August 23, 2024 • 25 mins
Curious if your investment manager is actually adding value to your portfolio, or just riding the market's coattails? Get ready to navigate the murky waters of investment performance with a mix of humor and hard-hitting analysis on Bullshit on Stilts! We start by unpacking the often confusing concept of "alpha." Using a relatable shed remodeling analogy, we'll show you how to determine if your portfolio is truly beating the market or just keeping pace. Learn how to compare your investments to the right benchmarks and measure the value of your active manager’s contributions.
Ever wondered how to spot a financial advisor’s smoke and mirrors during a market downturn? Reflecting on the 2008 financial crisis, we reveal how a seemingly modest return can actually be a win. We delve into the nitty-gritty of understanding investment performance and fees, arming you with the knowledge to avoid unnecessary losses and potential fraud. Discover why knowing exactly what you own and why can save you from financial disaster, and get the inside scoop on how the financial industry often overcomplicates things to keep you in the dark.
Should you go active or passive in your investment strategy? We break down the evolution of investment management, comparing the benefits of index funds in efficient markets to the potential goldmine of stock picking in less efficient ones. Hear about our humorous takes on financial terminology and the practical aspects of tax management. With engaging analogies and insightful discussions, we’ll explore whether your broker’s supposed genius is just luck in disguise. Tune in for a session that’s both educational and entertaining, perfect for both novice and seasoned investors.
We love to hear your thoughts, questions, and ideas. Send us a text!
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:01):
Welcome to Bullshit on Stilts, a podcast hosted by
two guys with vast financialbackgrounds and great bullshit
sniffers who call out the clichecrap, spackle and flap doodle
spewed by so-called expertsacross the landscape of
financial advice Identifying asdoctors of bullshitology.
You can count on your esteemedhosts okay, maybe knuckleheads
(00:24):
to bring you a lively, if notdeadly, mix of bullshitology.
You can count on your esteemedhosts okay, maybe knuckleheads
to bring you a lively, if notdeadly, mix of serious analysis,
hijinks and tomfoolery, allwithin a 99.1% bullshit-free
safe space.
Let's get after it.
So today, on Bullshit on Stilts, we're going to be focusing on
question number three in the FabFive for investing, which is
(00:47):
how are you doing?
Speaker 2 (00:48):
I'm doing just fine, kelly, and how are you?
I'm fine, I'm okay.
I'm a little tired, but youknow what?
My left toe is kind of sore theanswer to that is a throwaway.
That's not really an assessment.
It's an automatic response.
I'm fine.
Speaker 1 (01:01):
You mean in terms of interacting with people?
Yeah, like how you're doing.
Speaker 2 (01:04):
Yeah, you really aren't paying attention to me,
but you answered, you're fine.
Speaker 1 (01:07):
Yeah Well, I tend not to pay attention to you.
I mean, that's just, it's aknee jerk response, I think on
my part.
Speaker 2 (01:17):
Well, and you're making my point, because most
people don't pay attention totheir investment returns when
you ask them how they're doing,I'm fine, it's good.
Speaker 1 (01:20):
Well, I'm higher than I was last month.
I'm lower than I was last month.
Speaker 2 (01:24):
Right, right, which is really just volatility.
Speaker 1 (01:26):
And yet you ask the same person how did the I don't
know Detroit Lions do lastSunday?
And they'll give youplay-by-play commentary, you
know, as an example Interestingthey will.
Why is it so hard, do you think, to know how you're doing when
it comes to your investmentretirement accounts?
Speaker 2 (01:42):
Well, traditionally, most brokers didn't want you to
know how you were doing Don'tlook behind you so it really was
never quantified.
Now it has been in 401k plans,but I'm talking about the
traditional broker, kelly.
Why would they not want you toknow how you're doing?
Because more often than not,just like your typical mutual
fund, you're underperforming.
Commissions can really eat awayat your total return your net
(02:07):
return.
Speaker 1 (02:07):
You use the term alpha.
What does that mean For theperson driving down the 696 in
Detroit right now and they hearalpha?
What do they think?
Speaker 2 (02:15):
Well, I really don't know what it means, but I can
tell you what I've heard itmeans is that it is the return
that your manager adds over andabove what you could have gotten
with a passive investment likethe S&P 500 index.
So if the stock market indexand let's say it's the S&P 500,
(02:36):
returned 10%, but your broker orthe investment manager of your
mutual fund returned 12%, thatas two percentage points of
alpha.
Speaker 1 (02:45):
How does a person that doesn't do this as a job
trying to do it themselves?
How do they figure out?
How am I doing when it comes totheir investment accounts?
Speaker 2 (02:55):
All right, let's put this to remodeling a shed in the
backyard.
Okay, I can do it myself and Ihave a skill level to some
degree, but I'm going to paysomebody else to do it.
Did they do a better job forwhat I paid them than I could
have done myself?
In investing, I can put thatinto a passive index, but I've
hired you to add excess return,so how did you do?
(03:19):
No different than in management, I'm paying you to do a job.
Did you do that job?
And if I'm hiring an activemanager, I'm not asking him to
track a benchmark.
I'm asking him to add excessreturn because that's what he
told me he could do, minus allof the fees associated with that
.
Speaker 1 (03:37):
Ultimately, what we're talking about is compared
to what.
Right now, we're not talkingabout how did I do.
We're talking about comparinghow you did to something else,
and there's a difference inperformance.
Speaker 2 (03:48):
So let's start with the preferred flow of questions.
The first would be how did I doso?
If I have a stock portfolio,how did my stocks perform, let's
say, over the one year period?
Let's just use one year?
If I have bonds, how did mybonds do?
What if I've got both, Kelly?
Then you compare both.
Do I compare them individuallyor do I blend?
