Unlock the secrets of financial wellness with us, Clem Miller and expert Steve Davenport, as we guide you through the must-knows of investment statement reviews for the year ahead. Imagine a world where you effortlessly finesse your asset allocation for both strong growth and steadfast safety. Together, we dissect the nuances of investment fees, shining a light on how they nibble away at your returns and why embracing low-cost index funds and ETFs could be your ticket to financial savvy. With our conversation, you'll become adept at steering through income streams and tax efficiency like a pro, ensuring you're not leaving money on the table when it comes to your investments.
With Steve and Clem insights, we break down the complex tango between US and global investments, and how sectors like pharmaceuticals can add a layer of diversified growth to your portfolio. By the end of our discussion, you'll be equipped with a fortified strategy to withstand the ebbs and flows of market downturns and come out ahead, ready to delve further into the psychological plays of behavioral finance in our future talks.
Unlock the secrets of financial wellness with us, Clem Miller and expert Steve Davenport, as we guide you through the must-knows of investment statement reviews for the year ahead. Imagine a world where you effortlessly finesse your asset allocation for both strong growth and steadfast safety. Together, we dissect the nuances of investment fees, shining a light on how they nibble away at your returns and why embracing low-cost index funds and ETFs could be your ticket to financial savvy. With our conversation, you'll become adept at steering through income streams and tax efficiency like a pro, ensuring you're not leaving money on the table when it comes to your investments.
With Steve and Clem insights, we break down the complex tango between US and global investments, and how sectors like pharmaceuticals can add a layer of diversified growth to your portfolio. By the end of our discussion, you'll be equipped with a fortified strategy to withstand the ebbs and flows of market downturns and come out ahead, ready to delve further into the psychological plays of behavioral finance in our future talks.
Straight Talk for All - Nonsense for None
Please check out our other podcasts:
https://skepticsguidetoinvesting.buzzsprout.com
Clem Miller:
Welcome everyone to Skeptics Guide to Investing. I'm Clem Miller and today we're going to talk about reviewing your investment statements. How to start the new year. Steve Davenport and I will dig into the steps you need to take when starting the year so you gain confidence about your statements. Where do you start with your statements, Steve?
Steve Davenport:
There are a lot of ways to look at it, but here's my process. I look at fees first. I always know what you pay and what you're getting for it. The second thing I look at is allocation between growth or stocks and safety and bonds. That trade off varies based on your age. Then I look at income how much and how tax efficient is the income of receiving? Then, lastly, I look at taxes, because I want to understand any decisions I have to make that year and how they're going to be affected by taxes.
Clem Miller:
Steve, is allocation really the first thing or the most important thing you look at?
Steve Davenport:
On my list? It isn't. I look at fees as the easiest way for most individuals to improve their results. So, yes, you look at it once and you set it up and hopefully it's good. But I also think that, for individuals, understand how much you made for the prior year, how much you paid in fees to get to that result and then determine where you want to go from there. I think, understanding those numbers and realizing how much they are when you see your fees get into the $1,000 or more, you start to realize that this is something I can control and something I can manage and ultimately, I think that leads you to a better net result.
Steve Davenport:
I think people talk about returns in a gross sense, meaning with no fees, but we really started going to start to take this to. Let's talk about things in terms of a net Net. To you, what did you make last year? We tackled investments and personal finance a few weeks ago, but today I think, taking that deeper dive. When you look at your own assets, how do you evaluate your results and think about them? I think it can make you feel overwhelmed at first, but we're all responsible for our own results. Let's make financial wellness a priority for 2024.
Clem Miller:
Well, okay, Steve, that's great. What should our fees tell us?
Steve Davenport:
First, at fees, I like to look at it as different levels of fees. If you have an advisor, you're paying an advisor a fee and he collects it either monthly or quarterly. Those fees can be between 50 basis points up to 150 basis points. Level two is what funds or ETFs do you use to deliver those results? And they have a level of fees. So if you're paying an advisor 1% and he's putting 1% mutual fund in your account, that means you're overall paying 2%, and so that is starting to be significant. If the average return of your equities and bonds is 8% and you're paying 2%, 25% is going away to the person who's managing it for you. That's significant and that's something you should try to change.
Steve Davenport:
Level three is where are there any loads on the funds? Level? Funds have this fee that is associated with selling their product and therefore you pay that fee as a load, and it can be significant. Some of them are spread over three years, five years or seven years. And level four are there any commissions? Most places have eliminated commissions and they're not really a factor anymore. They and I did a study about fees and they said, looking at the returns, the most clear determinant of good returns is lower fees. So when we look for improving something, we can hear about an advisor or a fund that has great returns, aka ARC. But when you look at it over time and you look at what the fees are paying, it gets harder and harder to justify higher fees.
