Paul Winkler: And welcome to “The Investor Coaching Show.” I’m Paul Winkler, talking the world of money and investing.
The idea is to get to the point where you do what you want to do and have money work for you.
Maybe go visit grandkids, go travel the world. Maybe that’s not the most practical thing right now.
Well, I guess maybe it still is to some extent, but things come and go, don’t they? You notice that in life; it moves in cycles.
Things are great, then they’re not so great. Then they’re great, then they’re not so great.
And then you just go, “Well, okay, you’re just not going to figure this out.” Life is an up-and-down thing.
But the idea is to plan for that day when things are up and you can do the things that you want to do, and maybe that’s just traveling around the U.S.
Maybe it’s seeing things you never saw in this country. Maybe it’s going abroad.
Maybe it’s going and hanging out with family members in other places or just being able to go out to eat and do the things you like to do right in your neighborhood.
Maybe you’re a homebody. You don’t like to do any of that stuff.
But this is the show for that, and just helping you understand more about investing so that you’re not blindly trusting investment advisors and not blindly trusting mutual fund companies.
Because let’s face it, mutual fund companies are marketing to you, and they may not necessarily be telling you the right stuff either. You’ve got to be really wary.
Got an Investing Question? Send It to Paul
That’s what I like to do here on the show is educate, because the more you understand this stuff the less you worry about it, but the more difficult it is to actually lead you astray.
One of the ways you can do that is to ask a question by going to paulwinkler.com/question. That’s one way that you can do this.
What happens when you ask that question is we get an email that you have a question, and then we have your email address.
We can email you back when I have an answer or when I’ve done an answer to the question on the show. So we do it in a segment, and then we’ll send it to you.
Because the podcast is on the website: paulwinkler.com. And if you’re subscribed to it, you may actually hear it, but if you’re not subscribed to it, shame on you.
No, but seriously, you actually can get an email from us.
Anyway, we want to make sure that you get the questions answered. Again, it’s paulwinkler.com/question.
Why Not Invest in Mid-Cap Stocks?
Roy asked a question for the show, so I thought I would start off with that. He says, “You suggest eight categories of investments.” He said, “Large, small-cap, value, growth, U.S., and international.”
In general, when we talk about the market, “the market” is just too broad of a term. It drives me crazy.
What did the market do today? Well, which market?
If we look at some areas of the market, even though you have areas that are down quite a bit, there are other areas that are up quite a bit year-to-date.
Most people don’t realize that because all they hear is the term “the market,” which is typically just referring to big U.S. companies.
So you’ve got small companies, you’ve got large companies, you’ve got value companies here in the U.S. Value companies, and you’ve got growth companies, and so on and so forth.
“I’ve always had good returns with mid-cap,” he says. “What is the reason you’re not recommending them?”
Well, the reason comes down to academic, because that’s where I always focus is what do the academics say? What does the academic research say?
When you put together a portfolio, I’m not just looking at returns. I may sound blasphemous to say I’m not just looking at returns.
I’m also focused on risk-adjusted returns. Risk is a part of the equation when it comes to investing.
The Benefits of Risk During Accumulation Or Distribution
Now, I may have two portfolios with the same exact return, but I end up with really, really different outcomes because of the level of risk.
Now, in the accumulation phase, risk is not as big of a deal in the accumulation phase of investing. In the distribution phase, it’s a big deal.
But it can be kind of a big deal even during the accumulation phase, so don’t get me wrong about that.
You can have volatility that actually works for you because if you’re putting set dollar amounts away, you’re buying more shares when the market’s down and you’re buying fewer shares when the market’s up.
Well, if you don’t have that level of volatility in a portfolio or in the asset classes in your portfolio, you’re not getting that benefit of being able to buy more low than you do high. It can have an effect on accumulation as well.
The Goalpost Effect
But distribution is a huge area right there.
If we walk through it and go, “Okay, so what’s the deal here?” Well, there is something called the goalpost effect, and this is where you go back and look through history.
You go back to the 1920s, for example.
The University of Chicago has what’s called the CRSP database, C-R-S-P. It stands for Center for Research in Security Prices.
