Should You Consider QQQ?

Paul Winkler: Welcome to this hour of “The Investor Coaching Show.” Paul Winkler, talking about money investing questions that people have.

Why is it that investing is so difficult? Well, there are pretty common themes that people will repeat over and over again.

One of the questions that I got this week was in regards to … somebody was asking about a particular fund, investing in QQQ. It’s a fund—well, rather an ETF—that tracks the technology sector of the markets.

So if we look at tech companies, companies that are … you see them in the news every day. You use their products every day.

So it can be very attractive to invest in something like this. Very, very exciting.

“I’m on the cutting edge of technology.” But here is—it’s a huge mistake that people make, and they make it over and over again.

When Investors Base Decisions on Emotions

The mistake is, in essence, that I’m thinking, “Well, I’m really onto something. This is really, really good. These companies are making all of the new technology that everybody’s using, and it just makes sense to invest in them, doesn’t it?”

Not necessarily. People put large sums of money, and what causes them to buy a fund like this … it’s like people justify with logic.

They buy on emotion, justify with logic. You’ve heard that before.

So emotion: you have greed, you have fear, you have loyalty, trust—a lot of times blind trust, as I often talk about—and this is how people make decisions.

It’s a very subconscious thing. It’s not something you even think about in the least.

But it’s how we make decisions. Our subconscious.

And it’s like this little rudder driving the whole ship in the direction it’s going to go.

You think that you’re using your mind. You think you’re using conscious, cognitive logical processes.

You think that you’re really left-brained in this whole thing, but you are actually more right-brained in the whole thing. Right-brained being more artistic, emotional, that type of side of the thinking.

So anyway, what happens is people go, “Wow, look at the past performance of this thing. Wow, this has had great returns.

“Man, I could be financially set, and I wouldn’t have to worry anymore if I could just have a fund that does this all the time.”

And then you go, “Well, okay. So how do I justify this with logic?”

Well, I justify with logic by saying, “Well, these are the cutting-edge companies out there.”

And of course, cutting-edge companies would be where I’d want my money. That’s where I want to invest in.

I want to invest in the companies that are going to be coming up with the technology that I’m going to be using and everybody else is going to be using for the next 10–20 years and on out in the future. The companies that are going to change the world.

And literally, that’s their tagline in their advertising for the ETF is just that.

A Frequent Struggle for Investors

So if we look at this, it’s not something that we haven’t seen before. In the late ’90s, good grief, it was just such a difficult period of time.

I remember watching the financial channels and just going, “This is really weird.”

If there’s good news—there’s good news comes out, sometimes it would make markets go up even higher.

But if it was really, really good news, the markets would actually go lower. And you go, “Wait, what’s going on here?”

Well, the really good news meant that the Fed was going to come in, and they were going to do whatever they could do to slow the economy down.

They have some tools at their availability: raising interest rates, raising short-term interest rates, and their bond purchases when they’re trying to drive interest rates down, but bond sales when they’re trying to drive interest rates up.

So they have some things that they can do because if interest rates go up, people don’t borrow money anymore. Or they borrow much less to buy things, and that slows the economy down.

So there are all kinds of mechanisms to slow the economy down. That’s what they’ll try to do.

Well, every time there’d be a really good piece of news that would come out, that’s exactly what would happen.

Tech stocks were just rocking in the late ’90s. I mean, they were just doing so well.

I remember just getting out there, and I was talking to people and going, “You really don’t need to be doing this. This isn’t …”

And it was very frustrating because people would go, “Well, you know … ”

And I didn’t have all the experience I have now where I could go back and say, “Hey, no. Let me tell you in no uncertain terms why this is a bad idea.”

So I would just be frustrated that, yeah, I got this fund with a really great past performance, but past performance is no indication of future performance. You can read the prospectus like anybody else does.

And it was really hard because people just instinctively and emotionally gravitated to this fund that had unreal returns.

Well, of course, what happened over the next few years is a drop in that area of the market of 80%. People’s sense of invincibility just went out the door.

