Ed and Chuck elaborate on the investment process. 200 years of success. The 80-20 rule shows up again. Create leverage with debt. There are no pockets in shrouds. Fun mathematical principals with Chuck. The magic of compounding interest. If you want to loose money, leave it in your checking account.

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

Ed Sutkowski: Hello, I’m Ed.

Chuck LeFebvre: I’m Chuck.

Ed: Today’s topic, the investment process. By way of background, over the 200 plus year history of the stock market, equity markets, the average return adjusted for inflation is 6.5 to 6.75%. The average return inflation adjusted over the 200-year history. Now, there’s some ups and downs, we understand that, but if we were to buy and hold over that 200-year history, you do fairly well. There are a couple of rules of thumb that I like to look at on a daily basis or actually maybe a monthly basis. The rule of 72, at 10%, money doubles in 7.2 years. Think of that. At 10%, money doubles in 7.2 years.

Chuck: That rule is, take the number 72, and you divide by your interest rate or your rate of return, I should say, and that’s how long it takes for your investment to double.

Ed: Yes, that’s pre-tax.

Chuck: Right.

Ed: If you were to buy, for example, a stock, and leave it alone, and you’ve got the capital appreciation and the dividends, if you sum those up, you’ll get a rate of return over, on average, over the selected period of time of 6.5 to 6.75%. Now, Chuck, any comments about that? I mean, does that always work? I mean, projections. You lie two ways. You use numbers or you lie.

Chuck: Right. Well, I mean, so this is something that is worth keeping in mind. That’s an average rate, and I think it’s a pretty reliable rate to rely on when you are talking about long term prospect. By long term, I mean, people should be thinking about this in terms of the way their investments are going to perform over decades, rather than perform over years. The behavior of any type of system that has variations in its– Like an investment market, which has an average rate of return, but it has a lot of fluctuations, the idea is that the longer you observe that behavior, the closer it’s going to behave like the average. So, yes, I think you can rely on that, but the question is, are you looking at that for a short enough period of time? I mean, for a long enough period of time, that it becomes a reliable rule of thumb. If you are going use that rule of thumb and say, “Well, I’m going put this in for five years, and so I know at the end of that five years, here’s what I’ve got.” The answer is, well, you don’t know a thing about what you’re going to end up with five years from now. We can talk about what you’re likely to have, not certain to have, but likely to have 30 years from now. Don’t use this rule if you’re talking about a five year or six year or even a 10-year outlook.

Ed: This rule is applicable, not only to a young person, and by the way, the sooner you invest, the greater the amount, the more you’re going to have capital working for you, and you’re going to achieve whatever your ultimate destination is. I must tell you, after you engage in this process for a finite period of time, five years, 10 years, you’re going to realize the truth of that position, and try to put away more every year, and invest in a way that achieves that result. The rule of 80-20, Chuck, that happens to be my favorite.

Chuck: Yes. Well, there’s actually a couple of different rules of 80-20 that we talk about, right? One of them is that you get 80% of your return from 20% of your portfolio, so you can think of that, the 80-20 rule in that way, but I think what you’re referring to here is the other 80-20 rule, which has to do with how much leverage, essentially, you’re using in your investment strategy, right?

Ed: Yes. To the extent that you have money to invest, and you can borrow 20% of your total investment of $100,000, so you borrow 20%, and then you have 80% invested. Your leverage works out real well, and so the greater the leverage, the greater your debt, as a function of equity, your debt-equity ratio, the greater your upside. However, the greater your downside. Chuck, we talked about why people are psychologically opposed to losses. You have a $100,000, and you make 50, versus you lose 50. The psychology is, and the 50 that you’ve lost.

Chuck: It hurts twice as much as the– Yes, you feel that with twice the intensity, as an equivalent gain.

Ed: Because you’ve got to make 100% of the 50 to get back to 100.

Chuck: That’s exactly right. Of course, if you’re leveraged, like what you were talking about here, then if you start out with a 100,000 invested, and 20 of that is borrowed money, and 80 of it is money that you put in, well, suddenly that drops down to a $50,000 investment. Well, now you’ve got 50,000 invested, and 20 of that is borrowed. So, you’ve really gotten lopsided on the 80-20 rule.

