Transcription:
Paul Winkler: Welcome to the Investor Coaching Show. Paul Winkler talking about money and investing and teaching, because here’s the bottom line, the less you know about investing the easier it is to take advantage of you. If you don’t know anything, somebody can tell you anything and you’ll believe it. That’s the reality of things. You know, you better be an informed investor. And that’s really what I want to start the show off with today. Being an informed investor doesn’t mean you have to know everything, but there are certain things that are absolutely critical.
So I was having a conversation with some of my guys this week in the office, and somebody said something like, “yeah, I’ll do a segment on the sneaky things that financial advisors do to bring in new business.” Now, you know, that’s kind of a catchy thing, so I think I’m going to run with that. Now when we talk about sneaky, it’s not necessarily because they’re trying to mislead. I think it comes down to—I’m going to give the benefit of the doubt—very, very poor training. So I want you as the investor to be so well trained that you don’t fall prey to their poor training. Now, the job of an investment company, you know, whether it be a mutual fund company, you know, big mutual fund companies, big asset management companies, their job is to get you to move money to them.
Obviously that’s okay. That’s the name of the game, getting new business. There’s nothing wrong with that. How you get new business is very, very questionable. And there are certain things that investment companies do that fool the public because the public doesn’t know any better. And quite frankly, the advisors don’t know any better. When I was a broker, I didn’t know any of this stuff either. And I worked for a big investment firm. One of my guys worked for fidelity and the other one for American Express. It was called Ameriprise. Now another one for Merrill Lynch, another person that worked for a First Tennessee bank.
So we all came from that background. And I just, those are all the places that you know, where we used to work. And, and you know, this is what we were trained as well. Now, luckily we got past that and we were skeptical enough about the industry that we started asking questions and asking the right questions.
Comparing Funds to the Wrong Benchmark
Now, what are some of the sneaky things that they’ll do in the process of trying to get people to move money and change their investment tactics? One of the things that they’ll often do is something called benchmark. And I remember this happening to me. Good grief. This was well before I was doing what I’m doing now, I didn’t even have any academic training back then. I was a broker. I was licensed to sell securities, sell mutual funds. I had this happen to me and I didn’t know how to respond to it back then, because like I said, I was poorly trained at that point as well.
But I remember somebody coming in with a report and they said, “Paul, this mutual fund you’ve got me in is no good. And I was like, how do you know that? How do you, how do you judge that? And he says, well, this report, it’s a rating report, says it’s a two-star fund or something like that. And I was like, Oh, okay.
So, you know, that happened to me as well. But here’s what they’ll do. They’ll go, this fund is terrible. How do you know? Because compare it to this over what period of time over the last three years, for example. So I’m going to actually use a concrete example to help you understand this. Some, so let’s, let’s say that we’re talking about international stocks right now. If we look at international stocks, they have had a poor performance versus US stocks the past three years now, back in the first year of Trump’s presidency, international trounced us.
So I’m dropping that year out on purpose. Cause it would blow up the comparison. All of a sudden you bring more data. And then all of a sudden something that looked terrible before it looks great. And hence, you’re getting one of the points. If you only look at short term past performance, it’s really easy to make something look good. If that area of the market did better. Now, that’s the, when we diversify, that’s why we diversify because things don’t move together. If things moved together and they had great performance at the same time and poor performance at the same time, one of them isn’t necessary.
So it’s absolutely key to have broad diversification where you own something that does really well. Like for example, over the past three years, US stocks, you know, compared to international, like you have the US stocks from January of 2017 till now of about, let’s see about 13% per year. We look at that and go, Wow, that’s a really good performance versus international stocks, like a total international stock index, like Vanguard is 6%.
So you’d look at that and go, gee, that Vanguard fund really stinks compared to what compared to US. Well, wait a minute, it’s not a valid comparison. It would be like comparing two cars, maybe one, which is a big Hummer or something like that, you know, do they even sell those anymore? I don’t know. They’re big. And you can imagine that you’d be in way better shape in an auto accident in that vehicle than you would, let’s say a Prius or something like that. I mean, there’s no comparing the two. Now, if you compare them on gas mileage and you know, the Prius would come out on top, right?
How do you compare international funds?
So, you know, what you are comparing and how you are comparing is really, really important. Now, if we look at that’s a pretty easy international versus us now, it gets a little tricky when you’re comparing international to other international asset categories. So let’s say if I took like the Vanguard total international stock index fund, and there’s a fund that I invest in that invests in, in large international stocks, they have about the same return. Why? Because they’re comparable funds. Now, what if you compare the, you know, over, let’s say last three years from I’m doing everything from January one to 2017, just for everything I’m going to say now is for that period of time, take that Vanguard fund 6% now compare it versus the S and P like I said, 13%, but if you compare it versus let’s say an emerging markets fund, let’s say, let’s say we look at emerging markets.
