Originally Aired: June 27, 2014
Topic: A Rational Response to an Irrational Market, with P.J. DiNuzzo
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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- Introduction of P.J. DiNuzzo, CPA and PFS
- Ignore Global Distractions, Make a Plan and Stick with it
- Real Returns Are 4% Less Than Gains of Underlying Investment
- Dedicate a Portfolio to Your Basic Needs, Like Food
- Best Advice is to Stay the Course with Some Corrections
- Set Up Different Portfolios with Specific Risk Levels
- Difficult Times Have Come and Gone Before
- Track Your Expenses on Anything That Costs $10 a Month
- The Securities Industry Profits from Investor Anxiety
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.
Hana Haatainen Caye: Hello, and welcome to The Lange Money Hour, Where Smart Money Talks. I’m your host, Hana Haatainen Caye, and of course, I’m here with Jim Lange, CPA, attorney and bestselling author of the first and second edition of Retire Secure! and The Roth Revolution, Pay Taxes Once and Never Again. Jim’s guest tonight is P.J. DiNuzzo, CPA, PFS. He is a nationally recognized expert in investment management who has appeared in or on various national and international publications and TV shows. P.J. has been rated by Paladin Registry, Investor Watchdog as a five-star advisor, scoring in the top 1 percent out of over 800,000 advisors in America. His firm, DiNuzzo Index Advisors, Inc., has been consistently ranked as one of the top 500 firms in the country on numerous occasions by multiple national publications.
Tonight, P.J. and Jim will be discussing what would be a rational response to all this market turmoil, but before we get into the meat of today’s program, we feel morally obligated to tell you that Jim does have a financial interest with a portion of our guest’s financial planning practice. Usually, his guests, whether they are IRA experts, estate planning experts or even investment experts, are completely independent, and Jim has no financial interest in any business with them. That is not the case with P.J. DiNuzzo. P.J. and Jim have an agreement to split fees on accounts that Jim brings to him and they work on together.
Typically for these accounts, Jim will meet with the clients, and either he or someone in his office will examine such issues as Roth IRA conversions, how much the client can spend, what is going on with the client’s estate plan, their retirement plan and what is going on with their family, etc. That is a different skill than managing their money. That is what P.J. and his firm, DiNuzzo Index Advisors, does. Rather than paying each of us a fee or each of them a fee, they charge a fair fee. One percent per year or less for both of the services that Jim and his office and P.J. and his office would normally charge for just investment services. Coupled with the excellent results of low-cost index investing from Dimensional Funds with P.J. and getting strategic direction from Jim and the Lange Financial Group, they believe the client is getting outstanding big-picture advice, as well as excellent money management services and all for one fair fee that is typical of just investing advice.
Before I turn it over to Jim tonight, I want to remind our listeners that the show is live, so please feel free to call in with your requests for P.J., the number is, (412) 333-9385. Again, that is (412) 333-9385. Good evening, Jim, and welcome to the show, P.J.
P.J. DiNuzzo: Good evening.
Jim Lange: P.J., right now, and we’ll get to individual questions, but the overall theme of today’s show is, what is a rational investor to do in an irrational world? And I’ve heard this from client after client, nothing is like it ever was before, completely unique and individual time and some of the trends, when I show people five and 10 and even 15 70-year periods, they often think that none of that is relevant. That’s going to be, let’s say, one of the themes I hope to talk to tonight but rather than just going on a general area, I thought I would bring up some of the individual things that cause turmoil with our markets and the way we think. Let’s start specifically with the debt situation, coupled by some populist political victories in both Greece and France and certainly those countries, particularly Greece, is really on the ropes and that will certainly have some international influence.
P.J., how do you see what is going on in Europe impacting our economy and what, if anything, should investors do about it?
P.J. DiNuzzo: What I would say, Jim, from … and there’s a significant number of topics that you’re discussing. It’s almost like a culmination here, as you said, as far as investor motions with sort of what’s going on in the four corners of the world right now. From our perspective, we’d look at this as … our response to it would be to stay on your plan, and by staying on your plan, first of all, you’d have to have a plan. Our firm does not do any projections, prognosticating. We couldn’t have opinions as far as the Euro situation and Greece and the challenges with the socialist structure economically, but one thing that’s unique as you had mentioned earlier about the track record that one of the things that you’ll hear during situations such as this is the famous phrase, “It’s different this time,” and there are a number of very unique things, again, going on across the world, but when we go back and take a look at and what drives our confidence level in our portfolio management is, we know what our U.S. large index is, small, large value, small value, have done going back to, almost back to the mid-1920s, and if we think about that period of time, some things we can’t even appreciate now regarding world wars, regional conflicts across the globe, inflation, deflation, stagflation, presidential assassinations.