Ed: Yes. When I visit with folks about– And how to suggest investments, I don’t manage anyone’s money, nor do we, but in identifying the risks and rewards, we do understand that the possibility of the upside is very significant, but the downside is likewise even more significant. When you put together the rule of 72 in the rule of 80-20, you realize that it applies to every listener of this podcast. Irrespective of age. That is to say, let’s assume your age 80. Well, you’re investing perhaps not for yourself, but for your descendants. If you use that same theory, that why would I go to debt that is fixed income securities, I would continue to have my 80-20 rule available for my descendants. That’s the process should be replicated. Irrespective of your age, this rule applies. These rules apply. Chuck, any contra views on that?

Chuck: No. I mean, I do think that that’s something that sometimes people find quite jarring. The suggestion that as you prepare for your own demise, that one of the things you don’t do is try to get rid of all your debts. That’s contrary to popular opinion, to be telling people that. That they should hold on to those debts, and maintain a leverage position, which is exactly what you’re suggesting. In fact, I know that in our practices, that’s something that we deliberately create for tax reasons, and also just for performance reasons for a lot of clients. That in fact, there’s really no magic to this, to this idea of paying off all of your debts by a certain age or before you pass away or whatever, that the key is, do you have the assets that those debts can be paid off upon the need? But then don’t create an artificial need to retire that debt.

Ed: You got to get your head around the issue of carrying debt. Some folks want no debt on their house and want no debt at all. Going short with, for example, Treasury bills, one-month Treasury bills. Well, that’s interesting, but where are your concerns and where are your fears? Remember, it’s a game, and unless you’re able, psychologically able to handle a nominal amount of debt, and I’m not suggesting go to 90% debt and 10% equity or 80-20, reversing it, but I am suggesting that debt is an extremely important part of your portfolio, and get yourself psychologically ready for that. You don’t start with 100,000 debt, maybe a thousand, maybe 5,000, maybe 10,000, and someday you’ll get up to a million or two million or 10 million. Again, reaching that level, it is nothing more than a game. You’re not going to take it with you. Last time, I learned there are no pockets in shrouds, and there’s no other opportunities. People are trying. I’m trying, but I’m not sure if you are very successful, that gets another issue.

Chuck: Well, let me just jump in and say, before you move on, that combining these two rules of thumb here. One is kind of a mathematical principle, the rule of 72, and combining that with really what amounts to Ed’s advice, which is this 80-20 rule. Going back to the very first point you made, if you look at the average rate of return over inflation of 6.5%, that you get on an investment portfolio, this is in the equity market. So, apply the rule of 72 to that. What that tells you is that it takes over 11 years, between 11 years and 12 years, for your investment to double after accounting for inflation. Now, you take that same investment, let’s say 20% of that is borrowed money. How long now, does it take for that investment to double? The answer is, you go from over 11 years to under nine years for the investment to double. You might say, “Well, gosh, that’s only the savings of a couple of years.” This really shouldn’t surprise you, it’s a 20% acceleration, effectively in how quickly you’re able to grow your money.

Ed: You make it 50-50, you talk about a 50% acceleration.

Chuck: Right. The more you borrow, the more you’re going to see that acceleration, but I think the key here, and the reason why I think this is a particularly good rule of thumb, is because people will experience losses over the short term because of these fluctuations. So, if you have your investment drop in half in any particular year, if you start out with– That you’ve applied this 80-20 rule, what you end up with is now the percentage of your investment that is funded through borrowing is no longer 20%, it’s 40%. Which means you’ve still got a nice cushion before you’re going to experience any margin calls. Meaning, the way most of these custodian’s work is that if your debt exceeds 50% of the balance of an account, they’re going to start forcing you to sell assets in order to pay down that debt. If you stick with this 80-20 rule, what that means is you can ride out some of the roughest patches that the market is going to throw at you. Versus if you try to be more aggressive about this, you’re in a bad market. Suddenly, you’re going to find yourself being forced to sell assets, and in the course of selling those assets, you may be incurring extra taxes. Again, why pay a tax that you can avoid? This is a good rule of thumb, even though it tends to be a fairly– Even though the first lesson that someone might pick up from this is, “Hey, why only 20%? Why don’t I go with 50%?” There is your answer.