Speaker 1 (04:11):
them.
You analyze them individuallyand then combine them into a
sort of a sandwich, so to speaklet's call it and then compare
the combined performance to aappropriate combined benchmark
made up, in this example, ofboth stocks and bonds,
relatively speaking, the sameexact weight.
So if you had 60% of your moneyin stocks, you would have 60%
(04:35):
of that benchmark.
You're comparing yourself to bea stock index of some sort.
And likewise, if you had 40% ofyour money in bonds, you would
compare that performance thatyou achieved compared to a bond
index at about a 40% weight.
Speaker 2 (04:52):
So what would math look like?
And I don't want to get intotoo much air math on this,
that's what I like.
But if we had 60% in stocks?
I'm touching my calculatorright now, I know, yeah, I'm
touching my calculator right now, I know, yeah, okay, sorry,
yeah, if we had 60% in stocksand my broker told me that my
stocks performed 10%, I had a10% return net of all costs, but
(05:14):
the index was only 8%, forexample, the S&P 500 index.
We can assume, or it's apparent, that the broker added value
two full percentage points, thedifference between 10% and 8%.
Speaker 1 (05:27):
Yeah, I definitely think the broker wants you to
conclude that.
Now the question is was it justlucky?
Did you just own NVIDIA andthat's why you got the 10 and
the one name made it?
So Is that luck, Is that skill,or is that just taking a
position equative to the S&Pholdings?
Speaker 2 (05:45):
Well, I think it's very difficult to.
Speaker 1 (05:47):
I know I'm getting detailed right now.
Speaker 2 (05:48):
No, it's very difficult to assign skill,
particularly over the short term, and there are studies that
show it might take a decade todetermine if there really is
skill or you've just been lucky.
Speaker 1 (06:00):
Yeah, I know in institutional business back when
I was working in institutionalland big pensions endowments
they would typically rule ofthumb not change a manager for
at least three years.
Let's see how they do for aboutthree years.
They would also typically notinclude a brand new manager with
less than five years of a bonafide audited track record of
(06:20):
their performance.
So it's twofold.
Speaker 2 (06:22):
But I think you use the same metric three years with
personal relationships.
Am I correct with that?
Speaker 1 (06:29):
Typically three years for most people.
They are totally fed up withwho I am and they just walk away
, so it's their three year.
Yeah, me, I'm happy to go intoa fourth year.
But it's the humor, it's thehijinks and tomfoolery.
That just I guess it's just andthe crap spackle and tomfoolery
.
That just I guess it's just andthe crap spackle.
You had to use that one, thecrap spackle and the flap doodle
(06:50):
.
Absolutely.
Yeah, you never know what'sgoing to happen when you pull
out a flap doodle.
Speaker 2 (06:55):
So let's talk real simple, particularly when you do
it in a public place.
That's right.
I'll tell you right by thatwater fountain down by anyway.
Speaker 1 (07:01):
So the math is really simple, isn't it?
When it comes to how did I do?
On a simple basis, it's reallyfourth grade math, right?
So what is that math?
How would I take my investmentaccount at the end of the year
and figure out did I add anygrowth to my overall assets?
Did I lose some value in my?
(07:21):
How do I do that?
Speaker 2 (07:23):
Well, what you would do would look for the
appropriate benchmark for yourportfolio.
If you're in stocks, you'd haveto assign a benchmark.
Or are we more basic than that?
Speaker 1 (07:32):
I think we're more basic than that.
What I'm looking for is lookbefore we get to the benchmark
right, which is how did I docompared to something?
Speaker 2 (07:39):
Oh, I've got the answer.
Go ahead, I've got the answeranswer.
Speaker 1 (07:44):
I've got the answer.
I would take my starting valueand my ending value.
Did you call a lifeline?
Is that what happened?
Is that what just happened?
Speaker 2 (07:49):
Okay, All right, go ahead.
Yeah, actually, I would take myending value and minus the
starting value and whatever thatdifferential is.
I would divide that by mystarting value and whatever that
percentage is plus or anegative would be how I did.
Speaker 1 (08:07):
Yeah, and in fact you come out with usually a decimal
, and the little step is thenmultiply that by 100, and you'll
get your percent of yourperformance Right, good, bad or
ugly.
Speaker 2 (08:19):
Yeah, this is the booth question what the hell
does performance mean, what Imean, performance mean, what I
mean, what is what?
And we want to avoid the littlenegative sign in front of that,
the minus sign.
Speaker 1 (08:32):
However, let's talk about that because it's how did
I do If the market in the lastyear let's just use stocks for a
quick second was down 30%because of a bear market
correction and your account'sdown a negative 10%?
Should you be upset or shouldyou be patting if you're working
with a broker and advisor onthe back saying, hey, thanks for
(08:55):
taking care of me and coveringmy tail when the market has had
a huge correction?
I don't know whether anybody'sever said that to their broker.
We had a client.
I should say that back in 08,at the end of 08, right,
everybody remembers it's acatastrophic event, it's the
Great Recession, blah, blah blah.
We had clients that came in andwe had allocated to lots of
(09:15):
different non-market-relatedinvestments.
Their return for 08 was anegative 4.35%.
I can remember this like it wasyesterday.
They come in really nice folks,but they both were like well,
we're paying you guys to growour money.
I don't think I should be happywith a negative four.
(09:36):
I took that a little personallyand I got a little upset in
that the average long-termstrategically allocated
investment plans that we find in401ks and endowments and
pensions and so forth theaverage of just 40% stock and
60% bond was down between 24 and28 percentage points.
(09:58):
They ended the year at minus4.35.
And only until we helped themunderstand compared to what
where they're like.
Oh wait, I get.
I'm sorry, I don't know whatthe hell we were thinking.
So it does happen out there.
