This podcast was recorded on November 1, 2016.
Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick and I'm joined, as always, by Robert Brokamp, personal finance expert, here, at The Motley Fool. Hello, Robert Brokamp.
Robert Brokamp: Hello, Alison Southwick.
Southwick: And I also [00:00:30] Jim Royal. He's an analyst here at The Motley Fool and you do not have to sound as goofy as Bro just did.
Jim Royal: Fantastic. I'm able to achieve that.
Brokamp: He's a doctor. He doesn't have to do that.
Southwick: Jim is here to help us tackle our topic, today ... da, da, da!The world of finance and economics [has been] full of people saying that certain events would never happen. Sure, that will happen the day the Cubbies win the World Series. So today we're going to talk about a few "that will never happens" that actually happened in the world of finance. We'll also answer your question about how much you should invest in one stock. All that, and more, on this week's episode of Motley Fool Answers.
Southwick: It's time for Answers, Answers and this week's question comes from John in Queens. Royal, feel free to chime in.
Royal: Sure.
Southwick: "Alison and Bro. Love the show. Seriously, I'm that guy hitting Refresh on his iTunes at 7:01 every Tuesday morning."
Brokamp: Thanks, John.
Southwick: Thank you. "I've recently come across an investing platform, Motif.com. It allows you pick up to 30 individual stocks and essentially build your own custom mutual fund. My question is about how the individual stocks should be weighted. You can either weight each stock the same (in my case, each stock would be roughly 4% since I've come up with 25 stocks) or you can weight by market cap of the company, or you can customize and weight each one individually.)" So many options here! Oh, my goodness!
Brokamp: I know.
Southwick: "I did a mock test of weighting by market cap and instantly Apple became nearly 24% of my entire portfolio, which didn't seem advisable in terms of diversification or my own goals. So which would you choose?"
Brokamp: For those of you not familiar with Motif, it's actually an interesting little platform. You can either pick your own basket of stocks, or they have some of them preset and you can buy the whole kit and caboodle for $9.95. That's one of the benefits of it.
First, I have a general rule of thumb that you don't have more than 5% — maybe 10% of your portfolio — in one, single stock. Now I'm big in diversification. A lot of people, here, at The Motley Fool are more comfortable having a more concentrated portfolio. Certainly if you are investing in your company stock, then I would say definitely keep it to 5%. That, John, would lead me to say that you should definitely not do the market cap weighting where 24% of your portfolio would be in Apple.
Royal: Sure. And I have to second that, really. If you want to be passive about this, just equal weight them at that 4% figure or so. And maybe if there's something that you want a little bit more exposure to, like an Apple, move it up to 5%. Maybe 6% or something like that. But there's no reason, really, to have Apple at 24%.
Brokamp: Right. And we've talked on previous episodes about how many stocks you need to own to have a diversified portfolio. And if you look at academic studies, it's all over the place. I think in our episode we decided 30 was a good number. I've talked with some folks recently. They said 20. So I think 25 is a good range. Of course, it has to be diversified within those 25. If all 25 stocks are tech stocks, then you're in trouble.
Royal: Right, and again it's not 25 with one stock at 25%. It's more or less roughly equal among those to really get the benefits of diversification.
Brokamp: And as years go on, some stocks will do better. Once a company starts to become close to 10% of your portfolio, it might be time to cut it back.
Royal: Right.
Southwick: Say you're in a bunch of mutual funds. Should you worry about how much your mutual funds are concentrated? Like between your portfolio of stocks that you personally manage and your mutual fund, do you look at all? That seems like an impossible task.
Brokamp: It's difficult to do, but it's actually an excellent point. Morningstar has a good tool for that. It's called their Portfolio X-Ray. You put in how much you own of individual stocks as well as any mutual funds that you own...
Southwick: Oh, that's cool.
Brokamp: ...and it will say across all of your portfolio, you have 8% of your portfolio in Apple. We're picking on Apple because if you own an index fund, most of that, or at least one of the top holdings is Apple, because the typical index fund is market weighted.
