91 – Key Long Term Investment Decisions

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Episode Overview:

As promised, Ken continues discussing Paul Merriman and Richard Buck’s book “We’re Talking Millions,” this time focusing on points 4-6. Ken acknowledges that some of his opinions may differ from others – Ken aims to base his decisions on the research and facts available to him. Regardless, there is no assurances in investing. #4: Invest in many stocks instead of a few. #5: Keep your expenses low. #6: Invest in Index Funds, not Actively Managed Funds. Listen in as Ken expands upon these points and gives his perspective and personal experiences.

Transcriptions are auto-generated, please excuse grammar/spelling!

Happy day to you. This is Ken Kaufman, and I am thrilled. You’re here for episode 91, Key Long-term Investment Decision. So two things happening here. First of all, I realize that this is the week of Christmas, and a lot of folks are gonna be taking time off for the holidays and heading into different places. With COVID this summer, you know, many are staying home. I know many have quarantined themselves and they’re gonna do so religiously and as will their family members, and then so they can travel together and be safe together and know that nobody has COVID and nobody’s gonna pass it to anyone else in the family.

Whatever you’re doing, whatever your plans are, whether you have religious affiliations or not, whether you celebrate these holidays or not, we’re heading into this time of year. And in the last episode, I took this opportunity because I just received Paul Merriman and Richard Buck’s new book, “We’re Talking Millions!: 12 Simple Ways to Supercharge Your Retirement” and I love the content. It’s content that has made a big impact on me and the way that I do things. And I actually feel excited and somewhat compelled to share what these guys talk about because they’ve been creating content for a long time, and both of them are in retirement and doing these things because they are still interested and have a passion for sharing and teaching.

And in fact, they have a non-profit foundation that they use to try to promote all this content. But at this time of year, I think there’s some important gifts that we could be thinking about giving our future self. And they take this concept that there are these 12 ideas that they present in the book that each could be worth a million dollars if done and executed correctly.

Now, I talked about the first three of them in the last episode. They were save money instead of spending it all, start saving sooner instead of later, invest your savings in stocks instead of bonds and cash. Over a lifetime, starting earlier, saving money and not spending it all, and putting yourself into investments where you have the opportunity to make a higher return or hopefully the best potential return relative to the risk taken, each one of those could ultimately end up being a million dollar decision or more for you and for your family.

And I wanna take this episode and I wanna focus on points four and six out of the book. And I really bucketize these into the key long-term investment decisions that need to be made. And I realize I’m gonna get into some content that some may disagree with. And you may think that there’s a better way to do it. And I’m open to that. Everybody’s gonna have their own perspective. The interesting thing about investing is there’s no guarantee and no promise of what the future will bring, and what’s happened in the past is not always indicative of what future performance will be or of what will happen with anything.

And so at where we sit today, nobody knows who’s right. And that’s why the financial journals and the financial pundits, while they can say, they can talk, they give all kinds of opinions about anything to do with your finances, at the end of the day, none of them actually really know what’s going to happen. None of us do. And what I like about the next three points, and I’m gonna talk about is they’re academically-based, well-researched, but remember, even then the future could still hold something totally differently.

I, for one, like to try to make my decisions based on what the facts share and what the facts are telling me. So the four steps that I’m gonna talk about today, numbers four through six are invest in many stocks instead of only a few, keep your expenses low and choose index funds instead of actively managed funds. So starting with number four, own many stocks, instead of only a few. And the gentlemen who write this book, quote John Bogle who is the founder of The Vanguard Group, the largest mutual fund investment company in the world.

I don’t know how many…I’m sure it’s well over trillions of dollars under management that they have. I can’t remember what the numbers are. A very, very successful organization and John Bogle has led that organization for decades and passed away last year, the year before, somewhat recently. He said this, “Don’t look for the needle in the haystack, just buy the haystack.” One of many stocks…or I’m sorry, own many stocks instead of a few.