Speaker 2 (10:12):
Yeah, managing risk is a thankless job.
Oh my gosh, what you avoidedthem experiencing is always
thankless.
Speaker 1 (10:19):
That's a good way to put it.
That's absolutely a good way.
So, when we come back to how amI doing?
Real simple, right?
I can take my Decemberstatement, december 31st value
on my statement.
I can subtract from that numberDecember 31st of the previous
year's value and I come up witha plus or minus number and I
(10:40):
divide that number by December31st of last year's value and I
multiply that by 100, andthat'll give me my actual
percentage return of myinvestment over the last 12
months in this example, correct.
Let's go back to I think wetalked about this in the big Fab
Five, right?
The bigger podcast earlier,which was but what if we have
(11:03):
50% in stocks and 50% in bonds?
Do I still think of just thestock market when it comes to am
I doing okay or not?
How did I do?
How do you approach that?
Speaker 2 (11:13):
Just as a reminder, Well, you'd want to divide it.
Ultimately, now it might benice to know what your total
portfolio did, but to identifywhere there could be problems,
I've got to look at both theequity component and then if
I've got fixed income.
That component, yes, Because Icould have had excess returns in
my stocks.
But uh-oh, something happenedwith the bonds Sure, bonds.
(11:35):
That negates what I did withthe stock portion of my
portfolio.
So this is where you startseparating out, to start forming
benchmarks, or identifyingbenchmarks, to get into the
compared to what.
So the how did I do is verysimple math.
Take the ending value minus thebeginning value, divided by the
(11:58):
beginning value times 100.
Yeah, super simple.
That's for your whole portfolio,and then you do that if you
have different asset classes,distinctly different asset
classes.
So if you have a bond componentand a stock component, maybe a
real estate component, thenyou'd have to do it with three
different appropriate benchmarksIndexes of some sort.
Speaker 1 (12:20):
Yeah, it's an interesting thing.
Lots of people don't understandit, and yet it's probably
amongst the simplest things todo when it comes to measuring
how you're doing Right N minusbeginning, divided by beginning
times 100.
Speaker 2 (12:36):
Super simple.
Why do you think mostindividuals, most investors,
can't tell you how they're doingyet?
It is salient and has to be ontheir 401k statement.
Usually it's on the brokeragestatements now, but nobody knows
what it is.
Speaker 1 (12:55):
I do think that it's an issue around the way the
industry goes about bullyingconsumers.
This is way too complicated,you can't figure it out, and I
think that over time a personends up accumulating sort of
immediate reactions to thingsand if they open up a statement,
their immediate reaction is Ireally don't know what this is
(13:21):
telling me.
All I know is that the value is$10,000 higher than it was last
month.
So I must be doing okay and Ican't.
If I heard that and was paid adollar every time I heard that
over the practicing career Iwould have a retirement all on
itself.
Speaker 2 (13:34):
We were doing work with the SEC, state of Michigan
Regulators and CFA Institute andI forget who the nonprofit was
and the discussion was aroundinvestment fraud and at that
point the average person who wasscammed lost $14,000.
And sometimes there wasrecovery, but the net loss was
(13:56):
about $14,000.
But here's what's worse thanthat.
Mrs Johnson has a $200,000portfolio and because of
excessive fees, a lot ofcommission, a lot of churn and
underperformance, because ofthat she's losing $10,000 a year
(14:17):
.
And that's just not for oneyear because they catch the guy.
It can go on for decades.
Sure, yeah, so that's whereit's insidious.
Speaker 1 (14:25):
So when people don't know what they own, why they own
it and how they're doing,they're setting themselves up
for failure, and they're theones that put themselves there
for a failure to understand andknow how they're doing and
compared to what Don't you thinkthat, when it comes to the
(14:47):
consumers out there that do workwith an advisor of some sort,
when they do meet their advisor,whether it's periodically or
every once in a blue moon myexperience was always they were
asking me how am I doing?
They had no preconceived notionother than my accounts up or
down, that's it.
I think there was three clientsout of 128 families that I
(15:11):
worked with years ago.
Those three knew how they weredoing.
One knew everything about whatwas in that portfolio,
everything even down to thevoting for new board members,
and they would come in and askme who's John Smith?
Should I vote for John Smith?
And so forth.
My point is the vast majority ofpeople just want everything to
(15:33):
be on a remote control.
I don't want to do any work.
I want to set myself up to belied to, misled or something.
Do no preparation for mymeeting with my advisor hey,
mark, how am I doing?
And then I shut up and I sip onmy Coca-Cola and break little
pieces of the cookie Markbrought into the conference room
in order to tell me or answerthat question in a manner that
(15:57):
may or may not be very accurate.
Speaker 2 (15:59):
Often you get a lot of what's called explocative
gloss and you really don't get,you really don't get an answer.
So this falls under the categoryof the cost of not knowing.
And when you don't know thereis a tremendous cost and it can
be insidious.
So where we are in life is notthe last really stupid thing we
(16:22):
did or the last great decisionwe made on themselves over a
multiple year period, or neglectand poor decisions compounding
themselves over a multiple yearperiod.
That has you where you are.
So anyone in isolation example,last year not knowing how you
(16:46):
did in isolation, no big deal.
But year after year after year,the compounding of that,
negative or positive, has youwhere you are.
Speaker 1 (17:00):
Agree 100%, by the way.
And you said neglect and I wasthinking about the twigs in your
hair and how you just neglectto even comb your hair in the
morning, but that's not part ofit.
There was a family of fourliving there, a little fox
squirrel.
So how am I doing?
I've come across this frequentlywhere a consumer, an investor
out there, is working with aninvestment firm and they're
(17:22):
convinced to go into a managedaccount, managed account being
that, let's say, acme Widgetswill use, will protect the
innocents out there.
