Paul Winkler: And welcome. This is “The Investor Coaching Show.” I’m Paul Winkler. Talking about the world of money and investing. If you look at the statistics … and I like statistics, and I think you should too.
If you look at the statistics, people don’t quite have the retirements that they really should have based on market returns historically.
The Market Has Performed Well Lately
And I say that many times, “When you look at the level of growth markets historically,” and people say, “Well, it’s been kind of rough lately.” Well, no, it hasn’t been.
I was looking at some data yesterday regarding market returns, all various asset categories going back 20 years. And we’re talking about a period of time that included the tech bubble, 2008, of course, was kind of rough, early 2020, of course, with what happened.
But if you look at returns and go, “Is it fairly within normal bounds?” Absolutely.
So when I throw out numbers, and I’m talking about history. And the thing is that you have to actually follow the academic research with investing for this stuff to work out. Otherwise, if you’re not following the academic research, it’s all loss is the way I look at it.
If you go back and look at 50 years and say, “Well, what is $100,000 worth?” Well about $29 million, if you just capture market returns.
And you go, “Whoa, wait a minute.”
And people are trying to beat that. They’re trying to figure out which stocks are better than others. Which areas of the market to get in, which areas of the market to get out.
So I’m just using a single deposit right there. And that was just using that as an example. Of course, it’s a lot lower if it’s 40 years, but it’s still $9 million.
You look at it, it’s not terrible based on if you looked at the average returns of large, small, large value, small value, international, large international, small, certainly international small value, which is a more difficult asset category to capture.
And for those of you who really like the details, I typically would overemphasize that in an international portfolio, because it has more dissimilar price movement versus U.S. stocks. I don’t want everything moving together.
That’s the idea behind diversification. Have things that move in dissimilar fashion. But so actually going and following this research is just few and far between. You don’t see it very often.
The Basic Rules for a Portfolio
And I want to do a segment. This is for, well, the faithful listeners may know some of these things. May have heard me say this a couple times.
It’s going to be interesting, nonetheless, because it’s more recent data, but this is one to send to your friends who don’t pay attention to this stuff. That you know, they go to work and they just put all their money in target date funds.
And they have the investment companies, mutual fund companies, choose everything for them because they don’t want to be bothered. They’re not interested in this stuff.
And I’m telling you, it pays to be interested in this stuff.
If you take those market returns that I was just talking about, and let’s just use the number with 40 years. One hundred thousand dollars grows to just over $9 million over that period of time.
And you get the return that the average investor has actually gotten in markets, which is like with an asset allocation fund, like 3% or something like that, now the $100,000 is $326,000.
So you look at that and go, “It makes a difference.”
If you want to be going and vacationing with your friends and being able to have fun with them in retirement, you don’t want them saying, “I can’t afford it because I never listened to ‘The Investor Coaching Show.’ And I never learned anything about my investments. It was too much trouble for me to learn anything.”
And I’m telling you, this is not that onerous. It’s not that difficult. You can understand these things.
Now, one of the things that I always do with people typically when I first meet them, is I’ll go, “Okay, so you tell me what the rules of investing are.”
And I’ll walk them through a cycle that people tend to go through: “I have a fear of the future. Because I fear the future. I would like to have a prediction on the future, and I don’t know enough. So I’m going to let the mutual fund company make that prediction on my behalf. Because I don’t know what’s going to happen, but that’s their job. They should know that.”
And the reality is they don’t know either because you have to predict the future and nobody can do that. So that’s why you diversify.
If you could predict the future, why diversify? You don’t need to anymore. You just put everything that’s going to do best next.
So, number one, when I look at this, I say, “Okay, that’s the number-one rule of investing: diversify. So you give me the rules though.”
And they’ll say, “Okay. Diversify. Yep. Yep. I agree with that one. That makes total sense to me. Don’t put all your eggs in one basket. Okay, good. Excellent. We got this, we’re on the same page.”
Now, the next thing is, “Should I try to time the market?”
And some people surprisingly say, “Yeah. I think you ought to be able to figure out where things are going to go next and move things around.”
