Paul Winkler: Welcome. This is “The Investor Coaching Show.” I am Paul Winkler. I talk about money and investing, and maybe a little bit about conversations and things that have gone on during the week, which I think will be instructional for you as an investor.
It was kind of a fun week, wasn’t it? You got a debate. Things that were talked about during the debate were, I don’t know if I would talk about them from an investing standpoint or anything.
Predicting the Future
I did get into a conversation with some folks at Channel 5 this week. We were just blabbing about some stuff, just talking about things to talk about on TV and so on and so forth, and they said, “Well, at the beginning of the year you can talk a little bit about interest rates — what’s going to happen for the year? What do you think?”
And I said, “No, no, that’s what other investment firms talk about.” She started laughing, and I said, “No, seriously, but that is the investing world. That’s the kind of junk that they talk about.”
“What’s going to happen? What’s this going to do? Where’s market’s going to go?”
And the nonsense is that “This is going to help you.” Actually, what we know from the research is it increases risk, and we know that historically, it decreases returns.
It’s like all this stuff you want, right? More risk and less return. Yeah, that’s really great.
That is the thing that I find so frustrating about the investing industry. It is so driven by trying to get you to do things that don’t help.
It actually hurts, but that’s the investing industry. And it’s interesting to me when people ask me, “Hey, what do you want to talk about on TV, and what do you want to talk about on the radio?” They initially go to thinking this.
And no, that’s what everybody else wants to talk about. But that’s nonsense. And if I can break people of that, that is my biggest goal — to help break you.
You can be a tremendously successful investor, as I always say, without predicting the future, but unfortunately, the industry is so built around that idea that we have to do that, that’s what our job is, and everybody out there thinks that’s what investment advisors do. That’s what investment people do. And when they end up getting bad results from their investments, then they go, Well, the markets are terrible, you just don’t invest in the stock market, you don’t do these things.
I go, “No, don’t throw the baby out with the bath water. You don’t have to do that.”
Then on the other side, you have people that are just like, “Safety, safety, safety, safety. How do we get income? What do we do? How can we make sure that we’re safe, safe, safe?”
And I go, “Yeah, okay, great. You go broke safely.” That’s the other side of things.
What Are Your Investing Rules?
Income and retirement — we’re going to look at your income strategy. I heard a commercial this week — we’re going to look to see if you have too much equity exposure in your portfolio.
And it was coming from a firm that only does annuities, that does nothing with equities. And I’m like, yeah, okay, that’s really a great idea to ask somebody that does nothing with equity portfolios and diversified portfolios what the diversification is, because they have a dog in the fight.
They are trying to sell something that is non-diversified, and to talk about your diversification strategy is pretty counter to what their interests are, in my humble opinion. But these are the types of things that I try to educate about here on the show.
And one of the things that I was telling one of my guys this week, I said, “So let’s do this. Just run me portfolios from some people that have recently come in.”
Because people often ask us, “What do you look for? What are you looking at when you’re looking at an investment portfolio?” And the things that I’m typically looking at are: What do you do as an investor?
What do you believe to be true about investing? That’s what I often will ask people. What are the rules according to you?
The example I’ll give is that we go through a cycle, and this is why it’s so important: People tend to fear the future. They’re worried about what’s going to happen.
What’s the election going to bring? What’s going to happen this fall? What is the Fed going to do with interest rates? What’s going to happen with Russia?
What’s going to happen in Ukraine and Israel? Is that going to blow up into something?
What’s China going to do? Are they going to get involved? What’s Iran doing?
We’re so concerned about the future, and why not? I mean, you think about it. Yeah, it’s kind of a scary world we live in. So I want somebody to tell me what’s going to happen.
And the thing is this: When things seem to be risky as an investor, let me ask you this question, when things seem to be a little bit up in the air and seem to be a little bit risky and you’re thinking about investing, what do you as an investor require? You would go, You know what, if I’m going to take this risk, I need to have some promise of more what? You would say “return,” right?
Two Types of Risk
So when things seem to be the most risky, we would want to have some kind of a return potential or maybe even a higher return potential when things seem to be a bit scary. Just total logic speaking here.
I don’t want to go and stick my money into something just for a lower return. I am not stupid. I don’t want to do that.
So as an investor, I want some promised higher returns. Well, when things seem to be the most risky, we would expect that investors as a whole — and they do — require higher expected returns.
