The following is the transcript from Episode 17 of Retire Happy with Roger Gainer, a financial and business audio podcast.
Roger: If you wanna be happy for the rest of your life in retirement knowing that you’re not gonna run out of money is the cornerstone of that happiness.
Clark: You’re listening to “Retire Happy” with Roger Gainer, president of Gainer Financial and Insurance Services Inc. Whether you’re new to investing or even a professional, making the right decision at the right time with your finances can get tricky, so in this episode we’re gonna uncover the five most common myths associated with financial planning and investing. We’re gonna discuss how to avoid getting caught up in these different myths and how you can make smart informed decisions with your money. Thanks for joining us, I’m your host Clark Buckner, let’s jump in. Hey, Roger, welcome back we’re looking forward to talking with you, how are you?
Roger: Doing great. Still having a little rain here which just means we push the drought off a little bit longer.
Clark: Yup. Well, hang in there and buckle up because today we’ve actually got a pretty lively and extensive agenda on the “Retire Happy” podcast and we’ve got five different risks and myths more or less, so that includes risks and Walls Street myths. And so within those, we’re gonna talk about five different items. So, I’m just do a little teaser here and then, well, I think we should jump right in. So one of the myths that you hear often about is time in the market, another one is indexing, another is ETF and mutual funds panacea, number four understanding liquidity, and finally making sure you don’t run out of money. So, we can start in any order you want, but I’m really eager even though we can’t do a deep dive in these. Let’s follow your lead on, kind of, guiding us through what do we need to know about, what’s just a made-up thing, and what’s something that we should really be paying attention to. How’s that sound?
Roger: Okay, well, you know, I appreciate you want to hear about these different topics because I really think that these five issues are things that people are, generally, misled if you will. The “conventional thinking” really puts people in very difficult situations. Not through fault of their own, just through the faulty thinking and logic behind these arguments that put people into those situations. You know, Wall Street, I believe, is one of the greatest marketing machines ever assembled and crafted in the history of our planet. And this mechanism has convinced people to do and acts in ways that really is detrimental to their wealth. Wealthy people understand these issues and they handle risk differently than the middle-class, you know, we’ve touched on that topic before Clark. And, you know, we’re taught to accept risks that either we’re not aware of or we don’t understand, and we can jump right in on the first one, time in the market. Clark have you ever heard somebody say, “It’s not timing the market it’s time in the market?”
Roger: Well, and the theory behind that is that the market grows over time and maybe that’s fine if you’re in your 30s or 40s, but I work a lot mostly with people who are in their 50s, 60s and 70s who are really focused on living off their assets. And for those folks particularly, but even if you’re in your 20s, 30s and 40s, the longer you’re in the market the greater the risk. Now that does seem counterintuitive, but I’m a big math and science guy and the math is very clear, the longer you are in the market and it’s going up, the closer you are to a correction. And the longer we go without that correction, mathematically, the more severe the correction is. And right now, as I’ve mentioned before, we’re 9 years without a correction of 20% or longer. That’s the longest period we’ve ever experienced in the post-World War Two era. And the argument for time in the market versus timing the market is that you’ll miss the best days, and if you miss the best days you’re gonna lose a lot of the performance. Now I have a study right here in front of me that says, if you had invested $1 in the S&P 500 index on December the 31st, 1927 and held that to December the 31st, 2014 that that dollar would have grown to a $116.59. So that’s a very impressive cumulative return percentage of 11,558%. That’s impressive, isn’t it Clark?
Clark: Mm-hmm, yes.