Ed: Now, before we leave the 80-20 rule, I want to extend that not just in investment, but your everyday life. I will suggest to you that you will spend 80% of your time on 20% of your problems. If you’re an employer with multiple employees, you will spend 80% of your time on 20% of your employees. In your day job, you’ll spend 80% of your job time on 20% of your problems. That’s just the way it works. I wish I could understand why, except that that’s proven to be the case. Now, in terms of the accumulation process, before we turn to the issues of inflation and friction costs, I want to give you some numbers here. Let’s assume that you have $10,000, and you could set it aside, and you make 8% of that, and leave it alone for 20 years. So, that $10,000 will grow to $46,600. That’s a lump sum, $10,000 invested. If you invest $10,000 per year, over 20 years, that will result in $457,600. Combining those two, you started with 10, and you’ve added 10 per year over 20 years. The sum, after 20 years, is over $500,000. 504,200. Having said that, then this gets two issues. Number one, long-term investing. Number two, the magic of compound interest. I believe it was Warren Buffett that suggested, when asked, “Warren, why your success? Why do you experience this enormous success?” He said, “Two reasons. I’m living a long time in the magic of compound interest.” This is not rocket scientist information. This is basic logic. Having said that, Chuck, let’s address the issue of friction cost and inflation.

Chuck: Yes, I think it’s really critical for people to understand the amount that these various– I think friction cost is a good way of the general category here. These things that weigh down on the performance of your investing in your investments. The first of these is something we’ve already touched on, which is inflation. It’s really– Everybody has an understanding of what inflation is, but I think mathematically, the way that plays out, is something that people very easily ignore. Particularly when they’re trying to plan what is going to happen in their future. This is a confusing exercise when you sit down with, for instance, your typical experience sitting down with a financial advisor. They will give you, typically, some type of projection. Quite often you see this in looking through rose-colored glasses, where they’ll be pitching something where they’re projecting a 10% annual rate of return or a 12% annual rate of return or something like that. Then they’ll give you some numbers just very similar to the ones you’ve just gone through here, Ed, where they talk about how much money you’ll have 20 years in the future or 30 years in the future, and it will be some astronomical sum. That number, the further out in the future that number is representing, the less meaningful it is because you’re not thinking about– Your mind is going to think about that as if it’s in today’s dollars, when in actuality, you’re talking about– Those dollars will not go as far as 30 years from now as they will today. I think it’s always good to think about investment returns and think about what’s going to happen in terms of growth net of inflation because the impact of inflation is, essentially, it’s just like, you can just think of it like any other cost on your investment. It’s eroding all the time. Now, where this is really important is when people make comments like, I hear this comment all the time of, “I’m more interested in the return of my money than the return on my money.” That quote has been attributed to various people. I’m not sure exactly who was the first to say it, but I’m not sure how exactly, most of the time when people are saying that, they’re expressing that as a basis for their decision to not invest in something aggressive, but instead, to put their money in a bank account or something like that. They have completely disregarded the effect of inflation when they make a comment like that because typically, those very conservative investments are not keeping up with inflation. In fact, you will not get the return of your money if what you do is you stuff cash in a mattress or you put it in a regular bank savings account or a CD. The rates that we’ve seen in the last decade or so, those simply are not keeping up with the effect of inflation. You have to be putting your investment somewhere where you will achieve a rate of return that, again, we’re talking about overtime, will beat inflation. Otherwise, you’re not really making an investment at all.

Ed: You leave money in your checking account, you’re losing money.

Chuck: Yes, exactly. If you tell someone that, they roll their eyes and they act like you’re getting cute with them, but the truth of the matter is, that’s every bit as much losing money as if there was a– If the rate of inflation is 2.5%, you’re losing money by leaving it in your checking account, and every bit is real sense as if there was a 2.5% fee being charged against that account each year.

Ed: We’ll get into fees, costs, and expenses, but the other side of this is assessing your risk. I must tell you, over the 50 plus years that I’ve engaged in this day job, the variations and personalities are amazing. It wouldn’t surprise me to have businesspeople who are accustomed to take risk of $300,000 or $400,000 in a checking account.

Chuck: More than that, I’ll see that working with families that primarily invest in farm ground. It’s not unusual for them to have a million dollars sitting in cash in some bank account. When you ask them why, they, “Well, I might need it.” Is the answer.

