don’t know.
And then you’ll have people on the other side, and they’re getting excited about buying in that particular case. But then on the other side, there’s another side of this, and it is the side that scares investors and gets them to do things that are equally bad on the other side.
Forget about buying stocks, hoping somebody will pay a higher price than you. What about the people that are scared into selling things at the absolute worst time? What about them?
What are the news stories out there that scare you? I bet I can guess a bunch of them, and I’ll talk about a few of them right after this.
EPISODE 2
Paul Winkler: All right, I’m back here on “The Investor Coaching Show.” I’m Paul Winkler.
Market Efficiency
You know, it’s a shame. A lot of investors approach investing as kind of a game, and that’s what Warren Buffett is basically saying in his newsletter. He talks a lot about how the gamification of trading is leading to people that are increasing their speculation in the stock market.
And you have an era of connectivity. I mean, literally, it’s so easy. Now, there was Adam Smith, who wrote “The Wealth of Nations.”
“The Wealth of Nations” was a book that was written about, “Hey, how do we set up an economy to really make an economy grow? What can we do?”
And he was big on this idea of market efficiency or the invisible hand. Let people set the proper prices for things. He said that there were two things that were needed to make markets even more efficient: ease of information and ease of transaction.
So you’re an investor. You’re going out there and going, “I’m thinking about putting my money some place,” or “I’m thinking about taking money out of something.” Remember that, especially when you’re talking about publicly traded markets.
Now, if we get into private markets, that gets really weird, and I’m not going to get into that right now — into privately-traded securities. But publicly, if you’re looking at a mutual fund or you’re looking in an ETF or something like that, typically, that’s what you’re dealing with, is that.
And when we think about buying it, the wonder of it is that I can buy something, buy a stock, or buy an ETF, buy a mutual fund that holds different stocks inside of it, because a mutual fund might be a collection of stocks. Might be bonds too, but we’re talking about stock funds here, let’s say.
And those stocks are traded all the time. In other words, buyers and sellers come together to determine what’s a fair price for XYZ company, and the beauty of it is I don’t have to worry about whether I’m paying too much or too little.
Now, can it be a situation where you end up paying too much? Yeah, there might be news that comes out that says, “In hindsight, that was too much.” But that’s it.
That’s the idea of market efficiency — that we don’t know, except for in hindsight, that the price was wrong.
So when I buy, I can just relax and go, “I’m paying a price that’s proper, based on everything that is knowable and predictable.”
And that’s what Adam Smith said back in the 1700s. He said, “The invisible hand sets prices, and that can make an economy grow at a better rate than any other type of a controlled system.”
The Wisdom of Crowds
And let’s talk about a controlled system. You talk about socialism and communism.
The idea was that we could take somebody that’s really, really smart, or a group of people that are really smart, that know more than other people, and they would set prices. And they could control an economy that actually grows at a faster pace than anything else. That was the idea.
So if we look at that, the problem is that you have a person that may be really smart, but they don’t necessarily know everything. There’s a lot of stuff they don’t know. They don’t know everybody’s tastes. They don’t know news that’s coming down the road.
They don’t know when some crazy people are going to fly into a building. They don’t know when a war is going to start. They don’t know when a currency is going to collapse. They don’t know when somebody’s going to shoot off a nuclear missile or whatever.
And hence, they can’t really know what’s going to happen, and they can’t really know whether security is at a proper price. So it’s really the collective wisdom of everybody.
As a matter of fact, there’s a great book called “The Wisdom of Crowds” that talks about this and talks about how the collective wisdom of all people is really pretty profound. Here’s the example I like to give, in case you’ve never heard me say this: People go into a fair, and they have to guess the dressed weight of the oxen. That’s the contest.
And they have people that are really skilled farmers and people that don’t know anything. They don’t know a cow from a moose, and they’re guessing what this thing is going to weigh when they dress it when it’s all said and done. They bet what they think it’s going to weigh, and this guy, the statistician, decides to collect all the bets. And then what he does is he says, “Okay, just give me all the bets from the contest when it’s over, and tell me what the weight of the oxen ends up being.”
And the guy goes, “Okay, cool, yeah, I’ll do that.” And then he takes them all, and he adds them up, and he divides by the number of guessers, and he finds that they’re within a fraction of the pound, as I recall it was, of the actual weight of the oxen.
