Paul Winkler: Welcome to “The Investor Coaching Show.” I’m Paul Winkler, talking money and investing and educating.
Understanding Financial Information
So you may go, “Well, why do I need to be educated about this stuff? What’s the big deal?”
Well, the reason comes down to this: When we get financial information, we get it from places that are typically selling us things, and we don’t necessarily recognize it. Or the person teaching the information has unknowingly gotten their information from somebody selling them something.
It was early on in my career when I worked for a broker/dealer and worked for a big investment firm — and I’ve worked with many different big investment firms — and I was just lucky enough to fall into some academic research and get into that particular world. Because if it weren’t for that, forget it, I’d be probably as lost as last year’s Easter egg.
But the reality is that when I was in that world, I was getting most of my information about investing, talking about real estate and investing in real estate, and different real estate investment trust types of programs and annuity programs from the insurance companies educating us. A lot of the education came from the insurance industry. Matter of fact, the insurance companies run a lot of the big institutions teaching financial advisors.
Do you think there might be a conflict there? It just could be.
But what happens is people get that information, or a mutual fund company pays for the symposium that the advisor attends. I went to a lot of symposiums put on by mutual fund companies, with the companies, putting together ETFs (exchange trade funds).
I would go to things being put on by various companies that were putting out real estate investment trusts and limited partnerships. These companies would pay for us to go through their education programs. And guess what they taught you? They taught you about their products, go figure.
They talked glowingly, and they would go through this whole strategy session on how to use their products to the advantage of the investor. And they did talk about that, but the reality is it was more of an advantage to them, which is really what you were learning about. But it sounded great.
So I always tell people, this is why I want you to get this stuff.
You don’t have to know everything that we know, but I want you to understand something about it.
Checking Up on the Financial Adviser
And a lot of times people say, “I can’t possibly.” And I go, “No, wait a minute, wait.” And that’s what this particular show, this hour right now, I am going to walk through: How you can sneakily check up on the financial advisor.
You say, “Well, how do you check up? And how do I know that what I’m checking up on is accurate, or that it actually holds any water?”
The reality is a lot of what you know about investing is true.
You already know certain things about investing, but you just don’t know how to tell whether those things are happening in your own portfolio.
So that’s where I want to go with this. How do you look at things, if for nothing else, maybe to have a little peace of mind that everything’s okay? Or now there’s a problem, and if there’s a problem, you don’t want to be that person that doesn’t figure it out until you’re 70 years old, or 80 years old, and you’re living on way less, on a much lower standard of living than you should be living.
I’ve had conversations recently with people where that was the topic of conversation. “Oh man, I just wish I was better with money when I was in my 20s and my 30s, or 40s.” And the reality is we can’t go back and fix it — it’s too late at that particular point.
Understanding what we have to do right now is, to me, critical, so that’s what I’m going to do — I’m going to spend a little time on that now. A lot of people think they know more about investment — and this includes investment advisors. They think they know more than they actually do. A little bit of knowledge can make you dangerous.
Ignorance about Finances
There was a whole video about that — I was watching it — and it’s about how the brain hates the idea of admitting that it doesn’t know something. It was an interesting premise. It’s us, we hate admitting that we don’t know something because we don’t want to look bad. “Ignorance, no that’s terrible.”
No, the reality is ignorance is fine. I’m ignorant about a lot of things, and I’m ignorant about brain surgery, heart surgery and just about any type of surgery.
It’s just fascinating. I suppose I could get up to speed on it if I really wanted to take the time to do that, but I’m not going to because I don’t have the time. But what we do when we go to a medical facility, is we go into a medical facility and we blindly trust there.
Why can’t we do that financially? It’s a whole different ballgame. When you’re talking about a medical facility, you’re talking about people in that facility having gone through years of education and they’ve jumped through a lot of hoops. You’ve got the education process, you’ve got graduate school, medical school, you’ve got residency, you’ve got a lot of things that they have to go through that, quite frankly in the financial industry, you don’t have to go through.
I was talking to a lady the other day and we were just talking about that very thing. She goes, “Well, what are the educational requirements?”
And I said, “Well, let me just put it this way. One of the requirements to actually be a registered investment advisor representative, one of my guys saying it took the coursework and it took them two weeks. That was it. A couple weeks of study, and boy, he had everything that he needed in order to call himself a financial advisor.”
And you go, “What, two weeks? Are you kidding?” No, I’m not kidding.
