Would a World Currency Hurt the Dollar and My Investments?

Paul Winkler: And welcome. This is “The Investor Coaching Show.”

Paul Winkler, talking about the world of money and investing, and talking about just about anything to do with you moving from working for money and money working for you.

And of course, one of the things that I fail to mention a lot of times is that you can actually ask questions through the systems that we have, a couple of them.

One being the text line: 615-808-8543. And that is one way to do it. 615-808-8543.

The other way to do it is through paulwinkler.com/question. Paulwinkler.com/question, and then we can handle that right in here.

As a matter of fact, there was a question that was brought up that I thought I would answer here.

Now, so there was—a person asked a question:

“Been retired since May of 2019, but did not rollover government TSP fund, which consists of the C and S Fund.”

Okay, so this would be general for anybody.

If you have a 401(k), you know anything about indexing, this is a question that I can use just to help understand some of the things about basic tenets of investing that you want to know.

A Few Investing Basics

Because when you invest, you’ve got big companies: lower expected return, because they don’t have to pay as much to use your money.

You have to pay a higher price for their earnings because their earnings are more sure of coming in. Not assured of coming in, but they’re more sure of coming in.

Then let’s say a small company: that would be a little bit more tenuous, and you’re more worried about whether the company’s going to make it and survive.

Whereas a big company, they’ve got a lot of—they might have a lot of assets that allow them to weather storms better.

So in essence, we know that a bigger company might make it through something that a smaller company can’t.

And therefore, what happens when we go and project earnings into the future, that big company, we’re not as worried about whether they’re going to make it or not.

And it’s not that they will make it, it’s just not as worried, okay?

So when it comes down to it, we will pay a higher price for the earnings that we expect out of the company.

And consequently, we’ll pay more for their assets as well. When you’re buying a stock, you’re buying the rights, the assets, okay?

So you’ve got big companies. You got small companies.

You got value companies. Value companies are companies that maybe they’re trying to get their act together.

Maybe they don’t quite have everything together. And the reality is that maybe they don’t have the greatest of management or maybe they don’t have the greatest business model.

Maybe they’re in an industry that is struggling a little bit. So therefore, I won’t pay as much for their assets.

And what I’m doing is I’m just building in for myself a greater return potential by paying a lower price for their earnings, okay?

Now you think, “Well, that sounds risky.” It is.

And that’s why you have to get a greater return in order to put yourself in the position of taking on that risk.

Diversification Brings Risk Down

Now if you got small value, you got two things going on there. You got small, and you got distressed, and higher expected return there even more than anything else.

And then you got international, and you’ve got some of the issues with being a country that’s outside the United States, and what political risks and things like that.

So if you’re dealing with—like, emerging markets is even more political risk. And you’re dealing with issues that you may not be dealing with as far as currency swings.

So what happens is investors will demand—

Now the crazy thing about all this stuff is that when I start to throw all of these things in a pie together—and I just throw them all in the pot, let’s say—then what happens, my risks come down.

Because there can be some serious risks to just the United States. I mean, look at history.

Look at the Depression. Look at World War II.

Look at when all of a sudden, Pearl Harbor was attacked. Look at when we had the oil crisis in the 1970s.

Look at when we had the banking crisis. You can have things that affect the United States that don’t affect other countries around the world.

And therefore, let’s say, when we have the dollar devalued, that became a risk that was really the U.S., okay?

So when you have those risks that are—and I’m sorry. You’ve got literally 45–50 countries around the world that I might be willing to invest in companies inside those countries.

U.S. is just one country out of all of them, right? So as an investor, you got different places I can do.

Should I Worry About a Devaluation of the Dollar?

Now, the two funds that are named in this question are C Fund and S Fund. So this C is for large—it’s basically an S&P 500-type fund that the government has, the government TSP.

Thrift Savings Plan is what the TSP stands for.

And then you got the S fund. It’s what’s called the completion fund, which basically what it does, it holds everything but the 500 biggest companies. It’s what’s called the completion index because it completes the rest of the market and holds more medium-size companies, okay?

So the question is this: “I’ve been hearing of a world currency which I heard could cause the U.S. dollar to devalue and cause the stock market to go down. I’d like to know if there’s a TSP fund or funds that my money would be safe in if this happens.”

Well, in actuality, if you have a devaluation of the U.S. currency, then anything that’s U.S. would be devalued because we charge in dollars for our things, right?