Roger: And if you missed the 10 best days, that $116 would be reduced to $38.67 for a 3,767% gain. So that’s only about 35%, if you will, of the total gain. So yeah, we would have had a tremendous drop-off in our actual performance. So, that’s the part that Wall Street always tells us about, about why it’s so important to never sell, to never disinvest in the markets. But the part that they generally don’t tell you about is if you had missed the ten worst days in that time frame, just 10 days that your total return instead of a $116.59 would be $365.69. That one dollar would have grown that extensively for 36,468% gain. So missing the worst days has a much bigger impact on your overall returns than missing the best days. In fact, the proof to this is if you missed the 10 best and the 10 worst your performance would still go up. It would go up to a $121 instead of the $116. So, those downside corrections are much more impactful that you avoid losing money. Warren Buffett gets this, he has these two rules of investing. Rule number one, never lose money. Rule number two, never forget rule number one.
So, the other part of that argument is the long-term average rate of return, and you’ll hear this all the time that the market does 10% rate of return on average. Well, I have never seen the market return 10% in real terms over an extended period of time in the recorded history of our stock market. If you go back to 1896 when the Dow Jones Industrial Average was first introduced, it was introduced at a value of 65. Today, we’re just under 25,000, and if you look at what is the rate of return, what number interest rate compounds to get from 65 to that impressive number of just under 25,000, it’s less than 5%, 5% compounded. That’s a real rate of return on the index. Ten percent is an average rate of return. And this is part of the, what I call mathemagic of Wall Street. Easiest explanation, Clark, if you bought a stock for a $100, and a year later it’s $200, what percent rate of return did you get?
Clark: Oh, that’s a double, so whatever that would translate to.
Roger: Hundred percent all right.
Clark: Oh, right. I’m learning here.
Roger: Yeah, a 100% in rate of return. And then, if the following year that $200 stock moves back to a $100, your percentage of loss is what? Fifty percent, right?
Clark: Made no money.
Roger: Okay, so I started at a 100, and 2 years later I’m back at a 100, did I make any money?
Clark: Woah, no, yes…
Roger: You made no money, however, my average rate of return was 25%. That’s how the math works, and it sure is a lot sexier than telling you that the market is compounded according to the Dow Jones Industrial average at a little less than 5%.
Clark: All right. Well, this, kind of, translates I think over to this next point, when you talk about indexing you talk about the index, is that the same thing as indexing that we have on the agenda? Or is that something that’s totally different?
Roger: No, indexing is this trend that’s been going on in the markets really for about the last 20 years. It was a movement, almost a religion, and I always get nervous when investing becomes religion. It started by a fella by the name of John Bogle, who you may or may not have heard of, but he founded Vanguard, which I’m pretty sure you have heard of, right?
Clark: Yes right.
Roger: Okay, Vanguard mutual funds are famous for low fees and indexing. And the trend that Mr. Bogle noticed was that very few actively managed mutual funds beat their indexes over certain periods of time. And while you can see those studies and come to that same conclusion, you have to dig down a little bit deeper because the one thing I know for sure is if everybody’s doing the same thing, it’s not gonna work. And so, when he shared those findings and founded Vanguard, indexing was a very, very small part of how people were investing. Today, index funds make up about a third and a rapidly growing percentage of mutual funds. They have low cost and they seem to be most actively managed funds over time. Remember, time in the market versus timing the market.
But where you run into trouble with that expansive growth in indexing is that think about what the index really represents. If I’m buying an S&P 500 mutual fund, and I send in a $1,000 to Vanguard, say, or Fidelity, or any of them. Most mutual fund families have an index fund, an S&P 500 index fund, in fact. And that manager, I’m not hiring them to think, they have no choice, they have to take my $1,000 and they buy 500 different stocks. They have to buy those stocks, they don’t have a choice. Whether it’s a good day or a bad day to buy them it doesn’t matter, they’re gonna buy them. So what this is inadvertently done is it’s forced otherwise intelligent people to buy things they know they shouldn’t be buying at a time they shouldn’t be buying them. And what that does is it tends to inflate the valuation of the assets that are included in the index.
