Maximizing Your Investment Experience With P.J. DiNuzzo

Episode: 200
Guest: P.J. DiNuzzo
Originally Aired: August 16, 2017

The Lange Money Hour - Where Smart Money Talks

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
Listen every first and third of each month on KQV 1410 AM or at our radio show archives. Note: Some events referenced in our archives have already passed.

 

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TOPICS COVERED:

  1. Introduction of P.J. DiNuzzo
  2. Successful Investors Shut Out Noise of the News Cycle
  3. Different Investment Strategies for Needs, Wants and Dreams
  4. Keep Your Emotions Out of Investment Decisions
  5. “Am I Going to Be OK?” Is Investor’s Top Question
  6. Don’t Try to Time the Market
  7. A Diversified Portfolio Will Include Some Underperformers
  8. Rebalancing Portfolio Means Selling High, Buying Low
  9. Make Your Portfolio Globally Diverse
  10. Smart People Are on Both Sides of Every Trade
  11. The Market is More Efficient Than Most Active Managers
  12. Ignore the Latest Shiny Object and Stay Disciplined

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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.


1. Introduction of P.J. DiNuzzo

Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg along with CPA and Attorney Jim Lange, and this week, we welcome P.J. DiNuzzo back to the show. P.J. is a nationally recognized expert in investment management and was approved as one of the first 100 Dimensional Fund advisors. His Pittsburgh-area firm, DiNuzzo Index Advisors, Inc., was founded in 1989 as one of the first few hundred fiduciary, or fee-only, advisors in the United States, and it consistently ranks among the country’s top 500 investment companies. This week, our topic is the keys to maximizing your investment experience. P.J. and Jim will discuss things like why you should avoid market timing and shouldn’t try to outguess the market; why you should resist chasing past performance; how you can practice smart diversification; and how to manage your emotions to help you avoid making poor investing decisions. So, we have a lot of great information for you this week, but before we get started, before we even get into the program, congratulations are in order to Jim and to P.J. because the Lange Financial Group has surpassed a milestone just this past week, I guess, of $500 million under management, and another milestone that Lange Financial hit in conjunction with P.J.’s firm is that they are jointly managing $300 million together. So, congratulations to you both.

Jim Lange: Well, thank you, Dan, and welcome to the program, P.J. It’s always a pleasure to have you on.

P.J. DiNuzzo: Thank you.

Jim Lange: And as usual, I have my normal disclaimer. Usually when I have a guest on, I do not have any interest in that guest’s business. If they have written a good book, I might plug the book, but other than that, and I don’t share any royalties in that, so there is no ulterior motive or there’s nothing for me to be gained by promoting or saying good things about the particular guest. That is not true tonight with P.J. DiNuzzo. P.J. and I have a working relationship, or a joint venture, if you will, that basically works like, we work with mutual clients and we like to think that our relationship provides the best possible service at a price. So we think that most clients need two things: One is, let’s call it, strategy, how much Roth IRA conversion should you have, how much money can you afford to spend, what’s the best Social Security strategy, what’s the best tax-planning strategy, what is the best estate-planning strategy, how should you best educate your grandchildren. Some of these strategic decisions that our firm loves to do, we love to run the numbers, and we come up with what we call a “master plan” that might involve certain amounts of spending, Roth IRA conversions, Social Security, et cetera. And then, the other very critical element is actually investing the money.

P.J. and I are both big-time believers in low-cost index funds, and P.J. has a firm that uses what we both believe are the best set of low-cost index funds on the planet, a group called Dimensional Fund Advisors, and he’s the guy who actually invests the money, who determines the asset allocation, who actually works with clients on a day-to-day basis, and does the reviews, and they have a whole slew of services that, I think, just far surpasses any other advisor that I know. They do a personal balance sheet. They do a personal income statement. He has all this wonderful software that calculates percentages of succeeding in your retirement plan, et cetera, et cetera. But rather than P.J. charging a fee and our firm charging a fee, one of the ideas of low-cost indexing is truly low cost, so what we do is we actually have the same fee, both for his services and for my services, that he would charge, which is, at the high end, 1 percent, on the low end, 50 basis points, depending on how much money is invested. For most people, it will be somewhere in between probably closer to 1 percent, to be fair, but that covers both his fee and our fee. So our value proposition, with all due respect to other firms, we don’t really think we are necessarily competitors with other firms; we think our value proposition is so far above other firms that we kind of don’t even feel like it’s competition. So, anyway, that was, you know, fair warning that I can’t be completely objective about P.J. because I do have a financial interest.

But anyway, with that introduction, one of the things that we wanted to talk about was some of the things specifically that P.J. and his office do. So, P.J., one of the things that people love to talk about is which way the market is going to go, what’s happening with Trump, what’s happening with North Korea, all these things that, frankly, we really don’t have any control over. Have you been more successful on focusing on what you can control or being a little bit more, let’s say, subject to the news and subject to things that you can’t control?

