Paul Winkler: Welcome to “The Investor Coaching Show.” I am Paul Winkler, talking about money and investing.
When planning for that period in time when you are not necessarily going to be working for money, but money is working for you, lots of planning must go into that.
Choosing the Type of Investment Fund
If you’re thinking about that point in the future — if you’re owning stocks — you want companies in your portfolio and people working for those companies on your behalf to deliver income and earnings and returns to you. How do you choose those types of funds? Well, there are a lot of different strategies that people use to choose investments.
Sometimes people try to vote with their conscience when they invest.
And there was something that I came across in an email and I thought I would just address it. It was this particular product being talked about. It was a kind of like, for lack of a better term, a biblical ETF, something that was investing in exchange-traded funds.
You’ve got mutual funds, and they’re traded daily, and you have a daily ending value as of 4 p.m. Eastern Time. And they calculate the value of all the holdings, all the stocks that are held in the portfolio, and go, “Okay, the share price of this particular fund is X — that can be whatever, maybe $40 a share — and how many units do you own? How many shares do you own of it?” And that’s your account value.
Well, then you have ETFs that are traded throughout the day, and that value fluctuates throughout the entire day. And then what happens is if you want to buy it at 9 a.m. and then sell it at 1 p.m., you can do that.
ETFs, they’re becoming a popular choice. I don’t use them in every asset category personally, simply because of lack of funds that I really like in those categories. But that’s starting to change, little by little.
I find there are areas where they could be added, and there are very, very strict criteria that I’m looking for. What are they doing with securities lending revenue? What are the asset holdings? What is the price-to-book of the funds that are being held? What is the market cap of the particular stocks that are being held?
So I’m looking for very specific criteria, and if there’s something in that area, there can be tax advantages, expense advantages as well. You also have to look at how much they’re traded, making sure that you’re not ending up with something where there are some possible issues with the arbitrage that takes place inside of these funds.
Complicated stuff. I’m not going to get into it too much, but it was in general this question about this particular fund and the idea of, “Hey, can I vote with my conscience? Can I buy a fund that lines up with my beliefs and my values?” Now, this has been done quite a bit in a lot of different areas.
What’s Your Best Interest?
We’ve had ESGs that people were talking about forever. It’s not being talked about so much anymore. Environmental, social and governance — ESG.
And what happened is they pretty much — with the returns and how poorly these things did — stopped talking about them. But it was gimmicky. It was this idea: “Hey, this aligns when I’m environmentally conscious, and I want to own something that is focused on that. Or maybe there’s social concerns that I have and I want to own things that line up with that. Or maybe governance — how the portfolio is run and who’s managing the portfolio and so on and so forth.”
But what happened is, returns at the end of the day came in, and people are looking at these things going, “This is terrible, this is awful.” But then there was this push to have the Department of Labor allow these in 401(k)s and then the big argument was, “Well, the returns aren’t so good. Is this really in people’s best interest?”
If you work for a company, they’re supposed to choose investment vehicles that are there and are being managed to your best interest.
What’s your best interest?
Well, for a lot of people, you’re going to say, “My best interest is to make sure that I’ve got returns that’ll carry me through retirement. That’s what’s in my best interest, that I have something that is likely to give me the income that I need throughout the entirety of my retirement or when I’m accumulating money. Because if I miss out on returns, I may be living off of my kids or I may be living off charity, I might be living off of the government or whatever if I’m not. And so it’s not in my best interest to have lower returns.”
So hence, what happened is the Department of Labor says, “Hey, we’ve got to make sure that employers are keeping people’s best interest first when choosing investment vehicles for their employees.”
And then what happened is ESG came around, and they said, “You know what? We’ll make an exception for this. You can have ESG and we can do that. Even though historically the returns are lower, we’re going to say that the best interest of the employee has been served when you have these funds in there.”
Because for a while it was like, “No, this is not going to pass the test.” But what ended up happening is then it ended up passing the test. Very controversial.
Christian-Based Funds
And then you have this thing about biblical funds. Now, this has been around for quite a while — Christian-based funds and those types of things.
I’ve known people who had that as their entire marketing strategy. That’s all they do are religiously conscious mutual funds. And I never jumped on that bandwagon, and there are a lot of reasons I never jumped on that bandwagon.
