Episode 110 – Government Gridlock & Retirement Planning with guest P.J. DiNuzzo, CPA, PFS®, AIF®, MBA, MSTx

Episode: 110
Originally Aired: December 10, 2014
Topic: Government Gridlock & Retirement Planning with guest P.J. DiNuzzo, CPA, PFS®, AIF®, MBA, MSTx

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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Government Gridlock & Retirement Planning with Guest P.J. DiNuzzo, CPA, PFS®, AIF®, MBA, MSTx
James Lange, CPA/Attorney
Guest: P.J. DiNuzzo, CPA, PFS®, AIF®, MBA, MSTx
Episode 110

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TOPICS COVERED:

1. Guest Introduction: P.J. DiNuzzo, CPA, PFS®, AIF®, MBA, MSTx
2. Investment Strategies
3. What’s an Index?
4. What are the Differences between the Indexes?
5. Working with Lange Financial and DiNuzzo Index Advisors

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1. Guest Introduction: P.J. DiNuzzo, CPA, PFS®, AIF®, MBA, MSTx

David Bear:  Hello, and welcome to this edition of The Lange Money Hour, Where Smart Money Talks.  I’m David Bear, with James Lange, CPA/Attorney and author of two best-selling books, Retire Secure! and The Roth Revolution: Pay Taxes Once and Never Again.  As everyone knows, congressional gridlock shut down the federal government for two weeks and threatened the country’s credit rating.  While an eleventh-hour short-term solution seems to have been reached, what long-term impact might continuing political turmoil have on your retirement portfolio?  For perspectives on building the kind of retirement plan that can weather future political storms, we welcome P.J. DiNuzzo back to the show.  A nationally recognized expert in investment management, P.J. has been featured in numerous business publications and TV shows.  Approved as one of the first one hundred Dimensional Fund advisors, he’s rated a five star advisor by Paladin Registry investor watchdog, scoring in the top one percent of America’s more than 800,000 investment advisors.  Based in the Pittsburgh area, his firm, DiNuzzo Index Advisors, also consistently ranks among the country’s top five hundred investment companies.  In addition to potential financial repercussions from governmental gridlock, Jim and P.J. will focus on investment strategies to maximize your portfolio over the long run, including a ten-step roadmap for retirement income success.  It’s sure to be an interesting, informative hour, and listeners, since the show is live, you can join the conversation by calling the KQV studios at (412) 333-9385, and with that, I’ll say hello, Jim and welcome, P.J.

P.J. DiNuzzo:  Good evening, Dave.

Jim Lange:  Hi P.J.

P.J.:  Hey, Jim, good evening.  How are you doing?

Jim:  Good, good.  Before we get into the meat of the show, I do feel honor-bound under the full disclosure concept to disclose that I am not independent of you.  So, for example, when we have Ed Slott on, or we have John Bogle, or Jane Bryant Quinn, or any of the various experts that we have had on, sometimes I do put a little plug in for their books.  Ultimately, I have no financial interest if somebody buys their book, if somebody doesn’t, if somebody uses their service, or if somebody doesn’t.  I don’t think it would be fair if I didn’t disclose that I do have a financial interest in working with you, and I should describe that for a minute before we get into the essence of the…or the meat of the show.  P.J. is, I believe, one of the, if not the top money manager, certainly in the area of using low-cost index funds, and I have been extremely impressed with his work, particularly after working with him.  And to oversimplify the situation, if you were to go to P.J., and let’s say you had never heard of me, and let’s say you were going to say, “Well, here, P.J.  We’re interested in investing $500,000 with you.”  He would charge roughly one percent of the amount that he is invested (to be more technical, one-quarter of one percent per quarter).  If, on the other hand, you were to meet me, and you were interested in things like Roth IRA conversions, Social Security maximization, tax planning, estate planning, etc., but you were also interested in investing in low-cost index funds, P.J. and I have an arrangement whereby he would actually do the investments.  I would do the, let’s say…or I shouldn’t say ‘I’ because I have to include my office too…but I and my office would do things like Roth IRA conversions, Social Security, tax planning, how much you could spend, estate planning, etc., and what we would do is, we would charge a total of one percent.  So, rather than paying P.J. a fee and rather than paying me a fee, you would pay one fee, and then P.J. and I split this fee.  So, if you like some of the things that you hear tonight and you are potentially interested in working with the combination of me and P.J., you should know ahead of time that I do have a financial interest in you working with P.J. and me.  So, before I get into the meat, I just wanted to explain that.  Is that a fair characterization, P.J.?

P.J.:  Yes, very fair, very accurate.

2. Investment Strategies

Jim:  All right.  So, why don’t we get into the meat of tonight’s show, and of course, what’s going on in everybody’s mind right now is the shutdown, and perhaps even more scary for me, is potentially not paying our debts.  P.J., can you tell us a little bit about what you think is going on, and maybe how you think investors should react to this news?

