Transcript
Paul Winkler: So I hope all of you had a happy Thanksgiving and that you spent a lot of money on Friday and yeah, you’re going to keep the economy going because you know, it seems like there are so many voices out there trying to depress the economy. You think, you think everything went away after the election.
Downturns Are Temporary
Jim Wood: Yeah, there are some downturns, but the downturns are temporary. The long term trend continues to be up. And they talk about that. It’s referred to as climbing the wall of worry.
Paul Winkler: And you have people saying, Oh, the market hit record levels and you know, almost well, no, I can’t say almost, I didn’t see anything talking about that. Every other asset class did better. It didn’t see anything saying that in the news. And it’s just par for the course, you know, if they’re going to report on what the market did, it’s going to, they’re going to tell you what the Dow did and the S&P 500 and the NASDAQ, and as if nothing else existed. But yeah, that’s just business as usual.
Jim Wood: Yeah. There’s always these arbitrary benchmarks that get celebrated and, you know, and then they go up and then it can drop back down and it can hit that 30,000 mark multiple times. I mean, it can, you know, hit it, you know, 15 different times, but the first time he does it is for some reason a reason to celebrate.
Paul Winkler: One of the things I thought we’d talk about, let’s start off right away with, I’m just thinking we start talking about the myths of investing, you know, every once in a while, we’ve got to go back and revisit some things. And I think it’s important to revisit some of these, the myths of investing. Because if you look at why investors get poor results, it’s over and over again, I can point to that. It’s always that they have subscribed to some myth of investing and they’re pulled in by it. I’ve had more people say, well, you know, so-and-so said that this thing did really good in recent history. And you know, this is what this is what area of the market actually has done well.
And you know, this other thing that you own over here, so what myth is this? What are these other things that you own over here? Didn’t do as well. We need to get rid of the thing that you didn’t. And this is very popular this time of year. And the reason I bring it up is because people will actually do this for tax reasons. You know, they’ll get rid of something that has gone down and they’ll, they’ll do it to offset gains someplace else in a portfolio. And what are we looking at? What myth of investing are we looking at here is the use of past performance.
Jim Wood: Well, I, I just think of the buying and holding on onto stuff versus running around chasing returns.
Historical Performance
Paul Winkler: Yeah. It was, you know, looking at past performance and looking at historical performance. And, you know, we know that as you just said, Jim, I mean, when you look at that chart, it is a wall of worry, you know, it’s up and down and up and down, but what followed up down? So if I buy something based on past performance, why would we fall for that?
Jim Wood: But we do time and time and time and time again, it’s just crazy. You just see, you know, all my buddie’s, 401(k) earned 18%. And so I’m going to invest in what he has. Well, you don’t get to go back the previous year. That means nothing about what it’s going to do in the future.
Paul Winkler: Well, when did people really start to get interested in technology stocks? I hearkened back to that all the time, because it was such a pronounced and it was, it was making the news so much. I mean, there are, they’re all tons of little bubbles that people have chased. You know, people have chased gold bubbles, they’ve chased Bitcoin bubbles, they’ve chased energy stock bubbles. They’ve chased emerging markets, bubbles that have occurred. And that’s, that’s you notice that that’s in the news again, emerging markets are making the news again. And, and of course, you know, emerging markets already went up. So, you know, not, not to mean that it can’t continue to go up, but it makes the news. And then what happens is people chase it, like you said.
So what, what we do is we look at something and we see a pattern and then we chase that pattern. And it’s really, really tough to break people with that. So that’s one myth. And how do we know that it’s a myth? Well, because as you see, when you look at a market chart, it goes up and down. So, you know, that looking at past performance and another way that we know it’s a myth is that there have been numerous studies done of fund ratings and investment ratings firms when they rate something. And, you know, there are a lot of them out there, there are some that are more prominent than others, you know, and, and they actually do this. They’ll actually manage money in this way. So you’ll have fund management for an investment rating firm.
And what they will do is they’ll come in and, and they will look at funds and they will rate them based on performance. Well, so what are they looking at? They’re looking at past performance, but they get a little bit more sophisticated when they do it. Because nowadays, what they’re doing is they’re starting to throw in as their criteria or criterion. They’re looking at not only past performance and recent performance over one, three, five, and 10 years and acting like 10 years is a long time. It’s nothing. You can have somebody that randomly beats the market over a 10 year period easily. And there’ll be, you know, you might have like 25% of managers that might pull that off over a short period of time.
Now, do they repeat the next 10? You know? And the studies say, no, absolutely not. But here’s what the here’s what happens is they look at not only past performance, but they also do this, which seems more sophisticated. Oh, let’s look at risk adjusted past performance. So he beat the market. Okay. There’s a handful of people that beat the market, but who did it over the past three years or five years, it’s a really popular benchmark for people. We tend to focus on that. Who did it with the least amount of volatility. Oh, they are a really, really good, no, all you’ve done is you’ve taken this subset of people that beat the market and just found the ones that had the least volatility amongst them.
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Take a Look at the Downside
It’s still another random variable. And then what we do is we go, okay, well, you know, let’s not only look at that. Let’s take it as just let’s do let’s look at this, who did it with the lowest cost? Well, let’s say this, somebody I loved when Gene Fama, University of Chicago, Nobel Prize-winning economist, when he said this one time in a meeting and he was, he was talking about this. He was doing a lecture. And I was, eh, I was just really intrigued with what he said, but he says, look, here’s the way economics works, guys, if you have somebody that actually does outperform the market and does it with a low risk and shows the propensity to be able to do it, here’s what they’re going to do.
