Paul Winkler: Welcome to “The Investor Coaching Show.” I am Paul Winkler, talking money and investing.
Educating Yourself
You know, if you don’t get this stuff, it’s easy to take advantage of you.
That’s why I think that education comes from, not the insurance industry, not the mutual fund company, but the world of academia.
And the reality of it is, it’s not over your head. I ask people all the time, “Tell me the rules of investing.” They tell me the rules of investing and I go, “Okay, let me show you how the fun company is breaking that rule.”
For example, one of the things I’ll talk a little bit about is returns. You get great returns without any risks or anything like that.
Now, there are ways to reduce risks. I’ll talk about that as well, but the reality of it is, there is a lot of bad stuff being taught out there, and that is why I have the show. This is why I get into teaching this stuff, because I want to save people. I want to save investors from themselves, but also from the industry.
So I had a conversation with somebody this week and I thought I would start the show just talking a little bit about this conversation because I think it’s instructive. Now, one of the things that was happening, this happens to investors from time to time, is where they’re doing something and then they hear about their friends.
They hear about what their friends are doing. “Oh, my goodness. Look at my returns on this thing.” Then they’ll talk about some investment that they’ve got that has done really well or maybe their whole portfolio has done well.
You know, there was a study that was done of pension plans and they were looking at what drove returns. And I think it’s critical you understand what drives returns.
Portfolio Envy
Why do we invest? Why do we put money away for the future? Well, because we want a return on our assets, right? We want to get some kind of return so that we can live off of it.
It’s a difficult industry. It’s a difficult world because, on the one hand, we have greed pulling us, you know?
“I want to get high, really great returns. I really want to get rich and all that.” And then sometimes you have fear. “I just don’t want to lose everything.”
Those two things tug at each other, and those are emotional things that drive investor behavior. So it is really hard not to get sucked into that as an investor.
Especially when your friends are going, “Oh man, I got this thing. Look at what it’s done. Look at what I made on …” whatever, Bitcoin or large U.S. stocks, or let’s say that it’s tech companies.
Think about the late ’90s. People were talking about tech companies like, “Whoa, the sky is the limit. Look at how much money you can make in this. Look how much my portfolio grew.”
And then we get into portfolio envy. Jane Bryant Quinn talked about, oh, I can’t remember the term. She was a financial writer and she would talk about how it’s almost like magazines that you shouldn’t be looking at, and you get where I’m coming from.
But she was talking about the financial industry constantly doing that to investors. And you have investainment, I guess it was. Burton Malkiel, or no, John Bogle actually used that term, used to use that term quite a bit, investainment. It’s entertaining investing.
So, what happens is people will talk about, they’ll brag about their returns after they’ve done really, really well. And it leads us to go, “Well, I don’t want to miss out. I want that return myself.”
Return After Inflation
So you look at, in the past couple of years, an area that would be popular with investors would be what? Large U.S. companies. Why large U.S. companies?
Because they’re companies we know, we hear about, we read about them all the time, and that is really what has pulled people in.
Now if we went back, let’s say from 1970 through 1995, I’m going to use that period of time in history. I’m going to break the 1970s up between two different periods, 1970 to 1995, and then 1996 till now. If we look at different areas of markets that you might invest in, well, you might have money in CDs, treasury bills.
And some of those years, the interest rates were super, super high. And you go, “Wow, 17% was what the return on treasury bills was in 1982. Fourteen and a half before that.
You look at 12 and a half and 12.8% in 1984, and you go, “That doesn’t stink, right? Who would walk away from that?” I mean, look at that. Man, that’s phenomenal.
So, that is an area though, if you look back at that particular period of time, that was not making much return after inflation because inflation was so high. That’s why the interest rates were so high. That’s why in any period in history, when you look at interest rates being high, that’s the reason they’re high, because inflation is high.
So if we look at equities in those years, stocks in those years, like 1982, well, you had a 40% return in small value stocks. You had a 48% return the next year in small-value stocks. You had international small a couple of years before that, 35% return, and 67% return in international small companies a couple of years later in 1985.
Looking at the Past
So you look at that and go, “Okay. Yeah, that’s a whole lot lower than what treasuries were, but treasuries are safe.”
Remember, not after inflation. After inflation, your rate of return is less than 1% per year going back to the 1920s. But let’s say that, imagine you’re that investor and you’re talking to your friends and the year is 1983.
And your friend comes up and goes, “Man, I got this small value fund. It had a 17% return. Then it had a 40% return. Then it had a 48% return.”
And you’re going, “Whoa, that’s really good. I got to have me some of that.” And you jump on it and you have a 7.9% return.
You’re not upset about that, but you don’t realize that U.S. value stocks go up 16%. And then the next year after that, you got a decent return, an okay return.
But then international small goes up 67%, and 70% return the year after that for international large. And international small again, 40% return.
Well, you went after the thing that had done well from 1981 to 1983, not knowing that it wasn’t a tree that was going to grow to heaven.