P.J.:  Yeah, Jim.  You know, what we say is, we look at this, and we’re not being flippant or insensitive to it, but basically, we would look at, you know, what’s currently going on is basically market noise, and we would refer to it as noise for a long-term investor.  When we take a look at, as you and I have talked before, and as we know, we’ve got an 85-year track record with the indexes that we follow, U.S. large stocks and small stocks, and there’s been a lot worse things, such as World Wars, presidential assassinations, inflation, deflation, stagflation, etc.  So, again, not to be casual about what we’re going through now, but these things always get worked out one way or the other.  We’ve got a long-term upward growth bias just in our economy growing by two or three percent per year, a little bit of inflation on top of that.  So, there’s been an upward growth bias in our economy for the last couple hundred years.  So, we feel confident that that will continue to manifest itself in the near and intermediate future and long-term, as well.

Jim:  Well, this sounds like the opposite of a timing strategist.

P.J.:  Yeah!

Jim:  I can picture some people saying, “Oh my goodness.  We’re going down the tubes.  We’d better sell everything and convert to cash and bonds.”  And I can picture other people saying, “Oh boy, we have all this fear out there.  This is actually a great time to buy.  So, we’re going to jump in the market.”  So, you have some people that want to jump out and some people that want to jump in, and you’re saying (if I’m understanding you right), “No.  Now is basically the time to hold the course,” if you will.  Is that a fair characterization?

P.J.:  Yeah, Jim, that’s a good characterization, and as you know, intimately, you know, we walk all our clients that we work with through jointly as well as ourselves independently.  So, that was a very good point you made earlier that our clients we work with jointly are getting both of us, you know, your entire office and all of your resources, as well as our entire team, for the same price.  And as we walk them through the process, one thing that’s very unique is really identifying four individuals.  If anyone’s listening, they’re thinking, like, pre-retirement where they’re getting ready to retire, you know, the questions…when we take a look at individuals cases, they’re often off by hundreds of thousands of dollars regarding how they’ve been working with someone and what they should allocate towards…we would call it their ‘needs’ bucket: food, clothing, shelter, healthcare and transportation.  We just met, actually, with a prospective client last night that had over allocated about $150,000 to almost $200,000 to that needs bucket that they didn’t have to.  If you’re paying for some type of guaranteed product, if it’s an annuity, you know, why tie up money for the rest of your life paying three percent per year in expenses when it could be one percent?  So, it’s all really about customizing that process, and we find whenever we go through these periods of market tumult, that it’s a lot easier for clients to stay in their seat if they have, on average…we’ve got three strategies for the average client that we work with who’s retired, but a specific conservative strategy for those needs, a strategy with a little bit more in stocks, but still, we call it a ‘moderate’ strategy for their wants, and then growth in their portfolio for their wishes and dreams, and for their…we call it ‘legacy’ for their children and grandchildren and charities and the quality of life while they’re living.  And a lot of clients, as you know, Jim, that’s where we’re having, for a lot of clients, the most growth in their portfolios, which you’re the expert in, in the Roth IRA conversion area.  If we think of our money stacked from the floor to the ceiling, that money at the top that we’re never going to touch, it’s great to place it in something from 70% of stocks up to 100%.  It’s going to have great growth over the rest of their lives.

Jim:  All right.  So, let me understand this: let’s say somebody comes in with ‘X’ amount of dollars, and do I understand that what you’re saying is you’re going to try to actually calculate how much money they need in terms of cash for their basic needs, for their shelter, for their food, for their clothing, for gas in the car, and you’re going to allow a certain amount of time, maybe depending on preferences, and having that money in a more liquid, and perhaps, a lower return investment?

P.J.:  Yeah, lower volatility, something generally 20%, 25%, 30% in stocks, and really, the key is, Jim, that individuals just don’t know this.  I mean, it’s not an IQ test, so to speak.  They can be an engineer, an architect, they can be an attorney, a CPA, it doesn’t matter.  But most people, I think everybody, in life has a gift, that they’re an expert at something, but most people aren’t experts at multiple categories in multiple disciplines.  So, if they are an expert in those categories, they’re generally not an expert in the area of personal finance, and they really just don’t have any idea of really even, “What are my expenses?” while they’re working, let alone projecting these forward into retirement.  You know, “What are my need expenses going to be?  What are my want expenses going to be?”  So, that’s where you and I, with our teams, come in to be able to provide those answers and solutions.

Jim:  Well, I mean, I think most financial advisors…let’s say a client goes into the financial advisor and they ask them a bunch of questions about their risk tolerance and what keeps them up at night and things like that, and then they might say, “Well, okay, based on everything that you say, we’re going to recommend a portfolio of 60% stocks and 40% bonds, and so much in large cap and so much in mid cap and so much in small cap and so much in value and so much in growth and international, and then all the subdivisions thereof.”  But ultimately, they’re going to have in the…it might consist of a number of investments, but it’s basically one general asset allocation.  What you’re describing (if I understand this right) is several asset allocations within one portfolio.  Is that fair?

P.J.:  Yeah, under one household, under one roof, on average, we have three different strategies.  And what you mentioned, Jim, was exactly correct in that a lot of people, and in fact, most of the individuals that come to us, they’ve been bundled in a portfolio.  They may have 60% in stocks, or 70%, and if you’ve got a portfolio, for example, when you take a look at a lot of money that fled the equity capital markets in 2008 and 2009, if you had 60% or 70% of your portfolio exposed to stocks, and that was the money that was earmarked to pay your electric bill or your gas bill or your property taxes, etc., it’s no wonder why people, when their portfolio was down 30%-35% or more, that’s just too much to handle for those need expenses.  You really need a portfolio for those expenses, what our professional opinion is, that won’t drop by more than 10%.

