In today’s world of instant gratification and same day delivery, the idea of slow and steady growth seems boring. In this episode Dave and Steve discuss why diversification isn’t exciting, but it works. Check out the latest podcast to find out how to avoid getting sucked in to the hopes of 10x returns and why slow and steady wins the race!
Steve:
All right. Welcome to Plan For Life Now, episode number 82. Dave, we are back to our socially distanced, whatever you want to call it podcast.
Dave:
We had an amazing run of doing podcasts together, once.
Steve:
Yeah.
Dave:
And the attitude, if anyone hasn’t heard the [one 00:01:21], maybe you listened to a couple in a row and you heard the one we just did and now you’re listening to this one. What a juxtaposition from getting back together, COVID is over, all this stuff.
Steve:
But, I mean.
Dave:
To the variant. And the variant is a weird thing, but.
Steve:
Yeah, I know, but I don’t know if there was no variant right now, we might still be doing this long distance because you’re at the beach and I’m at home.
Dave:
True. But the attitude of everything.
Steve:
Yeah.
Dave:
Is different.
Steve:
Yeah. Definitely.
Dave:
I mean, it is different that you, and I personally understand why, but it’s different that you have to wear a mask again when I was getting used to not wearing one 24/7.
Steve:
Yeah. So, All right. Well, I’m not going to make any predictions about whether we’ll be doing it together in the fall because honestly.
Dave:
[inaudible 00:02:17] done doing that.Steve:
I have no idea. I can’t.
Dave:
We’re done with predictions about COVID in general. I wouldn’t even predict about how it’s going to affect markets and things like that. Although the market seems to be reacting as if nothing, it’s a non-factor. Seems like a non-starter with the markets.
Steve:
Yeah.
Dave:
But that could change. Who knows?
Steve:
No, you’re right. I mean, you get new case data. It doesn’t seem like the market really cares at all. So, all right. I had a couple of things here on my list that I wanted to talk about. One, just real quick, and I wanted to knock this one out. Dave, have you seen some of this discussion around mega IRAs and capping IRAs at certain dollar limits? Have you seen this whole discussion that’s been going on?
Dave:
Not too much.
Steve:
Okay.
Dave:
It has been a part of my summer reading here.
Steve:
Well, let me tell you where this originated from and why I think it’s a big much ado about nothing. I think this first started last month when Peter Thiel, who was one of the founders of PayPal, and obviously quite a wealthy individual now, he somehow, I don’t know how it came out or it was disclosed or whatever, that his Roth IRAs is worth $5 billion. It’s billion with a B there.
Dave:
Wow.
Steve:
And.
Dave:
Now, how can you even, okay, I’ll let you continue explaining. I have questions, but you’ll probably explain it in your, keep going.
Steve:
Yeah. And it also came out, he has not contributed to said Roth IRA since 1999, when he put in $2,000. And basically what he did was he was buying shares of PayPal back, when it was, he was one of the founders. So he essentially got it for nothing. And then it spiked tremendously in value and it’s worth $5 billion. And as you know with a Roth IRA, that means that that money will come out and come out 100% tax free, if he waits till age 59 and a half to take that money out. So, this has led to some people, and even some senators, to get up in his arms and say, “Oh my gosh, we should have caps or limits on Roth IRA, or”, I’m sorry, “Just IRA amounts in general.” And they’ve even thrown around some numbers saying, “Well, we want a cap IRAs at $5 million.”
Steve:
Which 5 billion, we don’t really have to worry about that. We don’t have any clients or personally, where 5 billion is coming into play.
Dave:
If you are one of those people listening right now, please go to the website and contact us.
Steve:
Yeah, right. But 5 million, hey, that’s actually coming into play with client accounts and personally stuff like that. So, that kind of got my attention there, but the whole thing, they’re drawing these false comparisons here. Now, Peter Thiel, this is a very unique circumstance where he is able to buy incredibly cheap shares and have this grow tremendously. The chances of that happening on a regular basis, that’s just not a normal thing. Now, contrast that with talking about capping out regular traditional IRAs, it just doesn’t make any sense because a traditional IRA, the IRS, the government, would love to have somebody like Peter Thiel investing money in a traditional IRA like that, because if it grew to $5 billion, that’s ultimately all going to be taxed as ordinary income.