Really, as trying as these times are for some individual investors, we would get back to our mantra, to stay on your plan, and oftentimes what we find when we’re meeting with individuals for the first time is, they really don’t have a plan. Under that scenario, I would agree that a high degree of anxiety, it would be appropriate because they don’t have a plan.
Jim Lange: Well one of the things … I mean, I kind of get it. I’m trying to picture what it was like, let’s even say, during the world wars, World War I, World War II, Korean War. I actually have a lot of engineers … if you want to make an engineer happy, ask them for the intricate details of the bomb shelter that they dug out, and I’m not kidding, by the way, and there’s a lot of engineers smiling right now, that they dug out in their backyard because they actually feared that there was going to be a nuclear attack, and so sometimes we think that we’re in such unique times that have nothing to do with anything else and that the scariest times imaginable and sometimes we forget, hey, we have been through, obviously not identical scary times but different times. Would you say that the people who have already gone through these different things, the world wars, the depressions, the inflation, the deflation, the stagflation, the presidential assassinations, people who were worried about literally getting blown to smithereens, that the people who actually stayed with their plan that whole time ended up doing better?
P.J. DiNuzzo: Yeah, they would have ended up doing better. The numbers for DALBAR research company out of Boston, Massachusetts, just over the past 20-year periods of time, the average individual equity investor has done between 3 to 4 percent per year, capturing only about 40 percent of the rate of return of the actual funds that they were in. Again, from our perspective when we’re doing our financial planning, retirement income planning, along and dovetailing that into the investment management strategy and asset allocations that are appropriate, that’s again what we see as that void, that lack of a plan, and in that case, as I said, if you don’t have a plan … I mean, there is going to be a high degree of anxiety in a lot of cases.
Jim Lange: All right. Now what you said, I want to dissect that a little bit because I think what you said is very important. What you’re saying is, is that this highly accredited research company came out and said that investors get between 3 and 4 percent less of an annual return than the underlying investments. Let’s say somebody is in the XYZ Mutual Fund and over a five or 10 year period, the XYZ Mutual Fund averages, let’s say, 6 percent rate of return including both dividends and appreciation, is what you’re saying is somebody who is invested in that mutual fund, and let’s forget fees for the moment, would be getting 3 or 4 percent less than the fund gets?
P.J. DiNuzzo: Yeah, with DALBAR, and if we use a round number just to make the math easy, if the average rate of return for the active mutual funded individuals are invested in over a period of time, if the total return was 10 percent, the average individual owner, their return was 42 percent, so let’s say 4.2 percent, 4 to 4.5 percent was their total return and what you see again is …
Jim Lange: Wait, so it’s a 5.8 percent difference?
P.J. DiNuzzo: Yes. Yeah, it’s astonishing, and it’s the same thing on the bond side also. Bonds aren’t any easier for the average individual to hold onto either. The average hold time for the average individual investor is approximately three years and three months, about three and a quarter years. They come to the party late and they leave the party early. They’re constantly changing their portfolio holdings, rotating every three to four years.
Jim Lange: All right, let’s bring that back to the situation in Europe right now. Let’s say right now that somebody has a well-diversified portfolio that includes some funds that have some companies that are headquartered somewhere in Europe, and right now, I know it’s pretty natural to think, “Oh my goodness, I have an interest in a mutual fund,” or in your case, because you do actually index funds, “I have an interest in index funds that are headquartered in Greece or France or one of these places with tremendous financial turmoil and I’m feeling pretty uneasy about it,” and let’s say that I get nervous, and I think, frankly, a lot of people were tuning in expecting you to say, “Oh yeah, get the heck out of everything that’s European,” but maybe the price of these mutual funds and index funds are lower exactly because of the turmoil, and that rather than it being something to be dreaded and feared, it might be an economical opportunity. Is that right?
P.J. DiNuzzo: Yes, it would be from a rebalancing portfolio perspective, it would be an economic opportunity. For … the first major asset class, if we just think of that in plain English of different areas across the world to invest in, U.S. large and small stocks, international large and small, merging markets, international large value stocks just went negative the other day. The year got off to a very nice start, but as the Euro crisis has continued to escalate, it’s showing up in the European prices, and generally, across the board whenever you’re investing in an asset class, as you said, you would hope that you know that these areas aren’t going out of business, that they are going to provide a … they’re going to regress to the mean.
