254: Should You Be 100% Invested In Stocks?

Welcome to Money for the Rest of Us, this is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host David Stein. Today is episode 254. It’s titled: “Should You Be 100% Invested in Stocks?”

I recently received an email from Matt, he’s a listener and a member of Money for the Rest of Us, Plus. He wrote, “I have a few ideas for some potential future topics. One deals with your take on a book called The Simple Path to Wealth by J. L. Collins, that is promoted on many of the blogs and podcasts in the financial independence community. I read the book and began investing in simple index funds, as recommended; however, I was never comfortable with putting all my eggs in one basket, as the book suggests. What is your take? Can investing really be that simple? Or is this just a better than nothing approach to investing for people who are not interested in actively managing their finances?”

Can investing be as simple as 100% stocks?

Yes investing can be that simple, you can put 100% of your portfolio in an index fund or ETF, a stock ETF. He recommends the Vanguard Total Stock Market Index Fund, tickers VTSAX. He points out it has 3,600 holdings. You’re effectively investing in every publicly traded company in the U.S. And your fortunes are tied to the ingenuity of the people working at those companies as they deal with the many complexities involved in the world, and had you invested in that particular index or fund over the past 25 years, you would have done very, very well. Now, you don’t necessarily have to just do an index fund; there’s always the question of maybe invest in a basket of individual securities.

I got an email, out of the blue, from somebody that calls himself Yerkie. He wrote, “For Jack Bogle, buy and hold is eternal. Your returns will be 0 for the next 10 years, just like 2000-2010.” Maybe, maybe not. He continues, “What were your returns for the year of 2018?” He’s asking me. “Negative 5%, like hold the bag Bogle index fund? In the year 2018, almost 900 stocks have gone up over 20% and almost 200 stocks have gone up over 100% if you know how to buy and sell. For the year 2019 there are over 180 stocks up over 50%, so far in just 4 months. Maybe you have a least one of them, maybe 2? No?”

Well, yes and no. Yes, I do own them because I own passive index funds and ETFs. I don’t own individual stocks, nor does J. L. Collins own individual stocks; he recommends this one ETF. Now I do not have 100% of my portfolio in stocks. When Yerkie asked what was my return in 2018, my returns were based on the philosophy that I shared, that’s also shared with the FI community. We talked about this in episode 243 and 244. The idea that you’re trying to increase your net worth, this after you’re financially independent, by the rate of inflation after spendings. Now that can come from investment earnings, it can come from other earnings for whatever side projects you work on. My net worth increased 5% in 2018. But he asked about investment returns. In 2018 the U.S. stock market fell 5%, as Yerkie mentioned. The global stock market, as measured by the MSCI All-Country World Index fell 9.5%. U.S. bonds were flat. It was a tough environment to invest. My portfolio gained, just the investment portion, gained 0.5%, so it wasn’t great, but it didn’t suffer a loss.

Can diligent analysis actually outperform the index?

Collins in his book, and it’s a very good book, it’s a very good book on the basics of investing if you want to become financially independent, it’s why the FI community recommends the book. But, I learned that something that I didn’t realize. I’ve met J. L., in the past, at FinCon. He said, in his book, that he met a guy on a cross-country flight, this was back in the late ’80s, the gentleman worked at an investment research firm and they talked the entire flight about stocks. And by the end of the trip, the guy offered Collins and a job. So he took it, a major pay cut he took, but hey, he was going to get all this information on these companies, because they had really bright analysts at the firm.

He points out that each analyst focused on maybe 2 industries and 6-10 companies. Some of these analysts were “Analysts of the Year” by the Financial Press. He said some of these folks were at the top of their game. They knew their industries very well, they knew their companies. They were talking to the suppliers, the customers, the receptionists often weekly or daily. Now, they didn’t get insider information, but they really, really knew these companies. Then, he saw how they did. He wrote, “And yet, accurately predicting stock performance remained frustratingly elusive.” He pointed out that these analysts were talking to the company, and the idea is that company’s management, knew what was going on, that they could forecast to take advantage of their competitors, to make sure that their stock price went up. They couldn’t.

One of my first jobs, after graduate school, is I was a planning analyst and I worked for AT&T Capital. My role was to make predictions, or a plan, I guess, for our little division of the company. You make up the numbers, you do your best. Is there any reason why it’s easier for CEOs just to buy back their stock, as opposed to investing in new initiatives? Collins writes, “Suddenly my enormous stock picking hubris was clear. Somehow reading a few books and 10K annual reports was going to give me an edge over not only the professional analysts who lived and breathed this stuff all day, every day, but also the executives who run the companies in question? I could succeed where they could not? Suddenly I realized why even rockstar fund managers find it almost impossible to best the simple index over time, and why more fortunes have been created brokering trades than making them.”

I had a similar experience as I spent years researching and trying to identify the most successful stock manager’s hedge funds out there. We had a 20+ person research team doing the exact same thing. It was frustrating because to outperform the index you need to be able to identify, beforehand, companies where the embedded growth rate, in terms of their earnings, are going to grow faster than what the market has already priced in, the consensus. What is the consensus of all the market participants think? They, as they transact, set the price for the stock, and the stock will go up if the company beats those expectations. And it’s very, very difficult. But there are those that will continue to try, and if you try you need to understand and ask 1 of the 10 questions that I discuss in my book that’s coming out this year. It’s “Who’s on the other side of the trade?” Who are you trading with? If you’re buying a stock, who sold it to you? More than likely, it was an institutional investor. Perhaps, one using more and more artificial intelligence, AI, machine learning, algorithms that are fed reams, and reams, and reams of information and make connections that humans could never connect to figure out what will potentially happen with the stock. And the algorithms decide to sell and it sells and we’re on the other side of the trade. We’re buying because we, as Yerkie suggests, want to be one of those that can identify beforehand one of the 100 companies that are up 50% this year. There are those that say you can do it.

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