7 Data Driven Principles All Successful Investors Know - Wise Wealth Podcast ep. 12

Well, hi, Josh. Welcome to this edition of the podcast. How are you doing? You doing well yourself? Very good. We've had to do a little homework in advance to get ready for this podcast. I think it's really good timing. Obviously the markets are kind of going up and down with all the tariff stuff going on, and we're trying to figure out as consumers and as advisors and all of us as investors, what we should be doing. So I thought the topic you suggested was great. And so we're going to talk about six principles. Every investor should know. And when we go through periods of market volatility, we always say to ourselves, this time it's different. But the reality is market volatility is, is not a bug of the market. It's a feature of the market. And in fact, we can exploit that volatility if we act with discipline. So maybe to start off the podcast, I'm just going to ask you a fundamental question and you can provide your insights. Sure. Super quick. It's funny. It's actually seven principles. Every successful investor should know because you added one last minute. Okay. I wish I could count better. So like I said, we've got some great principles that we're going to go over together that I think are, are very accessible. Some are a little bit more high level in terms of investing, but they're all very useful concepts to be aware of. So one of the things we were talking about is this idea of market efficiency or markets are likely efficient. What is meant by efficient markets as, as retail investors, what are the practical applications of that? What does it mean? Yeah. So market efficiency, I think is really fundamental to invest. It's really at the root of a lot of different philosophies about whether you should be actively buying and selling stocks in the market, or if you should own the market in some sort of product, like an index fund, even if the market is not efficient. Like there's many cases where you can show that there's price inefficiencies in the market. Most people would argue that you should at least treat it or you should act as though and make investment decisions like it is efficient. So at the core of efficient market hypothesis, it posits that market prices reflect all available information and that the prices are not necessarily correct or perfect, but they incorporate publicly available information. Now, because new information is unpredictable, you cannot predict price movements because the only reason why an inefficient market price has changed is because new information comes out. Now, the implications of this are given the prices instantly reflect new information, consistently outperforming the market using public data is nearly impossible. This unpredictability supports the use of passive investment strategies like index funds, which aim to mirror the market performance rather than exceed it. So, okay. So that's very helpful. I mean, I'd say that probably one of the most common questions to get asked of us by clients is given this and that's happening, what should we do? What do you think the markets are going to do? And the comment's going to be the market is already priced in the impact of that public information. The market's always already taken into account. And that question is so common. And so this basic understanding of market efficiency is gathering all known public information is priced into the securities. We already know how the market's gaming that set of facts, but there are other facts that we don't know. And so you alluded to that, which is Trump shoots from the hip. He almost makes policy right in the moment and known information until he says something. And then all of a sudden you see the volatility in the market as a market now has new public information that has to price in. So that's a tug of war back and forth all the time. Right. And that the prices might be incorrect when the new information comes out. Investors might buy and sell, and it might be priced incorrectly based on what the fundamental value of the asset is, but that doesn't matter. The point is that you can't predict that. So the price changes are not predictable, which means the market is still efficient. Right. Example of that is something like tax policy where you have current regime for taxes and the market knows what the tax code is and how it's going to impact the profitability of companies. And all of a sudden the government releases, you know, budget changes, tax policy changes. And in that moment, all of a sudden stocks get repriced based on that new tax code, which could impact their profitability. So it's a, it's just an ongoing process that happens, but it's very quick. Like it responds very, very quickly. So that idea of, of, of efficient markets, where did that idea come from? Like what are some of the initial sort of research done on the topic or who did that? Yeah. So this is a great question. It, it foundationally came from Eugene Fama's 1970 paper. So a review of theory and empirical work by Fama in which he kind of laid the groundwork for categorizing market efficiency into three main forms. He got a bunch of different things, but he kind of broke it down into weak form. So this is when today's stock prices reflect all historical information. So what this means is that theoretically you could use fundamental analysis, not technical where you use charts and trends, but fundamental analysis to find price inefficiencies to outperform the market. The second form of market efficiency is strong form. And this is when current prices incorporate all past and current information. So in this situation, assuming that this is true, you would not be able to use