Now, I say “expected” because things can turn against you, and you just don’t know what’s going to happen, and hence that’s what risk is.
Risk cuts both ways. You have upside risk and you have downside risk. There are two different types of risk that we deal with as investors.
And this is what you’re doing when you’re allocating your investment portfolio — you’re trying to mitigate some of this risk. You’re trying to balance the different types of risk that you’re dealing with.
So when I feel a little bit uneasy about things, what’s my tendency as an investor? Well, just stick my head in the sand or put all the money in fixed income.
I’ve had some meetings recently with people and I go, “Let me take a look at what’s going on.” And I look at their portfolio and go, “You’re all in cash.”
“Well, yeah, I’m scared.” “Yeah, you’re sitting all in fixed income investments.”
And I said, “Well, you’re scared of what?” “Well, I’m just scared of the government. I’m scared,” and I’m going, “Well, who prints the dollar?” “Well, the government.”
“So you have all your money in something that’s printed by the thing you’re scared of.” And they’re like, “Oh, yeah, that’s kind of crazy, isn’t it?”
And you’re breaking a rule of investing that you’ve heard forever. You know that you’re supposed to diversify, yet you’re not doing it. Why? Because you’re scared.
And what are you scared of? You’re scared of the government.
You’re scared of Washington, and yet you’re putting all of your money in fixed-income investments that are backed by what? The government. So that doesn’t make a whole lot of sense.
Buying High
Then you get people that stick money in gold and go, “Well, I’m scared, I’m putting it all in gold.” And I’m going, “Well, what happens if the price of gold goes really high? What do you think mining companies do?”
And they’ll say, “Well, they’ll mine for more of it.” Why? Because they can make money by finding it, and they can make a lot of money by finding gold when the price is high, whereas they can’t make a whole lot of money if they find gold when the price of gold is low.
So they’re going to work even harder to mine for more of it when the price is high, and if they find more gold or if they mine more of it, or if they go to the bottom of the ocean or wherever they have to go to get more of it, they increase the supply. And then what happens when you increase the supply of anything?
What happens if you’re a car dealer and you have too many cars on the lot? What do you do to get rid of them? You drop the price.
That’s exactly what happens. It works against you, and you have basically shot yourself in the foot by doing this. So this is what happens.
When we’re looking at investing, let’s say we’re looking around and trying to figure out where to put money, I hear this all the time. “What did you look at when you invested in these funds?” “I don’t know. The investment advisor chose them.”
“Well, what did the investment advisor choose?” “Well, as I recall, when they did the presentation to me, they were showing me the track record.”
“So basically, you put all the money in the areas that happen to have the best track record over a period of time, and what are you doing?
You’re putting all your money in the things that are higher and you’re buying high just because it feels good but then going forward, what ends up happening? These are mistakes that people make.
Analyzing Portfolios
So I figured I’d just find a couple of portfolios from different people that have come in recently. I’m not going to say any names, I’m not going to do anything, but I just want you to see the types of things we see.
I’m just taking three of the most recent, three or four most recent ones. And I’m not going to even say which office it was because it doesn’t really matter. Because like I said, I try to do everything to not identify people.
I don’t want to put any shame on people because it’s not their fault. It’s not the investor, it’s the investment advisor’s fault.
These huge banks and investment firms that are putting these portfolios together, it’s their fault.
But here’s what I’m saying, the first one. Okay, so how much is in cash in this person’s portfolio? How much when they brought it in?
We analyze, we look at, how much is in cash, and we look at how much is in short-term, fixed-income assets, intermediate bonds, and long-term bonds. We look at how much is in large companies, large value companies, small and small value companies, and international large, and international small.
First off, this person has about 33% in fixed income. So this is probably a person that’s not quite at retirement, but they’re nearing it. So they’re adding a little bit more fixed income and bonds in the portfolio, which is a rational thing to do.
But what types of bonds do they invest in? Well, number one, they got a little bit in cash, about 5%. Not too bad. I mean, that’s maybe a little bit high, but that’s not too bad.
How much in short-term fixed? Nothing. Nothing.
Well, what are they missing there? Little bit higher interest rates, so a little bit more interest rate risk in that particular instance. When interest rates go down, you can have more of a jump in that particular area, but you get a little bit higher interest rate too. But they had nothing there.
How much in intermediate bonds? About 14% was in that particular area, which depending on the asset mix, is not a bad mix to have in that area. But then they had long-term bonds and about 14% of their portfolio in long-term bonds.