And then you have to break them of that and go, “No, studies of pension plans—they had 91 pension plans in one study—and they found when they engaged in market timing, not one of them, not one, and these are the best, brightest, highly educated, lots-of-money-behind pensions. None of them could do it.”
So perish that thought. And then you go, “Well, should I try to pick stocks?”
And no, good grief. Most people, the visceral reaction will be, “No, no, you can’t do that.”
“No, I’m not going to try that. Okay, good. So we’re not going to try to do that. Pension plans as well, when they tried, they didn’t increase returns when they engaged in that behavior.”
And then I’ll say, “Okay, so what other rules?”
“I don’t know, what?”
“Well, bonds, what are they there for?”
“Bonds are there for safety.”
“Okay, good. Let’s write that down.” So I’ll have them write down everything they know to be true about investing.
Be Wary of Target Date Funds
And then we go, “Okay, so let’s take a look at actually how things are being managed in your investment portfolio.” I’ll do that with them.
So I’ll say, “Okay,” and I’m actually going to take apart a real fund that is a major fund used in 401(k)s, target day funds. And I’m going to use Fidelity’s in this particular case.
So they’ve got Fidelity Freedom Funds, and they’ve got their Freedom fund that has been around for quite a while. And if you look at it, it is what is called a “fund of funds.” It’s a mutual fund that invests in other mutual funds.
So the fund company is choosing which funds are going to be in it based on your retirement date. So if I’m going to retire, I think I’m going to retire in the year 2040, then I just buy the 2040 target date retirement fund. And that’s it.
And the whole reason this came up is I was talking to a lady the other day. And she goes, “I had this portfolio and it was chosen by somebody, and the person chose these things. And I brought that to the person at Fidelity. And I asked, ‘Can you look at this?’ And the person at Fidelity goes, ‘Oh, wow. You’re taking a lot more risk than you really should be taking. Let me change that around.’”
I say, “Well, let me guess, did they change it to the target?” And she didn’t really know. And I said, “Well, is there a number like 2040, 2045? Something like that?”
And she goes, “Yeah, that’s one of them.”
I was like, “Oh boy, it’s even worse.”
If the person is choosing a target fund and they’re choosing other funds, the target fund is meant to be the be all, end all. That’s just one choice and you don’t do anything else.
And it’s not a good choice as you’ll see in a second, but that’s the idea behind it.
Just put everything in that fund because Fidelity has chosen 25, in the 2040 fund, they’ve chosen 25 of their mutual funds to spread the money between. So you don’t do anything else.
So it’s like hiring a maid to clean up the house. And then you run around behind the person and you throw everything on the floor. Now, it doesn’t make any sense.
You’re undoing it when you add other funds to the process. So that is where this all came from, this idea for doing this little segment.
So what I did is I pulled up the 2040 fund. I said, “So this is a fund you’re retiring in that particular year. You just choose this one fund? What’s it going to invest in?”
So it invests in 25 Fidelity funds. The largest holding was the first thing that caught my attention and blew my mind. Because really when you’re dealing with stocks, you have established markets, you have U.S. markets, so companies that you would recognize, many of them, small companies, you may not recognize.
You don’t necessarily want all really big companies because they’ve already gotten there. They’ve already arrived. I want companies that have room to grow.
So small companies would be a really important part of my portfolio. So I wanted to own, as I like to say, Microsoft before it was Microsoft, before everybody knew who it was, I wanted to own that. But you’ll recognize a lot of them.
Now, if you go into international markets, you won’t recognize them. So you have international markets and you’ll have established U.S. markets. You’ll have more international markets, which would be something else you want in your portfolio.
So I want companies like Nestlé. I want companies like Nikon or Toyota, or whoever. Just think of companies that you might—L’Oreal—do business with outside the United States. And those companies would be located in typically more established countries like Germany and France and Great Britain and Australia and so on and so forth.
Then you’ll have emerging markets. Now with emerging markets, you worry more about is somebody actually going to protect my property rights? Are they going to protect my right to own property in their country?
And that can be tenuous. I mean, that’s why you have to be really, really careful jumping out into emerging markets.