I mean, if they’ve averaged a certain rate of return due to the premiums that are in that area of the market, yeah, you feel reasonably certain if you hold that over the rest of your life that you’re going to get close to that rate of return would be the expectations and again, I need to mention here, Jim, if anyone is scratching their head on this one that if you do your planning properly as we’ve discussed before, you need to take care of your food, clothing, shelter, and transportation costs, your fixed core expenses and retirement with a different type of portfolio.
That’s going to be something that’s guaranteed income and ultra-conservative portfolio, a U.S. ladder bond portfolio, et cetera, so you can truly match up the rest of your portfolio with your true risk tolerance, which is in a lot of cases, is individuals don’t have that taken care of, again, or hasn’t been any planning and then again, justifiably so, they have their entire portfolio floating up and down with the market and they’re reading the paper and watching the stock channels and looking at their portfolio and saying, “Hey, I have to grab my electric bill out of there somewhere,” and it does heighten their anxiety. They need to go through a more thorough planning process, take care of their risk capacity first, and get that out of the way where they can be able to enjoy the premiums that are available in the market over the rest of their retirement plan.
Again, we’re looking at, on average, at least a 30-year plan for every client that enters retirement. If we initially are talking to someone five to 10 years before they retire, you’re looking at a 35- to 40-year plan, and with that amount of time on your side, the probabilities are extraordinarily high that you’re going to achieve success.
Jim Lange: All right, I actually do want to get back to the different asset allocation portfolios because I think that’s really important, and it’s also very important in the context of our discussion, but one of the things that I heard was if you are … right now, let’s say Europe and international funds are down, presumably because of the exact things that we’re reading in the paper, but that you’re not going to be using that money to pay your electric bill.
That money is going to be invested in the long term, that if the price is down now because of what might be considered noise, that it actually might be a buying opportunity, and again, I know that you’re not an active money manager trying to outsmart the market, but I do know that you have both an automated and with a human eye look at asset allocation and diversification and rebalancing, so if somebody, let’s say lost a significant portion of their investment in, let’s say, international markets because it went down, that you wouldn’t say, “Oh gee, we better get out completely before it goes down more.” You would say, “Hey, this is an opportunity to actually get something,” not because it’s based on your analysis that it’s a great price but just because, based on the original plan that you had that had a certain percentage of international, you’re not lower than that percentage.
P.J. DiNuzzo: Yes, and you’d want to maintain that. Actually, right now, if you were in a scenario where you’re doing rebalancing in the portfolio and your clients are taking a withdrawal out of their portfolio, if there was a need to do the rebalancing trades in a scenario such as this, you could hypothetically be selling some U.S. large-cap stocks, which have done the best today, the S&P 500 and buying into some international large-cap stocks, which have done the worst. Again, emotionally your gut feeling when you look at that is, it’s counterintuitive. You would say, “This appears to be painful, why am I doing this?” But again, over the long run, you’re going to be well-rewarded by rebalancing in that manner.
Jim Lange: All right, so if I get this right, the natural reaction is, “Oh my goodness, Europe is miserable and we’ll talk about some of the other miserable areas of the world and the investment community, so I better get out,” but what you’re doing then is, you’re ultimately selling low and then when things “look good” or are back to normal, if there is such a thing, then you’re feeling good about it, then you buy. What you’re ultimately doing is, you’re selling low and buying high, which is, I guess, one of the primary reasons that a mutual fund investor gets such a small percentage, and what is it again? You said if it’s 10 percent for the mutual fund, that the average investor is only getting about 6 percent?
P.J. DiNuzzo: No, 42 percent of that number, so technically 4.2 percent is their rate of return in the last 20 years.
Jim Lange: See? That’s so incredible to me. Doing what probably a lot of people were expecting for us to say, “Hey yeah, Europe is miserable, get out of there,” or with the U.S. economy, “It’s time to gut all cash” or something like that, that if they do that type of behavior, which I think is fairly typical, particularly for a non-professional investor who reads the papers and who listens to the radio, et cetera, that they’re only going to get 4-point-something percent out of 10 percent for an investment that does 10 percent.
P.J. DiNuzzo: And what you had mentioned, Jim, whenever individuals do get out of the market and they want to get back in, generally the market has to move up at least 20 percent off of the bottom before the average individual is comfortable moving it back into the market. If you miss a 20 or 25 percent run; again, that’s one of the chief factors that contributes to that low rate of return.