technical or fundamental analysis to get higher returns in the market. And then the third form is strong form efficiency, where this states that all information, both publicly available information and privately insider information is completely accounted for in current stock prices. So now this all being said, most likely the form of market that we have is semi strong, where historical information and current information is incorporated in prices. Obviously it's hard to know whether insider information is incorporated in prices, but now I guess if you're listening to this and you're like, hey, well, this is all great, but what's the implication of this? Well, if efficient market hypothesis is true, there's no such thing as an undervalued or overvalued asset. And so the only way prices can change is from new information, which is theoretically random, meaning an attempt to predict prices is a foolish game to play. So with that background, empirical background, what are some of the practical for the average retail investor? How do they use that principle or understanding? Well, I think this is going to lead into my second point pretty well about forecasts and whether or not we can rely on forecasts. I think someone could probably argue and say, hey, markets are not perfectly efficient. We know they're not perfectly efficient and there's observable phenomenon like post earnings announcement drift, right? That you could theoretically take advantage of. So you could argue like, okay, well, I might take advantage of that and get market beating returns. But if you want to outperform the market, you have to find these opportunities in these places of mispricing before everyone else. You have to be smarter than everyone else. And then you also have to have a way to take advantage of them, which isn't necessarily true. And often there's costs involved to that, that would eat away at any excess return you generate. And so it really just is a terrible strategy to be like, I'm going to be smarter than everyone else. And I'm going to find these price inefficiencies and I'm going to beat the market because we know how many professionals and how many super, super smart people can't actually do that. So to think that, oh, I'm going to do it is not a great strategy. Yeah. So the practical action step there might be to, you know, if you want to participate in the markets, you buy a broad market low cost ETF structure, right? So you're owning the market and whatever part of the market drives performance, you own it. Okay. Perfect. Yeah. And that jumps into like returns are positively skewed, right? So a few stocks in your portfolio are going to drive the return of the portfolio. Right. And you don't know necessarily because you can't predict it. You can't predict which stock price they're going to drive that portfolio return. And so theoretically the best decision you can make is to own all of them and then you would own the one that drives it. And so, yeah, I think, I think it's a pretty solid argument. All right. So that's enough of me rambling on about market efficiency. I know, Sean, there's some topics you want to get into as well. So you have here term structure. What exactly do you mean by that? Yeah. Term structure or timeline. I mean, what I'm getting at, it's a very practical application that we use this idea when we're working with retired clients or clients getting ready to retire, which is the idea that the risk and return relationship of a security or investment approach changes with the time horizon. And so we often talk about timeline investing where, you know, the longer your timeline, should they hire the probability that the security you're using, particularly if you're a growth investor, will come into the expected long-term average returns that you are looking to achieve on the portfolio. In the short run, if you have an all equity portfolio, it can be wide variance in return year by year. But the longer you hold onto that security, the more you come into the expected average return on the asset. Way you manage risk with that security, and we'll talk about why it's so important to have growth or equity investments in your portfolio, is through timeline planning. If you have a very short timeline on your portfolio or a portion of it, then you need to understand how to structure the portfolio to deal with the short-term risks. So this is a very simple chart. Really what we're illustrating is just a timeline. This timeline is one through 10 years. And when you take a look at timeline, when you see volatility or risk, which is really defined as the swing rate on your security, the greater that swing rate, the more you want to push that particular security into the longer timeframe of your portfolio. So often when we work with clients, we're saying, okay, so let's build the income plan. In the short end, you've got a cash wedge or money that's going to be set aside for income payments or liquidity. And the further along that we get in this timeline, the more that we can feather in risk assets, high quality stocks, stock ETFs in the portfolio. And the reason we have confidence in doing that is that the longer the timeframe, the higher the probability we're going to come into the expected returns that we're modeling for the portfolio. We don't want to push those equity investments or those risk assets into the short term because we can't cope with the volatility. If you need money from your portfolio tomorrow and the market goes down, you don't obviously want to sell those assets at a bad time, but the longer the timeframe, the more you can leverage off timeline structure or term structure in the portfolio. So it's really important as an investor segment out