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The Smart Take:
Investing should be scientific and process-based. Speculating is more akin to gambling and lacking fundamental support. At extremes, it is easier to discern the two but can be shades of grey in between.
Hear Kevin discuss the forward-looking nature of the stock market and times why it can make investing sense (not speculating) to look through bad economic news.
And be sure to listen to the end where Kevin discuss process-based portfolio changes made in March, as a result of changing inputs, and why Vanguard’s DIY investors’ portfolio inaction was the wrong thing to do.
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Timestamps:
2:30 – Assumptions That Need To Be Made
9:20 – Looking Back On The Pandemic
13:29 – Looking Forward To The New Normal
22:30 – Rapid Changes
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The Host:
Kevin Kroskey – About – Contact
Intro: Welcome to Retire Smarter with Kevin Kroskey. Find answers to your toughest questions and get educated about the financial world. It’s time to retire smarter.
Walter Storholt: Well, hello, and welcome to another edition of the Retire Smarter podcast. Walter Storholt with you alongside Kevin Kroskey, president and wealth advisor at True Wealth Design, serving youth throughout Northeast Ohio and Southwest Florida. You can find the team online at truewealthdesign.com and schedule your 15-minute call with an experienced financial advisor on the team. That’s truewealthdesign.com.
Kevin, it’s great to be with you this morning. The podcast was in danger of not being recorded with my wife’s car troubles and just all the things happening in the world. We just have to overcome so many challenges to get where we are, but hey, the car started, life is good, and we’re rolling this morning.
Kevin Kroskey: Yeah, that’s good, and I guess full disclosure, Walter, I asked if everything was okay with your wife and her vehicle and you had shared that, “Yeah, I think I screwed it up and left the door cracked last night.”
Walter Storholt: It’s probably my fault. I probably was responsible for the battery drain, I believe.
Kevin Kroskey: It was nice of you. You’re a humble guy, Walter, so I’ll share this for you, but Walter’s wife, Connie, is a nurse and Walter is disinfecting her car every night after she comes home from work in the pandemic situation that we find ourselves, and so he’s going out, disinfecting his car for his wife, and just happened to leave the door cracked, apparently, so I think that’s certainly understandable, and I think that shows what a good husband you are, Walter.
Walter Storholt: Well, thank you. It’s not as bad as when I actually left the windows completely down, and I don’t know why I rolled the window down. I think I accidentally hit the button as I was cleaning, and then she went out the next morning, and there were all sorts of bugs and things inside the car. I was really trying to get fired from that responsibility, but it didn’t work. It’s still on my plate, so, but it’s good stuff, and yeah, we’re in it together, it’s a team, and makes her feel more comfortable to have a nice sanitized car to drive back to work in the morning, so it works out nicely.
Kevin Kroskey: There you go.
Stocks Lead The Economy
Walter Storholt: We’ve got a great show on the way today, Kevin, part of a two-part series that we’re launching here, talking about the market, investing, speculating, lots of different angles for us to cover here. I think the crux of the conversation, Kevin, is going to revolve around this somewhat puzzling idea, at least I know it’s been puzzling to me. I’ve heard lots of other people say, “Well, this has been weird over the last couple of months, how we get these bleak economic reports from the press, but yet we have this positive surge in the stock market.”
We’re in the midst of the pandemic. We still hear worries and concerns of having to shut back down, a lot of the unrest that’s throughout the country, and yet stocks just keep surging and going up positively, at least at the time of this recording. Is that great news? Are we ready for a stock market sell-off? There’s a lot of questions about it. Are people just speculating? Are we following true investing principles as a country as everybody is trying to figure out their financial futures here? I feel like I’m not alone in that level of confusion in this stark contrast that we have between the stock market and how the economy is performing. It doesn’t seem to compute on many levels.
