Investing Compass: The best lessons from 150 episodes
It's our 150th episode! We go through the best lessons from the last 150 episodes.
Mentioned: iShares Core Composite Bond ETF (IAF), VanEck Australian Equal Wt ETF (MVW), Vanguard MSCI Intl ETF (VGS)
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Mark LaMonica: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into account your personal situation, circumstances or needs.
Shani Jayamanne: Today is our 150th episode and a lot has happened. Obviously, in 150 episodes, we released them every week. We've shared different career progressions and life stages I guess, but you got a promotion.
LaMonica: Nothing's happened to me.
Jayamanne: You got a promotion.
LaMonica: You got married. You bought a house. Nothing.
Jayamanne: No, your life, your life is kind of downhill once you hit 40 , right?
LaMonica: Well, my life has been downhill for a while. I don't know about 40.
Jayamanne: Something to look forward to. But Mark, you have a new role.
LaMonica: I do.
Jayamanne: Yes. Do you want to talk a little bit about it?
LaMonica: Well, I mean, I think for everyone who's listening to the podcast it will probably be exactly the same.
Jayamanne: Yeah. It would just be focusing a lot more on content that you're now the director of Personal Finance Australia, which is very exciting.
LaMonica: Right. No, it is exciting. So I don't think there'll be much of a change except for I get to not do some stuff I did before. Which is good so.
Jayamanne: Okay.
LaMonica: So should we get on with this 150th episode? Unless you – do you have anything you'd like to share about your life?
Jayamanne: No, I think I share a lot on this podcast. So let's pull back on that.
LaMonica: OK, well, exactly. So that’s what you look forward to the next 150 episodes. So when we started Investing Compass, we of course had no idea that we were going to do 150 episodes or maybe even 5 episodes. But we have been very, very thankful that we've been able to build an audience and the audience is stuck with us. And yeah, I think we just wanted to say that we're humbled and grateful to be able to help people hopefully achieve their goals and that enough people find this interesting that we get to keep doing it.
Jayamanne: Yeah and we’ve said this a lot, and we will keep saying it – that it is our favourite part of our job. And having you listen means that we get to keep doing it and get to keep helping people – which means a lot to the both of us.
LaMonica: And one of the recurring themes in this podcast is that as much as we can provide guidance, investing is work.
Jayamanne: It is work on your part to understand what you’re investing in and why.
LaMonica: And it's work to educate yourself and continue that education. To evolve as the market evolves and the world around you evolves and ensure that you are as a self-advised investor still on track and pivoting as needed to achieve their goals.
Jayamanne: Yes – you’ve gotta work for your lunch. But – we’re gonna do some of the work for you today. If we look at our Investing Compass episodes – we’ve got over 430,000 words. That means that’s over 55 hours of listening to us. So we’d like to think that we are the only podcast you listen to –
LaMonica: But of course we know that's not true and we do encourage people to listen to other podcasts, read other perspectives and of course challenge your understanding and your view point to find what works for you.
Jayamanne: But the point is it is a lot of content to consume, so we, as we mentioned, we're going to do some of the work for you today. We're going to take that 55 hours of content and pick out the best bits.
LaMonica: I mean, don't we try to make all of it the best bit Shani? And we want to call out that we try to make every part of the podcast the best bit.
Jayamanne: We do, yes, it just doesn't work all the time. No, but we do script out our episodes because it allows us to peer review and fact check each other. We want to ensure that we add our perspectives and any insights that we can to each topic. We practice each episode before we record – this ensures that if we could say a sentence better – we can change it. If we can say something differently to make it make more sense to other people – we can change it.
LaMonica: OK, but people. Probably aren't that interested in how we make the podcast exactly, exactly.
Jayamanne: The madness of Investing Compass.
LaMonica: Exactly.
Jayamanne: So each of us are on a different journey, there are parts of the podcast that probably resonated more with you than others. But these were the episodes that resonated the most for the majority of our listeners – and those are the most popular topics by listens.
LaMonica: And there's a bit of a theme here, so maybe we should just keep making ones that are like these.
Jayamanne: Yeah.
LaMonica: That's what someone smart would do. But anyway. The first of these five episodes we're gonna talk about – actually the first two of those five episodes are about how the market's doing. So our state of the market podcasts and basically tries to guide investors on what they should do and how they should interpret the current environment. And we certainly want these episodes to be more than simply market news because anyone can tell you what happened. We want to take what is happening in the market and apply a consistent approach and mindset around investing. Because without this framework, investors can find themselves just chasing events after they've occurred. And that's not a formula for success.