Royal: Exactly. And so, similarly, Exxon might be in a variety of different funds, so you might think you're getting great diversification because you have an S&P 500 index fund or you've got a value index fund or you've got a whatever...
Brokamp: A dividend-oriented fund...
Royal: Dividend. Right. But Exxon is probably in every single one of those.
Brokamp: And is one of the top holdings...
Royal: And is one of the top holdings...
Brokamp: Probably....
Royal: ...in each of those. So you might have 9-10% of your portfolio in Exxon and not really quite know that.
Brokamp: Yeah.
Southwick: Is that something to be scared about? Like should everyone suddenly drop what they're doing? Is that a crazy example, or is that really possible?
Brokamp: No, I would say if you're like in John's situation where you're about to put a significant amount of money in Apple (in one of these bigger companies) I think it's worth looking at how much of it is in the mutual funds that you own. If it's a small-cap stock of a lesser-known company, [or] an international stock, it's probably not going to be a big deal.
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Southwick: Long-suffering Chicago Cubs fans have endured decades of loss and jokes at their expense. Yeah, that'll happen the day the Cubs win the series. Well, guess what? They did once win the series back in 1908, and just because something happened once a long time ago doesn't mean it won't happen again. The Cubs still may not win the World Series, but plenty of other stuff that people said wouldn't happen has happened. So joining us today to talk about five events [people] said would never happen (not you literally, though. You didn't say they'd never happen) is Royal Royal. He's an analyst, here, at The Motley Fool.
First of all, Royal, we brought you here for a couple of reasons. One, you're a really smart guy and you have a lot of knowledge in your noggin...
Royal: Thank you.
Southwick: We will get to that later.
Royal: Thank you. Oh, uh-oh.
Southwick: But we're also not big sports fans, here...
Brokamp: Well, not big baseball fans.
Southwick: Well, yes. Like Bro has his football. Rick has his other futball and I've got like curling.
Royal: I might be the last person in America who likes baseball, then, is what you're saying.
Southwick: No.
Brokamp: I think that's it.
Southwick: You're just one of the people we know that likes baseball. So we asked you to come on both as an analyst and also as a fan of baseball...
Royal: Sure.
Southwick: ...so lay it on me. The Cubs. Why is it a big deal?
Royal: Well, historically this World Series is really a kind battle between the very moveable object and the easily stoppable force. The Cubs haven't won in 108 years and it's not like the Indians are all that much farther ahead of them. It's been 68 years for them. So one way or the other some very drought-stricken team is finally going to win one.
Southwick: We should probably tell people that at the time that we are taping this, the Cubs have neither won nor lost the World Series. They are the Schrödinger cat of teams right now, but they are not off to a great start.
Brokamp: Right. We're taping this after Game 1...
Royal: Right.
Brokamp: ...in which Cleveland scored infinitely more points than the Cubs.
Royal: Already down.
Southwick: Already down. So, you know what? Maybe they won't win again. Maybe they will. So it got us to thinking about other events that people said would never happen in the world of economics and finance. We've got five of them, here, so let's just go through them.
Brokamp: Let's go.
Southwick: Let's do it. Number one, they said the housing market would never crash. I mean, come on. It's housing. It's so stable.
Royal: It always goes up, I heard.
Brokamp: Right. Well, most famously, Ben Bernanke, back when he was an economic advisor to President Bush [and] before he was chair of the Fed pointed out we've never had a nationwide crash in housing prices. So why would we ever expect it to happen? He said basically he didn't think that it was a bubble and that it would do much to the economy. Of course, he was wrong. Smart guy. I'm not trying to pick on him individually. His point was it never happened in the past, so why should we expect it to happen in the future? But, of course, it did. Housing prices nationally crashed around 30%...
Royal: Right.
Brokamp: ...and we're still not back to where we were. Getting close — within 5% or so where we were in 2006 — but we're still not there. So housing prices are still down from their peak.
Royal: I was just going to talk about no night games at Wrigley until 1988, and then boom, night games. They said it would never happen.
Brokamp: Is this a baseball thing?
Royal: Yeah, it is.
Brokamp: OK.
Southwick: That's good. Bring in the baseball.
Brokamp: Blame baseball for everything.
