Investing can be an intimidating prospect for beginners, with a wide variety of asset classes to choose from. But even experienced investors tie themselves up in knots over which assets to add to their portfolios as if there’s somehow a way to predict the future.
To be sure, the investment landscape is ever-evolving. But if you take the time to understand basic investment principles and the different asset classes, you stand to gain significantly in the long term.
In today’s episode, Dylan discusses bonds, stocks, and the vehicles that bundle them together: mutual funds and exchange-traded funds.
- [04:37] What are stocks and how do they work?
- [08:01] Four factors to consider when buying individual stocks
- [14:39] What are bonds and how do they work?
- [18:00] Three factors to consider when buying a bond
- [19:47] Why neither stocks nor bonds are ideal
- [21:15] What are mutual funds and how do they work?
- [23:46] Actively versus passively managed funds
- [28:04] The difference between mutual funds and exchange-traded funds
- [29:14] Example that illustrates the role that luck and skill play in investment success
[00:00:00] Intro: Forget the civilized path. It’s time to break the chains of debt and dependency, take control of our financial lives, and live free. This is the Fiscally Savage Podcast.
[00:00:16] Dylan Bain: Hello and welcome to Fiscally Savage. I’m your host, Dylan Bain. And today, I want to tell you about a time when I first started financial coaching. Like these were in the very first days when I actually started helping people get their financial house in order. And One of my friends at the time said, hey, you have a lot of financial knowledge, way more than me. And I just — I happened to have this portfolio that was gifted to me and I think it’s doing pretty good. I have a stock broker. But hey, could you take a look at it? Just give me your opinion. And so I opened it up and I took a look at it. You know, he gave me what his holdings were and what the individual stocks and portfolio were. And I’m going through it. I’m like, wow, like this portfolio massively outperforms the market. Like he must have the world’s best stock guys helping him with the portfolio because the returns are just almost absurdly large compared to something like the S&P 500. And then as I’m going through it more and more, I suddenly realize why. This portfolio has a number of stocks in it, but one of those stocks is performing really, really well right now. And when I start to test it, I pull out that one stock, and if you pulled out that one stock, the rest of the portfolio was underperforming the S&P 500, meaning that this person’s wealth was entirely wrapped up in one single company.
[00:01:47] Now, ladies and gentlemen, I tell that story because today, I want to talk about what are stocks, bonds, mutual funds, and ETFs. So last week, and if you haven’t listened to the episode, I’d highly recommend that you go listen to it. I’ll link to that in the show notes. But we talked about the basics of investing and the idea of when people are investing, they typically do it in, you know, 401(k) or an IRA, but there’s a lot of confusion around that. And the comparison I used was talking about a car. You have a company, like Toyota or Hyundai or Ford, then you have the car itself. I have a Toyota Corolla S. And then, I have the engine. It’s a four-cylinder six-speed manual transmission Toyota Corolla S and that’s my car. And your investment life typically operates the same way. You have a company — that’s Vanguard, Fidelity, or Charles Schwab. You have the, you know, our equivalent to the car, which is your 401(k), 403(b), or your IRA. You have a trim package, which is your traditional Roth. And then, you have the engine, which is the investments that actually make the thing go. And so what we’re going to talk about today is the engine components. And we’re going to talk about this in four broad categories. Yes, ladies and gentlemen, there was more than just these four. We will get to those at a later time. But for today, we’re just going to focus on stocks, bonds, mutual funds, and ETFs.
