The Logic Behind Your Stock Holdings | AWM Insights #145
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Episode Summary
Diversification is a key pillar of financial success.
Owning as many companies as you possibly can position your portfolio to pick up returns from generational performers, and increases your odds of not missing out on these best-in-class companies.
This concept makes its way into Global Markets as well. Maintaining exposure to different economies and regions with different industries increases your odds of success, and potentially can smooth out yearly returns.
The old adage of not putting all your eggs in one basket holds true here and usually leads to you having more eggs at the end of the day.
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Episode Highlights:
0:00 Intro
1:35 What do we look for while conducting research?
3:33 What is Global Market Capitalization and why do we use it as a starting point?
4:30 Diversification and why we still invest internationally during times of unrest.
5:58 Why do we use confidence in outcomes over any single arbitrary figure?
6:45 Why do we slightly overweight Domestic Companies and have a home bias?
7:56 What do active managers think about their funds and how do they invest their own money?
9:31 Pros of Passive investing over Active management.
11:09 General Structure of our implementation.
12:31 Text us
+ Read the Transcript
Brandon Averill (00:02): All right, we're back, Justin. Another episode here of AWM Insights. We're going to continue our trend, get a little deeper here and just talk a little bit. We're going to, I guess, hone in and talk a little bit more about how we actually build the equity, the stock ownership, however you want to call it, side of a portfolio for clients that are listening. I think it's an interesting time for the topic to come up and revisit. There's no shortage of news out there right now.
Justin Dyer (00:32): There never is.
Brandon Averill (00:33): Yeah, the Fed's going. People are trying to interpret what all that means. You got Home Depot out there warning that we're going to have a slowdown in the economy, but then with the next comment, they're going to deploy an extra billion dollars to give raises to all the hourly workers. Just confusion out there. I think short term, it definitely supports our thesis and what the evidence shows that you can't predict markets, right? I think when we get into this systematic approach, how we actually build things, we're not relying on these pundits. I think Morgan Stanley just came out, and I always find these fascinating, but says the S&P 500 could drop 26% in months, not 25%.
Justin Dyer (01:13): 26, yeah.
Brandon Averill (01:14): Not 30, but 26. Very specific.
Justin Dyer (01:18): Very precise.
Brandon Averill (01:19): But I'd love for you to just start to dig in a little bit why we have so much confidence in a systematic approach to building the equity, the stock portfolio, and we don't have to adjust with this noise. We want to pay attention to it, but we don't need to adjust with it.
Justin Dyer (01:38): Yeah, well the quick, it won't necessarily be short answer, but we pay attention to what the data says. I find it amazing. I mean, your Morgan Stanley comment, how many people acknowledge that we can't predict the future and then yet they go ahead and try and predict the future. I mean, it's amazing how often that happens. So what we really try and do is have the discipline not to do that. How we do that is to look at what the data says. We have to add a layer of logic and make sure the data and what it's saying about what we're doing for the future, there is an element of, I guess I don't want to say predicting the future, but you're making a judgment call based on what has happened in the past and expect it to go forward, carry forward. So we do apply some sort of logical framework, if you will.
(02:29): But starting with the fact that diversification is one of the true "free lunches" out there, but relying on what the evidence says within that diversification application really gives us a lot of confidence in building out portfolios. We always say, "Hey, success is a client meeting their priorities." And then how do we build a portfolio that gives us the best confidence in doing so while it's relying on the evidence? Quite frankly or quite simply. To jump into, or revisit rather, even a point we touched on last time and then I'll pause is the starting point, the evidence that we use, the central data point, at least when it comes to public market stocks, public market equity allocation is global market capitalization. All that is for those of you who don't know that, the term market capitalization, it's quite simply the size of a particular public stock market.
(03:32): The US as a percentage of the entire world or the globe is around 60%. You can look at what emerging markets make up as a percentage of the entire global stock market or international develop, places like Europe, et cetera. We use that as a starting point to say, "Hey, this is a great measurement or proxy on how investors collectively around the world are allocating their capital." They're voting with their dollars in a certain proportion and that gives us global market cap.
Brandon Averill (04:04): No, I think that's a great point, great framework for how we systematically go about things. I think one of the questions I often get from clients that are probably listening right now is we're, I think, on the anniversary of the war in Ukraine and with Russia and why in the world would we want to invest globally when we know the US is such an economic engine? I thought this was a pretty helpful stat and we talk a lot about the lost decade. We've referenced that before. But even more recently, if we just look back at 2022 and we look what happened, the US stock market was down about a little over 21% and then you start to look at other markets, they were still down. But the UK where, if you ask a lot of people, the economy is not doing well in the UK was down only about 8.8%. And then you turn to Hong Kong and you're down 2.9%. And then even the emerging markets. Chile was up 8.9% and Turkey of all places gained half a percent.
Justin Dyer (05:12): That's a shocking statistic.
Brandon Averill (05:13): It is shocking. It's some good news for the Turkish with all that's happening over there. But I think the point is that we just don't know. We don't know in the short term. We know that if you diversify across these countries, it gives you a benefit over the long term. So taking a really systematic approach and not taking an active approach to trying to figure out... I mean who would've thought to put their money in Turkey last year? I mean, I would love to meet that person. I think you take a systematic approach and it all turns back to confidence and outcomes and that's what really matters at the end of the day.
