Peter and Jonathan discuss what you shouldn’t do in the year ahead, including listening to market pundits, loading up on recent investment winners and procrastinating on crucial financial tasks.
Hosted by Creative Planning Director of Financial Education, Jonathan Clements and President, Peter Mallouk this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!
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Jonathan Clements: Hi, this is Jonathan Clements, Director of Financial Education for Creative Planning. With me is Peter Mallouk, president of the firm. I’m in Philadelphia today, Peter is in Kansas and we are down the middle. Peter, it’s January 4th, it’s start of new year and everybody out there is giving you advice about what to do in 2021. So today we’re going to do something slightly different. We’re going to talk about things that you shouldn’t do in 2021. So what’s on the top of your list, Peter?
Peter Mallouk: Well, number one, and this won’t be news to our listeners, but boy, do I hope 2020 highlighted it for everybody is do not listen to market pundits, market prognosticators, people that… Anyone that’s making a prediction about where the market is going with any degree of confidence, just completely ignore it. And the way I look at it is the more confident the person is that’s making a prediction, the less credible they are. It’s one thing to understand markets and how they work, it’s another thing to make short-term market predictions. So every year Barons does a deal where they get the top 10 strategists or the 10 top strategists I should say, and they ask them where they think the market’s going to end up. So they did this in December 2019 asking about 2020. They ask 10 of them, where would the stock market end the year.
And all 10 underestimated where the stock market would finish the year that they predicted the S&P 500 would finish anywhere from 3000 to 3,700, it finished higher than that. So if all 10 of them under predicted, and you look at what happened in 2020, I mean, if you gave them any of the headlines, they would’ve been more confident in their target. None of them predicted correctly. They also asked 10 strategists, where would the 10-year treasury end the year, and all 10, guess it would be between 1.5 and 2.2%. Well, it ended the year at under 1%. So all 10 wildly off in terms of where it went. If you followed their advice, you would’ve totally misplayed the bond market. So the message is really, if anyone’s giving you a market prediction, completely ignore it. Don’t discount it. Completely ignore it. Your investment decisions need to have a longer-term outlook. And I think 2020 was a perfect example of that.
Jonathan: So, if following the views of market pundits is going to lead you to lose money, this is probably the second biggest way to lose money is to buy whatever performed well last year. And right now there’s great risk. People out there are going to look at what happened in 2020 and they’re going to load up on those large-cap growth stocks that have done spectacularly well not just last year but over the past few years. We’re talking about Amazon and Facebook and Tesla and so on. And yet, as we know, buying from the top of the performance charts is often a recipe for financial disaster. Now, maybe it won’t be in 2021, but at some point, we are going to see international markets come roaring back. We’ve had hints of that in the latter part of 2020, ditto for value stocks, ditto for small stocks. If there’s something you shouldn’t do in 2021, it’s to pay attention to what did really well in 2020.
Peter: Yeah, there’s a really an interesting section in Random Walk Down Wall Street and also in one of John Bogle’s books, I don’t recall which one, where they look at the top funds from the seventies and they show that those top 10 funds in the seventies underperformed the market in the eighties. And the top 10 from the eighties underperformed in the market in the nineties and on and on. There’s that study that that was out over a time period where the five star morning star rated funds under performer the one star morning star rated funds. And Bogle talked about it in one of his books. And he basically was big advocate that it’s impossible to time the market. To your point about, we don’t know if this is the year international flips with the U.S stocks, but he did say that there’s this very powerful force in investing called regression to the mean that asset classes generally return to their historical norms.
So for example, if you look at the United States, the P ratio is much higher than normal, maybe not much higher than normal. In the big tech sector, it’s much higher than normal. But in the market it’s just a little higher than normal. International stocks is lower than normal regression to the mean tells us, and this is an oversimplification, but that at some point international probably come up a little bit in the U.S and catch up with the U.S one way or the other. And the question isn’t, is it going to happen? It’s usually when is it going to happen, right? That’s the impossible part to predict. Kane’s famously said, the market can stay irrational longer than you can stay solvent, right? So you don’t want to bet on it over the short run. But over the long run, just picking the winners and hoping that they continue to win is not usually the recipe for success.
Jonathan: Unfortunately, though, when it happens, it tends to happen for multiple years in a row. And what happens is people become overly confident and they end up loading up on these big winners. But when the reversal happens, it tends to happen swiftly and viciously. And people who have undiversified portfolios often end up paying dearly for their overconfidence.
Peter: That’s right. And most of these winners, most people lose in the winners. This is kind of hard for people to believe, but this happened with Bill Miller at Legg Mason Value, he was the only mutual fund manager to meet the S&P 500. I believe it was 15 years in a row. But the time that had the most investors in his fund was when he made very big bets on things like Fannie and Freddie in 08/09, and got absolutely crushed. Those investors lost a lot of money. So paring on to something because it’s done well 4, 5, 10 years in a row, so it has to continue, it’s not the right way. It’s not the right way to be an investor, good investor.