Number one, when I looked at the very biggest fund companies out there that were marketing themselves as religiously conscious, I often saw a lot of active management, a lot of stock picking and market timing. And you would look at the turnover inside the funds, how often they turned over, and I would see 100% or 120% higher turnover rates.
And then I would say to the person who was asking me about the fund, “Do you think that gambling’s a great idea?” And they’d be like, “No, that’s not necessarily what I think is a good idea.” And then we would talk about the turnover rate.
And you’re literally gambling by selling this set of stocks and buying this set of companies, and there are two ways of looking at it. You could look at it as gambling in that way, because what we know is — through the research — that when people are trying to pick stocks, what happens is they end up hurting returns.
There’s one study of pension plans that showed that when people engaged in market timing, 100% of the time they reduced returns when they engaged in it. It’s because what you’re believing is that the stock is mispriced. “I’m selling this company because I think it’s too high, and I’m going to buy this company because I think it’s lower than what it should be, and I’m going to make money by selling the thing that’s too high and then buying the thing that’s too low. And then when that goes up, I’ll sell that because it’s gotten up to fair value and that’s how we make money.”
And when you look at it that way, you are making the assumption that mispricing is there and that you’re smarter than everybody else. Now, if I think about it, that can actually go against biblical principles too.
Don’t think more highly of yourself than you ought.
If you believe you see a mispricing that nobody else in the world does, it’s kind of egotistical if you think about it.
So that’s that. And then you look at the turnover in buying and selling.
And the other way of looking at that is this: If you’re buying and selling companies, are companies all of a sudden very religiously conscious one minute and then they’re not the next?
Is it like how people can move in and out of being good? “That’s a good company, bad company. Oh, now they’ve become a bad company, we got to get rid of them.” And they’re going to buy the new good company, but then that company becomes bad at some point, and then you get rid of that.
Well, who owned it when it became a bad company, if that is indeed the case? You did because it was in your fund. So that’s another way of looking at this turnover. It doesn’t make any sense.
Quality of the Company
Now, if you look at the one that was being … I’m not going to even mention the ticker, the name of the fund, but I’ll just mention some statistics and make the point that I was making. It had 61% turnover in the past year.
Number one, if you look at the companies, 25% of them were tech companies, and you could say, “Hey, those tech companies, could they be helping pass information along that might be objectionable? Could they be used as a conduit to pass along objectionable information?” Well, yeah, they’re tech companies; technology is used all the time for nefarious purposes.
If we look at what the management style of the fund is, we ask:
What are they trying to do in the fund?
I actually read the Morningstar analysis of the fund in question and they said that the number one issue is that fees are a big weakness. They’re able to charge a lot of money, way more for this particular fund than other ETFs.
So number one, you’re paying a lot more. “Well, it’s because they’re screening for those religiously conscious stocks, so we ought to be able to charge more,” would be their argument. But that’s a high hurdle to clear.
And what happens is, when you have a lot of buying and selling, you have a lot of additional trading expenses that are actually being kicked up, but that’s not even part of the management fee.
You have the management fee, and then you have the high trading costs on top of that, and once you get through a lot of those extra expenses, you go, “Man, just kind of capturing returns of the market’s going to be incredibly hard.”
Then the other thing that they did here is they said that the portfolio strategy showed that it had, “maintained a substantial overweight position in momentum exposure and quality exposure compared to category peers.” In English, what we’re talking about here is that they’re trying to focus on the quality of the company.
Well, when you buy higher quality companies, those tend to be companies that have higher prices compared to earnings. Okay? So that’s one thing. You look at that, and you go, “I’m buying a higher quality company.” If I’m buying something that is a higher price compared to earnings, that decreases earnings yield, another return issue.
The Idea of Momentum
The idea of momentum is that an object in motion tends to stay in motion. So if a stock is going up in value — in fact, I’ll just read the way they put it in here. “Momentum exposure is attributed to holding stocks currently on a winning streak and selling those that are on a downtrend.”
What is the golden rule of investing? Buy low, sell high. What are you doing? You’re buying something, and it’s on an upward trend. Now that is a good way to break a rule of investing, number one, doing that. But the other thing is this:
Momentum can’t be a valuable strategy when you are looking at it as a way of reducing cost of the portfolio.
There has been research that shows that you can reduce the trading costs when you buy in that particular manner and you sell in that particular manner. But using it to increase the return of the portfolio has not been shown to be something that is actually valuable because of the cost of employing the strategy.