Well, 7% was emerging markets. But if I look at all other areas now, the emerging markets did better than international. But if I look at it versus let’s say small companies, international small companies, the fund I use for that 5%. So the Vanguard fund did better over three years right now, if we look at small values, we see that international small value is actually flat for that period of time. So that’s way worse than the total international fund.
Well, why because the total international fund is concentrated on very, very big companies. So that’s why compared so favorably and it compared to has the same return to a total international fund now. So if we look at just a short, short period of time, like that three years, you come away going, Oh, you know what? To international investors, a total international stock fund had better performance than a lot of other areas in the market. Internationally, not all, but a lot of them now let’s go back 20 years.
Let’s go back to, you know, 20 years. So cause now anytime that an academic looks at return history, they want more data, more data because you can have 20 year periods where US stocks have 0% return.
You know, if we look at periods of time, does that mean that I don’t need to own large US stocks? Well, no, what’d I just say, if you look at large US stocks, 13% return for three in normal. Okay. So you look at that and go, wow. I would have been really dumb to go and throw that baby out with the bath water, just because the short term performance or, and short term. Yes. Ten years can be short term. Okay.
And you look at it and you’d say, I don’t need to buy this fund. And I would have missed out on this huge performance. So you see how misleading short term returns can be. Now, if we go back 20 years, the total Vanguard total international stock fund, 3%. Now that’s versus let’s say emerging markets at six merger markets small at, at over 8% emerging market, small value, our value about a 7% return, almost 8% for international small value.
And remember that was the one that had no return for three years, right? 8% per year. Now those returns are historically lower than normal. So, you might be thinking, what happened to 10% return or 12%? Well, we basically, I’m going back. I’m not cherry picking years. I’m using what if you invested just before the crash, the tech bubble crash. So I’m being really fair by pointing out a period of time, which is I wanted to include all of the market downturns over the past 20 years in my analysis for you here on the show.
So I wanted to take the tech bubble, the banking crisis, Coronavirus crisis, or whatever we want to call this, that we’re going through right now. And if you look at that, that is a very reasonable rate of return over 8% and over 7% for a couple of those asset categories, almost 8%, the very worst of all the asset categories over that period of time that I would own, but I wouldn’t own a lot of it because I I’ve never owned a lot of international, large growth companies, 4%. So if you look at that and, and it’s still a little bit better than the fidelity one, but it’s about the same as just, just slightly under the Vanguard one.
Why? Because the Vanguard Flint one just owns a little bit more small companies. So what is making, why are these returns so different? Is it the skill of the investment manager? No, it is the asset category. It’s the area of the market held and that’s what drives investor performance. That’s why we want these things. You know, I might have a three year period where one asset category goes nowhere. I remember Gene Fama when I was studying him. He won the Nobel prize for economics in 2013.
And it was on multifactor investing in market efficiency. Well, I was going around the country and wherever he was talking, I would go and listen to this guy talk because he’s brilliant. And it was amazing what I picked up, but he actually, back in the late nineties, I was sitting in a kind of a small group of advisors with him. And we were just asking him questions. And he said, well, you know, Professor Fama, you said that we ought to own international small companies, small value companies this late nineties.
And I said, the five-year performance of that area of the market is zero. Why would we do that? The S&P 500 is up like 30% per year. And he said, you don’t look at past performance, that’s really bad. And he said, why are you telling me that you think that those companies can get off Scot-free and not pay anything to use your money going forward? And I’m going to be like, well, no, that doesn’t make any sense. You know, they’ve got to pay to use my money. And quite frankly, if they’ve had poor performance recently, I’d probably charge him more to use my money, because I have the risk involved.
It’s bingo. That’s exactly right. So going forward, what ended up happening was that area of the market quadrupled in value over the next 10 years, where US stocks did nothing, no return whatsoever.
So back to the advisor, how does the advisor get you to make an imprudent move by benchmarking it against?
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Market Timing in Disguise
They’re going to get you to do something. You know, if I’m trying to get you to buy an investment portfolio, that is, you know, our investment portfolio at our company. At this point in time, I say at this point in time to, they’re constantly changing it. If you look at style drift, and that’s where a fun company will actually change what areas of the market they’re exposed to, it’s all over the place.
