Paul Winkler: Welcome to “The Investor Coaching Show.” I am Paul Winkler, and we talk about money and investing, cover the news of the day, and educate.
People Don’t Understand Markets
Where are you without education? Because let’s just face it, people know a lot of stuff that ain’t so when it comes to finances. There are a lot of myths out there.
And a lot of it — just take my word for it — when you get into understanding a little bit about your finances and understand a little bit about the investing world, it’s not above your head. It is not above your head.
It’s not that you can’t understand any of these things, but here it is critical that you do because otherwise you’re going to read something and it’s going to pull you off. It’s going to pull you into a direction that you probably don’t need to be going and you won’t even know that you’re going a direction you don’t need to be going because you didn’t think you could understand it.
So the idea is to help you become a more informed, educated investor. And it’s not going to be too hard.
Right now it’s an interesting time because so often when I run into people, they invest in things that they’ve heard, maybe that their parents invested in. Or maybe in my case, my grandfather was really big into real estate, for example. So hence my mother was really big into real estate, and I’ve talked about this recently.
And then that was the sign of success, if you own real estate, “you are a successful person.” So hence that was a status thing if you could do that. And for a lot of people it still is.
A lot of people, they don’t know what else to do. They don’t understand markets. They don’t understand.
As I often say, if you’ve never heard me say this before, it bears repeating. When I’m teaching younger people, like when I’m in the colleges or high schools, I’ve done some things in the high schools around here, I’m typically starting the conversation by saying, “Hey, who are the most successful people that you know?” And I’ll get the kids to say Bill Gates, Warren Buffett, Elon Musk, just to name the people that they’ve heard of that are successful.
Then I’ll say, “Well, what do they all have in common?” They’re all business owners.
And I’ll say, “Guess what? You get to be a business owner without the hassle of having to run the business when you invest in the stock market. That’s why it has been this traditional that there are capital markets.”
Now, the reason that the public markets have been a place that people wanted to invest is simply because you have a lot of safeguards as far as auditing the companies, knowing what is going on inside the companies, knowing what their financials are, where the cashflow is going, what their marketing plans are because it’s all open book. You’ve got to have all this information so people can analyze it to determine whether they want to actually invest in a particular company.
Investing Based on Past Performance
Hence, that is why I find some of this stuff that’s written out there on investing to be kind of silly. Morningstar does all of this analysis on mutual funds, and they will actually grade your mutual fund with one, two, three, four, or five stars. Now, publicly, to their credit, they’ve told people that that is not a way of choosing mutual funds.
“It was never meant to be a way of choosing mutual funds.” It was something like that. I can’t remember exactly how the president of the company actually put that, but he said it’s not a way of actually doing that.
But here’s the reality: People do choose mutual funds that way. Investment advisors choose mutual funds that way because if you’ve got a five-star, it must be a really, really good fund.
Why would you ever think for a minute that a five-star wasn’t a great fund and a one-star fund wasn’t a terrible fund? So to say that that’s not, that just kind of covers them, right?
But let’s say we’re looking at stocks, they also rate stocks that way. One-star, two-star, three-star, four-star. Well, I would think that a five-star stock is a really great stock and I would think a one-star stock or a two-star stock is a really lousy one. Well, they have an article writing about how there are 10 stocks the best fund managers have been selling.
Now number one, this is loaded. What makes somebody the best fund manager? Past performance.
What do we know about investing that doesn’t work? Past performance. The top funds of the past don’t tend to repeat.
Matter of fact, the Wall Street Journal called it the five-star curse. That’s how bad it is.
So what happens is that a fund manager will play around and try to figure out which stocks they think are going to be better than others and not going to outperform others so they buy these stocks hoping that they will outperform. Because if they do, then they can be amongst the “best stock managers, best fund managers.” And then they can get all kinds of money flowing in their direction.
Ask Kathy Wood how well that works. She had this technology fund that was knocking the lights out of everything. And I’ve got text messages, emails, people asking me questions, “Hey Paul, what about this? What do you think of this person?”
And I’d be like, “Yeah, what do I think about the lottery winner last night? I think that they were lucky, and I don’t think that there’s anything that we really need to look into any deeper than luck versus skill and just go, ‘Hey, congratulations. You hit the lottery or you hit Powerball or whatever. You hit the jackpot over at the casino and just take your winnings and just run.’”