Dave:
Right.
Steve:
Either when he takes it out or if he dies, over 10 years when his heirs take it out. So, it is unique that it was a Roth IRA and it was a fantastic growth and all of that, but at the end of the day for regular investors, the government should look at that as, hey, this is a growing asset that we get to take a chunk out of. So if Bob and Mary Smith investor have $5 million in their IRA and they’re continuing to keep it invested and it’s going to grow, that’s good for the government because they’re going to get more tax revenue down the road.
Dave:
Right. It makes no sense to want to cap that from the government or revenue earning point of view.
Steve:
Now, I’m not saying that the government will always do things that make sense, but I was reading, or ever do things that make sense, but I was reading from one of the leading experts in the country, Ed Slott, he’s kind of known as the expert on IRAs, 401(k)s, distributions. He’s a CPA. And his take on it was, this is just, this is a nothing burger, it’s not going to go anywhere because there’s really an incentive there for the government to allow these IRAs to grow. And then they get the higher tax revenue.
Dave:
Right. So hopefully if you read that article, by you being the listener, you’re not worried about something that was probably just originally put out there to sort of start a fire. That’s not going anywhere.
Steve:
Right. Okay. But the main thing that I wanted to talk about today was an article Dave, that I had sent to you. And the title of it was, Diversifying isn’t Zesty. Diversifying your portfolio isn’t zesty, but it works. And the gist of this article here, is that most investors and we’ve known this, we’ve seen many reports that show this over time, most investors do not have realistic expectations about returns in their portfolio. And they started off this article quoting Mark Cuban, if you don’t know Mark Cuban, he’s the owner of the Dallas Mavericks. He became very wealthy after the tech bubble in the late 90s, early 2000s. I don’t even remember. Do you remember what company he sold, Dave? To make himself so wealthy?
Dave:
Oh, I don’t remember. Pretty sure he sold it to Yahoo.
Steve:
Okay. Yeah, I don’t even.
Dave:
And we see how well Yahoo has been doing. Yeah, I forgot. It might be something about a computer chip or something tech and he went from there.
Steve:
Yeah. And if you don’t know his reputation as a NBA owner, owns the Dallas Mavericks, he’s a very outspoken guy. He’s never shy about sharing his opinion on things. So he had this quote a little while ago where he said that this trend of diversification, he said, “Diversification is for idiots, that no one should diversify.” This is great for him, he’s a billionaire and he owns the Dallas Mavericks and he does very well at that. But they were making the larger point here, that most people, and this is kind of dovetailed with the whole meme stock thing. If you remember from a couple months ago, the whole game stock AMC.
Dave:
Right.
Steve:
Saga with all of these meme stocks, as they call them, shooting up tremendously and people getting rich off of doing that, that everyone is looking for these, what they call 10 X investments. A 10 X investment, something where you can make 10 times your money in a short period of time and that’s fantastic. We always tell people, “Hey, if you want to take some money that you would use for entertainment purposes, that you would take that money and you would go to Vegas or Atlantic city and you would gamble with that money, use that money to gamble in the stock market. But don’t use that money for planning your retirement, for counting on certain money to be there when you retire to produce an income.” That really needs to be segmented off.
Dave:
Right.
Steve:
And I think the biggest way to quantify this difference in understanding or lack of understanding, has to do with the expectations that investors have for asset rates of return over the next decade. And this is a study that’s been done several times and US investors expect their portfolios to generate long-term rates of return of 17 and a half percent after inflation.
Dave:
That’s an annualized number, correct?
Steve:
Yeah. 17 and a half percent per year after inflation.
Dave:
I’m laughing, but I hope you’re not one of our clients thinking, that’s what I expected. Why is he laughing?
Steve:
Right. I was counting on 17 and a half percent per year after inflation each year.
Dave:
Well, I’ve been getting the last few years, what’s the problem?
Steve:
Well, and that’s the problem, I mean, that’s the issue is that, you’ve heard about all of these investors on apps like Robin Hood, who trade stocks, just like it’s a game, like it’s a video game. So they’re trading them around and they’re getting 10 X returns. They think 17 and a half percent, they’re being conservative. Well, let’s put this in perspective here. And first of all, this study that was being cited, said 17 and a half percent now, two years ago when they did this study, investors only, quote unquote, only expected 11%. So.