Market timing. And why do they do that? Well, they want to shift over to what areas of the market had done. Well, why? Because they’re trying to sell the investor. So they, after an area of the market does well, then they shift over to it and they say, Oh, we see you look at it. We own this. And then you go, Oh wow. Really? You own, that was a five-year performance. It was blah, blah, blah, blah. Oh, wow. That’s really good. And then you don’t think to ask, did you actually own it during that five year period where it actually did that?
Well, no. Would be the answer if you ask that question, but you don’t know to ask that question, you know, how many changes, how many times have you changed your investment portfolio? After the, over the past 20 years? My answer would be, I haven’t. Now you might, as you’re getting a little bit closer to retirement, add a little bit of bonds, but I don’t get rid of an asset category, a stock asset category, whether it be international, smaller, small value, or US because that would be, that would be making the assumption that I know that the area that I’m getting rid of is going to have worse performance than the area that I’m buying to replace.
It is the most common mistake that pensions make bar none all the time. And, you know, and, and look, if the, the brightest best known most educated pension managers make the same mistake. What hope does the average investor have of not making that mistake? What hope does the average investment advisor have of not making that mistake? You know, this is really easy and it’s, it’s this way for a reason, because it sells investing is not like anything else that you do.
You know, if I want to go and get my car fixed, I’m going to find out who’s a good mechanic in town. How do I know they’re good mechanics? Because they fix other people’s cars and they end up working when they leave. If I want to hire a painter, I go talk to people and say, well, who painted your house? And how did they do? Oh, it’s garbage. You know, it, you know, I see paint marks all over the place and they got paint on the floor and, and they hit the ceiling and I don’t want to hire them. Why? Because their past performance wasn’t good.
And it makes sense that you don’t hire somebody based on past performance. Now, when I’m hiring funds or I’m adding funds to a portfolio, he can’t do that. Why? Because you could have something like international, small value that has no return for five years and then goes on and quadruples in value. You know why? It’s just because that’s the way markets work. They go up and they go down after up, what follows up down. So one of my buying, if I’m buying based on past performance, I’m buying things that did well in the past, if I’m getting rid of something that hasn’t done as well, well, that means down and what follows down often up.
So I’m getting rid of something before it does well. And then I wonder, why do I have bad performance with my investment portfolio? Why is it just not working out for me? And it is because the golden rule of investing is being broken, buy low, sell high. And it is so easy to sell people on this stuff, because it is appealing to your instincts. Go toward pleasure, go toward pleasure. Staying away from pain is playing on your emotions.
Greed. Let’s face it. Everybody’s subject to it. We hate to admit it, but we are. It’s so easy to bully. Oh, you know, you could have had this return over this period of time. Oh my goodness. Oh my goodness. I can’t believe that I could’ve had this return. And my fund manager really messed me up. Oh, you know, this fund, I hound this fund. I should have owned this fund over here. And then you go and make the move in the fund that you got rid of outperforms. The one you replaced it with, this is what we see in pension studies.
This is the problem in the investing industry. It is driven by sales. This is why being an educated investor is so doggone critical. If I look at large US docs, go back to the 1950s, go back to 1956. Yeah. That’s that’s. As far as we got data back, going back to large British companies and look at the return of large British companies versus large US. And you will see that they are darn near identical.
You know, look at small international versus small US. As far as we’ve got data going back 1970, you will see that international is just a little bit better, but they are similar. So don’t get fooled by this stuff. It’s really easy to be pulled down the wrong path. You have to be an informed investor. Now that goes a lot deeper than this, but, you know, getting any deeper on this show is going to be kind of tough because there’s so much area to cover, but this is just one of the sneaky tricks that mutual fund companies and investment advisors use to get you to do something that just may not be terribly prudent with your money.
“Your portfolio is too risky”
I think I’m gonna run a little bit more on this sneaky tricks thing. You know, so sneaky tricks that the investment industry, you know, another thing that you have to watch out for is, and it’s very related. We talked about past performance, not looking at past performance of funds and comparing the wrong funds to each other, the wrong areas of the market to each other.
Another thing that you’ve got to think about is fixed income investments versus stocks. You know, so what will happen here is let’s say you have a market downturn, market downturns, they are going to happen. You know, two out of three years, the market’s up one of three years, it’s going to go down. And when I talk about the market here, I’m just talking about just, you know, markets in general, all different asset categories.
And different types of areas like small and large often do move together, but they move in dissimilar fashion. Sometimes they go up together, sometimes they go down together, but not always, sometimes one can be up and the other down, and that’s really key. Now if everything moves down together, all different areas of the market, then what’ll happen is, you know, they come out of the woodwork, these investment companies, and go, you need to add more fixed income to your portfolio.
