Peter answers questions he received while presenting to major U.S. corporations.
Listen now and learn:
- How to invest for inflation
- The ideal amount of crypto in your portfolio
- What’s a reasonable amount to pay in fund expenses and advisor fees
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Show Notes
Last week I did a Live Q&A session for a variety of corporations that offer financial wellness to their employees through BrightPlan. As a quick background, BrightPlan is a total financial wellness solution that provides customized financial education to companies and their employees, digital financial planning with access to human advisors, automated investing to build wealth over time, and tools to manage your financial life.
Our team works really hard to democratize fiduciary financial advice and it’s so much fun to interact directly with the employees in events like the one last week.
Today I’m going to answer some of the questions that were asked and tackle a few questions we didn’t have time for.
As always, you can find show notes and resources at TheLongTermInvestor.com. Plus you can submit questions at the bottom of that page and sign up for my newsletter to receive all of my latest insights and recommendations from what I’ve been reading recently.
How do I protect my savings against inflation?
Historically stocks have outpaced inflation by a wide margin in the long run.
During inflationary environments, corporations pass on higher prices (wages, input costs, etc) to consumers, which in turn boosts revenue and earnings. Going back to 1928, both U.S. dividends and earnings have grown roughly 5% a year while inflation has averaged about 3% a year.
Sure, stock returns are below-average in years when inflation is rising or is above 3%, but over the long-run they are far and away the best way to protect your savings from losing their purchasing power.
This is a really good question that seems to be on a lot of people’s mind right now, especially since last week the U.S. Labor Department reported that inflation 7% in 2021, the highest in 39 years.
You don’t need to be an economist to realize that this headline is a big deal for Wall Street and Main Street. But as someone who works on Wall Street and lives on Main Street, I’m here to tell you that I’m not particularly worried about the recent uptick in inflation.
Here’s the thing: Inflation is already here and there’s nothing you can do about it. Trying to hedge against something that has already happened doesn’t make a lot of sense.
Inflation has historically averaged 3%, but that naturally includes times when readings fall below that level (as it has for most of the past two decades) and times when it’s higher than average (as it is today).
We are simply witnessing inflation following its winding path to an average outcome. Inflation’s path takes far fewer twists and turns than, say, stocks do on their path to an average outcome, but it’s still easy to notice big shifts.
And while the 7% inflation in 2021 is obviously very high – I’m not saying it isn’t high – it seems extremely unlikely to persist. Yes, if we had 7% inflation for multiple years in a row, that’s going to be harmful to the economy, but there are signs in the economic data that inflationary pressures are cooling.
Plus, the Federal Reserve has telegraphed its intention to tighten monetary policy to choke off inflation, even if it’s at the expense of short-term labor market health.
What advice do you have for someone just starting to invest in cryptocurrency?
Let me be 100% clear before I answer this question directly. I’m not anti-crypto. I think people assume that based on some of the content I’ve published over the years.
But I’ve been pretty consistent in my opinion on cryptocurrency from the beginning:
- Cryptocurrencies are fascinating and the basic idea is wonderful
- The range of potential outcomes is enormous
- Your financial plan’s success is unlikely to hinge on whether you own crypto or not
Most recently, I published an article when Bitcoin prices were peaking and podcast when the first Bitcoin ETF came to market that really pushed back on some of the false narratives and faulty reasoning people used.
That doesn’t mean I dislike crypto, I just dislike nonsensical investment logic.
With that disclaimer out of the way, here’s is how I would think about investing in any exposure. The starting point for discussion on a new portfolio exposure ought to be it’s relative market weight compared to your other portfolio assets.
For example, the global stock and bond market is roughly $200 trillion. Bitcoin’s market value is nearly $1 trillion. As an asset allocator, my starting point for this discussion would be 0.50% of the portfolio (that’s $1 trillion divided by $200 trillion).
Now, there’s more to the crypto space than just Bitcoin, so maybe you allocate more than that. Or maybe you acknowledge the uncertainty of a position to improve risk-adjusted returns and do a smaller allocation. (The uncertainty at this point is in large part due to the small and noisy sample size of the historical data. Similar uncertainty was present when emerging markets or REITs were first being added to portfolios.)