Hana Haatainen Caye: OK, guys, we’re going to have to take a quick break. I do want to mention to Jim because he brought up bomb shelters, we’re one of those families that has one in our backyard. 16-by-20-foot bomb shelter, complete with air holes, an escape hatch, the whole bit. That kind of was interesting.
When we come back, we’re going to continue this conversation and I do want to remind our listeners out there that we are live tonight. If you have any questions for P.J. or Jim, please give us a call at (412) 333-9385. We’ll be right back with P.J. DiNuzzo and Jim Lange on The Lange Money Hour.
Hana Haatainen Caye: Welcome back to The Lange Money Hour. This is Hana Haatainen Caye, and I’m here with Jim Lange and P.J. DiNuzzo.
Jim Lange: P.J., it’s actually interesting that you mentioned something about sticking with your asset allocation because I remember that one of my favorite financial authors of all time, Jonathan Clements, formally of the Wall Street Journal, used to say, “It’s more important to stick with your financial plan and your financial asset allocation than actually having the best one to begin with.” In other words, whether you’re somewhat conservative or in the middle or even aggressive, that it’s better to kind of stay the course, but I wanted to go back because you said something about, if you’re counting on your international stocks, for example, that typically are the most volatile or emerging markets or something like that, to pay for your electric bill next month, then maybe it would be pretty nerve-wracking to have investments in some of these volatile areas, but you also mentioned that you really, literally have different asset allocations for different purposes. Now I think a lot of people think that intuitively.
For the next year, I want to have most of my money in cash in something very conservative, then maybe one to five years, a little bit more aggressive, six to 10 years, et cetera. Can you talk … but usually, most financial advisors and for no other reason other than perhaps it’s just additional work to set up separate accounts, can you talk a little bit about separate accounts and different asset allocation strategies for different purposes of the money?
P.J. DiNuzzo: Sure, Jim. This all goes in with the heavy lifting up front instead of just everybody wants to get out there and just manage money, but there’s a lot of groundwork that needs to be laid first, and what we tell clients after we’ve gone through a personal balance sheet for them, their assets and liabilities, and a current income statement, retirement projections, one of the things that we’ll tell them hypothetically, if they were to mentally just hypothetically bring all their portfolios in and we were to monetize that and stack up their money from the floor to the ceiling and take a look at that stack, dollar bills towards the bottom of that stack versus the middle versus the top, although they may look the same when we pull them out of that stack, are really quite different. The initial at the bottom regarding cash reserves, if you have 12 months set aside for your average monthly expenses, at least 12 times that number, then the next … of course, that would be zero in stock, zero 100, certainly FDIC insured on most of those assets.
Then for that risk-capacity bucket that’s going to pay for that food, clothing, shelter and transportation, if we’re building a portfolio that, we’ll be somewhere between 20 and 30 percent in stocks … let’s say, on average, 25 percent in stocks and 75 percent in bonds, and you take a look at the last 50 years, even including ’08, ’09, the worst year for that, that portfolio, the worst year it was down approximately 5 percent. That’s something that, to have that extra growth, that most people can live with. Of course, if they couldn’t, then we make it more conservative.
The next layer for the rest of their expenses, and again, you mentioned earlier about maintaining purchasing power and a sensitivity of inflation, whenever you’re going through these periods that we’re going through right now, inflation is certainly not at the top of the average individual’s mind regarding investment management, but again, if you have a 30-year-plus plan for retirement, it is going to have a significant effect on your purchasing power for the rest of your life.
Let’s say at the end of the day on that portfolio, when you enter retirement you’re at 40 percent in stocks, 40 percent in stocks and 60 in bonds, then oftentimes clients will have money left over at the top of that stack, at the top of the pile, and say, “You know what? We’re analyzing this. We’ve done all of our cash flow, we’ve looked at this. We really have a pragmatically, just a very good feel for how everything is flowing and we’re probably not going to touch this money at this top of this stack, so this really is our legacy bucket.”
We just refer to it as the DiNuzzo money bucket stack analysis, so we stack this up and we assign it to different various buckets, and we often end up with three different asset allocations. One for that food, clothing, shelter and transportation, the guaranteed income. The next one for the risk tolerance, and the top one for the legacy, and that’s where we’ve come in contact with a lot of (inaudible) from the other side for the Roth IRA conversions, and really, this is on a time horizon based on children, grandchildren, heirs, et cetera, and those portfolios are often only 70 percent in stocks, up to 100, and those can be very comfortably maintained because you understand that those time horizons are at least 30, 40, in most cases, 50, 60, 70 years or greater.