The Suitability Standard
Now what’s the problem there? I was looking at one person’s portfolio this week, and they only had one holding, a huge investment firm.
The lady brings it in and says, “Hey, this is my mom’s portfolio. She really didn’t want to pay any taxes on the interest. So the person put her in municipal bonds.”
Well, number one, her mom is a low-income tax person. She doesn’t have a lot of money. So number one, putting her in municipal bonds makes zero sense because you’re actually getting a lower interest rate with municipal bonds than you would with a corporate equivalent but because she’s in a low-income tax bracket, there’s really no benefit of it.
So she’s accepting a lower interest rate with the same risk as a corporate equivalent type of a bond, getting a lower interest rate and avoiding taxes, but the problem is she’s paying just about nothing in taxes, so there’s not much to avoid. So the investment advisor just basically putting in her whatever she wanted did her absolutely no favors whatsoever. In fact, it was harmful.
But is there any penalty for doing such a thing? No, not in the investment industry. You can do whatever you want just as long as it’s suitable.
And that’s the problem: Most people are under that suitability standard. They just have to do something that’s suitable. Doesn’t have to be in their best interest, but they may say that they’re being in their best interest, and they use that terminology as long as it’s not recorded someplace.
Anyway, I digress. So 14% is in long-term bonds. What’s the problem there?
And oh, by the way, this municipal bond, it was literally a maturity date out in the 2040 range. And this is a person that is a very advanced age, number one.
The Duration of Bonds
But what happens with bonds that mature that far out? When you have interest rates, let’s say if interest rates go up, you can have a huge drop in value in these bonds. You might have a 1% increase in interest rates that drops the value of this bond by 20%. I mean, that’s huge.
And here’s a woman of advanced age. They put everything in one fund. Why?
Because she wants that one bond or that one bond fund. And why? Because she wanted it?
“Well, I really wanted arsenic.” Well, that doesn’t mean I’m going to give it to you. That’s not a good idea.
So number one, that’s the first thing I look at is the bonds in the portfolio. What types of bonds? How long is the maturity? You can look at what’s called duration on the bonds.
We see with these long-duration bonds that you’re looking at lots of interest rate risk.
You have interest rates swinging, and you don’t know where they’re going to be. You really don’t.
I mean, it can be all over the place, especially with as crazy as economic changes have been lately. Well, lately, I mean in all of history. I mean, they’re always changing.
But when you do this to investors, the investors don’t recognize how much risk they actually have until these changes happen and they lose the money. So that’s number one.
Number two, what I’m going to do next is I’m going to look at stock holdings, where they are and what areas of markets and where the problems are. And what I’m seeing here, just looking at recent people we’ve actually done portfolios for. And this is what happens somebody comes in and says, “I want you to just look at this portfolio. I want to see what’s going on.”
This is what I’m looking at. These are the types of things I’m looking at. So I’m not going in just pie the sky. I want you to see that there’s a method to the madness when you’re looking at a portfolio and what you’re looking for, not expecting you to do it, but I’m just showing you what we’re seeing because chances are super, super good that that’s exactly what’s happening for you, of course, if we haven’t already looked at your stuff.
Looking Into Portfolio Risks
Okay, so you’re an investor, you’re putting money away for retirement. You hand it over to a big investment firm and say, “Well, they know what they’re doing. Let’s give it to them. They’re a huge bank, really big bank.”
I won’t name the bank. I won’t name it because it almost doesn’t matter. I mean, we have some of our folks that actually came from the banking institution. So what I’m seeing here isn’t anything different than what Jonathan Walker, who came from two major banks in the Nashville area, was seeing.
So I just want you to see what’s happening and what the risks are. Okay?
So number one, we looked at the bond portion of the portfolio. The overall holdings of bonds weren’t bad, but the types of bonds were terrible because if you have a huge interest rate increase and you have a lot of long-term bonds, you can have your stocks and your bonds go down together. So that’s a big problem.
The bonds are supposed to be there to help prevent big declines in the portfolio or mitigate some of that risk when stock markets go down.
And a lot of times stock markets go down because of interest rate increases or because now the cost of doing business has increased, the interest rate that a company pays.
So let’s look in the stock area. Let’s say we look at different areas of the market, at different asset classes. Now this is my pet peeve with the media, whether it be TV, whether it be radio, whether it be investment firms. I mean, they do this all the time.