Now you want it in there because at one point the U.S. was an emerging market. So I want that in there.
But if you look at a portfolio and you go, “Well, let’s just really load up on that.” That’s kind of risky.
Simply because those are markets, like I said, they may not protect your property rights. Your right to own property in their country.
Well, the top holding—this blew my mind—for the Fidelity 2040 fund was their Series Emerging Markets Opportunity Fund. Seriously, number-one holding by far in the portfolio.
They had well over 10%. I think was 13% of the portfolio was sitting in that one fund. So you go, “Wow, okay. So they’re really taking a step out there with emerging markets.”
And these are big emerging markets companies. So really you have a situation where the one part of emerging markets that they chose, which are big cap, large cap, growth, emerging markets companies, that’s the area that is already selling for a fairly high price compared to historic norms.
And you look at it and go, “Well, wait a minute what happened to value? What happened to small cap? Well, no, it’s not in there. It’s just that.”
Now years ago, Fidelity did the same thing in 2008. Their top holding was a Commodity Strategy Fund back at that point. Now it’s still in the portfolio, but back in 2008, I remember, they went and changed the name of the fund, which is really, really interesting.
So now they’ve got the fund in their Commodity Strategy Fund, but it’s their series fund that they had in there. But that fund lost tremendous amounts of money going into the future. And it was the top holding of the portfolio, but it lost a tremendous amount.
Well, why? Because commodities ran up in 2008, then it was added to the portfolio, and then it came crumbling down. Now it’s way, way back in the pack. It’s near the bottom of the pack not, not quite … it’s the bottom half of the portfolio.
So they’ve dropped back how much money is in it significantly. Probably because it did so poorly that it doesn’t look good to have a lot of money in something that did so poorly.
So right there, you see this history of moving things around. Now that is something called turnover.
Now, when you have turnover, there’s two types of turnover in a portfolio. This is really important.
Remember, market timing doesn’t work. Market timing is when you change a portfolio based on a prediction about the future. If you have moved a certain fund up to the top of the pack as being the number-one holding, and worse yet after that area of the market already did well, that is a market-timing move.
And if done, after it’s already done, it’s like closing the barn door after the horse already got out; it’s just too late. But that is a form of market timing called tactical asset allocation.
And if you look at a fund’s turnover rate, it shows you what that is. Now 22% turnover, which means that pretty much everything is changed within a five-year period at that level of turnover. Four-to-five year period.
So you look at that and go, “Whoa, wait a minute. So that’s a lot of change in the portfolio right there for that to have happened.”
So that’s at the fund-to-funds level. That’s at the 2040 target date fund level. That’s how often they’re changing the funds in the fund.
You Must Pay Attention to Your Portfolio
Now, if you look at the funds themselves, you look at their top holding, which is the Series Emerging Markets Fund, how often are they changing the stocks? Well, the turnover in that fund over the last year, according to Morningstar, 117%.
So literally every stock was changed over the last calendar year if you look at that particular number and go, “Whoa.” And how did they do? Did it help returns?
Well in 2019 versus its category, or the area of the market that it is investing in, which is emerging markets, diversified emerging markets. It was under by almost 9%, 8.81%. It underperformed.
It had a positive rate of return. The rate of return was 9%. It should have been like 17%, 18%—that’s what that’s telling you. Then the next year it made money. It went up 11% last year. Well, it should have gone up like 12%.
And then so far this year up to September, it’s up, but it should have been up by 2% more. So they didn’t add value through that behavior or that activity.
And you look at it, what they would say, “Well, our management fees are really cheap.”
Oh, management fees are really cheap, but it underperformed by 9% and 0.5% and another 2% in the last three years. And those are the only three years that we have data on the fund.
So you go, “Well, wait a minute. That doesn’t sound like a real bargain to me.”
And people buy it based on what? The expense ratio. It’s a really low expense. It’s really, really cheap. But what happens, what really makes a difference, where the rubber meets the road, is return.
I mean, if you’re actually hurting returns through the activity, is that helpful? And I would submit, no, it’s not terribly helpful.
