We often discuss being a confident investor on the show, but confidence is only helpful if it’s combined with a disciplined, evidence-based approach rather than behaviors such as market timing or individual stock selection. Today, Paul shares an ad for Jim Cramer’s investing club that he saw on CNBC, where a client claims she is confident and finally “in control” of her investments. The ad reveals that Jim teaches people to “win at investing” through market timing and stock picking. Paul and Evan explain why you shouldn’t follow someone who offers club memberships and provides stock-picking advice. Later in the episode, Paul and Evan answer a listener’s question about the number of publicly traded companies in the stock market and how a diversified portfolio can be constructed.
Want to cut through the myths about retirement income and learn evidence-based strategies backed by over a century of data? Download our free Retirement Income Guide now at paulwinkler.com/relax and take the stress out of planning your retirement.
This material is for general educational purposes only and is not personalized investment, financial, tax, or legal advice. Past performance does not guarantee future results. Nothing here is an offer, solicitation, or recommendation for any security or strategy. All financial decisions involve risk, and you should consult qualified professionals before acting on this information.
Advisory services offered through Paul Winkler, Inc., an SEC-registered investment adviser.
Paul Winkler: Welcome. This is “The Investor Coaching Show,” and I am Paul Winkler, along with Mr. Evan Barnard hanging out with me in the studio today. Man, good to have you back.
Evan Barnard: Yeah, good to be back.
PW: Yeah, this is going to be fun. We got a lot of stuff. We got a lot of stuff. It’s been a busy week.
EB: I fully recovered from the IU victory last night.
PW: You fully recovered from it?
EB: Yeah, my dad is an IU grad.
PW: Did you like that?
EB: Yes.
PW: That was good. Okay.
EB: Yes.
PW: All right. Yeah. It was close, but you know.
EB: Yeah. Not.
PW: My goodness. That was crazy.
EB: Yeah.
PW: That was crazy.
EB: That’s why you play the game. You can’t just use a computer and see who’s going to win.
PW: Yeah.
EB: You’ve got to play the game.
PW: Yeah. It wasn’t even debatable on that one, as opposed to Ole Miss.
EB: Yeah.
PW: We’re not here to talk sports, though.
EB: There you go.
PW: That’s not my normal thing. Can you believe I even knew that stuff?
EB: Actually, I can’t. I’m stunned. You better be right with God. Paul knew some of the sports stuff going on.
PW: My son is really into it. My wife actually watches too, so it’s funny.
She’ll have it on. Now I go, okay, I’ll sit here. I’ll watch it.
EB: My mother was a football nut.
PW: Was she really?
EB: She loved it.
PW: No kidding. Yeah. And it’s funny because I’ll explain that I played for a couple of years. I played, but I was awful.
I belonged in the marching band. Did not belong. But that’s all right. Somebody’s got to be in the marching band too.
EB: There you go.
PW: Okay. So, onto investing topics. Lots of stuff to talk about there. I’m going to put two things together here.
So I think that there was this whole thing … because I watched CNBC. I don’t know, Evan, you watch CNBC a lot in the mornings, the financial channels, just to see what they’re having to say, not for investing advice by the stretch of the match. I ran across something I had written years ago.
And it was so funny. I named all of these financial publications, these magazines. And I said, “What do they have in common with Golf Digest?” And the point that I had written was that if the professional really knows what they’re doing, they’re not reading them.
EB: I thought you were going to say the ads.
PW: It’s like the golfers, Tiger Woods isn’t checking out Golf Digest on how to swing a club. So a lot of this stuff that’s put out there is just garbage, in my humble opinion. But I like watching it simply because they may be talking about what’s going on around the world. It’s more like what drove the markets to do what they already did.
EB: Yeah.
PW: You know what I mean?
EB: Well, that’s what I get out of it.
PW: Yeah.
EB: That’s not necessarily all of what they’re trying to produce.
PW: No, that’s not what they’re trying to put out there.
EB: Yeah.
PW: Yeah. No, for sure. It’s what you ought to do based on the news. Yeah.
EB: Frankly, my biggest use for CNBC is to be prepared for a question I’m going to get that day from a client.
PW: No, good point. Good point. Yeah.
EB: “What about such and such?”
PW: What do people think?