I’ll hear investment firms do reports on what the Dow did today, what the S&P 500 did, what the NASDAQ did, and I’m like, “Nonsense, nonsense, nonsense. Large U.S. stocks, large U.S. stocks, large U.S. stocks. Why are you doing that? Why are you lumping the entire market into one area of the market for investors?”
Is it because you don’t know any better? I don’t know what it is. You should know better. Go study the industry, go learn more, go get into the academic research on investing, and understand the different factors that drive things.
But in this particular case, this big bank has this person’s portfolio in stocks, 57% of it in US stocks, and 9% international. Well, wait a minute, the U.S. is just one country. If all of a sudden the U.S. starts really screwing up because we have bad leadership, let’s say even if we have good leadership, this can happen.
I mean, you can look at the 1980s, and we had decent leadership, but international stocks just did way better than the U.S. So it’s not really predicated only on the leadership, but it’s just one country.
And we look at it and say, “Well, literally we have about a six-to-one ratio of U.S. stocks to international.” So that right there is way off because if you have a weakening of the U.S. dollar, then you have a problem there.
Four Asset Categories
Now, if we look at the U.S. part of it, let’s break it down to keep it simple just to four asset categories or asset classes: large, small, large value, and small value. Just to keep it really simple. There might be more breakdowns that we’re not going to break into.
I see this all the time with portfolios. I’ll see how much we have a tech fund over here. We have this technology stock fund, we have this oil and gas, this energy fund, or whatever.
In this particular case, you have four asset categories, and about 43% of the entire portfolio is in large stocks. Well, you look at that and go, “What’s that compared to other areas?” Well, large value is only 6% of this person’s portfolio.
Where do we expect more return value? What do they have way overweighted? They have 43% large growth.
What did they overweight? Large growth. What did they put in large value? Only 6%.
So right off the bat, if we look at the academic research and historical returns, they’re just overloading that area of the market that has a lower expected return, and by the way, has very, very high prices.
So the bigger they are, the harder they can fall.
And this person, I’m sure had no idea this was happening before we went and analyzed the portfolio. Small companies, 8%, that’s it. Then you got 8% small growth, which is you got small growth and you got small value. How much is small value?
Where you’d expect the highest return value, 96% of the 20-year period’s value does better than growth. How much did they have in value? Did they load that up?
No. It’s 0%. You go, “Oh my goodness, are you kidding me?”
So literally, we look at this thing, and 57% of the portfolio is U.S. equity and only eight of it’s small companies. I mean, that’s a six-to-one. It’s just, “Wait, that doesn’t make any sense.”
Oh, then you have international large; 9% of the portfolio is international large. How much is in small international where you have higher expected return and it’s a better diversifier? It’s 0.07% of the portfolio. I mean, that’s it.
Owning Individual Stocks
So this is a professional putting this portfolio together. And then you go and look at the holdings of the portfolio. What are they actually holding?
And this is what I see. This is often when you look at wealthy investors. What do I see often with wealthy investors? And basically, that’s what we’re looking at here: Somebody is a wealthy investor working with a huge bank.
And what do I see when I look at the portfolio? Well, typically what we want is lots of diversification. And we know that if you run a company, let’s say that you run a company and you have a stock in your company, and your company has two ways of raising money for operations, they might issue bonds.
So they borrow money. So that’s what a bond is. You’re borrowing money as a company.
Now, as a company, do you want to pay more or less interest? Well, you want to pay less interest. As little as I have to pay to use your money, the better. That’s really what I want to try to do.
So when it comes to stocks, what do you want to do? You want to give away as little earnings as you possibly can for the use of the investor’s money because you’re rational. You’re not stupid.
So the expected return of owning a stock, a single stock, is no greater than it would be for owning all companies like that company.
So it would be irrational to own single companies because you’re not getting higher expected returns unless you believe that the stock is mispriced. If you believe that it’s selling for less than what it’s really worth, then it would be rational to own that individual stock, right? That is why investment advisors often own individual stocks.
But what is that believing that the price is wrong? That is based on the idea that you have a prediction about the future that is better than other investors. And what do we know about people’s ability to predict the future?
Why do we know that? Because professional managers can’t seem to beat guys like John Stossel throwing darts at stock tables. They can’t seem to beat when somebody’s just taking a dart and throwing it randomly. They can’t seem to beat the return, and Stossel’s done that year after year after year.