Dave:
[inaudible 00:12:38].Steve:
This has certainly accelerated in the past couple of years. Now, let’s contrast this to BlackRock’s expected rates of return going forward. BlackRock, if you’re not familiar, one of the largest asset managers in the world. They do a lot of research around, what are expected rates of return going forward. Here’s some of their expected rates of return. The highest [tier 00:13:08], emerging markets equities at 8.9%, European equities, 8%, US equities, so US stocks, 7.3%, US real estate, 6.4.
Dave:
I’m interrupting because I didn’t, wasn’t listening close enough. For this is for how long a period of time going forward?
Steve:
This is their expected rate of return over the next 30 years.
Dave:
Okay.
Steve:
So BlackRock is making these projections and obviously they’re just projections, but they’re using a lot of data here. They’re using demographic data, they’re using valuations of current stocks, growth expectations and company and countries and things like that. But if we get on down here to a global 60, 40, portfolio, 60, 40, portfolios kind of that benchmark balanced portfolio for somebody in retirement, they’ve got an expected rate of return of a little bit over 6%. And that’s, a lot of the time when we’re planning with clients, that’s pretty close to the number that we’re using for projected rates of return. And I think that’s a much more reasonable rate of return than assuming that you’re going to get 17 and a half percent.
Steve:
I think Warren Buffett, one of the greatest investors of all time, if not the greatest, has said that his long-term rate of return before factoring in inflation has been something like 18 or 19%. So, unless you are the next Warren Buffet, I don’t think you’re getting 17 and a half percent for long-term rates of return.
Dave:
But really, the danger. I mean, I’ve told countless times on this podcast, how many times I said it’s been beneficial. Not saying you go into [Wharton 00:15:06] is very good for doing our job, but it doesn’t hurt to be a history major. Because if you’re, when you look at history or there’s that phrase, people who don’t follow history, the lessons of history are doomed to repeat their mistakes, something like that.
Steve:
Yeah. That’s the gist of it.
Dave:
I don’t know what the phrase is, but it’s the gist of it. But, so when you look, I feel that the real danger to what you’re just saying is that we’re getting into this [low 00:15:34], which is very understandable for people who aren’t in finance or don’t really pay attention to this stuff from 2009 to now 2021 and a half, of the markets, for the most part with the occasional blips going up, at these incredible rates. Is this the greatest bull run of all time, if not, it’s not it’s way up there.
Steve:
I think just to be technical and throw around some knowledge.
Dave:
I know, there was one time it went up.
Steve:
1982 to 1999, US stocks averaged 18% per year. So, if those investors in 1982 [had to 00:16:16] said this, they would have been right on. But I think you’re right. This is up there.
Dave:
We’re in another one of these scenarios where you look at all the research and people are expecting 17% a year annualized return and the danger isn’t just to expect, that the danger is then to start living your life, other aspects of your life, like it’s going to happen. Since I’m going to get this much money, I can spend this much now on a house that costs way more than it should.
Steve:
Yeah.
Dave:
And I can spend this much on other stuff I want because I have X amount that’s going to keep growing at 17% annualized.
Steve:
Well.
Dave:
And then when history repeats itself and it always does and all of a sudden the next thing happens. It’s so odd with COVID that it was such a tiny blip on the screen, but not the kind of bear markets we’ve seen in the past.
Steve:
Right.
Dave:
That can go on and then muddle. Bear markets shock muddle for a couple years before things really take off again.
Steve:
Well.
Dave:
Stuff like that happens and you’re expecting 17.9% a year and you’re now spent X amount on a new house that then goes underwater and etc, etc. When you start living your life with the 17.9% expectations, that’s where the danger, all these statistics comes in play.