[00:03:10] Now, before we get going in starting to talk about these individual investments, the engine of our 401(k)s, 403(b)s, IRAs, or possibly HSA, depending on how you have things set up, I want to emphasize that the number one way to look at investing is as a game of risk, time, and emotion. Those three things are what are going to create an investing strategy that works. Managing your risk, understanding your time, and managing your emotions. Because investments are money, and money is emotional. So as we go through this, there should be no place where you’re sitting there saying, ah, Dylan told me to blah, blah, blah. I didn’t. You have to make your own investment choices based upon your own risk, your own time horizons, and what your capacity to manage your emotions are. If you are somebody who’s very risk-seeking, I’m probably not the place to get advice because I’m not very risk-seeking myself. If you’re somebody who has a very short time horizon like six months, well, I don’t gamble, so I’m probably not the person to talk to. And if you’re somebody who, you know, has an emotional feeling about loss, then, again, I mean, you should sign up for coaching with me so I can help you with that. But one of the things to understand is that these are the three things you’re managing: risk, time, and emotion. So with that in mind, let’s go ahead and start.
[00:04:37] We’re going to start with stocks. That’s the thing that everyone thinks of. Now, we’re going to go through kind of very briefly to understand what the stock is, and then maybe what are some things to look at if you have decided that you wish to pick them. Stocks are an ownership stake in a company or enterprise. Now, this is not universally the case. There are some certain circumstances in which purchasing stock is not purchasing an ownership stake. I am not covering those today on this podcast. So for our purposes and in general, stocks are buying a piece of the company. So if you go to the market right now and you buy one share of Google, you are now an owner of a very small part of Google’s enterprise. You are an owner in the company, and that is literal and legal. You have voting rights. Now, when you vote in that company, as an owner of that company, you vote your shares. That is, one share, one vote. It’s not one person, one vote. It’s one share, one vote. So there are other people who have purchased into a company like Google that have like a 10% share of that company. So if you are picking individual stocks, it’s actually — first off, you are outgunned by institutional investors like Vanguard and BlackRock, but as an owner, you do get a say. So you should vote that share because if you don’t, typically there are consequences to not actually taking an ownership view into the stocks that you own.
[00:06:04] When you have a piece of stock, you are entitled to the dividends and capital gains. Now, dividends are a payout that companies will make out of their profits or from their cash flow to the people who own the stock. Not all companies give dividends. Apple was a great example of this. For years, Apple did not give dividends. They instead reinvested it into the company. Steve Jobs was famous for telling investors on the board of directors of Apple that no, he was not going to give a dividend. He was instead going to expand Apple, which is part of the other thing you get when you own stock. You are taking a risk with the company, and if the company does well in theory, the stock should appreciate, which means that it will be worth more when you go to sell it than when you bought it. Those are called capital gains.
[00:06:57] Now, this game is complex with stocks and there’s a lot that I could talk about, everything from stock buybacks to leverage buyouts and all sorts of other things. But for the most part, just understand you’re buying a piece of a company and you’ll be able to profit with that company or lose with that company as part of the risk. Stocks are a higher-risk investment. They’re last in the case of a liquidation, so let’s say that you bought one share of a company that then was going to go through liquidation. So for example, you bought a share of Enron in 2000. Sounded like a great good idea at the time, but unfortunately, they went bankrupt in 2001, and you as the shareholder are the last to get money from the company that was liquidated, which means they took all the assets of the company and sold them and returned the cash to the investors of the company. This means that you have a higher volatility, but with higher risk comes higher returns. So if you’re somebody who’s seeking a higher return, then stocks are where you want to be. But understand you’re going to go for a ride. Stocks are going to be — make the highs higher and the lows lower. That’s how they work.
[00:08:01] Now, if you are sitting there thinking, well, okay. That sounds great to me. How do I pick one? Well, there are basically three things you need to consider. The first thing is a fundamental analysis of the company’s financial statements. Now, if you don’t understand what I just said, you should not be picking individual stocks. What that means in brief, though, is that you should be able to take a look at a company’s 10-K, that is, their annual report that they put out to investors that lists not only the management’s discussion and analysis, but also the financial performance of the company and what they view as their risks on an ongoing basis to be. You can then use that information to calculate things like your PE ratio, which is price to earnings. What is the price of the stock versus the earnings per share or EPS? And that 10-K will also discuss the competitive position that management feels that that company has. But if there’s one thing that I’ve learned from working in capital markets is that management likes to tell stories. So you as the investor have to decide if you think the management of this company are actually being honest and forthright with you. So if you are going to do this, you have to be not only looking at the company you think you’re going to invest in, but its peers in the market. So for example, if you’re saying that I want to be in mining, so I’m going to invest in a company, pulling one out of a hat like Freeport-McMoRan, one of the largest miners in the world, then you had better be able to tell me something about how Newmont Mining is doing because they are a peer in the industry.