So when we look at the devaluation of the U.S. dollar that happened from 2000 through about 2010, the dead decade, that was a problem mainly for U.S. investors just investing in U.S. stocks.

Now if you were an investor in—and I say a U.S. investor, I mean an investor that only had held U.S. assets. Because companies charge in dollars, and that was a problem.

And when you had this dead decade, there were a lot of problems as far as the economy went as well.

But if you held international stocks over that same period of time—you owned companies that were domiciled in Germany or in France or in Japan or Australia or whatever—then you did quite well.

Because the dollar devalued, and what that means is—let’s say that you have two currencies.

The dollar and the clam is an example I like to use. Kind of a silly example, but it makes the point.

Let’s say the clam is an international currency. And I can take one dollar, and I can trade it for a clam.

And I can buy something in another country that sells for one clam in that country. If that’s the case, then what I would do is I would take my dollar, I would convert it to a clam, and I would buy the widget, okay?

Now let’s take this example, and let’s say that all of a sudden, now I have a devaluation of the U.S. dollar.

And it takes two dollars to buy one clam because the dollar has devalued. It takes more of them.

And now I go to buy that widget that is made over in that other country. Now what happened to the price of that widget from an American standpoint?

It doubled. It went to two dollars.

Now if that happens, then I’ve got inflation on my hands, right? Well, inflation is good when we look at it from an investment standpoint because inflation means it went up in price, right?

Kind of a different way to look at inflation.

Mitigating Currency Risk

So now all of a sudden, my investment—because what am I buying when I buy an international stock? I’m buying a company from another country.

And if I’m an American citizen, and I buy stuff—or somebody buys something off of me. Another American citizen buys my portfolio.

Because what am I doing when I’m living off of my retirement money? I’m selling my investments to live off of them, right?

Well, what happened to my investment in a company outside the U.S.? It doubled in value, in my example, if the dollar devalued.

So I have money in a company outside the United States, and the dollar devalues. And then somebody has to go where it used to be, let’s say $50,000 worth of that investment.

And all of a sudden the dollar devalues, where it takes $2 to buy what $1 used to buy in that country. Now my investment went up to a hundred thousand dollars.

So this is another way we mitigate risk. We offset risk investing because we have currency risks.

So this thing about a world currency, that garbage has been out there a long time. That’s not what I’m worried about.

I’m not worried about a world currency devaluing the dollar, and all of a sudden—

There has been talk about that for many, many years. It’s typically somebody trying to sell you something, scare you to get you to buy something.

But the devaluation of the dollar is a very real thing that happens from time to time. You’ll have periods in time when the dollar gets weaker versus other currencies.

And that is why you invest in international stocks.

The Downside to TSP Funds

The problem you have with the TSP fund that you’re giving me as an example—

And the person’s named Donna. Donna, the issue is this, is that you don’t have I Fund in the TSP.

And you may not own it because, if you looked at the most recent history, international didn’t do as well as U.S.

So people would look at it and go, “Ah, that’s no good. That’s a lousy investment. That international stuff, I’m going to stay away from it.”

Well, the reality of it is, you look at the 1970s, and the U.S. looked like a lousy investment. You look at the early 1980s, and international look like lousy investment.

Then you look at the late 1980s, then U.S. look like a lousy investment. Then you look at the ’90s and international look like a lousy investment.

And you look at 2000–2010 and … getting the picture?

So what happens is that it goes through cycles, and you can’t predict them. You don’t know when they’re going to happen.

Now, that said, what you’ve got here is you got a C Fund, which is large U.S. growth companies; an S Fund, which is mainly smaller growth companies because it’s a completion index—smaller blend companies, growth, pretty much the same thing; then you got the I Fund, which is growth.

So you got growth, growth, growth. And where do we expect more return? Value. It’s the other side.

The government basically came out with a—

I remember reading a statement a few years ago saying, “Well, we’re thinking about adding value because the research shows that we really ought to do that. It reduces risk.”

And the one thing I’d seen said it was going to confuse investors; we’re not going to do it.

So they didn’t do that because—and it’s true. If you look at psychology, when you give people too many choices, it basically freezes them.

Even though it’ll be better for them, it freezes them in their tracks, and they don’t make any decisions. And they just thought that would be better than giving people too many choices.

So that’s one thing.