Jim Lange: Yeah, and that’s actually very interesting. We actually had a show that talked about different ways to invest different types of money. We were talking about how to invest IRAs and how to invest what’s called after-tax dollars and how to invest Roth IRA dollars, and if you’ll recall since my general preferred method of spending is to spend the money that you’ve already paid taxes on before your IRAs, and to spend your IRAs before you spend your Roth IRAs and to spend your Roth IRA dollars last, that’s kind of consistent with the bucket theory, which the Roth IRA is most likely what you might call the legacy bucket, and that might be invested, as you said, 70/30 or even 100 percent in stocks, which still, you’re getting safety through the enormous diversification. What is there … even with your 100 percent stock portfolio, what is it? Something like 18,000 companies represented …
P.J. DiNuzzo: Yeah, 18,000 stock worldwide in over 40 countries, so yeah. True full diversification.
Jim Lange: Yeah, so what you’re doing is, you’re getting your safety not necessarily by running to bonds. They’re going to pay not a lot in today’s dollars, but for long term money, you’re getting your safety through diversification, and if it goes up a little, down a little bit, you can probably live with it if it’s long term, and then let’s say for the more intermediate that might be IRA dollars, then you’re still going to have a different asset allocation than you are for, let’s say, this short term, either one year or even years one to five.
P.J. DiNuzzo: Yes, and that is correct, Jim. That ties in exactly to which you had in I know at least one of your books, that we are recommending … on average, we’re spending from the non-qualified taxable accounts first and generally sometimes there will be a blend in there because most clients, we want to identify over a long period of time. Again, we’ll set a minimum threshold on a lot of clients, we’ll agree on a minimum comfort level, so we’re taking assets out of those accounts, then secondarily, the IRA accounts as you mentioned and our final option is the Roths. We want to let those ride. In a lot of cases, we never even come close to touching them. It’s just from the taxable accounts plus the IRA assets.
Jim Lange: Yeah, I mean in a way I think that’s so smart because I’ve been intimately involved in probably hundreds of millions, maybe even billions of dollars of Roth IRA conversions that we have recommended or that we have ran numbers for or that, as a result of the talks that I’ve given all over the country or even the book, The Roth Revolution, and it’s pretty rare that I hear people actually spending the Roth IRA. Usually what seems to happen is and particular after our firm runs numbers — and we’re usually not fans of huge whopper conversions but a series of small ones — is that that money really is never spent and a lot of the conversions that I oversaw, let’s say, in the late ’90s and early 2000s are still sitting there, and that is the intent and it just makes sense that that money that will eventually go to children or even grandchildren.
I know in my own case, my wife and I made a Roth IRA conversion of $250,000 in 1998, and it is likely that we will never spend that money and that that money will go to our children or even potentially grandchildren, so it doesn’t make sense no matter how bad the euro is, no matter what’s going on with the populist political victories in Greece and France, to invest that in terms of a short term investment and that actually might, through rebalancing and specifically if I’m setting that account in a separate account that’s being managed differently, we have a much greater opportunity for significant growth, don’t we?
P.J. DiNuzzo: Yes, that is correct and just a … and I always draw back to one of the few things that supposedly intrigued Albert Einstein while he graced us, while he was on Earth, was the miracle of compounding. It may not seem like a lot. Again, numbers really don’t transfer too well through the radio waves here, but to compound at 2 or 3 or 4 percent or greater, something growing at 8 or 9 percent versus 4, 5 or 6, your grandchildren will have a very large smile on their face.
Jim Lange: Yeah.
Hana Haatainen Caye: OK, we’re going to take another quick break and when we come back, we’ll continue this conversation. We’ll be right back with P.J. DiNuzzo and Jim Lange on The Lange Money Hour.
Hana Haatainen Caye: Welcome back to The Lange Money Hour. This is Hana Haatainen Caye, and I’m here with Jim Lange and P.J. DiNuzzo.
Jim Lange: P.J., one of the things that I kind of get what you’re saying about some of the anxiety in Europe and the big, long picture, that this might be a buying opportunity but certainly not a situation where you want to dump everything. Let me tell you what one of my personal fears is, and I’m not quite sure what to do about it, both as a person and investor and somebody who gives advice to the public. Right now, we don’t know exactly what’s going on with Iran, but there is at least a reasonable chance that they are attempting to develop a nuclear bomb and nuclear material that could potentially be detonated, whether it be on Israeli soil, in Europe or even smuggled to the United States. Pakistan has quite a bit of … and that’s documented and known nuclear capabilities.
