Paul Winkler: Welcome. This is “The Investor Coaching Show,” and I am Paul Winkler, talking money and investing and all that good stuff. Wow, can you believe it? We’re there.
Reacting to the Election
It’s the show before the election. Oh yeah, of course, I get lots of questions about, “What do you think, Paul? What do you think? What do you think?”
And I’m doing a whole workshop on post-election thoughts on Thursday. Yeah, I think it’s Thursday. We’re going to be doing that. It’s going to be my reaction.
I have one client of mine, he was just like, “Yeah, I know what your reaction’s going to be, Paul. I know it’s going to be, no matter what, I know it’s going to be, ‘Companies are going to figure it out, they’re going to figure it out. They’re going to find a way and don’t worry about it.’”
And I said, “No, you have no idea what I’m going to talk about.” I said, “You don’t know.”
Because here’s the thing. Yes, usually when I talk about elections and I talk about who’s in leadership, I talk about how yeah, yeah, companies are going to figure out a way to get to profitability.
It’s like, for me, for you, for everybody, we’re going to figure out a way to make it somehow, and maybe it’s a little bit more challenging.
It may be that you’re having to figure out how to find an extra job if things aren’t going well, you might have to figure out how to earn more money or you might have to figure out how to reduce expenses for work-wise. Let’s say if you have an issue with work and things, maybe the economy goes against you or the things that you do for a living, maybe that is squeezed or there’s something wrong there, you’re going to have to find a way. So, well, companies do the same thing that you do.
Companies are going to, if all of a sudden taxes are raised on companies — and you just don’t know exactly what’s going to happen immediately, but if all of a sudden there are higher expenses that there is a slowdown economically or there are interest rate changes that are going against companies or whatever — companies are going to do whatever they’ve got to do to try to increase sales if they can. If they have to move into different marketplaces, they will, but they’ll reduce expenses.
The Stock Market as an Economic Indicator
I remember too well, doing this for over 35 years, I remember too well, looking around at when the economy was going poorly, what companies were doing and going, Hey, “Ain’t it interesting, the stock market’s going up and the economy’s lousy?” And you go, “Well, how can that happen? How does that happen?”
Well, the way it happens is you just reduce expenses and you lay off people like crazy. And then what happens is, of course, politically, that becomes very, very unpopular to whoever’s in power and all of a sudden, let’s say the economy’s not going so well and people get mad and they vote the other direction. And sometimes it takes a little while for people to kind of figure that out.
Or you have the other situation where things aren’t as bad as what people think they’re going to be — and the stock market’s a leading economic indicator — and the market will actually start to change or move in a certain direction based on what they think is going to happen, but they typically don’t. They undershoot or overshoot what the expectations are.
In the example I like to give — and many of these examples are out there — when Trump was actually in the very first time that he was elected, the stock market went through this huge drop. The futures had dropped and the concern was that things were going to be very, very bad.
A lot of people just thought that they were going to be bad. And you have people on and you look at it, you go, why is it so often that you have people on Wall Street split? And even investment advisors.
I saw a little study the other day on how investment advisors are fairly split. Now they’re a little bit more in favor, the study showed, of Trump winning than Harris, but they were fairly split.
And you go, well, why is it when you watch TV, you see people that are split that way as well that are in the market or they’re in the investing world or maybe they’re CEOs of companies? You can have certain companies that just love it when there is more regulation because it creates a barrier to entry, which can really mess up competition.
If you’re trying to compete and you’re a small company and you’re trying to move into a specific arena, but let’s say the barrier to entry is very, very high because of the fact that there are a lot of regulations that you have to work your way around, then you won’t be able to enter into that arena because it costs you too much. Well, a company that’s already in that arena has they have the ability to pay those expenses and work around it, or they have ways to find loopholes because of their size and because of the legal staff that they have. So you can look at it that way.
It’s very, very hard to figure out what’s going to happen with an election simply because there are too many moving parts.
You could have a situation, and I think this is really important for American investors, you could have a situation where maybe the election goes in a direction that isn’t so helpful for U.S. companies, but it’s super beneficial for international companies. That’s something I was teaching in a workshop and I was talking a little bit about last week, but it bears repeating.
Ranges of Returns
I was looking at all the different market segments, large U.S. stocks, and I have this vortex that I use, which is like I said last week, it’s like having a funnel sitting on its side and you look at the left-hand side of it and you’ll have ranges of returns that are all over the place and those ranges of returns that you can see for large U.S. stocks, you might have an expected return of 10%, but your return is never 10%, right?
