92 – Three Contrarian But Effective Investing Strategies


Episode Overview:

Ken continues his series discussing Paul Merriman’s new book “We’re Making Millions.” Points 7-9, some may argue, fly in the face of conventional investment wisdom. #7: Invest in Small Company Stocks. #8: Invest in Value Stocks. #9: Buy and Hold. Traditionally, large company index funds are recommended, so why Small and Value picks? Ken breaks down the research and logic behind Merriman’s arguments. He compares these stock picks to the traditional picks and provides numbers that may surprise you. What’s the 40-year growth rate for small cap stocks? Is paying for Amazon worth it?

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

Happy day to you. This is Ken Kaufman CFO and I’m thrilled you’re here for Episode number 92 3 Contrarian But Effective Investing Strategies. Now, if you’ve listened to the last two episodes, you know that I’m in the process of going through an overview of the book “We’re Talking Millions!: 12 Simple Ways to Supercharge Your Retirement” that’s written by Paul Merriman and Richard Buck. And I feel like the timing of this is perfect because this is the week of new year’s, this is the week when we’re setting new year’s resolutions. Hopefully you’ve been thinking about what you can and do to upgrade or update your financial plan and double down your efforts to continue to build your net worth.

That’s one of the main reasons why I decided to do this podcast in the first place, was to help give some direction, some motivation and some ideas and suggestions and tips for you to think about and consider. Of course, I’m never making specialized recommendations to any specific individual, because I don’t know anything about your situations and the intricacies of everything that’s going on in your financial life and otherwise but these are just things for you to think about and consider as you are making these financial planning decisions especially if you were taking this on as a do it yourselfer.

So as we talk about the next three in the books, we covered 6 of the 12 simple ways to supercharge retirement. Ways number seven through nine, I feel like are now starting to fly in the face of some popular opinions out there in the world and in the marketplace. And I’ll go ahead and I’ll call those out as we go, and I’ll tell you this as a strategy that I have found I think to be the best for my situation, it doesn’t mean it necessarily is the best for you, but maybe there are some things you can think about and to take into consideration as you are building your own plan and specifically your investment strategy. So these three things, like I said, they vary we’re going kind of off script. And like I said, I’ll mention some of those.

So there’s a small step number seven that could be worth millions of impact is the chapters titled invest in small company stocks. The next one chapter eight goes into invest in value stocks and then chapter nine is buy and hold. So right now in today’s world, a very common strategy, and I know JL Collins wrote a book about this, and it’s a popular strategy to just say, look, invest in the Vanguard total stock market index fund or the ETF version of that. So VTSAX is the mutual fund, and I think it’s VTI is the ETF symbol. And the recommendation that he makes is you should use this because it’s simple, it’s easy, every ounce of your portfolio that you want in equities, you go ahead and put it in VTSAX. It’s cap-weighted, that means the largest, most expensive stocks are in this index and it’s weighted heavily toward them.

Because again, from a market capitalization size, if you have a company that’s worth a billion dollars and a company that’s worth a million dollars, you’d be out of $100 going in, you’d be putting the math doesn’t work perfect here, but about $99 going toward those big companies and only $1 toward the small companies. And the strategy here is definitely it’s okay to be in VTSAX, there’s a great exposure to the whole stock market, love the diversification of that, but to add in the ability to have a little bit more value. And the next chapters on, or I’m sorry, a little bit more small company stocks, and the next chapter is a little bit more value can really make potentially a big difference.

So let’s jump into some of the research and studies and logic for why you may want to consider adding in small company stocks and value. So this concept of small company stocks is that for every Microsoft, every Apple, Google, Facebook, Netflix each one of these was once a small company and when they first came out, they were considered very risky investments. Today, they feel like a much more sure bet but their opportunity to grow starts to shrink. Like, for example, what’s the likelihood that a company that’s doing $100 million in sales could double versus $100 billion in sales, there’s a big difference there.

So it’s just that potential to double and triple and quadruple in size that starts to get more and more and more difficult. And you think about Google and Facebook and Apple, and they’ve reached so far into markets that there just aren’t enough markets to go and tackle to allow themselves to double, and so small company stocks actually have that potential. And in going through and looking at this, the small company stocks, I said that part already, they do have the potential, the Vanguard small cap index fund it owns about 1400 stocks, and these are considered companies that are small, and I’ll get into a little bit more of the definition on that. But they’re in companies that you probably have never heard of like Zebra Technologies, Steris, Leidos Holdings, Exact Sciences.