Either way, I’m in the camp of starting small in the total allocation. As for how much to allocate to specific coins, I approach this using the same framework as investing in individual stocks.
There is no compensation for taking on the idiosyncratic risk of an individual stock, so I would say that you should limit your total individual stock exposure to 5%. Buying an individual coin is similar to buying shares of Apple or Amazon – it’s a specific bet, and specific bets ought to be limited.
Any tips for investing in uncertain times?
The future is always uncertain. There are risks inherent in that. But that’s the reason you earn a decent return investing in stocks. Uncertainty and volatility of returns is the cost of higher expected returns.
My advice is to plan on downturns occurring with a similar magnitude and frequency as they have in the past. Last time I checked, the S&P 500 averages a 10% downturn about every 12 months, 20% downturns about every 3.5 years, and 30% or more downturns about once a decade.
Rather than try to predict when or why a downturn might occur, it’s far better to simply plan on them occurring. That’s how we build our financial planning models in BrightPlan and at Plancorp. Which, to me, makes rational sense because probability is the only rational way to make decisions about an unknowable future.
So that’s my best tip: plan on downturns occurring. That and stay the course when things feel uncomfortable.
How much is too much when it comes to expense ratios? Should I be worried about the fees associated with the funds that I am invested in and the fees that are charged by financial advisors to manage my funds. How big of an impact do they have in my long-term investment goals?
A few questions here, let’s tackle them in order.
According to Morningstar’s Annual US Fund Fee Study, the asset-weighted average fee fell to 0.41% in 2020. So that is a nice benchmark for fees, but it also matters what a fund’s strategy is.
That’s way too high of a fee for a broad market index fund. It’s maybe even too high a fee for a systematic strategy like a factor fund or ESG portfolio. But some funds charge higher fees because it costs more to execute their strategy.
It’s totally fine to pay more in fees if you are getting something of value, but I think that weighted average fee is a nice benchmark for your portfolio as a whole. The portfolios we manage at Plancorp and BrightPlan tend to be closer to 0.20% if they are anything other than a pure index portfolio (those have costs in the single digit basis points range).
As for advisor fees, what services you receive will really define whether you are paying too much. If you’re paying a fee equal to 1% of the assets being managed, and you’re only getting investment advice, I’d argue that’s too much. You can get investment advice for 0.25% from a robo advisor. I really emphasized this point in these presentations last week because all of the employees had access to the BrightPlan platform, which manages investment portfolios for that rate.
Now, if you’re getting proactive, comprehensive financial planning advice and being charged 1% of your assets, then I’d say that’s pretty fair. I’m not arguing that it’s cheap, but I think that a good advisor is worth their weight in gold. I have an advisor myself, so I follow my own advice on this one.
Now, to answer the final part of this question: how big of an impact do all these fees have in your long-term goals?
With fund fees, every dollar you pay is a dollar of return you don’t keep compounding.
A similar statement could be made about advisor fees…every dollar you pay is a dollar of return you don’t keep compounding. But I think that misses out on the function of an advisor.
Financial professionals are trained to manage money, yes, but we are really managing humans.
Money is easy to conquer. Humans are complex.
In a recent essay of mine, I compared the management of humans and their investment beliefs to how executive coaches or therapists help individuals navigate their natural human tendencies. Besides providing general support and encouragement, those professionals play a key role in identifying blind spots. They say things out loud that others are probably thinking, but don’t voice for some reason or another.
In many ways, that’s what I do in client meetings. I support and challenge. The immediate impact is often subtle. But over time, even the tiniest shifts in direction on a compass will lead you to an entirely different destination.
Not only does an advisor impact your long-term investment goals through ongoing redirections and interventions, but it’s also not uncommon for a financial advisor to earn a lifetime of fees by preventing a client from making a single mistake.
Cognitive and emotional challenges manifest differently for everyone. My advice is to find the person that can help you uncover your blind spots and advocate for your best interests. That is the person who will be worth their weight in gold.
What are some resources you go to personally to learn more about investing?
