Money Talk

Episode 52

Investing In Troubled Times

Welcome to our listener-supported podcast, Money Talk, uncompromised absolute financial truths behind financial perceptions with hosts Ed Sutkowski and Chuck LeFebvre. Let’s listen in.

Chuck: Welcome to Money Talk. This is Chuck.

Ed: This is Ed. Today’s topic is investing in troubled times. That’s a misnomer. It seems to me investing at any time is a troubled time.

Chuck: If you start during a time when it’s not troubled, it will eventually become troubled. You’re going to eventually have to run into the question of how to navigate through the investment world at times when markets seem uncertain, or you’re challenged to see whether you’re going to make a profit or you’re going to stay on track. It seems like this is the biggest challenge for most individual investors. They really sometimes lose a lot of sleep over exactly this topic.

Ed: I think everyone wants to make more money than their neighbor or more money than their sister’s husband. There’s something about this. A little bit of diversion. I looked at some numbers. They are incredible, I think. Everyone views that there’s all these people have all this money. Let’s talk about the top 1% of the population. Guess what an individual income would be in top 1%.

Chuck: See now, I already know this number, so I can’t guess it. I know that most people would guess a much– I think most people would guess a much higher number than the actual number, which, if I’m remembering right, is around $400,000, right?

Ed: Average is $401,622 per household and would need to earn $570,000 per year 

to be in the top 1%. Now, there’s some distortion there, but nonetheless that’s not quite what most people seem to think. What about per age? The average and median average, and median net worth by age. Let’s take someone 50, for example.

Chuck: Someone who’s 50. Now this is a number I don’t already know. Someone who’s 50 years old, and then the top 1%, their net worth?

Ed: Yes. $897,000.

Chuck: That’s it.

Ed: That’s it. 80 years old, $973,000. That’s less than $1 million.

Chuck: That’s not a big difference from a 50-year-old.

Ed: No, not at all. Then you get to the issue– I didn’t mean to stop you there.

Chuck: No. The interesting thing about this is that within that 1%, so in the United States, we’re talking about roughly 30 million people, right

Ed: Yes. 33 million.

Chuck: There’s a small number that we’re talking in the billions. There must be a large number of people where that net worth figure is actually quite a bit lower. Right?

Ed: Yes. We’re talking about the middle.

Chuck: That’s the average. 

Ed: Yes. 

Chuck: Not the median but the mean.

Ed: Right. The median is the center of the road, that median strip. 

Chuck: Right. 

Ed: The net worth of those in the US in the upper 1/10th of 1%.

Chuck: Now I’m going to suggest we must be into an eight-digit figure by now.

Ed: Go ahead.

Chuck: 50 million.

Ed: 43,000,207. Now to get the question of IRAs, my favorite topic. This is back several years ago. I don’t have the current numbers, but there was 791– This back in 2014. It’s either up or down depending on how you view the market and the nature of the assets. In the IRA, they’ll probably be stocks and equities, and bonds. The 791 taxpayers have IRA balances from $10 million to $25 million. 791.

Chuck: Wow.

Ed: 314 countrywide have those of more than $25 million.

Chuck: Part of the reason for that is that for most people, the limitations on the amount you can contribute are quite low.

Ed: Absolutely.

Chuck: If you’re trying to build up an IRA by actually opening up an IRA account. Let’s say you’re not a business owner, you’re just a person who works for a living and you decide, you’re going to open up an IRA and you’re going to contribute money into that IRA. There are just incredibly low limits on what you’re allowed to contribute. You can contribute more if you work for an employer who has a 401(k) plan.

Ed: We’ve traversed this more than once before. The idea is some kind of an arrangement that allows you greater contribution and flexibility.

Chuck: Right. The way to do it is to own a business and to set up a plan as the owner of the business that allows for aggressive contributions. We had an episode of the podcast, one of our earliest episodes, was talking about the cash balance pension plan, which allows people to funnel a great deal of money on an annual basis into– initially, it’s the cash balance pension plan itself, but then that can be rolled over into an IRA later on. Of that, what was the number? 320 some odd people-

Ed: Right.

Chuck: -who have the extremely larger IRAs. I bet a lot of those originated via that method.

