What You Need to Know When Making an Investment Decision

David Stein
David Stein October 10, 2019

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What should you think about when making an investment decision? David Stein, host of the Money for the Rest of Us financial podcast, explains what you need to consider when making decisions about your money. Learn how to measure an investment’s performance, and find out how you should react to a volatile market.

What makes stock values rise and fall, and how should these influence your investment decisions? Doug Goldstein, CFP® explains the influences behind the stock market, and how to respond to them.

Follow David Stein at http://moneyfortherestofus.net and on Twitter: @jdstein

Watch Money for the Rest of Us on YouTube.

Read the Transcript

Interview With David Stein

Join Douglas Goldstein, CFP®, as he interviews David Stein, producer and host of the popular podcast, Money For The Rest of Us. Why should you invest in emerging market stocks? Should you still stay in the market when there are frightening things going on?

Douglas Goldstein:  I'm very excited to be talking to David Stein, who produces and hosts one of iTunes’ top ten ranked podcasts called Money For The Rest Of Us. He's got tens of thousands of people listening to the show, which is filled with very good advice. I strongly recommend it. David, how are you doing?

David Stein:  I'm great. Thanks for having me.

Douglas Goldstein:  One of the things that people do is look for the next great investment strategy. The index lovers always say, “Why are you fussing around with strategies? Just buy index funds!” Does that make sense to you?

David Stein: I think buying index funds makes sense, but it doesn't stop there. That's just one decision. Where I get frustrated with the, “all indexing all the time” camp is, it's not just one decision. Once you believe the markets are fairly efficient, and that it doesn't pay to pay an active manager to try to help from the market, then you need to make the decision: Which index fund? What is your asset allocation? What is the mix? Do you adjust your exposure to different markets over time as conditions change? How frequently are they balanced? There are a lot of active decisions when it comes to passive indexing. As an institutional advisor in my previous life, we did both. You index portions, and perhaps you're active in other areas that are less efficient. But you need to recognize investor management and portfolio management. There are always going to be active decisions.

Douglas Goldstein: One of the questions people often ask is, “If I'm looking for an active manager, what shall I benchmark him against?” In most cases, people benchmark against the S&P 500, which to me seems a little bit strange. How do you think people should actually measure their results?

How Should People Measure Their Investment Results?

David Stein: You should look at a manager’s particular style and strategy. If they are a core large company, like U.S. Stock Manager, the S&P 500 is the appropriate benchmark. If they are a Small-Cap Manager – then it should be a U.S. Manager, Russell 2000. It's very important because if you don't use the right index, then you're comparing apples and oranges. What you think is either under-performance or outperformance could simply be that you’re using the wrong benchmark. The benchmark should match the universe of investments that the particular manager fishes in. If it's not a good match, then there isn't a good way to decide whether they have outperformed and earned their fee or not.

Douglas Goldstein: When people set up a core portfolio, they'll say, “I've got a manager who buys 5, or 10, or 15 different index funds because I like indexing.” That makes sense, but with each of these funds, the manager may overweight in the U.S. at some point or in some other country or in some specific sector. What's the reasonable benchmark, because how can you define it if the manager is using his discretion to decide where to go?

David Stein:  The ultimate benchmark would be the world market, the global market portfolio, and so an example is the MSCI All Country World Index. I used to run portfolios where we essentially invested in ETFs. We would use a broad-based index like that, and then if we were overweight in emerging markets or something like that, you would see that our performance was never going to be due to security selections, in terms of stocks or in the ETFs. It was always asset-allocation driven. This gets back to another issue when it comes to indexing. If somebody is truly passive, then they should own the global market portfolio.

With something like the MSCI All Country World Index, the minute they deviate from that, let's say put more in U.S. stocks or something else, then they're making an active bet. Most indexers, if they go out and they are just buying the Vanguard Total Stock Market Index at their U.S.-based investor, that's primarily U.S. based stock. They're making an active bet. Most investors tend to be home country biased and they own more exposure to their home country than the rest of the world. That's an active bet on your home country.

Douglas Goldstein:  Let's look at the global issue a little bit more. When I started on Wall Street about 25 years ago, the common wisdom was to put a little bit into foreign stocks because it sounded so unique - in order to diversify. But now it's obviously a big thing and it's easy to invest around the world. How does someone know where on earth to invest if he wants to be a little bit more active and focus? How do you make that decision when you're an armchair investor?

How Can An Individual Know Where To Invest?

David Stein:  You start with the foundation; start with global stocks. At the beginning, buy the world. You find an ETF that invests in all the investable countries around the world. You figure out how much will be in stocks, and you certainly have some bonds. My approach is, you want as many drivers in your portfolio as possible. If you're going to start, start with the global market portfolio; an MSCI All Country World Index ETF. It can be as simple as that. Then what you do is start looking at other areas that are undervalued, that have a higher expected return.

Right now, emerging markets are cheaper. Emerging markets stocks are cheaper than U.S. stocks, and they are cheaper than other developed stocks. They have higher dividend yields and have expected higher economic growth. All things being equal, they should have a higher expected return looking at the next decade. If somebody wanted to make an active bet, then having a little more on emerging markets makes sense. There will be those periods when it will underperform, it will be more volatile, but that's normal. You have to look at the market conditions to see other areas, but at the simplest, you just own the world and you do it as cheaply as possible.