Clem Miller:
Actually, Ark might be a good example of a manager that does well sometimes and does very poorly other times, and so the question is do you really want to pay a high fee for something like that? So I mean, Steve, back on fees. Obviously, index funds, ETFs that are tracking index funds, have quite low fees, quite low what are called expense ratios or fees, and it strikes me that most people or maybe not most, but a lot of people have already caught on to the fact that their fees are quite low. What do you say to that?
Steve Davenport:
I think that's great. For most people, I think it's a great solution. I think that what we want is simplicity and if we can leave our assets alone, time works in our favor. So lower fees, longer time horizon, don't trade as often those three things really determine success. Index funds usually vary between two basis points to 35 basis points. Mutual funds vary between 50 basis points and 300 basis points. That's 10 times the amount you're paying. They better deliver more results if you're going to pay 10 times more. Etfs are somewhat more than index funds because you have daily liquidity or interday liquidity. Etfs go between five basis points, but I saw a Bitcoin ETF at 150 basis points 1.5% that's a mutual fund like fee for an ETF, and then loads can add 2% up to 10% to your overall expenses. These are big numbers and you just have to understand what you're paying for.
Clem Miller:
Yep. So in my portfolio I use individual stocks and so there are only commissions for me. I don't pay anybody else expense ratios or anything like that. That's me, I feel like I've got given my professional background, I've got a lot of money. I've got the knowledge and experience to be able to do this investing individual stock, investing myself. But that's obviously not the case for everybody. A lot of folks just don't have the time or really the resources to actually do this kind of work themselves. So they're willing to pay some fees. It's just a question of how much those fees are.
Steve Davenport:
We use Morningstar for a lot of our analysis and it costs us a significant amount to get the value from all the analysts covering all the names, but it's a great asset when you have a limited amount of time to follow every company.
Steve Davenport:
So I believe that the individual has to make a decision. There's some, I believe in the Peter Lynch method of kind of in the Charlie Munger knowing what you own making sure you're familiar with it, that's fine. I think that for most people, an index fund with low fees is the right approach. The main thing is look at your assets and try ensure your portfolio is helping you accomplish your goals. There may be cases where a fund and ETF is beating the benchmark by 100 basis points and it's worth paying the 50 basis point fee, but there's a lot of cyclicality and it may beat them for three years, but five years, seven years, 10 years, it's behind. That tells you that there's a time and a place for every strategy and, as you mentioned, ARC had its time and its place, but it may not be the right time and place right now. You have to take responsibility for making your assets satisfy your plan.
Clem Miller:
So, Steve, I really like those thoughts. You mentioned asset allocation earlier. Where does that fit into the picture?
Steve Davenport:
I think that's the next area that you want to understand how much risk am I taking? Allocation is considered the holy grail for most advisors. It represents something like 90% of the results come from your allocation decision. Time is your friend when you're younger, and caution is advised as you approach retirement. There's a time to make back your losses if you start early. But a simple formula that some people use is to take your age, subtract it from 110, and that equals your equity percentage. Some people apply maximums and minimums of a maximum of 90% in equities or risky stock and a minimum of 25% Is real estate, an asset for investing or living.
Steve Davenport:
I think that when you look at your assets, we're talking about your investable assets, but the other things you own car, home and potentially a second home you need to think about how all of those assets are growing and how they affect your overall wealth. I think that updating your allocation once per year and getting it back in line, maybe in January when you're doing this review of your statements, is a good idea. Looking at it every day or five times during the day not a good idea. I think that when we look at our allocation, we wanna understand how much is in US assets versus non-US. The world's capitalization is 55% US, 45% non-US, but most people are more comfortable owning things that have a home country bias, meaning they like to own companies that are US companies. Is that a mistake? It hasn't been, because the US companies tend to have a better operating environment and also a systems and educated workforce. So people might only wanna put 20% in non-US assets.
Steve Davenport:
And the last thing I'd say about asset allocation is there's something in the middle and I'm a middle child so I call it the messy middle. I yield prefers utility or infrastructure reads. I think that there are some characteristics of fixed income, some characteristics of equity. Therefore they don't easily fit in one of those buckets. But that's where we get into a more complicated decision and I think that all of this is get started, understand, and then we start to get into these next questions about how to allocate more sophisticated way. What would you invest in when you were young, clem?
Clem Miller:
Ah, so I don't remember when I was young. That's just a joke.