Ed: I would say virtually all, not just a lot. Let’s make sure we’re together on a defined benefit cash balance plan. Just a short footnote here so everyone understands. You think of a defined contribution plan like an IRA, which is in your account balance, that’s your retirement benefit. In a defined benefit plan, think Social Security. Of that, you’re going to be receiving, not a lump sum, but an amount per month, theoretically adjusted to reflect increases in cost of living, and the present value of those payments is in effect credited to your account in a cash balance pension plan.

Chuck:  Right.

Ed: At age 62, you can cause that, even if you’re still working, to be transferred to your IRA.

Chuck:  Right.

Ed: And there you can go wild with commodities and the like. That accounts for this $25 million. Those that we’ve seen are never just from ordinary IRA distributions, although we can have some exceptions to that rule or that observation with Silicon Valley. 

Chuck:  Right.

Ed: They put an IRA together and get these stocks that have no value and boom, it’s worth 500 times, and especially if they use a Roth IRA. You could have $500 million in a Roth IRA, and distributions aren’t taxed.

Chuck: Even those probably started out as some type of employer-sponsored plan involving employer stock that then got rolled over into an IRA. Although I’m sure there are some people who just went out and got lucky and bought a stock when it was in its early days, and it really blew up for them.

Ed: Yes, but that’s overstated, Chuck, as you know that. That many people that have– we know the ones that have won. We don’t know the one– they’re highly visible,

Chuck:  Right.

Ed: But the losers aren’t around. 

Chuck:  Right.

Ed: You know, you see the restaurant that’s really doing well. Maybe that’s one out of five that’s made it for five years. 

Chuck:  Right

Ed: You don’t see the losers. They’re invisible. But if you keep track of your losses, you know that you have lost your– Let’s get back to this investing. 

Chuck:  Right.

Ed: The Dow Jones industrial average has been with us for 124 years. On average, and this is amazing, the return without dividends is 7.7%, and with dividends is substantially in excess of that. You get these numbers from different sources,  and you lie two ways. You lie or you use numbers. 

Chuck:  Right.

Ed: I think we can conclude that the average rate of return, including dividends over the 124-year history of the Dow Jones industrial average is 8%.

Chuck:  Right.

Ed: Make it easy. 10% money doubles in 7.2 years. 

Chuck:  Right.

Ed: That’s how this happens. So that if you buy and hold, and don’t have the friction costs of selling, guess where you’re going to be better off? Am I missing something, Chuck?

Chuck: You’re not missing this, but I think there’s emphasizing is starting early and holding on for a long period of time is a critical part of this process. That does two things. First of all, there is a greater opportunity for values to grow over a longer period of time. Second of all, what we’re currently seeing and what periodically you see is this volatility in the market where prices fluctuate. They go down, people get nervous. If you are I investing over a period of 15, 20, 30 years, those fluctuations essentially smooth out. Let me put it this way. Let’s say you’re going to buy, keep it simple, just a S&P 500 ETF–

Ed: Now, wait, what’s that ETF?

Chuck: That’s an exchange-traded fund. Think of it basically as a mutual fund, but one that you can buy on an exchange rather than having to deal directly with a mutual fund company to open up a new account. You can go to a regular brokerage house, and you can purchase that more efficiently just simply on an exchange. The question is, how reliably can I count on that having grown in value by the time I cash it out?  Well, the answer to that question depends a lot on how long you plan to hold it. If you’re going to hold that for, let’s say under a year, well boy, you probably have about a 60% chance that it’s going to be higher in value when you cash out, and about a 40% chance that it’s going to be lower in value. Let’s say you’re going to hold it for five years, now 90% chance that it’s going to grow in value, 10% chance that it’s going to be lower in value. If you say you’re going to hold that for 20 years, I’ll tell you, you are virtually guaranteed to have made money holding onto that.

Ed: Over the 10-year period, since the creation of the Dow. 82.6% of those 10-year periods are profitable. Average gains of 107.2%, and the average losses of 16.7%. That proves your point.

Chuck: If you look at, the likelihood of losing money drops to zero after a certain holding period.

Ed: That’s incredible. That doesn’t sound right.