In fact, there’s a really interesting study that’s been repeated several times over the decades. The S&P 500 is a managed index. About 40 to 70 of the components of the 500 components are dropped out and replaced each and every year. There’s a committee at Standard & Poor’s company that makes those decisions, and the companies that are kicked out of the index after an initial drop because all those managers have to sell that stock at the same time, they tend to perform better in the next several years. And the companies that are added after an initial jump because all these managers have to buy that stock, they tend to underperform their previous performance once they’re included in the index. And it has to do with this phenomenon of just money plowing in and these stocks are being forced upon the managers. They have to buy those shares. So when something becomes overvalued and the market starts to correct, generally speaking, that will accenturate…accentuate, excuse me, the move to the downside. So, if I’m overvalued to the upside, to the downside I’ll probably become undervalued and the momentum creates much larger swings in prices or amplitude. So when we see those kinds of movements, it’s just based on human behavior not the investment valuation itself of the different stocks or components of that index.
Clark: So, when you’re starting to talk here about the mutual funds, and also ETF is on our agenda, so panacea, mutual funds panacea, what is that and how does that, kind of, transition us to that next point of what you’re talking about now?
Roger: Well, surprisingly enough even today after, you know, going through some major market swings in the last 20 years, I still have people who come and tell me, “Well, my money is pretty safe because I’m in mutual funds.” Or “My money is safe because I’ve invested in ETFs.” And I asked them why they think, and they said, “Well, there’s a professional manager and they’re keeping an eye on my investment.” Now, when we look into their mutual funds, a lot of them will be index funds because they’ve gone to Fidelity of Vanguard and they’ve gotten a portfolio built of these things. So as we just discussed there is no real manager that…yes, there’s a manager assigned and their function is to buy and sell based on cash flows, not on evaluating stocks or other assets that are being held in the fund. So you don’t have any professional management, you’re not having a sell discipline.
And then, other funds, if you look at the prospectus, most stock mutual funds say that that fund has to be invested, not should be but has to be invested in stock. Sometimes it says 80% or 90% of the money in the fund actually has to be invested at any given moment. So whether it’s a good time or a bad time, the manager has some constraints, and I understand the reason why if you’re setting up an asset allocation model you want and you pull a stock fund to build out your model, you want to know that it’s in stocks. But a lot of people don’t realize that they have to stay invested even if it’s a bad time. So in 2008 even though things were going down, those managers really were, in many cases, constrained from selling even though they knew…
Clark: They probably should.
Roger: …what they were owning was going to keep losing. They, by law, could not sell because they had to meet their stated criteria of what percentage would be invested. The other part, ETFs, even more than mutual funds, are not all created the same. The rules that govern them…
Clark: What that does stand for again, Roger?
Roger: Exchange-traded funds.
Clark: Got it.
Roger: And the thing that people love about them is that unlike an open-ended mutual fund that, if I call my fund company or my broker and I say, “I want to sell it.” If it’s during market hours, it’s sold at the end of the day. After they value all the shares and give you a per share price, where the ETF is bought and sold all day long, so there’s more liquidity. And that’s the theory behind them is, well, they’re more liquid, so it’s much easier. But what people many times don’t understand is that there’s not a standardization. So you can buy QQQ ETF, which is the Nasdaq 100, one of the more popular ETFs or some iShares or other kinds of ETFs, and there are constructed internal cost structure, what they’re actually investing in and what hedging or other techniques are being used. A really rather complex and very hard to discern, and I’ve yet to meet too many people that have actually read what’s in their ETFs or understand what they’re actually buying and selling.
Fifteen years ago, when they were starting to become popular, I started day trading these little guys to see if some strategies that on the surface seem to make sense for protecting portfolios and things like that. And I was stunned at how these things performed in different market environments. And when I tried to figure out why, especially some of these leveraged ETFs, there are ETFs that go two or three times in index both on the long and the short side, those are really for day traders and not for hedgers. That’s just one example of it not being what it seems.
