Paul Winkler: This is “The Investor Coaching Show,” and I’m Paul Winkler talking about money and investing. If we look at topics that I’ve talked about over many years, one has come back time and time again, just simply because it’s something I believe so strongly in, and that is international versus U.S. diversification.
International Versus U.S. Diversification
If you look at how funds are typically managed here in the United States, you will find that in a lot of the target day portfolios there is a very, very strong U.S. focus. It’s funny, because it changed a little bit after international stocks did better.
After that happened, people started switching back to international, then U.S. stocks did better, and now they’re switching back. We call that “tactical asset allocation.”
Tactical asset allocation doesn’t work very well because it’s a form of market timing.
One of the things I tend to do is be very strong about keeping the portfolio fairly balanced between U.S. and international stocks. The reason being is that you’ll have entire decades where one does better than the other.
It’s not neatly tied into decades. You’ll find that the 1970s were very good for international stocks and the early 1980s were good for U.S. stocks. Then the late 1980s were good for international stocks and the 1990s were good for U.S. stocks; the 2000s were good for international stocks, and from 2010 forward has been good for U.S.
International stocks did a little bit better there for a while, but we’re early in the decade still, so who knows what’s going to happen next? It is interesting, although not too surprising, how the market fluctuates like that.
That’s the idea behind diversification. You may have long periods of time where one area does better than the other. Maybe you have an entire decade where small companies do better than large companies, or vice versa.
That’s the idea behind diversification, if you don’t know what the future is going to bring. And you don’t, by the way.
New Technology Increases Productivity
I remember having my first laptop computer. I was working for an insurance company, and in 1989 we would actually send our applications for life insurance over the internet.
What I was working with at that point in time was DOS, Disc Operating System, and it was arduous to go through and enter commands. To use a computer, you had to remember all sorts of junk and people thought to themselves, “Can somebody make a computer easier to work with?” Of course, Bill Gates did.
Then Windows entered the scene, and all of a sudden we had a much easier computer to work with.
In the United States, we used new technology much more rapidly than the rest of the world.
For years I remember reading about how international companies were still working with DOS, as well as how that was part of the reason that the U.S. had the leg up during that period of time.
Of course, later on and during the 1990s with the tech boom, tax rates went up, yet despite Clinton raising taxes, the stock market and U.S. stocks actually grew.
A lot of it was because of new technology, which increases productivity. So what happened was that later on technology started being implemented internationally.
Is the Dollar Supreme?
Well, I loved this article because it literally walks through that in a little bit more detail and talks a little bit about what’s going on right now. It reads, “Why is the dollar so strong? American innovation.” It goes on to say how the dollar is having a once-in-a-generation surge of supremacy all over the world.
Why is that immediately interesting? I can’t tell you how many emails I have received from people saying the dollar was going to crash. Yet all of a sudden, what we have is a once-in-a-generation surge of the dollar.
It’s literally the opposite of all the emails I’ve received and refuted over the last 10 years.
It’s really, really hard to predict the future.
I think the premise of the article is interesting because they’re talking about how and what caused the dollar to strengthen versus other currencies. Marvin Barth, a former U.S. Treasury economist thinks it’s all about innovation, the article reads.
He now runs an independent research firm called Thematic Markets, and his basic thesis is that the United States’ leading position in academic research and the close links of universities and business gave the country a head start in the computerization of the 1970s and early 1980s.
“With the internet in the 1990s and newer internet applications and artificial intelligence more recently, each innovation sparked a new wave of investment to take advantage of. This improved profitability and attracted foreign capital pushing up the dollar.”
That’s basically it. What happened is that companies used that increased profitability. Why? Because they increased productivity.
If you can produce things with fewer people, then you’re producing more things at lower cost, and that directly goes to profitability. That’s the idea.
It attracted foreign capital because now other people around the world wanted to invest in the U.S. companies that were doing that really cool stuff, and that pushed up the value of the dollar. Not only that, interest rates increase when productivity increases and when the economy heats up.