Just Acme Investment Companywants to convince me to use
their managed account and in amanaged account it means that
some financial analystprofessional is making decisions
(17:44):
on what to buy and sell insidethe account that is in my
account itself, right, so itmight be just stocks where
they're buying and sellingstocks and they're comparing
themselves to let's make it easythe S&P 500.
And yet they're charging feesfor doing that.
Rarely have I come along anddone analysis on that account
(18:07):
that demonstrates the account isanything but some of the top
holdings in the index itself.
Can you comment about how aperson should kind of think
through what they're doing withtheir advisor or with their
investment management firm whenit comes to managed accounts,
over just what we've talkedabout before funds, whether it's
(18:29):
an index fund, mutual fund, etfand does it make sense for most
people to spend an extra oneplus percent on a managed
account that simply oftentimesmirrors the index itself?
Speaker 2 (18:43):
Well, this might sound like glib opinion, but it
certainly is substantiated bylots of data that the average
mutual fund, actively managedmutual fund, does not outperform
its index, particularly overmultiple year periods.
Might for one year, might forthree years, but for whom, when
and for how long?
And is it really replicable?
(19:05):
And is it really skill, or isit just luck?
Well, you might take a decadeto find out one way or another.
My thinking is this why do that?
Why go through all of therigmarole of active management,
their investment philosophy, howthey select stocks, when I know
statistically you're not goingto beat the index?
So why I'm even going throughall of these financial ratios?
(19:30):
I can't optimize humanintention and it's all
retrospective, yeah, so some ofthose are silly.
Why am I measuring and doingratios on a loser?
I mean the average activelymanaged mutual fund.
Yeah, yeah, I would rather knowhow am I doing?
Is that number close to theindex or slightly above the
(19:52):
index?
I'll handle some tracking errorto where it might be a little
bit negative, but that's gettinginto the minutia.
Do I have the right assetallocation based on my time
horizon.
I have returns that areacceptable to me and are
tracking closely to the index,or are the index, then I'm
(20:12):
pretty happy with that.
So just there alone.
Why am I confusing this andcomplicating it the thing?
Speaker 1 (20:20):
that pops into my mind as you're talking is there
are some bonafide reasons why amanaged account might make sense
and typically it's fromtax-wise management and less of
the implementation itself.
What I mean by that is it'sawfully hard to manage losses in
an index fund, depending on howyou purchase that index fund.
(20:41):
If you purchase it over time,year in and year out, year in
and year out, purchase it overtime, year in and year out, year
in and year out, you can handleand actually grab a purchase
that's in a net unrealized lossposition and match it with
another purchase that's in a netunrealized capital gain and you
can kind of utilize that tooffset.
(21:02):
But most people that I everencountered, or even recommended
going into managed accounts,were really about the tax
management of the underlyingholdings that made up the
portfolio, where the managercould go ahead and optimize yeah
, fair enough, the tax lossversus tax gains at the end of
the year and that applies alsoto fixed income.
Speaker 2 (21:24):
Yeah, fixed income You're using there.
Speaker 1 (21:26):
Yes, there is that.
But beyond that, from astandpoint of, are you getting
alpha, let's say, excess returnsover the index that you follow
as your benchmark, or indexesthat you follow as a benchmark,
indices, indices, indices Ithought it was indexes.
Yes, and so like data and datumlike, if you say four of them,
(21:47):
you have to go indexes zucchiniand zucchinis, candelabra and
candelabrum.
Speaker 2 (21:53):
Wow, you're throwing this all out, aren't you?
Yeah, because I think it's alsoput your thesaurus away.
Speaker 1 (21:58):
Yeah, it's just, you know just like data and datum.
Speaker 2 (22:00):
The data are come on, you don't do that with anything
else?
Huh, candelabra zucchini.
So what terms should I use?
Speaker 1 (22:07):
indexes, indices, indices.
Okay, yeah, so if you're usingindices, you know you can, you
can apply those but I just lost.
Speaker 2 (22:15):
I just lost a very weak point I was going to make,
so hopefully I can recover.
I don't know what the hell itwas I don't know either.
Speaker 1 (22:24):
I'm thinking of fajita for lunch.
That's what I'm really thinkingabout when?
Speaker 2 (22:28):
were we?
Speaker 1 (22:29):
I don't know, but we're at 33 minutes.
Speaker 2 (22:32):
I feel like I'm at a restaurant.
You know the look on the faceof an individual where they're
looking for the bathroom andthey get this look on their face
like they're lost.
Speaker 1 (22:40):
Yes, that's kind of me right now.
Yeah, I agree, I agree.
Yeah, there's a little lostlook in your eyes, almost like
the puppies in that SarahMcLachlan song.
Speaker 2 (22:51):
I've gone too far, I've said too much already, yeah
let me just let this roll,because I want to get back to
what we were talking about.
We were talking about taxefficiency.
Speaker 1 (23:00):
We were oh, oh, oh, oh oh yeah.
Speaker 2 (23:04):
So here's the conversation to the client, mr
and Mrs.
Client, I've got some greatnews.
We've got some great loss carryforwards that we're going to be
able to offset at some point,because I totally murdered your
portfolio this year.
Speaker 1 (23:19):
My point is you can't run money without having that
conversation once in a while.
It doesn't exist conversation.
Speaker 2 (23:29):
Once in a while it doesn't exist.
That's right.
So as I have grown, I'veevolved into in my earlier years
from being a big proponent ofactive management to now not
very much.
Kelly, though you made a verygood point on the management of
taxes.
Speaker 1 (23:42):
Yeah, we talked about this before and I don't know
that it'll make this cast, butthere is the ebb and flow of
efficient and inefficientmarkets.