Share Turnover
What do I see in here? I see companies like, let’s see, a pharmaceutical company, a chemical company, a bank, and an individual stock in a bank. I’m not sure what that one company does, and a gas company right there, another fuel company, another fuel company.
Oh man, that’s another fuel company. So they own a lot of individual stocks in the energy sector. They must be betting, and you hear this term all the time in the investing world, we’re betting that this is what’s going to do well.
They must be betting that the energy sector is going to do well because of what they’re holding. And the investor, I’ll bet then that they don’t even know this is happening because most people just turn a blind eye.
Say you’re the investment person for this huge bank, you must really know what you’re doing. And I would look at this and go, “No, I really don’t think so.”
They have emerging markets. They do have a mutual fund in here, emerging markets, with 44% turnover, meaning 44% of the stocks are different from one year to the next. That tells you that they believe that the stocks are mispriced. So they’re buying and selling and trading.
Who are they buying and selling, trading those stocks to? Other investment managers.
So they’re selling something that they think is overpriced to somebody that believes it’s underpriced. One of them’s wrong.
This makes no sense. This is completely illogical, in my humble opinion.
So that’s one portfolio. So let’s take a look at another big investment firm. We’ll do that right after this. You’re listening to “The Investor Coaching Show,” and I think it’s instructive to see the type of things that we see, and what I’m looking for.
Part 2
Paul Winkler: All right. I’m back here on “The Investor Coaching Show.” I’m Paul Winkler.
Nonsensical Investment Advice
So this is something that I just think people need to know.
People blindly trust investment advisors.
I’ve said that over and over again, and I don’t know that people quite get that message. So I thought one way to do it is actually take a look at a couple of people that have walked in recently and said, “Hey, can you just take a look at this?”
Now, what I want you to get out of this is that some of these things I’m saying when I’m teaching just the little that I am, you’re probably sitting out there going, “Yeah, this doesn’t make any sense. These are big investment firms. Last one was a big bank, and they’re doing these crazy little things. What on earth?”
And you’re not sitting there going, “Well, I’m just taking Paul’s word for it.” When I’m talking about long-term bonds, you get that those bonds don’t mature for 20 or 30 years.
You’ve got a woman that is a very advanced age, like over the age of 95, by the way, in this particular case. But a bond that doesn’t mature until 2042, are you kidding me? And a municipal bond that pays a lower interest rate to help avoid taxes, but she’s in almost a non-existent tax bracket.
And then you go, “Well wait a minute. That doesn’t make any sense.”
And it’s all in a single bond. The money was all in a single bond. Then you really go, “Well, why is it all there?” Because she wanted a tax-free bond.
The investment advisor should have said, “You know what? No, no, I can’t do that, it’s not the one for you, and I’m not going to do that to you. I want to make sure that you’re taken care of.”
And you know what? If you explained it to her because she’s not a stupid woman, she probably would’ve said, “Yeah, this doesn’t make sense. Okay, let’s not do that.”
But the thing is that the advisor didn’t explain. Maybe, I don’t know if the advisor didn’t know the differential between the interest rates on municipal bonds and the risk of corporate bonds and didn’t understand the concept.
I don’t know. They should know it, but maybe not. I’m not going to go there, because you just don’t know.
Sector Funds
So you’ve got another one, there was somebody who has an IRA and they bring it in, and looking at the portfolio, this one is holding a lot of bonds or a lot of mutual funds. So the mutual funds are investing in different asset classes, some value, a little bit of growth, and there’s an international fund and another value fund.
That should have been a red flag. Wait a minute, why do we have two large value funds? That should have been a red flag to the advisor.
Then you’ve got a science and technology fund. So this is betting on a sector.
Now, the Wall Street Journal a while back had an article that said the most risky, the highest risk mutual funds that you can invest in, are sector funds.
Why? Because you’re betting on a certain area of the market.
Now, why would I bet on science and technology as an investment advisor? Because the investment advisor chose these funds, I’m not going to even pick on the investor — I wouldn’t pick on the investor anyway because they don’t know what they’re doing. I wouldn’t expect them to know what they’re doing.
But why would the investment advisor do that? Well, they expect that science and technology ought to have great potential for the future, right?
Hey, that makes total sense that those companies would do well because then they’re in an area where there’s rapidly changing technology, and the future’s bright. But does that mean that those companies want to pay more to use people’s money? No, it would be just the opposite.
So to expect higher returns, you’re expecting that they want to pay more to use people’s money. That doesn’t make any sense at all, but that’s what they did. They put in a huge amount of money.