Ed: I’d like to say there are typically older clients that have been the subject of catastrophic losses. Their ancestor went through the 29 debacle and lost everything. They cannot forget that. Even some younger professionals. “Hey, let’s think about putting more money.” “Nope, I want cash.” It is a strange phenomenon. It works against you in terms of your investing. Investment horizons.

Chuck: Right. I think that the critical point here is that you really need to think about inflation. Not as this abstract economic concept that affects your purchasing power year to year or requires your income to adjust each year, or that sort of thing, but when you have your investment hat on, you need to think of inflation. Put it in the same category as a fee or expense. One, you can’t control this. You can’t shop around for lower inflation. What you can do is you can look for investments, places to hold your money, that have at least a chance of outperforming inflation. Otherwise, you really do need to get in the mindset that doing anything other than that is in fact, losing money. You could have a good reason to want to lose that money, but you need to at least face the music and realize that you are in fact losing money, if you’re being too conservative.

Ed: How do you determine inflation? I’ve got this car, by the increase in the cost of the car. You can measure investment performance fees, but you can’t measure inflation.

Chuck: No, you can’t, but what you can do is, this is something that is very vigorously discussed and also regulated. Many people who are above a certain age especially, have vivid recollection of the 1970s when there was extremely high inflation. They’re worried that inflation is going to, at any moment, you could see inflation rates that take off and end up 8, 9, 10%. They view this as some kind of an animal that they just can’t possibly predict. The truth of the matter is that post that inflationary period, there were significant policy shifts in the way the Federal Reserve behaved. One of the primary purposes of the Federal Reserve is to respond to and prevent the acceleration of inflation. They have a target inflation rate. They call it the target inflation rate. Effectively, for the past couple of decades, at least, it’s been treated like it is a maximum allowed inflation rate. That’s anywhere between 2.5 to 3%. What that means is that you can predict that inflation is going to be somewhere below 3%, and somewhere above 1.5%. Really, that’s a pretty reliable prediction as you move forward.

Ed: Unless you’re getting more than a 2%– In the middle or 2%, rate of return, you’re losing money.

Chuck: That’s exactly right.

Ed: When measuring your investment performance, you always think about, “Is this fair?” You always think about, “I’ve got to get at least 2% or I’m losing money.” Then on top of that, determine the friction costs. I’m talking about advisor costs, commissions, and whatever.

Chuck: Right, and tax. Yes.

Ed: Let’s talk about tax.

Chuck: Yes. We had, in previous episode of the podcast, about the importance of tax, but there again, it’s something that you need to address or think about when you’re thinking about the various ways of investing. Because, in the examples that you gave earlier, Ed, when you talk about if you invest 10,000 now, in 20 years, that will grow to $46,600. That calculation is based on the assumption that all of the investment return that’s created by that investment is reinvested and has the opportunity to compound. Yes, let’s say you have a 30% tax rate on that, instead of an 8% return, you’re really having 70% of 8%. So, let’s say about a 6.5% rate of return on that investment instead. That’s what’s truly growing for you because part of that’s being bled off each year. There are options, in the marketplace, for investments that you can– This is something you can control, to some extent. You can invest in things that grow tax-free. You can invest in vehicles that where the entire vehicle at least has the deferment of tax. You can invest in investments where the rate of tax is lower. This is something that you need to think about, not it as an annoyance, but as something that really does impact the outcome of what’s going to happen to the growth of an investment over the long period of time that you plan to stay in the market.

Ed: Chuck, commissions fees.

Chuck: Same thing. Here, it’s very interesting. The investment world is one of the very few places in the economy where you can say almost with 100% certainty that the higher price you pay for a service, the lower the quality of the service.

Ed: That sounds like an upside-down observation. Could you expand on that?

Chuck: Yes, because if you think about what you’re purchasing when you pay for investment advice or investment management, what you’re really buying there, or what you really should be focused on in making that purchase is providing you with a return on your investment. To the extent you’re paying a fee against that, that fee is a direct drag on the ability to get that return on your investment. It’s just like a tax. It’s just like inflation. It just reduces the performance of the investment.

Ed: Actually, doing nothing, and oftentimes, that fee is not really disclosed because it’s not coming out of your pocket. It’s coming out of the subject investment.