The best learning for me is done by reading books. Here are two lists of books I’ve compiled that you may find useful:
- 22 Books That Will Make You A Better Investor
- 5 Personal Finance Books That Influenced My System For Building Wealth
Podcasts:
If you’re looking for something more retirement specific, Retirement Podcast Network has several shows that I think are really good.
Blogs:
What are the best ways to begin investing to take advantage of compounding wealth?
I think the best place to start is your employer’s retirement plan. For most people that’s a 401(k), 403(b), or 457 plan.
Definitely start by investing up to the match because that instantaneously doubles your money. So if you want to take advantage of compounding, then starting out by immediately doubling your money in a tax-deferred account is a pretty strong move.
Should I trade in a demo account first to learn about investing or jump right in?
Well, I’m going to really focus on the word “trade” here. This person is asking should they “trade” not should they “invest” in a demo account first to learn.
If you are truly just starting out, again, I urge you to use your employer’s retirement plan. I don’t think it makes sense for you to open another account to make trades if you aren’t maxing out your retirement plan.
Investopedia’s Stock Market Simulator is a good place to learn about trading, but know that trading isn’t easy. Winning for a few months or even a year is not indicative of how you will fare in the long-term. If trading were easy, nobody would need to work.
When you’re in a bull market, particularly like the one we are in, it makes trading look easier than it really is.
If you insist on having a trading account, then fund it with an amount of money you can afford to lose entirely, ideally no more than 5% of your total investments. If you lose it all, don’t add to it. If you end up performing well, don’t add to it.
If there were a way to consistently beat the market trading individual stocks, there would have been a Nobel Prize awarded for it already.
How should someone deal with risk for shorter timelines, ie people close to retirement?
When you’re approaching retirement and your financial house is in order, the primary concern is usually what we refer to as “sequence of return risk.”
This is the risk that you experience a bad string of returns at the time you are initially making withdrawals from your portfolio. If the market is down in the first couple years of retirement and you make withdrawals at depressed valuations, then you permanently impair the earnings potential for your portfolio.
Naturally there will downturns during retirement, but this is really just a focus on the first few years of retirement. One way to mitigate this sequence of return risk is to have a year or two of cash on hand that you can use to meet living expenses during a downturn early in retirement, that way your portfolio can have more time to recover.
But for many of the retirees we work with, they reach a point in retirement where they clearly have enough assets to meet their ideal retirement and some, so they start viewing some of the assets as actually having a time horizon aligned with those who are likely to inherit it. The result is that as people age in retirement, it’s not uncommon to see them ramp up risk in their portfolios.
Do small cap or mid cap stocks make sense in 2022?
Well, I have no idea if those will be the best or worst performing asset classes, or something in between.
But I do think everyone ought to have broad market exposure, which includes small cap and mid cap stocks.
We utilize three different strategies at both Plancorp and BrightPlan, depending on an investor’s objectives and constraints. Those three portfolios are the Index Portfolio, the Factor Portfolio, and the ESG Portfolio.
The Index Portfolio seeks to own the entire market according to market capitalization. So in that sense, it makes sense to own mid and small cap stocks in proportions according to their market weights.
The Factor Portfolio actually does overweight mid and small cap stocks. Even though it has broad market exposure, it gives greater weight in the portfolio to a handful of factors that have historically exhibited higher expected returns. One of those factors is “size,” which can most simply be explained as small companies tend to have higher returns than larger companies because they’re riskier.
The ESG Portfolio we offer provides fairly similar mid and small cap exposure as the Index Portfolio. With this portfolio, it’s more about overweighting companies that do a relatively good job addressing Environmental, Social, and Governance issues.
So in all cases, mid and small cap stocks play an important role within a globally diversified portfolio.
Resources
- Enter my 2022 Outlook Survey to try and win a $500 Amazon Gift Card
- 7 Things To Know Before You Invest in Bitcoin
- EP 19: Should You Invest in a Bitcoin ETF?
- Essay: Managing Humans
- Submit your question for the show through my “Ask Me Anything” form
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About the Podcast
Long term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence.
Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.
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