One of the biggest mistakes that Paul and Richard bring out in this book and make it super clear is that young investors get excited about trying to play with the stock market. And it’s tempting. I shared on this podcast in prior episodes, multiple times that I used to be a brokerage trader and I was in on the platform all day long watching what was happening, stocks going up, stocks going down. And I played with my own money in the market. And it was interesting because I was supposed to know a lot and have been an expert, but did not do nearly as well as I thought I should have.

And a lot of young people who had that mentality where I was at, they jump in and they just want to buy the brands that they know, buy the technology companies that they’re aware of and that they think have the greatest growth potential, which there’s nothing wrong with making those individual investments, it’s just really, really hard to succeed in doing it that way. Trying to win big with the stock market is a slippery slope game.

And one of the examples that Paul pulls out in the book is he says, hey, if you were really, really smart, and in 1986, you purchased $10,000 worth of Microsoft, and you saw this vision of where Microsoft was going, you bought into bill Gates and his vision, by the end of 1999, your $10,000 investment would have become $3 million. The interesting thing though, is if you were late to the party and didn’t buy anything until 1999, you opened yourself up to a world of hurt because within the next few months you lost half your investment and it took you the next 16 years just to climb out of that hole, not even create or make a gain in your investment in Microsoft.

And so knowing and understanding the timing of, you know, when you should buy these individual stocks and when you should get out of these individual stocks… A lot of people say, hey, well, I’m gonna buy low and sell high. Well, until you have the benefit of hindsight where you can look backward and have known what was the lowest and what was the highest day, you have no idea on any given day, if that really is the highest, or if that really is the lowest.

And I can just take one [inaudible 00:06:57], you know, global look at what’s been happening just this year because of COVID with the market. And in February, the markets tanked and everybody said, yeah, COVID and the market’s never gonna come back. Well, guess what, if you got out of the market, you missed out on a lot of opportunity because in the third, and in the fourth, even in the part of the second quarter, but third and fourth quarter, things have come roaring back and the S&P is gonna put down a massive return this year, so long as nothing happens here between now and the end of the year. But even if it does, it doesn’t matter because over time the point that Paul and Rich are making here with point number four, is that owning many stocks is way better than owning a few.

A couple more data points, and this is one of the favorite studies that Paul has brought up many, many times in the past. In fact, one of the things I love about this book is it’s like he’s taking his very best thinking and getting it all down into one place. And he talks about how there’s this study that comes out with this startling conclusion. And it’s that 10%, you know, over the past 90 years, the stock market’s returned to 10%. And when they dug in deeper, they found that that 10% return could be traced to fewer than 4% of all public companies, or in other words, that means 1 out of every 25 companies created the return. If you owned any of the other 24, maybe it was negative, or maybe it was a little bit of return, but the net/net between those was a zero. That’s painful.

The stocks, the way that all this translates out is it’s just really hard to know which companies are gonna be the big winners and create this gain that happens inside the stock market, or even better yet far exceeds that gain and, you know, offsetting losses from other companies.

As counterintuitive as it seems, academic study after academic study keep showing that when you invest in more stocks, not just one or two, but more, it leads to higher, not lower returns. Hence the point, owning many stocks is better than owning just a few. And there’s a strategy, and we’re gonna get into some of that here down the road. But I think the key takeaway here is you’re gonna almost always, or you’re almost certainly do better if you own many companies, instead of just a few. So that’s point number four.

Point number five jumps into investment expenses. And I really like this again, a quote, starting this chapter from John Bogle, founder of Vanguard, The Vanguard group, “The two greatest enemies of the equity fund investor are expenses and emotions.” Now this does not…this chapter does not take on emotions. It just takes on the expenses, but they go through and do a very interesting…or make a very interesting point that no matter what you invest in, every dollar in investment expenses that you save is added to your return, and then it has the ability to stay in your account and compound over time and can be very, very helpful.