EB: Well, as a matter of fact, don’t worry about it.
PW:
It’s just the idea that’s what’s in the Wall Street Journal. And I learned that, ironically, because my mother was a big fan of Rush Limbaugh back in the 1980s. She would listen to him and he would be picking apart something that was in the New York Times or the Washington Post or wherever.
He was picking those things apart and helping make sense of these things from his perspective. And I thought, Oh, what an interesting way to do a radio show. Take the news of the day, whatever it is, and the financial news, and go, “This is what is okay about this, and this is where they’re going, and this is where people can be misled.”
EB: Yeah.
PW: So anyway, I’m watching this thing, and it has a commercial. There’s a commercial for Jim Cramer’s thing. He has this investing club, and the idea is “We’re going to teach you how to be a confident investor,” which I hate because it’s the idea that I’ve used for years, and now all of a sudden it’s like, “You’re going to be a confident investor if you listen to what he’s saying.”
But my thing is that it bugs me that the information is, “This is how you ought to be managing your money.” And I’m shaking my head, going, “No, crazy. No, don’t, don’t do this.”
EB: Yeah.
PW: So they have this, Nik, if you got the audio up for an audio segment here — he does. Here is a testimonial in a commercial. So this is basically what the testimonial is.
Jim Cramer: We created the club to give investors more confidence in their investing decisions.
Speaker 4: I wanted to be able to manage and control my own wealth, and Jim gave me the confidence to be able to do that.
Speaker 5: Get invested. Join the club today.
PW: So I think it’s a false sense of confidence, feeling like I really have control over what? And that’s the problem you run into: Which stocks should you be in? And let’s study these companies so that you have “control.”
EB: Right.
PW: And you don’t have control.
EB: Which you don’t have.
PW: Yeah, you don’t have any of that stuff. Go ahead.
EB: Before you go on, anytime I hear someone use that particular word, “I want to be in control,” I just immediately go back to the Vegas studies of slot machines. And the slot machines that are push button, gamblers feel like they have less control over the outcome than if it’s an old school slot machine where you pull the handle because they can pull it fast, they can pull it slow.
PW: “I can let it go a little bit.”
EB: You’re out of control the minute you pull the handle.
PW: That is absolutely true.
EB: It’s the deal, but casinos don’t build tall buildings because everybody is winning.
PW: Yeah. Yeah. It’s that perception of control. So then you go, “Okay, so that’s what you ought to do.”
PW: Wait until you hear the next line on how you manage your money. You ready?
Here you go. This is good. Nice.
JC: Along with an index fund, I want you to own individual stocks. Not treat them. Own them, and let the power of compounding do its work. Most important.
S5: Mad money.
PW: That’s mad, all right. “I want you, along with an index fund, I want you to hold individual stocks, buy and hold them.”
Now, there are all kinds of things wrong with this. Number one, let’s say that we take an index fund, and it is a holding of many stocks. Let’s say it’s an S&P 500 index fund.
EB: Most likely.
PW: So you’ll have 500 stocks in that. Now, you’re going to also own individual stocks. So basically, what are you doing? You’re overweighting.
I remember, if he tells you to buy five stocks or 10 stocks or whatever, you’re overweighting those 10 stocks in the portfolio. They’re probably already in the S&P 500.
EB: And probably already overweighted.
PW: Yeah. And probably already overweighted because they overweight popular companies, well-known companies. So number one problem: If you’re really confident in those stocks, why do you bother with the index fund?
EB: Right.
PW: If you’re super, super confident that you’ve chosen the right companies, number one.
EB: Yes, yes.
PW: Number two, let me replay it again because I want you to hear this again.
JC: Along with an index fund, I want you to own individual stocks. Not treat them. Own them, and let the power of compounding do its work. Most important.
S5: Mad money.
PW: Not trade them.
EB: Yeah.
PW: What is the premise of his entire TV show?
EB: Trade.
PW: Yeah. I mean, literally has a segment every morning at 8:30 Central Time, just after the market opens, actually 8:40 or so. It’s called “Stop Trading,” but it’s actually telling you which ones to trade right now today.
EB: “Get out of this and buy and hold this new one.”
PW: Yes. I mean, that’s the whole premise of it is to do that. And he’s saying then make the power of compounding work for you.