Matter of fact, that was the largest holding in the portfolio: a science and technology fund. So you look at that and go, “Well, wait a minute, what on earth?”
And then you look at this, you look at the turnover ratios as I talked about earlier, how much buying and selling is happening. So if I have a 50% turnover, half of the holdings are different from one year to the next.
Well, you go, “Gosh, why would they change half of the holdings?” They’re selling things that they think are overvalued, but they’re selling it to somebody who thinks it’s undervalued. So like I said, one of them is wrong, so it’s a gamble.
Well, the first fund in the list in alphabetical order had a 71% turnover, and they had another one at 52% turnover. And they had another one in here as a banking fund.
Again, it’s another bet on banking. They’re betting on the banking sector. So they got two sector funds, the most risky thing. And this investor probably had no clue; I’m sure they had no clue.
Now, one of my clients, one of the guys that I work with, we share information on the funds, things that we’re looking at, and things that we’re seeing, to just help the investors. And this one had a 61% turnover. So what are they doing?
They’re basically betting on one bank and then they bet against that bank, and they bet on this one over here. And that means that they’re changing 61% of the holdings. So look at that and go, “Oh my goodness.”
Asset Allocation
Now, if we look at the asset allocation, the idea is that 91 to 94% of your investment performance is due to asset mix. So this person has this portfolio managed by a professional and about 4% of the portfolio is in cash and 79% in large U.S. companies. Now, that’s one heck of a bet on one country and one area of the market in that one country to have almost 80% of your portfolio in that one area.
Oh my goodness, they had 0.6% in value stocks. I mean, you’d expect more return out of value than growth. And what do they do? They load up on growth.
And the reality of it is when you have market downturns, historically, value tends to protect better on the downside, so there’s just nothing there. And then you have small companies at 0%. Small value, 6%, big whoop. A large international, which would move very much with large U.S. historically, 9%, but small international, which would be a better diversify, 0.13%.
So again, big investment advisors who should be well-educated are putting just about nothing there. And then you have another person come in with a single mutual fund, that’s all they have, all of the person’s money.
This is a major, major firm in the Nashville area. Everything is in one fund, and that fund is basically all in one area of the market, in large U.S. stocks. All of it, 100% of it. That’s all they’re investing in.
Well, 98%, not all, but pretty close to all is in that one area. How much turnover is going on inside that fund?
How much buying and selling? It’s 47%.
So half the portfolio is different from one year to the next, which breaks the rule of investing that we all have heard, which is buy and hang on to things.
And they’re breaking that rule of investing. And it makes me beg the question, does the investment advisor even know that that’s happening? They should.
Double Dipping
Our next one is a big 401(k) managed by a huge mutual fund company. So you have a mutual fund company manage your 401(k) at work, you put in your money, and this is a significant amount of money that this person has; it’s a very large investment portfolio.
So they have an international stock fund and an emerging market stock fund. They’ve got a global all-cap fund. What does that mean? That means that you’re investing in global. When you see that term, they’re investing in both U.S. and international.
Well, we already covered international, so they’re double dipping here, which breaks the rule of investing of what? Diversification, right?
Then they have a huge amount of money in large U.S. stocks and a huge amount of money in small to mid-cap. Well, mid-cap stocks are not a good diversifier. Why? Because mid-cap stocks move way too much with big companies.
So if we’re trying to diversify a portfolio, we want things that don’t move in tandem with each other.
Because if I have two things that move with each other, it’s like the old joke. If both of us have the same opinion on something, one of us isn’t needed.
Hence, I don’t want things that move with other things in my portfolio because that doesn’t help with the reduction of risk. And yet that’s their biggest holding is a fund that’s investing in an area of the market that moves with their second-biggest holding in the portfolio.
So they’ve got the biggest holding, moving with the second-biggest holding in the portfolio. And then they have the third one that’s investing in a value type of fund. But if you look at the price to book, which tells you whether it’s value or not, the prices are fairly high.
Now, this is way beyond the scope of this show, but I’m just looking at it from an investment advisor standpoint or somebody that knows the academic research and goes, “This isn’t very valuable.” It may be called a value fund, but it’s not very valuable.
And the turnover rate on the fund over the last calendar year was 192%. I mean, that is an insanely high turnover rate inside of a fund, again, managed by one of the biggest mutual fund companies in the world. And you would go, “Well, wait a minute.”