They gather data on everything. I love it because I have the actual data on my computer that I can go to and look at.
And the way they break up the market in the CRSP database is based on tenths. They look at the New York Stock Exchange and the old American Stock Exchange and the NASDAQ.
And they look at companies and say, “Okay, the top 10% of companies in the NYSE, New York Stock Exchange, and any like-sized companies on the other exchanges, that would be decile 1.”
“The next 10% largest companies, that’d be decile 2, and all the way down to decile 10 would be the smallest companies on those exchanges.” Right? That is how they break the market up.
Now, a lot of times they’ll group things. They’ll say, “Well, 9–10, 20% smallest companies. That’s going to be the micro-cap area.”
“And then 1–2 is going to be the S&P 500 in general.” It’s about the same size as those companies.
Now, these are cap-weighted, so it has the same issues that I always talk about with indexes in that they overweight big companies.
We can offset that to some extent by looking more at the micro side when we’re doing research. If I’m looking at 9–10, it’s more micro, but it’s the bigger micro companies that it’s going to dominate to some extent.
If you don’t know what I’m talking about, it doesn’t really matter. It’s not really that—I’m going, “Well, this is getting complicated.”
So let’s say we look at the market, and we say, “Okay, decile 3, 4, 5, we’ll call those mid-caps.”
If we look at that and say, well, what happens when we go back through history, all the way to 1920s, and say, “I want to just see in any given year, and I’m just going to put a little box around”—this is what they did—”the area of the market that had the highest return in, let’s say, 1927 and what had the lowest return in 1927.”
Did decile 1 have the highest return?
Well, what had the lowest return? Was it decile 9?
Okay, so if it is, then really big companies did better than small companies, or less bad.
The Importance of Dissimilar Price Movements
You could have both of them went down in value, but one went down 10% and the other one went down 30%. That would be the most dissimilar price movement, because every other return was between negative 10 and negative 30 in my example.
So you get the point. What I’m doing is I’m looking for dissimilar price movement.
Because what do we diversify for? That’s why.
We want dissimilar price movement because I want not all my eggs in one basket. But if both baskets are falling, that’s a problem.
I don’t have any place I can pull income from. Or if I’m putting money in and everything’s moving together, I don’t have something that’s gone down more than the other thing.
And if I have two things and one went down more than the other, well, when I’m putting money in, I’m going to be putting more money in the one that’s down further.
So if you think about it, what am I doing? I’m buying more low.
It’s even important in the accumulation phase, if you see what I’m saying.
We look at this and we say, okay, so when I go back through history, and I say, “Well, what had the best return in 1928?” Let’s say that it was decile 9.
And then decile 1 or decile 2 had bad returns or not as good returns. Well, then we got a year where we’ve got the other thing happening.
What’s Best for Diversification
If we look back through history, we notice that the most dissimilar price movement occurs with really big companies and really small companies.
We go, “Ah, if diversification is owning things that don’t move with each other, maybe then having more dissimilar price movement is a big deal, right?”
Maybe having that type of movement where things aren’t going together is better if diversification is good, right?
We can logically think about, well, why would diversification be good? It makes perfect sense when we think through the ramifications of risk, whether it be in the accumulation phase or whether it be in the distribution phase, okay?
Now we look back and we go, “Okay, let’s just step back and look at this chart now that we’ve highlighted the highest and lowest returning areas.”
And what we notice is that the highest and lowest returns tend to occur at the periphery, which makes sense if you think about it.
Big companies and small companies would have less in common with each other than big companies and mid-cap, because they’re both fairly big when it comes to medium-sized companies. It would make sense that maybe some of these same economic factors are affecting them, right?
That’s what we’re seeing when we go through history. When we line things up, decile 1 all the way on the left and decile 10 all the way on the right, and we’ve highlighted this stuff, we start to see this pattern that at the edges is where the activity is occurring.
It looks like a goalpost, okay? So hence, the reason, the “goalpost effect.”
An Example Based on History
Well, what happens is that we go, “Okay, so what implication does that have?” Well, lower volatility because I have that dissimilar price movement.
