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welcome to the best interest podcast where we believe Benjamin Franklin's advice that an investment in knowledge
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pays the best interest both in finances and in your life every episode teaches you personal finance and investing in
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simple terms now here's your host Jesse Kramer hello and welcome to episode 96
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of the best interest podcast my name is Jesse Kramer today we've got a fun one
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for you it's going to be a little uh end of year year in review of the podcast
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shouldn't take us too long just a few minutes but then I'm going to dive into
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an evergreen topic an important topic one that a lot of people ask questions about and really this is going to be an
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episode that I hope that people can point back to and say ah there's a really comprehensive answer to the
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question of well is now the right time to invest in the stock market whether it's because the stock market is doing
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really well or on the opposite side of the coins there will be periods when the market will go through a bare Market
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we'll have a a recession we'll have some of pullback and people will be fearful
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of investing during those times is now the right time to invest in the stock market so I hope to tackle that today
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and uh to explain a few interesting Concepts that are all interwoven into that question so that we can walk out of
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here not only knowing the right answer of of how and when to invest but also why that's the right answer and and how
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all these different puzzle pieces fit together before we get to that we do have a customary review of the week
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today this one is from ljb ljb gave gave us a five-star review on Apple podcasts
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and wrote in and said great listen this is a podcast I'm glad I finally stumbled
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on to Jesse does a great job of taking the everyday mundane and common topics and making them applicable to his
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listeners this is an easy add to the queue every time a new episode pops into my feed well ljb thank you for the kind
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words feel free to reach out to me send me an email to Jesse best bestin interest. blog we'll get you hooked up
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with a super soft t-shirt okay let's get into a little bit of a year in review
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like I said short and sweet we had 51 new blog posts as of this recording it's
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December 12th right now when I'm talking to you 46 weekly newsletters you know
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since the baby was born sometimes I missed a week or I combined two weeks into one newsletter but still 46 weekly
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newsletters you can subscribe to that on the blog homepage at bestin interest. blog about 2500 new subscribers to that
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newsletter when this episode comes out we'll have had 26 new podcast episodes
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every other week and total podcast downloads fantastic 41,000 downloads as of this recording we
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only had 12,000 downloads last year so that's more than a 3X growth with dozens
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of five-star reviews very very kind reviews uh lots of smart and exciting guests with all manner of financial
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expertise dozens of your questions answered on our AMA episodes so thank you thank you thank you engaging with
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you listeners that that's probably the best part about this project so please
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keep the emails coming keep the questions coming they're great uh it gives me something fun and interesting
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to talk about sometimes something that's fun and interesting to learn something
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new for me that I get to dive into and learn about to preempt a common question that I get no I don't collect any
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donations or subscriptions from you guys but instead what you can do is quite simple if someone in your life wants to
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learn more about personal finance investing financial planning send them this podcast or send them the blog send
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them a blog post or better yet albeit a little hypocritical of me please share my work to your network whether it's
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social media Facebook Reddit LinkedIn whatever hypocritical cu I don't really
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spend much time on Facebook myself or anything like that I try not to at least but if you're willing if you're so
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inclined that's wonderful or another big source of 2024's growth here on the
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podcast was my appearances on other Financial podcasts you know stacking Benjamin how to money choose fi catching
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up toyi a bunch of other podcasts so if you listen to other podcasts where you think you know gez Jesse would be a
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great resource for that audience I'd love it if you let me know about that or
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if you recommend me to that podcast host what will next year bring here for the podcast well for starters some more of
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the same I think a lot of the episodes are going to be you know similar I'll
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I'll do some chitchatting I'll do some monologuing I'll explain some some
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thoughts to you guys we'll bring on some expert guests to go deep on some things
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that I'm less familiar with I will say though I get a solid amount of feedback
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saying in short you know hey the more you talk Jesse the better I tend to like the episode it's very flattering thank
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you very much I do appreciate it and so I might sprinkle in a few more solo episodes we definitely do more ask me
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anything episodes I think those are some of the best received episodes out there
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or at the very least I do want to make sure that the outside guests who I bring in I want to make sure they can really
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bring the Firepower because I want to make sure that listening to this is worthwhile for you guys and hopefully
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the the 41,000 and Counting downloads that we have so far this year will continue to grow and I do also want to
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address one of the other goals of the podcast and that is the symbiosis with my professional life working here at a
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fiduciary F only financial planning firm in Rochester New York in 2024 so far about 25 listeners have reached out to
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inquire about working with me and for probably 20 of those people 20 of those families they just wanted a simple
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review a couple hours of my time they're DIY planners they don't want any sort of
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ongoing relationship with me they just want to pay me hourly or pay a planner hourly really just do a simple review
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and that's about it now I don't do the hourly model I do ongoing work for an
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annual fee with people who want an ongoing relationship with their financial planner ideally they want that
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for years if not decades to come uh generally I work with people who understand you know a financial plan