Jim:  All right.  By the way, is that not more work if you have multiple portfolios for each client?

P.J.:  Yeah!  Yeah, it’s a lot more work.  It’s a lot more of a pain.  You know, I’m sort of old fashioned.  I mean, it’s almost like the military ‘be all you can be.’  There’s a right way of doing things, and it’s a lot more aggravating, and the first consultation when we sit down with individuals, it takes almost the whole entire meeting, and we tell folks that we sit down with, “You know, please be patient.  It’s taken you and your wife,” you know, generally, we’re meeting with spouses, but it can be an individual, you know, managing the household.  But whether it’s an individual or a dyad, you know, a husband and wife, “It’s taken you forty years, approximately, to accumulate all these various types of assets that we’re going to analyze over the course of the next few weeks, or next month.  So, you know, please be patient.”  But just that first meeting, capturing assets, liabilities, income and expenses, and then be able to sort of normalize that for retirement, that’s almost the entire first meeting.  So, as you said, most advisors don’t want to do the, you might refer to it as, grunt work.  They just want to say, “What do you have to work with?  Let me get in there and start…”  As a lot of people in the investment world say, “Let me run the money.  Let me just start investing this.”  But they really don’t take a look at getting to know each family and each household on a personal level.

Jim:  Well, by the way, I will personally vouch for this because I’ve seen you in action, and in all fairness to people, you know, I should mention that we have roughly $88,000,000 that we are managing together, that is, you’re managing the actual investments, and I’m involved in some of the tax strategies, and I will tell you that people are really amazed at the amount of time that you put in, and it seems to me that if you have money set aside for basic needs for a certain period of time, that if you have a 2008 situation where the market goes way down, you can have the luxury of saying, “Okay.  Well, the market’s way down, but the money that I need for the next two years (or whatever the period might be) is already safely put away in cash and CDs and income that we were expecting through Social Security and a pension.  And therefore, rather than panicking and selling when it’s low, I can just maintain the course and not sell,” which has consistently happened, and perhaps you’ve had to wait a little bit, but the market comes back.  You didn’t turn out to lose any money because you were spending money that was allocated for short-term needs.  Is that also a fair characterization?

P.J.:  Yeah.  It’s just a lot easier.  As we tell folks, it’s a lot easier managing this proactively ahead of time, rather than…what happens to most folks is, you know, they gave their money to someone.  They’re ‘running the money.’ They’re just looking at it more from an investment perspective, and then whenever the you-know-what hits the fan, then they’re calling their advisor.  “Hey, just what exactly, what are we doing?  Why are we doing it?”  So, we’ve got a reason for everything.  So, again, it makes it a lot easier for clients to stay in their seat and not overreact when they have a conservative strategy for their conservative goals, a moderate strategy for their moderate goals, and a growth goal for their growth goals.  It sounds overly simplistic.  It just takes a lot of front-end time to get it set up, but once we get it set up, it works like a charm.

Jim:  Well, it does sound like a lot more work, but the other thing that I like about it is that it kind of takes some of the emotions out of investing, and I would imagine that a lot of people and a lot of investors really shoot themselves in the foot by leading with their emotions instead of just having kind of a calmer, steadier, more rational approach.

P.J.:  Yeah, you know, the behavioral sciences have won the lion’s share of Nobel prizes the last decade or so.  That’s really the emotions of individual investors why, when you take a look at Dalbar, an organization out of Boston that tracks these things, you know, how has the S&P 500 index done over 8% the last twenty years while the average individual managing their own money has done just a little bit over 4% with their stock component.  So, you know, really, they’re looking at it under that sort of big basket approach, and they come to the party late, they leave the party early, you know, they buy when the market’s too high, they sell when the market’s low before it fully turns around, and that’s really what a fully disciplined, complete financial approach that we work as sort of a recipe with DiNuzzo Index Advisors and the Lange companies put together to be able to cover, what we say, all four corners of your personal finance home to be able to have all of these questions answered ahead of time, and nothing’s perfect or easy, but it does make it a lot more reasonable to be able to live through these market volatility and market gyrations.

3. What’s an Index?

Jim:  All right.  Well, that’s about the third time you used the word ‘indexes,’ and I think some of our listeners are certainly aware of what an index fund is, but for those who aren’t, or for those who understand some, and the name of your firm is DiNuzzo Index Investors, could you tell our listeners what an index is, and the difference between, let’s say, a passively managed indexed fund versus a actively managed account?