Kevin Kroskey: No, I completely agree, and we’ve been getting a lot of questions about that from current clients as well as from new people that we’re starting to work with, and that’s the reason for talking about it in this two-parter, three or four-part, will actually to be determined, but whenever you’re looking at your retirement plan, I mean, we’re on the Retire Smarter podcast, you have to have some assumptions for what you’re going to earn from your investments longterm and those assumptions need to be at least within the ballpark of what is reasonable. You’re never going to predict it exactly, and the further you go out in time, let’s see, the more narrow the ballpark becomes, so if you’re looking at really short-term returns, hey, you could be spraying the ball anywhere within the ballpark. Maybe it’s going outside the foul lines and left to right field. Who knows? Maybe it’s going up in the middle, but it could be sprayed anywhere.
But as you go out in time, it’s more likely to go up the middle. It may go in left-center, it may go in right-center, but you’re truncating the tails if you will, and so that’s a good thing to remember when you’re thinking about this. I mean, time is certainly something that is really important when it comes to investing short term, lots of uncertainty, lots of uncertainty in needing to meet retirement income distributions or any sort of short-term cashflow need. Well, you better have it in a short term asset, but as you look out longer-term, you’re going to need to have your money grow over time for you. You’re going to need to keep up with inflation and be able to preserve your lifestyle and do the things that you want to do and at least have your money last a little bit longer than you do, so the longer-term money still needs to be in some riskier assets that have the more of the potential for growth.
That varies for everybody, but with where we’re at right now in 2020 has been an interesting year, and that’s an obvious understatement, but all of these questions about, “Hey, should I invest right now? Is it too much? I mean, is there still an opportunity that’s out there?” I mean, these are a lot of questions that we’re getting, and so I figured we’d really just dive into it and tackle it and see where it goes, and so where we’re going to start today is really talking, I think, more about the prudent side of the equation, really what stocks do and that forward-looking nature that they have.
Then in the next episode, we’ll get into, “Well, maybe when does that really become too forward-looking and maybe become more speculative in nature?” and I would really demark speculating from investing in the sense that we have a four-part podcast series that we did previously on our investing process that is very process-centric. You can certainly have inputs that you go through, and you construct your beautifully diversified investment portfolio that is ultimately going to be matched back to your financial life plan to support it and best align with the things that you want to do overtime.
Then, on the other hand, you really have this more speculative nature where it’s almost like the greater fool theory: “Hey, prices are going up. I’m going to go ahead and buy this and hope that somebody is willing to pay more for it so I can make money,” but there’s really not an underlying fundamental case or support for the higher prices. That sort of speculative nature is more easily seen in things like, well, Bitcoin or gold or something that is really doesn’t have an intrinsic value, necessarily, but it also can be in stock prices.
The dotcom bubble is probably the one that most people remember, but there are certain traits that are going on in the market today that bear quite a resemblance to the dotcom bubble, so we’ll start with more of the prudent side of the equation in this episode and then we’ll get more into speculative one in the next one. I think it would be good to listen to both of them together. I think you’ll get the point and counterpoint, and it’ll tell the whole story a little bit more effectively.
Walter Storholt: Do you want to start with the forward-looking side of things? Because just to play devil’s advocate, I’ve always heard that markets react to the news. If markets react to the news, then how can they be forward-looking? Because they’re reactionary to what’s happening in the world, so what hasn’t happened yet can’t dictate what’s going to happen in the market. I’ve heard both of those things said to be true about the markets, but they conflict with one another.
Kevin Kroskey: Let me simplify what you just said and say it another way.
Walter Storholt: ‘Kay.
Kevin Kroskey: You get paid for surprises. How about that, Walter?
Walter Storholt: You get …? Okay, hold on, I have to digest: You get paid for surprises? You’re going to need more context there.
Kevin Kroskey: All right, so-
Walter Storholt: I like it. I like it. It’s a new one.