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isn't a static onetime thing but instead it's a dynamic plan and therefore it's
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more than just a one-time engagement I generally work with people who either don't want to be diyers anymore you know
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there's just twoo much for them to lose or perhaps they never really wanted to
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be a diyer in the first place they just kind of stumbled into it I work with people who they want a third party to be
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involved on behalf of their spouse that's a very common one one one spouse I work with will be a pretty Die Hard
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DIY but for the sake of their potentially surviving spouse if something were to happen to them they
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want to bring me into the relationship as far as you know the finances go I work for people who no longer want to
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drive their own bus but instead want to focus on many of the other aspects of their life of their limited time left on
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this Earth and so they'd rather Outsource their financial plan their Investment Management to me of course I
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get that many people listening here probably most people listening here are diyers and I think that's wonderful I'd
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be happy to refer you if you do want a a planner to help check your work I'd be
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happy to refer you to one of many hourly planners who I know who I trust who do great work for their clients but
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ultimately yes this year many of the people who approached me they wen't a good fit I was able to refer them to
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someone who is a much better fit for me but five families this year who came through the best interest podcast they
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did reach out to me and we started an ongoing financial planning engagement together what's interesting I think is
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that three of those families Yep they're dedicated listeners whereas the other
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two were referrals from listeners in other words a listener said to themselves thanks but no thanks Jesse I
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don't need you personally but this person in my life who I know they don't
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listen to your podcast but they do need your help and I trust you to help them so to me that's a huge win-win they're
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getting the help they need it inspires me to keep putting this podcast out into the world you know helping people is my
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job it puts food on my table and it proves out the business model if you will of the best interest podcast share
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knowledge for free prove your expertise make it so valuable that people can't
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help help but share it the audience will naturally grow as the audience grows yeah some percentage even a small
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percentage of people might say you know what I need some professional help I trust Jesse at this point he seems to
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know his stuff the snowball grows so thank you thank you thank you for listening thank you for your questions
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thank you for sharing this podcast with others and helping it grow thanks for reaching out to ask for help for
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reaching out to refer others who are seeking help one of my go-to sayings here is that a rising tide lifts All
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Ships and I believe that the best interest is one of those Rising tides that is helping everybody involved and
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now I want to present such a cool uh a very meaty investing financial planning topic to you today my hope is that I'm
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able to do enough of a complete discussion on this topic today that it's going to act as an evergreen monologue
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that will always be able to point back to and say oh you've got questions about
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this topic well you should go listen to episode 96 of the best interest podcast and that topic is this question is now
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the right time to invest in the stock market as I said I'm reping this you might be listening to this in December
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of 2024 hopefully many of you are listening to this well after December of 2024 and heck for all I know the market
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might crash next week but whether the market continues its Relentless climb or whether it crashes tomorrow what I'm
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about to say here will still apply in other words the advice that I'm giving
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here is if I may say so Timeless right it's going to apply it's just sound
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investing principles that apply in a bull market and a bare market and everything in between if you're a diyer
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you'll probably know the struggle and the complexity with this question is now
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the right time to invest in the stock market you might have some of the answers such as well you can't time the
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market or just lump sum your money as soon as possible or you might know that picking stocks is hard and yes all of
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those statements are absolutely true but what I want to do today is explain and ideally explain really well why all
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those things are true and how all those ideas fit together into one cohesive investing framework because in my
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experience if you don't understand why the truth is the truth in financial planning or investing if you don't
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understand the why and if you don't understand how those truthful facts all fit together like a puzzle then you
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might be setting yourself up for a slippery situation when the world starts to cast doubt on the truth as you
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understand it you'll be more likely to abandon your beliefs or put more directly you can say things like don't
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time the market or diversify your Investments when the market keeps on hitting all-time highs it can cast out
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onto that you know are you sure you want to stay invested right now despite the crazy all-time highs or when Nvidia
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keeps on compounding higher and higher are you sure you want to diversify your assets away from Nvidia when US Stocks
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compound higher and higher are you sure you want to own International markets when stocks in general are just crushing
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bonds like they have been are you sure you want to own bonds understanding the why and the how Behind these types of
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questions will make you what I believe is an invulnerable investor you know that is an investor who will not succumb
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to fear who will not let short-term concerns overwhelm them who will not make short-sighted decisions that end up
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causing a long-term impairment of their Capital with that Preamble I want to start with Lynn and I want to thank Lynn
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Lynn is a dedicated listener and a reader Lynn inspired me today and kind of Lynn is one of my Muses here in 2024
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inspiring articles about social security and the stock market and now inspiring this monologue today back in August Lynn
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wrote to me and she said I'd like to move some of my money market funds into
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an S&P 500 ETF but I'm waiting for the market to drop I don't want to buy in at
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the all-time high especially because I'm earning so much in my money market fund