your portfolio based on liquidity needs. The shorter the timeline, the more risk adverse you need to be. The longer the time, the more you can take financial risk to grow your returns over time in the portfolio. So Josh, the next principle for investing might come across as a little bit controversial because there seems to be this belief in our industry that money managers and investment firms and economists have this amazing predictive ability and careers and fortunes have been made selling research based on this predictive ability. So maybe you could share your perspective on that topic about market forecasts and there's a lot of truth to that, or maybe there's some holes in that idea when it comes to research and how retail investors can use research. Yeah, no, it's, that's a great question. So I kind of titled this section as you should not rely on market forecasts. And this is kind of pulling from my first point about predicting future prices, but market forecasts are unreliable because they're an attempt to predict randomness, which cannot be done. So a new information is theoretically what changes prices. And so in a forecast, you're predicting what price you're going to be, which is unbelievably difficult. So what I want to pull up here is this first chart or analysis from dimensional in 2024, they released this analysis where they looked at forecasts by 10 asset management and investment advisory firms for the period of 2014 to 2023 tenure period. Their analysis included the major asset classes covered by most forecasters. So you'll be seeing on your screen now on the left hand side here, we have panel A so equities panel B U S fixed income and panel C REITs and commodities. So I'm just going to focus on equities for today. I think it makes the point. We don't need to get into other two. It's kind of a similar trend for those ones. And that was about from 2014 to 23, 23, right? That's correct. Yeah. 2014 to 2023. And so panel A presents the annualized compound nominal return forecast for U S development, excluding U S and emerging market equities. So that's the darker blue you see in the, in the middle there. And then the light blue is the realized returns of those forecasts or what those actually ended up being and dimension. I'll just read what they have here from it. So we see wide dispersion across forecasts in all regions. For example, forecasts from U S equities range from 5.5% to 7.7% annualized, which translates to a 10 year cumulative return of between 70% and 110%, pretty big gap there. And the realized return, however, lies well above the range at 11.5% annualized and a nearly 198% cumulative return. So it just kind of blew all the forecasts out of the water. So for emerging market equities, the forecast dispersion was even greater, although all forecasts turned out to be overly optimistic. So across all regions, equity forecasts differed from reality by 1.7% to 6.8% with an average error of a little over 4%. Over a 10 year period, that difference compounds as well. And it ends up being a really big difference. If the range of forecasts, cumulative return between 70 and 110%, or the realized return is 198%, it's a big difference. And so when you're making decisions, it's important to realize you might be making decisions with inaccurate or even false forecasts. Yeah, like the practical application of that is if you're preemptively in decisions with your asset mix based on this data, you're really hurting your performance. Yeah, exactly. And so they go on to say, given the level of variability we see and the accuracy of capital market assumptions, it's worth asking how much weight should we put on them when building portfolios? And I just think that's super, super important to think about. Like when you're looking ahead and you're looking at forecasts, but we know how inaccurate forecasts can be or usually are, how much weight do we put on them? And should we really kind of get anxious about the future based on these forecasts when they could be completely wrong? And in the next chart I'll show you, I'll make that point, I think, even better. The last thing I wanted to say was, if professionals are this inaccurate, why do you think you as a part-time investor could do any better? So you're up against a guy with Bloomberg Terminal, $30,000 a month pretty much. And so I don't know why, it's quite confident to think that you can do better than them. The one thing I would say to those of you watching is, and you'll see this very specifically in the next chart, but when you're watching BNN or Bloomberg News or any of the market channels where you're following the markets, Squawk Box or whatever, it's very important that you understand that that's entertainment. It is not a place you go to give you information on which you're managing your investment portfolio. It's a fool's errand. Now, if you are entertained by it, you find that the hosts are interesting and their guests are even more interesting, but do not make your investment decisions or strategy decisions around their predictive ability. Okay. So you've got another chart to show us. Well, on your point there, I think that's a great point. And actually I changed my name from this section from do not read market forecast to do not rely on them. Because for various reasons, I could see someone reading it, even if they don't take it as gospel. But yeah, I think if you're going to use it to make your own financial decisions, that's a dangerous game. So in this next chart, again, what we're looking at is the forecast versus reality in 2024. So equity analyst predictions versus actual for the S&P 500 index calendar year, price return in 2024. So at the top, you see the S&P 500 index. Under it is