 


2. Successful Investors Shut Out Noise of the News Cycle

P.J. DiNuzzo: Yeah, Jim, that’s really at the epicenter of the topic this evening. We were using the keys to maximizing your investment experience, and what our mantra’s been for 28 years is focusing on what you can control, and you hit the nail right on the head, Jim, that those are the majority of questions that we get asked. Those are very contemporary topics that you just mentioned, and we’re never being insensitive, but that really, in the big picture of someone having a successful retirement plan, is just noise. It doesn’t have any effect. It could have a potential deleterious or negative effect on their outcome, but really, it’s just noise, and I’ve said numerous times that I’ve never seen anyone in my 28 years of serving as a wealth advisor, I’ve never seen anyone fail if they’ve focused on what they can control and manage those couple of dozen variables as well as possible. Again, the majority of the conversation is around things that people cannot control, and I think it was in one of our other topics regarding behavioral sciences and the emotions of investing.

Jim Lange: Yeah, well, so right now, everybody is nervous about North Korea, everybody is talking about Trump’s reaction to the KKK and the neo-Nazis and whether his, let’s say, and then he kind of reversed course and then reversed course again, and, of course, these are the topics that you see on the headlines all the time, and I would imagine that you’re getting these kinds of questions. Well, what are the implications of what Trump said about North Korea? What impact does this have on the market? So, what do you typically tell a client when they say, “Hey, you know, I’m reading the news and I’m nervous. What should I be doing?”

P.J. DiNuzzo: Yeah, and again, Jim, I just had a couple of those conversations today that you just mentioned. We fielded a couple of those calls. But what we always look at is the big picture and focus in on what you can control, and we refer to it as our financial-wellness process, so DiNuzzo Index Advisor’s Financial Wellness Process, and that’s really a process from start to finish from the first time that we are introduced to what would be a prospective client. As you had mentioned earlier, Jim, I think our financial-wellness process is strongest. In the relationship that we have, I clearly feel that it’s strongest in that those are those four corners in a personal investment house we talk about all the time, with you in the estate-planning corner room and everything associated with that and the tax-planning room and everything associated with that, and then us with the financial planning, most specifically, retirement planning, retirement-income planning, then the investment management.

So if someone comes onboard, we go through our process. If they come onboard as a client, then we would like to have what would be a semi-annual meeting once every six months, and we call that a financial-wellness checkup. The financial-wellness checkup, as you said, we’re able to give our clients very specific direct feedback, unvarnished feedback, on their current status, and what happens is, most individuals are quite surprised, typically when we’re going through a bad market period, really how strong their overall plan is. So, if someone is just talking about investments, and, quite typically, folks that you meet for the first time or we meet for the first time, that’s the topic of investments, and, as you said, not just investments, but where we are at in the market right now with these political issues going on, what should I be doing?

 


3. Different Investment Strategies for Needs, Wants and Dreams

But really, we’re missing the entire picture, the entire forest for the trees. It’s our feeling that everyone should have a plan, and everyone’s individual plan, the footer or foundation would be assets and liabilities, income and expenses, and then modeling that, those expenses, for how would you like to live your retirement, husband and wife, partners, the household, whatever the composition is, and then we feel it’s of, I’ve always used the Mayo Clinic or the Cleveland Clinic, if you went for a two-day exhaustive physical, let’s be able to provide that exhaustive financial physical for our clients on a daily basis, and the best example I can think, Jim, for the noise that we were talking about was last year, we have to be careful talking about percentage rates of return, but, you know, 100 percent in an all-index portfolio last year was up 14 percent, 15 percent, something approximately I’ll say in that range, and the average individual who owned individual stocks or individual stock mutual funds last year, the average individual ended up slightly less in stock exposure at the end of the year. So you just can’t afford to be down, let’s say, 1 percent in a year when you could have made 14 percent or15 percent with your stocks, and we talked about focusing on what you can control. It would be to create and monitor that ongoing overall plan, of once again, you have a couple-dozen key variables. We talk about investments, of course, because a lot of people do have an interest in that, and to us, the plan is, Number One, the investments are 1A in supporting that plan. So, you know, create a solid plan, support that with investments that fit your needs and your risk tolerance. We won’t go into details about the buckets today, but we’re going to give very specific recommendations to clients on their cash-reserve bucket, their needs bucket, their wants bucket and their dreams and wishes bucket.