North Korea is also scary to me, and perhaps some of these countries might not even detonate something themselves but they might distribute to fundamentalist extremists and I would say even … I don’t mean to be a doom and gloom guy, but there’s lots of other opportunities for terrorists with chemical plants and transportation and stadiums and things like that, and as tragic as 9/11 is or was, there is the possibility of something on an even greater scale. How would that enter into the investment picture, if it does at all?
P.J. DiNuzzo: Well, that would enter, and Jim, I would just consider that under the same category of the responses that I had earlier in that we always think that it’s unique and what we’re going through and anyone’s individual life that other individuals haven’t gone through before, but we really have gone through never the exact same thing but it certainly rhymes with what we’re looking at now and again, to go back to our plan and if you stay on your plan and you have one, if you have your cash reserves amply funded, if you have your food, clothing, and shelter budget, if you will, your portfolio funded and you’ve got a moderate allocation in your risk tolerance, there’s really nothing you would want to do to upset any of those areas. Now, sometimes individuals will, in their cash reserves, have an extra item and be over and above what our recommendation is, and sometimes the topic of gold or precious metals will come up.
Very rarely would you ever see anyone, I think, responsibly, generally speaking, talk about having more than 5 percent of precious metals in your portfolio. Even for consideration, a million dollar portfolio, if someone had $50,000 dollars in gold, gold coins, et cetera, that would be a very large, a lot higher than the national average, certainly, but really that would be the extent of protection as far as portfolio insurance, just reacting … human emotions and there’s a lot of folks even on talk shows that give advice, and that’s really great that you brought that up because I’m just thinking of one thing that we run into an awful lot and we tell people that we talk to, both clients as well as prospective clients when we’re doing consulting work, that if you’re going to pay attention to anyone regarding investment advice, to only listen, and I can repeat, only individuals who are managing material money, that they’re managing large assets, not just a small amount, and that they have a, again, material track record, that they’ve been doing this and there’s a track record at least going back for decades.
What you’ll notice is most of the people that get people excited are not professional money managers. They’ve never managed a penny in their life, and if they have managed anything, it’s a small amount and or they don’t have a track record, so it’s completely different. When you put it in a context and these individuals have gone out there trying to grab sound bites and hoping, “Hey, if I throw enough things up against the wall, I’ll get a national quote at some point in time,” but when you go back and take a look at the things that they come up with, it’s … at the end of the day, it’s amazing how many times two, three, four years later, you look back and say, “Everybody was reacting to that individual and how ludicrous it is a couple of years later. Thank goodness I didn’t fall for that crazy advice.”
Jim Lange: Well, that’s pretty interesting because even if we think back about 2008, with the meltdown of some of our financial institutions, that if people had had their cash and short-term money set aside, that they would actually do pretty well. For example, can you give us a rough idea of, let’s even say, the worst 10 years, which is the last 10 years in the market, how people would have done with, let’s even say a 60/40 portfolio using the index funds that you promote, which are Dimensional Funds and through Dimensional Fund Advisors. Would they have done pretty well even with all the turmoil that we did experience?
P.J. DiNuzzo: We can argue that the first 10 years of this century that we’re living in right now was arguably, if we go back 150 years, the worst decade from a lot of perspectives, and our average 60/40 portfolio was north of 6 percent on an annualized rate of return after all fees, expenses, et cetera. We have to be careful how far we’re beating ourselves up and we’re talking about how bad the market can be. We never want to challenge the finance gods, as we say, that’s with a lowercase G; we never want to challenge them, but you would have a hard time replicating another 10-year period such as the last 10 when you had two uber bear markets, 2001 and ’02 and then ’08 and ’09 contained within that decade, and yet we still had a very reasonable, positive rate of return in the portfolio, and again, just to put it in perspective, with that 40 percent stock portfolio we were talking about earlier, Jim, that was down in the worst year in the last 50 years, about 14 percent, 20 percent stock portfolio was just down 4, 4 and a half. You can dramatically protect yourself with the asset allocation if it’s structured properly in your portfolio.
