Interest Rates Change. Confident Investors Don’t Overreact.

Paul Winkler: Welcome to “The Investor Coaching Show.” I’m Paul Winkler.

Evan Barnard: And I’m not.

PW: We talk about investing. And Evan Barnard is over here.

Wait a second, I was going to introduce you. You went and started. You messed up my whole intro.

Let’s start over. Hey, welcome to “The Investor Coaching Show.”

EB: Channeling Saturday Night Live, sorry.

PW: Yeah, yeah. Well, happy almost Memorial Day. And a huge, huge, huge weekend for patriots like us, and Evan, as a former, I guess, you’d call them former Marine.

EB: That is correct.

PW: Of course, this is a weekend for those who have gone on who did not make it through battle, of course, but we’re the kind of people that celebrate military just regardless. That’s just who we are, right?

EB: Well, absolutely. I mean, it was our family business going back to the first war for independence.

PW: Yeah, my father too.

EB: But I do always want to honor my roommate, who was actually one of the few casualties in the first Gulf War. First Lieutenant Michael Monroe was a TOW platoon commander.

PW: Wow. I hadn’t heard this story.

EB: And so I always honor his memory and his mom, she lives in Washington state. But it’s real. And there’s a lot of people, a lot of families that have sacrificed over 200 years to provide the freedom that we have.

PW: So, as people are running around having their picnics and all of that kind of thing, we also want to talk about that kind of stuff.

Cost of Capital

PW: Boy, what an interesting week. I don’t even know where to start on the show today. There’s so much going on.

Of course, the trade issues. This is so funny, though. The week started out, and the whole talk of the beginning of the week was, “What do we do?”

Atlanta Fed, the chair was actually on the financial channels talking about … I don’t know. Nik, you’re probably ready for any audio that I might have up my sleeve, right?

Nik: I’m ready for anything.

PW: All right. See, look at you. Look, he’s all ready. Because I want to head straight to that.

Because Bostic, the Atlanta Fed, was with a gentleman on the financial channels talking about cost of capital. I thought it would just be a good tutorial. We talk a lot about cost of capital here.

He was talking at first about some of the issues regarding what was happening earlier in the week. My take on this is how fast things change, but just check this out, and then we’ll talk a little bit about that.

Raphael Bostic: With this downgrade, it will have implications for the cost of capital and a bunch of other things. And so it could have a ripple through the economy.

Today, things are very much in flux, there’s a lot of uncertainty, and what it means for me is, before I want our policy to move in any dramatic direction, we’ve got to let things sort out a bit. So that’s kind of where I am right now.

PW: So you had some interest rates that went up early in the week. It was the long bond, particularly, that went up. And the concern is the cost of capital and how much it costs to use other people’s money.

Now, a lot of times I find that people will put money in fixed income investments, and they think, Well, it’s safe. I don’t have to worry about it. But there’s a cost of capital. And that is very highly correlated with inflation rates.

So, in other words, when you have high inflation, interest rates tend to be high during those periods of time, or the depreciation in the purchasing power of the dollar. So, if you’re an investor, and you’re feeling complacent about having a lot of money in fixed income investments, like CDs or something like that, maybe because the interest rate’s a little higher right now in the past year or two than they’ve been in years, decades, really, if you’re complacent about that, then you don’t recognize, probably, that it is because of inflation and inflationary things that have actually created this turn of events.

So, what has happened, it was interesting that we’re talking about the cost of capital implications. And here’s what he’s really talking about: It costs more to use your money. It costs more to use your money in everything.

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So historically, when we see increases in the cost of capital, we also see increases in the rate of return in future years in stock markets, but it may not be immediate. 

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So, an investor that looks at, let’s say, 10 years of data for most market segments, would look at it and say, “Wow, markets have actually been under their long-term expected returns in recent years, in recent history.” The reason that has been the case has been because the cost of capital has been lower in recent years. But that doesn’t tell you anything about the future, doesn’t tell you what’s going to happen in the future.

EB: Yeah.

What Really Drives Returns?