Royal: It will rear its ugly head, again.
Southwick: Do they just not want to buy the lights? Is that...
Royal: I'm not entirely sure of the background of that, but...
Southwick: The inner workings...
Brokamp: Chicago finally got electricity.
Royal: Yeah, yeah.
Brokamp: Actually, I was born in Chicago. They have electricity. Another interesting thing about the history of the housing market is Mark Hulbert, in an article for Barron's a year ago, pointed out that in all of the stock bear markets since 1956, housing actually went up in value in 14 of those 16. One of those times when housing dropped, it only dropped like 0.4%. The other time it dropped was the recent time.
There's another example. Up until 2006, housing actually was just as good a diversifier to your overall portfolio as bonds, but then came 2006 even until now. Once again showing just because something happened in the past doesn't mean it's going to happen in the future.
Southwick: Next one. They said stocks will always yield more than bonds. I mean, come on!
Brokamp: Right. For the history of the stock market that we know of (from the 1800s up until the first half of the 1900s), stocks actually yielded more than bonds. And it was considered the right way for things to be, because stocks were riskier...
Southwick: Right...
Brokamp: ...so you should be getting a higher yield from bonds. Then it reversed. It came close to reversing every once in a while throughout history, but then it always went back to where stocks yielded more. Then in 1958, stocks yielded less than bonds and it stayed that way up until 2008. And when this happened in 1958, basically they were saying that this is a sign that stocks are overvalued, because when the stock prices go up, the yield goes down. People were then saying, "Well, this is crazy. Stocks must be overvalued. We're going to sell our stocks and wait until they yield more than bonds." And if they really did that, they waited from 1958 to 2008.
Royal: Right.
Southwick: Whoa, that's a long time.
Royal: Right, absolutely. So a lot of that has to do with people's expectations. Because stocks are more volatile, they want a higher yield on those assets. But finally you got to a point where that investor mentality shifted and they said, "Hey, look. Because these companies are growing earnings, we're willing to accept a lower yield on them now with the expectation of capital gains over time." So it really was a substantial shift in the market psychology about why you owned stocks.
Brokamp: And it's almost a market-timing indicator. If I see this sell signal, I'm going to sell and wait until it turns green, again. But it didn't do that...
Southwick: Whoops.
Brokamp: Things do change.
Royal: And a little bit of it may be, as well, of people looking back at historical multiples, for instance. They're very similar. Hey, this is what they've always yielded historically; therefore, that's sort of a mean-reverting level. But there's no reason to say that that historical level was the right level. That's a values-based question that can change depending on how investors feel.
Southwick: The next one. They said stocks will never lose over a 10-year period. Come on!
Brokamp: So if you look at data for US large-cap stocks since 1926 (going to Ibbotson Associates) — most of that period that's the S&P 500, although before 1957 it was the S&P Composite — the worst decade for stocks was actually very recent (1999 to 2008). It lost an average 1.3% a year. Now in 1999 I was at The Motley Fool, as was Rick, and most of us were engulfed in the dot-com delirium, and if you said to any of us, "Oh by the way, the S&P 500 is going to lose money over the next decade," we wouldn't have believed you.
There were two decades that included the Great Depression where it lost a little bit of money, but not very much. And you could even rationalize that by saying [back in] the Depression, stocks lost money over a decade, but we also experienced severe deflation. The stock market went down, but so did prices, so your performance didn't actually lose purchasing power. From 1999 to 2008, the S&P 500 lost money and we had inflation, so people were actually worse off.
By the real lesson of that period is that you shouldn't invest in just one asset class. So while US large-cap stocks lost money over that decade, cash made money. Bonds made money. International stocks made money. Small caps made money. So anyone who had a widely diversified portfolio still did pretty well. It's the people who had their portfolios concentrated in an S&P 500 index fund who didn't do so well.
Royal: And again, it's a testament to why you need to continue to invest every month or every year, because nobody's putting all of their money in, in 1999 (hopefully, fingers crossed). They're buying throughout the period, and so it's a testament to you to keep buying. And buy more when it looks cheaper.