P.J.:  Yeah, sure, Jim.  That’s a great point.  Basically, we’ve got data going back into the 1920s.  Of course, there were stocks traded back in the early to mid-1800s, but if we go back to the early 1900s and into the 1920s, for the 1920s up and though the 1960s and even to the 70s, it was believed that somebody went to a better university, let’s say, you know, they went to an ivy league school, but they went to a better university.  Once they graduated, they burned the midnight oil, they worked harder, they did better research, and they could outsmart their fellow man, so to speak, as far as in the investing universe.  A Professor Fama from DFA came along and launched the new world, so to speak, the father of modern finance in 1965, and he said, “You know what?  We’ve taken a look at the research, and basically, if you were just to hold the largest 20% of the stock market,” and at that point in time, there was around 500 stocks, so a lot of the audience listeners may be familiar with the S&P 500 index.  But that was really the genesis, the largest 20% of the stock market, approximately 500 stocks, what if you just bought and held those stocks year-in and year-out?  Now, the audience has to remember, a lot of people think of indexes as monolithic and static.  If you think back, when I was in high school, you know, a lot of younger audience listeners won’t recognize this, but Bethlehem Steel was one of the largest companies in the stock market, whereas Microsoft wasn’t even a gleam in Bill Gates’ eye in a garage in Seattle yet.  So, it’s basically a survival of the fittest.  You’ve got these larger, older, more non-productive companies falling out, and you’ve got these younger companies.  Of course, a number of years ago, Google, Facebook, you know, even going back a little bit further, Microsoft, they were not included.  So, basically, the research that came up by Professor Fama and mostly through the University of Chicago said you’re going to be better off just holding a basket of stocks in the largest area of the market.  You’ll be better off holding a basket of stocks in the smallest area of the markets, similar to the Russell 2000.  Some audience listeners may be familiar with that.  If you go on Yahoo Finance, you’ll see they’ll track that.  And instead of trying to outsmart the market, these baskets, on average, over a ten-year period of time, outperformed about three out of four times.  So, there will be an active manager over a ten-year period of time that will beat their respective index.  But it’s a little bit like a needle in a haystack.  It’s only about one out of four on average over ten years.

David:  Is that the same Professor Fama who was just named Nobel Prize winner?

P.J.:  Yeah, it’s happy days in DFA land!

David:  Okay!

P.J.:  I was bouncing around the office like a teenage girl on Monday!  Gene, whenever we got the news that he had just won the Nobel Prize, you know, somebody that you know personally, I’ve got about a twenty-year relationship with Professor Fama going back with DFA to the early 90s, and somebody that you know that has been rewarded for his research since the early to mid-1960s.  But yeah, Professor Eugene Fama from the University of Chicago was awarded the Nobel Prize in economics this past Monday.

Jim:  And it’s basically for the same thing that you’re talking about…

P.J.:  Yes, indexing, efficient market theory…

Jim:  …saying that the markets are efficient, and it’s very hard for the people with the MBAs and the computers and all their analysis to outperform the market.  Is that fair?

P.J.:  Yes, that’s the essence of his research.

David:  Well, at this point, why don’t we take a quick break?

BREAK ONE

David:  And welcome back to The Lange Money Hour, with Jim Lange and P.J. DiNuzzo.  If you have a question or comment for P.J. or Jim, call the KQV studios at (412) 333-9385.

Jim:  P.J., you had mentioned before that when using an index fund, that companies, you used the example Bethlehem Steel, come and go, and companies that weren’t even around at a certain point when the index was still active are gone.  Is it fair to say that an index fund, whether it’s Vanguard or any other type of named index fund, will have, basically, formulas?  So, let’s say, a classic S&P formula might be the top 500 U.S. companies, but at a certain point, and then that point would be defined, if the company is no longer in the top 500, then that company would be sold, and then a different company, or, perhaps, more than one other company, would come and take its place, so that you’re going to have the top 500, but it’s not going to be decided, “Well, we’re going to sell this because we don’t like the way the price earnings ratios look,” or “We’re going to sell this because we think that the market for that product is drying up,” but just purely based on size, that that will also determine what goes in and out of an index fund.  Is that a fair characterization?

P.J.:  Yeah, that’s very fair.  There was a book written years ago.  We refer to it as ‘creative destruction.’  You know, there’re constantly new, embryonic companies growing and filling in new spaces in the economy, an obvious one recently over the last decade plus has been technology, but through this creative destruction, there’s always new companies growing out of the soil, and amazingly, growing into large companies.  It’s sort of funny, years ago, Microsoft was actually held in DFA’s…they actually have a micro-cap index.  They were one of the smallest 10% companies in the stock market, and today, obviously, most audience members would recognize they’re a behemoth.  They’re one of the largest 1% companies in the entire stock market.  So, yeah, it’s a constant evolution that goes on within these indexes.

Jim:  All right.  So, it’s basically as though it’s formulaic.  It’s not like somebody’s sitting around and saying, “I think Apple’s going to do really well with the new iPhone, so we’re going to buy Apple, and I think IBM is going to really have a problem with their new merger, so I’m going to sell IBM.”  It’s just a matter of formulas.

P.J.:  Yeah, formulas.

Jim:  Well, at a certain point, this company’s off the S&P, and at another point, another company is on.  Is that right?

P.J.:  Yeah, very rigid, very structured, very formulaic, that is correct.

Jim:  All right.  Now, let’s say that some companies do better than other companies, and if you have this representative, and I think it’s fair to say that you’re not going to own 1/500th of each company, but you’re going to own a representative share.  So, if you own the S&P 500, you’re going to own a lot more Apple than you are of whatever number 500 is.

P.J.:  Yes, that is correct.

Jim:  All right.  So, is it also fair to say that they will have formulas, that these indexes have formulas that will determine when and how much to buy and sell to keep somebody who owns the index consistent with that index?