[00:09:30] And so this fundamental analysis takes a lot of time, energy, knowledge, and computing power. And if you as the retail investor are thinking, “I could totally do that, I will be the first one to say, “Best of luck to you.” For me, I’m a CPA who’s worked in capital markets. I have audited these companies. My name is on some of their financial statements and I don’t do this because there are other people who are going to outgun me in this game.
[00:09:58] The second thing you’d have to look at for picking individual stocks is something called the industry and macroeconomic outlook. The industry would be whatever they do. So like Google, Apple, Facebook, Microsoft — they’re all in what we would generally call the tech sector. And so Amazon can be thrown in here too because they have Amazon Web Services. And so the example of the industry would be the tech sector. But if you know anything about those companies, you know that they’re far more than just peers in what we call the tech sector. For example, Microsoft is a category king of enterprise solutions. That’s what Windows is. That’s what, you know, Microsoft Office is. And they have been using their status as a category king for that to create a flywheel that’s just been producing cash for years. So if you’re looking at this, you have to not only look at the industry, but you have to then look at how the rest of the economy’s doing to determine if you think that this is actually going to continue. Apple has made themselves the category king of hand tablet computing, that is, iPads and iPhones. That’s their category. Their laptops, they may be fantastic, but they are nothing compared to the sales of PC laptops. Amazon, as a tech company, they’re basically a tech company that offers Amazon Web Services, where a lot of websites are parked in other e-commerce solutions. But they’re basically a cloud computing company with a delivery problem, right? That’s what we all think of as Amazon, but the majority of their money comes from the web solutions. That’s their category king. So you, when you’re comparing these, are not necessarily comparing apples to apples. And there are tons of companies that will give you the “insider information” on the tech sector. And I’ll be the first one to tell you, if they had that insider information and it was good and accurate, there is a 0% chance they would give it to you because they would trade on it themselves. So just understand this.
[00:11:55] And, of course, at the time of this recording, the United States Congress is continuing to fuck around with the debt ceiling because Republicans are making unreasonable demands and Democrats have their heads shoved up their ass. So that’s part of the macroeconomic outlook. Can the United States maintain its status as the largest economy in the world with a government that seems more interested in fucking with each other than serving the American people who elected them? Serious question, and wherever you fall is and should impact what stocks you buy if you’re going to pick individual stocks.
[00:12:28] The third thing here is diversification, okay? So like my story at the top, this gentleman’s portfolio is entirely dependent on one individual stock, and I have an example at the bottom of the show to go through with this. If that one company has a really bad year, my friend was going to have a really bad year. And if that company was found to have been embezzling funds and involved in massive fraud and goes bankrupt, he’s going to lose the vast majority of his wealth. He’s not diversified. He is in fact hyperfocused on one specific thing. And so if you’re looking at, I’m going to pick individual stocks, you should try to pick a diversified portfolio across many different industries. But my question to you is if that’s your goal is to manage your risk and your time and you’ve done the fundamental analysis and the industry outlooks and all the other stuff, why are you picking individual stocks when there are funds that could do it for you? More on that in a second.