But the thing is, most people didn’t have their money in the fund when it had the great performance. They had very little money in the fund relatively when the great performance occurred. All the money that flowed into that mutual fund flowed in after the good performance.
Is the Stock Market a Gambling Casino?
So looking at this article, it’s about the 10 stocks the best fund managers have been selling. Now that’s the first problem. Best fund managers, how do you define that, these 10 stocks they’ve been selling.
And you go, “Well, wait a minute. All this information on companies is public.” There’s a tremendous amount of information we can find out about any of these companies. Meta, Oracle, Uber, Bank of America, S&P Global, Alphabet, KKR, Microsoft, Roblox, CloudFare. You can look up information on any of these companies and you can find out a lot of information to determine whether the pricing is responsible based on all knowable and predictable information.
So these best fund managers, what are they doing? They’re gambling again. Why? Because if they can get it right on the upside and then they can get it right on the downside, protecting from the downside, then they can become legendary.
This is the problem. Most investors aren’t going to know if it’s skill or luck because they don’t really research it that much.
Now, the same thing with investing. People, they don’t understand the stock market. So a lot of times they just go, “It looks like a gambling casino to me.” And my answer to that is, yes, it is the way most people approach it.
But if you think about it, if I had taken $1 and put it in large U.S. stocks in 1926, that $1 would have grown to $14,000. It would have grown to well, well over $100,000 if we’re looking at small value stocks. And I didn’t have to figure out which companies were better than others. I just owned those particular stocks.
Now a lot of people just jump and they say, “Well, that’s what indexing is, Paul.” And no, indexing overweights the really big companies, and I’m not a fan of indexing in most asset categories.
So I just wanted to put that out there really quick for those of you that think that’s where I’m going right here. But here’s the thing, it is because they look at it and they go, “It’s a gambling casino.”
Horrible Diversification
Then what happens is people take index funds and they gamble with them. That’s the other thing that drives me crazy. You’ll have all these ETFs.
I was actually talking to a compliance attorney this week. We got into conversation about this and we were talking about just why I choose the types of investments that I use and blah, blah, blah. She was talking about why I do.
I said, “Well, I’ll just give you an example.” I get emails every day, just about, from people going, “Hey, would you sell our stuff? What do you think? Would you sell our stuff?”
And one of the things that they actually had talked about, they were using some of the language that I use, and they said, “It’s hard to find people that really know what they’re doing, blah, blah, blah, and we want to talk to you about it.” And I said, “Yeah, okay, yeah, blow smoke at me. Great.” It doesn’t work.
But one of the things that they said was that, “You ought to use this ETF. This is what we’re doing. We’re using factor investing.” One of the little buzzwords.
“We’re using factor investing and using ETFs to do these exchange traded funds.” And I said to the compliance attorney, I said, “I’m not falling for it.”
And I said it’s because the funds that they’re recommending, the diversification is horrible. If you look at the number of stocks, you have way too few stocks and you’re taking way too much non-systematic risk, which is the risk you take when you have too few companies.
If something happens to those companies, you’re sunk. You got a problem on your hands and you could lose tremendous amounts of money because you don’t have enough companies especially when you’re dealing with value stocks, because value companies can come and go and they can run into trouble and you want to make sure you’re really broadly diversified.
Now, if you own enough of them, research shows you can significantly reduce risk versus a portfolio that’s holding too much in growth stocks like what you typically see in target date funds, which is a default option in 401(k) plans. And typically in portfolios run by big investment firms, you will see that it’s dominant that they hold those big companies. And the reason happens to be because people are so familiar with those companies, they feel more comfortable and they’re more likely to leave their money with these big investment firms, not recognizing the risk that they’re taking.
When you’re not diversified across a lot of different asset categories, once the risks show up, once that happens, it’s too late.
When you had the 2000, 2001, 2002 downturns, it occurred so rapidly, or especially the 2008, 2009 downturns. Really the big stuff started in late 2007.
But once that downturn happened, it was like bam. You would have these horrible days. And it was just almost immediate that stocks would drop to this new super, super low level.
Or in 1987. There are a lot of examples, like in 1929 with the Depression. And a lot of people they’ve heard about and read that in school, but they didn’t really figure out that that can happen not only again, but will likely happen when you’re not diversified.