Yeah, compounding is great. It’s wonderful and everything, but that’s not what he’s teaching in these things. He’s teaching to analyze the companies and buy and trade.
EB: Right.
PW: That was the whole reason that indexes were invented, because people couldn’t pick which stocks.
EB: And why not buy and hold, in this case, 500 stocks, rather than buy and hold five stocks? If your goal is compounding over time, why bother?
PW: Right. So that was a question that was asked. And this question was in regards to investing: When are we diversified? So at what point do we actually say that we’re diversified and that we’ve done what we need to do?
And Shane, thanks for the question, by the way. I’ll give you a shout-out here, because this is a really good question. He says, “I figured out how to properly invest.”
He was kidding around with me. He says, “Just tell me what companies to invest in and I’ll do the same thing.” And I said, “There you go.” I said, “I’ll give you one company a day, and it will take me 82 years to name all of them.”
EB: Wow. Okay.
PW: So I did the calculation on how many stocks you’d hold in a portfolio and how long it would take. Yeah, so it would take you 82 years if you bought one new stock each day. Because I was just laughing.
“Tell me which companies.” He says, “I got time.”
EB: Yeah.
PW: And he’s like, “Whoa, that’d be a good topic.” He says, “I’ve been listening to you for years and I always assumed that maybe 15 to 30 companies was it.”
EB: Interesting.
PW: Yeah, I thought that was interesting. “How do you pick so many?” And a lot of people would want to know that.
Okay. I’m going to start with why is it not 15 to 30 companies, and where maybe does some of that come from? There was an old study that was done years and years ago. And if you look at, let’s say, the legal requirements in the United States for what is diversified.
A diversified fund, to be diversified, you’ve got to follow what’s called the 75-5-10 rule, which is where 75% of the assets are held in stocks or securities, cash or securities. It can invest no more than 5% of the assets in any one company. A fund can’t own more than 10% of the outstanding voting shares of any one company.
And you’ll often hear this idea of having a few companies. I remember when I got licensed to sell mutual funds, it was like 20 stocks. We talked about a 20-stock minimum.
And in some countries, it actually is that many companies. But when you look at that and say, okay, so that number one is you look at what a mutual fund must own, but does that make sense to do that? And where does the number 30 come from? Because you do hear that number from time to time.
PW: Matter of fact, I actually referenced it in my book, “Above the Maddening Crowd,” about incompetent investing. I talked about getting rid of non-systematic risk by adding more securities.
And there’s a graph that most … well, I was just going to say most investment advisors are aware of, but I’m going to take that back. They’re not. They should be aware of this.
And the graph basically looks like this. On the Y axis, the vertical axis —
EB: The up and down one.
PW: Thank you. Yes. You have the standard deviation of the portfolio.
That’s the level of volatility. That’s how high the hills and valleys are in the portfolio, how much it can go up or go down, or what the variability of the portfolio might be.
On the X axis, the horizontal one, it’s going to tell you the number of stocks. And Evan, you remember this particular chart, where it starts way high. So if you have very few companies, one or two companies or something like that, it’s an infinitely high, not infinitely, but very, very high standard deviation.
In other words, once you get to that many, you reduce the non-systematic risk pretty significantly. And in English, what that is, is the risk that something happens to any one company.
EB: And it takes you out of the game.
PW: Yeah. And systemic risk is going to be, hey, you know what, you’ll have an oil crisis or you’ll have … let’s say you’ll have … What’s that?
EB: COVID.
PW: You’ll have COVID, or you’ll have interest rate increases, or you’ll have an economic downturn, and that affects all companies pretty much. And maybe not all simultaneously by any stretch the same exact way. They won’t go up or down as much as each other.
You might have value companies go down 5% where growth companies go down 20%, something like that. But in essence, the systemic risk is a risk that happens to and affects pretty much everybody.
I think I put this in my book, where it’s like you have boats on the ocean. And if you look at all the boats on the ocean and the ocean goes up, all the boats rise, and they all fall when the ocean goes back down. So the system is the ocean, and then you have the individual boats on that ocean moving up and down in tandem with each other. Versus what’s the risk of one of those or two of those boats actually sinking as a result of it?
Now that would be non-systematic risk. That’s a problem with that particular boat that went under. Maybe it wasn’t well-suited to be on waves or something like that.