[00:13:27] I think the fourth thing, and I didn’t put this on my notes, but I’m going to talk about this now. One of the observations I made very early on in my adult life was that far more of the markets trade on stories and rumors than they do on actual factual information. And that is to say that we have a lot of people who will tell you like, wow, there’s momentum and there’s chart and there’s the golden cross of death and the jaws of doom and the vomiting camel. Like these are the chartists who will try to give you advice. They’re preying on your emotions and they’re creating a story. And so when you’re picking a stock, that’s something that you’re going to want to be involved in as well is understanding what’s the rest of the market saying about these guys because that story is going to influence people’s financial decisions far more than the actual technical analysis. Put it another way, we kind of do the technical analysis to justify the story we want to tell. And that goes back to, you know, how many auditors does it take to screw in a light bulb? I don’t know. How many did you have in mind? Well, that’s a joke that’s not really all that funny because of how true it is because at the end of the day, that’s basically what a lot of these people are doing.
[00:14:39] Okay. Let’s move on. Bonds. Bonds are a fancy way to say debt. So the stock market is huge, but the bond market is bigger. And it is — bonds are nothing more than a debt instrument. When you buy a bond, you are making a loan, right? The bond is just what they’re selling in the market. It’s just the thing that says that they owe you the money. And it will also, on the face of it, not only tell you how much money they owe you, but what is the interest rate and how much they’re going to be paying you. That’s called the coupon, but that’s not really all that important. These are very antiquated terms from like the very early 1920s. So essentially, you’re buying debt. So when you buy government bonds, you are issuing a loan to the government. If you’re buying corporate bonds, you’re issuing a loan to that particular company or corporation. That’s what a bond is. Bonds also can be — and, you know, this is where we get into things like CDOs or collateralized debt obligations that took down the economy in 2008. They’re basically taking mortgage bonds, which are mortgage debt, and packaging them as to one unit and then selling that unit as a bond. The other term that you hear for bonds often is something called fixed income, and they call it fixed income because bonds are going to make a regular payout denominated in dollars on a regular interval, whether it’s monthly or quarterly or annually, okay, so you know exactly how much money you’re going to get for this investment as time goes on. These are considered lower risk because there’s certainty into the cash flow. So if you don’t ever have to sell the bond again, you know exactly how much money you’re going to get returned over the life of that bond.
[00:16:14] There is an entire calculation that goes along with trying to figure out what price you should pay for that bond for those cash flows over that period of time. I am not going to cover that here. But again, if that equation is not coming directly to your mind or you don’t know exactly right now as you’re listening to me how to calculate it, you should not be buying individual bonds. This is over your head. And yes, you can get education, but there are people who spend their entire career working with that equation who I will promise you, ladies and gentlemen, do not fully understand it. And that should be terrifying, but it’s also true because at the end of the day, you know, trying to pick the right bonds is trying to figure out who’s going to default and who’s not going to. And if you had told me 20 years ago that the Republicans were going to hold the entire United States economy and position in the geopolitical world hostage to try to push through their own pet priorities, I would have laughed you out of the room but yet here we are. It would have been easier for me to believe the state for the Democrats, which is they shoved their head up their ass and refused to acknowledge that we have a problem and we have to deal with it. But again, I digress.
[00:17:31] Bonds are considered lower risk because in the event of a liquidation — so that is the you buy a corporate bond in XYZ Corp, it goes bankrupt, you’re first in line to get cash when the company’s assets are sold. And so therefore bonds are considered to be more stable. This is what when people say, “Oh, I’m on a fixed income,” they’re typically talking about social security, but this is also the standard advice for financial advisors to tell the people in their retirement — just buy a lot of bonds.
[00:18:00] Okay. How to pick one? Well, there are basically three criteria here, too. Number one is you want to know your credit quality. How do you know credit quality? Well, either A.) You can assess it yourself and I will promise you that if you’re listening to me, chances are good you don’t actually know how to do that, so you’re going to have to rely on something like S&P or, which is Standard & Poor’s, or Moody’s Analytics to assign a rating to this bond. And if you remember back to 2008, they get this wrong a lot. Why? Because they’re interested in the story. The story we had in 2007 was that mortgages were the best investment in the world because home values would never go down and people would always pay their mortgage first. And in 2008, we learned that this was completely bullshit. So it’s hard to actually assess these things.