Now, there are some market segments that when 2000, 2001, 2002 came crumbling down, some market segments did quite well, they actually went up. And most people don’t realize that because they didn’t own them.
Market Timing With Real Estate
So what happens is people approach this thing like a gambling casino, not recognizing that you don’t have to do that. It’s not necessary.
So then what they’ll do is they’ll say, “Well, forget it. I don’t understand it. I can’t do anything, but my dad owned real estate, my grandfather owned real estate, and that’s what I’m doing. I’m just going to buy real estate.”
Which leads me to another article in the Wall Street Journal that says, “You might be buying your house, or rental property, at the top of the market.”
Now what they’re doing here again is market timing. If you think about it, they’re saying, “Hey, the market may have topped out.”
But to his credit in this article, he actually says, “Well, we really don’t know.” But it just makes a couple points that I think are really, really important because I remember when the ’08 mess started to happen, ’07, ’08, I remember my wife and I, we would go out to these things. That was just what we did for fun.
We would go out to these open houses especially when they had a big property where you could go into multiple houses, they had lots of properties for sale, and you go and just kind of see what the technology was in the houses. It was fun. Great fun. We’d do that.
Well, I remember going into some of these places off golf courses. It’s not that we intended to buy or anything like that. We were just doing it for fun.
And we would look at the prices and go, “Oh my gosh. Well, I guess it’s cool they got an elevator in here.” But I was like, “No way. Oh my goodness, this is crazy what people are paying him.”
Well, he says here, “S&P CoreLogic Case-Shiller” — this is Wall Street Journal again — “U.S. National Home Price Index, which controls for changes in the mix of houses, is up 51% from the end of 2019.” You had 2020, and then you had a lot of revenge spending as I talked about after the Covid thing, you had this revenge spending. And what they did is they moved out of the inner cities and they started moving out in the country.
This is something I talked about a lot during that period of time, because they could remote into work. They didn’t have to necessarily show up at work. So they took that as an opportunity to get the heck out of the city. And once they got out of the city, they started driving the price up in suburbs all over the place, and that’s where prices started going up and up and up and up and up, right?
Well, what’s going on now is people are looking to go, “Whoa, up 51%.” He says, “Houses are really expensive and getting more so. For prospective buyers, it’s a crisis.”
Overvalued Real Estate
You all think, For owners, it’s a windfall if they’d sell. But a lot of them aren’t selling because they got to live someplace.
I always loved John Savage. He was a financial guy back in the ’80s. I would listen to him all the time in the early ’90s, and he would say this, he goes, “You know what? Your house is not an investment unless you sell it, move out into a tent, then it’s an investment.”
Because a lot of times people downsize, but they may downsize from a multi-story house to a single story house or something that has amenities that maybe they can move up in the long-term care area or something like that. But a lot of times when they sell, they don’t necessarily sell and buy something that is that much lower in price. Some people do, but just not in my experience.
So it says, but for everyone, it could be a warning sign. That’s what I’m saying. The buyers are paying out the nose. The sellers, a lot of them aren’t selling, so you don’t have as many homes out on the marketplace.
But they’re saying that homes are overvalued as they were near the peak of the 2000s bubble, he says, because that was what I was talking about — 2007, 2008, right? It’s according to a variety of metrics, including the Federal Reserve model.
He says, “Like any asset, the house is valued depending on several factors that all that have made the valuations stretched.” And so you have the National Home Price Index of 51%. That’s the first one.
The second one is the stream of income generated by the asset. So when you’re valuing an asset, whether it be a stock, or even a CD, if you tell me that an investment pays $4,000 per year and it’s paying 4%, I can tell you if it’s a CD, it’s worth $100,000, right? $100,000 times 4% is $4,000. I can back into the value.
Well, the same thing is true of real estate. I can back into the value on real estate.
Tell me what the stream of income is on the rental property, for example, and I can give you an idea of what the place might sell for.
Now, some people, like my mom, like my father, they way undercharge on rent. And because of that, he was just like, “I just want the property. I don’t want to have vacancies in the property.” So he would way undercharge.
So his rent would be like 4% of the value of the property. That’s the way he would do stuff because he just didn’t want to mess with it. And it made mom happy she owned a piece of property. But anyway, that was one way that you could look at it.
Supply and Demand in the Housing Market
Well, the owner’s equivalent rent is up 24%. That’s pretty big.