It reads, “Inventions don’t stay in one country for long.” I think this is a key point right here, but in each case, America’s head start gave it a few years lead before investments elsewhere looked as profitable.
Recency Bias and Currency Parity
Now, I’ve seen people give up on international portfolios because they think they haven’t been doing as good as U.S. portfolios. Well, are they forgetting the 10 years prior to that where U.S. stocks had a dead decade, zero return, negative return, and international did well?
How is it that we forget this stuff so soon? We just do. It’s called “recency bias,” when we think what just happened recently is what’s going to happen for the rest of the time.
By then, the earnings generated had flowed out into society and funded a consumption boom that eventually turned into a housing boom that financed building housing. The U.S. sucked in capital after losing its competitive advantage so the dollar had to fall and make it attractive to foreign money.
If you look at that point in time, that’s when international stocks did really well, if the dollar weakened. That means that it takes more dollars to buy something that is outside the U.S. because if I have a parity between the dollar and another currency.
In other words, I take $1 and I turn it into one yen, just for an example. If all of a sudden the dollar weekends, it will take $2 to buy something that costs one yen.
If it takes $2 to buy it, what just happened to that foreign good? It doubled in price from the American perspective. From an American buying it, they had to come up with $2 where previously they only had to come up with $1.
If I am the owner beforehand of that asset outside the U.S., what just happened? The value of the product, the thing that I owned just doubled, and hence, that’s the reason that parity doesn’t last forever.
You can have a strengthening of the dollar, and you can have a weakening of the dollar.
That’s just another aspect that actually causes dissimilar price movement between U.S. and international stocks. They’re basically saying that U.S. innovation is a big deal, and in the article it says, “It helps explain how the dollar’s long-run trends can carry on, even through temporary interruption of recessions.”
Economic Cycles
As evidence, Mr. Barth studied the length of cycles for various economic variables by using a frequency analysis technique from engineering. The cycle for the share of capital spending in gross domestic product matches that of the dollar for about 17 years. While things are important, the short run and such as monetary policy have a big influence on the long horizon.
Now, there’s a danger in looking at cycles in markets and that danger is that you might find that cycles shorten. For example, companies don’t last as long as they used to.
It used to be that a company would stay in the S&P 500 for over 60 years, almost 70 years, and now it’s down to less than 20. Companies come and go much more rapidly.
Companies have economic advantages over each other for less time. It’s simply because we have information exchange that is much more rapid. If I can find out what you’re doing as a company,what your competitive advantage is, and replicate it because I see what you’re doing and I hear what you’re doing and I can get information on what you’re doing much more rapidly, that would necessitate the shortening of the cycle.
People’s taste and attention spans are shorter too. Fashions don’t stay around as long as they used to.
Information exchanges much more rapidly today and that can shorten economic cycles.
Still, you can’t predict it. You don’t know when that’s going to happen, so trying to go into that depth of analysis is, I think, a little bit dangerous.
Don’t try to time this stuff. Realize that the dollar’s probably not going to strengthen forever.
This is why we diversify internationally and it’s just interesting to see how this goes back and forth. Maybe the U.S. is on an innovative upward swing, or it has been, but eventually other companies around the world will pick up on our innovation and start to use it.
You want to be there before that happens, because typically what happens with markets is they respond before the innovation actually starts to increase profitability in those companies, and by the time it happens, it is typically too late to get on board.
‘Confident Financial Planning’
Hey, folks, I want to tell you something I’m really excited about. My new book, Confident Financial Planning, is finally out. It’s in paperback, hardcover, Kindle version, and I actually have an audiobook version of it. It talks about building your financial castle. I use that metaphor throughout the book when talking about your investments.
Your financial plan is kind of like a castle. You have your savings and your emergency funds. I talk about that debt, good debt and bad debt. I talk about special goal funds and how to set those things up, as well as how to invest for those types of special things that you might want to do in the future.
I talk about the various types of retirement accounts, different types of taxation with investment accounts. I talk about real estate investing, the pros and cons of that, and how to project retirement assets. That’s how you protect your castle. It’s the risk management aspect of a financial plan.