P.J.:  Yes, that is correct.  Yeah, as you said, very formulaic, very structured, yes.

Jim:  All right.  Now, the best-known index, of course, is the Vanguard S&P 500 index, so it sounds like if somebody were to buy into that fund, that they would, in effect, be buying what is currently the top 500 U.S. companies, owned proportionally, and then as some of these companies come and go, the index (according to the formula) would buy or sell some of these companies.  Your interest would still be the S&P 500, but then you would still have buys and sells within the index itself.  Is that fair?

P.J.:  Yes, that is correct.

4. What are the Differences between the Indexes?

Jim:  All right.  But the S&P is not the only index, and even forgetting Vanguard or the different companies, there’s also, say, small company indexes and value indexes and international indexes and international small and international large and international value and emerging markets and emerging market value, etc., etc.  So, is it that these different funds have indexes of many different types of companies?  In other words, not just large U.S., but all these other types of companies that a lot of people have in their portfolios.

P.J.:  Yes.  Basically, every area of the market, both domestically in the U.S. and international (and including emerging markets), there are indexes covering every area of the market, and one thing that Professor Fama along with Professor Ken French had identified years ago was there’re certain areas, although there’re a lot of indexes out there, there’s really a smaller amount of areas where we would expect an additional premium over and above another area.  So, you just wouldn’t want to go out and blindly invest in every area.  You’d want to focus more and tilt a little bit more towards the areas that would provide a higher expected rate of return.

Jim:  All right.  Well, Professor Fama I know, you know, with his Nobel Prize and some of his other Nobel Prize associates, formed a company called Dimensional Fund Advisors, which is the company that you represent, and I think a lot of people sometimes have an issue trying to figure out what’s the difference between the different indexes?  So, for example, if you were to have, let’s say, a portfolio from maybe five or ten index funds that Vanguard put together versus a portfolio of five or ten index funds that are part of Dimensional Fund Advisors, what would some of the differences, not just in performance, but what would some of the differences be between owning, say, a diversified Vanguard portfolio and a diversified Dimensional Fund Advisor portfolio?  And for the moment, let’s take the dimension of actually having an advisor, which comes with you and DFA, or Dimensional Fund Advisors, where you don’t necessarily get that kind of service from…well, I don’t want to say anything bad about Vanguard because, by the way, I have a very high regard for Vanguard.  I think they are an excellent set of index funds.  But what would be some of the differences between a DFA and a Vanguard, conceptually?

P.J.:  Yeah, we would say, Jim, that Vanguard and similar companies would basically be emulating or copying what we would refer to as, basically, sort of, retail indexes.  The audience may be familiar with the S&P, Standard & Poor’s, for example, the S&P 500.  There’re a lot of Russell indexes for small-cap value, etc.  Internationally, there are a lot of MSCI Indexes.  So, they’re basically just copying or emulating that sort of off-the-shelf retail index.  And again, don’t get me wrong.  The market is so efficient that just these retail indexes will do better in the super majority of cases.  But DFA really approaches it from a completely different perspective, and one thing we’re keen to talk about with individuals, because DFA’s performance has, across the board, small-to-small, small value to small value, etc. across the board, has outperformed these retail indexes.  But we always like to talk about it from a position of understanding the fundamentals, and the fundamentals are: DFA is not attempting to outperform.  It really goes back to this research with Professor Fama and his team of colleagues in the late 1950s and early to mid-1960s, and it’s really about when you’ve identified U.S. small or U.S. small value or international small or emerging markets, small value, what have you, how can you most best capture the essence of that area of the market?  And that’s what DFA has really been in the upper 1%, or upper 10%, of all indexes, as far as capturing the essence.  One thing, you know, we get asked by clients all the time is how is DFA, their small-cap index is into its fourth decade now, how has it outperformed, for example, the Vanguard small-cap index for into the fourth decade now?  You know, what is it that DFA’s doing?  And it’s really the focus…DFA follows primarily a lot of what are called the ‘Fama/French indexes’ that they structured decades ago.  They’re really following a much clearer, specific science.  So, for our small-cap, Russell will say, you know, “We’re going to hold 2,000 stocks come heck or high water.  That’s how many we hold to represent the small-cap universe.”  Professor Fama and French, years ago, said, “You know what?  Some years, really, there might be 1,888 stocks in that year, on average.  Some other years might be 1,972.  Some other years might be 2,221.  So, we’re going to hold exactly however many stocks in the entire universe meet that criteria,” because, as I mentioned earlier, if there is, which there is identified over the last 85 years, if there’s a small-cap premium, the purer access we have to that area, the better our returns are going to be.

Jim:  Well, you mentioned the small-cap premium, meaning that over time, investors who invest in small companies, and I don’t mean mom and pop grocery stores, but let’s say, billion dollar companies instead of hundred billion dollar companies, will typically outperform the larger companies.  Are there also other biases that DFA has recognized and used to build portfolios differently, such as value versus growth?