And it really wasn’t about investment management, it wasn’t academic investment management, it wasn’t any of that stuff. It was more about rules and laws — what you can do, what you can’t do, what you can say and what you can’t say. It wasn’t what you would think of when it comes to financial planning and advising.
Now, a lot of people who are in the industry can talk a good game because they’ve read some, and they are interested in it, but what are they reading? In my own history, in my own experience in interviewing financial planners that wanted to work with us, even when they had degrees, I was just going, “Whoa, wait a minute, you don’t know enough yet.”
And I would have to back off and say, “Now when you go in, go get some experience, go work in a planning position someplace and then come back when you know a little bit more. And then continue to grab more education as you go.”
The initial education to get the financial planning degree was great and everything, but it wasn’t enough because unless you apply it, it’s like anything else. Unless you get into the industry and apply your knowledge, book knowledge is great and everything, but it has to go a lot deeper than that.
Making Sure Your Investment Portfolio Is Okay
So what I’m going to do is I’m going to walk through some things that are important, and how you can, through the back door, look to see whether everything’s okay in your investment portfolio or not.
I’ve put together a little booklet on this topic one time, so I thought it’d be fun to walk through. But what I was getting at in the book is that typically, without any formal training, we know some things about investing that just hit our logic bone, so to speak, and just make sense to the point where, you know what? If the way I’m managing my investment portfolio is in line with my beliefs, and my beliefs are logical and it makes sense to me, and I have heard some of these rules before, if those two things are in alignment, then I’m going to be okay. I’m not going to be worried about it.
But let’s say that you believe something and that you have a philosophy about the way money should be managed, and maybe it’s really logical and it makes a lot of sense to you. For example, you hear that you shouldn’t time the market. I’ll give that as an example really quickly, and I’ll come back to it in a second.
But let’s say that’s the thing. You go, “I shouldn’t be timing the market.” And then all of a sudden you find out that your money is being managed using market timing. Then you are going to have something we call cognitive dissonance, where what I’m doing does not align with what I believe, and I’m not going to be comfortable, No.1.
No.2, not the least of which is this: What happens if my returns are way lower than they’re supposed to be, because not only am I not doing what I believe to be the right way to manage money, but I’m being harmed by it? And let’s say that the investment industry is actually fully on board and managing money in this way, which they are.
They’re not going to tell me that I’m out of alignment.
And why is that? Well, since I’m on market timing, let’s just talk about it for just a quick second. Burton Malkiel from Princeton, John Stossel asked him this question, “Why are they engaging in this practice if it has the tendency to hurt investors and not help them?”
And Malkiel said, and I’m just paraphrasing, he said, “I’m not saying this is a scam; they truly believe that they can do it. The evidence is, however, that they can’t.” And that’s pretty close to an exact quote of what he said.
Now, why is that? It’s because of our egos. As a financial planner, let’s say, or an investment manager, if you’re basically going out there and working with money every single day, it’s really hard for you to admit that you can’t figure out what’s going to happen next and where things are going to go, that you can’t study enough to figure out which areas of the market I should be in.
Tactical Asset Allocation
And it’s not just pure market timing — being in the market or out of the market — because you’ll hear people say, “I can’t do that. Can’t do that.” You’ll hear financial people say, “You can’t do that.” But what they do is they engage in what’s called tactical asset allocation.
Actually in my book, “Confident Investing,” I talk about the statistics on how often funds are changed in that particular manner. It’s mind-blowing that it is not the exception, but the rule that this is being done, where you shift money between small companies. I think maybe large companies can do a little bit better because of the interest rate atmosphere right now.
Or I think I’m going to shift it over here to growth companies because I think growth companies are going to do a little bit better based on what’s happening, what the president’s doing, what the president’s not doing, what Congress is doing, what Congress isn’t doing, what’s happening in China, what’s the geopolitical risk, etc.
I think we ought to be doing this based on what’s happening right now and the valuations in this particular area of the market. And these little subtle changes are taking place inside of people’s portfolios and they don’t even know that it’s happening. Now, how do you ferret this stuff out?
Well, with that particular problem (market timing), it may be a little bit more difficult. But I’ll tell people to go back and look at their statements, to pull up a statement from five years ago or pull up a statement from three years ago — just pull up a recent statement and look at the asset mixes.
How much is in big companies? How much is in small companies?