Kevin Kroskey: … We talked about this whenever we did… I talked about why technology stocks must underperform going forward. It was a few episodes go, maybe a couple of months ago, and the example that I gave back then was, “Hey, here,” and I looked at the stocks in 2009 and how they were priced and what the earnings were, and then ultimately how they had done really, really well over the next ten years up and through the end of 2019 and basically if you own those stocks, you got paid for the surprise, their outsize growth or outsized earnings over that decade. If you had just owned the market, you would have done well over those ten years, but you wouldn’t have had the outsized return, so if you’re going to get outsized returns, you’re going to get paid for surprises, and that, yeah, as you indicated, it’s news, you’re predicting the future, something that hasn’t happened, something that is not currently baked into the stock prices, so to say, so whenever you get these surprises good or bad, that’s when it’s really going to be more of a market mover.
Let me put just a little bit more context to what’s been going on with the pandemic. If we go back to February when it started getting pretty serious in Ohio where many of our clients and probably many of our listeners are. Things got locked down in late March. It was March 22nd when the stay-at-home order was issued. Schools were shut down, I think maybe about ten days before that. You could just feel it. I mean, I was in Florida at the time and talking to my team every morning in Ohio. I mean, you could just sense it, that it was just palpable.
Leading up to the shutdown, economic activity had already slowed. People had already changed their behavior. They weren’t going out to eat, and they weren’t doing nearly as much. I mean, everybody probably remembers the grocery store shelves being barren and not being able to buy toilet paper or what have you, so those behaviors were already there, and they really preceded, ultimately, the stay-at-home order that Ohio issued, and it was one of the few states that did.
The economy really hadn’t… It was starting to get bad. It was starting to slow down. However, stock prices were moving much more quickly in anticipation of the slowdown and stock prices, many will remember if you look at it, I mean, they started going down a good bit in February and really sped up in early March, but they bottomed March 23rd. We’re recording this just after July 4th and the bottom on March 23rd. Really, the economic impacts were really just starting to be felt. This consumer spending, which comprises about 70% of the US economy, was just starting to slow down. People were saving more. They were spending more on groceries and stocking up their shelves and things like that. They’re cutting back on the travel, leisure, entertainment, things along those lines.
However, all the stock market and all the sectors that comprise the stock market were selling off pretty rapidly, and in fact, had bottomed down at least 30%. Some parts of the US market were down 40, 50%, close to 50% by March 23rd, but that was the bottom, and again, the bottom was reached well before a lot of the economic effects were happening, so the stock market is always looking forward. It’s what economists call a “leading indicator,” and so that part is normal, and a lot of times, people don’t necessarily get that.
I remember a conversation I had with a client after 2008, and they were sitting on a very large amount of cash, and I just asked them, I said, “What’s it going to take for you to go ahead and feel comfortable investing your cash?” He’s a smart guy, he’s an executive at Sterling Jewelers, which is headquartered in Akron, Ohio, just down the road from our office, and he’s like, “Well, I mean, I need to see unemployment going lower.” I’m like, “Okay, well, economists would say that’s a lagging indicator. If you’re waiting until the economy’s back in full employment, you’re probably going to miss out on a large amount of the rally.”
It’s one of those things where I get it. It’s somewhat counterintuitive. Things are bad; bad things are happening. The market switched in March and started going up and went up a good bit. Recording this in early July now, the US market, SP 500, was down more than 20% in the first quarter and it was up more than 20% in the second quarter, and that’s the first time that’s happened since the Great Depression, it was like 1932. Is this rational, or is this maybe a bear market bounce or something? Well, again, we’ll talk about that a little bit more, and frankly, only time will truly tell, but the disconnect between the economy and markets is not unusual, it’s just that you have to peel back the onion layers a little bit to really look through some of the current economic turmoil to really, “What can we expect as investors going forward?”
Market Expectations & Portfolio Changes
One of the other things I talked about in going through March was, this isn’t 2008, was a saying that I said a lot for several different reasons, but in the context of what we’re talking about today, again, consumers comprise about 70% of the market. Consumer spending took about four years just to get back to where it was before the global financial crisis happened before 2008 happened. It reached a peak in 2007; it’s falling off a cliff, it took a little bit more than four years or so to get back to where it was in 2007.
