How Should You React to Market Adversity? | Brandon Averill, Justin Dyer | AWM Insights #105
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Episode Summary
Easy answer: Stay in your seat! If you are contemplating making a change, your financial plan is severely lacking. Now is not the time to adjust your plan. Any solid philosophy already has the game plan in place and is positioned for this adversity. Preparing for times like this is the most important part of your disciplined strategy to win the game.
Stock and bond markets can and do go down together. This is normal and uncertainty in risk assets is a constant. It is the price we must pay for higher expected returns. If there was no chance to lose money, you would not be compensated for taking the risk.
In this week’s episode, Brandon and Justin discuss the unsettling headlines in mainstream financial media, why they shouldn’t make you nervous, and how to set your financial plan to weather turbulent markets.
Have questions for an upcoming episode? Want to get free resources, book giveaways, and AWM gear? Want to hear about when we release new episodes? Text “insights” or the lightbulb emoji (💡) to Brandon at (602) 704-5574 to join our new AWM Insights Network. On an iPhone? Click HERE to join.
Episode Highlights
(0:32) Brandon and Justin discuss stock picking and marketing timing. Is active or passive investing winning?
(1:44) Active investors are trying to beat a benchmark. The most common benchmark is the S&P 500 Index.
(2:06) An index is a defined collection of stocks. The Dow Jones Industrial Average has been around for over 100 years.
(3:20) Active Management is commonly compared to these indexes to determine if the cost of research and implementation is worth the return.
(3:50) You can’t actually buy an index itself but you can buy funds that very closely track its return. Plus, they have cheap fees.
(5:20) Dispelling the myths of stock picking.
(5:45) Active managers believe they can read the tea leaves and predict what’s going to happen. They also overweight or underweight sectors to “beat the market”.
(6:25) The evidence every year shows it’s impossible to beat the market consistently.
(7:09) SPIVA stands for Standard & Poor Index Versus Active report.
(7:30) The report compares the many S&P benchmarks to the actively managed funds and identifies which ones outperformed and which underperformed.
(8:50) 85% of active managers underperformed the S&P 500 over the last year.
(10:35) Can you find the small percentage of managers that do outperform?
(11:40) You can find better odds of winning than the 10 or 15% chance of picking the next outperforming active manager. You can get close to 50/50 in Vegas.
(12:20) If for some reason you decided to try to identify which fund will outperform in the future, what are the characteristics to identify?
(13:28) Taxes are frictional costs that drag on investor returns, and do not show up in these numbers. These hurdles also hurt investors' gains.
(14:22) The powerful takeaway: If you’re smart enough to take in the data. You can have a perspective change which will help you avoid the silly game of attempting to outperform the S&P 500.
(15:22) The amount of intelligent people with virtually unlimited resources is the reason the indexes are so hard to beat. This competition is what creates this efficient market which is a plus for investors that listen to the data.
(15:53) If stock-picking isn’t the right way to beat markets, should you just buy an index fund or is there another way to find outperformance?
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Justin Dyer: LinkedIn
Brandon Averill: LinkedIn
+ Read the Transcript
Brandon Averill (00:03): Well, Justin, welcome back. We got first podcast in the new office, so get the technical difficulties out of the way. Just warning everybody, if we've got a little noise vibration, that's what we're dealing with here. But it's the end of the quarter. Figured we might take a little deviation from our consistent theme here of trying to walk through some of the investing fundamentals and tune into what happened in this past quarter. There's definitely some headlines that are out there. We just thought we'd address them for all the listeners here, talk a little bit about how we think about things, and how to go through it.
Brandon Averill (00:42): We saw January, US stocks were at all-time highs, things were just looking unbelievable, and then unfortunately, we've had a slump since then, and ended up with negative returns pretty much across the board in the first quarter. We've looked at this and investors, there's all these worrisome headlines that are just dominating the news channels right now. The talking heads are probably loving this because ratings are through the roof, but we've seen things like Inflation's Hitting the Fastest Clips Since 1982, Giant Stock Swings Send Some into Bear Territory, The Fed's Set to Start Increasing Rates in Mid-March, that came out in late January.