So what happens? You have trading costs when you’re buying, and if you try to look at it as a way of increasing the return, it doesn’t work.
But as a way of reducing costs, yeah, it does work to reduce costs.
It has to do with the way you’re holding a portfolio because you hold it and then you don’t wait for it to go to a downward trend before you sell it. You’re just buying it on that upward trend and that reduces the trading costs on the front end, but once you hold it, you’re not selling it on the back end, if that makes any sense.
But the research on it is interesting, and that is the only time I’ve ever gone, “Yeah, okay. I can see using it, in that particular instance.” If you’re using it, just try to reduce expenses.
Making Good Money Decisions
However, as a return tool — which is basically what they’re saying here, “We’re using it as a way to increase returns” — it is not shown as being a good way of managing money. So you’ve got a really high expense ratio. You’ve got a lot of technology stocks in the portfolio — 25% of the portfolio in technology stocks — a high buy and sell, small number of holdings.
I mean, if you only have like 100 holdings in the portfolio, what rule of investing is that breaking?” Diversification. So you end up in that situation where you hold a portfolio, and maybe it aligns with what you think you want to have as a person, what you believe that you should be doing, but then what ends up happening is — likely because of expenses, because of turnover, and because you’re buying companies who have high prices compared to earnings — lower earnings yield.
You end up with a lot of negatives in all of this. So I’ve never been a big fan of this.
You’re saying, “I’m just going to buy companies that I believe are good companies.” And I just say, “Well, you know what? All have sinned and fall short; you’re not going to avoid bad behavior.” I don’t care what you own or who you own.
Then you’re trading stocks, one for another. You’re saying that this company’s good, this company’s bad, and then you’re going to sell this one and buy this one over here because this one’s gone bad. I mean, I think I laid out a number of different reasons, and I think that’s pretty clear why I’m not a big fan of this particular strategy and why this is not something I have ever used as a criterion for choosing investments for a portfolio.
If you want to do good things with your money, do the most you possibly can to increase your returns.
Make sure that you keep your risks down so that you’re able to do good things with your own money, and you make the choices as to what is good and not good, or what aligns with your belief system and what does not align with your belief system.
That would be the better way of going, in my humble opinion.
Downsizing Your Home for Retirement
So when you’re planning for retirement, a strategy that is often used is thinking, “Hey, you know what? We don’t need to live in necessarily as big of a house as we raised the kids in.”
Let’s say that’s the case. “Maybe we’ll downsize in retirement and then move to a smaller house and then go off into the sunset with less, as far as responsibilities, to upkeep. Maybe the house we sell, it’ll be a really high-priced house, and then we can buy a much smaller house, and that’d be kind of nice, right?”
And then you have a bunch of extra money. “That equity or the value that the first house was greater than the second house that we can use as an investment to help us retire.”
Well, there was an article in The Wall Street Journal this week and it was talking about how downsizing your home for retirement isn’t the money move that it used to be.
And it was saying that downsizing from a big house to a smaller dwelling is a rite of passage for retirees hoping to simplify their lives and shore up their nest eggs, but it might no longer result in savings in today’s housing market.
And they were saying what’s, in essence, happening right here is this: People trade to smaller homes, and you could have lower upkeep costs because the place is smaller — maybe smaller heating bill, air-conditioning bill, maybe you got a smaller yard. It’s less to upkeep in that particular way, and maybe it’s a much smaller square footage. Typically, you’re going to pay a price per square foot. So that was a way to eliminate some maintenance tasks as you age.
But what happened is that now we have this situation where mortgage rates are going up. Now you may not have a mortgage. It may not be, you know, “I’m not going to have a mortgage on the next place.”
But that affects the amount of inventory out there, is really what they’re saying here. Which, true, if you look at it when you have higher mortgage rates, what people do when they buy houses is they will typically look at what their mortgage payment is going to be compared to their income.
Mortgage Payments
Sometimes you’ll hear rules of thumb, like don’t have your mortgage payment be any more than, like, 30% of your income. Sometimes 20% is thrown around. So the lower it is, the more manageable it is, because you just never know when Murphy’s going to show up at the doorstep and something’s going to go wrong, and you’ll really wish you didn’t have a mortgage payment that was that high of a percentage of your income.
So you look at that and you go, “Well, I’ve got to be able to qualify for the mortgage too.” Now, because when you go to the bank, they’re going to go, “Hey, what’s your income? What’s your income history?” And they’re going to be looking at what you’re going to qualify for.