Chuck: That’s exactly right. There are certain types of investments where that is absolutely opaque. For instance, if you are investing in something that you– Well, I listened to what Chuck said before. He said, “I need to invest in something where I can defer paying tax, so I know what I’m going to do. I’m going to put my money in this deferred annuity.”

Ed: Single-premium deferred annuity.

Chuck: Single-premium deferred annuity. Right. The way that works, for people who aren’t familiar with it, is let’s say you have $100,000 to invest. You hand that money over to an insurance company, and they hold onto it for you over a period of 10 years or 20 years or 30 years or whatever, and then, at the end of that period, they pay that money out to you either as a lump sum or as a series of payments. Typically, it says a series of payments when that money comes out. They provide you with some type of guaranteed return, but typically, there’s also some feature of this contract that will allow that return to go up or down based on what happens in certain market.

Ed: Maybe an insurance feature.

Chuck: Yes, maybe a life insurance feature or whatever. This is an example where you really have no way of knowing, going into that contract, unless you have a great deal of comfort doing your very own mathematical calculations. Unless you’re willing to spend a great deal of time really analyzing all of the numbers that are presented to you, you have very little opportunity to understand what fees are being charged.

Ed: More specifically, we just saw a single-premium deferred annuity with all kinds of bells and whistles.

Chuck: It was amazing. It had every bell and whistle.

Ed: I couldn’t believe it. What are the commissions? Well, the management fee was 150 basis points.

Chuck: Right. 1.5%.

Ed: Which is outlandish. There was an exit charge, if you prematurely terminated over first seven years. There were built in loads. I couldn’t believe it.

Chuck: Well, and those are the disclosed fees. This is the thing that I always find excruciating about these insurance contracts, is that there’s fees that are disclosed, like the ones you’ve just described, but then the entire contract has some– There are additional charges and additional profits that are taken out of that by the insurance company, that you as the investor are just never told about. There are always these hidden charges as well. As far as I can tell, that’s true for virtually every insurance product, and when you’re talking about life insurance products, and by that I’m talking about life insurance and annuities. In my mind, those are both essentially life insurance products. What they offer you is, depending on the structure of the contract, various ways of deferring tax and potentially avoiding income tax all together in the case of life insurance. The trade-off there is that you’re never quite sure how much you’re paying in fees. Whether it’s tax or it’s a fee-

Ed: Or inflation.

Chuck: – or inflation, all of these things are friction costs, and I think it’s important, as an investor, to understand, to actually have– You can’t avoid them all. There’s always going to be a trade-off where you’re always going to be paying some kind of a tax or some type of a fee. There’s ways of getting these things very, very low, but getting rid of them completely is essentially impossible in the real world, which is why it’s important to understand what it is you’re incurring, in exchange for what you’re avoiding. Mathematically, they all do the same thing, which is that they prevent your investment from compounding as effectively as it does in the pure mathematical case.

Ed: I look at a couple observations that I want to share with you and challenge me in all of them if you care to. One, if it’s too complicated to understand, don’t do it. In other words, in a single premium annuity, if you can’t assess those costs, don’t invest. Unless you can explain it to a seventh grader, don’t do it. Second, these annuities prey on fear. I see a lot of folks that are residents in no tax states that are a little older, retired, and Mr. Slick will sell them these single premium annuities as a guarantee. You’re putting the risk of all these things on the shoulders of the insurance company, which is the worst possible investment for these folks. They prey upon fear. How do you hedge against a calamity? I’ve heard that estimate. “I’d like to hedge against a calamity.” “What’s the calamity?” “Well, the world coming to the end.” “We can’t hedge against the world coming to an end.” You want to hedge against a risk. You want to transfer risk. You want to not believe the person that tells you that, “Look, I for– If you just trust me, I can show you how I can make cows fly.” When someone tells you they can make a cow fly, what about a squirrel? Can you make a squirrel fly? How do you hedge against a calamity?