P.J.:  Yeah.  For years, in the market, Professor William Sharpe from Stanford won the Nobel Prize decades ago for a capital asset pricing model, referred to as CAPM, and that was basically…what was identified was the market premium of the entire market, and if you bought an entire market basket of stocks versus what we call the ‘risk free rate’ United States treasuries, there’s a large premium there.  You’re rewarded for that risk in investing in the market.  Then the next premiums that were identified were Professor Fama and French with a value…Professor Rolf Bands sort of broke the ice years ago from the University of Chicago into small-caps.  So, we had the market premium stocks do better than bonds.  We had the value premium, value does better than growth, and then the small premium, small does better than large over time.  And now, DFA, these are really heady days for us, so to speak.  These are the salad days here, I think maybe when we look back on it, but DFA just announced within the last year, Professor Fama and Professor French, about five years ago, broke the ice on this, and to make a long story short, there’s another premium that we’ve introduced which we refer to just simply as the ‘expected profitability/expected return profitability premium,’ and then just two weeks ago, about a week-and-a-half before Professor Fama won the Nobel Prize, they just released research on the fifth premium, which we’re just referring to at this point in time as ‘capital investment.’  So, these are very exciting times that we didn’t have.  The academic community had not identified a premium since the early 1990s, and now we’ve got another two that we’re working on here.  And we’ve been incorporating, as of about three or four months ago, the profitability premium into our portfolios.  So, we’ve never had a better solution for the S&P 500 and the S&P 500 for the twenty-five years I’ve been in business, but now DFA has a U.S. large profitability index, and the last forty to fifty years, with a track record of forty-plus years on that index, the future looks very exciting for us to be able to add value for clients in that space, as well.

Jim:  Well, that’s what it’s really about, and I’m trying to avoid talking about performance because there’re some compliance issues and I don’t want to confuse anybody, but I’ll certainly say that for anybody who really does take a good look, and either you or I would be happy to show them, some of these concepts that you’re talking about that are so good actually do end up being reflected in the performance of the funds and in the portfolio itself.

P.J.:  Yes, that is correct.

Jim:  As a matter of fact, I understand that there is also some recent recognition of Dimensional Fund Advisors because you see articles, you know, from time to time, but there was just some recent recognition in Barron’s.  Is that right?

P.J.:  Yeah, just a couple Saturdays ago, there was a tremendous write-up…and it’s always nice to get that independent third party confirmation when you have someone that has no skin in the game, as you said earlier.  You know, you get an independent third party confirmation.  They took a look at DFA, I think, ten or fifteen years ago, and you have to remember, the audience has to remember, when Professor Fama came out with his initial paper on efficient market theory in 1965 with his hypothesis, he was basically ostracized by even the academic community.  I mean, basically, in plain English, in Pittsburgh language, he was viewed as cuckoo.  I mean, you’re saying, you know, that you can just buy a basket of stocks and do better than individuals graduating from ivy league schools that have PhDs and MBAs and floors and floors of computer power, and we’ve got people on the ground out interviewing managers that…General Electric taking them out to dinner, picking their brains, everything else, and he was really ostracized for a number of years.  But again, what’s the old saying?  You can fight a legion of armies, but you can’t fight a legion of ideas, so to speak.  So, this idea, it is here to stay.  The markets are very efficient.  Every day, you’ve got a day where you’ve got 5,000,000 buyers and 5,000,000 sellers, they’re agreeing on a specific price, and if you had 5,000,000 buyers and 5,000,000 sellers come in and value a house in any suburb in Pittsburgh, that price that they’ve agreed upon collectively (millions of buyers, millions of sellers) is going to be very, very accurate relative to the fair market value of that residence.  No one’s going to be able to sit in Poughkeepsie, New York or Peoria, Illinois or Sacramento, California and say, “Hey, I can sit back here on high, and I can see mis-pricings in this market.  These millions of buyers and millions of sellers who looked at this property, they’re wrong.  They either undershot it or overshot it.  That just doesn’t happen.”  It’ll happen, you know, infrequently, but not frequently enough for somebody to be able to access that and take advantage of it.

Jim:  Well, as I understand it, there was another company that was formed roughly the same time, and it was known as ‘Bogle’s folly’ because John Bogle had a similar idea that…

P.J.:  And he was ostracized as well, yeah.

Jim:  Yes, he was.

P.J.:  Yeah.

Jim:  And Bogle’s folly, of course, is now…

P.J.:  The largest…

David:  Vanguard.

Jim:  …the Vanguard S&P 500.

P.J.:  Largest mutual fund in the world, yeah.

Jim:  Right.

David:  Well, you know, can we take one more break here?  Is this a good time?

Jim:  Okay.

BREAK TWO

David:  And welcome back to The Lange Money Hour, with P.J. DiNuzzo and Jim Lange.

5. Working with Lange Financial and DiNuzzo Index Advisors

Jim:  P.J., one of the things that I wanted to talk about, and I think maybe even if just a number of our listeners are interested, I think that it would be very valuable, is to distinguish the process that somebody might go through if they were interested in the combination of our services, because, you know, I belong to different financial groups, and I give talks around the country, and I will tell you: one of these days, I’m going to get somebody from the Big Eight, or I guess now it’s the Big Four, put my hand on a lie detector test and tell you that I don’t think that there is a better combination for people who are interested in low-cost index funds than you actually managing the money using Dimensional Fund Advisors, and our office providing some of the strategies: Roth, Social Security, tax planning, safe withdrawal rate, estate planning, etc.  But if we could be a little bit more specific, because, I think, frankly, one of the ways that you distinguish yourself is the process and the amount of time that you go through.  Now, I know that, by background, you’re also a CPA and you have a Master’s in tax and you think very quantitatively, and that you sometimes…I don’t want to use the word ‘torture,’ but you actually work out how much cash, or how much spending, people are going to have in the next, say, year or two years, and then construct portfolios differently based on your findings.  Can you tell us a little bit about the process that you go through for somebody who is interested in your services, and why that has worked out well for you, me and the prospect?