During efficient markets,indexes are extremely difficult
to outperform because in anefficient market everything is
working Well.
(24:02):
If you own the S&P 500, you own500 companies of thousands that
are listed in the America.
But if you have an investmentthat has exposure to all sorts
of names within the market, eventhe bad names or the names that
people don't have a lot ofconfidence in skyrocket.
And that is sort of an exampleof an efficient market.
(24:24):
Back in the 90s, a monkey couldthrow a dart at Wall Street
Journal and hit any stock and ifyou bought it you would have
made money in that stockEfficient market.
And then you get to inefficientmarkets where guess what Stock
picking rules the day duringthose cycles and scenarios.
Why did you use a monkey?
(24:45):
Because I was born in the yearof the monkey.
Let's wrap this.
Welcome to Bullshit on Stilts, a podcast hosted by
two guys with vast financialbackgrounds and great bullshit
sniffers who call out the clichecrap, spackle and flap doodle
spewed by so-called expertsacross the landscape of
financial advice Identifying asdoctors of bullshitology.
You can count on your esteemedhosts okay, maybe knuckleheads
(00:24):
to bring you a lively, if notdeadly, mix of bullshitology.
You can count on your esteemedhosts okay, maybe knuckleheads
to bring you a lively, if notdeadly, mix of serious analysis,
hijinks and tomfoolery, allwithin a 99.1% bullshit-free
safe space.
Let's get after it.
So today, on Bullshit on Stilts, we're going to be focusing on
question number three in the FabFive for investing, which is
(00:47):
how are you doing?
Speaker 2 (00:48):
I'm doing just fine, kelly, and how are you?
I'm fine, I'm okay.
I'm a little tired, but youknow what?
My left toe is kind of sore theanswer to that is a throwaway.
That's not really an assessment.
It's an automatic response.
I'm fine.
Speaker 1 (01:01):
You mean in terms of interacting with people?
Yeah, like how you're doing.
Speaker 2 (01:04):
Yeah, you really aren't paying attention to me,
but you answered, you're fine.
Speaker 1 (01:07):
Yeah Well, I tend not to pay attention to you.
I mean, that's just, it's aknee jerk response, I think on
my part.
Speaker 2 (01:17):
Well, and you're making my point, because most
people don't pay attention totheir investment returns when
you ask them how they're doing,I'm fine, it's good.
Speaker 1 (01:20):
Well, I'm higher than I was last month.
I'm lower than I was last month.
Speaker 2 (01:24):
Right, right, which is really just volatility.
Speaker 1 (01:26):
And yet you ask the same person how did the I don't
know Detroit Lions do lastSunday?
And they'll give youplay-by-play commentary, you
know, as an example Interestingthey will.
Why is it so hard, do you think, to know how you're doing when
it comes to your investmentretirement accounts?
Speaker 2 (01:42):
Well, traditionally, most brokers didn't want you to
know how you were doing Don'tlook behind you so it really was
never quantified.
Now it has been in 401k plans,but I'm talking about the
traditional broker, kelly.
Why would they not want you toknow how you're doing?
Because more often than not,just like your typical mutual
fund, you're underperforming.
Commissions can really eat awayat your total return your net
(02:07):
return.
Speaker 1 (02:07):
You use the term alpha.
What does that mean For theperson driving down the 696 in
Detroit right now and they hearalpha?
What do they think?
Speaker 2 (02:15):
Well, I really don't know what it means, but I can
tell you what I've heard itmeans is that it is the return
that your manager adds over andabove what you could have gotten
with a passive investment likethe S&P 500 index.
So if the stock market indexand let's say it's the S&P 500,
(02:36):
returned 10%, but your broker orthe investment manager of your
mutual fund returned 12%, thatas two percentage points of
alpha.
Speaker 1 (02:45):
How does a person that doesn't do this as a job
trying to do it themselves?
How do they figure out?
How am I doing when it comes totheir investment accounts?
Speaker 2 (02:55):
All right, let's put this to remodeling a shed in the
backyard.
Okay, I can do it myself and Ihave a skill level to some
degree, but I'm going to paysomebody else to do it.
Did they do a better job forwhat I paid them than I could
have done myself?
In investing, I can put thatinto a passive index, but I've
hired you to add excess return,so how did you do?
(03:19):
No different than in management, I'm paying you to do a job.
Did you do that job?
And if I'm hiring an activemanager, I'm not asking him to
track a benchmark.
I'm asking him to add excessreturn because that's what he
told me he could do, minus allof the fees associated with that
.
Speaker 1 (03:37):
Ultimately, what we're talking about is compared
to what.
Right now, we're not talkingabout how did I do.
We're talking about comparinghow you did to something else,
and there's a difference inperformance.
Speaker 2 (03:48):
So let's start with the preferred flow of questions.
The first would be how did I doso?
If I have a stock portfolio,how did my stocks perform, let's
say, over the one year period?
Let's just use one year?
If I have bonds, how did mybonds do?
What if I've got both, Kelly?
Then you compare both.
Do I compare them individuallyor do I blend?
Speaker 1 (04:11):
them.
You analyze them individuallyand then combine them into a
sort of a sandwich, so to speaklet's call it and then compare
the combined performance to aappropriate combined benchmark
made up, in this example, ofboth stocks and bonds,
relatively speaking, the sameexact weight.
So if you had 60% of your moneyin stocks, you would have 60%
(04:35):
of that benchmark.
You're comparing yourself to bea stock index of some sort.
And likewise, if you had 40% ofyour money in bonds, you would
compare that performance thatyou achieved compared to a bond
index at about a 40% weight.
Speaker 2 (04:52):
So what would math look like?
And I don't want to get intotoo much air math on this,
that's what I like.
But if we had 60% in stocks?