Now, we don’t know how long it’s going to take us to go ahead and recover that same sort of metric, consumer spending going through this COVID pandemic, but current estimates from a lot of just the economic thinkers, academics, big global banks, are that’s probably going to take about two years, so about half the time, and implicit in that is that, hey, there is going to be, whether it’s herd immunity, vaccine, we’ll see. It looks like my second home state of Florida is going down the path of really contributing to, “Hey, let’s reach herd immunity as soon as we can right now,” and it makes me think of Ricky Bobby and if you’re not first, you’re last, so way to go and be first in something, Florida, I suppose, but it’s really going to be truncated.
It seems like listening to a lot of the different health experts that are out there, that there’s certainly been a lot of positive developments. Hopefully, this thing is going to be able to be truly truncated here, at least in the more developed countries, sometime in 2021, probably going to take longer in some of the more emerging or less developed countries, be it India or what have you, maybe it’s going to take a little bit longer just because they don’t have the health system and the infrastructure to get back to where they need to be and just to really disseminate whether it’s a vaccine or it’s herd immunity, whatever.
But when you’re looking forward, you can look forward and say, “Okay, things are maybe going to get back to whatever this new normal is going to be in, say, two years.” Certainly, there’s going to be some shifts in consumer spending. We’ve talked about that in the past, nobody truly knows, but I think that certainly, COVID is going to change things, but at the same time, I think things are probably going to get back to some version of whatever the normal was, but shift a little bit. I don’t think it’s going to be a completely new world forever, quite frankly. I just don’t think that’s how people inherently behave.
But looking forward like that does make sense when you’re looking at stocks, and in fact, we’ve mentioned this a few times, but we did this for our clients in March. Right in the thick of it, whenever we were going through and having these big down days in March, and the stock market had reached more than 30% down, telling you, I mean, I’m not immune from having those emotional reactions, either. I mean, it was pretty severe for everybody. It was a health scare, which I think made it worse in many, many ways.
But what I figured I would do is at least briefly read an email we sent out to about a third of our clients, and we sent it on Tuesday morning, March 17th, and anytime that we communicate with people, even through this medium here, we’re in a regulated business, and you can’t puff anything up. I mean, we have very strict SCC regulations on advertising and communication and what have you, and so this is, just going to read the email as-is. We sent it out on March 17th. Here we go:
“In the past, we’ve discussed increasing risk in your portfolio if we believed return expectations warranted the increasing risk. We feel now is the time to consider doing so. A few points on the current situation: Compared to 2008, this is not a financial crisis, but rather a health crisis, which tends to be much shorter in duration. Current models from health experts are showing a peak in the summer months in the US, so that’s basically where we are now, and hopefully this does prove to be the peak, or close to it. Markets will overshoot to the downside due to fear and uncertainty. This will only become apparent in hindsight but happens in every crisis. Being health-related, the crisis and effects of social distancing will likely cause greater negative reactions in selling than past non-health crises. Markets are forward-looking, recovering well before the economy does. As coronavirus testing finally becomes more widespread in the US and positive developments on vaccine are announced, these are likely to bring calmer tones to markets and help them quickly turn positive, even as the economy still works through the turmoil.”
It goes on to provide a little bit more, but that’s really the main thing that we said, and we sent that out to about 60 clients or so, about a third of our clients, that again, had the ability or the risk capacity within their financial plan to go ahead and take more risk if it was warranted and so they could afford to take that risk. We had about 90, 95% of our clients that actually did follow the recommendation. Some people just didn’t feel comfortable, certainly understandable. Frankly, we were surprised that 90 to 95% actually did increase risk. We thought it was going to be more like 50/50, just because in March, I mean, it was scary and it’s still scary, but it’s not as scary as it was in March, I would say when it was just so new and it really just hit us and shocked us.
We sent that on March 17th. I certainly did not know that the market was going to bottom on March 23rd. The timing looks pretty smart, and I’m happy that it played out that way, I’ll take luck anytime that we can get it, but this was really us looking forward and saying, “Hey, even if earnings are zero in 2020 going forward and even impaired significantly in 2021 when we get back to 2022…” Because stocks had fallen 30, 40, some parts of the market, even 50%, we just felt that they had fallen too much. Thus, we sent the email. We’re happy that it played out how it did. We were able to look forward to the clients that had the ability to take the risk. The vast majority of them did.