PW: I did a video on something of this very nature. And what I did is I was walking through various areas of the market, various market segments. And I thought it would be good to have a visual for all of this, because when you’re trying to figure this stuff out, it can be difficult when you just hear me talk about it, but it could be doubly difficult when you don’t have anything to actually look at, as far as what’s going on and see these things.

Well, I started out the video, and I talked about: What is the biggest determinant of market returns? What’s the biggest determinant of, not market returns, I should probably say the investment advisor’s job, or the pension manager’s job, what really drives returns historically? What’s the real factor that we focus on, Evan?

EB: The mix of assets in your portfolio?

PW: Absolutely. “And for $200 you get the mix of assets.” “I’ll choose the mix of assets for $200.” Yeah, exactly.

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That’s the big deal: Market timing, when you’re trying to change your portfolio based on what you see happening. 

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That was 1.8% of the difference in returns historically. That was it. It was very minor. Other factors were 2.1, 4.6 was stock selection.

So, what do most people spend their time on? I noticed one of your articles that you had is something about that hot stock, Evan.

EB: Yeah.

PW: People think that that is a driver of returns, which stock that I own, right?

EB: Right. Yeah. And it usually has a great story. In listening to those factors and determining portfolio performance, we were doing a workshop last week in Murfreesboro. And we were reviewing some of the data from that study that came out in ’91, and I think ’86 the first time.

PW: Yeah, ‘86 and ‘91.

EB: Brinson, Hood, and Beebower

PW: That’s right.

EB: And so I was with another large national firm when those studies had come out. And they shared those statistics, but they phrased it as, “91% of the return comes from the mix. And if we get good funds at the right time, we can get these other 9% of the return that you deserve.”

PW: Oh yes, you’re nailing it. That’s exactly right.

EB: And the positive return all comes from the asset class. And to the extent — whether it’s a pension fund, individual — it engages in that other behavior, that’s a drag on return.

PW: That’s right. And that was the next slide in my video that I did.

EB: Yeah, cool.

Funds With Lots of Buying and Selling

PW: The next slide on the video was the various asset categories and how the professionals, when they got their hands on things and tried to improve performance, actually hurt performance. So that was the next slide.

Then the next slide after that, what I did is I just went looking for a fund that had a lot of buying and selling in it. So I found a fund, Goldman Sachs U.S. Equity Insights. I figured Goldman Sachs, everybody knows who Goldman Sachs is. Big name.

And one year it had 47% turnover, 121, in 2013 it had 203% turnover, 2014 it was 214. The next year, it was 224% turnover. Then 213 again; then it was 213, excuse me, not again, but it was 213% turnover the next year, 193, 186. Then it was 213 again. Then it was 193, 168, 199, 213, 214.

I joked, “They change stocks in here as often as some people change their underwear.” I mean, it was just very often they’re buying and selling.

And then what I did is I did what we do in our typical first workshop. I put a mountain chart of that fund versus the actual area of the market.

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You see, when the market goes up, the fund goes up; the market goes down, the fund goes down. They’re just moving in lockstep with each other. 

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That’s what you see. And the fund, my son insisted, as he was watching me do the video, “Dad, don’t forget to say that the fund underperformed the benchmark, the asset category.” And I said, “Okay, okay buddy, I’ll do that. Yeah, all right, I’ll do that.”

Then I did the next slide, I said, “Well, ‘Paul, I got this. I got this. I’m just going to put it all in a total stock market index fund, is all I’m going to do.’”

Now, we’ve talked about studies, how indexes are being traded as actively as stocks right now. So we’re finding that investors just aren’t really that disciplined, even with indexes, even though they were designed for that purpose.

Internet Feedback Loop

PW: But what I did is I said, “Hey, yeah, I’ll just buy this fund. It owns 36, 3700 stocks.” And what I pointed out is that 18% of the money is in value stocks, which is where you’d have higher expected return in large companies, 37% is in blend, and then 16% in growth. Only 3% in small value, where you’d expect the highest return.

So almost no money isn’t where you’d expect the highest return in that particular fund because of the capitalization weighting on the fund. Then what I did, Evan, was this. This was really surprising to me. Even me.