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I wrote back to Lynn this is back in August I sent her some articles and just some thoughts in general and I explained
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to her hey Lynn in short it might be correct for you to wait right now but historical probabilities dictate it's
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probably not correct for you to wait and even getting the timing correct the gains that you're likely to make are
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going to be probably pretty small and since that email well sure enough the S&P is up 8% not including dividends and
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Lynn wrote to me again last week and she said Jesse it seems like you were right
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with this market and I should have invested I'm personally against moving anything into the market right now
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though the financial Independence Community it's all about being Frugal and buying into this super high stock
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market feels like it's not Frugal at all for me how do you square that so that
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sets the table for what follows here listeners in the remainder of this episode I want to explain two massively
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important topics to you the first one is I want to explain why we invest in Diversified indexes like the S&P 500 in
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the first place and why we try not to invest in individual stocks we'll take a
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sidebar on the idea of beating the market and another sidebar into something called the efficient market
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hypothesis maybe these are terms that are familiar to you but I want to go deep on them today and explain them well
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so that you can walk away going okay now I really get it and then second I want to explain the concepts around timing
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the market the explanation will include these little sidebar min explanations of
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terms like Lum suum investing and dollar cost averaging and the cape ratio so first why do we invest in Diversified
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indexes like the S&P 500 in the first place and why do we not try to invest in
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individual stocks so one of the first lessons in long-term investing involves the challenge of picking single stocks
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we're told to avoid searching for the needle and the Hy stack and instead just
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buy the whole hay stack you know that's a John Bogle aism because it's amazing
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just how rare the needles are the there's a study by uh Arizona State Professor Henrik bessom binder and it
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perfectly illustrates the Rarity of the needles the needles being you know winning stocks and we'll cover some of
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the highlights of that study today now we recently discussed on the best interest this idea of a risk-free rate
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uh short-term us treasury notes provide that risk-free rate which is why T bonds
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treasury bonds are frequently used as a benchmark against which other Investments are measured so in the study
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that I'm going to cite here this professor Henrik bessen binder he asked himself how do individual stock returns
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compare against treasury notes the the risk-free investment the risk-free rate and the answer is not well since 1926
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four out of every seven stocks so over 50% four out of every seven stocks that have existed have underperformed
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treasury notes the majority of stocks lose to the risk-free rate despite stocks having significantly more risk
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than bonds so that's not a good thing right if we're taking on more risk in
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stocks we sure hope to get better returns in bonds and for most stocks that simply not the case if you want to
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outperform the risk-free rate picking individual stocks is a hard way to do so so we know that for out of every seven
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stocks or about 57% have historically underperformed the risk-free rate and if we owned all those underperformers our
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portfolio would look awful so let's start adding in some winners and trying to get back to even right how many
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winners do we need to balance out all those losers that 57% of losers and the answer is well we need the next best 30
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9% of stocks to get back to even if we take the bottom 57% which we're all losers and then we add in the next best
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39% of the stock market then we would get to a point where stocks a diversified stock portfolio of those
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stocks would have provided the same exact return as treasury bonds as the risk-free rate so that's 96% of the
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total Market okay that's the bottom 57% plus the next 39% giving you 96% of the
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total stock market for the past 100 years and you only would have received the same return as someone holding zero
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risk treasuries so despite those sobering stats though we all know we've talked about it here many many times
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that stocks in general the full stock market well it's crushed bonds over the
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long run so far in this little part of the monologue we're certainly not seeing
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it though are we well it turns out that the remaining stocks okay the top 4% of all stocks account for all of the stock
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outperformance in the past 100 years years as compared to treasury notes if you didn't own that 4% sliver if that
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wasn't part of your portfolio you missed out on all of the magic of the stock
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market that 4% sliver that's the needle in the hay stack the other 96% is just
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the hay most of which is actually rotting hay if only it was easy to identify those 4% of stocks that are
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needles or at least maybe the the 39% of stocks that are better than the risk-free rate but it's not easy it's
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quite hard in fact and we'll get into some this later academic studies of mutual fund performance again these are
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professional stock Pickers those studies show that only about onethird of fund performance shows repeatability or skill
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the rest of fun performance tends to be just luck most Professionals in other words don't necessarily discover their
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needles it's more like they stumble upon their needles and stumbling Upon A 4%
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needle a one in 25 stock that's improbable in and of itself the only way as far as I'm concerned to rely ibly
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stuff your portfolio full of the valuable needles is to buy the entire Hast deack you don't necessarily need to
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find the needles and you certainly don't hope that you accidentally stumble upon
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them instead you need to guarantee to yourself that you own all of the needles and that's by buying a small sliver of
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every single stock out there and yes buying that whole Hy stack does mean you'll also be buying the bottom 96% of
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stocks too with returns only as good as the risk-free rate but you're certain to
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capture the sought after 4% of stocks as well providing all of the outperformance
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of the stock market and you might ask yourself like really is it that hard to find the needles well commenting on Bess