There were these commercials on TV where these people would be just, “I don’t want to just beat the market. I want to beat it up, I want to trash it, I want to smash it, I want to hit it over the head.”

And it was just bravado all over the place. And turned out to be false bravado because, of course, the next couple of years, those commercials disappeared in a big way.

So the stocks that made up the index were really the big technology companies. And they were the benefactors of what was going on in late ’90s because technology was … Moore’s Law and technology doubling at a pretty rapid race.

Which Stocks Benefit From the Impact of COVID?

Now, you have recently, COVID. People having to operate out of their houses, can’t go to the office.

Computer sales—up. Software usage—up.

Zoom—up. Zoom, nobody hardly ever used that before this.

Now, you’ve got a lot of companies—Amazon, people buying things. Instead of going to stores and buying things, they started buying things online and got addicted to it.

So even when it started to dissipate, some of this, then, by no means …

I was talking to one of the delivery guys, and he says, “I can’t wait until this is over. I can’t wait until all this junk’s over,” and he’s just going on and on.

He’s one of the guys delivering all this garbage to people’s houses. So he’s like, “I’m so ready for people to actually be shopping at normal places again.”

They have to be run ragged; that’s the only thing I can think. As I think about it, that’s probably what he was concerned about.

So with that, the companies that did very, very well under this were the technology companies, right? And so far this year, the news with the virus is …

Look at South Africa. I was looking at a chart this week, and it was this rapid rise in cases and this rapid decline.

So a lot of people are coming out saying, “You know what? This may be pretty short-lived.”

And with a declining, of course, that doesn’t bode well for the technology companies because we don’t need them as much. Not that we don’t need them; we don’t need them as much.

The whole pricing of these companies was predicated on the idea that these guys would be the bomb going forward. This would be everything in our economy.

So like I said, you look at the ads for this ETF, and they said they hold stocks that are changing the world.

One of the points I’d like to make here is that, historically, it’s not the stocks that changed the world that had the best returns, but it’s the companies that use the products made by the companies that changed the world.

So if you look at a just regular old company, boring old companies, value companies—which might be manufacturing, those types of companies—they’re using the technologies to increase productivity, which helps them.

Projections, Expectations, and Returns

Now we’re sitting there focused all on these companies coming up with the technologies and forgetting that there are companies using that stuff that benefit from it significantly.

What happens is that—and I like to use this example from time to time because I think people, it resonates with them, makes some sense—but let’s say that we look at a company, and on a scale of one to 10, we go, “Oh, this company is a 9.7. They’ve got a future that’s so bright. They’re just really, really rocking and they’re really doing well.”

And the future turns out to be fairly bright, but it’s a 9.6. Their stock prices will drop because they have to hit the projections, or what people expect of them, because what I’m paying in price is really predicated on what the future of the company is.

Because every time you buy a stock, you’re buying it off of somebody that is giving up the future. They’re giving up the future profitability, they’re giving up the bright future that this company has, and you’re going to benefit from it because you bought the stock from them.

So if they’re going to give that up, they want a pretty penny to give that up. They want a decent payment to give that up because, let’s face it, they’re not going to benefit from it.

So what they do is they sell it for a very, very high price. And how do we determine if this is the case?

Well, we look at price-to-earnings: the companies, what they’re selling for, for every dollar of earnings. We look at price-to-book as another measure that we can look at.

And in both of these areas, this particular trust is pretty doggone expensive. Now I’m not saying it’s overpriced, that it’s poised for a crash, although it struggles when things don’t turn out the way everybody’s thinking.

It certainly can. We saw 80% decline in this particular fund, in this particular ETF.

You look at the year 2000, 2001, 2002, all three years the returns were very similar. Negative mid-30% range.

Yes, you are hearing me right. Negative mid-30% range. Returns.

I mean, really bad. And what caused that?

Well, they didn’t hit the projections. Things didn’t quite turn out as swimmingly well as people thought they were going to.