Look at your funds. Do you see big fund changes?
Maybe one fund is gone that you used to own, and now you don’t own it anymore. Maybe it’s an energy fund, and you don’t own that anymore. Maybe it’s a technology fund that just started to pop up in your portfolio recently. Now you see it there, but it used to not be there.
Or do you see a real estate fund that used to not be there but is there, or vice versa, the other way around? Now you see these changes. Maybe you had a fund, but it’s gone. Or that the asset mix has changed significantly, changing how much you have in stocks versus bonds.
Typically you see these little pie charts where you see how much is in stocks versus bonds. And you can look at that, just study them and you’ll figure it out.
Now it’s one of those things that I always tell people, if you just want us to look at it, it’s fine, we’ll do that. But here, I’m just telling you, this is something that you may want to look at yourself just to get a warm fuzzy feeling that it’s okay, or a “Wait a minute, maybe something isn’t quite right here.”
Using Style Boxes
Now, another thing that I’ll look at is what’s called a style box to see what’s going on, and I’ll look at, let’s say, a particular fund. Maybe you have owned that fund for the last 5 or 10 years, with no change while you’ve owned that fund. But if you go out there on the Internet, you can actually look at Morningstar and you can see what the style box was.
It looks like a tic-tac-toe box, is the way I describe it to people. You’ve got nine boxes, and if the box in the upper left-hand corner is filled in that is telling you that its large value is what the fund is investing in. If it’s the upper right-hand corner, that’s large growth and it’s a different area of the market.
With value stocks, you hear about Warren Buffett, the value investor. That’s why you hear about him because he would invest in value companies, or companies who had low prices compared to earnings and book value.
Now, if you look at the upper right-hand corner, that’s growth companies. Those are going to be companies that have a high price compared to their assets — the book value. And so what happens during some periods of time is those companies may do better or they may do worse. In 96% of 20-year periods, growth underperforms, and large growth underperforms.
So the upper right-hand box underperforms in 96% of 20-year periods. Let’s say the middle set of boxes is filled in. Those are mid-caps as you’d expect, the middle of the nine boxes. Remember, it’s like a tic-tac-toe box. So the top three are going to be large companies. The middle, that’s going to be mid-cap. And the bottom set, as you probably guessed, they’re small caps.
If it’s on the bottom right-hand side, it’s small value, and if it’s on the bottom left-hand side, it’s small value. On the bottom right-hand side, it’s small growth. And in the middle, they call it a blend. It’s typically a blend between value and growth, and you might hear it referred to as core.
But in essence, you’re looking for this.
You can typically find style box history on a fund that you own, and you can look to see if the style box changes from one year to the next.
Again, if this is something you can’t find on your own and you want us to look it up, we’re glad to. But this is something that I tell people to look for.
Also, do this: Read the prospectus. There’s an old saying that says, if somebody tells you something about themselves, believe them. If there’s something negative they tell you about themselves, then you can believe it.
Well, if you read the prospectus in the beginning of the funds when they issue these things, you can read these things and it will tell you, “We look for undervalued companies. We look for opportunities.” You see that type of language out there.
“We look for areas that are undervalued or overpriced to get rid of the overpriced ones and buy the underpriced areas, or the areas that are poised to rally.” You see the wording like that in the fund. That’s what they’re telling you, that they are shifting money between these areas based on what they think is going to happen.
“We’ve looked in our crystal ball.” Just think of it that way. “I’ve looked in my crystal ball, and here’s what I think is going to happen.”
Managing Money Properly
Well, so we just dealt with one rule of investing right there. I have heard forever that I shouldn’t try to time the market, and yet this is the rule in the investing world, not the exception. This is one of the things we want to look for, and if I believe that market timing doesn’t work, but my portfolio is being managed that way, that should be a red flag.
Now I’m going to go through a couple more rules in just a second, and we will walk through a couple of other things. Now, the other ones are going to be easier to find — a couple of the other ones are going to be a little bit easier to find — so don’t panic that this is already too complicated. I just gave you probably the hardest one.
I probably shouldn’t have started with the hardest one, but I wanted to start there. It gets a little bit easier from here. Some of the things you can look at, and it may be quicker for you to find a couple of these things.
But again, if I am just blindly trusting a financial person, I may be putting my trust in somebody who A., doesn’t have the education that I think that they have, and B., whose values and what they believe aren’t in alignment with what I believe and what I know to be true. And that’s cognitive dissonance.