Clem Miller:
Well, when you were more sane than you are now let's put it this way, and I guess back then it was pretty much US and passive ETFs. I knew I didn't have enough money or accessed information to do individual stock selection. But all that has changed and I feel like I can certainly do that now. I wanted to address one or two points I think that you raised when you were just talking. I think that you know the messy middle, some of those things high yield, preferred infrastructure, you know, maybe those things are. It could be that those things are beyond the reach of some retail investors.
Clem Miller:
There are some nuances to a lot of these asset classes that are complicated or confusing, so I'm not so sure that I would recommend those. And US versus non-US that's worth the whole podcast in and of itself. So I knew that one would get you excited. I mean, I'll just point out one thing, which is you don't necessarily want to go by market capitalization. You know 40% of the earnings of the S&P 500 companies come from overseas. So by investing just in the S&P 500, you're actually getting a lot of global economic exposure. You're not really limiting yourself in that respect.
Clem Miller:
The reason to invest in in my opinion, the reason to invest in international stocks is to be able to have exposure to stocks that you just can't get in the United States. You know, if you're going to invest in a US pharmaceutical company and I know we're going to be talking in this round of podcasts about Lilly and Nova Nordisk but if you're going to invest in Lilly, why not invest in Nova Nordisk? They're both companies. One just happens to be overseas and one just happens to be in the United States. So what you know, what's the difference? You know you go where your opportunities are. I agree.
Steve Davenport:
I'm really just giving people a rundown of things that they consider in their allocation. I'm not recommending to anybody to do any particular asset class. I'm just saying that there's risky and they're safe. There's cash as the safest asset and maybe there's an Ark fund that's the most risky, or there's an individual name that you want to invest in game stuff. All I'm saying is that there's a spectrum and people will invest on that spectrum, and I think that when I look at retirees and their decision making, it's all about income. Am I getting enough income? Can I get income from other sources besides bonds? And that's where some of the interest in preferreds, infrastructure and other utilities stuff comes from.
Steve Davenport:
I'm not saying it's right for everybody. A young person shouldn't be investing in these utilities. They should be focused on growth. So I think that as we age, it should change. There's so many variables here. I'm not trying to come up with anybody's asset allocation. I just want people to understand it and I think that when it gets to looking at some of these assets, it's not always clear and I think that, like you mentioned the US companies that have great foreign presence, like Coke, 80% of their revenue is coming from overseas. So, yes, is it a US domestic company? Absolutely. Is it really a company that only depends upon the US economy? Absolutely not. So I think that it gets complicated, and that's why we're trying to do this is to try to simplify it for people and give them some good ideas.
Clem Miller:
So, Steve, you were talking about income and I'm wondering can you sort of run through the income that comes from particular areas? I know you've got some thoughts about safe versus risky Sure Buffet approach. What would you say to these?
Steve Davenport:
So when we're looking to be retired and cut back on work, it's the income you can generate that will give you the freedom and the options on your life in terms of what you can do. Most of people have a social security and they may have another pension or other assets. So I think that they look to their portfolio to provide additional income and when we look at our two main asset classes risky they'll typically yield between zero and 4%. When we look to safer assets now, they're yielding somewhere between 4% and 7%. So do we put it all in safety or do we still keep a little bit of risky? I think the answer is that we're going to have a retirement that will probably last from 65 to 85. It's a 20 to 30 year period. That period is going to need some growth, so I think you have to mix the two in a way that makes sense for yourself.
Steve Davenport:
Historical returns for risky assets are about 8%, which about 1.5% is going to come from the dividend or the income, but most of it's going to come from the growth and the safe assets 4%, and most of it is going to come from the income. So those two assets are going to do different things for your portfolio and different things for you. When we think about inflation at 2% eventually, maybe after a few years and fees of 1% to 1%, there's things that are going to eat into those returns. And if you just have a return of all safe assets and you've got inflation at 2%, taking that little way, that's not going to lead you to retaining your spending power. So Buffett had a simple solution.
Steve Davenport:
He said, if he was to die and what he'd tell people to do, he'd say 80% in the S&P 500 and 20% in Treasuries. And if you think about that, the yield, you know the return will be somewhere around 7.2%, with fees somewhere under 10 basis points. That's a pretty efficient portfolio that's going to have pretty good results and the 7.2% is going to most likely cover inflation and still give you something left over for growth. So when we think about all of these things, we need to start thinking about gross and net. Gross means a total return and then net, net of any taxes, fees or other items. So I think it's really about understanding your income is something that you don't need to do right away, but as you're a person of time and I know you and I are trying to figure out where is that income going to come from, how are we going to get it and how?
Clem Miller:
Safe, is it so, Steve, you mentioned taxes as being a key element here. Can you talk a little bit more about that?