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and biter study Jason zag of the Wall Street Journal wrote traditional advice on diversification says you should own
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at least 15 to 30 stocks in order to reduce your risk but in a sequel to his research paper Professor Besson binder
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found that a portfolio of 25 stocks still has a 64% chance of under performing the total Market super stocks
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the needles are so scarce that you need to hold hundreds even thousands of companies to be near certain of matching
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the Market's return in other words listeners small portfolios they miss too many needles the odds are stacked
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against you you need to own hundreds or thousands of stocks to ensure you own those needles but by the time you own
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hundreds or thousands of stocks you're essentially building your own Index Fund
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so why bother going through the time and effort to do so when you can simply buy
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an index fund with a single click that in short is the argument behind index investing especially in more efficient
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markets like the US Stock Market the stock market has very few needles missing out on them negates the purpose
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of Stock Investing in the first place your best bet literally is buying the whole hay stack here's a quick ad and
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then we'll get back to the show did you know my written Blog the best interest
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was nominated for 2022 personal finance blog of the year and it's been highlighted in the Wall Street Journal
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Yahoo finance on CNBC I love writing especially when that writing is to share financial education and I usually write
00:18:35
one or two articles per week you can read them all at bestter interest. blog again the web address is bestter
00:18:43
interest. blog check it out I want to read you from an article about this phrase uh beating the market the whole
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Hy stack that's the market and many of us have heard before that you can't beat
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the market so I want to dive into that statement because on its face and to Fair it's a wrong statement but again
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understanding why and how it's wrong and understanding the better ways to phrase
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that statement is going to help each of you listening to be better long-term investors you cannot beat the market we
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hear this warning all the time let's say it's the S&P 500 Index or the dowo index
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or the NASDAQ or a total stock market index fund or something similar to that these people who say you can't beat the
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market what they're saying is you cannot outperform a diversified pool of stocks
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but if we peel back the onion on that guidance we Face two logical issues the first is there's an averaging problem
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the Market's return is an average of many different stocks you can't have
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every individual stock losing to an average of those stocks the logic of that just doesn't work second if my
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stock picking strategy loses to the market as people might suggest then my anti- strategy should beat the market
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you know if one person is losing well just do the opposite of them if they're
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going long on certain stocks just go short on certain stocks those same stocks and voila if I lose you'll win
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thus at least one of us has beaten the market so that was a quick little logical aside that shows that clearly
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it's not true to say you can't beat the market it's an incomplete statement it
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needs more details it needs more backup and it leaves people a little bit misinformed it's one thing I want to fix
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today so yes you can beat the market but you need to understand how and when and
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why and answering those kind of questions today will lead us to the following conclusion the question isn't
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whether you can beat the market or not you can the question is why bother cying see thousands of people beat the market
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every day every month every year some investors have beaten the market for decades it doesn't take prodigious
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intelligence it only takes the right temperament so anyone who says you can't
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beat the market they're misinformed but the first truth is it's quite hard
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consistently beating the market is hard that's what the needle in the hay stack
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has to do with right you need to find those 4% stocks or at the very least you need to ensure that you're in that 39%
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part of the stock market that beats the risk-free rate and you need to really maximize your time spent there now
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consistently beating the market though after any fees you pay well that makes it extra hard if fees aren't involved
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it's possible to beat the market not easy but certainly possible when someone
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else is managing money for you if they charge you a fee well that fee eat into your profits and since those profits
00:21:16
have been eaten well beating the market becomes even harder it's like in golf if
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you begin your round with a few Strokes already on your scorecard it's still
00:21:23
possible to shoot under par but much much harder now truth number two about beating the Market is it's not 50/50 and
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what I mean is you might think at this point so without fees 50% of stock Pickers would beat the market and 50% of
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stock Pickers would lose to the market that is a logical conclusion assuming though that stocks performances follow a
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normal distribution or a bell curve human height as an example forms a nice natural bell curve you get a standard
00:21:49
distribution with an average most people relatively close to the average and far
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fewer people who are multiple standard deviations away from that average but stock performances do not follow a
00:22:00
normal distribution this is an interesting exciting and an important fact instead stock performance more
00:22:06
closely follows a longtail distribution most individual stocks perform worse than the average but a small number of
00:22:13
high performers beat the average to explain what I mean by that imagine I have 10 stocks in front of me nine of
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those 10 stocks are worth $100 the 10th stock though it's worth $1,100 so I have nine stocks at 100 I
00:22:27
have one stock at $1 00 what's the average value of these stocks well if you followed my math the average value
00:22:33
of those stocks the total value is 2,000 and I have 10 of them so the average value is 200 nine of those 10 are only
00:22:40
worth 100 nine of those 10 are underperforming my average the one that's worth $1,100 well it's
00:22:46
outperforming my average so if I'm going to build a portfolio from those 10 stocks and I hope to quote unquote beat
00:22:52
the market I really have to hope I have some ownership of the one that's outperforming the average
00:22:59
that in a nutshell is the way that the stock market works and always has worked there's some interesting data I I cite
00:23:04
some data in this particular article from 1983 to 2006 tracking 8,000 individual stocks over that time it
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showed that about 40% of stocks lost money over that time yikes 64% of stocks though underperformed the average okay
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64% underperformed the index got beat by the market the remaining 36% of stocks outperformed the market so it wasn't