the, for 2024, under it is the S&P index historical average of 12.3%. Below that is the forecast or the analyst predictions from a lot of different analysts. So JP Morgan at the bottom there, Morgan Stanley, Scotiabank, Wells Fargo, a lot of big names there. And we're looking at it here and you can notice that they were not very good. So the average forecast had the expected price return of the S&P 500 in 2024 to be about 1.7%, the highest had it around just under 10% and the lowest had a negative, like 12 and a half percent. In actuality, it ended up being 23.3%. So predictions drastically underperformed actual returns. All forecasters predicted S&P 500 index return below the historical average, even of 12.3, and in actuality, it turns out returns were double or nearly double the historical average. And the difference between the lowest prediction and the actual was more than 35%. So question for you as a viewer, should we really be relying on these crystal balls if we know they're going to be unreliable? I mean, I think the obvious answer is no, but maybe someone else has a different answer. No, that's a great overview. I mean, and of course, throughout our podcast, we'll be casting out ideas about how to deal with that, right? As investors. And one of the practical ways is again, own the broad market, be disciplined. Yeah, obviously like this is just one year, right? So you could be like, oh, well, there's other years where forecasts were way more accurate. You as an investor really have no way to predict. So there's two predictions. You have to predict which forecast are going to be right. And the forecast are predicting the prices. So that's just a level of prediction. I just don't see a feasible. And so how are you going to predict which manager is going to do well? I don't know. And also, how do you know that the manager that does well is doing well because of their strategy versus it's just luck, I don't think you can really prove that one way or the other. I mean, we could talk about this for hours. I mean, SPV, SPIV, so the center and pores index versus active. I always get that wrong. They released their 2024 year end analysis. So active versus passive, and we don't need to get into it too much, but on average, 80% of active funds underperform their benchmarks, which is just pretty crazy. And so, yeah, I'll just leave that point there, but past performance is not a guarantee of future results. That's my last point. All right, Sean, I'm going to throw the ball back to you. So you had another point you wanted to get to, I think this is 0.4, which you had time in the market beats timing the market. So do you want to maybe elaborate a little bit of what you mean by that? And yeah. Yeah. I mean, I think many people listening have heard that before, but it's a really important principle to reinforce. And I'm just going to bring up a chart that helps to illustrate why trying to market time is so, so difficult. So let's take a look at the chart. So what you see on the screen is the best and worst trading days happen close together. This is the US stock market S&P 500, 1988 to 2019. And what you're seeing here is the daily market swings over that time period. This is the definition of volatility. Every day there's ups and downs. Now, the reality is if you looked at the cumulative return of this time period, 88 to 2019, the mountain chart looked fantastic, right? So the market did very well over this time period. But just step back there in the short term. Are you going to be able to time the good days and bad days in this particular market cycle? I'd say it's impossible. In fact, just take a look at the 20 best trading days in the green and the 20 worst trading days in the red. And what you see here is the fact that they're, they're just compacted right up against each other. So for a lot of retail investors, I know they believe that somehow you can watch the news and look at the economic tea leaves and you'll begin to see patterns where things are beginning to improve and there's going to get some traction and the data and confirmation is just going to get stronger and stronger and stronger. So you'll know, okay, this is the time to move back into the market. We can assure you, and you can see it in this chart, that predictive ability will not exist because the noise in the market day to day will not give you any confidence that this is the time to head back in. And this is really a good illustration of why the market doesn't work. And it's one of the reasons why rebalancing is so critical. You need to have a part of your portfolio that is just everyday rebalanced to take advantage of these short-term swings. And if you do that and your portfolio consistently rebalances into these down drafts, then you're going to greatly increase the probability of having above average performance on your portfolio over time. Yeah, that's a good chart there. Honestly, I think that that point is just perfect after the topics I've talked about. Time the market well, you have to time it twice correctly. You have to time it before it drops and then you have to time it before it goes back up. And to do that once correctly is difficult enough and to do it twice is incredible. So yeah, I think that's a great point. Yeah, and I don't think we're going to get into it in this particular video, but I think the reality is because psychologically we weigh loss much more heavily than the potential for gain. Psychologically satisfying to leave the market because you're concerned about loss and it's not nearly as satisfying to get gain by moving money back into the market. So what happens is we have these psychological and emotional barriers to get part two of that strategy right, which