I took the CRSP 1-10. For those of you who don’t know what CRSP is, people ask me, I had a client going, “I got this data on the stock market investor returns,” and every place he was looking, it was giving him that the average investor got a return of 6 to 8% or something like that.

And I said, “Well, it may be.” But he’s talking about going back to 1970. And I’m going, “We just don’t really have data on investor returns going back to then.” “But I found it in multiple places!”

And I said, “Well, even the co-founder of Reddit was on TV talking about how bots are giving us information, and it’s like a feedback loop where they’re getting information from each other. And it’s just, they’re spitting out the same information, because Bot A, gets this information, and then says it’s this number, and then Bot B, you go to Bot B, and it gets its information from Bot A, who got its information from God knows where.” And he says, “Well, what do you mean the information on the internet’s not good?”

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I said, “It’s like dipping your bucket into your septic tank, and then dipping it into the septic tank a second time and expecting I’m going to get better stuff.”

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He didn’t think it was as funny as I did.

EB: Yeah, that’s it. That’s a gruesome image.

PW: I know. I know, I know. Sorry, sorry, sorry if you’re having lunch right now. But no, seriously, so what I did was this, I said, “Okay, here’s where we get data: Center for Research in Securities Prices, University of Chicago.”

And I took the S&P 500. And I laid it on top of a CRSP 1-10, which is the total market. I laid it on top, I laid the graphs on top of each other. And what blew my mind, Evan, you get to see this, and if you’re watching —

EB: Turn your radio up really loud and you can see this picture.

PW: No, if you’re watching, look at how —

EB: Pretty similar.

PW: Is that crazy? And if you look at the two charts, it’s unbelievably tight.

So in other words, what Evan is looking at that you guys can’t see is a mountain chart where you see the stock market going up, down, up, and down. It’s a jagged line going from left to right up. And they literally are identical with each other.

Looking at Recent Past Performance

PW: Then what I did is I said, well, what if we go and we look at the returns of different asset categories over different periods of time, and I took from 1975 to 1984, and I said, “If you’re an investor at that point in time, you’re sitting there looking at small value stocks, going, ‘That’s where you put your money. It’s a whole 10-year period, Paul. That’s where I’m going to put my money, from ‘75 to ‘84, because that area of the market had the highest return, 37% per year. I could get rich making returns like that.’”

And then over the next period of time, it was not even close to being the top asset category; it was number five out of all asset categories. And then the next period of time, it was again. And then the next period of time, it was small companies. And it was international small companies, international small value.

And U.S. was okay, U.S. large, S&P 500 plus seven. And then the next period of time, which is what the period we’re in here, because I was looking at 10-year periods, 10-year rolling periods, and I did 2015 to 2024, S&P 500 13% per year.

And then what I did is I said, if you’re an investor, what are you going to do as an investor looking at this and going, “Wow, the most recognizable companies out there, large U.S companies, are rocking it”? And it was the top area of all areas. It had a 13% return.

International did five. International large. Small US did eight, which is okay, but it’s not 13.

Micro-caps did about seven; international small companies about six. International large value wasn’t bad, it was about 11 over that period of time. Not bad, but it wasn’t 13, right?

And then you had U.S. small value, 8.73, about 9%, but it wasn’t 13, is my point. Right? So if you’re looking at it and going, “Diversification is just stupid.” And of course, so far this year what has happened?

EB: International has rocked the house.

PW: Totally. Yeah, 15 to 20% return. But if you were an investor and you invested based on the past 10 years, you would’ve totally missed that.

But then I went back to 1970 until now. And Evan, you get to see this. Okay, see that chart right there?

EB: Aha.

PW: Yeah, if you were in the middle, you’re here.

EB: Right.

PW: If you were in all large U.S., you were all the way at the bottom. At the bottom. Return-wise, you were all the way at the bottom.

And we’re talking about not a minor difference in accumulation, it was a major difference in accumulation.

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Really all I want you listening out there to hear is do not get sucked in by recent past performance, which is how the industry tends to market investment products. 