So you look at that and go, “Wow, rents are really getting up there.” It’s making it hard for people that want to rent property to actually rent property.
The third factor is the interest rate at which the asset is financed and its future income. Higher valuations can be justified by lower rates, but what are we dealing with right now? Higher rates. So that’s been a problem.
And then it says the model that the Fed’s semi-annual financial report has incorporates all these elements. So you got those three factors, and the Fed is looking at all those elements and saying that homes are now 25% overvalued.
Now, are they going to be right? Who knows? I know the Fed doesn’t even know everything. They may put something out there.
But here’s the thing, is that you look at this and you go, “Well, you’ve got the number of homes supply, and then you’ve got the demand. And the demand — what is it going to be? What is the supply going to increase? Are more people going to build homes and therefore the supply is going to get into an oversupply, and then all of a sudden prices are going to drop?”
I mean, you’ve got a presidential election coming up. Could you have a situation where all of a sudden immigration has a major change and that creates less of a demand for properties? And that drops the price significantly.
Because if you have a number of properties out there, but the demand goes down, that can significantly affect the price of the property.
And all of a sudden you’ve got a situation where, bam, it comes down because somebody decides that they’re going to close the borders. Now, if we look at the situation, you can’t predict this, but here’s the thing: Diversification is always, in my mind, the biggest key to successful investing.
When you have a person that is overly concentrated in anything — whether it be large U.S. stocks like you see in the target funds and things like that, or index funds, they’re overweighting the large companies, or you see an over concentration in real estate — or you see an under concentration in an asset class and you own too few stocks in an asset category like I was talking about there with the mutual fund managers owning too few companies — that’s when you run into problems. When you ignore the academic research and you do things just because “My dad did it, my grandfather did it, my grandmother did it,” or whatever, or you do things because you think you know where markets are going, whether you think that they’re overvalued or undervalued, either one of those things are a problem.
This is why it is so critical to put your fingers in your ears so often when you’re listening to people giving advice on investing, even in places that are storied magazines or newspapers when it comes to the world of finance. Recognize that they often put things in there just to get you back looking at those pages and seeing the advertising on those pages. The educated investor, I believe, will be a more successful investor.
Gold and Inflation
I know there was something about gold, and one of the guys gave me an article on that, and I thought I’d comment on that real quick right after this.
All right, back here on “The Investor Coaching Show.” I’m Paul Winkler, talking money and investing, and educating because the more educated investor, in my humble opinion, is a more successful investor.
Now, if you’ve ever heard me talk about gold as an investment, you’ll know that I’m not a big fan of gold as an investment. I don’t even say, “Have just a little bit of it in your portfolio.”
Some people say, “Oh, just a little bit’s okay,” like just a little bit of arsenic is just fine. “It’s just fine. Just don’t worry about it. You’ll be fine.”
I look at it and go, no. If I have a diversified portfolio, I have gold mining companies in there. I’ve got some exposure, albeit, but at least I own a company that’s producing something.
When I’m looking at collectibles or I’m looking at anything like gold or silver or commodities, there’s no cost of capital. Nobody’s paying to use my money.
So, historically, a hundred years ago, you could buy a good men’s suit for an ounce of gold. Today, you can buy a good men’s suit for an ounce of gold. No rate of return after inflation.
Now, some people will point to short periods of time where you have jumps in the value and they say, “No, no, no. Look at how well it’s done.” And no, no, no, no, no. You look over history and anybody can pick a period in time that something’s done well, and that’s how people get sold stuff.
But anyway, this article in the Wall Street Journal says, “You bought gold at Costco. What are the taxes when you sell it?”
And Chad up here in the Gillisville office gave me this, and I thought, this is good. It hits the topic from a little different position.
Now, gold is glittering. Recently its spot price was $2,360 an ounce when this article was written, up about 21% over the past 12 months. And that’s where people go, “Hey, look, it’s a great investment.”
Some buyers are snapping up gold bars offered by Costco. This is what people do. After something jumps in value, then they go, “Look, this is brilliant. Let’s do this.”
No pun intended. Gold. Brilliant.
“Let’s buy. Let’s buy some coins. Let’s buy some gold because look at how well it does.”
No, it just did. It went up, but you don’t know what it’s going to do.