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quite like my example of having nine underperformers at $100 per stock against one outperformer at 1100 per
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stock but the same idea applies you have 64% of stocks that do pretty poorly you
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have 36% of stocks that do so well that they bring the average up a couple other
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interesting stats from that particular study for what it's worth is that the
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mean average annual stock return over that period was negative 1.06% per year and that the bottom 75% of stocks had a
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cumulative Total return of 0% in this particular study all of the positive performance from the stock market in I
00:24:02
think it was a 27 24 year period came from the top 25% of stocks okay so what does this have to do with beating the
00:24:08
market well the research tells us that beating the market is not a 50-50 proposition over this particular time
00:24:14
period a single stock only had a 36% chance of beating the market there are many bad to mediocre stocks there are
00:24:21
far fewer good to Great stocks so again if you're only picking a few stocks you're likely to miss out on the big
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winners you're going to lose to the market if you're picking many stocks
00:24:31
well then you're simply going to mimic the average return neither beating nor
00:24:34
losing to the market you've just created your own index fund and that's why it's
00:24:38
hard to beat the market there's also a Luck versus skill problem in picking stocks the stock market as we've already
00:24:43
covered here it's a mixture of luck and skill it's notoriously difficult though
00:24:47
to discern between those two skill being a repeatable thing luck being the opposite something that's not repeatable
00:24:54
if you invest via active stock picking you'll face some scary questions like
00:24:58
have you recently beaten the market if not why are you investing in that way assuming you have beaten the market is
00:25:04
that skill or are you just lucky and then last I mean do you really have the knowledge and the skill to accurately
00:25:10
assess those other two questions it's a pretty convoluted spaghetti logical mess
00:25:15
in your head now the stock market is a notoriously efficient market and we should talk about what that means it
00:25:21
means that there are so many different investors who are armed with so much information about various companies
00:25:26
their stocks their earnings their futures that any single person cannot consistently know enough to know whether
00:25:32
today's stock prices are right or wrong whether the market is overvalued or undervalued whether today's smarter
00:25:38
decision would be to buy or sell it's just too hard to know that consistently
00:25:43
to know more than the market consistently that's what an efficient market means and thus the efficient
00:25:48
market hypothesis essentially States there's no such thing as skilled stock picking because that so-called skill
00:25:54
would suggest that someone does know more about today's prices whether they're right or wrong or at least that
00:26:00
some investor can outsmart the rest of the market with some sort of consistency now the efficient market hypothesis has
00:26:07
a lot of research behind it it's won Nobel prizes it's part of the backbone
00:26:10
of index investing that said it's not necessarily this iron law of Nature and
00:26:15
there are many smart people out there who find some pretty serious flaws in it Warren Buffett and Charlie Munger
00:26:20
perhaps most notably among them personally I think that at least here in the US Stock markets are mostly
00:26:26
efficient and that at least most of us those of us listening diyers simple investors we would do better by
00:26:33
believing that markets are efficient in other words you and I we don't have the
00:26:38
time the resources the knowledge or in other words the skill to consistently know more than the rest of the market
00:26:44
and any such skill is likely to be found in those who put in the most time in other words the 80-hour weeks of a Wall
00:26:51
Street Pro are likely to be more skilled than the 20 minutes that you spend watching my Uncle Jim Kramer on CNBC now
00:26:58
are you you sure you want to play that game against those Wall Street experts wouldn't the average return from an
00:27:02
index fund be simpler easier less stressful and more dependable to reiterate all this saying nobody can
00:27:09
beat the market is like saying nobody is taller than average it's a little bit
00:27:13
dumb but you'll notice that my tone has kind of changed over these last few minutes because yes you can beat the
00:27:19
market it's just a logical necessity but it's also complicated it happens less
00:27:23
than 50% of the time it's hard to repeat sometimes it's just luck you're invest
00:27:28
ing fees are probably going to reduce your likelihood of beating the market that's just basic math and even if you
00:27:33
do beat the market was it skillful was it just lucky if you're a DIY investor
00:27:38
is the time that you commit to that act of investing is that worthwhile and then
00:27:42
last are you smart and unbiased enough to even answer all these questions in the first place these kind of
00:27:48
complications all point in the same direction namely why bother trying to beat the market in the first place it's
00:27:54
not that you can't beat the market it's just not worth trying so one thing I
00:27:58
haven't really touched on quite yet so far in this monologue is why picking stocks is such an interestingly Hard
00:28:04
Exercise in the first place I mean it's fine and dandy to say okay most stocks
00:28:08
underperform it's fine and dandy to say only the 4% needles lead to all the outperformance over the risk-free rate
00:28:15
why is it so hard to find those 4% needles I mean surely there must be a way to do so because simply who's to say
00:28:21
whether a Stock's price is too high or too low or fair and for that we need to
00:28:25
understand how are stock prices reached in the first place they're BAS based on
00:28:28
two simple things how a company is performing its earnings and how much investors are willing to pay for those
00:28:33
earnings sometimes that's called the multiple the multiple can be thought of
00:28:37
as How likely do I believe that this company's earnings will continue into the future a simple example let's say a
00:28:42
grocery store is earning a million in profits last year how much would you pay for that store uh $3 million $5 million
00:28:49
$10 million well that's a three or a five or a 10x multiple and that number is going to be related to how confident
00:28:55
you feel that you could take over the store keep keep its earnings at a million dollars per year or ideally even
00:29:01
grow those earnings for enough years in the future so that you can get your money back and then some a Stock's price
00:29:07
works exactly the same way it's just a business just like the grocery store is
00:29:12
but it's easy to forget that fact and that leads me to a wonderful question I
00:29:15
once got from a client here who had about 20% of her money in Starbucks now 20% of your money in one company that's
00:29:22
a lot you could say it's a latte in one stock I'll see myself out after that
00:29:26
joke and for comparison Starbucks comprises about 0.20% of the S&P 500 now the S&P 500 should only be a portion of
00:29:34
an individual stock Holdings which are only a portion of an overall portfolio so to have 20% of your total assets in
00:29:40
one stock that's just way too much when I started explaining that thought process the client understandably
00:29:46
protested and she said Jesse there's a Starbucks on every corner in America why
00:29:51
would we sell it that logic totally understandable after all she's right there is a Starbucks on just about every
00:29:57
corner in America the premise is true but the client's conclusion therefore why sell Starbucks that doesn't follow
00:30:04
the premise and that's the logical misstep I'll dive into a good company
00:30:08
doesn't always make a good investment Now My Hometown Pride Kodak was once one
00:30:13
of the most visible companies in the world it would have been easy to sit there in 1985 and think man codak is
00:30:19
everywhere they own the global film Market the same way that GE owns consumer electronics and Sears owns
00:30:24
department stores why would I ever diversify out a Kodak well the share price went from $90 per share to zero in
00:30:32
about 17 years the stock market and economic history are littered with good companies going broke it's called
00:30:38
creative destruction and it's essential part of a healthy economy but it's
00:30:41
terrible if you happen to own those specific stocks now investor Peter Lynch is known for many quips but perhaps none
00:30:48
is more famous than his saying invest in what you know know what you own and know
00:30:53
why you own it unfortunately many investors interpret that quote as invest in what you've heard of and own it
00:30:59
because you've heard of it and what they've heard of naturally are popular