[00:18:53] The second thing to understand is the duration of the bond. So if you have a 30-year bond versus a six-month bond, they’re going to pay out differently because of the duration of the bond. And, of course, there’s the interest rate risk. So right now in order to combat inflation, the Federal Reserve bank continues to raise interest rates. And we, as the United States, continue to believe that’s the only thing you could do for inflation, which is not true. But as interest rates go up, the prices of bonds go down. So if you had to sell them and liquidate them, for example, if you were a large tech-focused bank located in Silicon Valley, you might have to sell these things, but, of course, interest rates went up, your bonds went down, which means now they’re worth less than what you paid for them and — oh, yeah. That’s how Silicon Valley bank collapsed. So again, these are — there’s still risk involved. It just happens to be lower. And, of course, the last thing is how much money am I going to get and what is my total return going to be.
[00:19:47] Picking either one of these is a crapshoot at the end of the day. Like this is the real thing. There are entire legions of people who spend their entire careers trying to forecast the future. They are, for all intents and purposes, modern-day fortune tellers. And just like the fortune tellers of yore, the modern ones are no better at actually predicting the future, and this is why we see so many financial headlines where people are saying, well, this one guy who called this one thing is back with another prediction. Yeah, yeah, yeah. There are people who called the 2008 Recession because of course there were. Everybody in 2007 was saying the market might go up, down, backwards, sideways, forwards, turn into a puppy, turn into a puma, and run away. Every prediction possible is in the market at any given time, so the probability of somebody being correct about what’s going to happen with a particular asset, industry, or stock is 100%. But the probability that you can determine who is going to actually have the right prediction is next to zero. It’s the same with the lottery. The chances somebody is going to win is 100%. The chances it’s going to be you is astronomically small. And it’s important to understand this. There is money to be made, and there are some people who are really, really good at this. And when you really start to look at it, do they actually have an advantage or not is an open question that people debate very, very aggressively.
[00:21:15] But you might be sitting here going, “That sounds awful. Dylan, you’ve convinced me. Individual stocks and bonds, trying to pick those sounds like a loser’s game. I don’t want no part of it.” Hey, cool. Welcome aboard, brother. There’s a better way. The better ways are mutual funds and ETFs. What is a mutual fund? A mutual fund is a pool of cash. So you get — you and 10,000 of your closest friends together, you all put some cash in a pool, and then you use that cash to buy a basket of stocks because the spending power of all 10,000 of us is going to be greater than the spending power of any one of us individually. And if you remember, if we’re buying stocks, we are going to be buying ownership shares in a company, and it’s one vote for one share. And like I said earlier, well, you’re not going to be able to outcompete those institutional investors. Who are the institutional investors? It’s the mutual funds. When you look at the publicly traded companies of the United States, BlackRock and Vanguard are almost always the largest investors in those individual companies. So the company I work for, the top two investors are BlackRock and Vanguard. And the company I worked for before that, well, it was a private partnership, but all the companies that we were auditing were Vanguard and BlackRock. Why? Because Vanguard and BlackRock have the largest pool of cash to go buy stuff.
[00:22:47] So it’s the mutual funds that are actually the ones that are the institutional investors who are then actually putting people on the board of directors. So when you own a mutual fund. You and your 10,000 friends will vote as to how the fund is going to vote. And then, that fund will turn around and then go to those individual companies and they will vote in a block as to what the fund decided. And so this is a hugely powerful tool because these mutual funds can buy just about anything. If you want to invest in it, I promise you there’s a mutual fund out there. You think, oh, cannabis, it sounds like a great field. There’s a mutual fund that only invests in cannabis stocks. I think healthcare is the way to go. There’s mutual funds where they only invest in healthcare stocks and healthcare bonds or any other combination of investments. So the game now becomes no longer choosing the individual companies but choosing the individual sectors or strategies that that fund is offering.
