You Don’t Want To Find These 3 Phrases in Your Advisor’s ADV

Paul Winkler: All right. I think we’re back here. A little audio problem there.

Paul Winkler, “The Investor Coaching Show.” If everything always worked well, we’d probably probably get cocky, wouldn’t we, Nik?

Nik: I’m just glad. Well, we’ve gone how long? A year and a half without any audio issues.

PW: Without anything.

Nik: Yeah. I’m just glad I caught it quick because I heard a click and then I lost audio and I’m like, what?

PW: Bam. Gone. Okay.

Nik: It just turned off.

PW: Right. Right.

Look at the Disclosure Documents

All right, we got this. Okay, so here is the thing.

Now, Evan made a comment about this. Typically, when I see 401(k) plans, I’ll see they’ll have — and I see investment firms do this a lot — projections for retirement. They’ll have calculators on their website, return calculators, and if you have this much money, or especially 401(k)s, I see this a lot, where they say, “Here’s how much income you can take from your portfolio.”

And people think, Oh, this is how much income I can take. Well, yeah, that presupposes a certain rate of return that may or may not actually come through because of the way that the investment manager is handling the money.

I was on Channel 5 this week, and one of the things that Ben Hall, actually, the reporter over there at Channel 5, he said, “So Paul, you know like a …” Well, we were talking about one of the better questions that was asked — there are lots of good questions, I shouldn’t even say it that way — when I was teaching over at Trevecca this week.

So I had two groups of students, two different days that I went over there, and I was teaching class and walking through academics, evidence-based research, how markets work, putting portfolios together, and just so on and so forth. Because these are all, they were fourth year, I guess, third, fourth year accounting students, they wanted to know the in-depth, the nitty-gritty, the real detail stuff.

So I’m walking through this and one of the students said, “Paul, how often is this stuff implemented in the investing industry?” And I said, “You win a prize for that question.” I said, “Because I almost never see this research actually implemented.”

And if you look at how portfolios are typically managed, you don’t see this very often. I was telling this story, I was relaying this story to Ben on Channel 5, and he goes, “Well, what do people look for?” And I said, “Three things.”

I said, “Get out a piece of paper.” And I didn’t say that. I probably should have said that.

“Get out a piece of paper. No, you listen out there. Get out a piece of paper.”

Look for this. Look at the disclosure documents for the investing firm managing money. If it’s us, you don’t even have to bother.

But if you do this, go ahead. You’re going to look at us on ours, too, because you’re not going to find these words, but this is what you look for. Number one, look to see, and it’s ADV Part 2, that’s what you’re looking for if you have an investment firm, and it can be an investment firm that says, “We act as a fiduciary.”

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I hear commercials all the time: “fiduciary, fiduciary.” Even our commercials say “fiduciary.” But I always say: It’s not a high enough standard. 

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And the reason I say it’s not a high enough standard is because what I’m about to tell you, if they have in their ADV Part 2, under how the investments are to be managed, it’ll be something like that. The verbiage will be something like that.

Words to Look For

If they have the words “We use fundamental analysis. Fundamental analysis.” That is translated to stock picking.

If they have technical analysis, that is what is called charting. So you’re looking at patterns — past patterns — to determine where the market will go. The problem is markets are random past patterns, a huge waste of time, but they do it.

That is technical analysis. Tactical asset allocation is the third word that I look for, the third group of words that I look for.

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Tactical asset allocation, that is market timing in disguise.

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Tactical asset allocation is where you’re moving money around in different market segments. “I think that small value stocks are going to do better this time than small growth is going to do or large value.”

For example, the Vanguard website said, if you look at the note that they had this November last year, they made their predictions for the next 10 years, and they said, “We think that large U.S. growth stocks are going to be the worst area of the market going forward.” And you will go, “If they think that that large growth stocks are going to be the worst growing forward, how much money of their clients would they have in that area of the market?”

And the answer would be, “Well, next to none.” Right? Well, if you look at how much money they have in large companies in general, in large blend, large growth, according to Morningstar, they have like 92% of their clients’ money in that asset category.

Well, number one, first mistake, trying to make a prediction about what’s going to do best or worse going forward is tactical asset allocation. Number two, not having your client’s money in the areas you think are going to do better is probably a problem. Just saying.