I'm touching my calculatorright now, I know, yeah, I'm
touching my calculator right now, I know, yeah, okay, sorry,
yeah, if we had 60% in stocksand my broker told me that my
stocks performed 10%, I had a10% return net of all costs, but
(05:14):
the index was only 8%, forexample, the S&P 500 index.
We can assume, or it's apparent, that the broker added value
two full percentage points, thedifference between 10% and 8%.
Speaker 1 (05:27):
Yeah, I definitely think the broker wants you to
conclude that.
Now the question is was it justlucky?
Did you just own NVIDIA andthat's why you got the 10 and
the one name made it?
So Is that luck, Is that skill,or is that just taking a
position equative to the S&Pholdings?
Speaker 2 (05:45):
Well, I think it's very difficult to.
Speaker 1 (05:47):
I know I'm getting detailed right now.
Speaker 2 (05:48):
No, it's very difficult to assign skill,
particularly over the short term, and there are studies that
show it might take a decade todetermine if there really is
skill or you've just been lucky.
Speaker 1 (06:00):
Yeah, I know in institutional business back when
I was working in institutionalland big pensions endowments
they would typically rule ofthumb not change a manager for
at least three years.
Let's see how they do for aboutthree years.
They would also typically notinclude a brand new manager with
less than five years of a bonafide audited track record of
(06:20):
their performance.
So it's twofold.
Speaker 2 (06:22):
But I think you use the same metric three years with
personal relationships.
Am I correct with that?
Speaker 1 (06:29):
Typically three years for most people.
They are totally fed up withwho I am and they just walk away
, so it's their three year.
Yeah, me, I'm happy to go intoa fourth year.
But it's the humor, it's thehijinks and tomfoolery.
That just I guess it's just andthe crap spackle and tomfoolery
.
That just I guess it's just andthe crap spackle.
You had to use that one, thecrap spackle and the flap doodle
(06:50):
.
Absolutely.
Yeah, you never know what'sgoing to happen when you pull
out a flap doodle.
Speaker 2 (06:55):
So let's talk real simple, particularly when you do
it in a public place.
That's right.
I'll tell you right by thatwater fountain down by anyway.
Speaker 1 (07:01):
So the math is really simple, isn't it?
When it comes to how did I do?
On a simple basis, it's reallyfourth grade math, right?
So what is that math?
How would I take my investmentaccount at the end of the year
and figure out did I add anygrowth to my overall assets?
Did I lose some value in my?
(07:21):
How do I do that?
Speaker 2 (07:23):
Well, what you would do would look for the
appropriate benchmark for yourportfolio.
If you're in stocks, you'd haveto assign a benchmark.
Or are we more basic than that?
Speaker 1 (07:32):
I think we're more basic than that.
What I'm looking for is lookbefore we get to the benchmark
right, which is how did I docompared to something?
Speaker 2 (07:39):
Oh, I've got the answer.
Go ahead, I've got the answeranswer.
Speaker 1 (07:44):
I've got the answer.
I would take my starting valueand my ending value.
Did you call a lifeline?
Is that what happened?
Is that what just happened?
Speaker 2 (07:49):
Okay, All right, go ahead.
Yeah, actually, I would take myending value and minus the
starting value and whatever thatdifferential is.
I would divide that by mystarting value and whatever that
percentage is plus or anegative would be how I did.
Speaker 1 (08:07):
Yeah, and in fact you come out with usually a decimal
, and the little step is thenmultiply that by 100, and you'll
get your percent of yourperformance Right, good, bad or
ugly.
Speaker 2 (08:19):
Yeah, this is the booth question what the hell
does performance mean, what Imean, performance mean, what I
mean, what is what?
And we want to avoid the littlenegative sign in front of that,
the minus sign.
Speaker 1 (08:32):
However, let's talk about that because it's how did
I do If the market in the lastyear let's just use stocks for a
quick second was down 30%because of a bear market
correction and your account'sdown a negative 10%?
Should you be upset or shouldyou be patting if you're working
with a broker and advisor onthe back saying, hey, thanks for
(08:55):
taking care of me and coveringmy tail when the market has had
a huge correction?
I don't know whether anybody'sever said that to their broker.
We had a client.
I should say that back in 08,at the end of 08, right,
everybody remembers it's acatastrophic event, it's the
Great Recession, blah, blah blah.
We had clients that came in andwe had allocated to lots of
(09:15):
different non-market-relatedinvestments.
Their return for 08 was anegative 4.35%.
I can remember this like it wasyesterday.
They come in really nice folks,but they both were like well,
we're paying you guys to growour money.
I don't think I should be happywith a negative four.
(09:36):
I took that a little personallyand I got a little upset in
that the average long-termstrategically allocated
investment plans that we find in401ks and endowments and
pensions and so forth theaverage of just 40% stock and
60% bond was down between 24 and28 percentage points.
(09:58):
They ended the year at minus4.35.
And only until we helped themunderstand compared to what
where they're like.
Oh wait, I get.
I'm sorry, I don't know whatthe hell we were thinking.
So it does happen out there.
Speaker 2 (10:12):
Yeah, managing risk is a thankless job.
Oh my gosh, what you avoidedthem experiencing is always
thankless.
Speaker 1 (10:19):
That's a good way to put it.
That's absolutely a good way.
So, when we come back to how amI doing?
Real simple, right?
I can take my Decemberstatement, december 31st value
on my statement.
I can subtract from that numberDecember 31st of the previous
year's value and I come up witha plus or minus number and I
(10:40):
divide that number by December31st of last year's value and I
multiply that by 100, andthat'll give me my actual
percentage return of myinvestment over the last 12
months in this example, correct.
Let's go back to I think wetalked about this in the big Fab
Five, right?
The bigger podcast earlier,which was but what if we have
(11:03):
50% in stocks and 50% in bonds?