Chuck: It’s true. You can’t find, for instance, a 40-year period of time no matter when you pick for your start date or when you pick for your end date, you can’t find a 40-year period of time where the S&P 500 or the Dow Jones Industrial has lost money. It just hasn’t happened. There’s no reason to believe that it ever will happen. In other words, if the end date is Black Friday and the market has experienced the largest crash in the history of the market, if your start date was early enough, you still made money if that was your sell date.

If you hold long enough, then you are not only virtually guaranteed to make money, you’re virtually guaranteed to make more money than if you had made really any other investment that you can buy on an exchange. I’m obviously excluding starting your own business or having real estate, or something that involves active participation. If you’re talking about publicly traded securities, whether fixed income or equitable securities over a long enough period of time, nothing you invest in is going to outperform investing in stocks.

Ed: Some statistics, the best 10-year period that’s been measured is ’89 through ’98. Dow gained 323%. The worst 10-year period, ’29 through ’38, 1929 to 1938, was a loss of 48.4%. There’s risk. Risk is the price you pay for an additional return. If you’re going to be in a certificate deposit at the bank or the government bonds, is not very risky and the return is not very significant also.

Chuck: I would argue that even there, you do incur risk, it’s just invisible.

Ed: The inflation.

Chuck: Right. The risk you incur is the fact that you may or may not be keeping up with inflation at any given time. The certificates of deposit are my pet peeve here. Because what happens is you buy a certificate of deposit. When you buy one, you have people who like to buy these things. They go from bank to bank and they figure out who’s got the highest rate and, oh my gosh, I’m going to go to bank X because they’ve got a special, and the CD rate is Y%, so they buy this, and then it matures. When it matures, the bank will roll that into an extremely low-rate certificate of deposit. Unless you are going to go around and shop bank to bank and find the best rate, again, every single time that matures, you’re inevitably going to end up with a very low return investment with a CD.

Ed: Chuck, I couldn’t agree with you more. In my travels and watching what people do or don’t do, and that’s really the issue, what you don’t do, and very, very bright people, whether it’s a savant as far as a business is concerned, or an academic achiever, the idea is risk tolerance or loss aversion. In my limited travels, running across a fair number of individuals that have a couple of bucks, it’s astounding to me that very, very bright people, engineers for example, wow. They are investing in CD’s.

Chuck:  Right.

Ed: They are investing in CDs.  What was it? Is it a mathematical issue that everything has to foot? You are a math major. I’m not beating you up, but I’m trying to understand. It seems that those with the greater quantitative experience tend to be more risk averse than fellas that majored in philosophy or English.

Chuck: I’m probably not a good example there so I can’t excuse those folks or explain to you what the thinking is. Although I can guess that what it is is having the comfort of certainty that if you invest in something that has a fixed rate of return, then you know exactly how much money it’s going to make. If you invest in something that is market-driven, then you can’t predict what its performance is going to be.

Here’s where I would push back against that kind of thinking. Almost immediately I feel like I need to push back against that thinking and say, but wait a minute, over a long enough period of time, you can come close enough to predicting the way that it’s going to perform. The difference between what the lowest end of the range of a variable investment like a stock and compared to the certain return of a fixed investment like a CD is wide enough that you’d be crazy to invest in that low-return, high-certainty investment.

Ed: It seems to me that the investment advisors in the– When folks tell me, “My investment advisor says so and so,” and I said, “Did the investment advisor showed you that advisor’s balance sheet for the last three years.” “Oh no, that’s not relevant.” It’s go ahead and do what I tell you, not what I do sort of thing. 

Chuck:  Right.

Ed:  I get back to the issue of risk aversion, loss aversion. Those that I’ve been around that seems to enjoy some degree of financial success above the average are looking for change. Their mantra is change is constant. Boy, this is a new day. They don’t necessarily make investment changes, but they’re willing to handle risk. Am I crazy?

Chuck: No. You’re absolutely right. I want to backtrack and talk about the investment advisors for just a second because they’re my pet peeve, and I’m really frustrated with one at the moment.

Ed: Only one. 

Chuck: Only one. Only one comes to mind at the moment. But, because what they have learned, they’re smart in this way, which is that they have learned what Danny Kahneman in his research has taught folks about this concept that psychologically you experience a loss as being about twice as important as experiencing gain.  Right?