[00:23:46] And, of course, mutual funds come in two flavors: actively managed and passively managed. An actively managed fund is going to charge you a higher fee because they’re going to be very hands-on and you have to pay the guy in his team in order to manage this fund. But note that over 85% of active managers underperform their benchmarks over a period of 10 years or more. So it is rare. Only 15% of actively managed funds have a track record where they have outperformed their benchmarks on a timescale of 10 years. And if you are early in your career and you’re investing for the long term, which is how you build an inevitability in your financial life — Now, there are some funds that do it. The Fidelity Contrafund has outperformed its benchmarks over the period of time from 2000 to present. That’s a true statement. But a lot of funds, if you go to a company like Morningstar and look at the five star funds, these are the best funds of 2023 that they’ve rated, almost all of them are going to underperform the market next year. Why? Because of this thing called regression to the mean. And there’s a great example in the market right now. There is an investor, her name is Cathie Wood, and she made headlines for something called the ARK fund. She’s an active manager, and the ARK fund had phenomenal returns for about a two-year period of time. So everybody then piled into that fund, and it’s tanked since then. Why? Because for a short period of time, Cathie Wood had an advantage over the market. Almost all fund managers have this period of time in their careers. But everybody started looking at what she was doing and copying it, and as a result, she regressed back towards the mean. She has not had those returns with the ARK fund in the last few years.
[00:25:35] So the option to not do active is to do passive. What a passively managed fund is it’s a much lower fee. So for example, the Contrafund charges 85 basis points to pay the managers to actually manage that fund. And when you actually look at its performance over that period of time, its overperformance over something like the S&P 500 is actually completely eaten up by the fees you have to pay for it, so you’re actually no better off than if you had just used a passive fund because an S&P 500 fund is going to charge you one basis point. So to try to get superior returns, you’re paying 85 times what you could for the same net result. What a passive fund does is it picks an index. The S&P 500, Dow Jones Industrial, Nasdaq Composite — these are terms for baskets of stocks that are considered the index of the market, something that informs us and gives us an insight as to what the market is doing. And so a passively managed fund is just going to pick that index, buy all the stocks in the same proportion that are in that index, and then just hold it. That’s it. That’s all they’re going to do. Now, could you do this yourself? Sure. But why do it yourself when you could have somebody else do it for an extremely low fee?
[00:26:44] When it comes right down to it, these passively managed funds are the benchmarks that all of these active managers are trying to beat. Remember over a period of 10 years or greater, 85% of them fail to actually beat passively managed funds. And again, just like with our lottery example, some funds will actually do better. That’s a hundred percent certain. But could you pick them is a much lower probability. Nobody knew that Contrafund was going to overperform. It was a guess, and the people who guessed right are the first ones to grab a microphone and tell everybody about it. But the ones who didn’t pick correctly, who had just as strong of an argument back in 2000, well, they never tell anybody about it because nobody brags about their losses.
[00:27:31] And so it’s important to understand that these types of funds are typically where the vast majority of Americans are going to actually do their investing. And with mutual funds, you generally only have access to the funds that are managed by the company you chose as your investment vehicle. So for example, if you chose Vanguard, you’re going to have access to all the Vanguard funds, but you probably won’t have access to funds at Fidelity. And this is true for Fidelity. If you’re in Fidelity, you have Fidelity funds. And if you’re there, you don’t have access to the Vanguard funds. That’s just kind of how this game gets played.