In the late 1970s, the same exact thing happened and it came crumbling down. It was awful. And people were just absolutely shell-shocked when the price of gold dropped because they were thinking, well, wait a minute. Inflation’s not done.
In the 1980s, we still had high inflation, but gold was going down. What on earth was going on?
I always say, “Look at the correlation of gold and inflation.” It’s non-correlated.
It’s got a huge standard deviation, a huge level of volatility, and not the return that is commensurate with the volatility that we see. We don’t want to take risks that we’re not getting paid to take, is what I always tell people.
Hoarding Gold for the Future
But I’ll go on. Many buyers don’t know or care about the taxes on gold sales. They look at it as a hoard. They want to hedge against chaos instead of choosing an asset like stocks.
Think about it: What is chaos? If everything falls apart, I don’t know that I’d be worried about whether I had gold or not.
I’d be worried about whether I had guns and knew how to plant plants and knew how to do that kind of thing. That’d be more what I’d be thinking about.
I harken back to that Twilight Zone episode where the guy was down and out and everything was just horrible and he was at the edge of the desert and he wanted a drink of water, and he wanted to hand over his gold for a drink of water. Because that’s all he cared about. I won’t ruin it for you. If you’ve never seen the episode, it’s really good.
But, anyway, so they’re saying, “Well, what if there’s not an IRS? Then we won’t even have to worry about taxes.”
And this one guy goes, “Well, there will always be an IRS, and there will always be a Federal Reserve,” he says. “I buy gold as a long-term investment in monetary disorder.”
And I look at it as go, well, what would be a more likely thing? Because gold is very impractical for buying and selling things. What would be more likely is somebody using crypto as a way to buy and sell things as an alternative to cash.
And in some countries, not many, but some countries, that’s what it’s being used for. But that doesn’t make it an investment either.
That’s another commodity. It’s a currency, and it’s very speculative because you’re hoping that it will go up in value versus something else, and that is highly speculative, as we’ve seen.
Taxation of Gold
But anyway, I’ll go on. For many reasons, today’s gold buyers could become tomorrow’s sellers. That’s exactly what happened in their early ’80s. People, they couldn’t get rid of it fast enough.
And you got to learn about the taxes. Taxation of gold sales seems straightforward, but there are nuances people need to be aware of.
Gold sales are capital gains, and the rates are different than you might have for other types of things like stocks.
It’s just a different thing. You look at gold, precious metals, and collectibles, things like that, furniture, jewelry, art, wine stamps, and so on and so forth. If you’re in a top tax bracket, your income tax bracket is 24% or below. The rate on long-term gains for things like gold, it’s the same as your ordinary income, so it’s 24%.
Let’s say you have a 22% top tax rate, then your tax rate’s 22%. Now, if you’re above that, you’re at 28%. So you look at that and go, “Wow, that’s a different deal.”
Because let’s say you’re in a 10 or 12% tax rate, your capital gains tax rate is zero, and then it’s 15%, then it goes 15% for tax rates above that until you hit the very, very, very highest tax rate. Then it’s 20%. But that is much lower than what you’re finding here with gold.
So, we look at this and go, “That’s a problem, but wait a minute. What if we put our gold in an IRA like they advertise on TV?”
Well, the problem is it’s not cheap there either, as they point out in the article. Many IRA sponsors don’t allow gold holdings.
Fidelity does. They’ll take your money, and so they’ll let you do this. It charges 2.5% to buy $10,000 of gold and another 2% to sell it. So there you go.
It’s like, who makes the money at the casino? The casino does. They don’t care if you gamble.
They just want you to play the game. As long as you’re playing the game, they’re happy because you got two and a half percent to buy, 2% to sell, and then you got quarterly fees for storage because you got to store the stuff too, because what happens if you don’t store it?
They actually gave an example in this article. It says, “What if you’re storing your gold yourself at home or in a safe deposit box? Don’t even think about it,” they said. “If IRA owners act as custodians of their accounts’ gold, it likely counts as self-dealing and makes the entire IRA taxable.”
A Rhode Island couple who stored IRA gold at home learned this lesson the hard way in 2001 with McNulty v. Commissioner. Tax Court judge ruled that they owed $270,000 in tax on IRAs holding $730,000 plus penalties that likely exceeded $50,000. There you go. That’s another reason to not get excited about that stuff.
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.