Jonathan: So, overconfidence among investors is perhaps the worst trait possible because overconfident investors tend to make these big investment bets. So one thing that you should try to do in 2021 is to not be overly confident to have the humility to diversify broadly. One of the things that caused us to move away from those broadly diversified portfolios and to become overly confident is by listening to our colleagues and listening to our neighbors who are boasting about how they have beaten the market. And I would suggest without full proof, but I would suggest that whenever you hear your neighbor say that they’ve beat the market, or your colleagues say that they’ve beaten the market, be extremely doubtful because in all likelihood, they’re not calculating their performance properly. They’re probably not benchmarking it against any appropriate market benchmark. They’re not risk adjusting their returns from the amount of risk that they’re taking.
And there’s a grave chance that they are actually only talking about the investments they continue to own. And they’ve conveniently forgot about all those sorry losers that they sold last year and the year before that and the year before that. So whenever you hear anybody boasting their beat in the market, be extremely skeptical and don’t, for goodness sake rush out and imitate their strategy because you’ll probably end up buying whatever’s done well recently and end up regretting it.
So Peter, one other thing that I think people should avoid doing in 2021 is diversifying in the wrong way. So yes, you should own a broadly diversified stock portfolio. Yes, you should only a broadly diversify bond portfolio. But no, you shouldn’t diversify the financial advisors you use. And no, you shouldn’t have accounts at multiple brokerage accounts because in the end, if you have multiple financial advisors, you’ll end up getting conflicting in advice and probably incur too much in investment costs. And suddenly, if you have multiple financial accounts, there’s not much added element of safety but you will end up making your financial life more complicated. It’ll be more difficult for you to track and it’ll be more difficult for your heirs. Do you see people making this mistake frequently?
Peter: Yeah. And it comes, I think mainly from not understanding the distinction between where the safety lies and also not understanding the distinction between a money manager and a wealth manager. So for example, a lot of people go, well, I don’t want a Bernie Madoff thing to happen, so I want to have multiple advisors. So you can have 10 advisors that take custody of your money. So if you were going in investing in 10 real estate strip malls and you were handing somebody money and that you were counting on that person’s report every quarter that it was real, well, they have custody over your money, and hopefully, they’re not stealing from you and 99.9% of the time they’re not. But at the end of the day, you’re writing a check to their LLC and you’re hoping that they’re honest people or you count it, you’re done the due diligence to make sure they’re honest people.
Same thing if you as a money manager, when people hired Bernie Madoff, they wrote to check the Madoff Investments, he put it in his account, he took it out of his account, and went and bought a yacht or a condo or whatever. It wasn’t at a third-party custodian. So most advisors use third-party custodians like Creative Planning. We use TD Ameritrade, Fidelity, Schwab, Pershing, we don’t have the client’s money at Creative Planning. So you’re safer to have one advisor that does not have custody of your money in the first place than to have 10 that do. I think the other distinction is this money manager versus wealth manager. So if you’re looking… Your neighbor is a money manager and he invests in small-value stocks, well, yeah, if you’re going to put some money with her, it’d be nice to diversify with other money managers because you’re only in one segment of the market.
Maybe need a money manager that does bonds and one that does stocks and one that does something else. But if you’re working with a wealth manager, and that’s what Creative Planning is, the wealth manager’s job is to sit on your side of the table and basically go look at the universe of investments and say, Okay, here’s what goes in small stocks, here’s what goes in large stocks, here’s what goes in bonds, here’s what goes in alternatives, and let’s go find the best way to invest in those spaces. So you could actually be more diversified with a wealth manager than with four or five money managers. So really, to figure this out, you have to understand the risk and what you’re dealing with. You don’t want an advisor to have custody of your money and you want your advisor if the assets are going to be with them to be a wealth manager. In those situations, it’s better to have all your assets with that wealth manager because to your point, you get the fee break, there’s more coordination, taxes are easier, you’re less likely to sell something in one account and buy it in the other and negate the effects of it from a tax perspective or a return perspective. And it becomes obviously simpler overall.
Jonathan: So, Peter, up until now we’ve been talking about investment issues, but of course, what we’re ignoring here is a huge chunk of people’s financial lives, everything else, this sort of financial planning aspect of their financial lives. And then when it comes to these things we’re talking about things like estate planning, buying life insurance, trimming the size of a big stock acquisition, saving for retirement. The big danger here is the people procrastinate. So if you have these issues outstanding, for goodness’ sake in 2021, don’t procrastinate. Yeah. It may not matter this year that you don’t have life insurance. Yeah, it may not matter this year that you don’t have an estate plan, but at some point, it could be crucially important. And by the time it’s crucially important, it’s way too late to do anything about it. Are there particular areas of people’s financial lives where you see procrastination that’s particularly damaging, Peter?