And what happens, as investors, is we’re getting sucked in by our emotions. There are all kinds of research out there—I’ve referred to research here on the show many times—of investor returns versus market returns.

Investor returns are way lower than market returns, literally for nearly four decades. This isn’t anything new.

And it’s precisely because investors desire to buy or hold onto investments based on recent past performance.

I mean, why is it somebody wants to buy this fund? Why is it somebody wants to hold a large sum of money in this fund?

I would submit that it’s not because of some very strong logical process. The reality of it is the person probably has no clue how high the prices are of the companies that are held in this portfolio compared to the book values, compared to the earnings.

It’s an emotional thing, and that’s exactly what we see with investors over and over again. Emotions driving the bus, and then people end up in retirement with not enough money.

It happens so many times, and I just tell people, “I would so much rather learn from other people’s mistakes than learn from my own mistakes. That would be so much nicer.”

Maximizing Returns Compared to Risks

Now, another thing you can look at, another way of looking at this, is risk and return. When we talk about risk and return, when we talk about academic processes, we are looking for how to maximize expected return for given levels of risk.

There are Nobel Prizes in Economics that are based on this.

So what do we look at? We look at standard deviation.

And standard deviation—you may have learned about this in school—it’s basically approximately two-thirds of your returns are going to be between one standard deviation plus or minus the return of a portfolio.

Ninety-five percent of returns will be between two standard deviations, 99% between three standard deviations. That simple.

So if you put together a portfolio that is very largely comprised of large U.S. stocks, S&P 500-type companies, standard deviation is about 20, long-term expected return about 10. So that means that you could have returns anywhere between 10 plus 20—30%—and negative 10 two-thirds of the time.

So in any given year you’ve got a two-thirds shot it’s going to be between negative 10 and positive 30. Well, that means 32% of the time it’s going to be outside that.

Well, 95% of your returns are going to be between 10 plus or minus 40, two times that. So 50% return, and on the other side negative 30. I mean, that’s pretty nasty.

You have a negative 30% return, that’s fairly significant. It takes a 42% return to just get back to where you were.

Remember, if you have a negative 50% return, it takes a 100% return to get back to where you were. You can’t just have the same return up as you did down to get back where you were.

Now, if we look at the QQQ and say, “Well, what was the return from the year 2000 until now?” It’s just over 7%.

You go, “Oh, big deal.” Compared to other areas of the market, big deal, right?

What was the standard deviation? Remember 20 was big; 27 is what it is.

So you look at that and go, “Wow, that is an incredible amount of risk to take for not such a great return over that same period of time.”

Now why is risk so important?

Well, because you could take two portfolios with the same exact expected return, same exact expected return, and the order of returns—whether it goes down then up, or up then down, or how the returns come in order—will significantly change what your outcome is and how much money you end up with, or how much money you don’t end up with or how little you end up with, especially if you’ve bought after good past performance.

Because you think about it, markets go up and they go down. What follows up? Down.

What are they doing? Purchasing based on past performance, which is based on short-term good returns, which just happened recently in an area of the market that actually benefited from a virus.

Don’t Rely on Short-Term Past Performance

So no, this is not a good idea. You’re investing in a sector of a market.

So you’ll have market segments, market asset classes, large and small and large-value and small-value and international. Those are asset classes.

Now, you can have sub-sectors inside there like technology and energy and consumer durables and so on and so forth. You’re basically betting on one little sector to do better than everything else.

In other words, what you’re betting on is that these companies that are so good and so wonderful and have such great technology, they’re just dying to pay you more money to use your money. They’re just dying to pay you more money.

When you look at it that way, you go, “Well, wait a minute. That doesn’t make any sense. If they’re so great, they ought to really pay me less to use my money.”

And that’s what we have seen over the past 21 years: 7% return, just a little bit over.

So anyway, don’t get enamored with short-term past performance. And yes, five, even 10 years is short-term.

Now it is so easy to let our emotions drive the ship when it comes to investing, but your emotions aren’t going to pay the bills later on.

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