Then you can come back and, especially if you’re going and getting pre-qualified, they say, “Here’s how much you can qualify for. Go forth and look for a new home.” And you’ll look based on what you can qualify for.
Well, as interest rates go up, what happens? That payment obviously goes up.
This is because the way your payment is calculated. let’s say if it’s a 30-year mortgage, they’re going to take the value of the mortgage — how much money you’re borrowing times the interest rate.
So let’s say that that amount you’re borrowing is $200,000, and the interest rate is 7%. So that’s $14,000 of interest. Well, that will be what you’re paying in that year roughly, and then you’ll have a little bit more that you’re paying than that because it will be calculated.
So let’s say you pay that $14,000 in interest and then you put another $4,000, let’s say, in paying down the principal. Well, the next year, your mortgage amount won’t be $200,000; it’ll be $196,000, let’s say. And then the interest will be calculated on $196,000 and then you’ll have a little bit more going toward the principal.
And as time goes on, more and more and more goes to the principal. And then what happens is at some point in the future, the principal amount is zero and your mortgage is done.
So what happens, as you’ll hear people say, is when you have a really long mortgage, a lot of interest is paid and not that much principal, and that’s why sometimes people try to shorten the mortgage to 15 years.
Paying Off The Mortgage
The problem that you can run into, and the thing to think about regarding that, is the more extra that you pay toward the house, the more you’re investing in real estate.
Because if I want to get the money back out, I’ve got to either refinance the house or I have to sell it, and you might end up with that situation where a disability happens.
So sometimes when people will look at mortgages, I might actually say, “Maybe have the longer mortgage, but pay the same amount that you would’ve paid with a 15-year mortgage.”
So sometimes that can be a strategy — have a higher payment — but only if you have enough money in savings, because it’s not as liquid.
I’ve got to sell the house or refinance to get the equity back out, and I really want to make sure, primarily, that I have a really good cash position from a standpoint of emergency funds. Sometimes you’ll say three to six months. You’ll hear that, or one year’s worth of spending in savings. It’s not unusual to hear that. When you’re younger, it might be even a struggle to get the three months’ worth of spending in savings.
But what happens if people put so much extra money toward their mortgage to try to pay it off early, and then they have that emergency — they’re disabled, something breaks, or they have to replace a roof or whatever. Getting the money back out of the house isn’t so easy.
They may go, “Well, I’ll just get a HELOC.” And you go, “Well, yeah, they’re callable loans.” And you can end up in a situation where the bank calls the loan on you. A lot of people have gotten in trouble with that, so it gets a little bit complicated.
But the thing that I’m talking about here is maybe if you’re in a good substantially solid cash position — retirement funds are well-funded and all of that — then maybe you can start making extra payments toward mortgages. And it really depends. I don’t like to get into too much of specifics here because in a financial planning context is when we actually have those types of conversations, being very specific.
What Do You Do?
But the point here is that when you have interest rates going up, what happens is most people don’t have a lot of money to put down on a house when they first buy it. So what’s happening is there is an increasing demand as interest rates increase for those lower-priced or lower-size homes, 750 to 1,750 square feet.
Since there’s only a limited supply and there’s more demand for those as interest rates go up because of how high their mortgage payment is going to be, naturally what happens is that prices go up.
So what happens? You have this high-priced house here that you’re selling, and you have the lower-priced houses going up in value, and the differential between them is reducing or it’s shrinking.
You don’t get as big of a bang for the buck when you sell the high-priced home because there isn’t as much demand for those things.
But you’re buying something where there’s greater demand. What happens is that leads to less of an equity benefit of selling the high-priced home and actually downsizing, and until those inventories catch up with the demand for these properties, that is what they’re saying here is likely to be the case continuing going forward.
So hence, what do you do? This is it. It may be delaying retirement. Some people may be doing that.
Some people may be just going, “Hey, you know what? I’m young enough. I probably should just make sure I save more just because I never know if when I retire, that same thing will start to happen.”
Just recognize that there could be these little things that creep up that are unexpected that cause one of your retirement plans — like selling a big house and buying a smaller one to make up the difference in your loss or your lack of retirement savings — may not be a strategy that works out in every instance, and this is a good example of a period in history where that strategy is not as beneficial as it used to be.
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.