Ed:  Yes.

Chuck: The investment advisor community has incorporated that. I don’t know if they’ve read Kahneman’s writings or anything, but they’ve definitely incorporated that lesson into their practices in this way. They have figured out that they can deal with a client who’s upset that their investments have not kept up with the market when the market is on a terror. That’s much easier to handle that client than someone who’s upset because their investments lost money when the market has gone down. So what they tend to do, I can’t find an exception to this rule,  what the investment advisors tend to do is they will preach diversification. You hear that word all the time. They don’t just mean buying, for instance, a S&P 500 index fund rather than an individual stock. They are saying you have to invest partly in stocks and partly in fixed income securities no matter how long your investment outlook is. They insist on incorporating some low-risk investments into a portfolio. Why? Is that 100% of the time what’s in the best interest in the investor? No, but 100% of the time that’s what’s in the best interest of the investment advisor. Because they know that customer is going to come in and say, “Wait a minute, my account lost $50,000 this year. Am I invested correctly whenever there’s a correction?” They want to not have that conversation. They’ll let you not make money during good markets in order to avoid having that uncomfortable conversation with you during the bad markets. As an individual, you are better off losing money during those bad markets in order to make more during the good markets if you have invested for the long-term.

Ed: Losing money means you’re assuming that there’s been a sale. 

Chuck:  Right.

Ed:  If you’re looking and your account’s gone down, you haven’t lost money until you sell it. 

Chuck:  Right.

Ed:  The question is who’s telling you what, and what kind of experience do they have? I’m not denigrating every investment advisor, but what I am saying is you got to watch out how much are you charging for this, and what’s the results that you’ve achieved? What’s in it for you? I see this in transactions where you’ll have an investment banker say, “You got to sell this and it’s a great idea.” Wait a minute, what do you have to sell? I’m getting X percent, that’s why you got to sell it? 

Chuck:  Right.

Ed:  Well consider the source. The Warren Buffet approach and for that matter also Peter Lynch created a story who managed the fund for Fidelity, wasn’t it?

Chuck: I believe so, yes.

Ed: Over X number– in his quote is, “Making money in the stock market is not to get second out of them.” In other words, keep the stocks.

Chuck:  Right or stay in the market.

Ed: Stay in the market.

Chuck: That doesn’t mean you have to hold on to every individual stock. If you own 20 different positions and when you have a market correction like what we’re in the middle of now, it’s not a bad time to look at, wait a minute, are some of these holdings things that I really don’t want to keep for the long-term? Why? Because they might be at a loss right now or the built-in gains might be lower than they would be in the future. It’s a great time to say, wait a minute, GE, maybe I don’t want to keep holding that for the next 30 years. Great time to get rid of that and then buy something that I think I do want to hold for the next 30 years.

Ed: Expectation of gain in the future.

Chuck: Yes, but to say, I’m just going to get rid of the stocks and invest now in bonds because I feel some pain over the fact that the total value of my account has gone down during this market correction, in my view, that’s a mistake.

Ed: I agree. Chuck, one final comment about diversification. We look at diversification or typically we’re told to diversify your investment portfolio. I look at it a little differently. Your investment portfolio should be X and everything should be in percentages, rather than dollar amounts. You do dollar amounts, you’re going to lose sleep, but if you talk about percentages, you’re going to make it easier. If you have 10% of your portfolio,  assets, investable assets in stocks or listed securities, that’s fine. Then what’s the other 90%? You have farms, you have an apartment, little pieces of other assets. As you go along the chronological age, you’ll be diversifying. I want you to think diversifying not only within your investment performance portfolio I should say, but all your assets.

Chuck: That’s true.

Ed: People lose sight of that.

Chuck: Except your home.

Ed: Except your home. That is not an investment.

Chuck: Right, which people think of as an investment, but it is not. You just have to wipe that clean from your balance sheet and think about everything else as if it’s part of an investment portfolio.

Ed: By the way, the numbers I gave you on net worth included your home. 

Chuck:  Right.

Ed: It’s really not quite a fair number, but the point is–

Chuck: Isn’t it incredible?

Ed: Yes.

Chuck: Think about that. You’ve got 800 and some odd thousand dollars as net worth–

Ed: Includes your home.