Jim Lange: Well let me ask you this, so right now I know that there’s a lot of people who are freaking out. I see them in my office if not every day, at least quite often. I’m thinking about one woman, “Oh no, everything is different,” and I’ll tell you what else is funny, I certainly have a lot of different type of clients but I have actually two groups that I do a fair amount of work with. One are the college professors, and they’re certainly a very bright group and politically, they tend to be on the liberal side, and I also work with a lot of engineers and they’re also a very bright group and they tend to be on the conservative side and the engineers say, “Oh man, this country, if Obama gets elected, we’re just going down the tubes. It’s going to be terrible. I’m really afraid, more afraid than I’ve ever been.” And then you talk to the college professors and they say, “Oh man, the way the economy is with those Republicans, I’m so afraid.” It’s interesting, and I guess your reaction is, whether you’re a Republican or a Democrat, that the best thing to do is to start with a good long-term financial plan and then stick with it, is that fair?
P.J. DiNuzzo: Yeah, that’s correct. Not to start backward and picking investments and letting that lead your decisions. You really need to start with a good, solid plan and work forward, and then surprisingly, if you just follow your nose, when we go through the process with prospective clients and clients, it really is … even though we arguably are talking about very high-level concepts, it’s brought down to a very blue-collar level and very understandable.
Jim Lange: Well what you do, frankly, and I’ve been in business over 30 years, I’ve never seen any financial advisor do the detail work that you do even down to the cable bill and the phone bill and you do that to help you develop those different buckets that you were talking about, is that right?
P.J. DiNuzzo: Yeah, that’s correct. I mean it seems rather anal, but we tell clients, if it’s $10 or more per month, we want to capture it and we do a very … categories in there for adult beverages and different things as well, so we’re making sure we’re taking care of everybody… I’m a wine guy myself, so we want to make sure we got that red wine. I want to make sure I got that in the budget, but yeah, it really is important and really brings a lot of confidence to it because one thing that we tell individuals is that we’re not going … we can’t just sit there. A lot of times people come in and they expect, OK, you’re the expert, give me the answers, and some people are a little bit dismayed in initial conversation when we tell them, really as far as this goes, we’re in a room full of equals and it’s a collaborative process.
It’s customized for each and every individual and new family-unit individual that we come into contact with, and if we work through it together and they’re surprised at how well it comes into focus and how much of it they understand, and also how high of a comfort level that they have and we’ve been told numerous times over the years that there’s … people joke around like you said, they come in your office. We hear, “Hey, it’s hard to tell you guys apart. You all wear suits and you talk well, etc.,” but at the end of the day, we’ve heard … I can’t even put a number on it, of how many people have said, “When I get a lot of answers from people and they tell me what to do and give me your life savings, let me manage it, but they don’t know any of the data or any information we just went through.”
“They don’t know what my home equity line of credit payment is, what my electric bill is, what my car payment is, if I have one,” and they understand. I’ve often said that Pittsburgh and Pittsburgh investors in the town is not … don’t just inherently … I mean you do in your client base, but they don’t really have a Ph.D. in life, I mean a Ph.D., but they do have a Ph.D. in life, not in investing and just a lot of blue collars. It’s a very high common-sense level in and around Pittsburgh and southwestern Pennsylvania and the process that we go through really appeals to that Ph.D. and common sense that Pittsburghers have.
Jim Lange: Yeah, I sometimes think of the millionaires next door that I think both you and I service and I know I particularly have a lot of clients, and what’s interesting is, this is something that a lot of Pittsburghers and let’s say the two groups have in common, the engineers and the college professors, where a lot of my clients started life with not a lot of money. They got married even relatively young and they had the mortgage payment and the car payments and the kids’ braces and then the kids’ college and it was really tough to save money, but when they put away money in their retirement plans and a lot of them are IRA-heavy, but there’s often a huge difference between what they had, even if they made the same amount of money and it all comes back to the asset allocation that they chose for those many years.
For the people who were, let’s say, risk-averse or trying to time the market, they often got hurt and they might have 50 percent or less of the people who had a better asset allocation, recognized that the money was long term and had the money more in the market and particularly in your case, with the 18,000 different companies and the extreme asset allocation, and the other thing that you guys do that I like is that you tend to weight or overweight areas that have traditionally done better, like small-cap versus large-cap or value versus growth.
P.J. DiNuzzo: Yes.
Jim Lange: Well, let me ask you this, there’s all this anxiety out there, and like you said, the average investor is getting 6 percent less than the underlying investment that he is invested in or she is invested in. Who benefits from all this anxiety? You hear … I don’t want to name names because I don’t want to be sued, but you see crazy people running up and down with their hair on fire on TV and on the radio, warning people about this and that. Who is this anxiety serving?