Steve Davenport:
Sure, I hope that I can help, but here we're getting into a very specific area where individuals have different states and cities and municipalities that may tax them in certain ways. So I recommend that you talk to your accountant and you understand how your local, city or state taxes investments. When we're looking at taxes, we're talking about taxes on gains or losses from the sale of the security in one of your taxable accounts and on income that you receive. So income and capital gains have different tax rates and you need time to understand what they are. As you think about your assets, there are many choices for you to defer or to pay taxes.
Steve Davenport:
Today You're going to earn more or less next year. Is your job? Is you or your partner changing jobs? What are the tax rates going to be over the next five or 10 years? There's a lot of people who are worried about the amount of debt the United States has and what that means for tax policy. These are all good points and good things to think about, because some people say, oh, I don't want to pay today's tax rate. In five or 10 years we might look back at 2024 as the golden age to assault securities.
Clem Miller:
Yeah so.
Steve Davenport:
Where do you think tax rates are going? Clem, did you put an even bet between higher and lower?
Clem Miller:
Yes.
Steve Davenport:
Really. Yeah, I tend to believe they're going to go higher.
Clem Miller:
Yeah, well, I mean, certainly, with the fiscal deficit being what it is, it could go higher, but also we're seeing some pretty strong economic growth and that might help to close the fiscal deficit without higher taxes or without significantly higher taxes. So I think it's I give it 50-50 actually. Well, you're pretty optimistic, yeah, so, Steve, I usually well I often am optimistic. I thought you were a skeptic On many things, but not on everything. So, Steve, let's turn to our mailbag. So we have here a question Are index funds the best choice for everybody?
Steve Davenport:
I think the ETFs offer a great one-stop solution. Like all solutions, you modify and adjust as your needs change and as your education and comfortable with these ideas changes. I think for an individual who wants to structure something, that they can set it and forget it, these are a very good solution. What do you think individuals do in stocks, Clem?
Clem Miller:
Well, I think that the younger you are, the more you want to invest in ETFs or actively manage mutual funds, even despite the fees. I would do your research, of course. I think as you get older and have more assets, then I think you can expand into other asset classes and also into specific stocks. Again, if you're going to buy individual stocks, they should be stocks that you know something about, not based on who you talk to at a cocktail party or something like that. I think you should really have done some research before you invest in particular stocks and, as you, there's a transition period here too. There's a long time period between when you're young and when you're older, in which you can gradually move, as your knowledge level increases and your assets increase, from more of an ETF-only approach or a passive-only approach to an approach where you're using all active or active mutual funds or investing in stocks by yourself. So it can be a transition period as well.
Steve Davenport:
So, Clem, I mean I would summarize and say that, first of all, looking at statements and having assets that you can look at and evaluate is a great place to be right. It's nice to have assets versus have no assets and worry about the future without some of the things that can help you. The first thing is fees matter. I think that fees are an important part of how you manage your life and the expenses you pay for things. It matters a lot when you talk about the magnitude of the assets you have in your investments. Allocation is your comfort with risk? How comfortable are you with you know, when you go to sleep at night and you hear the market was down 3%, does it bother you or does it not bother you Because your time horizon matters? A couple of assets starts to be more of a factor as you get older and you start to want to use those assets to cover your expenses. They evolve, your needs evolve and taxes, like fees, can make a difference. So anything else to add, Tom?
Clem Miller:
I would add just a couple of things. One is you know no asset is truly safe. You know even treasury bills, treasury bonds, I should say which you know have no credit risk per se. Credit treasury bonds do have interest rate risk as rates go up, bond prices go down and vice versa. So there is risk associated with the so-called riskless assets. So I'd keep that in mind. I would say safer, I guess, is better, yeah. And then I would say that I would agree entirely with you, steve, about you know, if the market goes down 3% in a day, not to panic and sell.
Clem Miller:
It's really important not to panic and sell. In fact, if the market goes down 3%, 5%, 10%, that's the time to be buying stock, not a time to be selling stock. And if you're comfortable doing that, then you're somebody who should be investing. But that's you know behavioral, psychological thing that you know that investors should like. You know what's a good entry point. That's what professional investors call it An entry point for buying. You know, into the market or into individual stocks, you need to be comfortable buying low and selling high and not the opposite.
Steve Davenport:
So maybe we should do a behavioral podcast.
Clem Miller:
I think we should at some point.
Steve Davenport:
Okay, well, thanks everybody for listening. I hope you appreciate it and I hope you give us a like and a share. We don't have ads and we do this as a way to give back and we hope you enjoy it and we look forward to our next podcast. Thanks, everybody.