Event-Based Investing

Hello and welcome once again.

It is Mr. Stillman's Opus. I'm joined this week by a very special guest. That is Mr. Dan Caprill in Cincinnati, Ohio, or right out of Cincinnati. Where are you exactly, Dan? I mean, we're one of those cities where no matter where you live, you use Cincinnati as your mailing address. If I told you where exactly we were, nobody would know. So we're lucky if people know where Cincinnati is.

Cincinnati works. Fair enough. And founder of Matson and Caprill, you've been a financial advisor for how many years, Dan?

I think we're going on year 21 this year. How about that? So always interested to hear the perspective of folks like you. And I know one thing that you're big on, Dan, is how news affects the markets. And you always see people investing based on what's happening in the news.

And I know you feel that's a bad idea. Well, it is a bad idea because, you know, if you think back to, let's go back to high school math, you know, when we were kids, I remember always asking the teacher, and I'm sure you probably did too, am I ever really going to need this in life? And they would always say, oh, yeah, you're going to need it. And sometimes you still wonder that. But there was a, there's an old formula that it's referred to as the transitive properties of inequalities.

And then basically, what it said is, if A is greater than B, and B is greater than C, then by default, A is greater than C. So if I'm taller than you, and you're taller than Walter, then by default, I'm taller than Walter. Well, you can apply that to investments. I mean, I think we can all agree that the news of the day is unpredictable. I mean, we don't know what's going to happen until it actually happens. And we also know, and I think we all can agree to this, that investment markets react to news. So if the news of the day is unpredictable, and markets react to news, then by default, aren't markets unpredictable? Makes sense to think so. Right?

Okay. And yet, so much of investment strategy is built on an assumption about what the future is going to be. So you'll hear these experts on all these shows. And they'll talk about what stocks they think are hot and why they think they're hot. And what most people are unaware of is that 80% of all efforts to outperform market averages fail year in and year out. You'd actually have a better chance picking stocks and beating market averages by throwing darts at, say, the Wall Street Journal. Well, people have done this with monkeys. Oh, they have. Oh, you know, there's many studies. Yes, you can go, you can Google that they've had monkeys pick stocks.

They've had chickens pick stocks, you know, they'll just peck the paper. So yeah, no, you can do this. And, and it's been done. And again, and again, the the random selected portfolio beats a lot of the experts.

All right. So why is that? Well, part of it is what we just mentioned the issue of not having information before anyone else has it. Now, again, if you had that, if you could get, say, next week's newspaper today. Or you could get information before anyone else has, assuming you weren't breaking the law in doing it, and there's a lot of laws, you could defeat market averages. I mean, certainly every year, there is one stock that outperforms all others.

And if you knew in advance what that would be great. But I always I always get a chuckle when I when I listen to people who think they can beat market averages. And, you know, after giving them that little formula about news being unpredictable. My next question to them is, all right, well, let me ask you this, then, how many stocks do you own? Then they will say, I don't know, 15 2025.

And I'll say, Well, why don't you just own one? And I get this weird look as well, one of them is going to outperform all the others, right? And then they have to admit Yeah, but I don't know which one that is exactly. And yet, you think you can just limit it to just 20 or 25, when there's over 15,000 out there that are traded.

So that's, that's the issue at play here. Now, the other reason that efforts to beat market averages will fail, is because there's a lot of cost involved in trying to beat market averages, because most professionals just don't buy and hold 25 or 30 stocks. Now, they're trading all the time. And trading costs money, forget the commissions.

There's something known in the investment world as the bid ask spread. And the way it works is kind of like buying a new car. You know, if you were to go buy a new car in the morning, and you decided after driving it home, you hated it, and you returned it. Well, you know that you're not going to get all your money back, you'll get most of it back. But that car has technically depreciated.

What's the rule? You lose $3,000 as soon as you drive? If you drive it off the lot?

Yeah. You know, nowadays, you'll you'll see these these ads now where they'll say, you know, no, you can keep it for a day. And that's fine. But the general rule is, yeah, you take it off, and you want to bring it back.

