Paul Winkler: Welcome to “The Investor Coaching Show,” talking about the world of money and investing and educating along the way. Now, for the education part, the coaching part, sometimes people ask, “Do I have to know this stuff?”
The Psychological Process of Investing
Yeah, you better because if you don’t know this stuff, you’re investing your money with companies and advisors where you don’t know what they know and what they don’t know. The level of education to actually call yourself a financial planner is abysmally low. I think it needs to be much, much higher.
One of the things that happens is investors go through a psychological process. What causes investors to get really bad returns and investment advisors to make bad mistakes are really the same stuff. People have fears of the future and of what will happen next. They try to predict the future.
The investment industry takes their predictions to the media in hopes of getting something right. And if they hit it right, then what they will do is they will go out there and trumpet how good their returns were. And the media will search them out.
Whoever had good performance over the past year, past two years, or predicted the last big upturn in the market or big downturn in the market, let’s go interview that person because we want to see what they think is going to happen next.
If we can talk to them and say, “Hey, you figured it out last time. Do you know what’s going to happen this time?” That’ll attract viewership because everybody wants to know what the last winner has to say, right? Because what they do is they attribute that luck to skill is really what’s going on.
The media wrongly attributes luck to skill.
So what I’ve got to do is help offset some of that because I want you to know what I am doing and why I am doing it. I want you to know what expectations to have. Sometimes the investment industry says all that matters is cost.
I’ve done shows in the past where I talk about how that’s really wrong because there’s more to the story when it really gets down to it. There’s a lot of elements or a lot of ingredients in baking this cake of being a successful investor.
Let me just set this up and say, one of the things that we have been talking about for the past month are the issues with the banking industry. The issues of the banking industry have been bonds with the wrong duration.
Trusting Banks
So what they do is they take investor money and reinvest it. An investor makes a deposit at the bank, the bank takes that money and they reinvest it in something. They were investing it in bonds that were too long in duration. So with a seven duration, if the interest rates go up 1%, those bonds go down 7%.
Well, there’s a problem because people came and said, “Hey, I want my money back.” And they come in to get their money back and they go, “Well, your account’s not really… It was invested in these bonds and these bonds aren’t worth as much as what you deposited,” and that got them into trouble.
That’s where you had all kinds of issues where people thought, I don’t know if I trust my bank. So we had a lot of conversations about FDIC limits and all those types of things. And you would think that after coming out of that type of conversation, people would think, Maybe cash isn’t quite as safe as I think it is and maybe I’ll rethink not being diversified.
Especially so, when there is talk about the dollar depreciating in value and other currencies around the world and those types of things. If the dollar drops down in purchasing power worldwide, then what will happen is it’ll take more dollars to buy things, which is hyper lots of inflation.
Market timing by definition is any change in your portfolio based on a prediction or a forecast about the future.
I am not saying that’s going to happen, but that is what you hear a lot of talk about.
Never in a million years would I have thought, “Oh, I better talk about this again,” but I do, because if I’m hearing it out there are people thinking this everywhere.
The idea going around in maybe what I need to do is just go start pulling money out of stocks and putting it into more money market accounts or something like that because they are paying decent interest right now.
Now, let me talk about this concept from a couple different angles.
Avoid All Forms of Market Timing
So when someone thinks, Maybe I’ll put money out of stocks and put a little bit more money in bonds. I’m going to go and I’m just going to yank some money out of here and put it over here because now I’ve got a savings account that may pay 5% or whatever. That’s what I’m going to do. Well, that is market timing because I’m assuming that that 5% there is going to exceed the return of whatever I’m pulling the money out of.
Tactical asset allocation is still market timing.
Now, if you look at pension plans, I’ve talked about this before, there was a study done of almost 100 pension plans. What they were looking at was stock selection, how they chose stocks, when they moved money between different areas of the market called tactical asset allocation, which is a form of market timing.
They looked at asset allocation, they looked at other factors like expenses and those types of things. They found that the thing that drove the returns, what explained the returns, bar none, more than anything was the allocation of assets between large companies, small companies, value companies, growth companies, international, U.S., fixed income investments, and bonds. That’s what was important.
So they say, “Wow, let’s see, how about stock picking and the market timing? How about that element? How did that affect things?” It had a negative effect. In one study, 100% of the pension plans hurt returns when they engaged in that. Maybe if the pension plans can’t do this, just maybe you can’t do it either.
Maybe investment advisors can’t do it. Because we’re talking about the most sophisticated investors out there who couldn’t do it. What are the odds that you’re going to do it? I mean, just the odds are abysmally bad.
So when somebody says, “Hey, maybe I should… Let’s just go and do this cash thing.” Well, you think about this and go, what are your odds of being successful? I looked at the rolling 10-year periods throughout history. So a rolling 10-year period would be like 1928 to 1937.