This is what I see happen with investors time and time again. We complete patterns in our minds.
We go, “Wow, this thing is really doing well.” And I go, “No, it did well. Can we use past tense language?”
Can we go, “No, it did well. You don’t know what’s going to do well next”? And what happens with investors is they get pulled into a story, and all of a sudden a piece of news comes out. And this week was no exception.
I talked about that last hour, but this week was no exception where you had new information on AI. And all of a sudden, all the companies we thought were going to be the winners, the ones that were going to knock it dead, ended up not necessarily being the winners going forward.
It may not be. We don’t know. We really don’t know. I mean, there’s just too much to be known or learned to really figure out what’s going to happen going forward.
But as an investor, what we do is we listen to these siren calls and these people tell us, “Hey, this is what’s happening.” And the point I made to this person was, “Go back. Let’s go back in time.”
Do the Prudent Thing
When I was first learning about the academics of investing and getting into all of that, this was the late ’90s. And yeah, I was watching CPC. I was watching these financial channels, and they’re just talking about tech stock after tech stock, what these companies are doing, how the technology is expanding and where it’s going, what’s going to be coming next, and how the information is doubling.
And we’re going to be all using this stuff, these computers, and it was all real. Technology was going to be the future, but we didn’t know who the winners were going to be.
And as news comes out in 2000, all of a sudden we find out, “Oh wow, this may not be really what it all’s cracked up to be. We had no idea this was going to happen.” And you have companies going out of business. You have companies that are cooking the books.
You have companies that are coming out with false information and people don’t realize it.
And they’re going, “Whoa, wait a minute. I invested based on this information.” And there are people that lost their entire portfolios just thinking that they had it down, and their confidence level.
I remember teaching workshops around that time and people were listening to me going, “Yeah, right, Winkler. Whatever.” And they’re kind of half listening to me because they had this confidence that they had it all down.
Well, then you had an 80% decline in tech stocks. You had a 40% decline in large companies, large U.S. companies, companies that were the darlings. You know, you had these huge declines.
And I said to this person, I said, “You know what? There was something else that was really funny that happened.” And she said, “What?”
And I said, “Then I started getting pushback because everything that they owned had done so badly and gone down so much and they lost so much money that they were going to hang onto it until it came back.” I’m like, “I can’t win for losing because I’m trying to get people to do the prudent thing,” and the prudent thing is to diversify.
Hot Hand Fallacy
The prudent thing is to not buy based on past performance because we know past performance is no guarantee. And that’s what it says in the disclosures. “It’s not a guarantee,” but to get people to actually do it, oh my goodness.
Even though legally, the fund companies had to put this out there, they just didn’t believe it for some reason, that past performance wasn’t an indicator of future performance. So what happened is that people, it went down and they were like, “I’ll just hang on when it comes back.”
And then I would say, “Hey, look, look, look, look, look. When you were in high school or when you were in junior high, probably more likely, the thing that got you into trouble, let’s say maybe it was fighting. The thing that got you into trouble, was it the likely thing, if you want to get out of trouble, to just fight more?” You know, it was probably not a good idea.
You got in trouble for hitting that kid in your class. Go hit him again and you’ll probably be out of trouble. No, that’s not the way stuff works, but that’s what we do with investing.
“That thing that I lost money on, I’m just going to hang onto it.” And then on the other side, “The thing that I did so well with, then I act like I’m in a gambling casino. Hey, I’ve got a hot hand,” and you’ve got … it’s called the hot hand fallacy.
There’s actually, in psychology, that concept that, “I have a hot hand. And man, I need to keep playing at this roulette table because I’m getting it done.”
And then what ends up happening is people wonder, What hit me? Why did I just get blown away with this investment? I thought I was doing what made sense — past performance. They said the future was going to be so bright for technology.
And right now there are people out there that are saying, “Wow, have you been looking at pricing, share pricing in different areas of the market?” And the funny thing is, this is what cracks me up about some of these mutual fund companies.
For example, Vanguard, they have a section on their website. And we don’t have a thing against Vanguard or for them or anything like it. You know, I look at fund companies, and I’ll pick on anybody because we don’t represent the fund companies.
Right? We don’t sell investment products. We don’t get paid commissions. We don’t do any of that kind of stuff.
And here’s what they have on their website. They have Vanguard Capital Markets Model forecasts, okay? So number one, what do we know about forecasting? It’s probably not a good idea.
I don’t know about you, but I’m not much on going to a palm reader or somebody that’s looking into the crystal ball to try to figure out what’s going to happen with my future. This is not me. I’m just not doing that.
I don’t like to try to predict the future because I recognize that I’m pretty bad at it and pretty much everybody else is too.
So, it’s not a good idea. But you see right on their website, forecasts. Now, if a fund company has a section on their website about forecasts and they are managing money for you, do you think maybe they might be using some information from their belief system that they have an ability to forecast in the management of portfolios? They just might be.