As we’ve said before, a typical retiree has, on average again, three different investment strategies, one for the needs, one for the wants, one for the dreams and wishes. The need is conservative to moderate. That’s paying for food, clothing, shelter, health care and transportation. The wants for all other expenses, and then the cushion, or for long-term spending or extra spending or gifting, is in that dreams and wishes bucket, and then, I think that’s really where the beauty of the indexing comes in, Jim, that, you know, the average active mutual-fund manager sits in her or his chair for approximately, I believe, it’s eight years on average. So, you have a real hard time modeling a retirement plan for 30-plus years for a household using active management because, and granted, that gal or that guy may have had a great run for five or 10 years, but now someone else is sitting in that seat as the lead advisor for the fund. So, you know, let’s structure the portfolio along the dimensions of expected returns, you know, using indexing as the base, we’ll talk about that, again, in a little bit, the indexes on average doing better three out of four times versus trying to outsmart the stock market, diversify globally. Everybody agrees with diversification until something in their portfolio is underperforming, whatever everybody’s paying attention to, and then they don’t like diversification. “Hey P.J., that looks like a weed in my garden. Let’s pull that out.” So, contemporarily, international investments have been underperforming our domestic U.S. market for the last one, three, five years, but again, everybody knows the right thing to do, so to speak. I don’t think anyone goes to their physician and ever walks out and says, “Well, that’s earthshattering information that they gave me.” Everything that they tell you, we all know, but again, how hard is it following through on that great advice? And as you mentioned earlier, on focusing on what we can control, managing expenses, managing turnover, managing taxes, you know, we said before, if a dollar saved is a dollar earned, 1 percent less in fees and expenses is 1 percent more in the pockets of everyone that we meet. Vanguard, of course, as everybody’s heard of, you know, is the lowest expense mutual-fund family in the country. DFA is sort of right behind them. So, you know, just on the investments, if we were lower than 95 percent to 99 percent of the universe as far as mutual funds, that’s a big benefit for our clients, and then the behavioral sides, the emotions of investing we’ll talk about in a little bit, you know, staying disciplined through market dips and swings. That’s when individual investors, when they go through the spring, summer, fall and winter of the portfolio growth, expansion and contraction, that they’re selling some or most or, heaven forbid, all of their investments, and we know, again, that two out of three times, the average individual investor’s gut reaction is going to be incorrect when they are pretty much convinced that they should be buying more or selling.

Jim Lange: Well, I’m going to pick up on two things that you said. The first that you kind of glossed over, which was the DiNuzzo Stack Analysis, and I believe that that is a wonderful feature of your firm that both helps behavior and it helps return. So, is it fair to say that rather than having, let’s say that somebody comes in, and let’s say that they have 60 percent equities and 40 percent stock, and maybe that’s appropriate, but that you wouldn’t say, “OK, you’re going to have one portfolio. You’re going to have multiple portfolios, and one of them is going to be a safer portfolio that, if the market goes down, you’ll still be fine, and you’ll still have food on the table and you’ll still have gas in the car and you’ll still have shelter over your head.” And then, another portfolio, let’s take the extreme, that’s going to be a, let’s say, wishes and dreams and perhaps more of a long-term portfolio, and you actually go to the trouble of having different asset classes. So, for example, the Roth IRA, which you are likely to spend the last, if ever, that might be in the long-term bucket that might be invested in small companies and maybe emerging markets and things that might be a little bit more volatile, but ultimately will lead to a higher return, and then the short-term bucket and the needs bucket might be more cash and CDs and bonds. You kind of glossed over that, but I actually think that that’s incredibly valuable, so I just wanted to point that out as part of the value proposition that we offer, and frankly, it ties in very well with us because we’re running numbers every year. We always come up with, let’s call it, the masterplan for Roth IRA conversions, and by the way, sometimes the amount of money we can save on Roth IRA recommendations can pay our fee for 10, 20, 50 years if people actually do them, which they usually do.

 


4. Keep Your Emotions Out of Investment Decisions

The other thing that you talked about is that you used the word “behavioral” finance, or managing your emotions, and you mentioned the example that the market does better than people in the market, and I think we go back to the Dalbar studies, who basically, to oversimplify, say that the S&P 500 index does much better than S&P 500 index investors. How can that be, P.J.? You have the S&P 500 index, who, over a certain number of years, returns whatever you want to use, maybe 11 percent over a very long period, maybe a little bit less for a shorter period, and then you have individual investors who at least claim that they are S&P investors, and their long-term returns are much lower. How can that be?

P.J. DiNuzzo: Yeah, that gets into what we were talking about, the emotions of investing, you know, coming to the party late, leaving the party early. We go through this roller coaster of investing and people are selling some or most or all, or they’re adding to their portfolio, and a couple of other things we have on the agenda this evening, you know, regarding chasing performance, market timing, et cetera. Again, you add all these small factors up and individual investors may be performing one-half as well as the mutual fund that they’re in, and this is the same thing, Jim, for active mutual-fund managers, and I had not heard this data before, but Peter Lynch is one of the most famous active managers of all time at the Fidelity Magellan fund, and the gentleman was making the case the other day from the data that he analyzed that the average investor did not make money owning that mutual fund, and Peter Lynch was the best at what he did at the time. I know I’ve seen the other data that the average individual investors, we talk about Dalbar, the three best consecutive years that Peter had did about, again, one-half of the total return that they average per year. So, those emotions for individual investors, very, very challenging.

Jim Lange: Well, I remember, there’s a guy named Murray, and I very clearly remember him saying, “You see the advisor sitting next to you? He should manage your money, you should manage his money, and you’d both do better because you’d keep the emotions out of it.” And, let’s say, it’s not very much of a stretch to say that — and he actually believes that that alone is worth the fee of paying an advisor.

P.J. DiNuzzo: Yes.