(05:51): I think I saw on Yahoo Finances that one of the quotes is it takes three and a half million to retire. And I thought that's kind of interesting. But what was really interesting to me about that is that it wasn't like, "Hey, I need 15% returns to retire. I need 20% returns, I need 5% returns." It was a specific number based, I'm assuming, on some priorities that have been laid out. There's a stream of cash flow that people need. That's how we get to the three and a half. Now we know everybody is different and that's why we build customized portfolios. But it was just a good reemphasis of, "Hey, all of this is geared towards an outcome."
Justin Dyer (06:32): Yep, exactly. And within those statistics, it goes back to not predicting in the future. Now again, we're not blind or it's not like we just say, "Okay, let's take that number and then set it and forget it." We do have actually a home bias. We live here in the United States. We consume in US dollars. There is an attraction, call it a behavioral attraction, if you will, or psychological attraction to US markets. They've performed well. We're also very attuned to them how they're performing on a day by day basis. You hear about it on the news, you go to Bloomberg or Yahoo Finance, you'll see what the US stock market is doing. If you ask somebody what international or emerging markets has done year to date, chances are they don't know or don't have a feel for what's going on around there. So we do have a home bias even though we're starting with that global market capitalization, the starting point. But again, we're using a logical approach and a framework to build these portfolios to give us more staying power, more confidence in future outcomes.
Brandon Averill (07:42): I think when we start to think about this, 'Okay, great, Justin, Brandon, we've got this. I understand 60% of my portfolio is going to be allocated to the US, maybe a little bit more for that home bias, and then the rest is going to go international. Totally makes sense to me." But then from there, do we just take the passive approach? Do we buy these index funds? That's pretty nuanced. We won't go down a rabbit hole there. Or do we go active? I think most people probably know even the active managers are turning on themselves. There's a fantastic article that's circulated in the company this week written by Robin Powell. I think he calls himself the Evidence-Based Economist or something like that.
Justin Dyer (08:27): Yep, that's right.
Brandon Averill (08:28): But really fascinating guy. I encouraged anybody to go watch his videos or read his articles. But there was a great study on these active managers and it was pretty funny just to see these guys. Here's a quote from one of them. "I don't see any reason why this trend towards passive management won't continue. All of my own money is in index funds."
Justin Dyer (08:51): That's telling you something. Yeah.
Brandon Averill (08:52): Yeah. Hopefully clients that listen to this know that all of our money is invested in the exact same way theirs is. It just blows my mind that people still do that. But point being is that, okay, let's move over, and do we go passive or are there opportunities that we're still trying to outperform the market?
Justin Dyer (09:11): Great question. And there's some nuance to it. I mean, the place I'll start is that passive is a great solution and this isn't a black and white answer either, but passive is probably similar to global market cap, a great starting point for us. But then you look at the academic research, let's see what the evidence says. This is along those lines. Well, it acknowledges the fact that low trading costs, low expense ratios or overall cost of management make sense, which are all attributes of passive investing. You can favor part of a broad index and have a likelihood to outperform that index. Those are parts of the market like value companies, I know we've mentioned these, but it's worth repeating. Value versus growth companies. These are companies that are trading at a relative discount. Smaller companies versus large companies, companies that are more profitable than others. You favor those three categories and you have a higher expected return versus the index.
(10:17): You take, again, a lot of the attributes of the index, keep turnover low, keep trading costs low, keep overall expenses low and taxes as well. A lot of those variables feed into low taxes, but then by tilting, if you visualize an ice tray, kind of tilting it towards one direction and the water trickles down accordingly. That's how tilting to these various "factors" feels or is implemented in practice. And it gives us a confidence that you can still outperform. You get all the benefits of the index. It's like having your cake and eating it too, get a lot of the benefits of an index, but we still actually have an expectation that we're going to outperform.
Brandon Averill (10:59): I think that's a great framework. So just to revisit it, we're starting very much so with a global market cap. What are global markets actually worth? We're going to implement a small home bias there. So we're actually going to put more of that money in your portfolio into the US. And then when we go to actually implement, we're going to take a look. I thought one good thing you said is we're not going full force into small value profitable, right? We're just tilting. We're putting a little bit of extra exposure, so you still maintain that broad diversification, you're still getting access and you're still allocated to the biggest names out there, the growth oriented big companies. You still have investments in those. However, most of your money is going to be where evidence shows we have higher expected returns over time. I think kind of putting a bow on this whole thing, the reason why we feel so comfortable being able to do that is because we know that you guys have the right financial structure in place.
(11:58): We spend so much time on the priorities and understanding those, and what that allows us to do is to build this stock portfolio in a way that is diversified for the long term, allocated towards those higher expected returns. That's just ultimately going to help you to achieve your outcomes over time.
(12:16): Hopefully this made sense. We'd love to hear from you. If it didn't make sense, for sure shoot us a note, but let us know how you want us to expand as well. You guys know the phone number by now probably, but it's 602-704-5574. And until next time, own your wealth, make an impact and always be a pro.