You don’t have 10% unless you’re Bernie Madoff. You don’t get 10%, 10% return, 10% return, 10% return.
No, you’ll see it’s up 32%, it’s down 16, it’s up 25%, it’s down five, it’s up 40%, it’s down 20. It’ll be in a range, but a little bit over two-thirds of those returns will typically be 10% plus or minus 20. So it’ll be somewhere between 10 plus 20 or 30% return, 10 minus 20, negative 10% return. Well, that accounts for two-thirds of your returns historically.
Historically, it’ll be between those two. Well, if I go, how about 95%, being confident in a 95% level? Now you take that 20, take it times two.
So 20 times two is 40. It’s 10 plus 40, a 50% return. You could have a risk of a 50% return or 10 minus 40, negative 30% return.
Now what happens is we start to throw in other areas of the market, which is a problem that I see investors not doing. As a matter of fact, I had some conversations this week.
I was at a board meeting over at Trevecca and I was having conversations. We deal with charitable giving and dealing with setting up trusts and setting up charitable giving intent and investment portfolios, making sure that you’re going to be taken care of throughout your retirement, and then what do you do after that? Do you have kids that you want to give money to?
If not, who do you want to receive assets and who do you want to help out? What do you want your legacy to be? That’s a big topic of conversation.
Well, one of the things that I see an awful lot of is overconcentration in big U.S. companies.
And I’ve talked about it here and I was thinking, we just got to get this message out there because enough people don’t see it. But if you look at that range of returns, 10 plus 40, 50%, 10 minus 40, negative 30, that’s a heck of a big range of returns.
That’s a big downside risk. And you can literally go 10, 15, 20 years and have zero return in that area of the market. And I hear these stories, and you’ve probably heard this before too, unless you’ve never listened to any financial media at all.
Odds of a Higher Return
But Warren Buffett talks about putting money — his wife’s money — in an S&P 500 fund. When he passes away, he wants it all to go to an S&P 500 fund. And people take that and go, “Well, if it’s good enough for Warren Buffett, it’s good enough for me.”
And I’m like, “No, no, no. Wait a minute.” Recognize here is a guy who could put it all there. You could go three, four, five, six, probably 18 centuries and win no return and his wife’s going to be fine.
She’s not going to be living 18 centuries. She’s got enough money. They spend very little. I mean, they live in the house that they lived in the 1950s.
He could do that just fine; you can’t. It’s not a good idea for you.
He likes to make a statement about that. And this, it’s true. If you look at investment advisors choosing amongst that universe of stocks, 500 companies, and their ability to get higher returns, choosing amongst that universe and from what the S&P 500 has historically done, I mean, you got a better shot winning a lottery almost. Well, it’s not quite that bad.
But there are really bad odds that you’re going to get a higher return historically than the market does.
And that’s why you have guys like John Stossel in 2020, when he was on Fox Business and he’d throw darts at the stock tables and he’d beat the professionals all the time. So the odds of you doing better than that are terrible, but that’s not where the story is supposed to end.
What you should be looking at is looking at other areas of the market because during those periods of time, if I use the 20-year period from the late 60s to the early 80s, so the mid-60s to mid-to-early 80s where you had no return in the S&P 500, over that same period of time, you had British small companies literally knocking the lights out return wise. I mean, if I recall right, I think it was something like British small companies had like 16, 17 percent per year return during that period of time.
Japanese companies, I mean you basically had the Nikkei, which is like the Dow. We have the Dow, and I’ll talk about the Dow a little bit later, but you had the Nikkei go from a thousand up to, if I recall, it was 50,000 or something like that.
I mean, it was this huge meteoric upturn in the Nikkei during that period of time. Now, it came down some after 1989, but over that same period of time you had from 1966 to the early 1980s, the Dow was at a thousand and it landed at a thousand.
Looking at Patterns
I mean, it was basically at the same level, so large growth companies, literally not a whole heck of a lot going on. And then you’ll have other market segments like when large U.S. stocks had no return between 2000 and 2012, you had small value companies, which nobody really paid any attention to. I’m just telling you, nobody was talking about small value in the late 90s, nobody.
Now you know what my professor was saying, “Yeah, you got to make sure you’re doing this.” And he was talking about international companies and small companies and value companies. And he was talking about it because he wasn’t coming from “past performance is a good thing” to look at it. He did not.