So number one, that first rule of investing is stock picking. Well, I guess we hit two there. Stock picking and market timing. We hit two rules of investing that are both being broken by this particular fund.
Now, if we look at another rule of investing, what about diversification? Because that’s really primary; everybody knows we ought to diversify.
Well, this is a fund, as I said, of 25 funds. So it has 25 mutual funds in it. So let’s see, did the funds own different types of stocks?
Because they really should be in different universes, maybe one fund should be holding really small companies. Maybe another one might be holding microcap companies. Another one might be holding … really, really small.
Another one might be holding growth companies, large ones, and another one might be holding large value. You ought to be in different areas. That would make some sense.
Well, I did an overlap analysis on the stock funds inside. And an overlap is where you’re looking at: Do they own different stocks?
Well, five of the mutual funds inside of the portfolio own Microsoft, five of them own Apple, four of them own Amazon, and nine of them own Google. And Facebook is owned by, let’s see, about seven … somewhere in there … seven different funds in the portfolio.
UnitedHealth Group, it looks like it’s about eight of the funds inside of that. So eight funds own that one stock. And Bank of America, same thing.
So I can go down … Wells Fargo … I can go down through all these. Comcast is held by like nine of the funds inside there. And Samsung is held by six of them and General Electric’s owned by six of them. So on, so forth.
So what are you catching here? Not diversified, overlapping, owning the same things. So if two of us have the same opinion on something, one of us isn’t needed.
Same thing if two funds have the same stocks, when that stock goes down, you’ve got a problem on your hands. And that’s literally what we’re seeing here.
People typically do this, and this is why I like to point this out. People will just typically buy a fund. They go, “I’ll just let you guys handle it.”
Do you really know what your investment manager is doing? Do you understand what’s going on in your portfolio? How the portfolio is diversified? What areas of the market are?
And you don’t need to know everything, but you just need the basic rules of investing that you’ve known them to be forever. You’ve heard them your entire life. Are they being followed?
If we look at these portfolios, we say, “Well, clearly not being followed.”
And if we look at the holdings versus U.S. versus international small companies versus large companies, you’ll notice something that these portfolios really strongly favor U.S. versus international, typically.
And in this particular case, they favored the international, which is weird. It’s a turnaround, which is a little bit disconcerting that they’re going in favoring an area of international markets that’s such a precarious area, really, holding emerging markets.
But then you’ve also got the portfolio as far as large versus small companies. And it is overwhelmingly holding larger companies in the portfolio.
That’s another thing that I noticed when I was reading through this. Overwhelmingly, large companies are overweighted in the portfolio.
Giant companies, about 38% of the portfolio, large about 26%. So right there, put that together, and you got about 64% of the portfolio, really huge companies, medium-sized companies another 16%.
So there are more big companies right there. So we’re looking at about 90% of the portfolio, when you add everything up.
Over 90% of the portfolio is anywhere from mid to giant companies, only about 7%, 8% of the portfolio, according to Morningstar, is actually holding the area of the market, which is small caps.
So you look at that and go, “Whoa, wait a minute. That’s a huge difference.”
And small companies are the better diversifier. As I said earlier, I want to own those companies before they become big companies.
So now I think you’re starting to get a view for why investors get such low returns versus markets, versus what historically they should have gotten. It comes down to this type of thing.
It’s not paying attention. It’s just going, “Hey, I got better things … I can’t understand this stuff.”
Now I’m hoping that some of the things I’ve said, you’ve understood. It wasn’t too complicated. I need to be following the rules of investing as I know them.
And that is why you don’t have to understand everything. You don’t have to know everything, but it is why you really want to pay a little bit of attention to this thing.
People spend, as I often say, more time planning their vacations than they do the biggest vacation they will ever take. That is their retirement.
And that is what this show is about and what we exist for as a company. And that’s Paulwinkler.com. That’s the website.
There’s more education there. And that’s how we work with people. We educate those people that really want to understand this stuff, and not necessarily know everything that we know.
That’s really why we exist. And I think it’s absolutely critical to make sure that you avail yourself of that. My humble opinion.
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