Dan Weinberg: Tonight, CPA/attorney Jim Lange is talking with our frequent guest, nationally recognized investment-management expert P.J. DiNuzzo. They’re talking about the keys to maximizing your investment experience.

Jim Lange: And one of those keys is what P.J. calls the DiNuzzo Stack Analysis, and I had referred to that earlier, where instead of just having one portfolio, he has each client with multiple portfolios for different needs and different timing of that portfolio.

 


5. “Am I Going to Be OK?” Is Investor’s Top Question

P.J. DiNuzzo: Yeah, and I think, Jim, just if I could add one thing onto that, you know, something, like, we’re talking about the financial-wellness process may sound a little bit nebulous, but what the audience wants to know is we talked about, you know, from the first time that you meet someone, whether at a workshop, at your office, the first time we meet them, there is a management going on of assets and liabilities and income and expenses, and our goal is to “make it happen” for our clients, to have them seize their life dreams, to do what they want to do, to live their life the way that they would like to, and for us, again, to make that happen, and there is management as far as it’s not age specific, but specific assets versus liabilities, income versus expenses. So that’s the footer and foundation, and I’d look at the money-bucket stack as being the framing and all those load-bearing walls as the next most important structure, and I would just make the point to the listeners in the audience that if you’re pre-retirement or at that point, that you really want to know what is your needs exposure or your needs goal, just how much does my household need for food, clothing, shelter, health care and transportation. The second most important question we’re asked, and we talk about this spring, summer, fall and then winter of investing, let’s say we go through that cycle approximately every five years. When we’re in winter, the market’s either in correction or in a bear market. It’s down at least 10 percent, if not 20 percent or more.

The second most important question we’ve got asked for 28 years is, “Am I going to be living under a bridge, P.J.?” That’s a pretty important question! So, obviously, somebody’s losing sleep if they’re thinking they may actually live under a bridge. We’ve been asked that question by individuals with well over $5 million of investible assets numerous times. So, this isn’t just something like maybe you think you’ve undersaved. So you really want to know the answer to that question. Just how much do we need and what kind of shape are we in going through this winter for our food, clothing, shelter, health care and transportation?

And the most important question we get asked the most is, whenever we’re going through a bad market period, “P.J., are we OK? Are we going to be OK?” And translated, the average household, what they’re stating, is “Am I going to have to materially modify my lifestyle and not get to do things that I want to do the rest of my life to get through this period?” And I would implore the audience of listeners again that you absolutely want to have the best answer to that question as possible. So, as you said, Jim, I’m glad that you reiterated that managing that personal financial house, the money-bucket stack, those are all the basic building blocks, again, for what we refer to as our financial-wellness process.

Jim Lange: Well, I do know that, you know, I mentioned the fact that you prepare both a personal balance sheet and a, in effect, cash-flow statement, and clients have said that no one has ever asked the level of detail that you have, and you don’t do it just for the heck of it. That actually becomes part of the bucket analysis.

P.J. DiNuzzo: Yes.

 


6. Don’t Try to Time the Market

Jim Lange: So, people with different spending, even if they have the identical portfolio, they’re going to end up with a different plan, and I know that one of your favorite sayings that I have picked up on is that everybody’s a snowflake, and that’s really true with your planning because we see the results of it, and people are just thrilled. In fact, sometimes, between what people fill out for us in terms of listing all their assets, and sometimes some of the information that they fill out for you, that in and of itself is a true financial education for them.

So, one of the things that people sometimes like to do, and they like to be very clever, and particularly, with all due respect, some of our do-it-yourselfer engineers, is they like to say, “Well gee, now’s really not a great time to buy. You know, the market’s really high. In fact, I think I’d better get out of the market.” Do they wait for somebody to ring a bell at the top or at the bottom? And don’t they have to be right twice to time the market; that is, when to get in, when to get out? So, P.J., you’re a smart guy. You’ve been doing this for just about 30 years. Are you pretty good at timing the market?

P.J. DiNuzzo: Horrendous. I don’t even try. I wouldn’t even think about it, you know.

Jim Lange: So, what is your thinking on timing the market when you are managing somebody’s money, and particularly if they even come to you and say, “Oh gee, you know, I thought when Trump won the presidency that the market was going to go down, but it went up. But oh, it’s only a matter of time because they’re all crazy and the Democrats are crazy and Congress is crazy and it’s all going to come crashing down. So, I’m going to get out of the market, and then after it goes crashing down, then I’m going to go back in.” What would you say to somebody who says that? And frankly, I know there’s a lot of people in the audience who are thinking that right now.

P.J. DiNuzzo: Yeah, and I’ll go to recent history again, Jim. You know, I mentioned briefly last year, you know, three major selling events in 2016. We got off to actually the worst start in a hundred years for the stock market. Pretty much the first seven weeks of the year, the stock market was down, down, down, supposed to be going into a recession in the Euro Zone, et cetera. There was a lot of selling the third and fourth week in February last year, then we had the Brexit election in the spring, just a tsunami of selling. Tons of people selling out of stocks, going into bonds and CDs and cash, and then another selling spike blow off in the fall, and again, we never talk politics, but there was a lot of selling whenever Trump won the presidency, and that’s what led to that gross and dramatic underperformance that the average individual experienced in their portfolio by selling out of stocks in a year when there was double digit returns to be made with being invested in stocks.