I mean literally, he was going, “This is stupid. Don’t look at patterns. Markets don’t have memory.”
That’s one of the things he would say. They don’t look at what has just happened and have a memory and apply that to what’s going to happen going forward.
That’s just not how markets work. Different market segments, but yet that’s what investors do. They tend to look back at these patterns and it’s called “False patterning.” They look at patterns that have happened in the past.
And the recency bias is another type of patterning where you’re looking at recently what happened and what’s likely to happen going forward. And for investors, this is a problem and I’ve seen it continuously, and I saw a lot of it this week as a matter of fact.
I saw a lot of it as I was getting into conversations with people. One of the points that I was making is don’t get complacent because if we have an administration change here, we’re going to have an administration change, but how different it’s going to be can vary widely.
You’re going to see that different market segments may benefit significantly differently than others based on the new regime coming in. But in the workshop, one of the things I’m going to be talking about is not necessarily markets.
Tax Policy Changing
I’m going to be talking about tax policy, because tax policy could be vastly different depending on who gets in. Because you’re having state taxes, that’s going to be one issue that could be talked about a whole lot.
I mean, right now you’ve got an exemption of 13,000,990 something like I think it is. So literally you have a lot of assets that can be passed from one generation to the next with no taxes, and you double that for a married couple because of what you have called portability.
So you have the ability to bunch those two things together and now all of a sudden you’re looking at going down to seven million. That’s literally what happens after 2025.
But you look at that and go, “Well, wait a minute, is that going to change?” Well, a lot of that depends on who is in office.
Now, some of you’re sitting there going, “I’m not worried about seven million either, Paul,” and that’s fine, so that may not be an issue. But what about income taxes?
Right now we have income taxes at the 10, 12 percent tax bracket. Now we could see 12 go away and we go to 15. You got 22 and 24, those two brackets could go away and you got 25 is what replaces it. So a lot of people are going to be looking at a higher income tax.
Then you’ve got on the other side, you got the possibility of, “Hey, I’m looking at the possibility of reducing income taxes altogether.” I don’t think eliminating makes a whole lot of sense. I don’t think that that would happen.
Typically, what happens when somebody is a good negotiator is they will throw something out there that is really kind of crazy almost in hopes that they just get a little bit. It’s like coming in and saying, “Hey, you know what? I’ll buy that car off of you.”
And you’re trying to sell it for $10,000, and they’ll say, “I’ll pay you six for it.” And you’re like, “Nah, you got to be kidding me.”
“Okay, how about eight?” “Okay, deal.” They shoot in the middle, right? Like that.
Well, it’s the same thing with taxes. You could say, “Hey, we’re going to eliminate,” but you might just reduce the taxes. There may be a significant reduction.
What Will Change?
Well, so much for the people who have been sold the idea of converting a lot of money into Roth IRAs paying taxes right now at higher rates only to avoid lower rates in the future. You could look at that and go, “Oh man, I can’t believe it did that.”
That is a risk because a lot of times what happens is we do things for emotional reasons. We want to avoid taxes. Hey, nobody likes taxes, but is there a possibility, and I’ve been talking about this for a long time, that you have a consumption tax?
We’re talking about tariffs and you look at that and go, ‘”Eh, tariffs.” And some people say, “Well, that could be a huge problem.” Because we pay tariffs, right? We pay.
That’s an increase in the goods and the consumers pay it. But you’re looking at it and going, well, if it’s used strategically as a way of reducing imports from certain countries that they’re not terribly happy with, or countries that are setting tariffs on us in return.
So there’s just a lot of stuff that’s being done for negotiating purposes and it’s really hard. I mean, we look through the glass dimly. It is really, really hard to figure out what’s going to happen.
But I think it’s going to be interesting as we get into next week, we’ll see, does anything pan out? Does anything change?
What’s going to happen? Who wins and how divided? Is there a division? With Congress versus the Senate versus the House versus the presidency?
Then with division, sometimes markets love division because you can’t get things through that quickly and you got to think about them a little bit more.
So I think that’s going to be interesting. I’ll be talking a lot more about that on Thursday. That’ll be a workshop that if you go to my website, PaulWinkler.com, you can actually sign up for that workshop. I’ll be talking about that.
Things That Are Bad for Your Wealth
Now, I’m going to talk about something I did see. There are a couple of things that I did see this week, just because I look at people and they say, “Hey, Paul, can you look at this portfolio?”
