Paul Winkler: All right, this is “The Investor Coaching Show.” I’m Paul Winkler talking about money and investing. This show has always been more of an academic approach.
Disinterested Investing?
Somebody this past week asked why it is that we are more academically driven than sales and product driven like most of the industry. He said, “I like them because they’re disinterested.”
In other words, it wasn’t something where we’re trying to push a certain agenda. Now, there are some academics out there that are agenda driven. I’ve seen it and it’s very frustrating when it happens.
The idea of science has become, it’s almost a dirty word in some cases because sometimes it’s used as a way of driving people to do something that you want them to do as a manipulative tool. One of the things that I have always said is why I want you to understand investing.
There’s a logic to it because you have to rely on yourself. Michael DelGiorno always says that he wants to understand investing because, if he understands it, he is the person he can trust.
You’re the person that you can trust.
The more you get what you’re doing and why you’re doing it, the less you’re blindly trusting the investment industry. Because, unfortunately, a lot of times the information you’re getting is just simply bad.
Now, one of the things that I talked about a lot this week is the idea that risk is always with us. So often what we see in the marketing, investment planning, and advisory side of the investment business is that we have to have safety.
We’re looking for security. We’re looking for safety. We’re looking for stability of the portfolio. You hear those types of terms used all the time. Can you think of anything that is supposed to be more stable than your bank?
You and Your Money
I mean, really, when you look at it, you’re not ever supposed to have to worry about whether you can get your money back. Prior to the 1930s, there was always a question, are you going to get your money back?
Is there going to be a run on the bank? Is there going to be any kind of a problem? And that was never an issue. But when you get into the banking world, we have the FDIC, but above those limits, we don’t have necessarily those guarantees.
That’s what people were really worried about. The other thing that I like to point out is how often that is the insurance industry as well. We think about annuities and we think about life insurance products and we think about these guaranteed income products and all those things.
What are they backed on? We don’t think about that when we read the fine print on these contracts that it always says, “Based on the financial soundness and the credit paying ability of the insurance company. Well, the question is, what is this insurance company investing in? What kind of bonds are they investing in?
Because you’re an intermediary between you and your money, to just say, “Hey, they’re going to be great. Everything’s going to be okay,” isn’t a good idea. You have to raise your eyebrows and say, “Well, wait a minute. If some of these banks are going through all kinds of difficulties because of their investments, doesn’t it make sense that maybe some of the insurance companies are going through some of these problems as well?”
Duration risk is real.
What happens is 30% of the money of insurance companies are in high risk bonds, and what type of risk is that? That’s credit risk that they just simply can’t pay back the loans.
When you’re dealing with low quality bonds, junk bonds, as we call them, but you don’t call them that in the industry if you’re trying to sell them, you only call them that if you’re calling them what they are, some of the junk bonds out there, you’re dealing with companies that if the economy gets really bad, these companies cannot repay their debt because they’re out of business and they maybe have to sell their assets, and you may get a fraction of the dollar on it when they do that.
Duration Risk
The other issue is this, it may not even be a credit risk. It may just be a duration risk, the idea being that, if interest rates go up, these bonds go down in value. If that happens, and if people want their money back sooner than later, these companies and these banks in this particular case have to get rid of the bonds.
They have to sell them. They have no choice in the matter in order to give people their money back. That’s not a risk that a lot of people think about.
So in the investing process, I’ve often talked about having a diversified portfolio. Now, you’re not talking about just sticking all your money in bonds. You’re not just talking about sticking all your money in large U.S. stocks.
I actually had a conversation with a guy whose retirement income plan was to stick all the money in the S&P 500. Matter of fact, I was talking about that in a newsletter.
Taking a 5% income of a portfolio of all U.S. stocks, even though it’s all stocks with an expected return of 10%, if you’re just taking a 5% income out of that portfolio, well, you’d think if it’s 10% expected return, you would be able to do that with no problem.
Wrong. Because you decimated the portfolio over the past 22 years, decimated it. I mean, literally drove it almost down to nothing. If you were taking a 5% distribution off a $1 million portfolio, you didn’t have a whole lot left. Why? It’s because of the sequence of returns risk, which is when markets go down, if it hasn’t done well and you’re selling it, you’re selling low.
The golden rule of investing is buy low, sell high. Yet so often what happens is something doesn’t do well and people go, “Oh, this hasn’t done well, I think I’m going to get rid of it.”
It’s just backwards. The investment industry’s backwards. Why? Because of instincts, emotions. Instances drive people so often when it comes to investing. Their instinct is to run away from pain, go toward pleasure, inner emotions, trust, fear, greed.
Fear and greed drive people to do the exact wrong thing at the exact wrong time.
So when we look at risk in general, it’s really important. You have to be able to measure it.
Reducing Risk
Well, you can’t control something you can’t measure, and that is why it is so important. And it’s important just to recognize there is no such thing as a risk-free existence. The thing that we thought had absolutely no risk whatsoever, the banking system, has everybody up in arms all week long.
There is no such thing as risk-free investing.
Really the way we reduce risk is really, really broad diversification, and we just don’t typically see it ever anywhere. I look at target date funds.
From what we know about investing, it’s one of the ways we reduce risk. For example, you look at the first part of 2000, 2001, and 2002. Value stocks did fine during that period of time. Growth stocks did terribly, negative 40% returns. Small company stocks did fine during that period of time. Small value did fine.
You would think that they’re more risky categories, and they are, if you look at them in isolation; but when you put them in portfolios, what we know from academic research is that because they don’t move with the other areas of the market, they can reduce the risk of the portfolio.
So often people don’t own those types of things and, because of that, they end up with a lot more risk than they think. It’s like the person driving down the interstate at 75 miles per hour. Is it over the speed limit?
Yeah, it’s over the speed limit. But if everybody’s doing it, what’s the likelihood that you’re going to get in trouble? Pretty much nothing. The investment industry often does the same things as one another.
They engage in the same practices, but their likelihood of getting in trouble is pretty low because everybody’s doing it. You can’t go and arrest them all. That’s just the way it works.
So, anyway, you may wonder, why are there so many of these shows and why does so much of this stuff sound the same?” That’s why.
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