So, when you buy a mutual fund or an ETF because the managers in an actively-managed stock fund, for example, they’re buying and selling stuff, and I’ve seen stock funds with hundreds and hundreds of stocks in them and that are traded constantly throughout the year with hundreds and hundreds of trades, you don’t know what’s actually in there because they don’t have to tell you, but once a year. There’s a quarterly print of the holdings in a portfolio, but outside of that you’re never going to know everything that’s in that portfolio. And there’s a little phenomenon called window dressing, where certain mutual fund managers will go out and buy whatever’s hip or trendy just so when they print those contents, the inventory of investments, it shows that they had Apple or Facebook or whatever the hot stock was even though they didn’t have it for most of the period. They wanted to show that it’s there to make people happy for the few people that actually look. So, that’s why I tell you that it’s really important to review those positions periodically. And then, of course, managers change. So your mutual fund, you know, the classic example is the Magellan fund. Have you ever heard of that one, Clark?
Clark: I’m not.
Roger: Well, a Magellan, 25 years ago, was the stock fund. It was the poster child for great mutual funds. And there was a fellow by the name of Peter Lynch, who was legendary manager on Wall Street, and when that fund started to get too big, he decided it was time to retire because it was…He made his reputation on small capitalization stocks, and now is a $50 billion fund and you couldn’t buy small capitalization stocks anymore. So they brought in a new manager who actually put half the fund in to treasuries, and made a mistake and it lost a lot of money. And then they fired him and they hired another guy, and he put in his own philosophy for managing Magellan, but a lot of people still think Peter Lynch runs Magellan, or they’ve owned Magellan since Peter Lynch was the manager, and they just don’t understand why it’s not the same, you know, great performance. So, it’s important to check from time to time what’s going with your mutual funds, who’s the manager, and what are they investing in, and how long have they been there, and where were they before they came.
Clark: So, before we start talking next about understanding liquidity, what do you say to the person who…I know you’re saying with mutual funds, with some of these…to someone trusting someone else, they don’t wanna think about it, they just wanna trust the professional. And what you’re revealing is that may not be the best. You need to really look closer to what you’re doing. So, what do you say to the person, “I just don’t wanna think about it. I just wanna give it to someone and trust them.” If I’m hearing you right that sounds like that’s not an acceptable approach.
Roger: Yeah. I think this is great discussion because, yes, that is a conundrum. A lot of people don’t wanna be involved their investments day-to-day or even months to months, and sometimes even years-to-years. So we always, here at Gainer Financial, try to match asset classes based on that type of criteria. It’s one of the reasons we use the thought organizer to, kind of, figure out where people are coming from and how they feel about these different types of investments. We have a very big tool box. There’s a lot of different ways to get from point A to point B depending on how much time you have and what’s going on with the tax codes and as well as markets, but knowing your objectives in yourself and how you feel about things. There’s been plenty of studies done that because of emotions people in general make very poor decision in buying and selling on both mutual funds and stocks.
Morningstar has a rating where they try to show how good a job the management of a mutual fund does of preventing people from counterproductive behavior. Yet, even the professionals are subjected to those kinds of things because a lot of times they have an idea, but they don’t have a discipline. They don’t have the wherewithal to say, “Okay it’s time to sell or okay its time not to sell” based on dispassionate criteria. Face it, nobody likes to lose money and it doesn’t feel good. So when that, sort of, stuff starts to happen, your emotional makeup and your ability to deal with volatility is frankly, it’s critical.
I have a client right now after working with her for years and years and years, there are certain things that she says, “I don’t want any more of those kinds of assets.” even though those are the things that help her sleep better at night. And so we’ve nibbled at a few different kinds of investment strategies. Right now, one of the things we have is so a small portfolio, they see how she’ll do with it, very conservatively-managed stocks. And these are, you know, the big old names and it’s a very focused portfolio that has done extremely well in bad conditions but that doesn’t mean that it won’t have volatility. And she’s contacting our office couple times a week going, “Wait, it went down.” And then wait a day and it goes back up. I mean, you know, we’re about to have a little conversation about whether or not this is something that is appropriate for her because of that anxiety, not because of whether or not the markets are gonna do well or the managers doing what they set out to do. Manager is doing a fantastic job in very difficult market conditions and that’s why we took on this particular manager. But it’s just not right for her and that’s the bottom line.