P.J.:  Sure, Jim.  I’ll try to make this as brief as possible.  You know, you try to keep everything to ten steps or less to be able to keep people’s attention, and the ten steps that we’ve come down to in our process, initially, we start off with folks, we refer to it as the ‘life planning’ level, setting goals and objectives.  A lot of times, individuals really haven’t given any thought to…you get married, your life’s hectic, you worry about having a job, you start to have a family, maybe you have kids, you have a couple, a few or a bunch of kids, maybe grandkids later.  You’re working, you’re just throwing this money over your shoulder, but you never really sit down.  And it’s amazing.  Some meetings are a little bit uncomfortable, to tell you the truth, because if it’s a married couple, for example, there’s often times when a husband and wife have been married for 25, 30, 35, 40 years and have never really sat down and had this conversation.  “Oh, okay.  Those are your goals and objectives.  Really, that’s not what I want to do.”  So, going in different directions and not really being on the same page.  So, we take a lot of time at the beginning.  You know, what are goals and objectives?  What’s important to you?  And it sounds corny when I say it, Jim, but we just refer to every situation as a snowflake, every individual, every husband and wife, every family unit, whoever you run into, complete different goals, objectives, and we always take a lot of time at the beginning to let individuals know where other human beings have gone wrong.

So, this behavioral science, as we’ve said before, our innate abilities that we have, we’re very highly wired to avoid danger, and there’s often overreaction to the stock market, the capital markets, the financial markets, and in order for individuals to only have performance of a little bit over 4% the last twenty years, when the S&P 500 performed over 8% total return, that’s a lot of mistakes.  And everybody makes mistakes, but that’s not just one or two or three.  That’s multiple, multiple mistakes.  So, understanding where others have gone wrong before from a behavioral science perspective.

Then, we just roll up our sleeves and we get into the good old-fashioned financial planning.  We develop that balance sheet.  As we say, a lot of sayings we use are corny, but, you know, our financial house is only going to be as sturdy and sound as our footer and foundation.  So, we’ve got to build a solid footer and foundation financially, personal balance sheet, assets, liabilities, personal income statement, the income and expenses, we want to know what are fixed and what are variable expenses.  And then, as you’ve seen before, Jim, we’ll draw up what we refer to as the ‘DiNuzzo money bucket stack analysis’ where we identify…if we tell clients, metaphorically, if they think that if they both walked into the office for that initial no-cost, no obligation consultation, with a couple of metaphorical wheelbarrows, 401(k)s, 403(b)s, IRAs, mutual funds, CDs, bank accounts, checking accounts, and you dump all that on the floor and say, “Hey, DiNuzzo and Lange, we’ve been working on this our whole entire lives for 30, 40 years, and we never really paid attention to it.  Can you help us make some sense out of this giant stack of assets on the floor?”  So, if we think of that as money, we stack it from the floor to the ceiling; let’s start to identify that again.  What is our cash reserve?  We want to have at least twelve months in a cash reserve bucket when we go into retirement so we’re not flinching when something happens in the market.  “Hey, I’ve got at least twelve months of my expenses, maybe even up to three years.”  If we’re able to go through that next bucket we talked about earlier for food, clothing, shelter, healthcare and transportation, go through the next ‘want’ bucket for the additional vacation, travel, gifting to children, and then if we have a quality of life or legacy bucket on top, then once we do that, Jim, what we say is, we now have a roadmap that we know approximately how much money to put in stocks in these approximately three different strategies that we have (conservative, moderate and growth).  We know how much to put in stocks.  We know how much in withdrawals.  We have to withdraw from the portfolio.

So, if we come in and take a look initially…and it’s amazing, Jim, when individuals come in and talk with us, they’re not sure if they really are able to make it or not, and we go through this process and they have $400,000 in extra money.  I mean, their faces just light up.  It’s like they grow three or four inches just sitting in their seat.  In other cases, we’ve had folks come in and think they’re well ahead of the game, and they’re sort of letting off the gas pedal a little bit, and they’re short a couple hundred thousand dollars.  So, it’s by going through this process, we’re able to bring everything into focus.  Then once we do bring it into focus, it’s what you were talking about earlier, and it sounds very trite, sounds very commonplace, but we all talk about diversification, and what listeners listening to the show wouldn’t say, “Yeah, diversify.  Who doesn’t know to diversify?”  You don’t want to put all your eggs in one basket.  But really true diversification, and one thing that, you know, you and I, Jim, have been on the same page with this, when I started my practice years ago, I just went and looked at the largest, smartest, best performing portfolios, the foundations, endowments, institutions, and you take a look at, you know, two-thirds of stocks in the U.S., one-third in international, two-thirds in large, one-third in small.  I mean, our average DFA portfolio owns well over 10,000 stocks in over 40 countries across the globe.  So, real true diversification in the areas we want to, that you mentioned earlier: value, small and these other areas, and then set that asset allocation so we’re able to say maybe 30% in stocks for the food, clothing and shelter, 40% or 50% for the want expenses, anywhere from 60% to a minimum of up to 100% for the wish list, for the legacy and quality of life assets.  And then, what we say, at that point in time, Jim, is what I got back to, because I took my lumps investing in the late seventies and through the eighties, and what I finally found out the hard way that the market was very efficient.  And if the listeners can just think, you’ve worked your entire life, for thirty or forty years, why try to invest and put your life savings invested on that needle in a haystack philosophy?  Let’s take what works three out of four times over the average ten-year period of time, and then if someone does get that far down the road with us and say, “Hey, I’ve taken a look at this.  I do believe indexing really works.  The market is efficient, so efficient that you can’t outsmart it, especially not over the next thirty years of my life.”  Then that’s where I came up with DFA.