00:31:03
consumer Brands and companies with a high frequency in society you know those with many stores with many products with
00:31:09
long histories but what Lynch actually meant in his quote was the more familiar you are with a company the better you'll
00:31:16
understand its business and its competitive environment the better chances you'll have of finding a good
00:31:21
story that will actually come true you can't just know Starbucks because you
00:31:25
enjoy a latte or because you see it on every corner you must know its business fundamentals its competitors its
00:31:31
potential future Pathways the market doesn't care about popularity or frequency of its stores it only cares
00:31:37
about popularity and frequency in so far as those factors positively or negatively affect the objective
00:31:43
Financial fundamentals of the business riffing on that previous stanza Concepts like popularity and frequency they're
00:31:50
both Hallmarks of a company's past right the stores you see the brands standing
00:31:54
in our culture the companies here to for investment returns are all a function of
00:31:59
what the company has done in the past but the stock market is forward-looking the thousands of investors who buy and
00:32:05
sell stocks and determine their daily prices they don't care about the past they are quite literally trying to
00:32:10
predict a company's future they're pricing in that anticipated future into
00:32:14
today's fair value quite understandably most investors or at least many investors don't understand that they
00:32:20
don't do that they either shape their opinions based on the past popularity frequency past investment returns or
00:32:26
they react to current day new news and those are both mistakes the intelligent investor thinks about the future but any
00:32:32
statement akin to Well Company ABC will be great in the future that's a pretty
00:32:36
challenging statement to make accurately nothing against Peter Lynch but most of
00:32:40
you know I'm a pretty big fan of Uncle Warren Buffett who is famous for saying
00:32:44
it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price even if
00:32:50
Starbucks is one of Buffett's wonderful companies is it trading at a fair price
00:32:55
most people including many investment professionals are terrible at determining what a fair price truly is
00:33:01
and price is a defining feature of any investment I frequently use the Honda Civic example to explain that idea is a
00:33:07
Honda Civic a fair car sure is it a good to Great car maybe would you be happy owning a new Honda Civic many of you
00:33:14
would say yeah sure I'd own a Honda Civic but would you pay $100,000 for a new Honda Civic no way it's not enough
00:33:21
to say Starbucks is a good company perhaps a great company that's a challenging enough statement on its own
00:33:26
we must go further and ask ourselves is Starbucks trading for a fair price and quite simply most of us are terrible at
00:33:33
determining what a fair price truly means at least when it comes to stocks and play along with me let's assume for
00:33:38
the sake of argument that my client was correct because Starbucks is everywhere it must be a good stock to own and it's
00:33:44
trading at a good price if that's true does it necessitate that Starbucks should still comprise 20% of their
00:33:50
portfolio or put another way is Starbucks one of the top five companies in America right 100% divided by five is
00:33:57
20 % are there only five good companies in America right I bet you could rattle off 10 equally recognizable publicly
00:34:04
traded companies in the next 30 seconds try it they're everywhere any way you
00:34:08
cut the cake or the biscotti a 20% position in one company is severely overweight in financial planning we want
00:34:15
to reduce our range of potential outcomes that's why we diversify in the first place having 20% of your money
00:34:21
tied to one single stock leads to a wide range of potential outcomes for what it's worth that client did listen to our
00:34:27
compy Council and has been divesting out of Starbucks at least as tax efficiently
00:34:31
as possible and that listeners concludes the first part of today's idea the idea
00:34:37
of why we invest in Diversified indexes like say the S&P 500 in the first place
00:34:42
and why we try not to invest in individual stocks here's a quick ad and then we'll get back to the show serious
00:34:49
question why do podcasters constantly ask for ratings and reviews yes they do help highlight our shows to new
00:34:56
listeners they help straighten just find us on Apple podcast and Spotify it's
00:35:00
totally true and a good reason to ask for ratings and reviews but I have something more important at least more
00:35:06
important to me I want to know if you like this stuff I want to know if you like my podcast episodes my monologues
00:35:12
my guests the information I share with you and the stories I tell I want to improve and make your listening more
00:35:18
enjoyable in the process so yeah I would love to read your reviews and sure if you throw a rating in there too that's
00:35:24
great if you like what I'm doing please share it with me me it's such a great
00:35:28
feeling to read your feedback I'd love to read your review or see a rating on
00:35:33
Apple podcasts or Spotify thank you now for the second part of today's idea I
00:35:39
want to explain the concepts around timing the market this explanation will include little sidebars like lump sum
00:35:45
investing dollar cost averaging the PE Ratio or the cape ratio so going back to Lynn's question Lyn's original question
00:35:52
it makes so much sense right with the market at all-time highs right now like it is here on December 12 of 2024 why is
00:36:00
right now a good time to invest right surely we should be buying low and selling high but you want me to buy High
00:36:06
you want me to buy at an all-time high okay first I want to explain the cape ratio Cape cyclically adjusted price to
00:36:13
earnings it's very much related to the price to earnings ratio which I think we
00:36:16
touched on before it's a way of measuring what stocks are selling for their price against how well those
00:36:21
companies are doing financially their earnings and the cape ratio is smoothed out over time to account for inflation
00:36:28
that's the cyclically adjusted part of it capap cyclically adjusted price to
00:36:33
earnings ratio now logically speaking Lynn has a pretty good point here we know that the S&P 500 price is at an
00:36:39
all-time high and we know that price is one of the great equalizers in determining if an investment is good or
00:36:44
not right our Honda Civic example or the hamburger example are Burgers good yeah
00:36:49
hamburgers are good would I pay $100 for a hamburger no I wouldn't price matters
00:36:54
okay quality is one thing but price is important too torically the S&P 500 Cape
00:36:59
ratio oscillates between 10 and 25 and generally though not always the lower the PE the better the forward-looking
00:37:07
investment opportunity that makes intuitive sense or at least I think it should the lower the price that I'm
00:37:13
purchasing my investment the better my long-term returns will be but does that mean that we should avoid investing in
00:37:20
any sort of stock market altogether simply because the PE the price to earnings or the cape ratio is high the
00:37:27
answer there's no not really just because the cape ratio is high it still might be smart to invest and we're going
00:37:33
to link something in the show notes an article I wrote called timing the future Market Cape versus future returns and in
00:37:40
that article you'll see some pretty interesting graphs that I put together where we could point to plenty of times
00:37:45
where the cape ratio was 25 or 30 very much on the high end and the future inflation adjusted 10 year returns or 20
00:37:52
or 30 year returns were a perfectly normal and acceptable five six 7 8% just because the cape ratio is high there is
00:38:01
no Golden Rule stating that you must avoid investing for reference right now as of this recording the cape ratio is
00:38:08
at 38 which is very very high by historical standards and again going back to Lynn's point if I'm paying a
00:38:15
very very high price for the stock market compared to historical standards surely that can't be a good thing surely
00:38:21
I must be spending $100,000 on a Honda Civic right now well I hear you Lyn now the cape ratio hasn't been below 25
00:38:30
since the year 2014 and that has some people seriously concerned are we in this massive 10-year bubble of high
00:38:37
valuations and at some point is that bubble going to pop maybe I might not know enough to have an answer that
00:38:43
question but I do know the counterargument here I think it makes a lot of sense and I'm going to try to lay
00:38:48
it out Simply 100 years ago the American economy was pretty Hands-On manufacturing production factories
00:38:55
buildings stuff that is expensive to make and expensive to scale meaning if Ford let's say Ford wanted to double its
00:39:01
car creation capacity it had to buy new land and build new factories and train new people and put in new assembly lines
00:39:09
and all of that is really expensive for a company to do and It ultimately eats into that company's earnings and growth
00:39:15
in other words it was really hard for those kind of companies to rapidly expand their profit margins but today