And you go, “Whoa, wait a minute. Nobody knew the right weight, but collectively, people got it? Whoa.” That’s like the stock market.
Everybody’s collectively betting on what the price of a stock is.
What happens here is that these speculators are betting that they’ve got a better bead on what it should be actually worth, and Buffett basically said the gamification of trading is going against that. It’s going against this whole idea of market efficiency.
Why? Well, because it’s probably easier than getting on an airplane and flying to Vegas. It’s easier than going to a casino.
“It’s legal. I can do it in my living room. I don’t have to go anywhere, and I can get that dopamine hit,” is what he basically said.
Ease of Information and Ease of Transaction
He said the speed of communication and the wonders of technology facilitate instant worldwide paralysis.
What is he talking about? Well, you think about what Adam Smith said.
He said ease of information — if we have better access to information, then we can figure out what the right price of the security is, because we have everybody betting, and we have all of their information. Betting, I use that word loosely.
We have them all making a determination on what they think the stock is worth is maybe a better way of saying it. And therefore, we have this information, and it’s brought to bear quickly.
Now, ease of transaction — if I can trade on that information easily, now I’ve got something. That’s where market efficiency comes from, and what he’s saying here is, “With the speed of communication, I can do this in my living room, and I have this ability.”
This makes it super easy to do this. Then what happens is you’ll have speculators that are using the stock market like a casino, as the article basically says.
Case in point. Remember who’s really making the money here, though? It’s the house. And that is so true.
Before the break, I said that on the other side of the coin, you’ll have people that are betting against the stock market, and you’ll have people that are making money that might be the house on the other side of the deal. Now, that might be short sellers that bet on the stock market going down. That might be it; that was the GameStop thing.
That was all short-seller stuff, but it may be people at the bank, your friendly person in the bank that doesn’t really understand the stock market that well. And I have people that work with me here. Some of my folks that run the offices, that’s where they came from, and they will tell you stories about what it was like working on the bank side and just how they didn’t know what they didn’t know.
Uncertainty and High Market Returns
So what happened was that they were saying, “Hey, you can put your money here. You’re nervous about the market. Let’s put your money in the CD. Let’s put money in this annuity over here or whatever because it’s guaranteed.”
And then you’re thinking, “Well, guaranteed sounds really, really good because I’ve got so much uncertainty.” Now, when am I going to be more attracted to guarantee?
When I’m scared, when I’m nervous, and when I think maybe I could lose money, I’m going to go and I’m going to move more toward that. And what, historically, have we known about markets and when they typically have the highest returns?
It’s when things seem the most uncertain. That’s really when we typically see the highest returns, historically.
That’s because what investors require is when there’s more risk, they require more return. So typically, what happens when people feel bulletproof and feel like everything’s great, that’s when they’re speculating. They’re jumping into stocks, and we saw this.
I remember in the late ’90s, I would be invited because I was studying under these academics, and clients of mine would go, “Paul, you have to come talk to my investment club.”
And I said, “What? Do you want to break up your investment club?
“You don’t want me there. I’m the last dude you want in your investment club because I’ll make everybody mad. I’ll tell them that what they’re doing is wasting their time.”
And I would go in, and they’d be cordial enough, but they wouldn’t pay any attention. I was right.
You don’t want to mess with people having fun, but they would be investing in different stocks and things like that, and I would say, “You know, that’s kind of a waste of time. Markets are efficient.”
Fixed-Income Investments
But when you’re dealing with let’s say fear, you’re often looking at, “Hey, let’s put our money over here.” And there was an article, actually. I’d say it was Smart Money.
It was talking about back in 2008. It said the brokerage firms were talking about how much money they were putting in fixed-income investments, and it was huge. It wasn’t a little number; it was huge.
Smart Money actually made this point, to their credit: It makes money for the investment firms, but what about the clients?
Which was phenomenal because they wrote this article before the market went up. They did it before the market actually meteorically shot up 68% to the end of the year, if you were diversified. It was a huge run-up in the stock market, and they made that point.
The investment firms are being more conservative. They’re adding cash to the portfolio.
You look at the mutual funds back then, and I would be looking at people’s portfolios and going, “You’ve got this stock mutual fund. Do you realize it has 20% of money that is just sitting in cash in a stock mutual fund?” And they’d be sitting there going, “No, I had no idea.”