P.J. DiNuzzo: It really, at the end of the day, again, it is the people, the financial media and the securities industry. The securities industry, on average, loves anxiety. They love turnover in a portfolio because turnovers equal cash flow. They really don’t have any inherent reason to be behind a buy-and-hold strategy. I’ve been amazed, and every time I hear the story over the years when someone will come in and they’ll bring a family member in and sometimes it’ll be a middle-aged client and they’ll bring Mom or Dad in or Mom and Dad and they’ll say, “Mom and Dad are just getting some really terrible service and I just can’t get over … They have a portfolio and it’s a sizable portfolio every time when they discuss it and they’ll say, ‘I just can’t get over … they’re not getting any service, any recommendations, any help, et cetera,’” and I’ll just respond by saying, even without knowing anything about it, I’ll say, “Well they’re just buying and holding. They’re just holding onto the stocks that they have in the portfolio,” and every single time the son or daughter will say, “Well how do you know that? You don’t even know anything about them,” and I’ll say, “Well that’s why they’re not hearing anything back from their guy because there’s no revenues there, there’s no income there.”
It’s really the more you can get people excited and anxious, the more trading there’s going to be, and again, the securities industry just loves it. You take a look at any of these periods of high anxiety, all of the, let’s even say lower cost brokerage firms, the discount shops, their volumes just spike through the room, and it’s an extraordinarily profitable period for them from trading expenses.
Jim Lange: Yeah and see, where you and I have a different model, which is what I would call a true fiduciary model, where we both not only have a moral but a legal obligation to do what we think is best for the client, so rather than charging a client every time we buy or sell something, we actually have a fee, which I mentioned earlier, that we split. Me doing the, let’s say some of the conceptual stuff, the Roth stuff, how much you could spend, some of the tax savings, estate planning, retirement planning, et cetera.
You’re doing the investments, and we don’t make money every time there is a buy or a sell, and that’s actually a much different model, and the other thing is and I don’t want to mention any companies but we have a moral and legal obligation to do what is best for the client, not what is best for our employer or the wirehouse or whatever financial company that somebody is working. You also sometimes talk about what you call the mall location of capital and I know that we have quite a few golfers out there, so maybe you could change this to a golf analogy to the types of investment mistakes people make and who does well in the long run.
P.J. DiNuzzo: Yeah, it seems like a lot of the younger authors have been spinning … Charlie Ellis, decades ago had written a book and basically, a lot of people just refer to it as, “how to win the loser’s game,” and in it, he was a tennis fan and it’s the exact same story with golfers. When you talk to world-class golfers or world-class tennis players, you’ll get the same response when you ask them, “Well how do you win? How are you at this extraordinarily high level?”
And everyone expects them to say, “Well I’m out hitting the ball. I’m hitting it harder or longer or faster, etc.” But what you’ll hear from them time and time again is that “My goal is to have the fewest errors and make the fewest mistakes and that the fewest errors and fewest mistakes equals success,” winning the tournament, winning the championship, et cetera, and it’s a direct story, direct analogy into our business when we start off with using strategic asset allocation. Jim, you mentioned earlier, not being tactical, not trying to time the market, which a lot of people are going through this emotional pull right now. Oh, looks worse. I had 70 percent in stocks, I’m going to move down to 30, cut it in half, what have you, then to diversification, indexing versus active and rebalancing. Buy along those four major road markers in investing, you’re going to have less errors and less mistakes at every fork in the road, which is going to put you in the winner’s circle at the end.
Jim Lange: Yeah, it sounds a little bit boring. You’re not going to have the thrill of doubling, tripling or even doing better with your Apple stock, for example, but you’re also not going to have the enormous losses that you might with a more active strategy, and it sounds like this is actually what some of the writers might call kind of a grown-up approach, which is a series of low-cost index funds using well-diversified portfolios, and in your case, actually the different buckets of different portfolios.
P.J. DiNuzzo: Yes. Slow and steady wins the day. When you talk about the adult approach, I would say Jack Bogle of Vanguard is the ultimate adult. I mean, he’s the senior member of our area of the world, and Jack has been preaching the benefit of indexing since the 1970s, along with the team at DFA and yeah, the ultimate adults, slow and steady, minimize your errors, and have a plan and stay on your plan.
Jim Lange: Well, we don’t have time to go through the actual investment results but they are pretty impressive.
Hana Haatainen Caye: OK, I want to thank you for listening to another Lange Money Hour, Where Smart Money Talks.