Do I still think of just thestock market when it comes to am
I doing okay or not?
How did I do?
How do you approach that?
Speaker 2 (11:13):
Just as a reminder, Well, you'd want to divide it.
Ultimately, now it might benice to know what your total
portfolio did, but to identifywhere there could be problems,
I've got to look at both theequity component and then if
I've got fixed income.
That component, yes, Because Icould have had excess returns in
my stocks.
But uh-oh, something happenedwith the bonds Sure, bonds.
(11:35):
That negates what I did withthe stock portion of my
portfolio.
So this is where you startseparating out, to start forming
benchmarks, or identifyingbenchmarks, to get into the
compared to what.
So the how did I do is verysimple math.
Take the ending value minus thebeginning value, divided by the
(11:58):
beginning value times 100.
Yeah, super simple.
That's for your whole portfolio,and then you do that if you
have different asset classes,distinctly different asset
classes.
So if you have a bond componentand a stock component, maybe a
real estate component, thenyou'd have to do it with three
different appropriate benchmarksIndexes of some sort.
Speaker 1 (12:20):
Yeah, it's an interesting thing.
Lots of people don't understandit, and yet it's probably
amongst the simplest things todo when it comes to measuring
how you're doing Right N minusbeginning, divided by beginning
times 100.
Speaker 2 (12:36):
Super simple.
Why do you think mostindividuals, most investors,
can't tell you how they're doingyet?
It is salient and has to be ontheir 401k statement.
Usually it's on the brokeragestatements now, but nobody knows
what it is.
Speaker 1 (12:55):
I do think that it's an issue around the way the
industry goes about bullyingconsumers.
This is way too complicated,you can't figure it out, and I
think that over time a personends up accumulating sort of
immediate reactions to thingsand if they open up a statement,
their immediate reaction is Ireally don't know what this is
(13:21):
telling me.
All I know is that the value is$10,000 higher than it was last
month.
So I must be doing okay and Ican't.
If I heard that and was paid adollar every time I heard that
over the practicing career Iwould have a retirement all on
itself.
Speaker 2 (13:34):
We were doing work with the SEC, state of Michigan
Regulators and CFA Institute andI forget who the nonprofit was
and the discussion was aroundinvestment fraud and at that
point the average person who wasscammed lost $14,000.
And sometimes there wasrecovery, but the net loss was
(13:56):
about $14,000.
But here's what's worse thanthat.
Mrs Johnson has a $200,000portfolio and because of
excessive fees, a lot ofcommission, a lot of churn and
underperformance, because ofthat she's losing $10,000 a year
(14:17):
.
And that's just not for oneyear because they catch the guy.
It can go on for decades.
Sure, yeah, so that's whereit's insidious.
Speaker 1 (14:25):
So when people don't know what they own, why they own
it and how they're doing,they're setting themselves up
for failure, and they're theones that put themselves there
for a failure to understand andknow how they're doing and
compared to what Don't you thinkthat, when it comes to the
(14:47):
consumers out there that do workwith an advisor of some sort,
when they do meet their advisor,whether it's periodically or
every once in a blue moon myexperience was always they were
asking me how am I doing?
They had no preconceived notionother than my accounts up or
down, that's it.
I think there was three clientsout of 128 families that I
(15:11):
worked with years ago.
Those three knew how they weredoing.
One knew everything about whatwas in that portfolio,
everything even down to thevoting for new board members,
and they would come in and askme who's John Smith?
Should I vote for John Smith?
And so forth.
My point is the vast majority ofpeople just want everything to
(15:33):
be on a remote control.
I don't want to do any work.
I want to set myself up to belied to, misled or something.
Do no preparation for mymeeting with my advisor hey,
mark, how am I doing?
And then I shut up and I sip onmy Coca-Cola and break little
pieces of the cookie Markbrought into the conference room
in order to tell me or answerthat question in a manner that
(15:57):
may or may not be very accurate.
Speaker 2 (15:59):
Often you get a lot of what's called explocative
gloss and you really don't get,you really don't get an answer.
So this falls under the categoryof the cost of not knowing.
And when you don't know thereis a tremendous cost and it can
be insidious.
So where we are in life is notthe last really stupid thing we
(16:22):
did or the last great decisionwe made on themselves over a
multiple year period, or neglectand poor decisions compounding
themselves over a multiple yearperiod.
That has you where you are.
So anyone in isolation example,last year not knowing how you
(16:46):
did in isolation, no big deal.
But year after year after year,the compounding of that,
negative or positive, has youwhere you are.
Speaker 1 (17:00):
Agree 100%, by the way.
And you said neglect and I wasthinking about the twigs in your
hair and how you just neglectto even comb your hair in the
morning, but that's not part ofit.
There was a family of fourliving there, a little fox
squirrel.
So how am I doing?
I've come across this frequentlywhere a consumer, an investor
out there, is working with aninvestment firm and they're
(17:22):
convinced to go into a managedaccount, managed account being
that, let's say, acme Widgetswill use, will protect the
innocents out there.
Just Acme Investment Companywants to convince me to use
their managed account and in amanaged account it means that
some financial analystprofessional is making decisions
(17:44):
on what to buy and sell insidethe account that is in my
account itself, right, so itmight be just stocks where
they're buying and sellingstocks and they're comparing
themselves to let's make it easythe S&P 500.
And yet they're charging feesfor doing that.
Rarely have I come along anddone analysis on that account
(18:07):
that demonstrates the account isanything but some of the top
holdings in the index itself.
Can you comment about how aperson should kind of think
through what they're doing withtheir advisor or with their
investment management firm whenit comes to managed accounts,
over just what we've talkedabout before funds, whether it's
(18:29):
an index fund, mutual fund, etfand does it make sense for most
people to spend an extra oneplus percent on a managed
account that simply oftentimesmirrors the index itself?