Investment companies in the past have been very, very good at concealing and hiding how and where and when they get all their fees that are reducing the potential return of your portfolio. And of course, it’s always good…if a portfolio is gonna way outperform someone else and you only have to pay a percentage of that outperformance or that alpha in a fee, then that makes sense. The challenge is, is that in many, many circumstances, it’s just not the case. They then went and did a quick example, which I thought was interesting and I think helps put everything in context.

So consider taking two very popular, actively managed U.S. mutual funds. And by actively managed, that means they have managers, and they’re constantly trying to beat the stock market, whether that means they’re trying to beat the S&P 500 or something else. And in this case, they said, let’s go ahead and pick Fidelity’s Contrafund, which is very, very popular, and the American Funds’ The Growth Fund of America.

Contrafund manages $111 billion in assets. The Growth Fund of America manages $188 billion in assets. And so between the 2 of them, there’s about $300 billion that they manage. The Contrafund has an expense ratio of 0.85%. So it’s just under 1%, 0.85%. The American Funds’ The Growth Fund of America is at 0.65%. So it’s closer to about a half of a percent. What they found when you run the numbers on this, that means $172 million are being paid in fund expenses every year.

When you take the returns of those funds, or I’m sure when you…when you take the equivalent index, which is the Russell 1000 growth index, and it’s available through the iShares Russell 1000 Growth Exchange Traded Fund or ETF, and there are other funds that try to mimic that index as well, the expense ratio is 0.19%. So again, the Contrafund, if you recall, was up there at 0.85%, 0.19%, that would be a 0.66% or basically two-thirds of a percent in expenses that you could save.

And you might think, well, who cares? What’s the big deal? I’ll get to that here in just a second. The Growth Fund of America at 0.65%, there’s a 0.46% variance between what the index fund had done…did. And so you say, well, okay, that’s cool, but the index fund is just investing in stocks in those index. It’s not actively trying to find the best funds out there and pull them together. So what if these other funds outperformed by at least two-thirds of a percent, or by at least 0.46% to say, hey, it was worth it, I’m willing to pay some extra fees because I’m getting better performance?

In their analysis here, they found that over the last 10 years, the Contrafund underperformed the Russell 1000 growth index by 1.5%, and The Growth Fund of America underperformed by 2.6%. Incredible that not only are you paying more, but you’re getting less in return in these two examples that were pulled.

So what that would really mean is, is if an investor chose to invest in, in this exchange traded index fund, instead of these actively-managed funds, they would have been able to save $115 million a year in expenses. That’s across the whole, you know, $300 billion portfolio that those 2 organizations managed together. And so that’s…the point is understand the expense ratios, understand what you’re paying for. In some ways, the financial world has been like healthcare, where you don’t really understand what you’re paying if the insurance company is just paying for it, in this case, they were taking your own investment funds and paying and covering their fees. So we’ve gotta be really, really careful. Watch out for big fees.

And then they hit a couple of other points on fees. They say don’t buy the load funds where there’s a front load or a backend load. Watch out for high cost and high commission products like variable annuities. Pay attention to taxes. I’ll touch on that in just a second. Be aware funds that engage in frequent trading, which incur costs that can be cleverly hidden from your view. And again, if they’re trading a lot, that can be spurring capital gains tax that gets pushed through to your portfolio, even if you’re not taking dividends or capital gains out.

So that’s the power of going down the road of looking to cut expenses, tons of opportunity there, and could end up being…depending on how early you start and how long you stay in being invested, could save you a million dollars over the lifetime of your investments.

Step six that I wanna hit on just quickly is to choose index funds. This point was just kind of made already in the last chapter covering expenses. Out of the book, “A Random Walk Down Wall Street,” it says, “Index funds have regularly produced rates of return exceeding those of active managers by close to two percentage points.” So index funds means I’m gonna invest in an entire index, and I’m just gonna buy what’s in the index and not decide…try to pick which companies are better, which ones are worse, and invest more or less, or only invest in the ones that I think are gonna be better. It’s just buying the whole index or in essence, buying up big chunks of the market and owning lots of different companies, not a few, and definitely not trying to beat performance.