So investing in a small group of small company stocks definitely is too risky. To expose yourself to a broad index of those stocks can be actually really, really good, and here’s why. So from 1928 to 2019, the U.S. small company stocks had a compound annual return of 12% compared to 9.9% for the S&P 500, so roughly about 2% more return per year from that 1928 to 2019 timeframe. And to put that in dollars, an investment of $10,000 way back when over a 40-year-period, that has a 12% return that would generate $930,000 of balance that’s before taxes and everything else, you’d only have $436,000 at that 9.9%. So it’s really this concept of an extra 2% over a 40-year-period of time, it can actually double investment return.

So when we take this kind of 40-year window concept, and we think about it, the average 40-year return for small company stocks was 13.8% when you look at that 1928 through 2019 timeframe. There were 78 periods in there of 40-year returns, 13.8% was the average return over each of these 40-year periods, which really means that extra. So instead of 9.9%, you were at 12% before now you’re up to 13.8%, your $10,000 investment is now $1.76 million instead of $930,000. And that’s better by three times in the S&P 500, which would be about 11% in each of those 40-year periods or $650,000.

The other interesting thing is because you say, oh, wow, okay so it could go up but what about the worst period? So they did the research and looked and the worst 40-year period for small company stocks was just slightly below the average 40-year return for the S&P 500 or this Vanguard total stock market index that is popular by the JL Colin’s book and many, many others. And again, those portfolios, they do have small company stock, but they’re very underweighted because small cap is small and the big guys are big and so more of the dollars are going there when you make the investment.

So to be clear here, a small company stock is generally defined as below… It depends on who you ask here, it could be below $2 billion in annual sales, it could be below $5 billion in annual sales, but generally speaking, a large company stock is $10 billion to 15 billion in capitalization, anything above that would be considered a large company stock. So the interesting thing over time, the small company stocks, they have this record of producing higher returns than their larger counterparts yet a lot of the popular wisdom today and some of it’s true, there’ve been periods of time where the large company stocks and investing in the S&P 500 or even a total stock market index where it’s outperformed small company stocks.

In fact, for the last decade, it’s been mostly true, but that does not mean… the past isn’t the perfect predictor of future results. And it could just be that the last 10 years small company stocks have been out of favor and perhaps they’re going to come back into favor. I know here in the fourth quarter, they started to come back into favor, but again, who knows, we don’t know, nobody knows, but when we look back at history, it tells us that small company stocks are getting a bad rap right now, but historically they can generate higher returns. And it’s a very interesting idea to consider adding a small company stock index fund with your S&P 500 or total stock market fund to layer in. And there is some more potential risk with these smaller company stocks, and the volatility, and risk in investing usually means volatility, so the ups and downs can be wild and crazy.

You have to be willing to stomach that compared to, you know, some of the other investments, but still I think very worth considering. And it’s contrarian to what a lot of people say today about just simplify and don’t worry about, and you’re exposed to small cap in these other funds, I think it’s worthwhile to consider. Step number eight talks about now value stocks. So there’s a difference just like there’s a difference between large company stocks and small company stocks and the risk and potential returns associated with them. There’s also a difference between growth company stocks and value company stocks or would be considered a value stock.

So the difference here is growth stocks are generally large, they’re well-known and people are very excited about them because, you know, they’re the Facebook and the Google, the thing stock, so Facebook, Alphabet, Netflix, Google, and you can go down the list of Tesla would certainly be up there that’s getting a lot of hype right now and it’s joining the S&P 500 and everything else, so those would be considered growth stocks.

And generally for growth stocks, because they’re more popular and they’re more in demand you tend to pay a higher premium for those versus value stocks or companies that aren’t as well known maybe they fallen out of favor for a period of time, maybe they’ve got some bad management and they’re going through a turnaround. And so there’s some more risk associated with these, but you can often find value stocks at really a value compared to some of the big company with amazing earnings and so on and so forth. So where supply and demand drives, what something costs in the stock market it’s the same thing.