00:39:23
many of our biggest companies work much differently than that if Microsoft wants
00:39:27
to sell 20% more office licenses they don't need any additional Capital overhead to do so they just sell more
00:39:34
licenses many companies in today's digital age they work the same or at least very similar ways to Microsoft
00:39:41
right they don't have these massive Capital requirements to grow like the ones that existed 30 or 50 or 100 years
00:39:46
ago and as such those companies can grow their earnings much faster than historical standards and if that's true
00:39:53
maybe I am perfectly okay to pay a 38 times Cape ratio today because I believe the earnings portion of that equation is
00:40:00
likely to rapidly increase in the coming years turning today's price into quite
00:40:04
the bargain the point being that while the cape Ratio or the PE Ratio is generally helpful it's not necessarily
00:40:11
smart to believe that the PE ratios of the 1950s ought to instruct how we invest today and then going back to the
00:40:17
main point of today just because a PE ratio is high we can still have strong long-term future returns going forward
00:40:25
it's hard to time the stock market based on PE r ratio alone instead there are a
00:40:29
couple simple tried andrue techniques when it comes to investing your money into the stock market probably some
00:40:34
things that you might have heard of before to start I want to tell you a story from 2022 which was in the middle
00:40:39
of a bad year for both stocks and bonds and those kind of bare markets they make
00:40:43
you question should I just wait for the bottom before I invest and reader of the
00:40:47
blog pulson he wrote in during that year and he said Jesse I'm not tempted to
00:40:51
sell anything in my 401k or Roth IRA but I don't know why I should continue buying at least not at this point with
00:40:57
the market doing what it's doing it's not going up anytime soon can I contribute money to those accounts as
00:41:02
cash and then wait to invest once the market hits its bottom it was a great question and yeah you could try pson you
00:41:08
know that's what I responded to him but I don't think he should and there are a
00:41:11
few reasons why and these reasons apply to you listening today because timing the market in the way that pulson
00:41:16
suggested first it barely affects your future portfolio second it's really hard
00:41:21
to execute well and third it makes your life demonstrably worse along the way so
00:41:27
here's a story of three hypothetical fictional investors mostly they're identical investors we've got normal
00:41:33
Nick we've got good timing Gary we have bad timing bill normal Nick good timing
00:41:38
Gary bad timing Bill all three investors started their investing in 1985 when they were 22 years old they're now 59
00:41:45
and they're approaching retirement and some other facts about them all three of
00:41:48
them used the S&P 500 index funds for their stock Investments all three invested $200 a month in 1985 and then
00:41:55
increased their contributions by 5% per year until today so now they invest around $1,200 a month and all three
00:42:02
invest via dollar cost averaging we'll dive into that term in a couple minutes
00:42:06
the point being is they invest whether the markets are high they invest whether the markets are low and they buy in
00:42:12
between as well except for one time now during the great financial crisis that threw a small wrench into their plans
00:42:18
Nick normal Nick well he stayed the course and continued his monthly contributions but Bill and Gary they
00:42:24
wanted to try something different good time and Gary with his good timing he managed to time the market perfectly he
00:42:30
stopped investing just like Paulson wants to with the question that inspired this article Gary stopped investing at
00:42:35
the market top in 2007 he saved all his cash he then perfectly timed the market bottom in March of 2009 deploying all of
00:42:43
his cash into the stock market so he timed the market to Perfection twice he stopped investing at the perfect top and
00:42:50
then he began investing again at the perfect bottom bad timing Bill also timed the market top with Gary but when
00:42:57
the the true bottom hit in March 2009 bill was convinced that there was more room to drop so as the market recovered
00:43:02
Bill waited and waited and waited he thought a new bottom would eventually come so he didn't deploy his cash until
00:43:08
2013 when the market price had fully recovered to 2007 levels and his wise wife screamed at him to get back into
00:43:14
the market now fast forward I wrote this article in 2022 how different were Nicks
00:43:19
and Gary's and Bill's portfolio at that point well Gary was best after all he
00:43:23
timed the market perfectly twice and he had 1.46 million bill was worst after all he missed many
00:43:30
buying opportunities for about 5 years but he had $1.38 million and then Nick was right in the middle at $1.42 million
00:43:39
so again Gary with the best perfect timing 1.46 bill with the worst 1.38 and Nick in the middle at
00:43:47
1.42 the perfect Market timing around 2008 which was a huge crisis right that got Gary a 3% Edge over normal Nick and
00:43:56
Bill mess up big time yet Gary only has a 6% Edge over him in the long run Gary's perfect Market timing wasn't
00:44:04
actually that important now notably though Bill and Gary when they chose to time the market they didn't sell any of
00:44:11
their old Investments all they did was choose not to buy new Investments if they had sold their old Investments
00:44:18
though and then re-bought later our conclusion would be much different bill would have lost another 20% of his total
00:44:24
portfolio as of today despite perfectly timing the market top okay he sold at the perfect time but because he didn't
00:44:32
buy back in until it was three or four years too late his portfolio would be down about 20% today and Gary who was
00:44:39
perfect twice at the top at the bottom his portfolio would be about 50% higher today so it just goes to show if you're
00:44:46
only perfect once with Market timing you could be down 20% like bad timing bill you have to be perfect twice like Gary
00:44:56
to actually be up up a large amount and that begs a question do you feel that lucky personally I like where normal
00:45:02
Nick is at he didn't worry at all about timing the market zero skill zero luck
00:45:07
and also zero stress he just kept on buying and he's in a great place this is
00:45:11
a scenario where the juice simply isn't worth the squeeze the squeeze again is
00:45:16
double Perfection you have to be right twice if you manage to be right the first time ceasing your buys before the
00:45:22
market bottom you'll likely be plagued by bad timing bills issue when Market is
00:45:27
at Peak pessimism right when the market is truly at the bottom that's Peak pessimism do you have the skill and the
00:45:33
knowledge and the balls of steel to deploy your money into that market or are you a dumb wouldbe Market timer like
00:45:40
the rest of us are and then what's the juice you get for that squeeze well it's
00:45:44
a 3% boost on your final portfolio or maybe this time will be different maybe you'll get a five or six or a s% boost
00:45:50
on your final portfolio and while your money is out of the market sitting on the sidelines what will you be thinking
00:45:57
are you just going to be chilled out and relaxed with ice in your veins or are you going to be a nervous wreck worried
00:46:02
about when to get back into the market not only can this squeeze cost you money but its psychological cost is
00:46:07
unavoidable Gary sure he gained 3% but he also gained some white hair he was out of the market for 18 months 18
00:46:15
months is a really long time are you willing to wait 6 12 18 24 months or more for a bare Market to end now
00:46:22
personally I'm not trying to time the market over that period of time I don't
00:46:26
want to sit on my thumbs and hope that I time it perfectly who knows how long it'll take for us to return to all-time
00:46:32
highs when the next bare Market hits I don't want to test my skill with timing
00:46:36
the market I don't want to test my blood pressure by staying out of the market so
00:46:39
that story introduces an idea dollar cost averaging many of us are doing it without even realizing it that term
00:46:46
interestingly it it kind of has two definitions though they're somewhat related the first definition of dollar
00:46:51
cost averaging is to make a series of investing contributions on regular intervals such as the way that many of
00:46:57
us might contribute to our 401K accounts every two weeks $500 comes out of my paycheck into my 401k and it's invested
00:47:04
into a Target date fund that's dollar cost averaging now the second definition
00:47:08
though it involves starting with a large sum of money and then making the decision to deploy that money into an
00:47:13
investment over a specific period of time now that in my opinion is a great idea for Lynn to consider today rather
00:47:20
than dumping 100% of her new investable money into the S&P 500 today perhaps she
00:47:26
decides to contribute 10% of that money every single month for the next 10 months that way if the market does tank
00:47:33
in February or whatever some of her money will benefit from that future price drop now both of those definitions