EB: Or it hit a bridge going out of the harbor.
PW: You hit a bridge. Yeah, there you go. I like that. That’ll work.
PW: So, maximum portfolio diversification is basically considering the global market, all the industry sectors, and all styles of investments available, and if you’re looking at it, you can add up to thousands of individual stocks, which might be needed to actually get rid of all that risk. And the original study done in 1970 was a study that was looking at the variability of returns.
And it looked at standard deviation, mainly looked at standard deviation is what it did. And they used that, and they came up with the idea that about 30 companies were what you needed to get rid of, and 95% of the benefit of diversification was captured in a 30-stock portfolio was the result of the study. And what they did is they only looked at standard deviation.
And what happened is there was a subsequent study, and I know this is a bit nerdy, but it’s important to get. I’m going to build up to how many stocks. There was a SERS price study where they looked at R-squared, and they were looking at diversification as a percent of variance.
And what they did is they were looking at tracking error, those two things. So, they were looking at both of these things, and you’re looking at variants in terms of portfolio returns. You’re looking at tracking error in terms of what does your portfolio do versus a benchmark?
If it’s large value stocks, how well does it move? How closely does it move to the Russell 1000 value, which is a totally different area of the market?
What they found was that 90% diversified with only 60 stocks is only relative to a particular market in question. And what they found was that if you really wanted to get rid of all of this or most of this non-systematic risk, you had to have a lot more. You had to have a lot more in these areas.
And you’re not only doing that in one area, though. This is the issue: You want to get diversified in large company U.S. stocks, but you also want to get diversified in small value and large value and international value and international growth and emerging markets and so on and so forth.
And then inside of that, let’s say we’re just talking about large U.S. stocks, you’re going to want to have telecom and utilities and energy and consumer staples and materials and information technology and all of these different things. So you’re wanting to diversify in there.
And you look at that and you start to think, Oh my gosh, I’ve got to have that many companies in small value stocks. And I’ve got to make sure I don’t own just a few small value stocks, but I’m making sure that I own the telecoms in that area and utilities in that area and the energy companies that are inside of that subset and the healthcare and the financials and the consumer discretionary. And you start to go, Wow, this might take a lot of companies to get diversified when it really gets down to it.
EB: Yeah.
PW: A lot more than meets the eye. And if you say, “Well, what would we own in our portfolio?”
Well, in large U.S. stocks, we would have about 500 companies. Large value companies, we’d have about 300 plus. Small companies, if you look at U.S. small companies, we have over 2000 in that particular market segment, and microcap, another 1,700 there. So they’re very, very small companies, and another thousand in small values, 1,000 plus.
And international, now we’re not just dealing with the U.S., which is one country, we’re going to be in 40 to 50 countries around the world. We’re looking at how many big companies are in all these countries that would be worthy of being in a portfolio, and you’re looking at somewhere in the neighborhood of 2,600 plus.
That’s a lot of companies. And then value, international value, it’s going to be fewer because they’re going to be more distressed companies.
But you’re going to have 500 plus in that particular area. And then international small companies, now you’ve got a lot, 3,400 plus. So you look at this, you go, “Oh my goodness, we’re starting to add up to thousands of thousands of companies in a portfolio.”
EB: And we’re getting rid of a lot of non-systematic risk.
PW: Yeah, and that is a big deal. And not only that, but you might have a systematic risk that is only affecting the United States.
EB: Right.
PW: So I might have something that happens, like say the dollar dropping in value.
It could have a pretty significant positive impact on international companies.
EB: It did last year.
PW: Sure did. Heck yeah. Well, 2000 through 2010. I mean, that was a pretty significant thing, where international did so much better than U.S. stocks.
PW: So, how the heck do you do that? Well, this is commingled vehicle territory.
Commingled is basically the idea that, let’s say, I have 500 companies I want to invest in. And let’s say that in the old days, I would have to worry about using round lots, 100 share units, to really keep costs down. And let’s say the share price is $50.
Well, I have to have 500 companies, $50 a share, 100 share units. You’re talking about $2.5 million just to get diversified in those 500 companies. And a lot of people don’t have that amount of money.
If you’re looking at microcap companies, you’re looking at 1,700. International large companies, 2,600, as I said earlier.