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That’s what they tend to get you looking at.

Asset Allocation Funds of Major Mutual Fund Companies

PW: What had happened is I decided, well, yeah, before I tell you what happened, I’m going to tell you what I did. I went and looked at the asset allocation funds of major mutual fund companies, and I looked at two different periods of time for return data.

I looked at Putnam, I looked at Schwab, I looked at Vanguard, LifeStrategy Growth for Vanguard, Schwab MarketTrack. I looked at T. Rowe Price, I looked at JP Morgan Investor Growth, I looked at Fidelity Asset Manager. And the way I chose was I wanted moderately aggressive asset allocation funds.

I looked at Goldman Sachs, I looked at Franklin Growth, I looked at Principal, I looked at VALIC, I looked at all of these different huge mutual fund companies. And I looked at their return from 2010 until 2024, the end of 2024. Rates of return are about 9, 8, 8, 8.8, 9, 9, 10, 9, 7, 7.

Now, over that period of time, just to put that in perspective for you, you had large U.S. stocks that had a return of about, it was a higher 10, 11% return over that period of time, I think, as I recall, something like that. And international is a little bit smaller.

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So if they were diversified between large and small companies, they would’ve had a return. That makes sense, the return was that. 

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Then what I did was this: I looked at the return for the previous period of time, the 10-year period from 2000 until 2009. These are asset allocation funds. And I wanted to make the point: This is what happens when you look at what the investment industry tends to do, what they tend to do.

And the Putnam Fund 1%, 1.3%; Schwab 1.33. The rate of return for the Vanguard Fund, 1.39% per year. That was it.

EB: Wow.

PW: T. Rowe Price, they were the winner, 3%. JP Morgan, 1.85; Fidelity Asset Manager, 1.48; Goldman Sachs, 1.32; Franklin Growth, 1.81; Principal, 0.77; VALIC, 1.74. Almost not a hill of beans’ worth of a difference between them.

EB: Wow.

PW: Why? It is because of what we have been talking about on this show for 25 years. I’m telling you folks, this is what happens in the investing industry.

Make America Rich Again

PW: So it gave me an idea for a commercial that I’m going to do. And everybody’s talking about MAHA, right? “Make America Healthy Again.”

And I’m thinking what we need to do is MARA. Rich again, okay, MARA.

EB: Make America Rich Again.

PW: Or wealthy, or MAWA, whichever. You’re thinking the same way, you’re thinking the same way.

And I’m thinking, you got all these food additives, they’re making people sick, and it’s not just every once in a while, you get bad investment management; I just named all the major mutual fund companies out there.

EB: There you go.

PW: It wasn’t just a, “Oh, Paul got lucky and found somebody that managed it poorly.” No, this is what is going on in the industry.

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These food additives are bad; these practices in the investment industry, I’m telling you, are bad news.

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EB: Red dye number five is the new Bitcoin.

PW: Bitcoin’s going too far the other direction. I mean, yeah, Bitcoin’s bad, but this is even, this is just normal practice.

EB: Yeah.

PW: This precedes even the invention of Bitcoin.

EB: Well, I think the illustration continues, frankly, of almost every food product has additives.

PW: Yes.

EB: Just like every portfolio has this squirrely stuff going on.

PW: Yeah.

EB: And frankly, whether it’s academic investing or healthy eaters, we’re the freaks.

PW: Yes.

EB: We’re the freaks doing things the right way.

PW: Yeah. And it’s my point, we’ve got unhealthy practices hurting people’s portfolios, you’ve got annuities, you’ve got commissions, you’ve got active management, and it’s all under the guise. And you hear the marketing.

And I don’t know if I’ll have time for this in the commercial, but you hear this thing, we’re fiduciaries, and I’m like, the fiduciary, that standard, sounds good. Keep the best interests of the client first. But the problem is, the standards are way the heck too low. And what passes as being, keeping the client’s best interest first, you can get away with a lot of junk and call yourself a fiduciary.

EB: Yes.

PW: Unfortunately. This is why I believe that the educated investor is going to be the more confident investor, and is going to be the more successful investor.

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.