Steve:
Well, I mean, let me tell you where I’ve seen these kind of irrational expectations manifest themselves when working with people. Because I think for the most part, with most reasonable people, they’re not, most people who are planning minded, planning oriented, who are the ones that we are meeting with, they’re not expecting those kinds of rates of return every single year. So I don’t know who, what their sampling is, who they’re talking to, but let me tell you where I do see these unrealistic expectations being manifested. And that’s when it comes down to this idea of diversification and spreading out your assets over not just large cap US stocks. That has been over the last 10 years, what I will tell you has been absolutely incredible, is how much large cap US stocks have outperformed every other asset class. Hasn’t even been close.
Steve:
They’ve beaten small caps, mid caps, international stocks, emerging market stocks, real estate, they’d beaten everything. And pretty handily every single year. That’s really where I see this kind of thing manifesting itself, is people saying, “Wait a second, why do I need to own international stocks?”
Dave:
Right.
Steve:
US stocks are always the best. They’re always going to be the best.
Dave:
Right, great point.
Steve:
And there’s a chart that I’ve shown to some people, and we’ve had this discussion and it shows US stocks between the years, 2000 and 2010, and it lists 45 different countries and the returns of those stock markets from 2000 through 2010. And during that time period, US stocks were in the bottom, I think it was bottom four or five, out of those 45 countries. And then from 2010 to 2020, US stocks were the second best performing asset class. So, I don’t know what the next decade will hold, but it’s, I’m guessing they’re probably not going to be the best or the second best, they might slip down and sort of revert to the [meme 00:20:05] there, so.
Dave:
Right. But you and I both, we’ve been doing this so long that we remember the era when people would say, “Are you sure I should have some money in something that mimics the S&P 500?”
Steve:
Yeah.
Dave:
Why would I do that?
Steve:
Well, I.
Dave:
Then of course, why would I have any money in international, more recently?
Steve:
Yeah. And I distinctly remember.
Dave:
Yeah. I mean, we’ve been doing this for a long time. I mean, it’s like we go through, nothing says more about diversification than being in this business for over 20 years and hearing people, literally the thing that’s booming now, they were saying, why do I have any money in that? And that goes through almost every category of asset class.
Steve:
Yeah. I mean, I have this distinct memory of meeting with a woman in 2007 and she had all of her thrift savings plan, which is the government, a 401(k) plan, she had it all in the iFund. And I thought that was the iFund is international stocks. I always say these things, I expect everyone to know them, international stocks. And I asked her, I said, “Why do you have everything in the iFund? That’s a little bit concentrated.” She looked back at me like I was the dumb one. And she said, “Well, it has been the best performing asset for the last, however many years, six or seven years, so I just put that in there last month because it’s been the best performing.” And to her, that made so much sense.
Dave:
Right.
Steve:
And people now are doing the same thing, they’re looking at the S&P 500 saying, “It’s been the best performing, why would I put money in international stocks, small cap?” Etc.
Dave:
Right. And it’s so interesting. Well, the end of your story is basically going to be diversifying is the thing that works best in the long run.
Steve:
Yeah.
Dave:
And it’s interesting, the humility involved in what we’re just trying to do with clients, which is to project similar to the BlackRock 30 year expectations, when we make projections of what we think we can get you or you can expect with your money and figure out how much you can live on based on that and what’s the best way to get us to that number is, what’s one of the best returns obviously going to be over that long period of time. And that’s where ultimately diversification comes into play. It’s the making sure if you’re going to be a patient investor and a smart investor, we got to get you there. And the best way to do it is that. It’s not about believing in something, it’s really just more about fact.
Steve:
Yeah. All right. Diversification is not zesty, but it works.
Dave:
There you go.
Steve:
All right, Dave, enjoy the beach today.
Dave:
All right, Steve, enjoy [steamy 00:23:07] Potomac. Not like it’s not steamy here.
Steve:
Yeah.
Dave:
It’s steamy here. I can only imagine. And I, excuse me. Gaithersburg, not Potomac.
Steve:
It was 99 here.
Dave:
What was it? 99?
Steve:
Yesterday. Yeah.
Dave:
I just want one quick comment and then we’ll let everybody go.
Steve:
Yeah.
Dave:
We don’t need the feels like temperature. It’s 99. Feels like 115, yeah, no kidding. Was about to use a bad word there. I don’t need it. Don’t need the feels like. I get it.
Steve:
All right, we’ll leave you there. We’ll check in again next month. Take care.
Dave:
All right.