In this case, that “A Random Walk Down Wall Street,” it says that active managers are getting beat by index funds by close to two percentage points. Now, this is a highly debated topic. There are those on both sides of the fence. Some think managed funds, it is the only way to go. Others think that index funds are the only way to go. I definitely fall on the side of index funds. I’ve been in the industry, I’ve seen, and I just, I have confidence, a lot more confidence on the index fund side. But again, you make your own choice. I’m not dictating or telling you what you should do.

I just am, you know, taking…taking us through this book, talking about what the academicians have found as well as some of my own personal experiences. And you’re gonna have to obviously get advice and make the decision for yourself. The concept here is that the funds have lower expenses, because they don’t need to be actively managed and have people constantly working on it.

They generally are more diversified, which means less volatility or what’s referred to in the investment world as risk, meaning the more stocks you have, then some will go up, some will go down, but they kind of average each other out so you don’t have a huge swings in losses or gains based on what, you know, just one company is doing or what might happen. They level each other out.

And they don’t trade as much because they’re not trying to beat the market. They’re not trying to get out of one holding and get into a new holding to try to post great returns for their prospects that they’re trying to get to invest in their fund. And so there’s less trading costs which there…you know, there’s just costs that exists there.

And so the real benefit of going on the index side is you’re buying entire chunks of the market. And all of the studies that I’ve seen that I feel like are good and credible, they point to the fact that the index funds perform better over time than managed funds. There might be a short term where a managed fund will grow and do really well, but over time, the index has…just tend to beat them. And again, like I said, this is an ongoing debate. There’s two sides to this story. I understand both sides very well, and I just know the choices that I’ve made for myself and I’m just sharing that.

So there is a study that found…that looked at a 15-year period and have found that the S&P index funds did better over a 15-year period than 92% of all large company actively managed stock funds, better…95% better than mid cap funds, and 94% better than a small cap or small company funds. So over 15 years, that can make a big, big difference in your investment return.

So an index fund that’s likely to…I mean, I guess the bottom line that they make in this point that I wanna share, and I feel like it’s very relevant, is that it’s likely that the index fund is going to end up over a period of time, it might be 10, 15, 20, 30 years, it’s going to end up in the top 10th percentile of its like investments, you know, measured up against actively managed and the index options. And if that’s the case, not only are you gonna be up in the top 10 percentile, which should feel very acceptable and…when you look at all of the different investment options that are out there, but the fact that it’s exposed to less volatility, it’s gonna have lower expenses, this is for me, the compelling story about why index funds really are the way to go and to avoid actively managed funds. It just makes good, logical sense, and you can look historically at what’s happened in the past.

So there it is. It’s a hit on index funds, which is a hotly debated topic, and going that route, picking that route with your investments, driving the expenses down inside your investments, understanding how those work, and then driving them down, and then making sure that you own lots of stocks, not just a few.

I’m gonna keep going with this. We’ll hit number 7 through 9 of the 12 Simple Ways to Supercharge Your Retirement from the book by Paul Merriman and Richard Buck called We’re Taking Millions…or I’m sorry, We’re Talking Millions! And we’ll go ahead and hit 7 through 9 next time, and then we’ll hit 10 through 12. I think this content is really important, and I wanna make sure that all the listeners have a chance to be exposed to it, and let it start to influence how you think about and how you evaluate how you wanna invest for the long term. Many, many thanks to you for joining today. This is a wrap for episode 91. Happy day.

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Join Chief Financial Officer Ken Kaufman as he helps you track and hack your net worth. For those seeking financial independence, your net worth is one of the most significant measurements of success. Using his two decades of financial experience, Ken Kaufman helps you overcome your financial obstacles and look onward towards a better, brighter financial future.

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