Remember the Rules of Investing
Then you have a Vanguard fund. That’s another fund in here. It’s a 41% turnover rate in the portfolio and a 3.5 price to book, which is getting way up there.
That’s really getting high compared to markets around the world, with some markets being down in the neighborhood of close to one or just above one and some a little bit below one, and now you got this one selling for three and a half times that. So this is the type of thing where I just want you to get the idea.
Then if you look at the portfolio mix, 79% is in large U.S. stocks, and your different types of the asset mix in here is — again just weighted, without belaboring it — way overweighted in large companies, very underweighted in smaller companies (which are better diversifiers), and internationally all large — almost nothing small company wise. This is the problem that we see, and most investors don’t realize it’s happening.
So number one, this is the first thing that we look at. Number one, what I like to do is this, and I go, “Okay, what are the rules of investing?” Buy low, sell high.
“Okay, so did you buy based on track record?” Maybe sometimes people know that they didn’t and sometimes they don’t know.
What’s another rule? Buy and hang on to things. So look at the buying and selling going on inside the portfolio.
It’s right there for you to look at. There’s a way to go and grab this information because if I believe something, I believe that you don’t trade all the time, you don’t engage in this.
And I’ve heard about churning. You go look up churning on the internet regarding stocks and you realize this is an activity that regulators are just very much against, that this is a bad thing. This is a bad practice by investment firms.
You start to go, “Well, there’s churning. Why is churning so bad?” Because you have transaction costs every time stocks are traded.
You have bid-off or spread costs every time a stock is bought and sold, and you can have commissions inside the funds.
You have these transactions because investment firms don’t do trades for free. Now, it may not be part of your management fee that you’re paying, it isn’t part of your management fee, but this is something that we look for.
So, we look at these things. Well, what do you expect when you go in and talk to somebody? What should you be looking at?
What To Look Out for From Investment Firms
So often what people hear is a sales pitch for the investment firm. “We’ve got great research, we’ve been around for 179 years. We’re bigger, we’re huge.” And you go, “Well, sometimes being really huge, that just tells me that you guys made a lot of money.”
It’s like that academic, one of the academics I studied under, he talked about going down to Wall Street and getting a tour, and the broker is pointing out into the harbor and saying, “Hey, look out there.” And this professor is going, “Yeah.”
The broker says, “Those are all the brokers’ yachts.” And the professor goes, “Well, where are all the clients’ yachts?”
So just because you’re big, that doesn’t necessarily mean good. Investment firms do a lot of things that make them very big and make them very wealthy and give them big buildings and big institutions that they can bring you in these marble hallways. And the reality of it is so often it is the investor that doesn’t even realize that they’re getting taken advantage of.
And individual stocks, I’ve talked about this. You see these people with large portfolios and you see a lot of individual holdings, and you’ll see that they’re betting on certain areas of the market, or they’re betting that that company wants to pay more to use their money than another company. It’s irrational.
It doesn’t make any sense that one company wants to pay any more to use your money than any other company.
It doesn’t make sense that you have the ability to tell me which company is underpriced and which one is overpriced. We know through research and people throwing darts that people throwing darts typically get higher returns than professionals. And we’ve seen that over and over again.
There are some really funny experiments out there where they’re showing, that look, literally random luck, monkeys throwing darts, outperform the professionals. So when I see individual stocks right away in somebody’s portfolio, I’ll go, “You got a problem here.”
Because if I want to get diversified in the S&P 500 companies, $50 a share let’s say is the average share price, and selling in round lots a hundred share units, it’s $2.5 million to get diversified in one area of the market that has 500 companies. Then you go and look at, for example, small companies.
You might have 2,400 companies in that area. Small value might have 14, 15, or 1,600 companies in that area. Large value might have 400 or 500. You might have 800 international large companies and 4,800 small international companies.
And you start to add this up, and there are very few people that, number one, would have $40 million or $50 million to get diversified in all of these areas and really have broad, broad diversification.
Now, some people say, “Well, you don’t need that many companies.” And the reality of it is the academic research says yeah, it’s actually the more the merrier. You get rid of that non-systematic risk, the risk that something specifically happens to a small number of companies.
So the pros just aren’t that pro. And this is what we show people when they come in for us to take a look at the portfolio. And it’s not, “I have to take your word for it.” It’s based on rules that you know and you’ve heard forever, and you want to make sure you’re following the rules that you know to have peace of mind around investing.
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.