Now the other thing is that you don’t have any—it didn’t mention the G Fund, which is going to be short-term fixed income, and then the F Fund, which is intermediate bonds.

And the thing that you got to be really careful about those is, again, it’s dollar denominated. They’re bonds.

So in effect, if the dollar devalues, you got the same problem right there.

So in inflation, that’s what dollar devaluation is, right? It’s inflation.

It’s prices going up, but they’re not going to keep up.

What to Do With a TSP

So what to do about this? Well, I would want to be, as soon as I possibly could be, way more diversified than the TSP allows you to be.

I would want to own those big companies that are U.S. Yeah, it’s great.

Okay. C Fund, that’s fine.

S Fund, it’s a mid-cap fund, and that’s problematic to me.

Like, if you look at last year, just to give you an example: the C Fund had a rate of return of about 28%. Well, if you look at large growth companies, it was about 28%.

So that kept up. That’s fine.

That’s an indexed fund, and it works well.

If you look at the S Fund with the TSP, Thrift Savings Plan, it was 12.45%. Well, if you look at actual small-caps last year, they were up over 30%.

30–33% return versus 12%.

So you see that owning medium-sized companies wasn’t terribly helpful. And it doesn’t give us the greatest of diversification.

Like small value stocks. Remember I talked about value?

Well, that was up almost 40% last year versus 12% on the S Fund. So it can be a really, really big difference, long run.

International fund: Their I Fund was up 11.45%, but international value stocks, where we expect more in return, was up over 18%—almost 19% last year—and international small value was up about 16% last year.

So you can see right there what you’ve got as an issue is that a lot of areas in the market that you want to hold don’t get represented with the Thrift Savings Plan, the TSP.

And hence, when you have the chance—

People come in here, and they go and say, “What do I do with this?”

And I go, “Here are the choices. This is what you got with the—”

Now, one of the things that the Thrift Savings Plan does well is, number one, it lets you save a lot while you work for the government.

The amounts that you can put away are high, over $20,000 if you’re under the age 50, and then another $6,500 if you’re over the age of 50. You got the catch-up provision with it.

So you can put a lot of money away pre-tax in the Thrift Savings Plan.

The other nice thing about it is when you’re in the accumulation phase in retirement planning, more volatility is okay because you’re putting money away on a regular basis, and you got dollar-cost averaging going for you.

You’re putting money away if the market’s high. You’re buying fewer shares.

The market’s low, you’re buying more shares.

So it’s not as big of a deal when you’re in the accumulation phase. When you’re getting into retirement and you’re taking distributions or getting ready to take distributions or may need to take distributions, that additional volatility actually works against you.

Because if the market’s down, you have to sell more shares to get your income. Market’s high, it’s all great.

So that is really what I look at when it comes down to what do you do.

Why Is Diversification Essential?

And then if I’m only basically given the choice of five asset categories: large companies, a small-cap fund that is very mid-cap heavy like the S Fund is, I Fund, which is large international—again, it’s the area of the market that’s the highest priced in international because it’s just like U.S. large companies. Then you got the F Fund and the G Fund.

You have basically five asset categories. And I want to hold a lot more than that in retirement.

So as far as the main question, which is, is it because of a world currency that I would want to do something different? No, that would not be the reason.

The reason would be a whole lot more fundamental. It’s really much greater diversification.

And then making sure that I own other areas of the market whose prices would be a lot lower compared to earnings and book value, therefore greater expected return.

But the reason that they’re really great is because they have a tendency, historically, going—we got data going back in the 1920s—having more dissimilar price movement, which is, by definition, why we diversify: because they don’t move together.

It’s like the old “having all your eggs in one basket” and making sure that you have lots of baskets.

Because, hey, you can go long periods of time with no returns in U.S. stocks or having—like we just went through the dead decade.

We went the 1960s up and through the early 1980s where large U.S. stocks had no returns after inflation.

So that’s why you do it.

Boy, sometimes you ask me what time it is, I’ll tell you how to build a watch.

But I really believe that you can understand it and that, as an investor, you really want to understand this stuff.

Because once you get this, and you understand that it really goes along with my general logic in what I know to be true about investing—“I’ve always heard that diversification is important”—well, now you know why.

I’m Paul Winkler. You’re listening to The Investor Coaching Show on SuperTalk 99.7 WTN.

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Historical Performance of Indices

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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. 

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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.

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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.

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