Okay, so what? Well, let’s say that you took a portfolio—
And just for the fun of it what I did is I just ran some numbers for the show using the database just to make the point.
What I did was I looked back and I said, “Okay, let’s say that in 1926 that we had $100,000.” Okay?
And we just took out five grand every year, $5,000 out every year, and we were living off of that money.
And I had one portfolio that was a mixture—this isn’t scientific at all. I didn’t really get into value, growth, or any of that stuff.
I just used large and small just to keep it really, really simple.
So I’d use S&P 500 and CRSP 9–10, and had half my money in each.
What if I did that versus what if I put my money in mid-cap?
Now, what happens is this, is that I go from 1926 til now, and I literally had about eight to almost nine times as much money left in the portfolio that was divided between large and small versus the one that was medium-sized.
Okay? Huge, huge difference in the amount of accumulation left.
You go, “Whoa! Wait a minute. What is going on here?”
Well, part of it is the fact that if you think about it, if I have a portfolio and I’m rebalancing, and one does really well and I’ve got more dissimilar price movement, that rebalance is more effective.
Because if I got one that takes off and the other one’s kind of not doing much of anything, what am I going to do?
I’m going to go, “Oh, it’s supposed to be 50% large and 50% small, and now it’s 60% large because large had a good year, and 40% small because small had a bad year.”
“Ah, okay. I think we ought to go and sell some large and buy some small. Bring it back to 50-50.”
With that, that’s one of the effects that you have, and that’s buying more low, selling high, and managing the portfolio in that manner.
By the way, when I was doing this in the data, I was just rebalancing monthly is what I was using in the research.
If I look at that and go, “Wow! Okay, so that’s a big difference.”
Now, why is it that so many fund companies were talking about mid-caps? Why were the mutual fund companies … ?
Well, mutual fund companies are trying to sell stuff to you.
I mean, that’s their job is to sell things. That’s why they exist, right?
Looking at Recent Numbers
If I look at what happened during the period of time—this is something I did a show on, where I was talking about medium-sized companies and how I was seeing this stuff in the advertising. And medium-sized companies had higher return.
If you look from 2000 to 2015, it was—the return of medium-sized companies was higher than our portfolio of large and small. So it was higher.
You look at it and go, “Why don’t I want to do that?”
Matter of fact, one of my guys, Jim, was telling me that a client had actually asked that.
He says, “My portfolio that you guys are watching over, it’s mid-cap, right?”
“Well, no, it owns large and small.”
“Well, on average though, it’s mid-cap, right? Why don’t I just own mid-cap?”
Because of what I’m talking about here. It’s a big thing to keep in mind that you separate these things.
Because big companies are going to be very different from small companies for lots of reasons. Economies of scale versus the ability to change on the dime when it comes to technological changes, to implement new technology and things like that.
So if we look at mid-caps, though, from 2000–2015, we’re going, “Yeah. Why? Why do you bother to do that? Just own a mid-cap portfolio.”
And the mutual fund company started coming out with ads and going, “We got this mid-cap fund, and this is the return on it.”
And people go, “Hey, wow, that’s really, really great.”
What if you, over that same period of time from 2000 to 2015, what if you took an income from the mid-cap portfolio versus large and small? What happened?
Well, it was a close call because of the higher returns for mid-caps. But the small and large portfolio actually ended up at a higher value.
So if you put $100,000 in and you took out $5,000 per year, you have about $126,000 left—or $128,000 left, excuse me—at the end of 2015 in my example, versus $126,000 in the mid-cap portfolio.
So again, it wasn’t a big difference, but you see that the difference did run in favor of the portfolio that was mixed between the two.
Now, if you go to 2021, and if you did that and you go, “Well, what was the difference from 2000 through 2021?”
Well, now you’re looking at a difference of somewhere in the neighborhood of about $40,000. It’s a much bigger difference over that period of time.
So what does that tell you?
Well, the mutual fund companies were selling people on medium-sized companies, and it really wasn’t a good idea to have followed that advice because just over a short five-year, six-year period, the whole thing changed to be a much, much larger difference between the two.
You see? Because technically we’re starting out about the same dollar amount, right?