And I remember back in the day, this is mid 1990s when I was working at Fidelity Investments as a brokerage trader, while I was placing far more often for big well-known companies, I was doing that way more often than for small companies. And so just even that one random sample tells me that there’s a lot of excitement around these companies that are catching a lot of media and getting a lot of hype. And what that means is there’s higher demand and so possibly some of those stocks could be overpriced.

So this whole concept of kind of being off the radar screen and being value-oriented it could be that they’re having some market share slipping like these are some of the issues that could cause it to be down, it could be that they sell sort of boring products, not so interesting or exciting, or they sell products that consumers don’t know about because they’re the plumbing or the technology behind the scenes that are successful or being successful, there’s just less demand for these.

Here’s a quick example, the Vanguard value index fund, so this is the one mentioned earlier. You are gonna find in there a lot of names that you’re gonna know actually, so Berkshire Hathaway is in there, Johnson & Johnson, ExxonMobil, Procter & Gamble, JP Morgan Chase, Bank of America, all of those are what you’d say well-known companies but they would be considered undervalue relative to where the market’s at. And the way that this concept of is it a growth company, or is it a value company it comes down to what’s called a price to earnings ratio, and the price to earnings ratio tells us how much does the stock cost relative to the earnings that the company is generating?

And here’s a really good example. So when the authors wrote the book, which is fairly recently, I think this past summer Amazon stock price was 115 times its earnings per share, so it means for every $1 of earnings that Amazon creates, you pay 115 times that to own that company now, out in the world, if you were to go and try to sell a company, you know, say you run a small business and you want to go sell it, you might be able to sell it for 3 or 4 or 5 times, or if you’ve got this really amazing business and its unique technology might be able to sell it for 10 times your earnings, in this case, Amazon is selling at 115 times. So it’s popular, there’s a lot of belief that it’s going to grow and a lot of excitement, but you’re definitely paying a premium for that.

If you take again, the authors did this now… at the time of writing which was over the summer, they also then took a look at Bank of America stock price, and they found that it is trading at only 10 times its earnings. So that’s a big difference, 115 times earnings versus 10 times earnings or this price to earnings ratio, that’s a big difference between what you’re paying for these stocks. Now you could say, well, I believe in Amazon and it’s really gonna grow, that’s great and that’s interesting, and it very well could grow. And, you know, based on everything we know and it’s popular, it could definitely grow.

But the value of Looking at value and considering it and layering it into your portfolio and again going to the Vanguard total stock markets fund or S&P funds, they are generally not as value oriented as they could be because the S&P 500, a lot of times has very growth oriented company stocks in there. And so when you commit to and say, I want to get some more value in my portfolio, you can merely add as a percentage of your investments, you can say here’s a value fund or that follows a value index and it focuses on these companies with lower prices to earnings ratios, and there could be some more opportunity for you. And again, based on the historical returns, it says that there’s definitely an opportunity.

The reliable data on value stocks goes back to 1928, I’m reading from the book here for just a second. An index of value stocks from 1928 to 2019, had a compound return of 11.1%. If you remember the S&P 500 compound return was 9.9%. So there’s more than a 1% variance by investing in value. Now should somebody invest all in value or all in small company? Well, that’s to be determined or decided, but in my mind, it makes a lot of sense to own the whole stock market and then layer in some extra value and some extra small cap to potentially get more return. Now it’s all within an index environment and a passive investing environment to do that, so that’s small cap stocks and value stocks need to consider if you want to add those into your portfolio.

There’s more volatility so they swing up and down more and you can get very nervous, and, you know, creates some nervousness around what’s happening with your portfolio. But over time, these have shown that and this is just looking at the historical past no guarantee of what will happen in the future, but they tend to generate slightly better returns which over time can make a massive difference over a 40 year period, a massive difference in outcome.

Now the last one, which is the small step number nine, it’s called buy and hold. John Bogle, again, founded Vanguard, an absolute icon in the investing world. He said this, “I’ve said stay the course a thousand times and I meant it every time. This step of buy-and-hold is especially easy because it tells you to do nothing.” Here’s the first time somebody is going to come on and tell you don’t do anything in terms of making recommendations about what you should do with your money, don’t do anything, buy and hold. The problem is it’s not as easy as it sounds because our emotions start to get the best of us.