Now you start to get into some really big money to get diversified. Even if you’re using odd lots, which are less than 100 share units, you’re still dealing with a lot if you’re doing odd lot trading.
And you go, “Oh my gosh, how do I do this?” Well, that’s where we mingle or commingle; everybody’s money goes into a bucket and we in common own the bucket.
That’s the concept of a mutual fund. We’re mutually owning, we’re mutual owners of this basket of stocks, and I’ll have one mutual fund.
I’m not a big fan of asset allocation funds for that reason. Typical asset allocation funds. And when I say typical asset allocation funds, you’ll see funds that’ll invest in U.S. stocks and they’ll have international in there and they’ll have bonds in there and they’ll have cash in there and they’re trying to do it all for you.
EB: And you’re creating a distinction between that and a lifestyle fund, correct, or a target date?
PW: Well, a target date fund could be an asset allocation fund in my mind. It’s a specific type of asset allocation fund, targeted at a particular date that you’re going to retire. I’m going to retire in 2040, I just put all my money in a 2040 fund and it’s an asset allocation for a person retiring in 2040, supposedly. But I say supposedly because there’s a lot of research showing that one size fits all, fits nobody.
But that’s what most people default to in 401(k) plans. The idea is that when I own one fund, one mutual fund that invests in large companies, and I have a totally separate fund that invests in small, I can determine what percentage I put in one versus another based on time horizon, based on my goals and those types of things.
So I like funds. Personally, as much as I can, when I’m looking at somebody’s 401(k), I’m choosing individual funds that are completely focused on a market segment.
PW: But what you want to look at, and this is one of the things that has blown my mind, when I’m looking at 401(k)s, and I’m sure you see this, Evan, where you’re looking at a fund and you go, “Well, this is a fund investing in small U.S. stocks.” And then I’ll look at how many holdings are in it, and I’ll go, “You’ve got to be kidding me. They’ve got less than 100 holdings in this.”
EB: Sixty-eight, 70.
PW: Yeah. And you just go, Are you joking? They consider that diversified because when you’re dealing with smaller companies, I want more, not less, because now we’re dealing with some even more significant issues — that they’re smaller companies that are more volatile. The more the merrier.
Now, why the more the merrier? Let me just take it to an extreme. Let’s say I buy two stocks. Now those companies get to use my money when I own their stock.
Now, they’re going to pay me to use my money. They’re going to pay me in what? Earnings. So they’re going to pay me earnings and that in exchange.
Now, if you own a company, let’s say you’re the owner of a stock, or let’s just use an IPO for just a simple example, you’re the owner of the company and you’re selling shares out on Wall Street. You want to give up as little of the earnings as you possibly can to get as much money out of me as you can possibly get. You want me to pay a boatload for every dollar of earnings if I’ll do it.
EB: Right.
PW: I mean, that’s the bottom line. Now, let’s say you are the buyer. Well, you want to pay as little as you can.
Now you have to come to an agreement. How much am I willing to pay? And how much will you accept to give up these earnings?
Mr. Owner, Mrs. Owner, how much will you accept? Now, what happens is that that number is determined by the risk involved.
In English, what is the risk that those earnings are going to come in? What return do I have to have to get me to part with my money? And let’s say that that return that I must have is 10%, just to use a nice, round number.
And that’s what I have to get for you to get my money out of me as the investor. You’ve got to do that.
Okay. Now, let’s say that I look at that and I say, “Okay, so that’s 10% return. That’s what I need.”
Now, what will have to happen? We come up with that number. Well, that number will be the same regardless of what company is at that same risk level, 10%. Whether it’s 500 companies or two companies. So if the expected return is exactly the same, 10%, then, as an investor, why would I buy individual companies and get the same return and accept all that extra risk as a result of it?
EB: Right.
PW: So that is why we diversify very, very broadly. Good question.
It took a while to answer it, but I wanted to make sure I got through all of that before we headed for a break. Thanks, Shane. Appreciate that.
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.
Today, Paul and Evan talk about the catastrophic drop in Bitcoin’s value and why Bitcoin traders keep digging their heels in, hoping
This week, Paul has been methodically taking you through the basic principles of building a portfolio that will help you reach your
When we discuss investing in the stock market, most people think of investing in individual stocks. Paul shares that the returns with