Market Forecast
But then they have these funds called index funds, right? And you have index funds. The idea behind the index fund is it doesn’t pick stocks, it doesn’t time the market or anything like that, but it cap weights, it overweights really big companies.
And a lot of people, they’ll just choose these portfolios that are indexed because, “Hey, can’t we just index the portfolio?” And I go, “Well, where do you expect more returns, small or large companies?”
And they’ll go, “Small companies.” Where are they overweighting? Large companies.
Okay, they’re overweighting the area where I expect lower returns. Maybe that doesn’t make sense.
And then you look at their mixes of assets in U.S. and international, and you see mainly U.S. companies — that’s where the leaning is, to that particular area of the market. And you go, “Okay, so they have those funds that are managed, where you just pick it.” And if you’re retiring in 20 years or whatever, or 30 years, you just pick the time horizon that actually fits when you’re going to be retiring.
Okay, so now you get this. Got the idea that some people will end up that they’re having the money managed and they’re stock picking and market timing with it because that’s on their website. They actually talk about doing that.
That might be what they end up doing. They’re using active management is what that’s called, or they may just go to the target date type of portfolios or the index funds or something like that.
Now, if they believe what’s on their website, I want to kind of build this up, if they believe what’s on their website that they have a forecast that they believe could be helpful for investors in the future, if they’re leaning in their portfolios that are managed for somebody retiring in 20 years or 30 years and they just do it all for you, where do you think that they would lean more of their investments if they believe their forecast? Will they lean it more where they think that returns should be higher? Right?
That would make sense. Well, what did I say that they’re actually leaning toward? Large U.S. growth companies, right?
Now on their forecasts, and the forecast as an asset class performance, there’s a 10-year forecast on this. Their forecast is that large U.S. growth is going to be the absolute lowest-performing asset category in the next 10 years.
I kid you not. That’s on the website. They think that large-cap is going to be the second-lowest performing.
If you just look at U.S. versus international, their belief is that U.S. is going to be underperforming everything else. Yeah, no joke.
Where did they say that they’re leaning more money? U.S. Where did I say they were leaning more money? Large cap.
What are they overweighting? The two things they think are going to be underperforming going forward. You can’t make this stuff up.
So when we look at that, we say, number one, “Ah, it’s not a good idea to do forecasting,” but when you do forecasting and you believe you have the ability to do it, and then you lean the portfolios the other direction, that seems to be an issue to me. I don’t know.
Dysfunctional Investing
Maybe it’s just me, maybe I’m just crazy, but here is what investors tend to do. Investors go, “Well, what did well?” And maybe this is an explanation for why it’s being done.
Investors tend to lean toward, what just did well recently? And that would be large U.S. companies.
And because investors believe their customers believe that area that just did well is going to continue to do well, maybe that’s why they lean that way. I don’t know. But recognize that this is a bit dysfunctional, number one.
Number two, this is what happened to investors in the late ’90s too. Investors were heavily, heavily weighted in big U.S. companies. And then you had the dead decade, literally dead decade. No return for 12 years in that asset category.
And when that happens, it’s not like you just get a 2% return per year. That’s not the way it works. Normally, you’ll have something. If you look back at history, you might see 30, 40% declines in markets when the party’s over.
You know, in the mid-1970s, that’s exactly what you saw happen. In 1987, that’s exactly what you saw happen. In 2000, 2002, that’s exactly what you saw happen. In 2008, that’s exactly what you saw happen.
And it is fast and furious and you can’t fix it in time. And this is why it’s so critical to make sure that you don’t walk away from the rules of investing, in prudent investing.
When’s the best time to be prudent? Whenever you figure out what prudent is.
But too often what people do is they wait until the accident happens and then they start to fix things, and that’s a problem. So investing, what I’m looking at is going, “Hey, you know what?” There was one of my clients, a rocket scientist. I’ll never forget when I first met him I said, “Wow, I’m going to have a rocket scientist as a client.”
And he goes, “You just might.” And he has been a phenomenal client for many, many years, a couple of decades.
But anyway, one of the things he sent me was this thing about “Diversification Means Always Having To Say You’re Sorry,” and I love that article. I don’t know if I can still have it someplace, but it’s the idea that when you diversify, you’re always going to have something just doing wonderfully well and you’re always going to have some stuff that’s not doing much of anything. And that’s the idea.
Diversification is the idea that you don’t have everything moving in tandem with each other because if everybody has the same opinion on something, then some of us aren’t needed. And that is the rule of investing as well.
You always have lots of different things that do well in different economic terrains. I don’t know what the terrain is, going forward. We can make a guess as to what it’s going to be going forward, but to know for sure, forget it, perish the thought.
We don’t have the future. We don’t have a crystal ball that works.
And you don’t have to be a person that knows what the future is to be a successful investor.
But unfortunately, the investment industry is built on that idea. I just think it is dysfunctional.
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.