Brandon Averill (01:32): We start to see all these headlines, Justin, and then we start to see the returns behind it, that we did have a rough quarter. We start to wonder, at least it's now natural to start to wonder, "Hey, if inflation is printing this high, is that negative for me as an investor? How do I combat that? Should I combat that? Stocks are down. Should I just be throwing the baby out with the bathwater? Should I sell out? Should I change up my portfolio?" I think most people probably know what our answer's going to be, but maybe give us a little color on when we start to see these things pop up, and these aren't totally crazy headlines that are worries we shouldn't be worrying about, they do take some planning, so I'd just love for maybe you to comment through on, hey, given the current environment and what's happening, I mean, what should we be doing, if anything?
Justin Dyer (02:28): It's a layup of a question, man. In all seriousness, I want to start with a pretty easy answer to that question, which is if you're reacting to this, or your philosophy is such that a little bit of market adversity causes you to change your entire game plan when it comes to your portfolio, your investments, you weren't doing it right to begin with. Any solid philosophy should have a plan in place to deal with adversity, just full stop, and when that adversity hits, because it will hit, you can't all of a sudden change that plan because you become uncomfortable, or because the talking heads online are saying something new. It is the time and place to be disciplined for that plan, for that practice to really take hold.
Justin Dyer (03:33): Honestly, this is where the bulk of value can be gleaned over the long term if you "stay in your seat." I was actually at a conference earlier this week and there is a guy who had a presentation literally called that, Stay in Your Seat, because if you look at the long term, markets climb a wall of worry. I mean, Brandon, you hit on a couple of things that have been going on in this first quarter. There's this is kind of a little microcosm of what I'm talking about here. Clearly, markets have pulled back a little bit from, from their all-time highs over the first quarter, down mid-single digits, really across the board, whether that's in the US, developed, international, emerging markets, real estate, and even fixed income, because as we've heard, inflation's higher, interest rates have spiked, and that's been a headwind for a lot of markets.
Justin Dyer (04:29): But that is normal. This is part of the expected game of investing, if you will, the uncertainty that just exists, the volatility that we know happens within markets is why you expect a healthy rate of return over the long term. You are putting your capital at risk. All of these buzzwords that we might hit on or that you might read in the financial press about uncertainty, capital at risk, et cetera, et cetera, these are the periods of time, while difficult potentially to see some of these numbers, you never want to see negative numbers, but it's why we expect positive returns above inflation, positive returns above a treasury bond, whatever it may be. It's why there's a reward for long-term investing and equity or risky-type assets.
Justin Dyer (05:29): Let's start there, or really, you can start and kind of end there. I mean, it is truly the answer. You want to have a plan in place that acknowledges, hey, on a daily it's roughly a flip of a coin. It's slightly positive that markets will be positive on any given day. Fast forward that to a month. It, it becomes roughly two-thirds positive, one-third... Or excuse, not two-thirds, in that ballpark, between two-thirds and three-quarters positive and one-third and one-quarter negative. Then you extrapolate that over to an annual basis. We get a little bit more certainty that most years are positive, but there's a very real chance that a given month or a given quarter, or even a given year is going to experience a negative return, and this most recent quarter is no different.
Brandon Averill (06:27): Yeah, I think that's a good point, Justin. I mean, it's no secret, right? We're talking about it. We had a tougher quarter, a tougher 90 days. It's natural. Like we talked about, it's natural to start to get a little worried, to at least start to question, "Hey, am I doing the right thing?" Like you said, I mean, even with this last 90 days taken to account, you start to look at the one-year returns, right? The one-year returns are across the market pretty much positive. When you go out to five years, they're positive across the stock market and the bond market 10 years, again, it's even more positive, so you start to look at this extrapolation. Let's think about all the things that have happened in the last 10 years, right, all the things that we've had, COVID, we've had ups and downs geopolitically, we've had an invasion of Ukraine. There are a million things that have happened over the last 10 years, and yet if we would've just stayed the course, reduced that noise, we'd have a positive outcome.