And then what happens when we have cognitive dissonance is we will not have peace of mind. We will not be relaxed about money, we will not feel a sense of confidence that I believe that you should absolutely have.
If I’m putting money away in something, I don’t want to throw good money after bad.
If it’s not being managed properly. I’d rather just withhold, thank you.
Part 2
Paul Winkler: Okay, so let’s say I’m trying to figure stuff out. I worry about not having enough money in retirement, so I hire a financial advisor.
I hire somebody who I think is going to handle my car repairs, and I hope that they are going to be good at that. Well, how do I know that they are good at that? Well, my car runs when I walk out of the place, right? How do I know that, let’s say, the plumber is qualified? Well, they walk out of my house and I’m not having leaks all over the place.
There’s evidence and the evidence is immediate. In the financial world, the evidence may not come down the road until 30 or 40 years. You may not know just because markets go up and they go down.
When they go down, that doesn’t necessarily mean things are bad. When they go up, that doesn’t necessarily mean things are good. So how do I figure out whether I’m doing things that are in alignment with what academic research says?
Well, you have to know a little bit about academic research, but even if you don’t know a whole lot about it, you probably know a few things just intuitively.
Market Timing and Stock Picking
Don’t time the market. like I was just talking about. You hear people say it all the time. Well, what you’ll find out is that it’s very subtle, the way investment firms market time. They engage in tactical asset allocation, moving money around. And I just gave you one of the ways to actually figure that out. And if you miss that, you go back and check out podcastpaulwinkler.com. But these are the things that you need to know.
So one of the things that I tell people to look at is, number one, trying to pick stocks. You’ll hear people picking a company, and they make it big because they find the hot stock and they do really well. But now it’s kind of a running joke: “Hot stocks.”
People, I think, intuitively know that trying to pick hot stocks is probably not the best way to manage money. And you go, “Well, yeah, that doesn’t make any sense to me. That’s not me.”
I was talking to somebody the other day, she said, “I don’t change anything around.” I said, “I’m not talking about your changing anything around. I’m talking about the advisor or the fund company changing things around.” Well, how do I know?
So when I buy stocks, I don’t try to figure out what’s a hot company or what’s a really great company to jump into.
Now you may think, “Well, I just want to own the companies that I’ve heard of, that I know.” And the reality is, most of the companies we know, we know because they have done well in the past and they are already selling for high prices. So the future return potential is often significantly decreased as a result of that.
So what happens with fund companies is they’re always trying to find those hot stocks. They’re looking for the great companies because if they can get a good return over a short period of time, they can use that information in their advertising. They can use it to attract new money.
Turnover Ratio
So how do I know if they’re engaging in this process? Look at something called the “turnover ratio.”
Now, if you own a mutual fund, you can go out on the internet and look up that mutual fund — take the mutual fund name, and you might look for the ticker. You’ll have these five letters ending in X, and those letters will tell you how to find that particular fund — ABCDX, or whatever.
But you can look at the fund name, the XYZ Growth Fund A (it might be an A share, or it might be just to the ABC growth fund or whatever). That’s the share class, that letter afterwards. So institutional, front-end load or whatever. But what you’re looking for is to look at that fund and then look for the turnover ratio.
Search engines are great for helping you find this stuff these days.
You can look at that and look at the turnover of the fund.
Now, typically it’s going to differ. The turnover ratio that I’m okay with will differ based on the size of the company, but let’s say it is a large US blend or growth fund. I’m typically looking for a turnover ratio that is less than 10%. In most years it’s going to be less than that.
Now if it is a small cap fund, some years it may be less than 20%, maybe 10%. Maybe it’s under 10%, maybe not because small companies become medium-sized companies, and when they become medium-sized companies, they need to be moved on.
I’ve seen 30% in some really active years, but when I see 60%, 70% and I see 40, 50, 60, 70, 80 and 90%, I’m going, “Whoa, wait a minute, this looks like a real problem.” Because that’s telling me — let’s say it’s 60% — that 60% of the holdings are different from one year to the next.
So then I might be looking at value funds. I might be looking at a large value fund, and if I see 10% to 12%, that’s getting a little bit high, historically speaking. I usually don’t want to see it that high. But a lot of these funds out there, you might see 67, 80, 90% turnover. That’s telling you that there’s an issue. There could be a big issue with that.