If you want to find out more about that, you can go to paulwinkler.com/book.
Good Asset Management
A question came up, a client of many years was asking this question, and I thought it would make a good radio segment. The question was about how to know whether there was good asset management going on, or good investment management, or if there were problems, and how to potentially figure out what those problems were.
There is a process for this. You want to be able to do a quick self-assessment on an investment portfolio.
Most people don’t take the time to do it, but it’s worth just thinking about. The way I approached it was this: How do I know that I ought to be looking at something and making changes in my investment portfolio itself or in how it’s managed and who’s managing it?
One of the things that you do is this. I always refer back to the rules of investing and the things we know to be true about investing, just intuitively know to be true.
Well, I know that I ought to buy low and sell high, right? I don’t mean market timing when I say to buy low and sell high.
One of the things I try to get people to avoid is buying based on track records.
The first thing I do is think back to how you bought your investments. Did you look at the track record? Did you look at short-term history and look at if the fund did well over the past 3, 5, 10 years?
Tech stocks had the best return in the late 1990s. If you looked all around and asked, “Hey, which funds had the best returns?” It would have been anything that had a lot of tech in it.
Now, the other thing to look at is which fund managers really seem to know what’s going on and seem to have a good grasp on the future. That, again, is looking at the track record.
You’ll hear people say that so-and-so has been in the investment industry forever. Well, do you know what markets do? They move in cycles.
Markets move in cycles.
They go up and down. What follows up? Down. What you’re doing is you’re just buying all those things that recently did well and you end up buying in and all of a sudden it doesn’t do well anymore and you’re sunk.
Stay Away From Market Timing and Stock Picking
Another thing you do is this: don’t buy and sell, and buy and sell, and buy and sell. Buy and hold onto things, because what you’re doing otherwise is market timing and stock picking.
Buy and then hang onto what you buy, for the most part.
Look at turnover ratios inside mutual funds. You can actually go online or look in the prospectus and see the turnover ratio. If you have a 30% turnover ratio, it means 30% of the stocks are different from one time period to the next.
A 50% turnover ratio means half the stocks are different from one year to the next. Well, that shows you that the investment manager believes they can fix stocks and therefore could also be timing the market.
That’s another thing, intuitively I know I shouldn’t be buying and selling, buying and selling. If the fund manager is, you may want to take a look at what’s going on and why that’s going on.
Now, turnover can be higher in some areas. A ratio of 20% to 30% isn’t unusual, for example, in small company stocks because small companies become medium-sized companies.
Turnover as a result of, “I think this company’s going to do better than this one over here,” is problematic. If I start to see higher turnover rates, it tends to be a red flag for me.
Read the front of the prospectus where it talks about investment objectives. That will tell you if they’re likely to do that. You can typically tell by the language if they’re going to be moving money between various areas of the market.
Another thing that I look for are the types of bonds. I don’t want high-yield bonds. I don’t want them investing in high-interest-rate bonds because these companies have to pay high interest rates because there’s lots of risk. Bonds should be there for safety.
High-yield bonds tend to go down when the stock market goes down because when the economy gets weak, they start to drop in value. So it ends up being very, very dangerous to do that. Also, if I see 10-year bonds and beyond or longer-term bonds, that tells me there’s a problem.
The rules of investing: Buy low, sell high. Don’t buy and trade, and don’t try to time the market. Make sure that you own various areas of market diversification.
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*Advisory services offered through Paul Winkler, Inc. (‘PWI’), an investment advisor registered with the State of Tennessee. PWI does not provide tax or legal advice: please consult your tax or legal advisor regarding your particular situation. This information is provided for informational purposes only and should not be construed to be a solicitation for the purchase of sale of any securities. Information we provide on our website, and in our publications and social media, does not constitute a solicitation or offer to sell securities or investment advisory services, or a solicitation to buy or an offer to sell a security to any person in any jurisdiction where such offer, solicitation, purchase, or sale would be unlawful under the securities laws of such jurisdiction.