 


7. A Diversified Portfolio Will Include Some Underperformers

So, again, the emotions, we know that they’re wrong two out of three times, and the challenging part about diversification is exactly what makes it work. By being diversified also pretty much guarantees, you know, I’d say half of our job is managing emotions, and we tell folks upfront that in every year, there’s going to be something in our portfolio that is not going to be a stellar performer. That’s just the definition of diversification. But by taking U.S. large, U.S. small, real estate, international large, international small, emerging markets, you’ve got a number of different cycles. If you want to think of that roller-coaster analogy, there’s a number of different cycles. Some might be in a full-growth mode while others might be coming down and slowing up. Some might be stalled out towards the end of summer, so to speak. You know, you do want that exposure. We positively want exposure via indexing to international developed markets and a tiny bit to emerging markets. We want exposure to real estate. We want exposure to U.S. large and small, and it’s always amazing when you take a look at an image regarding market timing, the best and worst performing asset classes, something will be Number One one year and it’s in last place the following year and may go back to number two or three the year after that. So, again, Charles Ellis wrote the book years ago, A Loser’s Game, you know, trying to time the market is a true loser’s game, and again, someone so close to that forest that they can’t see the trees, and they’re not going to be able to develop, I’d say, a world-class plan by themselves, and you’d even mentioned, Jim, I know you’ve had the pleasure of interviewing Jack Bogle a number of times, and, you know, even Jack, Mr. Bogle, has come around over the years that, you know, we do feel, you know, Jim and myself in our heart of hearts that every individual could be best served by working with a quality advisor and the value that they could bring to the table. Now, we know, you know, that you’re not going to fit a square peg in a round hole, that there’s a lot of people that aren’t comfortable, that don’t want to delegate, whoever it may be, but we’re at the point right now, with those couple of dozen of key variables that we mentioned to, you know, I’ve never seen anyone from your side, from the estate-planning side, the customized beneficiary designations, the Roth IRA conversions, harvesting capital gain, you know, the capital-gain recognition, what we’re doing on our side, the financial-wellness process, the indexing management, rebalancing the portfolios; I mean, there’s just tons of value to be added, and again, one of the big values is avoiding market timing, managing your emotions, that, again, is about one-half of our conversations that the nine wealth advisors at DiNuzzo Index Advisors have with our clients is talking to them about managing their emotions and keeping them from making a bad decision and doing the wrong thing.

Jim Lange: Well, let’s just talk about timing for one more thing, because I know you’re not a market timer, but you do rebalance. So, could you distinguish between rebalancing and market timing?

 


8. Rebalancing Portfolio Means Selling High, Buying Low

P.J. DiNuzzo: Yeah, that’s a great point, Jim. Rebalancing is a very highly structured, rule-based process that forces us to make the hardest trade on earth. When we’re rebalancing a portfolio, so if the audience, Jim had mentioned a 60/40 portfolio a couple of times, 60 percent in stock, 40 percent in bonds, let’s just say, for example, we don’t want that portfolio to get above 70 percent in stock. It’s actually more specific than that regarding each position by position, the band that we put on those positions, but what we want to do is when a position is grown above its band, we want to give it a haircut and place it in an asset class that hasn’t grown as well, hasn’t grown as fast, and, in fact, maybe has shrunk a little bit. It’s a trade that we all know is the holy grail of trades, and that is selling high and buying low, and it forces us to do that every time through the benefits of regressing to the mean with the database we have with the indexes. We’re confident that it’s not an if, it’s just a when — when is this trade going to pay off? It may pay off in six months, three months, it may take a year or two, but when everything regresses back to the mean, back to its average, you know, we’d love to buy something when it’s down 1 or 2 or 3 or 4 or 5 percent for the year, and that often is a conversation, especially with clients in the first year or two, educating them. Yes, we are selling something that’s up 25 percent or 30 percent year-to-date and placing it into something that’s down a couple percent, but again, we’re forcing ourselves to make that, you know, ideal trade of selling high and buying low, and that adds value over time, incremental value to the total return of the portfolio.

Jim Lange: Well, yeah, and it relates a little bit to the behavioral investing because when something’s going well, people don’t want to sell. But you, as a disciplined advisor, are going to, to use your words, take a haircut, which is to sell a certain position, and then, and this goes also completely against human nature, is that you actually buy something that isn’t doing well, and that isn’t timing, that is going back to your original plan in terms of diversification and asset allocation.

Well, let me ask you a question about diversification and asset allocation. So we all believe that America is a great company, and we have been schooled that the S&P 500, whether it’s a DFA 500 or a Vanguard 500, but let’s say the top 500 stocks in the United States. Why not just keep it simple and say, “OK, I’m going to be 60/40 or 70/30 or whatever is appropriate, and my stocks will just be the plain old simple S&P 500, and then I’ll have some fixed income also.” Why not just keep it simple and have large U.S. companies for S&P 500 for the stock investments?