You know, the dealer's markup. He's already spent that on next week's newspaper ads. So you're not going to get that back. All right. Now, imagine if you did this every day, every morning, you went out and bought a new car.

And every evening, you brought it back. Well, eventually, you would run out of money, right? I mean, because you're not getting it all back. That's, that's unlike most types of retail, where if you return it in new condition, you get all your money back.

All right. So it works the same way with investing, the money that you have to spend to buy any security is more than what you would receive if you simultaneously sold it. So if Corporation XYZ is trading for $100 a share as $100, I want to buy it.

Now to sell it, I might only get $99. And there might be some additional transaction charges. But let's just assume there's no other transaction charges.

There's just that. And the reason that that markup exists is because when we're looking to buy or sell stocks, we don't run an ad in Craigslist. Now we have to go to the exchange. And on the exchange are companies that specialize in certain stocks. They're called market makers. And they will buy that stock and they will mark it up. If you want to buy that particular company, that's where you go, probably for the best deal, but they mark things up, just like any retailer is going to just the way Walmart operates, you know, they buy goods from Procter and Gamble, they mark them up, and they sell them to you. Okay, we get that. But the average portfolio, particularly through the mutual fund industry that are actively managed, has a turnover rate of 80% a year, which means that they are buying and selling 80% of their portfolio throughout the entire year.

And that will cost you money how much depending on the stock, but I've seen studies anywhere from two to 5% a year is lost on just these transactional charges that many mutual funds incurred, not all. Many do. And it's because they're all trying to beat market averages. What we have to accept is that yes, Mark, that the news is unpredictable. And we also have to accept the realities of life. And I think that if you're going to be realistic about the future, then by default, you must be optimistic about the future. And I say that, because if I could go back in time, let's say I could go back to 1900. And let's say I met my great grandparents at that point in time, and my great parents came over from Ireland right around that time. So imagine if I told them, okay, for the next forget, forget the next 117 years for the next 50 years from 1900 to 1950.

I give them all the bad news of the day. And just go back, there's a lot of bad news between 1900 and 1950. Depression, a couple of world wars. Oh, and not only that, I mean, the World War Two, I mean, everything that that involved was horrific. And then and then when World War Two ends, we're going to replace the bad guys, the Nazis with a new set of bad guys called the communists. And that's going to go on on until you know, well after the century ends.

All right. So that's what we're laying out here for them. Now, there is no way they would think for one step, they probably would doubt that there would be life on earth. Because when I get into that whole nuclear war discussion, it's gonna blow their minds. They're gonna be like, Oh, yeah, no, because I mean, they just, how could it pay? How could there be life?

All right. They probably have no kids or anything along those lines. There's absolutely no way that they could conceive the quality of life that their great grandchildren live today. Couldn't conceive it at all.

Heck, an iPhone, they couldn't conceive that. So throughout all the bad news, all the things that have occurred, the it's like, it's like water in the cracks. Good news somehow found a way to seep its way through. Now, that's largely because we've been fortunate to live in a capitalist economy. Since then, you know, the days of feudalism are over, you know, the days where you got wealth by raiding another nation, those are over. We now, you know, for the most part, we act in a cooperative matter of trade. And as a result of that, what we consider poor here in the United States, is actually wealthy, if you go to countries like, say, India, and some of the other third world nations. I'm not trying to belittle the difficulties of poor, but you know, one of the ironies is that in the United States, a capitalist society, one of the major health issues surrounding poor people here is obesity. And I don't know if you see the irony in that, but but I certainly do.

That's how far we've come. So if you're going to look forward in the future, I don't see any way you cannot feel optimistic about it doesn't mean we're not gonna have our problems. And what is going to drive that success is going to be corporations, where as investors, if we're buying and holding and rebalancing a diversified portfolio, we so more improve our chances for success. If we do it that way, then if we're constantly manipulating the portfolio, trying to get it right at the right time, I need to be in this stock only on its updates. I only need to I want to be in this market only on its updates.