Douglas Stein: We've been focusing on index funds and how to choose them and how to benchmark what you're doing. We were leading towards this question of timing and being a little more specific about where you invest.

There’s a philosophy out there that says “It's not timing the market, but time in the market” and then there are people who say, “Look around.” We've got an election we're dealing with. What would you say to a client who says that he believes in long-term investing, but he’s scared to be in the market right now? He thinks it's going to be terrible and he wants to sell out. Is that the right decision to make, or how should people deal with the fact that there are some pretty frightening things going on?

Should You Sell Out When There Are Frightening Things Going On In The Market?

David Stein:  If somebody feels that things are going to be terrible, it's a terrible reason to leave the market. I believe that it is appropriate to objectively, and periodically look at what the market conditions are. Look at what valuations are. If an area of the market is extremely overvalued, then it's okay to reduce your exposure to that. You do not have to ride the market up and down like a rollercoaster, all the time.

I look at valuations. When global recessions hit and the U.S. is included, the market, on average, loses 45% around the world. As a result, I want to look at data that looks objectively at what the risks are of recession. Examples of that type of data are the monthly purchasing manager indices surveys that are done around the world. They're a very tight correlation to ultimate economic growth.

If there's a high risk of recession, it's okay to reduce your stock exposure.  The other thing that I look at is what's called market internals. It's a level of fear, greed, momentum, and trend because investment markets are driven by math. They're driven by dividend yields, valuations, and annual growth, but they're also driven by emotions. When you have an internet bubble or a huge housing bubble, it's okay to reduce your exposure to get out of the way.

When Is It A Bubble And When Is It Industry Growth?

Douglas Goldstein:  How do you know when it’s a bubble and when it’s industry growth?

David Stein: Bubbles show up in valuation. It’s hard to figure out a bubble in San Francisco, but if you're somewhere else, and you see that housing costs relative to median income are stratospheric, that's a bubble. It's okay to make an adjustment, and it's the same for stock. If the PEs of stock are 50, that's a bubble. It's okay to reduce exposure, but you can't do it based on feeling. You have to look at it objectively and then make incremental steps. It's very, very difficult to get timing right and to try and get in and out of the market.

A good risk manager is always looking at where we are, and if risks are high they're going to reduce the risk. If the risks are low, like they were after the great recession, where valuations got very cheap and yields on bonds were incredibly high, that was a time to take risk. At that time, most people didn't want to because they were terrified.

Douglas Goldstein: How do you deal with that? They're suffering from worry and anxiety, and they’ve literally seen blood in the streets. How do you become confident enough to buy?

David Stein: You take baby steps. You don’t do it all at once; you average in. We suffer from regret aversion. As humans, and investors, we're afraid we're going to make a mistake and the way that you overcome that is if you happen to be out in the market, then you slowly move in. Now if somebody is terrified of the election right now, perhaps you reduce risk. You can sell some of your stocks.

You don't necessarily get all the way out because the objective data right now does not say that; there isn’t a high risk of recession. Valuations are a little higher than normal. In the U.S., I would say they overvalued, so I have less in U.S. stocks than I might otherwise, but you just want to look at the objective data. It's okay to make incremental decisions; that's what risk management is. It’s “all or nothing” decisions that cause people to get whipsawed.

Douglas Goldstein:  Let’s assume that someone has listened to this show today, gets all excited, and begins to take those small steps. He watches his investments for a few months, maybe a year, but then he loses his momentum. He still needs a solution for dealing with long-term growth. For people who aren't so interested in making these decisions and following it so closely, what's the best way for them to manage their portfolios over the years?

How to Manage Your Portfolio

David Stein: Do an asset allocation and understand what you can earn from investing. Some people have no idea about what they're going to earn from investing. I remember I had a guy that asked me the other day, “What's a reasonable return for investing in stocks? Before I could answer, he says, "It's 80%, isn't it?" He had bought a stock and it went up 80% - that had been his experience. But before anyone can invest, you need to say, “Okay, here's a reasonable expectation for stocks or bonds, based on where we are today.” Not what they have done historically, but based on where we are today. Once you have that, then you can choose your allocation and if you don't want to make adjustments, then you don't. Then it's buy and hold, and low fees, and the bulk of time that people should spend is finding ways to save more. Very few people get rich investing.

The way you get rich is by saving more and spending less. That hits the compounding. The adjusting over time can help you manage emotion. Then, when you have a huge sell-off like in 2008, that can certainly save some angst and a lot of money that was lost. The reality is that we've been in the secular bull market since 2009 and most of those investors that rode it down lost a lot of money. If they stayed in, they made it back. It was a horrendous ride and not one I would have taken, but it's a way to invest and it works for a lot of people, if they can handle their emotions.

Douglas Goldstein:  That's right. I think that a big part of it is handling emotions. David, how can people track you, follow you, and follow the work that you're doing?

David Stein:  The best place to go is my website: moneyfortherestofus.net. That's the home for my show or they can find me on Twitter @jdstein.

Douglas Goldstein: David Stein, thanks so much for your time.

David Stein:  Well thanks. It was fun.       

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