Peter: Well, I mean, there’s no place where it’s more damaging than life insurance and estate planning, the two things that you hit. I have people every now and then go, It’s time we did our estate plan and is it okay? I haven’t done it yet. I’m like, Well, yeah, you’re alive, so it’s okay. You haven’t done it yet, right? I mean, the key is we just need it in place before you become incapacitated or die. And I think the incapacitating part, a lot of people underestimate, 75% of us at some point in our lives are incapacitated. So an state plan is an easy thing to procrastinate because we don’t expect to become incapacitated or die tomorrow. But boy, the consequences, I mean, it’s really hard to overstate the grief you are causing your family if you don’t have these very basic documents in place.
Really hard to overstate what a mess it is and how stressful it is. And so it’s just a pretty easy thing to get done and getting that will and trust done and those powers of attorney are really critical to people being able to handle your affairs if you’re incapacitated or die. Life insurance to me is the saddest one because life insurance is such an easy fix. If you’re reasonably healthy, you can get a term insurance policy for just almost nothing. No one wants to sell it to you because no one can make money selling term insurance. But if you have debts, if you’ve got young kids, and if you’ve got to pay for college, if you’ve got a mortgage, you have to have almost certainly some term insurance in place to make sure that the people that you leave behind have the money they need to accomplish those things.
And I have a story I wrote about, and I think I wrote about it twice in two books because it just early in my career and it really shook me about an oncologist who was a new client, he was a physician, he’d read that insurance is horrible. And I was in my late twenties and I had recommended that he get a term insurance policy and I did the projection with them in front of them and he’s like, No insurance is bad. And shockingly, within two months, this oncologist, physician got cancer. And it was only a short few months after that that he passed and I still work with his family and they never recovered from it.
His wife was not ready to go back into the workforce and had to, the daughter struggled with high school, there was all kinds of financial stress. They wound up moving states three, four times. It was just heartbreaking to see. And a term insurance policy in their case would’ve been six, $700, right? It was not a big thing. And so to me, those are the big, big, big things are a term insurance policy if you need it, and an estate plan. All other things we’re going to talk about investing in 401(K), these are about optimizing things, but if you don’t have term insurance or an estate plan in place, you’re really kind of negating a lot of the good that you’re doing by not getting those simple things done.
Jonathan: So, before we move towards the end of our conversation, Peter, I just want to hit on a couple of other things that people shouldn’t do in 2021. First of all, if you’ve got a lot of cash sitting in a checking account or in a savings account or your local brick and mortar account, don’t leave it there. Even if you don’t want to take any more risk than a savings account, at least put the money into an online savings account. You can increase your return over the next 12 months by half a percentage point simply by going from your local brick-and-mortar bank to an online savings account. And you probably will do significantly better if you venture out into the bond market or into the stock market. So you’re going to say, don’t leave a lot of cash sitting in your local brick-and-mortar bank. And the second thing not to do in 2021 is don’t do stupid stuff. Don’t buy leveraged ETFs. Don’t day trade stocks. Don’t put all your money into Tesla. Don’t carry a credit card and the balance. I mean, these are just basic, fundamental, don’t be stupid things. So for goodness’ sake, in 2021, don’t be stupid. Fun part of our podcast as usual, Peter, tip of the month. So what do you have for me?
Peter: So, it’s a good time of the year to talk about 401(K) contributions. So many employers have a 401(K) plan, if you’re fortunate enough to work at a place that has a 401(K), one of the things you can do is you can go to the HR and ask to accelerate your contributions. We tend to take what we can put in the 401(K) throughout the year and divide it equally between every paycheck. But if we can accelerate that so that more goes in earlier in the year, it gives the money longer in the market to compound. So if you do that every year, you’ll almost certainly come out ahead. The one caveat there is you want to make sure that your employer doesn’t match per pay period. Because if they do that, if your employer has a match, you may miss out on part of the match. So you just want to make sure that you can contribute… In a dream scenario, you want to contribute as much as you can to the 401(K) as early as possible without losing an employer match if one exists.
Jonathan: And so, for me, Peter, the tip of the month is doesn’t wait until year-end to take crucial financial moves. At the end of the year, and we’ve all just been through this, a lot of people take their tax losses towards year-end. They rebalance their portfolios at year-end. They give to charity at year-end, but these should be year-round activities. Tax losses don’t just happen at the end of the year. The need to rebalance doesn’t just happen at the end of the year and charities need money, surprise, surprise, throughout the year. So don’t leave these activities until year-end. If you can do it throughout the year, you’re probably going to be better off financially. So don’t wait till end of the year for these things.
Peter: Yeah. I mean, the typical creative planning client had very nice returns in 2020 and had losses on their tax return because we were tax harvesting in March. We were doing it when the opportunity was there, and if we had waited until later in the quarter, we would’ve missed some of the opportunity, if we waited till the end of the year, there was no opportunity. So you have to be thinking about these things year-round. If you’re viewing it as a year-end transaction, you’re definitely not optimizing.
Jonathan: So that’s it for this month. This is Jonathan Clements, Director of Financial Education for Creative Planning. With me is Peter Mallouk, President of the firm, and we are down the middle.
Disclosure: This commentary is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.