[00:28:04] But you might be sitting there going, “Well, but I’ll go with a company like M1 Financial, and I really like them.” Well, hey, brother. Me, too. I like them too, but they don’t have mutual funds ’cause they only do buying and selling. So how could you possibly invest in mutual funds? That’s where the exchange-traded fund comes in or ETF, and ETF is basically just mutual fund shares sold on a stock exchange. Everything I just said about mutual funds applies to ETFs except you can buy them on the market instead of from the company. And then, a lot of times you have something like the Vanguard S&P 500 index fund, which is the one Warren Buffett recommends, and it trades as an exchange-traded fund, which is just a fund that holds shares in the mutual fund for the company. So pick your poison. It really doesn’t matter which one. You’re going to get the same thing either way because typically they are, in fact, at the end of the day, legally the same thing.
[00:28:59] So to recap, stocks are ownership stakes in companies. Bonds are debt instruments in individual companies. Both are really hard to pick. But mutual funds will provide you with the opportunity to pool your money together to have a superior footprint in the market.
[00:29:14] But I like data. Do you like data? I hope you like data. If you’re listening to me, I really feel like you should like data. So here’s what I did. I put together a portfolio. And I put this portfolio together because I wanted to demonstrate exactly what I was talking about at the top of the show because there are plenty of opportunities. So in this particular case, I’m using a free web program called Portfolio Visualizer. And what I did is I collected a bunch of stocks that in the year 2000, in the year 2000, were some of the hottest stocks. These were stocks that people in the year 2000, if you had gone to them and said, “Hey, I believe that this portfolio will outperform everything, you know, from now until 2023,” people would have believed you.
[00:30:01] And so here are the stocks that I put into this portfolio: Walgreens, Procter & Gamble — now, you might not know who Procter & Gamble is, but they’re a conglomerate that does a lot of household products. For example, if you have purchased anything from Tide, Pampers, Olay, Head & Shoulders, Oral B, Vicks, Old Spice, and so on, you have been purchasing Procter & Gamble products. Now, of course, there’s also Pfizer. This is the pharmaceutical company who has one of the COVID vaccines, but they also make Viagra and all sorts of other drugs; AT&T, the telecom company; ExxonMobil, the world’s, quote unquote, most profitable company; IBM, International Business Machines; and GE, General Electric, who in the year 2000 people thought of GE as a titan of American industry; and then, of course, one of the backbones of this new emergent thing in the year 2000 called the internet, Cisco Systems. So that’s our portfolio. What I did is I put all those companies together and I just assigned them 12.5% of the portfolio, so an even distribution, and ran it against the Fidelity Contrafund and another portfolio that was exactly the same as the first one except instead of Cisco, I put Apple in there. And then, I benchmarked them all against the S&P 500. So for those of you who know what rebalancing is, I’m just going to never sell anything, so there is no rebalancing in these results.
[00:31:33] But portfolio number one, these companies — Walgreens, Procter & Gamble, Pfizer, AT&T, ExxonMobil, International Business Machines or IBM, General Electric or GE, and Cisco Systems — how did it do? Because over that period of time, we’re going to start with a balance of $10,000 and put $5,000 in a year, which means that we have now to date have put in $125,000 into this portfolio. How much money do we have? And the answer would be $325,000 or an average compounding annual return of 16%. Damn. Not bad. That sounds great. I more than doubled my money. I should be happy. And for that, I had to pick these individual stocks and everything went fine. But how did my benchmark, which was the S&P 500, do? So my portfolio of stocks, the stocks that everybody said were going to do really, really great, they got $325,000 and the S&P 500 got $535,000 or a compounded annual rate of return of 18.6%. So you’re looking, ladies and gentlemen, at over a 200 grand difference for just investing in the S&P versus trying to pick these stocks. You might ask, “How did the Contrafund do?” Well, the Contrafund got $650,000 or a rate of return of 19.6%. Okay, they did great, but I already said they did great. Oh, wait. But what about those fees? Well, when you factor in the fees, it’s not materially different than the S&P 500. Okay.