Brokamp: Right. And if you're retired, it's a testament to having a good five years' worth of your income out of the stock market so you're not constantly selling a portfolio that is constantly going down.
Southwick: They said interest rates so low [that] some are even negative? That will never happen. That doesn't even make sense.
Brokamp: It really doesn't make sense.
Southwick: It doesn't make sense.
Brokamp: In June, Bill Gross tweeted this. He said, "Global yields lowest in 500 years of recorded history. $10 trillion worth of negative-rate bonds. This is a supernova that will explode one day." And if you don't know, Bill Gross is a pioneer in the bond fund world. He's often known as the "bond king." He co-founded Pimco back in the early 1970s and he's now with Janus. This is a guy who knows bonds.
But he's right. Interest rates are just crazy low, including negative interest rates. It's almost hard to conceive what that is. But for the most part it's coming from central banks in developed countries like Japan, the ECB, Sweden. Basically you're saying, "I'm going to give you $1,000, and [you're] not going to [give me] $1,000 back." That's it. That's the investment. I'm basically paying you a storage fee to hold my cash.
Royal: Sure.
Brokamp: But even US interest rates. In July, the 10-year Treasury hit 1.4%. That's the lowest it's ever been. Business Insider had a great graphic that showed the rates on 10-year Treasuries back to when George Washington was president, and when you look at that, you really can appreciate that we're in unknown territory. This is a whole new world for bonds.
Southwick: What comes next? What is that supernova moment?
Brokamp: Well, we don't really know. We've never done this before. It's pretty crazy.
Royal: You've just got the world so awash in cash, right? Assets looking for returns. And the question is how do you, in fact, cycle that through your economy? Instead of having this money searching for financial assets, how do you get it pushed through your economy? And it's a difficult thing to do.
Brokamp: Yeah. And while we don't have negative interest rates here in the US, Janet Yellen has not taken it off the table. We'll see what happens.
Southwick: The last one. They said Japan will never get out of its debt hole. And when I say "debt hole" like that, it sounds really naughty, doesn't it?
Royal: Uh-oh. Where's your mind at?
Southwick: Excuse me.
Royal: Yeah.
Brokamp: I have no idea what you're talking about, but go ahead.
Southwick: It sounded aggressive. All right, whatever.
Royal: Investors have been betting against Japan for a couple of decades. They call it a widow-maker trade, because investors have been betting against Japan escaping this debt black hole.
Brokamp: And by the way, the widow-maker is a term that was first applied to the heart, or the left artery, because when you get blockage there, you're going to die, and that's why they call it the widow-maker. It's applied to this trade because these people — if I understand this right — are shorting Japanese bonds...
Royal: Right...
Brokamp: ...because they think they have to. They have to. The market's going to collapse. But it doesn't happen, so it's causing these people heart attacks because they're making these big trades that are just not paying off.
Royal: And just losers. And every once in a while there's somebody who comes up [and says] this is finally going to be the year where it ends, and just consistently it's been a losing trade. In fact, what's happening now is that the Bank of Japan is buying that debt from private holders (just normal investors) and "monetizing" it. Putting cash back out there.
And what's happening now, in fact, is that Japan is rapidly reducing the amount of its public debt that's held by public investors ... the fastest in the world, in fact. So the hope, the expectation is that you're going to put more money out there and people are going to be able to spend it. And to some extent the US has been doing that, too.
Really the question is does that work? There's the expectation that this is going to continue for at least the next few years, and at that point, debt that's going to be held by private investors is going to be about 100% of GDP. Previously it had been close to 200%. But what's the endgame here? Does the Bank of Japan cancel that debt? Don't know. It's really unclear what the endgame, what the final result of this is going to be. But investors who thought this is a sure, slam-dunk investment have for 20+ years gotten killed.
Brokamp: Japan's an interesting story for a couple of reasons. First of all, it's really the question of how much debt can a country have and still function?
Royal: Right.