Clark: It makes sense. It makes sense. And I know you mentioned the thought organizer earlier and that’s something that we try to make sure to mention on each of these conversations because that’s a great next step as you’re thinking about what’s right for you and it guides you through that process. So, to continue on, while we got few minutes left, understanding liquidity and making sure that you don’t run out of money. These next couple might be related. These are the final two, but lead us away.
Roger: Well, liquidity, you know, people come to me all the time to say, “Well, see I don’t wanna tie my money up. I want it to be liquid.” And I understand why people would like to have the ability to cash out everything in a moment’s notice, but if you think about it after what we’ve just discussed about emotional decision making, in a way, a lack of liquidity helps create an investment discipline that’s much more long term. And what’s interesting, the people who understand this are investment bankers and hedge funds. They are not super liquid. They invest in things that aren’t super liquid, and they invest for the long term, and they make tons and tons of money. And it’s that lack of liquidity that actually reduces risk in those asset classes. But today, we’ve seen a tremendous growth in creating liquid vehicles to hold illiquid assets. So, some of those liquid vehicles are ETFs and mutual funds. I’ll give you an example, have you ever heard of what they call high-yield bonds also known as junk bonds?
Clark: It sounds, sort of, familiar.
Roger: Okay. Well, junk bonds created a tremendous upheaval in our economy back in the late ’80s, early ’90s. There was a guy named Michael Milken and they were doing leveraged buyouts and these what we call non-investment grade bond. They were less than credit-worthy borrowers, but the yields were high. They pay at a big interest rate because they were riskier. And we had a whole savings and loan crisis because savings and loans were investing in these things, and the economy had a down turn and it was just a big whole mess.
And to this day, it’s still an asset class that allows certain great things to happen in our economy, and it’s not gonna go away. Companies borrow money, and if they are less than credit-worthy or they are in higher-risk type of businesses, they gonna pay higher interest and that’s attractive to some borrowers. But unlike government bonds, government bonds trade in Chicago and New York, and in the commodity pits and they’re incredibly liquid. Billions and billions of dollars trade, change hands every single day. In fact, the bond pit in Chicago is it trades more dollar volume than the New York Stock Exchange by a factor of several each day. So it dwarves the stock market in terms of just the dollar volume of what’s exchanged.
So, we can be pretty accurate with our estimate of the value of a treasury bond because there’s so many people buying and selling them every day. That’s what market creates pricing action just by the mere buying and selling. And we also have liquidity because there’s so many market participants. But a corporate bond may only trade few times a year. Some issues certainly not hundreds of thousands of times a day like a treasury might. So you don’t have a lot of liquidity in that market, the demand is spread out, but when you put those assets into mutual fund, an open-ended mutual fund, there’s a rule that says the mutual fund company has to redeem your shares, if you requested during market hours they have to redeem the shares at a value set at the close of the market that day. Well, if something isn’t trading very often, the valuation is based on a guess. It’s an appraisal. It’s not a market-set valuation. So right away, you don’t know for sure if the share price in mutual fund is accurate because the only way to really test that accuracy is to sell the underlying assets, right?
Roger: So, when we start to see a crash or a negative price action, however, you want to put it in junk bonds, and I say, “I’m getting nervous.” I call in to the mutual fund company, the Fidelity and I say, “Sell my bond fund.” They have to turn around and sell, but there’s not a lot of buyers, and so they can’t, they get a low bid and that knocks down the share price. And then the next guy who wasn’t going to sell, now he sees the share price dropping and goes, “I’m afraid I’m gonna get stuck here, so I’m gonna sell.” And then there’s more selling and there’s not enough buyers in these illiquid assets. And so now price activity on the downside in particular is going to be accentuated because of that lack of liquidity actually in the asset class, but the fact that the mutual fund company has to raise cash to redeem your shares. So they don’t guarantee your share price, but they do guarantee that they will redeem shares at some price. That’s the risk. So we’re adding risk to an already risky asset class by adding liquidity.