Comparing Data
I said, “Let’s divide the money up between the S&P 500 large U.S. stocks, small companies as measured by the Center for Research in Securities Prices data. We didn’t even make it academic. We divided evenly between all four asset classes and then compared it against treasury bills.
Now, treasury bills are when the government borrows money for a short period of time. So what we did is just used three month treasury bills and just said, “Hey, what happened if I had put my money in those treasury bills, the short term safe, no volatility as far as markets go?” If interest rates are supposedly high, a lot of people have been comparing recently with the 1980s when it was 9% returns.
So you imagine the temptation now at like 5%, let’s say, if you can pull that off. You can’t find it in many places, but there are some places if you have enough money that they may pay you 5% of your money.
Recognize that what’s going on right now isn’t something that’s just brand new.
Now if we look at what happened in all these rolling 10-year periods, and you look at something called equity premium, as an academic would call it, they would say, “What is the return above treasury bills during the 10-year period?”
For the first two periods we used, the return of stocks was below treasury bills. Remember, we went straight into the Great Depression. But it was only 2%, just a little over 2% under. That was it. It wasn’t a huge difference if you look at that period of time.
If you took the first period and went one more year out, 11 years, you actually got back to positive territory where the equity premium or stocks did better than bonds.
So number one, you look at that and go, “Whoa, okay.” Then you have to go all the way out to 1965 through 1974 to find another 10-year period, and that was the period which would’ve included some of those high interest rates, the Carter years. And you look at that and go, “Wow, okay.”
Outperforming
But again, it was only a little over 1% difference in returns. Not a big deal. That fixed income outperformed equities over that period of time. And then you look at 1969 to 1978, again, got the Carter years in there, because we had higher interest rates, but again, not much over. The stocks underperformed treasuries in that one 10-year period by 0.32%. And that’s it.
So basically, I have named for you all the 10-year rolling periods. And if you look at it and go, “There are a lot of 10-year periods from that period of time. About 96% of the time, the equities or the stocks outperformed or had a premium over and above.
Now, what were those premiums? How much higher were the returns? Well, you had 4%, 10%, 11% from 1932 to ’41, and then 14% was the premium. Now remember, just to give you a better idea because sometimes these percentages don’t mean anything to you. If you have a 2% outperformance over a 20-year period, you have approximately 40% more money. It’s a big deal. It is a really, really big deal.
The ones that are small are 3.59. There’s 1968 to ’77, which is close to the one where it underperformed. It was above by 1.36. But if you look at that last period of time, and if you looked at what small company stocks did during that period of time, small international and large international companies, it wasn’t even close.
So if you were able to diversify more, is the point I’m making, then that premium where the premium wasn’t there or the stocks didn’t have a higher return than the treasury bills, well, you still outperformed treasuries or fixed income.
If you are able to diversify more, you’ll likely be able to outperform others.
What’s going on here is this panic that we go into as investors. It’s a primal panic that we go into where we just see a bad year in the stock market. Anytime you have a bad year or anything goes wrong in the economy, out of the woodwork the media’s going to come and they’re going to pile on you with the most negative, most scary predictions about what’s going to happen in the future.
Driven to Win
Then all the voices of doom and gloom will come out and they will sound prescient. They will sound like, “Wow, these people have really got it going on. They sound like they really know. And why is it that we think that they really have it going on? Because what they’re saying coincides with what we’ve just seen in stock markets last year.
Now, last year was a rough year. Now large U.S. stocks, which is what most American investors are overweighted in, got hit even harder last year. Really, if you were diversified, you shouldn’t have been hit.
So there were some asset classes that were only down a few percent last year. But here’s the point, when somebody starts talking and it coincides with what you’re seeing, all of a sudden now they have credibility and you listen even closer.
Especially when we’re driven to win, maybe we’ve been taught since we were kids to win, win, win, win, and all of a sudden I have an investment portfolio that doesn’t do as well as fixed income investments. Now then I go, “I’ve got to do something. I can’t just sit here, I have to do something.”
We think that we’re actually in control.
Then we do something. If you look back at some of the worst market downturns historically, when you look at these negative bad returns, what happened right after? Just when I would’ve been tempted to jump out and get out of the stock market and move off to the sidelines, well, that’s when you saw your really huge returns.
So you look at that and go, “Whoa, wait a minute. Well, what about the 2000 through 2002?” Well, remember you had 2008, but even with 2008, your premium from 2003 to 2012 was still 7.44% per year.
Remember what I said 2% is. It’s a big deal. It’s a really big deal. So really watch it. It can be easy to be sucked in and scared to do the wrong thing. Wall Street loves it, because the more you do transactions, the more you buy and sell and you get out of this and get into that and do that, the more they make. But my job on this show is not to make you profitable for Wall Street.
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.