 


9. Make Your Portfolio Globally Diverse

P.J. DiNuzzo: Yeah, Jim, and that’s a great point. That’s a confluence of a couple challenges that we have on the agenda this evening. You know, you’ve got that market-timing issue. You’ve got chasing performance along with a challenge of being underdiversified with just being the S&P, and again, U.S. large-cap stocks, as represented by the S&P 500, have outperformed international approximately the last one, three and five-year period of time, and again, the longer we get these disconnects, the more challenging it is for individuals to stay diversified. Approximately one-half of all investible assets in open and free markets on the planet Earth are in international markets. So not to have any exposure in international, when again, these cycles are very often operating at different levels and at different heights and depths than the U.S. market, you know, there’s just a lot of long-term value, and again, if our goal is to make as much money as possible with as little risk as possible at each asset allocation, you know, practicing smart diversification helps us to reduce risks that do not have any extra expected return. It’s one of the sort of few free lunches in the market, and again, we can go back and take a look at a period when people were plowing into the S&P 500 in 1997, 1998 and 1999 and the subsequent decade, and all the listener needs to do is go and take a look at the S&P 500 from January 1, 2000 to December 31, 2009 versus a globally diversified portfolio. You can’t afford, especially in retirement, or pre-retirement, those mission-critical five years prior to retirement, to make a major mistake and have the market move against you and cost yourself what was that free lunch by being underdiversified because you were chasing performance.

Jim Lange: And I think you have all kinds of empirical evidence to prove that that is true, both with the classic Roger Ibbotson, who, by the way, has been on our show multiple times, and then some of the Nobel Prize winning research of Professor French.

P.J. DiNuzzo: Yes.

Jim Lange: All right. So, you mentioned a couple times market pricing, and what is market pricing and why should we embrace market pricing?

 


10. Smart People Are on Both Sides of Every Trade

P.J. DiNuzzo: Yeah, Jim, market pricing, it’s amazing how little, I guess, individuals think about a trade when someone, you know, it may be a client or it may be a prospective client or somebody that I just meet on the street is talking about investments, and they’re going to buy an individual stock or a stock mutual fund. But a lot of times, the individual stock they’ll be talking about, you know, they’re forgetting that there’s someone else on the other side of that trade, and, you know, we say, professionally, that typically the person who’s on the other side of whatever trade you’re making is an individual investor, is a lot smarter than you think that they are. I mean, they literally are smarter than you. So you’ve got to consider, you know, they’re dying to sell something to you that you’re dying to buy, and you’d better be careful about that or vice versa. So, just taking a look at, you know, we talk about embracing market pricing, over 80 million shares traded per day, a dollar volume of over $300 billion. You know, the market is very efficient, especially over time, pricing out Microsoft, Google, Johnson & Johnson, what have you, on a second-by-second basis, and again, very smart individuals on both sides of those trades, on both sides of the trade, the buy side and the sell side, and to think that you’re going to, in a majority of situations, be able to outsmart the market with the trade you’re placing, well, that ends up in the data that we see at the end, as you referred, to Dalbar and the other specific research of individual investors underperforming.

Jim Lange: As you were saying that, I was remembering what Professor Ibbotson said. This is Roger Ibbotson, who is, again, one of the great pioneers of asset allocation, who actually talks about broader diversification completely consistent with what you are saying, that will ultimately reduce the amount of risk and increase the return. But I do want to say one thing that I just remembered that Dr. Ibbotson said. He said, “If you’re sitting around a poker table and you can’t spot the sucker, it’s probably you.”

Do you have any statistics on how do people who try to outguess the market do? You know, they say, “Oh, the new iPhone’s coming out. I bet Apple’s going to go up.” Or, “Oh gee, you know, I heard that there’s a problem with this manufacturer. I think I’m going to sell.” So, people try to outguess the market, and they do it both in terms of asset allocation and they do it also on when to sell and buy. Do we have any statistics on whether this works, or, if it doesn’t work, what percentage of the time it doesn’t work, and how these types of active money managers who are guessing about the market, how they have done?