is when do I go back in the market? Yeah, so difficult. So Josh, the next question is a really important one. It's often thought of as one of the eighth wonder of the world, which is time and compound interest. Now, we often encourage people, you know, if you're near retirement, have already gone through most of your capital accumulation phase and you've been accumulating capital. This may not be super relevant, but it could be really relevant for your kids, your grandchildren. And so we always encourage people to pass on this information to underscore the importance of this next principle. So Josh, maybe you can share your thoughts. I thought I'd make my last point a little bit more positive. I feel pretty negative and a little bit cynical. And so this last point I think is empowering, which is when you start early and you have a long time horizon, you can really get amazing, amazing results with your investments without having to do anything crazy or relying on luck. So why is a long investment horizon so powerful, even when we compare it to starting later, but saving the same amount? So what I mean is starting at 20, saving a little bit, age 65 versus starting at 35 and saving the same amount in total as 20, you will do way better because of the time difference starting earlier. So that'll make more sense when I show a chart in a second here. But so why is so powerful? So compounding can turn a modest investment amount into substantial sums. A longer term time horizon reduces risk. So long term investing allows individuals to weather market volatility. Volatility becomes less relevant over a longer time horizon or as horizons increase. Additionally, volatility is risk. Risk is what you're getting compensated for. So by accepting inevitable short term volatility, you position yourself for higher potential returns in the long run. And by utilizing a long term time horizon, you turn risk like market volatility for your advantage. What I want to do next is pull up a chart here and you'll see it on your screen. And I'm going to talk a little bit about some of the assumptions that are going into this chart. So what you're seeing are a blue line, a dotted purple line, a green line and a red line. The blue line is starting at 25, saving till age 65. And that's the nominal rate of return. So our nominal amount, which ends up being about $621,000. And then the green line, sorry, is if you started at 35, same thing, nominal amount. And then the red line is if you started at 40, I'm assuming an 8% nominal rate of return. I'm assuming that you started with $0 in the account and that your monthly contributions for starting at $25 or $200 a month, which is extremely modest. I'm also assuming that for starting at 35 and 40, I wanted to demonstrate here is that even if you save the same amount, your total amount is going to be lower. So that's why we see here again, there's a little box here. The contributions for all scenarios are $96,000. So they've all contributed $96,000 to the account. However, there's a big difference in what the total number at age 65, the difference between 35 and 25 is 41%. So 25 is 41% more than 35. 40 is 54% less than 25. So starting at 40 versus 25. And then that purple dotted line, that's the real return if you started at 25. So inflation adjusted return. And you do almost as well as the nominal return if you started at 30. So I just threw that in because it's a little bit interesting. And so, yeah, I just thought that would really kind of demonstrate why it's so important to start early. And that I think probably maybe some people might be thinking, well, obviously who would start later? Who would start at 35 or 40? But it's incredibly, I think, common based on if you look at the data on how much money people have saved, life gets in the way, right? Expenses come up and we think we'll start investing and then we get married. We have kids and then we don't start until suddenly our income has gotten to a certain point where we have room to start investing. But at that point, to make up that time and to make up the power of compounding, the rate at which you would need to save is astronomical. And so I would just encourage you if you're watching this video, don't wait. Compounding is your friend. Your friend is easy to do. Again, we often talk about Vanguard, but Vanguard's got some very low cost mutual fund options that are perfect for investing. And so, you know, low cost, set up an OU bank account, just do it monthly and get it started. So yeah, really important principle, particularly for you younger investors out there that are thinking about it, but there's always another expense at the end of the month. Anything else to add there, Josh? That's actually my last point. I'm going to throw it back to you. So with this topic here, you want to talk inflation protection. So what did you mean by that? Yeah. So the first thing I'd say is that inflation or purchasing power, what a relevant topic these days, right? Everyone's experiencing an erosion of purchasing power because of inflationary pressure or maybe tariff pressure. But we worry a lot when it comes to investing about market risk. But the reality is one of the biggest risks that we need to contend with is inflation and purchasing power risk. The risks that our money won't go as far because of inflation. And the ironic thing is that as people get older, they begin to de-risk. They're concerned about short-term market volatility, and they're not taking seriously the impact on their cashflow because of inflation. And one of the most common things I hear from people, okay, I'm 60 now, I'm 65, and I now need to really de-risk my portfolio and buy government bonds and GICs and high yield