At the same time, we told them that this was not a short-term timing decision. In fact, we made the trades to increase risk over a period of weeks because we didn’t know if it was going to be the bottom, we wanted to reduce the timing risk, and we just felt that it was prudent, so that’s what we did. We certainly said that things could get worse before it gets better. There is no reason why the stock market couldn’t have gone further down, but also right around the time that we sent that email, the Fed had really stepped in and started doing a lot of unprecedented measures, Congress stepped in, all this happened much, much more quickly than what happened in 2008 and we look forward, and we’re happy that we did.
Here we are now in July, and it looks like, “Well, hey, the market’s bounced back quite a bit,” and Walter, I don’t know about you, but economically, I mean, things… I heard somebody call it the “careful economy” right now, and “careful” seems pretty accurate for most places. I mean, people aren’t exactly back to normal. Thankfully, I was out last week and getting, I do the grocery shopping when we have to go out, and I saw a lot more masks. We’re still actually in Florida, my family in Florida. We just did not feel comfortable traveling back to Ohio and just introducing any risk as we were traveling back, so we just decided to stay put, and now Florida is numero uno hotspot in daily new cases, but at least we can still be safe in our home.
When I did go out last, it was the most masks that I’ve seen, so it seems like certain people are getting the message. At the same time, we had a July 4th party in our neighborhood. We didn’t have it, our neighborhood had it, and my wife took my older daughter down to see the fireworks that they were having. She said there was probably a hundred people gathered together, no masks, not a single one, and not really any social distancing, so my wife stayed away and allowed my daughter to see the fireworks, stayed, just didn’t intermingle with anybody, and so it looks like a lot of people in our neighborhood are going for the herd immunity, and they were mostly younger people, my wife shared.
But on the other hand, when I was out of the grocery store, I’m seeing a lot more people than what I had been wearing masks and being more careful, and so that’s my little microcosm down here. Ohio certainly seems to be a little bit on the safer side in general, but everybody’s having this fits and starts, ebb and flows, and by no means is the economy back to normal right now. It’s still going to take some time to go ahead and be there where people truly feel safe, and we can go out and just get back to whatever our normal lives are or our new normal lives are going to be, but prices have looked forward, and now it becomes a question: “Well, are they looking forward too much?” We’ll talk about that next time.
Vanguard DIY Investors Doing Right & Wrong
One other thing that I wanted to mention before we wrap this episode up, I read something from Vanguard recently and what Vanguard said was 90% of their retail accounts did nothing so far in 2020, so they didn’t panic out March, which is great, they stuck around for it, but you also did nothing. On the surface, it may sound good that “Hey, they did nothing, they didn’t panic out,” but frankly, if you, again, I’ll use the peel back the onion a little bit here, that’s not necessarily the right thing, either. When stocks sold off in March, and they sold off darn quickly, I mean, the things that we were doing and what should have been done, quite frankly, were stocks went down a lot.
We’ve talked about rebalancing. March was a great month to go ahead and get a rebalancing bonus because you were selling the things that had gone up in value, or at least fallen less, even some higher-quality bonds did fall for a couple of weeks in March, but stocks had fallen much, much more significantly, so we were selling the things that had done well to buy the things that had done poorly and buy low, sell high. Again, the basic rule of investing. If you are a taxable investor, have a joint account or trust account. None of our clients are really going to be paying any sort of capital gains taxes this year because we were proactive, and we realized losses in March. We bought a similar but not identical substitute security for what we sold and realized in terms of the tax loss and basically reestablished our position at now a lower cost basis and all of our clients are going to be getting benefits from that when it comes time to file their 2020 tax returns.