Watch Out for “Opportunities”
Now, sometimes there are mitigating circumstances, but it’s rare that you might have a high turnover in a particular year because of some weird thing that was done in the fund. Typically, when you’re seeing that, and you can read the prospectus again, look at it.
What does the fund manager think their job is? Finding undervalued stocks. Looking for areas that are overvalued, moving those out, and looking for “opportunities.”
As I often say, that’s a buzzword that you really want to watch out for because the, “opportunity” means that they think that they can read the tea leaves and figure out what’s going to be hot in the future.
So that changing of the stocks inside of the portfolio, you think about it. You have multiple mutual fund managers out there, and quite often — as some of the academics have joked — if you’ve got one fund manager selling a stock and another person buying it, one of them is going to be wrong.
So when they engage in that type of process, here’s why they’re doing it: If they can beat their benchmark, the area of the market that they’re investing in (let’s say it’s large growth, or small growth, or large value, or small value or whatever) — if they can beat it for a short period of time, then they can brag and say, “Wow, look at us.” And then money flows into their mutual fund.
I mean, look back a couple years ago. Kathy Wood had this tremendous performance, and all of a sudden everybody was writing about her. “Oh my goodness, what a fund manager. Oh, phenomenal returns.” Then all of a sudden, this money flowed in and the bottom fell out. It didn’t work out so well.
Or Legg Mason Value Trust, that was another one. I beat the market like 15 years in a row or something like that, Bill Miller. And then all of a sudden, everybody’s talking about him, then all of a sudden the hot streak went away and people lost a tremendous amount of money.
So this happens over, and over, and over again, and I could keep going on with examples.
I’ve been doing this well over 30 years, and I’ve seen it over and over again.
So that’s another rule of investing: Don’t try to pick stocks. Buying and selling and trading and all of that stuff, those are some things you can look up. You can look it up in the prospectus, even the prospectus toward the back. Typically you’ll find where it has the turnover ratio, year over year, and you might see like five years worth of turnover. But turnover tells you how often they’re turning the portfolio over.
Now with bond funds, it’s not as big of a deal because bonds mature. I’m talking about stock funds here.
The Education of Financial Advisors
Now the next rule of investing is one that I hear all the time. Matter of fact, I hear it being talked about as the way to choose mutual funds. And I’m going to talk about a rule of investing that you probably intuitively know, “This is probably the way I ought to do things.” You’ll get why this is a bad deal.
Okay, so as an investor, you’re sitting there going, “I don’t know whether everything is being done properly in my portfolio. I have a financial advisor for that. They’re supposed to know those things.”
The education bar is not quite what I believe it ought to be.
You look at most industries, and the financial industries somehow get a bit of a pass when it comes to level of education.
Now, not in all countries. There are many countries where the requirement is pretty high to be a financial person. I remember Jonathan Clements actually wrote about this one time. He says that you go to some countries — and not even well-known countries like Germany or France, but some small country — and in order to call yourself a financial advisor, you have to have a fairly stout degree to be able to do that.
So in essence, what happens is a lot of people in America are their own pension manager. It used to be that you had pension managers who managed things, and they were pretty well-educated.
But in America, you might have a financial advisor, but you don’t have a clue about them; they just call themselves that and you think, Well, there’s got to be some big hurdle that they have to jump to be able to do that. And my answer would be, “Not necessarily.”
I’ve talked about studies like the Indiana University/USC study. I love to refer to it because they basically said, “Hey, you’re going to try to hold people to a fiduciary responsibility standard. Well, let’s take a look at the investment portfolios of financial advisors.” Oops. They’re making a lot of mistakes.
And so what they found in the study was a lot of mistakes, and bad ones. And not only when they’re working, but even when they’re retired and they have no incentive to be mismanaging their own portfolio, to be able to say, “Ms. Jones, I’m managing my portfolio the same way I’m managing yours.”
So you get rid of that, and you still have these problems. So what are some of the problems? Well, this is what I’m pointing out. You’ll see lots of stuff on my website about this.
The Funds’ Track Record
But anyway, what’s the next thing? Not necessarily in order, we can look at one of the basic things that we are told so often in choosing mutual funds: Go back and look at the track record. Look at how the fund has done over 3 years, 5 years, 10 years.
You may think, Well, 10 years is better than 5, right? Not necessarily. You may have a fund — I just named a fund in the last segment where the person beat the market for 15 years — and you go, “Well, what happened? Did the person lose their touch?”