Chuck: Well, yes. You do hear that question from time to time. I always find myself having to test that assumption in the conversation because one person’s definition of a calamity might mean something very different than another person’s definition of calamity. If you’re really talking about, we’re headed towards a Mad Max type world, which some people are actually worried about that, the answer is, well, then, you want to hedge against that, then stockpile water, right? Quite often, people are talking about something that’s more like an economic calamity. Those folks tend to be very interested in gold as a hedge or as a– The one thing I can say about gold, even though I typically think that it ends up not being a good long term strategy for people who are really trying to accumulate wealth, is that it does hold its value. You know this thing we were talking about, the very first of the friction costs, inflation, if you’re interested in the return of your money without regard to the return on your money, then gold is kind of your dictionary definition of how you achieve that. You’ll get out of gold, essentially, what you put into it, plus inflation, and nothing more. It’s kind of like cash that adjust for inflation, in that sense. I think that our listeners should be people who are not interested in simply treading water but are interested in building wealth. If you’re interested in building wealth, then you can’t do that and constantly be looking over your shoulders and worrying about the next apocalypse. What you need to be able to do, is you need to be able to take a long-term approach towards investing. That means that if there is a calamity in the next three years or five years or 10 years, no matter how severe that is, that your investment horizon involves not just the calamity itself, but the recovery from the calamity. So that by the end of your investment horizon, you’re back to having performance that is in line with these long-term average rates of return that we’ve been talking about. If you really do believe that 40 years from now or 50 years from now, we’ll have a calamity that you’re able to predict today, that we will still have not recovered from by then, then long term wealth accumulation is probably not for you, just to be perfectly honest, Ed.

Ed: That’s okay.

Chuck: Right.

Ed: This approach, the 80-20 rule, the rule of 72, the systematic investing tax, this friction, is not for everyone. By the way, you’re not to be criticized or denigrated or not respected because that’s your view. Everyone has a different story, and everyone has a different view. All we’re saying, I think, is look behind what’s being told to you.

Chuck: Yes, and specifically, in this conversation, I think what we’re talking about is that when you’re interested in– This particular episode is about sort of the basics of the investment podcast, and you notice we’re not really spending any time at all talking about what investments constitute great investments and what investments constitute poor investments, and how to maximize performance. What we’re talking about is the cumulative effect of these friction costs. Inflation, tax, commissions and fees. Particularly on that last one, the extent that there are commissions and fees that get buried in complicated, heavily marketed products, and how significantly those friction costs can weigh on the final outcome of a long-term strategy. I think that the important takeaway here, Ed, is that when you’re thinking long term, rather than looking for that one stock, or that one company, or this great hedge fund, or this private equity company that’s going to make you a gazillion dollars because they’ve unlocked the secrets to great performance that’s going to make you a millionaire overnight. Lesson number one is, understand your friction cost and control them. Then, once you have a firm understanding of those, you’re ready to start thinking about particular investments that you’re making.

Ed: I think of the rule of advertising, and I’ve said this before, and that is, if it’s heavily advertised and its food, don’t eat it. If it’s a service, it’s heavily advertised, and the individuals populate themselves in “Positions of grandeur or respect in the community” don’t use that individual. In other words, if it’s advertised, you must look at it through, not rose-colored glasses, that these people cannot make cows or squirrels fly. They can, and we’ll get to the question of friction cost in a later podcast. Look behind what you hear, and make sure you do not treat your adviser as a friend. If you want a friend, get a dog. An individual who is supposed to educate you on what your risks and rewards are.

Chuck: Yes. All that marketing, every bit of marketing that you see, costs money. That money is coming from investors like you.

Ed: Yes. The greater the amount of the marketing, the fact is the worse the investment.

Chuck: Well, that is not just an aphorism. This goes back to a point that I touched on earlier, which is that these fees, this is just a very real mathematical fact. The more you pay in fees for investment management services, the worst your portfolio will perform. You just can’t escape the fact that those fees are a drag on performance. I know that the sales pitch that’s out there is that a good manager or a good investment adviser is going to tweak performance to such a significant extent that the fees will essentially pay for themselves. There might be one or two people out there somewhere in the United States that actually have managed to do that over the long term.

Ed: A long-term. More than five years? I don’t think even those people do well over more than five years.

Chuck: Well, for instance, there’s a mutual fund, the Fidelity Contrafund, is a mutual fund that involves active management. Their fees aren’t huge, but it’s not an index fund. Their fees are reasonable fees for an actively managed mutual fund. The last time I checked that, Fidelity Contrafund did outperform the broader equity market nine out of the last 10 years. Over the 10-year period, outperformed the market over that 10-year period. That’s a pretty good example of an active manager that actually has managed to create value that exceeded the fees that were charged by the manager. What I’m saying is that that’s just extraordinarily rare. You don’t necessarily know, going in, that that’s what you’re going to get. The surest thing to do is to look for the fees that are as minimal as possible.