Clark: That makes sense, and now…and it tails back to what you’re saying about people how they make emotional decisions and that that’s definitely not a recipe you want involved with that.
Roger: Well, you know, making emotional decisions, emotions can be stressful sometimes. Think about it. You can create joy, but you can create depression, too, through emotions, or sadness or grief. You know, there’s a wide variety of human emotion. And when we get emotional, you know, judgment gets clouded and so that’s how we make those decisions. So, putting yourself in positions where that’s not likely to happen is really…it’s counterintuitive to everything you’ve, sort of, have been taught over time. But the things that you want to have liquid are care. You want your cash to be liquid and you want to make sure you have cash that’s how you mitigate risk. It’s not by adding liquidity to a high-risk asset class. That will make it even riskier.
I can go through absolutely example after example of illiquid stuff like REITs that are publicly traded. These are real estate investment trusts and again real estate is not super liquid, right, but if we wrap it in something that is super liquid, we’re gonna ratchet up risk because we’re gonna create more volatility in the underlying valuations of those assets. There’s the thing called MLPs that now you’re finding in mutual funds. MLPs are master limited partnerships. They invest to a large extent in oil and gas pipelines and other infrastructure, mostly in the energy business. And these again are not designed to be liquid, but you put a liquid wrap around them and you’re gonna exacerbate. We had a massive correction in these things as a result of that about two years ago, where they dropped dramatically in pricing when we had a little hiccup in the oil market. But it was even more impacted on these liquid investments because the underlying assets weren’t liquid. So you had to find buyers by discounting what you were selling, so you could get cash to cash these folks in. Makes sense?
Clark: Right, it makes sense. And I think you’re also just alluding to this last item making sure you don’t run out of money. You’re talking about having enough cash, making that your liquid asset, but any final thoughts you have to wrap us up as it relates to making sure you don’t run out of money?
Roger: Well, I’m halfway through writing a blog post on this exact topic, so we should have that ready for publication in the next couple of days. So our listeners should keep an ear out and an eye out on their inboxes when we send out our next newsletter, that discussion of not running out of money and why it’s so important. I could just say that that if you want to be happy for the rest of your life in retirement knowing that you’re not going to run out of money is the cornerstone of that happiness. And people who put themselves in a position where they could lose to markets, sickness, other external factors, these people have stress that definitely reduces their enjoyment of the golden years, and after all our motto here is “Retire Happy” and the cornerstone of retiring happy is making sure that your bills are paid even if you live to 110.
Clark: I love it. I think that’s a great way to wrap up today’s conversation. So next step is to go and get the thought organizer.
Roger: Yeah, go to the website. It’s at the bottom, scroll down to the bottom of page one and you can request a download of a copy of the organizer there, and get yourself thinking about these situations, about the risks that you might be subjected to, and how you can make them work for you.
Clark: Good deal. Roger, thank you so much.
Roger: Thank you, Clark. You have a great day.
Clark: Thanks so much for listening to this episode of “Retire Happy.” Be sure to head on over to gainerfinancial.com to download your thought organizer to get started. Roger L. Gainer, ChFC California insurance license number 0754849, is licensed to sell insurance and annuity products in California, Illinois, Arizona, Pennsylvania, and New York. Roger L. Gainer is an investment advisor representative providing advisory services through HFIS Inc., a registered investment advisor. Gainer Financial and Insurance Services Inc., is not owned or affiliated with HFIS Inc., and operates independently. Thanks again so much, and we’ll see you next time.
Roger holds the coveted and well-earned designations of Chartered Financial Consultant (ChFC®) and Retirement Income Certified Professional (RIPC®) from the American College. He is also a licensed insurance agent for life and health insurance and a Certified Paralegal for Estate Planning.