If you’re not doing anything, and those are two things that everybody should be doing, the other thing that I just talked about, about certain clients where we increased risk, I mean, that was a portfolio as a strategic change. Other clients, we actually changed their spending plans a little bit, we raised a little bit more cash. Some clients were in more high-risk situations for their employment continuing, so again, maybe they were able to afford more risk coming into 2020, but now the continuation of their employment is much less certain, so hey, we got to respond to that.
Both from a financial planning perspective, things have been changing and changing quite rapidly, as well as from an investing perspective. Things have been changing and changing quite rapidly, so while not panicking out is good, it’s certainly not enough to really make the most of what you have and make sure that you’re being proactive, given the uncertainty of the pandemic that we’re in.
Some things to keep in mind: Again, the stock market and the economy, they’re not the same thing. It is reasonable to look through some of the turmoil that we’re in and have gone through. In the next episode, we’ll talk about maybe when that becomes a little bit irrational and a little bit too much, but when it comes down to your financial planning, the investments have to be in alignment with it. Again, things have been changing very quickly for many people in their personal situation from a financial planning perspective, and certainly, all of the inputs for the investing process have been changing quite quickly as well, which ultimately means we’ve been doing a lot more portfolio work this year because of the dynamic nature of things. I think it’s really important to keep those in mind and just be very prudent and proactive with your planning and with your investments.
Walter Storholt: I was chuckling on this side of the equation here, Kevin, as you were talking about the do-nothing approach. I was like, “Well, I can do that. I can sit around and do nothing,” so it’s interesting to hear that people who do this for a living also just sat around and did nothing while you were busy trying to take advantage of opportunities and being proactive about some of these things. There’s a big difference between value there, I think, in terms of advice and instruction that you get versus somebody that’s just like, “Hey, things are unpredictable. Let’s do nothing versus those who are proactive.” I think that’s an interesting testament to your team and the way that you guys view things and points back to that process that you laid out. That was back before the pandemic when we talked about your investing process and the principles behind it, or at least maybe right at the beginning of it, so it’s neat to see how that has played out through all of this, and played out well from what it sounds like, right?
Kevin Kroskey: Yeah. I read the email about the risk increase, and clients are… I’m quick to acknowledge luck in what we did. Again, the decision that we made in March was looking out. It wasn’t looking out a few weeks or a few months. It was really looking out a couple of years, that was the underlying thesis of the decision. Nobody knew what was going to happen in March. There’s still a very wide-ranging of economic outcomes, so I’m not trying to pretend that I have a crystal ball or anything, far from it. However, it was more of the looking forward aspect, and for those clients that have the ability to increase risk, we did so.
Now, at the same time, here we are in July, and in the next episode, we’ll talk about, “Well, hey. Really, I mean, has it come too far too fast? Do we maybe need to rethink some of this?” I guess that’s where we’ll leave it for today, so I’ll toss it back over to you, Walter. We’ll leave the audience hanging a little bit.
Walter Storholt: That’s a great point because it did come roaring back quickly. Have we come back too quickly, and what kinds of problems does that create? We’ve all probably heard the word “speculation” before. You don’t want to speculate with money, but what does that really look like? Can we define it? Can we illustrate that against just true investing? We’ll counter those two things against one another on the next episode as we continue part two of our conversation about this whole idea of when the stock market diverges from the economy and how do you reconcile those differences. That’ll be coming up on the next edition of Retire Smarter.
In the meantime, if you have questions about your own financial plan, need an advisor to look at your plan with you, talk to you about your financial future, how you can better structure yourself for retirement and overcoming any obstacles financially that you might face, reach out to the True Wealth Design team. You can go to truewealthdesign.com and click on the “Are We Right for You” button to schedule your 15-minute call with an experienced advisor on the team today. Again, go to truewealthdesign.com and click on the “Are We Right for You” button. You can also call the old-fashioned way, (855) TWD-PLAN, that’s (855) 893-7526. For Kevin Kroskey, I’m Walter Storholt. We’ll see you on the next edition of Retire Smarter.
Disclaimer: Information provided is for informational purposes only and does not constitute investment tax or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness can not be guaranteed. All performance reference is historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.