[00:33:17] But what about the last one, Dylan? The one where you pulled Cisco out and put Apple in. How did that one do? Because we put in $125,000, and in our first stock portfolio where we picked these stocks and weighted them equally across the whole portfolio, we went from 125 that we put in and got 325 at the end of our experiment. What does this portfolio, where the only difference was we traded Cisco for Apple? The answer is $2.2 million. That’s the difference. The substitution of Apple between one portfolio to the other portfolio is the difference between $325,000 and $1.2 million. That’s huge. In the story that I had at the top of the show, that’s exactly what was going on. This person had Apple in their portfolio. And because Apple has wickedly outperformed all of these other companies, it’s carrying the entire portfolio.
[00:34:16] Now, that’s an amazing return, but one of the things to understand is that we started our experiment in the year 2000. And I remember that because I was just starting a computer science degree in the year 2000 and I had asked people about the Apple iMac. It was that weird colored computer that they had. And people would laugh and say Apple is going to go bankrupt; that Apple has no chance against the PC. Apple will never be a good company. In the year 2000 to say, “I’m going to take out Cisco and put in Apple,” people would have laughed you out of the room. So you would have had to make a huge gamble whereas Cisco — people, I mean, it was the backbone of the internet, which was this brand new thing at the time, and people thought it was going to be great. But Cisco has actually declined in value over the same period of time. In fact, when you look at the difference in the portfolios, the real gains for Apple are really just 2007, 2009, 2010, 2019, and 2020. Those years by themselves are what makes the difference here.
[00:35:25] And so the point that I’m really trying to hammer home is, yes, there are portfolios and ways we could have done that in the hindsight look like brilliant moves but honestly were really just dumb luck. And the smart money at the time would have told you don’t do that. And there are literally tons of these companies that have exploded because for one reason or another and other ones that have just tanked when they had every reason to succeed. At the end of the day, the reason that we say that investing is a game of risk, time, and emotion is that because we have to understand our risk profile. If you want to chase the $2.2 million, God bless you and I wish you luck on your journey. But the reality is we don’t know what the future holds, and past performance is not indicative of future performance. The future is unwritten and unknown. And one of the things that I didn’t put in these portfolios that I could have would be a trick to say one of the hottest companies in the year 2000 that was expected to just be a huge winner for the next decade was this energy company called Enron that filed for bankruptcy in 2001 because of a massive accounting scandal. WorldCom, which was another telecom on par with AT&T, they followed suit. Same with Tyco. So nobody could have seen that coming. Nobody knew. I mean, somebody probably could have seen it coming. The accountants should have seen it coming. But the reality is that you as the retail investor would not have seen it coming, and that would have just removed an entire chunk of your portfolio.
[00:37:01] So if you’re looking at it and you say, “I want a lot of risk,” well, then, by all means, go pick some stocks. But if you’re like me where I’m kind of moderate in my risk, I want to go live my life. I want to invest and not have to think about it. I want to focus on the things that I want financial sovereignty for — spending time with my wife and my kids, helping and mentoring young men, building a better world for my daughters to grow up in. That is why I do things like Fiscally Savage because that’s the life I want to live, and those are the doors I want to open for my clients. Picking individual stocks is just a one-way ticket to a lot of anxiety. And we should be investing for the long haul, not for the short games. And when it comes right down to it, we have an emotional charge to all of this, ladies and gentlemen. And I’m going to talk more about that next week and how to play the emotions of the investing game. But for today, I just want to leave you with my own story of struggling to figure out what the best thing to do with my portfolio is, not just for myself, but for my children because they’re investors, too. Their college funds are invested in the market. And understanding that investing is about risk, time, and emotion, I started to focus on the “why;” that I wanted to be able to create wealth in my life, but I didn’t want to spend my life focused on it. And so I simplified. I used low-cost index funds for everything, knowing that the returns would be good; that if nothing else, I was always going to get the benchmark that everyone else used; and that at the end of the day, the emotional load would be low enough for me to just focus on my life.
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