Tactical Asset Allocation

So those are the things I look for: fundamental analysis, stock picking, technical analysis. You’re going and charting and looking at patterns and making investing decisions based on that or tactical asset allocation, that is another form of market timing because you know you think about it, and as I explained it to the kids, I said I was hoping that they weren’t, no pun intended, triggered by this.

But I said, “Imagine you had somebody playing Russian roulette and they had one bullet in the gun. Pretty dangerous, right? Yeah, not a good idea.

“Well, when you’re market timing in general, you have stocks and you’ve got cash. If I think stocks are going to go up, I’m going to move all my money out of cash and I’m going to put it all in stocks. If I think stocks are going to go down, I’m going to move all my money out of stocks and move it all into cash.”

And I said, “Now imagine you’ve got large stocks, small, large value, small value international large, international small. You’ve got five-year bonds and two-year bonds and three-year bonds and cash. You have all of these asset categories. Now you have this Russian roulette game with six bullets in the gun.

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“It’s not any safer when you’re trying to time between multiple areas of the market, you see.”

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That is what we’re talking about there. That’s why tactical asset allocation is just a huge problem and a waste of time.

And really, if you look at asset allocation funds, when I was talking about that DALBAR research earlier and how bad their returns were in asset allocation funds, the general public and investment managers, mutual fund managers, why the returns were so bad going back 30 years.

It’s because now you’re playing between three different asset categories in general. So you’re basically doing that tactical asset allocation. So that’s number one that I tell them to look for.

The Impact of Diversification

Now, the thing that you look for, what you want is you want the investment firm not engaging in those processes. They’re buying asset categories and they’re holding asset categories in areas of the market in proportion to what we want as far as our goal.

For example, if I have a goal and I’m saying, “Hey, I’m retiring in 10, 15, 20 years, 30 years, whatever.” Well, I can hold almost all stocks. As I close in on retirement, I’m typically going to add fixed income, bonds to the portfolio. And that really depends on somebody’s flexibility.

Matter of fact, I ran a study and it blew my mind. We were just playing around with this idea of, well, what if you, in the year 2000, took an all-stock portfolio and you took all stocks and you just took your required minimum distributions, and you’re looking at the 2000 market. Markets were kind of crazy, 2000, 2001, 2002.

Now if you’re diversified, you wouldn’t have seen a decline in value in 2001 and 2000, or 2000 or 2001. That was the tech bubble bursting. But if you were diversified, you didn’t see that problem. Now most people, you think, Man, I would’ve just totally crashed at that point in time.

But 2002, you had a decline. It didn’t really matter how diversified you were. In 2008, you had a decline. It didn’t really matter how diversified you were. So you would’ve had some fluctuations in the income.

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But it blew my mind how well an all-aggressive portfolio did over the past 25 years if you just followed through and made sure you were diversified. 

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Now, some intestinal fortitude would’ve been needed to put up with the ups and downs that occurred over that period of time. So it’s not likely that you would use that asset mix. But here’s the point: Making sure that the asset mix is congruent with what you’re trying to do and how much income you’re trying to take, and making sure that you don’t go off the reservation and lose discipline at the worst time, that’s really, really critical.

Currency Risk

Typically, you’re going to be holding a little bit more U.S. than international, simply because you’re an American investor. That’s what you’re going to be doing is focusing more on services that you buy here in America. So currency risk is a bigger deal.

So I make sure I have a little bit more international than U.S., make sure I have a little bit more value than I would growth in the portfolio. Even though these companies are companies that you would think, Wow, what are they? By definition, they’re distressed companies. Then you go, “Why would I own distressed companies in retirement?”

Well, if you think about it, what happens when people hear this thing? “Well, we have dividend paying stocks in retirement and live off the dividends.” That’s what you’re doing. You shouldn’t do all that there, though.

That’s crazy — putting too much money in dividend-paying companies. But value companies.

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If you look at history, you’ll notice that during big market downturns, value companies tend to do better than growth companies do. 

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And that’s what’s happening so far right now, as a matter of fact. That is the area of the market that is flourishing, even though people are just in a world of hurt with U.S. portfolios. People that were in all U.S. or those target date funds or those types of things are seeing declines.

It is the value areas around the world that are actually rallying that should have taken away some of that risk and gone up during this same period of time. So this is why as an investor, we look at time rise, we make sure that the investment philosophy lines up, and make sure that we’re not moving with every sway of the wind. Every piece of news that comes in, “I’m thinking about doing something a little bit different.”

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.