I would submit that they never had a touch. What happened was they got lucky.
Out of tens of thousands of people trying, there’s going to be somebody who has a great, market-beating performance.
But to mistake that for skill is a problem.
So look at how the funds were chosen. Remember back to when you put your money in the funds. Do you even remember?
I’ve asked this question to some people and they just don’t even know. They don’t even know how the advisor chose them. You could ask, “So how are we choosing these things?” Just kind of casually ask how the funds are chosen. “Well, this fund, look at this track …” If they’re pointing at the track record, then there’s a problem.
Used to be that there was a company — who shall remain nameless, very prominent around here, very well known — and they would put out these books, and they were really nice. They would look at your portfolio and they would say, “Oh, look at your portfolio as it is right now. And this is what we recommend.” And they would have all the funds that they were recommending, all five star funds.
Then what they would do is say, “This is what would’ve happened had you been in these funds during the past 10 years,” or whatever period it was I’ve forgotten how many years it was. I think it was 10. “This is what would’ve happened.”
And you look at it. You can imagine reading this hard bound book. This thing was nice, and you go, “Wow. Oh my goodness. I way underperformed what I would’ve had, had I had the funds these guys are recommending.”
Funds That Underperformed
What you didn’t know, and I did happen to know — I knew the company really well — was that they didn’t even own the funds that they were recommending during the period of time that they were showing.
So what, in effect, you were doing is you were looking at the pie in the sky, but you wouldn’t even have that performance with them because they owned a different set of funds during the previous 10-year period than what they were showing you that you ought to buy.
Well, being the ornery guy I am, I kept that book. I have it in my office still to this day. And what I did is I actually tracked the funds that they recommended and what their subsequent performance was from the date that they actually recommended them. And it was bad.
In some cases, it was like 3 to 10% — 10% wasn’t unusual. The funds underperformed their benchmark going forward from the time they recommended them. They underperformed by that much.
And people that bought them unwittingly; they didn’t know it because they don’t even know how to check this stuff.
Do you know how to know whether your funds are doing what they ought to be doing?
I would venture a guess that the vast majority of people listening to me do not know. They don’t have a clue how to benchmark because it’s not something the industry goes out and teaches you, because if you learned it, if you understood how to benchmark, you’d fire them.
You’d be like, “Get away from my money. Don’t touch it. Get away.” But this is something that I think you ought to know how to do. I always tell people how to keep up with us. I think that’s absolutely critical.
You ought to have a way to just be able to look at things. It doesn’t have to take more than a couple minutes every quarter to know — in an objective way — whether everything is going the way it ought to be going. And so often we kind of miss that.
Now, what’s another thing that we can look at?
Mid-Cap Stocks
Now, here’s another thing that’s not so obvious because I’ll have to tell you a bit of the research behind it, but if I look through a portfolio and I see mid-cap stocks in it, that tells me that there’s a little bit of an issue. Now, why?
Well, because there is something called the “goalpost effect” in investing. If we look back through history all the way to the 1920s, we see that typically the highest and lowest returns occur at the very biggest and very smallest of companies.
What we look for in diversification is dissimilar price movement. We want to own things that aren’t performing well at the same time. So that’s what we want to see is the highest and lowest returns at different peripheries.
Now you think, Well, don’t they just cancel each other out if one goes up and the other one goes down? That’s not what I’m talking about. If I have one thing that goes up and the other thing goes down as much as it goes up, and that’s always what happens, then yeah, you’ve got zero return, right? It doesn’t make any sense.
Well, what we notice about markets going back through history — and you’ve probably seen the mountain charts before — is that they start way down here and they go up and up and back and forth and up and forth, but they’re basically going up at a diagonal.
That diagonal is going to be dependent upon what asset class it is in the return history on that asset category. One area might be a historical return of 10%, one area may be 12%, another maybe 11%, but that goes back and forth and back and forth.
And since they go up to the right diagonally, if I own something else that’s moving with it, what happens is they both tend to go off of that diagonal, if you can kind of picture it in your mind. But they don’t have great performance at the same periods of time.
One may go up 45% where another one only goes up 5%. Or one goes down 15% and the other one goes down 5% and one area goes down 30%. You might have an asset class that goes out like the S&P 500 last year, 18%. In 2022, it went down 18% where small value stocks went down 3%.
Now it was a different performance. They both went down, but they went down to very different degrees.