Brandon Averill (07:36): The other question I often get from clients or people that I'm talking to is, "Oh, that's well and good, but what if we would've actually timed this thing right?" Let's go to the timing deal, right? If we look at the evidence there, or lack of evidence, but let's trick ourselves into thinking that there's some evidence that we actually could. I thought there was a good stat, and we were talking about this before we started, Justin, there was a study done, a perfect timing strategy. This was done from 1972 through December of 2021. It was if you had $1,000, and I think they called him Perfect Tommy, picked every single perfect time to move in and out of the market, that $1,000 over that period, would've grown to 1.8 million. Absolutely astonishing, right, if you were able to pull that off.
Brandon Averill (08:35): The flip side, though, is if you were absolutely awful at pick the timing there, you'd have ended up with $949, so we've got a pretty big deviation. We know that people can't be perfect. People probably aren't going to get it absolutely wrong, but do you want to have a stream of outcomes in that scenario? No, I don't think that's anybody would want that. I think there are just things that pop up, right? There are events that we cannot foresee. I don't care who you are. Nobody has that crystal ball to look for certain events. When those big events happen, it's typically the ones that just wash everybody out. When we look at the evidence, it time and time again tells us that you cannot continue to time the market.
Brandon Averill (09:24): I think this is even more evidenced by there is a segment of people out there that do believe they can move in and out of things that are called "tactical asset allocators" and Morningstar recently did a report on these managers to figure out, hey, maybe there are some indicators that we can move to bonds or move to cash or move to equities at different times and actually create some alpha or some benefit for our investors. Unfortunately, the of data just doesn't support it. What we saw is over the three-years timeframe, this is ending August of 2021, over three years, those people cost their investors 2.13% per year. You go out five years, they cost them 1.5% per year, and you go out 10 years, that 10-year mark that we've been hitting on, they cost their investors 2.75% per year. That is astonishing. On top of that, you're probably paying these people a lot of money to do that.
Brandon Averill (10:30): Anyways, I know I went on a little bit of a rant there, but I think at the end of the day, you hit on the head, you got to a plan, and if you have the right plan, you can start to deal with some of these maybe inflation or rising rate impacts.
Justin Dyer (10:43): Right. I want to dig into that a little bit, too. How should we think about that, given the current set of circumstances that we're experiencing? Inflation probably being the one that's potentially top of mind, maybe the Ukraine war, geopolitical events.
Justin Dyer (11:01): But let's start with inflation, that's been a hot topic for some time now. If you go and look at the data, there's two ways to think about it. Do you want to outpace inflation, or do you just want to protect, or hedge yourself from against unexpected inflation? Most investments will keep up with expected inflation over long periods of time. When we experience periods of unexpected inflation, I'm really emphasizing that, because that's essentially what happened right now. All of a sudden, some people telegraphed it, some people thought, "Oh, the system is awash with money and whatnot. We should expect inflation." No one can necessarily, again, predict that future time and time again, but we're experiencing inflation right now. It was unexpected by the market is how to think about it in this context.
Justin Dyer (11:59): The way we think about that is there are certain priorities that are unique to each and every individual that are incredibly important to make sure at a minimum, we keep up with inflation, unexpected inflation, again, making sure we hit on the difference there. These are important needs over the relatively short period of time, intermediate period of time. "Hey, we need $10,000 a month to live on for the next 10, 15, 20 years." We don't really want to take a bunch of risk with that and put that type of money into equity markets, but we still want to make sure that is hedged to keep up with unexpected inflation, so there are tools out there in the market called "inflation-protected securities." TIPS is another term that you might hear. We build our portfolios based on your custom priorities and match those priorities in the value of them to an inflation-protected type portfolio.
Justin Dyer (13:05): Trying to keep things really high level here, but that's one way to think about that. That hedge is unexpected inflation and make sure you're purchasing power. Your ability to maintain that quality of life is protected for a relatively long period of time. Maybe it's shorter for you. Maybe it's longer for others, but again, just trying to keep it high level.