Brokamp: And they keep exceeding expectations in terms of how much debt you can have and still function. And the other thing about it is we talk about being long-term investors here at The Motley Fool. Japan, up until maybe two or three years ago, is the second-biggest economy in the world, so a significant economy. The Nikkei, which is its primary stock index, reached almost $40,000 in 1989. Where is it today? Seventeen thousand dollars. So it's less than half where it was 27 years later. It just [changes] the whole perspective [about the benefit] of long-term investing and that sometimes, even if you hold on for decades, an investment doesn't pan out.
Royal: Right.
Southwick: We're rooting for you, Japan.
Brokamp: Yes. We hope you can figure it out, because we're heading in that direction, at least in terms of debt. So you make it work so we can figure out how we can make it work.
Royal: Now we say Japan is 20 years in the future.
Southwick: Oh! They are. They are in the future. What is the lesson, here, for everyone and for all the Cubs fans out there?
Brokamp: For me the lesson is we make a lot of our investment decisions based on history. We invest in stocks for the long run because there are plenty of articles and sites that show that if you buy the stocks and you hold on for a long time, you do all right.
But sometimes things happen that have never happened before, so you have to be prepared for scenarios that haven't happened in the past, but could happen in the future. And for me, that means being very diversified in your portfolio so that if something does blow up, you have something else that will do well.
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Southwick: Incredibly wrong predictions aren't just limited to finance and sports, so let's keep poking fun at people who were brave enough to take a stance and were incredibly wrong. So in addition to never having night games at Wrigley, which we already covered, here are a few others we found of people making really awful, horrible predictions.
The first one goes to Irving Fisher. He said this in 1929: "Stocks have reached what looks like a permanently high plateau."
Brokamp: Well, Mr. Fisher unfortunately said this, of course, right before the Great Depression, so that was very poor timing. And the thing to understand about him is that he was a big deal. He was the preeminent economist in the United States at the time, so for him to say that really told people that "the stock market's gone up a lot in the Roaring Twenties, but we're OK. I'm going to just keep holding on." So his reputation took quite a beating after the Depression.
Southwick: Another famous person once said: "It will be years, not in my time, before a woman will become Prime Minister." And of course the famous British person who said that was Margaret Thatcher in 1969. When did she actually become Prime Minister?
Royal: It was the early eighties.
Brokamp: The eighties.
Royal: 1982 or 1983.
Southwick: So just a few years later.
Brokamp: She was sandbagging, I think. That must have been it.
Southwick: Also famously Decca Records rejected the Beatles by saying, "We don't like their sound, and guitar music is on the way out."
Brokamp: When you look back [at] the history of popular music, guitar really was seen as this lowbrow, cheap instrument, and when it became more popular, it was like, "Oh, people aren't going to stick with this. Bring back the bands." I remember Nat King Cole singing a song about Mr. Cole won't rock and roll because it was considered such a lowbrow form of music.
Royal: Ah!
Southwick: Ah! A lot of these are interesting because they're people who maybe their livelihood is under attack, here. For example, we have Darryl Zanuck of 20th Century Fox who said in 1946: "Television won't last because people will soon get tired of staring at a plywood box every night."
Brokamp: I kind of wish he was right, but it's not true.
Southwick: It's not true and people are increasingly watching movies (not in the theatre) but staring at that plywood box. Also along the lines of technology — this one's a fun one. In the early '40s, IBM's president, Thomas J. Watson, said: "I think there's a world market for about five computers."
Royal: And that persisted, actually, for quite a while. Even IBM said, "Who wants to own a personal computer?" I think it was back in the '70s. Just very long resistance.
Southwick: What can you do with it? It takes up a whole room and it just whirs. It makes all this heat. It's just like, "Ugh, who wants one?" Also along the lines of that is YouTube's founder, Steve Chen. He said: "There's just not that many videos I want to watch." He was concerned about YouTube's long-term viability. So those are just a few more examples of people who were very, very wrong about where we ended up. And we can make fun of them because I don't make outrageous predictions, either, so I'll just stay safe.
Well, who do you think is going to win?
Royal: I think the Indians are going to win.
Southwick: Yeah?
Royal: Not the Cubs. They'll never win.
Southwick: Bro and I know nothing about baseball, so us predicting this is like, "I don't know."
Brokamp: I was born in Chicago. My mom's family is from Ohio. I have a split favorite, here, so I'll say Cub/Indians. Can I say that?