Just doing nothing by getting your strategy set up, I’m not saying just buy randomly and hold, get your strategy clear, understand what risk tolerance you have? How much equity? How much bond? What’s your portfolio needs to look like? Get it in place and let it ride. And a little bit later I think we’ll talk about the rebalancing concept to make sure that things don’t get too far out of whack and out of alignment with your strategy, but this buy and hold philosophy is so, so powerful. The challenge is as human beings, our emotions play with us and they make us actually motivated to buy at the absolute wrong time.

Let me give you an example, the market’s up at a certain level, and then the market starts to go down and goes down and goes down and goes down. And at some point we get tempted to say, “Oh, I cannot handle to see my portfolio drop in balance anymore.” In fact, Paul Merriman in the book calls this, I can’t stand it anymore syndrome where you just can’t stand anymore. So market goes down, down, down, down, down, and then you say, I’ve got to get out, so you get yourself out. And you may be right, the market may continue to go down.

The challenge that you always have, as soon as you get into this timing game because as soon as you sell because of news or media or what you think’s gonna happen in the economy or anything else, as soon as you sell, other than if it’s part of your long-term strategy and you’re liquidating part of your portfolio, because you need to live on it or whatever goes into that whole financial plan, this emotional market timing is extremely dangerous because you actually until you have the benefit of hindsight, you never know where the bottom is, and you never know where the top is.

So what happens is we given to our emotions, and I saw this happen to somebody in 2007, 2008, when the market really went down, I saw somebody say, “I can’t do it, I cannot handle this anymore,” and they got out of the market and they got into an annuity with a guaranteed 3% return. And they’re like, fine. I’ll just take my 3%, I can’t handle the variability. The challenge is not only did they get out at one of the lowest points in the market, but from 2010 up until 2020 they missed out on some massive returns, I’ll mention those numbers here in just a second.

I’m just gonna stay with this concept so if you think of the letter V and the market’s going down, and then the very bottom tip of the V when it starts to go back up, that would be when the market goes back up and goes back to where it was, or, you know, potentially goes even higher, we just never know where that is and our emotions tell us to do all the wrong things, we got out on the way down, and then the market goes back up, but we’re questioning ourselves.

And is this really what if it goes back down again? And what if? What if? What if? What if? We often get paralyzed and we wait to get back in until the market has gotten past where we were and then we feel stuck because we think, “Oh, I was in the market at a lower price, and now it’s gone back up higher and I can’t get in now.” And a lot of times we miss out on potential gains. I saw this happen a couple of years ago when the market went down right at the end of the year, a bunch of people got out, by the first quarter, the market was back up. So it happened with COVID earlier this year in 2020, where the market went down significantly in February and into March and then in the summer went back up and it’s kind of fluctuated up and down and right now, as of this recording were all time highs for the S&P 500 and for several of the indexes across the board.

And so the point here is market timing, nobody actually really knows what’s gonna happen today, tomorrow or in the next year or 10 years but if you look at history, if all you do is look at what the academic say, and you look at what investing in stocks means, which is it’s especially in indexes where maybe some companies got a favor and go out of business. But there’s always new ones coming up and new ideas, innovation, entrepreneurship is driving, economic success actually throughout the entire world, even what would be considered, you know, third world markets you still see a lot of entrepreneurship and a lot of value being created.

As long as you believe that that is it’s true, regardless of short-term or even long-term spikes or dips in the stock market, over time the stock market goes up into the right based on history and based on the entrepreneurship and innovation of people just in general. Dan Sullivan, once says, in fact, I work with a gentleman name is Emmett Scott, he’s a CEO of our organization, and he often says or he quotes Dan Sullivan saying that until humans came along, everybody thought that oil was just something that got stuck on the bottom, or, you know, oil slate was something just got stuck on the bottom of a camel’s foot, but the innovation and imagination and creativity of humans learned how to actually refine that and turn it into something that powers the world, and again, we could argue about clean energy and everything else.