00:47:40
of dollar cost averaging share in common the idea that you're buying assets regardless of price that you're willing
00:47:46
to accept that sometimes you might buy High other times you might buy low and in the long run it's all going to
00:47:51
average out either way you are not timing the market that all said we should cover an interesting piece of
00:47:57
math and a term called lump sump investing in short if we look back on Market history would we be better off
00:48:03
taking that Lin approach of 10 deposits over 10 months or should we invest it all at once as soon as possible looking
00:48:10
back in history about 34s of the time you would have wished you made the lump sum investment upfront that should make
00:48:17
sense I think because if we look at Market history we can easily see that it has a terrific habit of going up over
00:48:22
time as such any sort of waiting to invest that we do well historically it's
00:48:27
worked against us the market goes up and if we're waiting it's going up away from
00:48:31
us in general if I knew that regret was not a human emotion I would always always always recommend that people
00:48:38
invest their money in a lump sum as soon as possible but regret is a human emotion and we must be aware of that
00:48:44
fact and it feels pretty bad to lump suum your investment today only for the market to go down next week therefore if
00:48:51
you're worried about investing Everything at Once then dollar cost averaging can be your friend allowing
00:48:56
you to slowly but surely get your money into the market over time depending on your level of hesitancy you could dollar
00:49:02
cost average for months or even years so that's how and why we should continue
00:49:07
investing even during froy markets like this one because we don't know whether
00:49:10
it's a bubble that's about to pop or simply another stair higher on a long
00:49:14
staircase that could go on for years or decades into the future here's a fun
00:49:18
fact though you know Lyn's thoughts right now understandably is the market is so high surely it's not a good time
00:49:24
to invest but I also got messages like one from Christina in March of 22 where the major part of Christina's message
00:49:30
was the market is down should I continue investing humans are natural worriers and it's funny that whether the market
00:49:36
is up or down people will worry about whether continuing to invest is smart Behavior but if we look at the
00:49:42
Historical track record we see that continuing to plot forward in our investments is a smart thing to do and
00:49:47
the list goes on as far as reasons why not to time the market for example in General market performance comes in
00:49:53
clusters as of this recording the S&P 500 is up 28% so far in 2024 about 20%
00:50:00
of that 28% came from the best four months this year the remaining eight months account for the other 8% of the
00:50:07
28% I could point to any Year and that same pattern would exist market returns come in clumps and the more I try to
00:50:13
time the market the harder and harder it gets to make sure that I'm capturing
00:50:17
those infrequent clumps for example if I look at weeks instead of months I see that 20 of this year's 28% comes from
00:50:24
the best seven weeks in the market if I look at days instead of weeks I see that 20% of this year's 28% return comes
00:50:32
from the best 12 days in the market the more you try to play around with the perfect time to buy or sell your
00:50:37
Investments the more likely you'll be sitting on the sidelines for one of those four important months or one of
00:50:42
those seven important weeks or one of those 12 important days and to be fair because you might have heard a similar
00:50:48
stat like that one before but I've never seen anyone discussed this that losses
00:50:52
are also concentrated too for example the worst 12 days days so far in 2024 are down a combined 22% so avoiding
00:51:01
those terrible days that's a good thing too right it is except for the fact that
00:51:05
we have more good days than bad days and usually the good days are more consequential than the bad days and
00:51:11
missing out on those good days it really really hurts if you don't time the market you'll always be in the game
00:51:17
during those good months those good weeks those good days and yeah there will be bad times too but zooming out
00:51:23
that's an okay trade to take all the good days to outweigh the bad days and this final point for you listening
00:51:28
has a bit to do with the efficient market hypothesis again but I want to re-emphasize markets are inherently
00:51:34
complex and influenced by a wide range of factors that interact in unpredictable ways these factors include
00:51:40
economic data indicators like GDP growth or unemployment rates or inflation or interest rates markets often react not
00:51:47
just to the data itself but whether that data aligns with or deviates from expectations the market is a function of
00:51:53
geopolitical events political instability elections intern AAL conflicts trade policies can all cause
00:51:59
sudden and unpredictable Market swings corporate earnings and News Right company specific developments like a
00:52:04
earnings report or a product launch or a management change can lead to a sharp movement in stock prices uh natural
00:52:10
events natural disasters pandemics breakthroughs and Technology can Ripple effects across Industries and markets
00:52:16
then you just have investor sentiment Mr market right human behavior plays a really significant role in Market
00:52:21
movements fear greed herd mentality can lead to irrational buying or selling and
00:52:26
that just amps up the volatility nowadays with technology you have Market feedback loops right reactions to an
00:52:32
initial movement can trigger further buying or selling due to algorithms and margin calls investor psychology
00:52:39
compounding volatility and then you just have random noise daily Market fluctuations result from minor random
00:52:46
events a rumor a small trade that are just difficult to predict is a little bit of the butterfly effect just not
00:52:52
tied to any sort of fundamental change because those factors are interconnected and can influence each other in
00:52:57
unexpected ways accurately predicting short-term Market movements is nearly impossible even for experts and that
00:53:03
unpredictability underscores why attempting to time the market is risky and why a long-term disciplined approach
00:53:09
often yields better results going back to ly's most recent statement it seems
00:53:14
like you are right Jesse with this Market I should have invested I'm personally against moving anything into
00:53:19
the market right now the FI Community is all about being Frugal and buying into this super high Market feels like it's
00:53:24
not Frugal at all for me do you square that well Lynn I'm right for now for all
00:53:30
I know the market could crash 20% in the first quarter of 2025 wiping out all the
00:53:34
gains since August and actually proving you right for waiting but more often than not as I've talked about here today
00:53:41
waiting like you've done won't have been a smart thing to do and if you are
00:53:45
proved right let's say the market does crash next month I'm worried it might
00:53:49
teach the wrong lesson and that lesson will be when my gut tells me not to invest I won't invest and if there's
00:53:56
anything I know about this world and the stock market it's that there's always a
00:53:59
negative reason in your gut to make you hesitate from investing and looking back
00:54:03
in time those gut feelings would have led to a lot of lost compound interest so if you've made it this far I hope
00:54:10
I've done a good job explaining why we invest in Diversified indexes like the
00:54:15
S&P 500 in the first place and why we try to avoid investing in individual stocks and second I hope I've explained
00:54:23
the concepts around timing the market or not timing the market Market really including dollar cost averaging lump sum
00:54:30
investing the cape ratio and those kind of things if you ever have doubts in the
00:54:34
future about whether now is a good time to invest I hope you'll come back and
00:54:38
give this a listen and again I want to thank you all for tuning in to the best interest podcast not only today but
00:54:43
throughout 2024 making it the best year of the podcast yet this is so much fun for me thank you for all the kind
00:54:49
reviews and ratings on Apple podcast and Spotify thank you for all the emails and
00:54:54
questions please keep them coming a very happy holidays to you and here's to a
00:54:58
terrific 2025 thanks for tuning in to this episode of the best interest podcast if
00:55:05
you have a question for Jesse to answer on a future episode send him an email at
00:55:09
Jesse bestin interest. blog again that's Jesse at bestter interest. blog did you
00:55:16
enjoy the show subscribe rate and review the podcast wherever you listen this helps others find the show and invest in
00:55:23
knowledge themselves and we really appreciate it we'll catch you on the next episode of the best interest
00:55:30
[Music] podcast the best interest podcast is a personal podcast me for education and
00:55:37
entertainment it should not be taken as Financial advice and is not prescriptive
00:55:41
of your financial situation