11. The Market Is More Efficient Than Most Active Managers

P.J. DiNuzzo: Yeah, you know, just to piggyback on that, it’s interesting that you get these great minds, Roger Ibbotson, Jack Bogle, you know, you’ve interviewed numerous great minds, dozens and dozens on your radio show over the years, and how similar they’ll sound in a lot of cases. I mean, I was just thinking about Jack Bogle, you know, we’ve talked about in our shop, at our practice, at our firm, Mr. Market, and, you know, the tuition, the cost of the tuition as far as learning about how to invest in the stock market, as you said, if you don’t know who the sucker is at the table, very well it’s yourself, and Mr. Market can extract some very high tuition as far as that learning curve for individuals, and one of them in attempting as you question to outguess the market, the market’s pricing power works against the active mutual-fund managers who try to outperform through the stock picking and market timing that we discussed, and it’s amazing, you had asked, you know, one of the pieces of information that we had this evening that the data is in through the end of December 31, 2016, and over the recent 15 years, from 2002 to 2016, only 17 percent of U.S. active stock managers were able to outperform their index benchmark. So if the audience can think of it, less than one out of five of the active managers that you may think of engaging, less than one out of five was able to outperform. So, again, if they were managing a U.S. large-stock portfolio, less than one out of five outperformed the S&P 500. If they were a U.S. small-stock manager, less than one out of five, on average, was able to outperform the Russell 2000 index. So, again, it speaks back and hearkens back to that market efficiency that we’ve talked about, and this all, again, folds back into that financial-wellness process, or financial-wellness checkup, and to make it as easy as possible for our clients, we give them a little financial-wellness score. So, we’re giving them a score on their needs bucket, their wants bucket and their overall plan, so how better to support that plan, when it all comes down to probabilities, I’d love for us to have tomorrow’s newspaper or some type of crystal ball. Those aren’t available. We’re faced with probabilities, and let’s take these extraordinarily high probabilities for how efficient the stock market is and support the plan for the rest of your life to give you the highest success possible by filling those slots on the stock-and-bond side of your portfolio when we come up with that ideal asset allocation with indexes on the stock as well as the bond side.

Jim Lange: Well, P.J., I just had a guy in my office today, a retired engineer, and I think that he would rather have a root canal than pay an advisor anything. So, we were really talking about other issues other than money management. But, you know, he always wanted to pick my brain a little bit, and then he started telling me about this one particular Vanguard fund, and he was saying he wanted to invest very heavily in the Vanguard fund, and it was an index fund, to be fair, but he wanted to invest very heavily because it has been doing so well. How would you advise people who, in effect, like to chase particular funds, or even stocks, for that matter, who have, let’s say, recently done very well, or, for that matter, the opposite and done very badly?

P.J. DiNuzzo: Yeah, chasing performance, Jim, that typically blows up in the average individual’s face, just as much whether it’s with active mutual funds or indexes. You know, we had mentioned earlier the run that the stock market went on from 1995 to 1999, for five straight years, and the S&P 500 did phenomenally well, and every year that it outperformed, more and more money plowed in to, and again, this is an index, the S&P 500, whenever it blew up around March of 2000, and again, lost a total of 50 percent in 2000, 2001 and 2002 in total. So, individuals can get burned just as bad, but chasing this performance, I’ve never had an individual that I can ever recall in 28 years, and you meet an awful lot, I don’t know anyone who meets more prospects than you do, who’s ever come to us and has recently purchased a terribly performing mutual fund. People don’t do that. So what do individuals do? You know, the research indicates that individuals are doing their homework, they’re reading their Money magazine or Kiplinger’s or the Wall Street Journal or their newsletter or whatever it is, and they’re picking funds that typically are in the top 25 percent performance over the recent five-year period of time. That’s the performance that they’re targeting typically and the period, and unfortunately, those stock mutual funds, since we’re talking about stock mutual funds, very rarely continue to outperform over the subsequent five-year period of time. Actually, less than 25 percent less than even just the pure averages what your expectation would be. Individuals are thinking, “I’m purchasing 10 mutual funds that have outperformed the last five years. I’m expecting all 10, or, at least, seven or eight or nine, to continue to outperform.” And in reality, only two or maybe three in that subsequent period outperform. So it gets back to the loser’s game. I mean, chasing past performance, the average individual’s very comfortable. We’ve always called it “buying that performance.” So they’re investing in it. They feel comfortable. “Hey, this mutual fund averaged 12 percent a year for the last five years. I’m buying that performance,” and thinking it’s going to happen going forward, and again, unfortunately, as we mentioned, only in a distinct minority of cases does that occur. In a super majority of cases, they are left with a very bad experience.

 


12. Ignore the Latest Shiny Object and Stay Disciplined

Jim Lange: Well, I know, for example, a lot of people listen to, let’s say, people on the TV like Jim Cramer, and, to be fair, if you actually listened to Jim Cramer and you followed his advice, today, you would have a million dollars … if you started with $2 million! But that’s really what you’re talking about is trying to avoid that kind of noise, that kind of hot tip, that kind of, let’s say, undisciplined investing.

P.J. DiNuzzo: Yeah, undisciplined investing, being distracted by that shiny object. And as we’ve had the common thread through today’s show, Jim, it really has no positive potential bearing on your overall plan, on your household’s success in retirement, for more than a quarter century, by chasing performance. Get your plan as solid as possible. Know all of your variables. Attack those two-dozen variables as well as possible. Again, I’ve never seen anyone fail who’s managed everything that they can manage as well as possible. You don’t need tomorrow’s newspaper to be successful. Know where you’re at regarding your plan. Structure it as well as possible. Support the investments with an all-index portfolio of low-cost, and there’s no guarantee of performance. Of course, you know the disclaimers, but again, we do know how efficient the market’s been, and I tell folks all the time, indexing is done better approximately three out of four times, let’s say, every rolling 10-year period, 10-year period, 10-year period, 10-year period, et cetera. If it only did better 60 percent of the time, I’d be elated with that. Again, anything over 51 percent, when you’re in the highest competition on Earth, if the market efficiency did better 60 percent or 65 percent or 67 percent of the time, we’d be equally elated with that using that as a long-term plan for your long-term retirement success for you and your household.