Speaker 2 (18:43):
Well, this might sound like glib opinion, but it
certainly is substantiated bylots of data that the average
mutual fund, actively managedmutual fund, does not outperform
its index, particularly overmultiple year periods.
Might for one year, might forthree years, but for whom, when
and for how long?
And is it really replicable?
(19:05):
And is it really skill, or isit just luck?
Well, you might take a decadeto find out one way or another.
My thinking is this why do that?
Why go through all of therigmarole of active management,
their investment philosophy, howthey select stocks, when I know
statistically you're not goingto beat the index?
So why I'm even going throughall of these financial ratios?
(19:30):
I can't optimize humanintention and it's all
retrospective, yeah, so some ofthose are silly.
Why am I measuring and doingratios on a loser?
I mean the average activelymanaged mutual fund.
Yeah, yeah, I would rather knowhow am I doing?
Is that number close to theindex or slightly above the
(19:52):
index?
I'll handle some tracking errorto where it might be a little
bit negative, but that's gettinginto the minutia.
Do I have the right assetallocation based on my time
horizon.
I have returns that areacceptable to me and are
tracking closely to the index,or are the index, then I'm
(20:12):
pretty happy with that.
So just there alone.
Why am I confusing this andcomplicating it the thing?
Speaker 1 (20:20):
that pops into my mind as you're talking is there
are some bonafide reasons why amanaged account might make sense
and typically it's fromtax-wise management and less of
the implementation itself.
What I mean by that is it'sawfully hard to manage losses in
an index fund, depending on howyou purchase that index fund.
(20:41):
If you purchase it over time,year in and year out, year in
and year out, purchase it overtime, year in and year out, year
in and year out, you can handleand actually grab a purchase
that's in a net unrealized lossposition and match it with
another purchase that's in a netunrealized capital gain and you
can kind of utilize that tooffset.
(21:02):
But most people that I everencountered, or even recommended
going into managed accounts,were really about the tax
management of the underlyingholdings that made up the
portfolio, where the managercould go ahead and optimize yeah
, fair enough, the tax lossversus tax gains at the end of
the year and that applies alsoto fixed income.
Speaker 2 (21:24):
Yeah, fixed income You're using there.
Speaker 1 (21:26):
Yes, there is that.
But beyond that, from astandpoint of, are you getting
alpha, let's say, excess returnsover the index that you follow
as your benchmark, or indexesthat you follow as a benchmark,
indices, indices, indices Ithought it was indexes.
Yes, and so like data and datumlike, if you say four of them,
(21:47):
you have to go indexes zucchiniand zucchinis, candelabra and
candelabrum.
Speaker 2 (21:53):
Wow, you're throwing this all out, aren't you?
Yeah, because I think it's alsoput your thesaurus away.
Speaker 1 (21:58):
Yeah, it's just, you know just like data and datum.
Speaker 2 (22:00):
The data are come on, you don't do that with anything
else?
Huh, candelabra zucchini.
So what terms should I use?
Speaker 1 (22:07):
indexes, indices, indices.
Okay, yeah, so if you're usingindices, you know you can, you
can apply those but I just lost.
Speaker 2 (22:15):
I just lost a very weak point I was going to make,
so hopefully I can recover.
I don't know what the hell itwas I don't know either.
Speaker 1 (22:24):
I'm thinking of fajita for lunch.
That's what I'm really thinkingabout when?
Speaker 2 (22:28):
were we?
Speaker 1 (22:29):
I don't know, but we're at 33 minutes.
Speaker 2 (22:32):
I feel like I'm at a restaurant.
You know the look on the faceof an individual where they're
looking for the bathroom andthey get this look on their face
like they're lost.
Speaker 1 (22:40):
Yes, that's kind of me right now.
Yeah, I agree, I agree.
Yeah, there's a little lostlook in your eyes, almost like
the puppies in that SarahMcLachlan song.
Speaker 2 (22:51):
I've gone too far, I've said too much already, yeah
let me just let this roll,because I want to get back to
what we were talking about.
We were talking about taxefficiency.
Speaker 1 (23:00):
We were oh, oh, oh, oh oh yeah.
Speaker 2 (23:04):
So here's the conversation to the client, mr
and Mrs.
Client, I've got some greatnews.
We've got some great loss carryforwards that we're going to be
able to offset at some point,because I totally murdered your
portfolio this year.
Speaker 1 (23:19):
My point is you can't run money without having that
conversation once in a while.
It doesn't exist conversation.
Speaker 2 (23:29):
Once in a while it doesn't exist.
That's right.
So as I have grown, I'veevolved into in my earlier years
from being a big proponent ofactive management to now not
very much.
Kelly, though you made a verygood point on the management of
taxes.
Speaker 1 (23:42):
Yeah, we talked about this before and I don't know
that it'll make this cast, butthere is the ebb and flow of
efficient and inefficientmarkets.
During efficient markets,indexes are extremely difficult
to outperform because in anefficient market everything is
working Well.
(24:02):
If you own the S&P 500, you own500 companies of thousands that
are listed in the America.
But if you have an investmentthat has exposure to all sorts
of names within the market, eventhe bad names or the names that
people don't have a lot ofconfidence in skyrocket.
And that is sort of an exampleof an efficient market.
(24:24):
Back in the 90s, a monkey couldthrow a dart at Wall Street
Journal and hit any stock and ifyou bought it you would have
made money in that stockEfficient market.
And then you get to inefficientmarkets where guess what Stock
picking rules the day duringthose cycles and scenarios.
Why did you use a monkey?
(24:45):
Because I was born in the yearof the monkey.
Let's wrap this.
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