They’re going to raise their fees because they’re worth it. And what will happen is they will raise their fees to the point where the comparative advantage has gone, because there aren’t that many people that can do it. And then I was like, eh, that’s basic economics, isn’t it supply and demand? You don’t have an unlimited supply of people that can do this. Right. And if you find somebody you think can do it. Yeah. Then you raise the prices.
Jim Wood: It’s something I talked to in client meetings quite frequently showing them kind of the range of outcomes and talking about, okay, well, if we want to get rid of the down some of the downside, then we have to potentially give up some of the return. And so he said, well, we have to get rid of this stuff down here, which is the downside. We’d like to keep this part up here, which is the upside, but we’re not able to do that. Nobody’s figured that out yet. And then I’ll add if somebody did figure that out while everybody else would do it and it would go away.
Paul Winkler: That’s exactly right. And that was a good point. So it’s not unlike some of the effects that we’ve seen in the past where markets went up in certain months. Well, people bought in advance of those months.
Jim Wood: I think I’m talking about the tenure track records. And just thinking about if that was the only thing that’s important, then you look at the tenure track records. And then at the end of 2010, you would have run screaming away from large US stocks. Well, what was the best thing or at least one of the top couple of asset categories for the next 10 years, it was large. US so you said that what was called the dead decade followed by a decade. That was really good. And it’s just back to the point of diversification, you don’t know when any of that’s going to, yeah.
Paul Winkler:Now we’re going back to the other we’re in and we’re and people, it was the whole dead decade, that terminology really stuck. Why, why did it stick so much now? We’ve had dead decades where let’s say emerging market stocks did nothing or international, small companies did nothing or international, large companies did nothing. We’ve had those decades that have happened, but I’ve never once heard that terminology used for those other asset categories. Why did it stick when it was large US stocks, because Americans are overwhelmingly enamored with big US companies. And that’s why that terminology.
Jim Wood: Yeah. And that’s what they report on the news every night back to, you know, the doubt, but for the S&P 500. And those are the things you hear about.
Financial Trends
Paul Winkler: We look at, let’s say large US companies, small us companies, you know, these, all these different areas of the market. And we say, okay, so why can’t we look at this past performance? And it comes back to the problem that even pension fund managers, when studies have been done of these managers that are smart, well-educated, well-informed, very, very advanced degrees, you know, in asset management. And you find that they can’t, they can’t repeat their performance, or when you choose funds, based on that criteria, what ends up happening is you end up with underperformance in the future.
And we see that over time. But here’s, what’s, what’s curious, one of the trends I’m seeing right now, and I’ve seen it, a lot of 401(k)s are fund rating services being hired to manage investment portfolios. Now, it was really interesting because about 20 years ago, there was a firm, and I’m not going to name them because they are amongst so many that did this and still do it. But basically they chose all funds based on four and five-star track records. That’s how they selected things. If it had a high rating, they would choose it. Well, I kept a book for quite a while.
And that book, what I would do is I would go and say, okay, here’s what the book, here’s what they were telling you to buy in this particular, I think it was like 2005 or something like that. I can’t remember what the end year was. The book that I had had. It was a really, really nice, hard bound book that they used to give to clients. And they would say, you know, here’s your portfolio right here. Here’s what you own. And if you’d own the funds that we’re recommending that you buy right now, here’s what your performance would have been over the past 10 years. So they would use that to suck people in. And then what I did is I took that book. I just had, I just held onto it for a few years. Didn’t have to hold on to it for long, I only had to hold onto it for a couple of years. And I re-ran the reports on those funds that recommended the underperformance going forward.
They chose based on the best performing funds in the past and adjusted the underperformance. I’m telling you that the best underperformance and the best performance going forward was under the market by 3%.
Jim Wood: And it’s back to what are the funds that are currently being sold. It’s the funds that are four and five stars that are, you know, there were the managers getting interviewed now and how smart they are and all that. But none of that is persistent.
Online Services
Paul Winkler: The internet is going to help us be better investment managers, because we can go out there and we can look up information. And younger people are very susceptible to this, very susceptible, because what they do is they read, read, read, read, and they don’t realize that they’re being marketed too many times. They think, you know, that there’s some sophistication in what they’re doing, because they’re looking at risk-adjusted, looking at sharp ratios, maybe even, you know, correlation, coefficients, or they’re looking at our factors. And, and, you know, they go, well, you know, I am really getting this, because look at this, I can say the word. And, you know, they don’t realize the randomness of it is what ends up happening and they can get pulled in.
And then the problem that I see so often, cause I’ve had people come in here and say, well, my son told me to do this. And I just shake my head and go, Oh my goodness. They’re well-meaning, they’re trying to help you, but they’re getting information from all the wrong places. And it’s really, really easy because that’s who you trust. Right? My son wouldn’t lead me astray. My brother wouldn’t lead me astray. You know, my, whoever wouldn’t lead me astray and no you’re you’re right. They probably wouldn’t, but they can be led astray so easily because they don’t know what they don’t know.
Jim Wood: Well, all of these online services markets, Oh, we have all these great tools. You’re going to have these tools and you’re gonna be able to draw charts and lines and things that are going to tell you how to invest. The professionals have better tools and they are not successful at doing that as a green. Yes.
Paul Winkler: Well, who could predict 9/11? Who could predict the tech bubble bursting, who could predict, you know, the real estate crash who could predict the tsunami, hit something. Yeah, exactly. Who could bring, you know, it’s
Listening to The Investor Coaching Show, Paul Winkler, along with Jim Wood.
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