Jim Lange: Well, I think sometimes people forget, whether it’s an individual stock or a set of stocks like an index fund, is that you are actually buying businesses, and usually, over time, if you buy businesses, you get a higher return than if you lend money than if you lend money to businesses. So fixed income, in effect, is lending money to businesses, buying businesses, and there is certainly a premium. That is, you can expect to get a higher amount of return if you are taking the risk of buying a company, because there is a risk, certainly in the short-term and potentially in the long run, that you’re going to lose money. But there are different types of companies, and let’s just limit the discussion for a moment between large companies and small companies, and when I say “small companies,” I’m not talking about mom-and-pop grocery stores, I’m talking about maybe a billion-dollar company. How have, say, the large companies done against the small companies, and what we have seen when we analyze portfolios is that people typically are what we would consider way overweighted in large companies and way underweighted in small. How would you advise an investor who’s trying to figure out how much they should have in large and how much they should have in small, particularly if they come to you and they’re comfortable with large because they’ve heard of all the companies in the large and even in the large indexes?

P.J. DiNuzzo: Yeah, Jim, you know, the financial markets have rewarded long-term investors. Investors expect a positive return on the capital that they supplied to the markets, and historically, you know, the equity markets we’re talking about have provided that growth of wealth, and as you said, our average portfolio that we have for our clients, if we take an X-ray of all the indexes that we own, we typically own at least 14,000 stocks in over 40 countries on Earth, and those are, as you had mentioned, two of the main asset classes, we’re all more familiar with companies in the U.S., and the large-cap stocks, I mean, the number for the last 89 years now is approximately 10 percent or a little bit over that per year, and it’s not so much the 10 percent. Right now, we would say, going forward the next 10 years, U.S. large caps may produce a 7 percent, 7½ percent, maybe 8 percent rate of return, but it may be 7 percent, something in that range. We’d be very happy if it’s 11 percent or 12 percent. But it’s all about what is that difference between owning a broadly diversified portfolio of U.S. large blue-chip stocks and what is that risk that you can earn in treasury bills or CDs? If you’re a long-term investor, that is the only thing that grows. CDs don’t grow, bonds don’t grow, and in order to be able to take that withdrawal out of your portfolio, let’s say, approximately 4 percent over time, inflation at 2½ percent, you know, the listener has a 6½ percent hurdle. You’re not going to be able to do that with CDs and/or with bonds. Small caps, we have those in every client’s portfolio, we believe there is a small-cap premium. Small caps have done close to 2 percent per year better than large caps for 89 years. I mean, albeit, we own more U.S. large cap than small by a 2-to-1 ratio, but small caps, and when you take a look at the miracle of compounding, how that money’s grown over time, are definitely an absolute integral part of what we believe should be every individual investor’s long-term portfolio.

Jim Lange: And finally, let me just ask you one other question, talking about the premiums. How does gold fit in? Because everybody’s always asking, “Well, gee, should I buy gold?” And it seems to me that gold isn’t a company, so you’re not really investing in a company.

P.J. DiNuzzo: Yeah, Jim, with gold, as well as a number of other investments, there is what we’d say is no factor or premium. Premium may be a little bit better to understand. The premiums in the market that we discussed, in your and I conversation, we were going back and forth recently, were the equity premium for stocks in that stock’s doing better than CDs or bonds. We believe in the small-cap premium that you asked me about. So, small cap’s doing better than large over time. We believe there’s a value premium. that value, we believe that it should do better than growth over time. Also, more highly profitable companies, we believe that they’ll do better than lower profitability companies over time. So you’ve got those four main premiums, and we would complement that, as well. I know you talk to your clients as well as I talk to mine and our joint clients about the benefits of momentum, as well, and momentum is not at the level of an empirical fact or premium, but DFA, for example, Dimensional Fund Advisors, does include that into the management of every one of their stock mutual funds.

Jim Lange: And just very quickly, because we’re just about out of time, but if the listeners are interested in utilizing the combination of our firm doing the strategy, the tax planning, the Roth, the Social Security, the how much you could spend, the estate planning, educating grandchildren and those types of strategic issues, and P.J.’s firm, please give our office a call at (412) 521-2732 to see if you qualify for a free consultation.

Dan Weinberg: All right, and you can also connect with Jim through his website www.paytaxeslater.com. While you’re there, you can also get a free digital copy of Jim Lange’s latest book, The Ultimate Retirement and Estate Plan for Your Million-Dollar IRA, including how to protect your nest egg from the pending death of the stretch IRA. That’s it for this installment of The Lange Money Hour. For now, I’m Dan Weinberg, and for Jim Lange, thanks so much for listening, and we will see you next time for another edition of The Lange Money Hour, Where Smart Money Talks.

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