Ed: One of the issues that I face all the time is that, how do you simplify investing while the stock market– My rule of thumb is, I look at the gross domestic product, and to the extent we have an increase in the GDP, we have an increase in the stock market. If you are confident that under this economic system, our system here in the US, we have constant increases in the gross domestic product. We don’t really have increase in the stock market. The idea is to find someone who’s going to outperform the increases in the gross domestic product. Rare, over 30-year period, unusual, over a 10-year period, but almost impossible over a longer period.

Chuck: Well, I would edit that comment a little bit, Ed, because I think that the key is, if someone is claiming that they will outperform the market, they need to outperform the market by a buffer that is larger than whatever fee that they’re charging.

Ed: Yes.

Chuck: Otherwise, there’s really no point in outperforming the market if the fee for doing so exceeds the outperformance. You’re losing money versus the market in that particular scenario. I think what is quite often the case, when you talk about some of these investment managers that are charging– We see this, where there are some firms that will charge 1.5% or 2% per year, to manage investments. I don’t care how good you are, that’s impossible. That example I gave you earlier with the Fidelity Contrafund, we’re talking about fees that are under 1%. They’ve managed to pull it off over the long term, but they didn’t give themselves a very high hurdle to clear with the way they set their fee structure. Someone who comes into this conversation saying, “Well, I’m going to charge you 1.5%, or 2%, or 2.5%, or it’s going to be 1.5% plus 10% of your investment gains,” they will never clear that hurdle over the long term. They might get away with it for a year or two, but it’s just impossible. That, I think is, going back to this comment about making squirrels fly, someone who claims that they can do that consistently year over year, is in fact telling you that they’re going to make squirrels fly. You need to treat that the same way.

Ed: Well, squirrels may be okay, but cows, I’m just not sure they could do cows. Before we terminate today’s podcast, I wanted just to allude to, how do you manage your affairs, so you’ll feel good about where this is going? I get to that as periodic self-reporting. You should be updating, as of the end of each month or quarter, at least, or some annually, your pre-tax balance sheet. Showing assets and liabilities. Hopefully, on a spreadsheet. Then you do cash flow projections. How much money is coming in, how much money is going out, and what’s the tax? The idea is, the beginning of the year, you do these projections, and you update them every quarter or semi-annually, and see where you’re going. So, you have a little bit of comfort, you know where you are. Finally, a little more sophisticated, if you’re going to leverage, you make sure that the dividends that are being received, with respects to the investments that you’re making in the stock market, cover the 20% of the debt. In other words, after you apply dividends against interest, you are positive and not negative. Then you can carry that investment over a long period of time. Chuck, in a way of a summary of today’s podcast, we’ve discuss the investment process, the 200-year history of the stock market, rule 72, 80-20 rule, what total returns are, in friction costs, inflation, and more specifically, commissions and fees within the friction costs. Don’t think you can make squirrels or cows fly. That’s not going to happen, mathematically, and finally, periodic self-reporting. Make sure you engage in the process of educating yourself as to where you are and where you’re going. Don’t rely upon a computer program published by your best friend. Look at everything on your own and read and get a little educated on some of the basics. Chuck, anything you want to add.

Chuck: No, I don’t. Although I will say that I just looked up, because I’ve mentioned this fund a couple of times, to make sure that I was accurate in everything I said here. This Fidelity Contrafund, if you look at 2009, 2010, 2012, ’13, ’15, ’17, ’18, and so far in 2019 it, in each of those years, has outperformed the S&P 500. It wasn’t quite nine out of 10 years because in 2011 and 2014, in addition to 2016, it underperformed. That’s three out of 10 that it underperformed. That’s probably about as good as you’re going to see when you talk about an active manager.

Ed: We’ll get into that under successive podcasts. Especially, we talk about, why do taxes matter? We’ll blend that in, and taxes are one of the friction costs we’ve described.

Chuck: Right, exactly.

Ed: Okay, talk to you next time.

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