So I got a chance to look at a lot of portfolios that I don’t normally get a chance to look at as much. And I’m seeing some things that I want to teach you to look for as signs that there might be a problem or that somebody has recommended that you do something that could be really bad for your wealth.
You talk about doing things that are bad for your health, I want to be talking about things that could be bad for your wealth, because I see a lot of stuff.
And I’m going to talk a little bit about some of the things I’ve seen in the past, and I’m going to see someone tell you about the things that I see now and how to ferret that stuff out. Yeah, so Paul Winkler.com is the website. So yeah, if you want to jump on there and just sign up for that, you want to get on there for my post-election workshop.
I’m going to be out there Tuesday with all the folks from the station out there, Wilson County, I guess it is? So that’ll be a lot of fun. I’m really looking forward to hanging out with everybody.
So I had a lot of people who were having me take a look at investment portfolios and just asking me about stuff at something I was at this week. One of the things I see a lot of, and let me just speak to this because it was something that I don’t talk about a lot because I just thought for sure people aren’t doing this, investment advisors aren’t doing this, and I was shocked how often I saw it.
The Four- to Five-Star Curse
But it’s when somebody will pull up a portfolio and say, “Hey Paul, look, here are all my holdings,” and I will go through them and if I see a lot of four and five-star funds, I’m like, “Whoa, whoa, whoa, whoa. Wait a minute. Wait a minute. There’s a problem here.”
As a matter of fact, there was a guy who was an ex-financial advisor and he and I were taking a look at something and he pointed out some stocks and he was pointing out the star ratings and I said, “Don’t pay any attention to that. Do not pay any attention to that.”
And he goes, “Oh.” And I said, “Yeah.” I said, “The Wall Street Journal actually had an article mocking that and they called it the four- to five-star curse, literally called it the four- to five-star curse.”
It is not like staying at a hotel. If you go to a hotel and it’s a five-star hotel, you’re probably going to get decent service. It’s probably going to be a pretty good experience. Even a four-star hotel, it’s going to be a pretty good experience.
If you go and buy four- and five-star funds, you’re probably looking at, not definitely, but you are probably looking at, it’s going to be a bad experience. And we know this from the research.
The reason is that markets go up, they go down, and what follows up, down? If you have a good past performance, past performance does not tend to continue. It doesn’t tend to carry on.
And if I see somebody with an investment portfolio of four- to five-star funds, four- to five-star ETFs, I’m usually going, “There could be problem here.” And you go, “Well, why?”
Well, because it is quite probable that if you’re not managing a portfolio, there’s an investment advisor managing this portfolio, and they just added those funds. Because if it’s not persistent, if you don’t find that the good performance is persistent, that it continues on, then chances are super good that that fund was added after the performance was good.
Then what happens is you own it. And then it underperforms while you own it. And then they go, “Hey, we got to get rid of this.”
And they get rid of it and then they buy the next performer that did well during the most recent period. But here’s the problem. You own it when it’s doing badly.
You don’t own it when it’s doing well. That is so often what happens.
Portfolio Analysis
I remember somebody brought in a book and it was super, super nice, I mean a hardbound book, a really nicely done portfolio analysis. And they brought it in and said, “Here. Here’s my stuff.”
And what I did is I followed it, I took the funds that they recommended that the person buy, and I just held onto the book for a little while, the recommendations that they were making. Now in the book, what they did was this, and this is how it’s often done.
They will say, “Hey, look, the stuff you own right now, if you had owned what we’re recommending, here’s how much better your performance would’ve been.” So what they do is they appeal to your sense of greed and your fear of missing out because “You weren’t doing what we recommended. You didn’t have those things, so you didn’t get that better performance. You need to go with us and put your money there.”
So what happened is they had this whole list of recommendations and they said, “Here’s what you need to do.” Well, I dug into it. The fund, the investment manager, the investment advisor company in question, did not themselves hold the funds that they were recommending during the period of time that they were showing. Which is a little bit disingenuous.
They’re telling you, “Hey, if you had owned the funds we’re recommending you would’ve done this much better.”
Well, they didn’t even own them during that period of time and they didn’t tell you what they did own during that period of time, by the way.
So that’s pretty bad. But furthermore, what they did is they had this list of funds and I just followed them for the next few years. I wanted to see how they did versus their benchmarks.
Now, different areas of the market have different returns. Like with small companies, you might have a ten-year period where small companies don’t do that much. They don’t do that well.