Well, in the prospectus, they said they could do this. They said that they could do this, that it was something that was part of the investment policy. They could do it, so they’re not lying to you.
They’re doing what they said they could do, but did you know that they were doing it? And they said no.
When your investment manager is putting more money in cash and more money in bonds or more money in an area of the market that just ran up recently, did you know that they’re doing that? People don’t often recognize that that’s what’s happening, and it’s just another form of speculation.
The Ease of Investing
So I’ve been talking about this whole hour Warren Buffett eulogizing his old friend, Charlie Munger. And Buffett basically said the stock market is increasingly casino-like. He’s seeing emotions come into things way more now and the level of education is just not there. And I think that that’s so true, not only if you look at the studies of investors and the public.
There’s been a group that has been, they’ve been actually going in and asking people questions, and just trying to get the pulse of people and find out how much they really know about what they’re doing with their money. And it’s been eye-opening how little people know.
And he’s pointing out that younger investors are approaching the stock market more like a casino. Why? Because it’s more available to be treated that way than ever before.
I mean, you used to have to set up a brokerage account and you’d have a broker that you’d work with. There were transaction costs that were much higher. So it made it harder to buy and sell and buy and sell. Think about that.
If you have some kind of a barrier to entry or some kind of a deterrent to trading too much, excess expenses would be that. So I don’t know what the data is, and it’d be interesting to see the data — I don’t know if it’d be so hard to gather the data — to see if investors are getting worse returns now than ever before, because of the fact that expenses are lower, oddly enough.
It makes it harder to actually stay disciplined because you don’t feel the pain of trading.
Man, I never really thought about it that way, but it could be interesting. But Buffett’s basically saying that people are treating it this way and because it’s almost making it into a legal casino, they’re buying and selling, buying and selling, doing all kinds of things that they shouldn’t be doing as he points out in this article.
How to Get Away From Gambling in Investing
The point is, how do we get away from this?
Well, number one, if you’re dealing with an investment advisor, I want to know what they think their job is.
So what do you do? How do you approach things? And have them tell you what their job is and get as specific as possible.
How do you select companies for the portfolio? Now, if they start talking about how they do their analysis of companies, you have a problem right off the bat, or how they choose mutual funds.
If they’re looking at the historical performance of the funds and things like that, you already have a problem because they’re looking at the track record, and with the track record, we know that markets do what? They go up and they go down. Markets go up and they go down.
If I’m choosing my mutual funds based on what had a good track record, a one, three, five, and 10-year track record, I could be choosing funds that are really super high. I could maybe be choosing five, six funds that all invest in the same market, the same part of the market, that just happened to do well recently.
And an easy example of that would be investors looking at mutual funds in the late nineties, and buying several mutual funds that were investing in technology stocks. You might’ve had six or seven mutual funds, but they were all investing in the same area of the market that had that run-up and did not own any small-cap value stocks, which actually didn’t do as well, or international small companies that didn’t do as well, but took off and did super well in the 2000s. But you don’t even own them, because you don’t own them, because you didn’t choose based on asset class; you chose based on track record.
So I want to know, are you choosing based on how you’re doing it? Asset allocation should be based on asset classes. I want to see that they’re holding very, very big companies, very small companies.
How did you choose a small company fund? And you ought to be able to understand it.
Are the companies really truly small? What’s going on?
What’s the turnover rate in the funds? If I see a lot of turnover, that’s telling me that the stock funds are turning over or trading a lot, which shows me that they believe that there are mispricings in the market. It’s a warning sign.
How often do you change the funds? What’s the criteria?
What’s the rebalancing? How do you rebalance? Well, the right answer to me would be based on deviations from a target. Or better yet, if I’m looking at certain asset classes, I can do rebalancing based on cash flows.
And you might have to write this stuff down. Go back and listen to the podcast and write some of these things down. But look at the prospectus of a fund that you’re investing in. If you see that the fund manages your beliefs, their job is to find underpriced stocks and get out of overvalued markets, or look at the markets and do tactical asset allocation, that could be a sign that there’s a real problem there.
So there are just a few things. But recognize that most people approach investing as gambling and they only know that they’ve been doing that when it’s too late.
I’m Paul Winkler. Go to paulwinkler.com, there’s a lot more there. You can go to the website and educate yourself to your heart’s content.
Advisory services offered through Paul Winkler, Inc an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.