Between the two in 2015, the end of 2015, we are only a couple thousand dollars different from each other, but we ended up $40,000 different.
So you go, “Whoa, that’s a big deal!” Okay?
Learning to Measure Risk
Now what is happening here is—I think you can kind of see, from the difference between the two of them, that what happened was that risk is something that you have to consider in the investing process.
You can’t just throw that out and forget about it.
But so often, the mutual fund industry, all they do, they have a tendency to just market based on what is easy to compare.
Now for the average general public, the easiest thing to compare is the return of one thing versus another. And they don’t even think about the impact of risk on the investment.
People say that: “Well, risk is important.”
And this is one of the 20 questions I always ask people when they first become clients: “Hey, do you understand how to measure risk in the investing process? Tell me, how do you measure it?”
And they sit there and go, “I don’t know.”
“Well, is it important to you?”
“Yes, it is tremendously important that I control risk.”
Well, how do you control something that you can’t measure? And that is where the rubber meets the road.
So I think it’s super, super important.
So why mid-caps, why not mid-caps, that’s it. Really gets down to it, it was just a marketing thing by the investment industry.
It was funny because there was one fund company that was actually trying to make the point that “you can save trading costs by not selling small companies when they become medium-sized companies.”
And I just shook my head and go, “Good grief, you guys are just missing the boat. You’re again trying to market to people.”
And to me, the marketing just gets in the way of good decision-making. And if you can get to understanding more about investing, the marketing doesn’t affect you as much.
So really appreciate that question. Great question.
Really, that was fun to answer that, Roy. So thanks.
And if you got a question: paulwinkler.com/question.
It doesn’t have to be that complicated. It can be something fairly simple that you want to run by me.
But by all means you’ll see that I like to answer these questions.
So take a quick break right here on SuperTalk 99.7 WTN. This is “The Investor Coaching Show.”
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*Advisory services offered through Paul Winkler, Inc. (‘PWI’), an investment advisor registered with the State of Tennessee. PWI does not provide tax or legal advice: please consult your tax or legal advisor regarding your particular situation. This information is provided for informational purposes only and should not be construed to be a solicitation for the purchase of sale of any securities. Information we provide on our website, and in our publications and social media, does not constitute a solicitation or offer to sell securities or investment advisory services, or a solicitation to buy or an offer to sell a security to any person in any jurisdiction where such offer, solicitation, purchase, or sale would be unlawful under the securities laws of such jurisdiction.
Historical Performance of Indices
Past performance is no guarantee of future results.
This Presentation includes historical performance information from various global stock market indices. Market performance information is included in this presentation solely to demonstrate the potential benefits historically associated with diversification of asset classes and does not represent or suggest results PWI would or may have achieved when managing client portfolios. Investors cannot invest in a market index directly, and the performance of an index does not represent any actual transactions.
Historical stock market information is derived from returns software created by Dimensional Fund Advisors LP (DFA). DFA is a registered investment adviser that, among other things, specializes in and sells statistical market research and mutual fund management. DFA obtains some of its market data from the Center for Research & Security Pricing (CRSP), part of the University of Chicago’s Booth School of Business (Chicago Booth).
Backtested Historical Performance
This Presentation includes historical performance information from various global stock markets and registered open-end investment companies or “mutual funds”. Some slides describe hypothetical portfolios that are derived from various market indices described more fully in the References to Indices section of the endnotes.
Why Does PWI Utilize Hypothetical Backtested Performance?
Slides that depict hypothetical backtested performance are used by PWI for pedagogical or educational purposes only and are intended only to demonstrate how the market (or various segments of the market) has historically behaved as well as the benefits of diversification. PWI also seeks to educate investors on the general strategy of focusing on capturing market returns, utilizing various asset classes to remain broadly diversified, and highlighting the benefits of eliminating stock picking, track record investing, and market timing. In some cases, PWI may utilize backtested historical performance to depict what the firm feels investors should seek to avoid (namely, stock picking, track record investing, and market timing). PWI does not configure, alter, or otherwise use hypothetical back-tested model portfolios in an attempt to artificially enhance or impair performance, does not link hypothetical performance with actual performance, and attempts to apply the hypothetical data based on objective criteria consistently applied throughout the presentation.