And then all of a sudden they do super, super well. You just don’t know how they’re going to do or when the performance is going to come in.
But you’ll have single years where a small company stock fund might go up 70%. I mean bam, just like that. And a lot of that performance occurs in a very, very short period of time. If you’re not there, you’re out of luck, and if you bail out before that happens, you’re out of luck.
Recommended Funds Underperforming
So one of the funds that they recommend that the person buy was a small-cap financial fund. You recommend and you benchmark that, I benchmarked it against the DJ financial asset category because that was its benchmark. That’s what Morningstar benchmarked it against.
Well, over the next three years, the fund underperformed its benchmark by 8%, then 7.6% the next year, and then by 9.84% the year after that. Well, so much, I mean like 30%, almost 30% out underperformance. I mean brutally, brutally bad.
And then they had another fund that underperformed where if you had put money in this thing, your fund, your money would’ve grown. Your $10,000 would’ve grown to about $14,000.
Better than poked in the eye with a sharp stick. But it should have grown, according to Morningstar, to 18,000. So that’s about a $4,000 underperformance on a $10,000 investment.
Then the next fund, I mean it’s just literally almost 3% per year underperformance, 3% per year for the next 10 years, the next fund that they had recommended. So much for its outperformance before, then when they recommended it, it was like bad luck for the fund.
Once they recommended it was like the curse on the fund. They recommended it and then it underperformed.
The next fund that they recommended was a small-value fund. And then it went on to underperform, not only when I did the analysis here to date, but it had a one-month underperformance, one-year underperformance, three-year underperformance, five-year underperformance, and 10-year underperformance. I mean basically in every time period you could think of, it underperformed.
Then the next one, same thing again. Same thing again on a small value fund. another small-cap equity fund that went on to underperform 12% and 4% and 1%. So literally it’s really bad luck.
Now, is it bad? No. This is what they found in research on pension funds as well. Pensions engaged in this same type of activity.
Studying Pensions
With pensions, you think, “Hey, these people are well-educated. They do a lot of analysis. And they look at their funds and they want to make sure that when they look at a fund in their pension, they want to make sure that they have the best fund for their people that are in their pension plan, for their employees.”
Well, what they found in the pension with the funds that had underperformed, they said, “Hey, these funds didn’t do so well need to get rid of them. Hey, what’s a fund that has a little bit better performance in that area of the market? Oh, the ABC fund had a better performance. Let’s get rid of the XYZ fund because it’s pretty bad, and let’s put the ABC fund in its place because it’s done better over the past five, 10 years.”
The study of pensions was brilliant because the graph was really good. They had the ABC fund way outperforming the XYZ fund, which was way under.
Then they had the line of demarcation when they made the change in the study. They got rid of the XYZ fund because it had underperformed. They bought the ABC fund.
And what happened, it was almost comical how they had changed places. The XYZ fund that had such bad performance in the previous period of time went on to outperform. The ABC fund that had done so well went on to underperform.
Now, the problem was the people who were in the pension plan got the bad performance of XYZ when it had done poorly, and they got the bad performance of ABC when it had done poorly. So they’re the ones that took it on the chin, but they felt good about themselves.
“Hey, we’re getting rid of the loser. We’re putting in the winner in its place.” That’s the problem with this method of managing money.
So look at your statements. Here’s the thing, real quick before we go on a break. Look at your statements right now. Look at the fund names.
Maybe take a list or if you’ve got a really good memory you don’t need to do this, but write down a list of the funds that you own. And look at the list of funds that you owned five years ago.
If you’re seeing changes, now there may be minor changes because maybe that one fund was replaced. Like if I replace a fund, it’s because there’s a lower-cost version of it, but that’s rare because you try to keep the expenses as low as you possibly can.
So you don’t have a lot of changes. You shouldn’t do that. You shouldn’t have lots of changes.
But if you’re seeing changes in funds like this, and you’re getting trading reports all the time, it’s a good sign that they may be getting rid of the losers that you were in when they were losers, and putting you in tomorrow’s losers. And this is what you look out for.
I look at, when I see four and five-star funds and that’s all I see in a portfolio, that’s one of the things that tips me off to do the second step, which is to look at a statement from three to four years ago. Because I’m telling you, the four to five-star curse is what Morningstar basically said and I have seen it over and over again in my career.
These funds do not tend to persist. That’s what we know from the research.
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.