So with mid-caps, the issue really is this: You don’t have as dissimilar a price movement historically. And because of that, what happens?
Things move too much with each other.
Now, that becomes a real problem when you get to retirement and you’re starting to take an income. If you have one thing that zigs and the other one zigs with it, then all of a sudden you’ve got a problem. Your portfolio isn’t able to deliver the income because when they’re both zigging down, you’re having to sell more shares to get that same level of income. That’s the issue.
So really with medium-sized companies, I don’t typically like to have mid-cap stocks in a portfolio.
I typically say there are a couple exceptions. If I’m dealing with a 401(k), and I can’t find a good value alternative, I may use a mid-cap value because that will be better than not having that asset category. That’s typically better than just missing the area altogether just because the diversification benefits.
Choosing an Advisor
Okay, so when you’re investing, you’re going, “How do I know that the advisor knows what they’re doing? Where is the level of education?”
A lot of times we don’t really know what the level of education of the advisor is and I’ve talked to people many times: “How did you choose your advisor?” “Well, a friend of mine said that they recommended the person.”
And I say, “Well, how did they choose? Is your friend a financial expert?” Well, no, they wouldn’t be hiring an advisor if they were an expert in the area. So they may be recommending somebody because they’re nice.
So you got to have a little bit more. I think there needs to be a little bit more.
There’s got to be a way that you can look at things and know whether somebody’s philosophy of managing money lines up with yours.
Now, I’ve given a few rules of investing, and they’re basic things that you’ve heard forever.
Don’t try to time the market, how to ferret that out. I talked about that.
How to determine whether stock picking is happening, trying to pick the hot stocks or pick the hot areas of the market, and what’s going to be great in the period coming up or whatever.
Tactical asset allocation, I’ve talked a little bit about that, how to ferret that out.
Look at turnover ratios. Looking at “style drift” is what it’s called when you’re looking at the boxes changing and things like that.
Look at your statements from years ago. Compare them to now. Are there big changes that could tell you that there’s some market timing going on?
Look to see if they’ve recommended, or just in your memory, have they recommended things like saying, “Hey, you need to be putting more of your money in gold.”
People talk about gold, and I go, “It’s not an investment. There’s no cost of capital.” We look at that because it goes up and down based on supply and demand.
I hear financial people say, “Well, as long as you don’t have any more than 10% in your portfolio,” and I’m going, “Why would you want anything? I don’t want just a little bit of arsenic in my food. No, thank you. That doesn’t make sense.”
If you’re a dietician saying, “Well, as long as you don’t have too much arsenic, and no more than 10% of your diet isn’t arsenic, you’re fine.” No, that doesn’t make a lot of sense. I’m sorry, I’m not going there.
Bonds in Your Portfolio
Another thing that you think about is bonds. What are bonds for in your investment portfolio? When you think of investing in the bond market, what do you typically think of? What word comes to mind?
If you’re like most people, it’s going to be the word “safety.” So safety is the idea behind fixed income bonds. What can we look at there?
Well, we can look at the credit rating of the bonds, and you can actually find this information on your bond funds. If you own a bond fund, you can look at what the credit rating is. If you see AAA-, AA-, or A-rated bonds, then they’re lending money to companies or governments that have a high ability to repay. But if you start to see BB- or B-rated bonds, those lower rated bonds, then there’s a problem.
Another thing to look at is duration — if I have seven, eight, nine, if I have too much in my average duration.
For example, I look at my portfolio, and I would say my average duration summary is between two and three — a fairly low duration. You don’t want really high numbers there because what those high numbers represent is this: If interest rates go up that’s how much those bonds can go down in value.
Remember, what are we there for? We’re there for safety. If interest rates go way up, you can have stocks go down, as we’ve seen, and also your bonds can go down with your stocks.
There’s a problem because what happens is interest rates can affect profitability of companies, but they can also affect bond prices in a negative way.
So those are things that you just look at and start to ferret out some of that stuff. The education process you can start with on our website, paulwinkler.com. There’s lots of videos on there.
And of course, you can call up or go to one of our offices and talk to somebody.
And if for some of these things you’re like, “I’m not going to go through any of this stuff you just talked about” — well, that’s what we do as well. We help you out with that.
Becoming an educated investor, I think, is critical.
Don’t blindly trust the investment industry. It’s not an industry that you can blindly trust.
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.