Limitations of Backtested Historical Performance.
PWI did not begin managing client funds until 1999 and any hypothetical portfolios utilized in this presentation (whether prior to this period or after this period) are not intended to and does not reflect the performance of actual account managed by PWI and do not represent any PWI-managed client portfolios. Back-tested performance has inherent limitations, including, but not limited to:
Each hypothetical portfolio or sample asset class mix shown was designed recently with the benefit of hindsight after the performance of the markets during the relevant time period was already known. Backtested historical performance do not show the results of actual trading by PWI of clients’ assets, nor are the returns indicative of PWI’s skill in managing a client’s account. No inference is made that clients would have had the same or similar performance results if PWI managed their assets for any part of this period. Because back-tested performance does not represent actual trading in client accounts, it may not reflect material economic and market factors, as well as the impact of cash flows, liquidity constraints, investment guidelines or restrictions and fees and expenses that would apply to actual trading.
Most presentations that utilize backtested historical performance will be used to educate investors on the general strategy of focusing on capturing market returns, utilizing various asset classes to remain broadly diversified, and highlighting the benefits of eliminating stock picking, track record investing, and market timing. This general strategy was available during most time periods, however, certain asset classes may not have been easily accessible by the average investor. Index funds were not available until the 1970s and access remained limited to retail investors until the 1990s.
Backtested results presented here assume that asset allocations would not change over time or in response to market conditions, which might have occurred in the case of actual account management. PWI asset allocations strategies have not changed significantly since the firm was created in 1999, however, there has been some updates as additional economic research becomes available, and new investment products make investing in certain segments of the market possible.
The annual return information of the hypothetical portfolios assumes the reinvestment of dividends, but does not include the deduction of fees or expenses which would reduce returns. Hypothetical or sample portfolio returns generally exceed the results of client portfolios managed by PWI due to several factors, including the fact that actual portfolio allocations differed from the allocations represented by the market indices used to create the hypothetical portfolios over the time periods shown, new research was applied at different times to the relevant indices, and index performance does not reflect the deduction of any fees and expenses.
Both the backtested hypothetical portfolios and PWI’s own asset allocation formulas may change as additional economic research becomes available, and new investment products make investing in certain segments of the market become available.
Hypothetical allocations do not include fees. Although the hypothetical portfolios are not intended in any way to be viewed as model performance of PWI, you should understand that actual client portfolios are subject to the deduction of various fees and expenses which would lower returns. For example, if a 2.0% advisory fee was deducted quarterly (0.5% each quarter) and your annual return happened to be 10.00% (approximately 2.0% each quarter) before deduction of advisory fees, the deduction of advisory fees would result in an annual return of approximately 8.0%, due, in part, to the compound effect of such fees. Advisory fees charged to PWI clients, whether directly or indirectly through a mutual fund, are described in PWI’s Form ADV Part 2A.
It is possible that the markets will perform better or worse than shown in the hypothetical backtested model, and that the actual results of an investor who invests in the manner PWI recommends may lose money.
Historical Performance of Indices
Advisory fees charged to Paul Winkler Inc. (PWI) clients, whether directly or indirectly through a mutual fund, are described in PWI and Matson Money’s Form ADV Part 2A. Past performance is no guarantee of future results. Portfolios cited are PWI 60/40 diversified and 95/5% stock v. bond portfolios.
This Presentation includes historical performance information from various global stock market indices. Market performance information is included in this presentation solely to demonstrate the potential benefits historically associated with diversification of asset classes and does not represent or suggest results PWI would or may have achieved when managing client portfolios. Investors cannot invest in a market index directly, and the performance of an index does not represent any actual transactions.
Historical stock market information is derived from returns software created by Dimensional Fund Advisors LP (DFA). DFA is a registered investment adviser that, among other things, specializes in and sells statistical market research and mutual fund management. DFA obtains some of its market data from the Center for Research & Security Pricing (CRSP), part of the University of Chicago’s Booth School of Business (Chicago Booth).