Sure, that would be great. It's just not possible to do unless you can get tomorrow's newspaper before the news of today actually occurs. So this is just common sense. And yet, we still see people, you know, trying to manipulate markets. It's not it's not investing. It's speculation. It's gambling. Now, you don't have to take my word for it. There are people far smarter than me that have won Nobel Prizes, you know, making this this argument as most recently as 2013, when Gene Fama won the Nobel Prize for work he did in the 60s, where he basically made the point that a stock is only worth what somebody's willing to pay for it.

But common sense. But what he would say is, look, if IBM is trading at 50 bucks a share, that means the entire planet is in agreement that it's worth $50 a share. It's just like your house. If you list your house for, say, $300,000, but the most anyone's willing to give you is $275. Well, what's your house really worth? I hate to tell you, it's worth $275. You may have paid $300,000. You may have paid $300,000 and put $100,000 of improvements into it.

Until someone shows up with the cash, it's worth $275 because that's the only offer you got. Well, if that's true for real estate, why isn't it true for stocks? Well, it is true for stocks. So don't tell me that a stock is undervalued or overvalued.

There's no such thing. It's worth what somebody's willing to pay for it. Only the new and unknowable information is going to come to move that stock price. Now, you can speculate if you want. And if we're talking about speculation, fine, your opinion's as good as mine. But I thought the whole idea here was to invest intelligently.

And investing intelligently shouldn't rely upon a crystal ball. It shouldn't rely on speculation. Now, nowadays, I'm hearing speculation being replaced by the term algorithms.

Oh, we've got this algorithm that's going to, it's the same thing, folks. It's a prediction about the future. And every time one of these soothsayers are wrong and the graveyard is full of these gurus, is they'll usually come back and say, well, I might have been wrong about when this was going to occur, but not that it's going to occur.

Well, that's a nice out. You know, I was, I might have been wrong about when the market was going to hit $40,000 or when it's going to fall to $6,000. But I, you know, but it's going to happen. Well, that's like saying, yeah, I was, when I went to the roulette table and I put my money on $12,000, it didn't come up $12,000.

And my response, oh, well, I just got the timing wrong. It's going to come up $12,000. Well, of course, it's going to come up $12,000.

Eventually, it's going to come up. So you get, you get that a lot. You also will get them say, well, I didn't know this was going to happen.

Or who could have foreseen that happening? Of course, that's the point you don't know. So, you know, take, learn something from index investing and asset class investing, which is getting away from speculation and more importantly, lowering operating expenses. And if you do that and you have the discipline to stay with it, statistically speaking, your chances for success are far greater than any type of speculative strategy.

Well, so what are we supposed to do? Do we just run out and buy an S&P index fund and call it a day? It's not that simple.

No, it's not. The problem is that when I say index fund, that's exactly what people think. They just think that there's one index.

And in reality, there's many indices. There are large companies. There are small companies. There are value companies. There's companies here in the US. There's companies abroad. There's companies in developed nations and in emerging markets. And there's fixed income. There's bonds. We're not, you know, when someone's investing, I don't have any assumption that all the money is going to be in stocks.

In some cases that's true, but in other cases, no. So what I'm saying is that if you're going to invest for the long term, you're going to have some money, yes, in an S&P 500 fund. But you're also going to have some money in a small cap fund. You're going to have some money in a value fund, all indices. You're going to have some money in a large international fund. You're going to have some money in a small international company fund.

So by doing that, you might be in 40, 44 different countries. You may have 12, 13,000 holdings. Now the other thing is to understand how these different asset classes perform over time in relationship to each other. The S&P could be up and the large international can be down. Well, that's called diversification. And the key here is to blend your assets in such a way so that statistically you get the highest possible return with the lowest amount of volatility.