But jumping back to this buy and hold strategy, buy and hold is contrarian. You hear it a lot, especially young investors like to say,” I’m jumping into the market” and “hey, I’m getting an Acorns account, I’m getting a Robin Hood account, I’m doing this, I’m doing that. And who wants to be in my investing group? And let’s talk about investments, let’s do our analysis and let’s do these different things and let’s go in and let’s start playing the stock market.” The interesting thing is I’ve never heard any of these guys come back and say, I made millions. It’s a very, very rare occurrence they’re engaged in market timing and there’s just, there’s no, sure bet, no sure thing.

So by engaging in a strategy where you’re diversified across asset classes, you also have lots of stocks in lots of different industries and areas of the world what that does is it gives you the ability to sit back and say, I’m going to buy and now hold, and I’m gonna stick with my strategy if the market goes down, if the market goes up. Again, this chapter, all the authors are saying is you don’t have to do anything, just hold onto it, and don’t do anything else.

A couple of quick stats here, these statistics come from studies that say that those who are timing the market tend to do worse over time than those who do a buy and hold strategy. So it says here, “A rigorous study of investor behavior that’s been ongoing for 36 years has concluded that time after time that the average individual investor fails to achieve not only the returns of the stock market, but even the returns of the mutual funds or ETFs that they’re invested in.” And the reason why is because they are making decisions to buy and sell and exchange in and out of those funds and they literally give up billions of dollars of gains by making these short-sighted decisions.

One of the key findings of the study is that investors who buy and hang on are consistently more successful than those who move in and out of markets regularly. Further in this 2020 report, Dalbar said 20 years of data from 2020 through 2019 indicated that the S&P 500 had an annual compound return of 6.06%, so it was just round that’s about that 6%. Yet the average investor in equity mutual funds achieved a compound return of only 4.25% because so many of the investors buy and sell instead of staying the course, which is buy and hold. In other words, actual investors earned only 70% of what they could have earned by very easily doing nothing at all.

So this strategy of buy and hold doesn’t mean you’ll beat the market, it doesn’t mean you’ll beat the indexes, but it does mean you’ll get the returns of them, whereas those who tend to jump in and out tend to miss out on those opportunities. So the real world demonstration I started talking about, I knew this individual in 2008, he pulled all his money out, said I’m done, put it in a 3% annual interest rate annuity. And in 2009, the market came roaring back and it kept going up and it kept going up.

And what the study show is, let’s see, it says many of those investors are in this case, this friend of mine, there were so badly burned by what they would describe as the behavior of the market and what we would describe as their counterproductive behavior. They never got back into the stock market at all, and missed the huge U.S. stock market opportunity from 2009 to 2017, that 10-year period didn’t include even one losing year, but it did have seven years of double digit gains and a compound return of 15.3%. So that’s an annualized compounded 15.3% return that would have turned a $10,000 investment in 2009 into $36,000. So a 3.6 times return over just a ten-year period, those are phenomenal returns.

But there are a lot of people very, very scared that were getting out of the market in 2008, that V went down and somewhere along the way, they said I’m out. And then it started going back and so I can’t get back in I’m too nervous, I’m too scared, I can’t stand it anymore mentality. And they missed that opportunity. So some people regard market timing as a defensive strategy against bear markets but a much better way to actually to defend your money is by holding an appropriate part of equity and fixed income in your portfolios.

So it doesn’t say just don’t or we shouldn’t just own equity stocks we need to find the right blend. You use fixed income to mitigate risk, your equity portion of your portfolio should be buy and hold based on a strategy. And again, today, these three contrarian against what a lot of people either those that are active investors, that are trying to pick stocks and play that game and buy and sell and buy and sell and continue to rotate through their portfolio or if you just want to buy that index fund, that’s invested in a total stock market index or in just the S&P 500, but you’re not exposing to small company stocks and value stocks and as much as you possibly could.

Generally speaking, these are very contrarian viewpoints, but very, very worthy of your consideration as you think about building your do-it-yourself -investment-strategy. I hope this has been helpful. The next episode we’re gonna cover the last three suggestions from the authors. I hope this format is helpful. And again, if you have any questions, feel free to reach out, always happy to engage with the listeners and answering any questions here on the podcast. Many, many thanks to you for joining today. This is a wrap for Episode 92. 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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