Justin Dyer (13:25): Then on the flip side, it's outpacing inflation. We've touched on this at various times throughout this podcast. One of the best ways to keep up with, or outpace inflation, excuse me, is in the equity market. It doesn't mean quarter over quarter, month over month, that there's going to be lockstep movement between the equity markets and what we see with the inflation data, doesn't mean that whatsoever. It means over long and periods of time, equities, stock outpace inflation quite handsomely for a lot of the reasons I touched on earlier, right? You are being rewarded for risking your capital for the uncertainty that exists to have these geopolitical events somewhat come out of left field, right?
Justin Dyer (14:12): That is just the playing field that exists. There are going to be future crises. Kind of by definition, that's the uncertainty that often comes up through the form of some sort of crisis, not always, but often, and kind of by definition, a crisis is called a crisis, because no one really thought about it beforehand, so it's inherently unpredictable. I think just trying to hopefully tie a bow on all this where we said, "Hey, having a plan beforehand, having a portfolio in place that deals with situations like we're seeing right now, that's critical," and then tying that to some tangible examples about how we actually think about that for you all as long-term investors.
Brandon Averill (14:59): Yeah. I think to get somewhat nuanced on that, Justin, I think this goes back to why you should have a very personalized plan, right, because if you don't have a personalized plan, some advisors throwing you into a 70/30 portfolio, 30% of your portfolio is tied to fixed income and bonds, for instance, and in a rising inflation environment, yeah, there's some protection there potentially, but if that portfolio, maybe that allocation to bonds is far too large, or essentially too small, but the point is that you're giving something up there. Let's say that you only need 20% for your priorities. Now, you have 10% that is getting eroded by that inflation when it should be in the stock market, it should be in portfolio growth to outpace that inflation rate.
Brandon Averill (15:51): I think it could certainly go to the flip side. I think the point here is having that plan, but making sure that it's also very, very customized to your priorities. I think this also, for those DYI or do-it-yourself investors out there that are listening to this potentially, I think that's also a question you got to ask yourself is really wrestle through those things and make sure that you're adjusting your portfolio and think about the difficulties of potentially doing that. I think that's certainly a great mark for why you would include an advisor, somebody that's paying attention to that on a very regular basis and helping you to work through those priorities.
Brandon Averill (16:34): We certainly have had a rougher quarter when you look at a return perspective, but we certainly encourage everybody to take a step back, look broader, look longer term, make sure you have that financial structure in place, because if you do, if you have that protective reserve, that essential spending prior, already allocation set aside, all of this is just noise, noise that you should be ignoring and not worrying about. This is just part of the process. It's you hit on it, Justin, it's why we get rewarded to be investors.
Brandon Averill (17:09): Some of the key takeaways, actionable things for you this week, tune out the noise. This is all noise. If you have the proper financial structure in place, which is key takeaway number two, look at your portfolio, make sure that it's matched up to your priorities. If it's not, pick up the phone, call your advisor. They're not mindreaders. Sometimes they need to be queued into things that have change in your life. Help them to make sure that it is tied to your priorities. Then the last thing is just rely on the evidence, so as you're looking at your portfolio, what's in there, think about what the evidence actually says rather than the sexy sales pitch. It's a heck of a lot easier for most people to sell the predictive model that gets to our croc brain, right, that we think we can outsmart things, but go back to the evidence. The evidence tells us to just have a plan, tune out the noise, and be diversified.
Brandon Averill (18:07): With that, we're going to close on for this week, but would love to hear from you. As you know, you can text me, comes directly to me, that number again is (602) 704-5574. If you shoot me a text, you include the light bulb emoji or the AWM Insights, we're going to be giving away some swag, as I've mentioned before, but would also love to get your questions via that avenue. We'd just love to hear from you be able to stay in touch. Again, that number is (602) 704-5574. Until next time, own your wealth, make an impact, and always be a pro.