Backtested Historical Performance
This Presentation includes historical performance information from various global stock markets and registered open-end investment companies or “mutual funds”. Some slides describe hypothetical portfolios that are derived from various market indices described more fully in the References to Indices section of the endnotes.
Why Does PWI Utilize Hypothetical Backtested Performance?
Slides that depict hypothetical backtested performance are used by PWI for pedagogical or educational purposes only and are intended only to demonstrate how the market (or various segments of the market) has historically behaved as well as the benefits of diversification. PWI also seeks to educate investors on the general strategy of focusing on capturing market returns, utilizing various asset classes to remain broadly diversified, and highlighting the benefits of eliminating stock picking, track record investing, and market timing. In some cases, PWI may utilize backtested historical performance to depict what the firm feels investors should seek to avoid (namely, stock picking, track record investing, and market timing). PWI does not configure, alter, or otherwise use hypothetical back-tested model portfolios in an attempt to artificially enhance or impair performance, does not link hypothetical performance with actual performance, and attempts to apply the hypothetical data based on objective criteria consistently applied throughout the presentation.
Limitations of Backtested Historical Performance.
PWI did not begin managing client funds until 1999 and any hypothetical portfolios utilized in this presentation (whether prior to this period or after this period) are not intended to and does not reflect the performance of actual account managed by PWI and do not represent any PWI-managed client portfolios. Back-tested performance has inherent limitations, including, but not limited to:
Each hypothetical portfolio or sample asset class mix shown was designed recently with the benefit of hindsight after the performance of the markets during the relevant time period was already known. Backtested historical performance do not show the results of actual trading by PWI of clients’ assets, nor are the returns indicative of PWI’s skill in managing a client’s account. No inference is made that clients would have had the same or similar performance results if PWI managed their assets for any part of this period. Because back-tested performance does not represent actual trading in client accounts, it may not reflect material economic and market factors, as well as the impact of cash flows, liquidity constraints, investment guidelines or restrictions and fees and expenses that would apply to actual trading.
Most presentations that utilize backtested historical performance will be used to educate investors on the general strategy of focusing on capturing market returns, utilizing various asset classes to remain broadly diversified, and highlighting the benefits of eliminating stock picking, track record investing, and market timing. This general strategy was available during most time periods, however, certain asset classes may not have been easily accessible by the average investor. Index funds were not available until the 1970s and access remained limited to retail investors until the 1990s.
Backtested results presented here assume that asset allocations would not change over time or in response to market conditions, which might have occurred in the case of actual account management. PWI asset allocations strategies have not changed significantly since the firm was created in 1999, however, there has been some updates as additional economic research becomes available, and new investment products make investing in certain segments of the market possible.
The annual return information of the hypothetical portfolios assumes the reinvestment of dividends, but does not include the deduction of fees or expenses which would reduce returns. Hypothetical or sample portfolio returns generally exceed the results of client portfolios managed by PWI due to several factors, including the fact that actual portfolio allocations differed from the allocations represented by the market indices used to create the hypothetical portfolios over the time periods shown, new research was applied at different times to the relevant indices, and index performance does not reflect the deduction of any fees and expenses.
Both the backtested hypothetical portfolios and PWI’s own asset allocation formulas may change as additional economic research becomes available, and new investment products make investing in certain segments of the market become available.
Hypothetical allocations do not include fees. Although the hypothetical portfolios are not intended in any way to be viewed as model performance of PWI, you should understand that actual client portfolios are subject to the deduction of various fees and expenses which would lower returns. For example, if a 2.0% advisory fee was deducted quarterly (0.5% each quarter) and your annual return happened to be 10.00% (approximately 2.0% each quarter) before deduction of advisory fees, the deduction of advisory fees would result in an annual return of approximately 8.0%, due, in part, to the compound effect of such fees. Advisory fees charged to PWI clients, whether directly or indirectly through a mutual fund, are described in PWI’s Form ADV Part 2A.
It is possible that the markets will perform better or worse than shown in the hypothetical backtested model, and that the actual results of an investor who invests in the manner PWI recommends may lose money.