Now I'm not going to mislead you. If the S&P crashes, probably those other asset classes are going to go down too, but they're not necessarily going to go down by the same percentage. So you take last year, for example, everyone talked about what a great year was for the large US stock market. It was an even better year for the small stock market, phenomenally better, but they don't talk about the small stock market in the newspaper. They talk about the big stock market. So if you were up, say, 12% last year, that's great. But you probably should have been up 20% because if you had owned the entire US market, you'd have been up closer to 20. So that's the advantage there of not selectively picking stocks because when you're just buying the S&P 500, well, you're still kind of stock picking.

Because what did you do? You said, well, I'm just going to buy these 500 and I'm going to ignore the other 2,500 that are being traded. And here's a little insight for you. Small companies tend to outperform large companies over time. And they do it in a more volatile manner for all the obvious reasons.

But it was certainly in my lifetime that Microsoft was this little company coming out of a garage. And that's the whole idea. You buy companies on hold. So no, the key here is when you're going to buy equities, you want to buy many different asset classes. But you want to blend that with a level of fixed income so that your overall volatility is equal to what you need it to be. Now, if you're in your 20s and you're perfectly okay being 100% equities, as I'm okay being 100% equities, fine.

Yeah. Write it out. But don't limit yourself to 500. Don't limit yourself to just a large US stock market. Bring in value.

Bring in small. And do it both US and abroad. 60% of the world's investments are outside of the United States. You cannot ignore that. Biggest point that I'd like folks to focus on is what you said about the different indexes. And everybody thinks of the S&P as being an index fund, and that's the S&P. Well, when I look at my stock ticker here on my phone, the top three things I have are SPY. Well, that's your S&P index fund. But then I have MSCI, which is your international index. And then AGG, which is US aggregate bond index. Always fascinating to watch those three and how they move in relation to each other. Sometimes they're correlated, but usually not. Add another one.

CRSP9 and 10. Because that's going to capture the smallest 20% of all companies traded. And that's where, like if you were in that last year, you had a phenomenal year. So yeah, that's the point. All these are going to move differently at different times. That's why we want to be diversified. So I want you to own many things. I want you to own a lot more things than what you're probably owning. The other thing to keep this in mind is that for some of you who might think, well, I already got seven or eight mutual funds.

I'm fine. One of the interesting things that I always notice is that when I meet with somebody and I look at their portfolio, many times those seven or eight funds are actually buying the same companies. So they're not really diversified.

What you really are is redundant. So fund selection is extremely important. I don't want my small cap fund to own a single company that my large stock fund owns. And I don't want my U.S. large stock fund to own a single international company. I'll buy a fund for that. What happens, though, particularly in what we call actively managed funds, is style drift. That fund managers in their desire to capture returns quickly will abandon their core discipline and will go buy other things. And that may or may not work.

It's speculation. But if I'm trying to build a portfolio, I can't have that. I need for my large stock fund to stay true to large stocks. I need my small stock fund to stay true to small stocks. If he wants to go over and buy some international, I already own those companies through my international fund. So picking the fund is extremely important. You need to have that discipline in place in order to make sure that you're going to get that consistency of return that you're looking for. Otherwise, you don't really know what you own, and that's not a good way to plan for your future. Very well said. I have a friend who tells his clients, I have no idea what's going to be up next year, but I do know that we're going to own it in your portfolio.

Whatever it is, we're going to own it. If you have the discipline to go through that process and understand returns are not going to come in a linear fashion, then you have a much greater chance of being successful as an investor. If you lack that discipline, and there's little things I can see in people where I know they lack it. One of them is they like to look at their returns every day.

Not a good thing to do. I always wonder, do farmers dig up seeds every day to see if they're sprouting? No, they trust the process. It's the same thing with investing. But if you have that discipline, and you understand that, you understand that wherever there's positive movement, I'll get it. And where there's negative movement, I might have that too, but it will be offset.

I don't have all my eggs there. Then I think you have a much greater chance for being a successful investor long term. Dan Caprill, financial advisor in Cincinnati, Ohio, founder of Matson and Caprill. You will be invited back, sir. Always good to talk with you. Same here, John. All the best to you and all your listeners. Very interesting. And we'll talk with you again right here, same time, same place on Mr. Stoneman's Opus. Have a great week.