Royal: Your identity is really still bound up in the Cubs losing, right?
Brokamp: I guess so. I don't know.
Southwick: Aw! I'm just going to say the Nationals. I don't know. I thought they did pretty well this year, right?
Brokamp: They came close.
Southwick: They came close. All right, Royal. Thank you for joining us...
Royal: Thank you.
Southwick: ...this week on the show. You actually get to do the shout-out to our listeners this week.
Royal: Yeah. So shout-out to Cedrick and Melissa in Paris. They were part of my All-Luxembourg Trivia Team when I was in Paris recently.
Brokamp: And you just went into the bar and said, "Hey, people sitting there at that table. I'd like to join you for trivia."
Royal: Exactly. And they were familiar with Motley Fool Answers.
Southwick: Which is crazy to me.
Brokamp: That is pretty cool.
Southwick: What was probably crazier for them is that they were like, "Oh, fine. Whatever. Come join our team." And then you were like, "Oh, we're from The Motley Fool." And they were like, "Oh, wow. That's so cool." I imagine. This is how I imagine it went down, but with more French accents. Or Luxembourgian accents. And then they were actually smacked in the face with just how smart you are at bar trivia. You are a force to be reckoned with at bar trivia.
Royal: Absolutely. The first lines of novels — bring it on.
Brokamp: Remind us why that is. You have a Ph.D. in...
Royal: Literature.
Brokamp: There you go.
Southwick: Don't go up against Royal Royal in bar trivia. That's all I'm saying.
Royal: I'm working on my Jeopardy! tryouts, so...
Southwick: Oh, that would be awesome.
Brokamp: That would be cool.
Rick Engdahl: So were they starstruck? Did they say, "So what is Southwick really like?"
Royal: Well, I told them about Brokamp's coconut bras.
Brokamp: The listeners aren't familiar with this, but I have a long history of scanty cladism here at The Motley Fool.
Rick: Oh, they're familiar. They're familiar.
Royal: Naturism for you continental people.
Southwick: I didn't know you once wore a coconut bra. Did you really?
Brokamp: I have worn many bras, actually in my day. That's not true, everybody. It's not really true.
Southwick: It actually is!
Brokamp: I dropped my pants, once or twice, in company meetings, but that's it!
Royal: I mentioned that to them, too.
Brokamp: But I'm just friends with everyone in the company.
Southwick: And what did you say about me?
Royal: I don't know anything...
Brokamp: Scandalous about you.
Royal: Scandalous. Yeah, exactly.
Brokamp: You're just awesome, I think, is all he said.
Rick: You had your chance for scandalous when your friend was on the phone.
Southwick: Scandalous.
Rick: Something about tumbling down a mountain in your underwear, I believe.
Southwick: Oh, did she talk about that?
Brokamp: Yeah!
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Therese Oneill: Tell everyone about the time you fell down that hill on the Swiss Alps and your skirt flew up over your head.
Southwick: Can we have non-underwear-related stories about me?
Oneill: Sorry! It's what I do for a living. And you handled it with such Southwick aplomb. You landed on your tushy with your hands folded in your lap. It was so dignified. You fell down an Alp, for God sakes! And there was a bunch of teenage boys watching, and when she landed, it was like, "My goodness gracious me." And she just folded her hands and sat quietly.
Southwick: Yeah.
Oneill: And the boys were like, "Oh my goodness." They were [00:28:45] so they were like, "Oh, uh, ma'am. We didn't see a thing." [00:28:49]
Southwick: Yeah, yeah. I once did that. Also in France, by the way...
Royal: Oh, yeah.
Southwick: Yes, yes. It was also in France.
Royal: It sounds like a French thing to do.
Southwick: Just fall down a mountain in your underwear.
Royal: No, no.
Southwick: Well, when in France...
Royal: I've seen London, I've seen France...
Southwick: All right, that's enough for today. The show is edited Parisianally by Rick Engdahl. Our email is [email protected]. Drop us a line. For Robert Brokamp and Royal Royal, I'm Alison Southwick. Stay Foolish, everybody.