Your portfolio is just too risky. Oh yeah. Yeah. It is. It is too risky. Yeah. Cause I just lost a bunch of money. And then what happens? You lock in the losses and then the market recovers and then, you know what? This market’s recovering. You gotta get back in. Well, the problem is that most of the market upturn occurs at the very beginning of the process or the very early stages. You know, the biggest upturn in the market for 2009 occurred back in March, same thing this year.
Now, if you didn’t get in, if you weren’t there in the early stages, when it jumped back up, you missed a whole lot. So one of the sneaky tricks is just to show you, Hey, you don’t look at this. This cash is safe and you ought to put your money there. And then when the market comes back, we’ll jump back in. The problem is it’s too late.
The consumer price index is up 50% just from the year 2000 until now is 20 years, 50% increase in expenses and costs. Now, if you have all your money in cash, guess what? You’re getting your lunch eaten over that period of time and fixed income investments aren’t designed to help protect against inflation. That’s why it’s critical to know this stuff. Don’t get taken advantage of when people kind of play with your emotions and your instincts.
Pulled Down the Wrong Path
It is so easy to get pulled down the wrong path. Yeah, because our instincts are just, you know, there were, there were there, there were designed to help protect us. Maybe when we were fighting the woolly mammoth or something like that, you know, run when you see danger. Oh my goodness.
You know, when you see something that looks like fun, go to it. I always use the example of weightlifting, you know, is exercise and weightlifting. Good for you? Yep. Is there a line at the gym? No. Why? Cause it’s painful. There’s a line at the ice cream shop. That’s what people will line up for. And the reality of it is what we ought to do so often doesn’t feel good. And that’s what makes it so hard to be a successful investor, but what’s easy to sell to you is ice cream. That’s really easy to try selling gym memberships. That’s not easy.
Nobody wants to do that. Are you kidding me? That’s like work and yeah, I know. It’s good for me. I get it. I understand it. I know it’s good. I know I ought to do it, but oh man, it’s so much pain and I have to go there and I actually have to sweat. Oh my goodness. That’s crazy. I don’t want to do that. You know? So getting people that, that’s why that I call is it’s the way it’s called the investor coaching show. You know, coaches get you to do things so you don’t necessarily want to do.
To me, that doesn’t seem like it’s a really good idea going and loading up on something that is selling for a much, much higher price. And that’s what you’re doing when you’re buying based on past performance. You’re just loading up on stuff that did well in the past.
That’s what rating services do; they rate things based on past performance, you know, that works really well with cars because a car’s past performance will probably be its future performance. A dishwasher’s past performance will probably be its future performance. So, you know, if you go and you’re looking at buying anything just about any mechanical product, you can look at past performance because it’s probably going to be indicative of future performance. But the securities industry, they actually have to print it on the prospectus: past performance is no indication of future performance.
If It Were Easy, Everybody Would Do It
So why do we do it then? Because it is instinctive. It is just built into our DNA to act this way. And you do find that if you look at the investor returns versus market returns, historically it’s, it’s not even close. Yeah. Look at the returns.
And then that’s typically way, way off the investor gets a way lower return than the fund. Why? Because they buy it after it has done well, they get rid of it after it does poorly. And they go, Oh man, this thing didn’t do anything. I was a terrible choice. I think I’m going to sell it. And then you might as well just take out a gun and shoot yourself in the foot because that is exactly what you’re doing as an investor. You’re shooting yourself in the foot when you do that. But people do it all the time.
And I get it. It’s not easy. If it were easy, everybody would do it. The reason that investors aren’t doing it is because it’s not easy. It takes a special kind of person to do something that is hard to do. And the reality of it is if you go and say, well, I just don’t like the risk. I’m going to go and stick all my money in cash.
Now you got that other risk that I talked about in another 20 years. And the inflation has been fairly low over the past 20 years and still costs went up 50%. Some people would argue it’s even higher than that. And if the inflation numbers are actually artificially low, well be that as it may, might be. And if that’s the case, costs went up even more than 50%. And you’re sitting there in an investment vehicle that doesn’t have hope of helping you out. That could be a really difficult retirement.
Actually had a conversation with a guy this week and his dad had put all of his money in the early days of his retirement because he was nervous. He put it all in fixed annuities and now his dad in his eighties, he’s living social security check to social security check because it didn’t work out so well. You have to pay attention to all risks. Watch for the games that the investment industry plays to try to sell you things it’s not necessarily in your best interest.
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