savings accounts. That is a pervasive thought. So all of a sudden I'm retiring and I need to become conservative. And this gets back to that point that I talked about before. You need to look at your retirement planning from a timeline perspective. If there's some capital that is in your retirement portfolio, that's not needed for seven, eight, nine, 10 plus years, which is likely if you're 60 in your health, that you're probably going to live until your mid eighties or later. So you need to stratify timelines so that you can push something into your portfolio that's going to give you some inflation protection. So I've got a, just a little chart I've put together to illustrate the point. So this chart is very, very basic, but what we put together was a consumer price index, basically from 2005 to 2025, five-year GIC rates, the S&P TSX, the Canadian market, the S&P 500, and then the MSCI world markets. And we started with $10,000. So the first point I'd say is if you look at the inflation rate here at the bottom and five-year GICs, they basically track against each other. And if you're concerned about purchasing power risk, even coping with taxes down the road, then you can see with the market indexes, yes, in the short term, there's volatility. So you can see 2005, then 2008 hit, that was a pretty bad time in the market. And then eventually the market started getting traction. So you can see that we had the green, which is the Canadian market. Didn't do super great over that time period. We had the dotted line, which is the global index. And then we have the US market, which in the last decade has had spectacular performance. But if you want to inflation proof your purchasing power in your portfolio, and particularly if you can extend the timeline on some part of your asset base for retirement, your retirement accounts, this is why you want to have equities in your portfolio. It's a very efficient way of coping with inflationary pressure so that the total value of your portfolio is larger to cope with the additional spend that you're going to experience over time. So that's the main point, Josh, is just take inflation risk seriously. It's one of the biggest risks that retirees need to cope with because often a lot of their incomes are non-inflation adjusted. And then the last point I would make, which is the last point in this presentation or podcast is make sure that whatever strategies you employ in your investment portfolio are strategies that you can stick with and implement. Josh and I can talk a lot about what the best strategies are, but the reality is the best strategies are the strategies that are going to work for you. And the way you get clear on that is you, you need to become very detailed in our estimation. And one of the things we do is retirement income planning for folks to help them plan out the timeline, how much they're going to take from the portfolio, what kind of returns you need. Don't take on more risks than is necessary to achieve your financial goals, but take on sufficient risk and compartmentalize timelines and then slide in securities that are appropriate for each of the timelines. And that detailed planning is made clear through effective retirement income planning. So that's kind of my last couple of points. Any comments there, Josh? Yeah, I think that one point, the best strategies and one you can stick with, I think is really, really vital. I think that holds true with pretty much every area of life where if you have a nutrition plan, it doesn't matter how optimal you think your nutrition plan is. If you can't stick with it, it's not optimal for you. Just like it doesn't matter if theoretically the best portfolio for you is a hundred percent equities. If you freak out and lose sleep every time the market drops, then it's not the best portfolio for you. And poor returns because you're theoretically selling in this example, right? You're selling when the market's down and you're going to be losing money. So the best strategy is the one that you can stick with for sure. Yeah, that's a really good point. And you come to understand that investment planning combined with financial planning or retirement income planning is part, it's part math, it's part understanding the science and the research around capital markets and financial planning principles, but it's also part art. The art component is the psychology, the emotions and the temperament. We all are all different. And you can have two family groups that have identical financial circumstances, but their goals and their risk temperament, their psychology are different. And that will lead to different kinds of solutions. Absolutely. Yeah, for sure. So I think concluding again, for those of you that are, you know, this particular podcast covered a lot of different topics, hope that was helpful for you. But there is in the show notes, a link back to our website, if you want to learn more about how to get clarity on these topics and retirement income planning, there's a link back to our website. And you can also set up a complimentary call to learn more about our services. Yeah. If you're at retirement or already retired or, or 30, 40 years away from retirement, there's value in planning for your finances. So for sure, go schedule a call and we'd be more than happy to connect and talk about that. So, yeah, I hope you got some value from this. If you made it this far in the video, honestly, I love talking about these ideas and I think about them all the time and over time I'll hopefully get better at articulating them because they can get pretty nuanced and abstract there, but we can't all be Ben Felix. Anyways, thank you for watching and yeah, we'll catch you next video. Take care.