Years ago, I was using the Vanguard indexes in the late 1980s, and when DFA was willing to accept me in the early 1990s, I was elated because my core belief was that they were the best index manager in the country.  And then, once we put this all together, it sounds like a lot of finance, a lot of numbers and everything, but it’s all about…you know, the last step is really, you know, place this on a glide path, place these portfolios where they’re going to get more conservative over the rest of our lifetimes, the money that we’re taking withdrawals out of.  And the key word in this whole process is ‘relax.’  We really want to relax.  We don’t want to be losing sleep, worried about our portfolio, watching it on a daily basis.  We want to have the confidence, invest like the largest portfolios in the country.  And one thing we didn’t talk about, Jim, the beauty of these indexes in DFA: low fees, low expenses.  I mean, it’s extraordinarily powerful.  Our fee across the country, across the region, and the investments that we hold in a portfolio, are very low fees, very low expenses across the board, as well.

Jim:  Well, again, I think I want to avoid talking specifically about performance, but one thing that I can talk about is that the combination of people working with both your firm and our firm, and we really kind of got going less than two years ago, and we’re up to about $85,000,000 already.  So, this has been literally explosive growth considering the size of our firms.  Can you tell me, do people stick?  So, let’s say that…you know, I think that if somebody, at least the kind of clients that we want, we’re not looking for a one- or two-year relationship.  In fact, if you do all that work that you described, and then that doesn’t include the Roth analysis that our firm does, the Social Security analysis, the tax planning, the projections, etc., etc., if we only keep a client one or two years and we’ve done all that work upfront, or even after just a year, then that’s not going to work out very well for us or the client.  Can you tell us a little bit about the retainage rate that you have had, let’s say, in your own firm, and then the retainage rate of our clients that we have worked together?

P.J.:  Yeah, Jim.  Yeah, our retention rate working together has been actually north of 99%.  Our retention rate has been in the high 90s.  The 25 years we’ve been in business, it’ll fluctuate 97, 98, 99, but especially with us working together, we have an extraordinarily high retention rate, very high client satisfaction level.  So, again, 99% is a very high retention rate, and it really is all about customizing.  You know, we tell folks whenever we first meet with them that we know we’re not a perfect fit for everyone.  We’re not salespeople.  We’re wealth managers and financial planners.  We’re willing to invest two to two-and-a-half, even sometimes three hours, at a meeting for two meetings, so four or five, maybe even six hours of face-to-face time to get to know someone.  We go back to the office and do hours and hours of homework.  So, we’re willing to invest that because, as you said, Jim, a lot of firms…and that’s the difference between your practice and ours working together, that other individuals look at people, sort of tell them anything that they want to hear.  Let’s get them in and start billing them.  Even if they fire us after a year or two, we made money off of them.  But in our case, we look at a long-term perspective.  Even if someone left us within five years, to me, it would be a disaster.  We’re looking again for long-term relationships.  We don’t want to force anything.  We want to be an excellent long-term fit for someone for the rest of their financial life.

Jim:  I know David is squirming right now, but…

David:  You bet!

P.J.:  Yes, he is!  Yes, he is.

Jim:  I will just mention one other last point, and that is that both your firm and our firm are what are known as ‘fiduciary advisors,’ meaning that we not only have the moral, but the legal responsibility to do not what is best for us, but what is best for the client.

P.J.:  Yes.

Jim:  And I’ve seen statistics as high as 90% and higher of the financial firms are not fiduciary advisors.

P.J.:  Yeah, we’re in the minority.  Yes, sir.

David:  Well, at that point, we could go on, but let’s stop here and say thanks to P.J. DiNuzzo.  You can reach him at his firm’s website, dinuzzo.com.  Thanks also to Dan Weinberg, our in-studio producer, and Lange Financial Group program coordinator, Amanda Cassady-Schweinsberg.  As always, you can hear an encore broadcast of this show at 9:05 this Sunday morning, here on KQV, and access the audio archive of past shows, including written transcripts, at the Lange Financial Group website, paytaxeslater.com.  And finally, please join us on Wednesday, November 6th at 7:05, when we’ll welcome Social Security expert and writer, Mary Beth Franklin, to the next new edition of The Lange Money Hour.

END

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