Chuck: $400,000 may be a home, right?

Ed: Yes. Anyway, the idea of net worth of folks, it’s just crazy where everyone’s attacking these mega millionaires. There aren’t any–

Chuck: There’s three of them.

Ed: There’s three of them. You got less than 500 people with more than $25 million in their IRA. How do they get there? They earned it. Is there something wrong with earning it? I don’t get it. The idea that there’s so many multi-million-dollar folks around is wrong.

Chuck: We’ve talked about this before, but this is the reason why the estate and gift taxes together collects so little revenue for the Federal government. It’s a tax that applies at a high rate, and for some estates, it collects a tremendous amount. You’re right, you see sometimes we’ve had clients who’ve written seven and eight-figure checks to the IRS as part of estate tax return and yet there are so few collections. It just doesn’t add up.

Ed: That number I gave you, the 12,060,000 shelters virtually all those folks. 

Chuck:  Right.

Ed:  Still you get a tax basis increase or step up. The idea is have appreciated securities die and move to a state where there’s no estate tax. 

Chuck:  Right.

Ed:  Very simple, but people aren’t going to do that. “Oh, I’ll let the heirs pay the tax.” That’s the game they’re playing and I get that. The message that I found just incredible is that the US is not populated with that many people with that much money.

Chuck:  Right.

Ed:  That was a shock to me thinking, oh man.

Chuck: This is the reason why the tax code seems to develop in the direction of increasing the tax rate. This has been written by several people about how quite often the tax burden ends up being placed on people, what you would call the upper middle class income earners. Really, it’s income taxes where the revenue is generated. The sweet spot seems to be the people who are making several hundred thousand dollars a year, but not millions of dollars a year.  Because there’s enough of them that you have a significant tax base there, and there’s enough money being made that when you collect a percentage of it, and for each of those taxpayers, it’s not a trivial amount of money. When the government’s looking for revenue, that’s where they’re going to go look over and over, and over again. If you’re above that window or you’re below that window, the amount of revenue being collected by your demographic is ultimately not going to be a great percentage of the tax base.

Ed: They can afford to pay it. The idea of redistribution of wealth by Piketty, the Parisian economist of the bottom set the basement for Obama, et cetera, about redistribution of wealth, it’s nice, but there aren’t that many people that may have that much money.

Chuck: That’s the thing, is that there aren’t that many of them. Because they are few and because they are– we’re not talking about the 1%, we’re not talking about the 0.1%. We’re talking about the 0.01% or the 0.001% that can certainly afford to play enough of a cat and mouse game here, that you’re never going to be able to effectively collect anyway. It’s a fool’s errand.

Ed: We’ve seen clients with more than $100 million in assets and the tax bill is zero.

Chuck: Exactly. It’s not actually all that hard to achieve.

Ed: No. It’s just–

Chuck: Wait a minute, no, we’re just great lawyers.

Ed: I’m the most popular and famous Polish lawyer on the fourth floor of the Commerce Bank building. Incidentally I’m the only one, but that’s okay. The point is this is not rocket scientist stuff. 

Chuck:  Right.

Ed:  I’m not saying that your dog, Jack, can do it, but a little thought and what’s going on and why are we doing this? We haven’t got to the question we’ve addressed before, as you accumulated this wealth, then how do you give it away?

Chuck:  Right.

Ed:  Are you going to destroy the need for a descendant to enjoy the journey and is looking for doing—

Chuck:  Right.

Ed:  Anyway, that’s holdover. We’ll get to that again, which happens to be my favorite toy. 

Chuck:  Yes.

Ed: This is fun. I wish everyone good reading and think about the book, The Anxious Investor by Scott Nations, Mastering the Mental Game of Investing. The more you read the less you’re going to–

Chuck: Understand these statistics. You really need to understand these statistics before you make any kind of decision and stay cool-headed about things.

Ed: Risk averse doesn’t mean you shouldn’t be in the stock market.

Chuck:  Right.

Ed:  I am not suggesting you should be margined, which is a whole different– I’m not sure people want to do that. I cannot see why anyone shouldn’t be in the stock market long-term. 

Chuck:  Right.

Ed:  Thanks, Chuck. We’ll visit again. 

Chuck: It was fun.

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