Jayamanne: And then two of the episodes were about ETFs. One was about building a portfolio with 3 ETFs – which makes sense. A lot of investors just want simplicity in their portfolio. The other was the case against ETFs – and this was a critical case against why you shouldn’t invest in ETFs. And if there was theme here it is simply that any investment product is a means to end – which is achieving your goal.
LaMonica: And then the last was an episode that we thought and was is popular across all life stages, paths of life and is pretty consistent regardless of your individual goals that you are trying to achieve. And that is passive income.
Jayamanne: Alright So let’s pull our top insights from these episodes.
LaMonica: Okay. Why don't we start with the market episodes and the first one was published in January, and the other one was in May of 2022 so a little bit old, be we’ll hopefully apply those lesson today. So the one in January was a little bit different. It was speaking about markets, but a worst-case scenario and we called it a disaster response.
Jayamanne: Militaries play war games, governments run disaster response exercises.
LaMonica: And this was Investing Compass running an exercise to see what would happen in a worst-case scenario for equity markets.
Jayamanne: We described market movements in the fourth quarter of 2021 where we saw the riskiest parts of the market as represented by small cap growth shares – or small companies trading at high valuations – starting to implode. And since then, that has continued. The riskiest investments, SPACs and crypto have continued their retreat. In short, investments lacking in fundamentals fell significantly. Companies without earnings and cashflows were hit hard.
LaMonica: And this happens repeatedly throughout market history. We can all get a little manic about certain types of investments from time to time. But as Warren Buffett says it is only when the tide goes out that you see who is swimming naked.
Jayamanne: But what we outlined in that episode was not simply the speculative parts of the market getting hit. We said that in order for a true meltdown to occur we needed to see losses spread from small cap growth shares to large cap growth shares. The market darlings that make up so much of the major indexes and have driven the market higher since the GFC.
LaMonica: And in many ways we saw that happen in 2022 as the large tech shares that drive US markets fell significantly in price as interest rates continued to rise. Since then that trend has reversed significantly with a huge rally in those very names in 2023 even as most other shares have not done well.
Jayamanne: And I think if we go back to that disaster response episode and what has happened with the market since, there are a couple different lessons that investors can take from it. The first goes back to that Warren Buffett quote. We always need to be wary of extrapolating trends too far into the future. Investors use these extrapolations to justify all sorts of things that really aren’t explainable unless the trend continues.
LaMonica: In this case it was the notion that interest rates would stay close to zero for the foreseeable future and that inflation had been tamed. That in turn justified the high valuation levels on some of the most speculative investments as well as some of the large tech names that made up so much of the market. It also led to some assumptions about consumer spending in the face of record low interest rates. It is worth challenging these assumptions just to see what the impacts would be on your portfolio and your personal finances.
Jayamanne: The next lesson is for both active and passive investors to always remember the implications of market cap weighted markets. In both the downturn in 2022 and the surge so far in 2023 we’ve seen that the biggest shares – especially in the US market – drove the returns for both active and passive investors. The performance of a relatively small number of shares can drive markets. Remember that the performance of the overall market is not reflective of the performance of the average share.
Our next market update showed these lessons playing out. On May 10th of 2022 we saw that over the previous three months in the US large cap growth fell around 28 and a half percent. That is the worst performance of any combination between style – meaning value, core and growth – and market cap meaning large, medium and small companies.
LaMonica: Looking at the NASDAQ we saw some remarkable movements. 45% of the shares that trade on the NASDAQ were down more than 50%, over 20% are down more than 75% and 5% are down more than 90%.
Jayamanne: And we warned that if this spread to large cap shares or the biggest companies it would drag down the indexes. When the second episode was released in May, year to date the NASDAQ was down more than 28% and the S&P 500 was down close to 18%.
LaMonica: And in this episode, we spoke about why markets fall. There are instances when investors pay too much for the risk that they are taking on. The valuation and the expectations that are priced into an investment are both so high that it is almost impossible for any future events – either company specific or economic or geo-political to meet those expectations.
Jayamanne: So when those sky high expectations for a company, for the economy or for future returns aren’t met, the market falls. And that fall can be fast, and it can be significant. And the jargon that is put out to describe this phenomenon by the investment industry is that we are seeing repricing of risk.
LaMonica: And what this means is an acknowledgement that investors had bid up prices to the point where the return they were setting themselves up to get, was not fair compensation for the risk they were taking. They saw a future that was just full of endless possibilities for good things. Double digit returns, endless technological innovation, a stable geo-political situation, competent and clairvoyant central bankers and accommodative politicians. Motherhood and apple pie or as Alan Greenspan put it - irrational exuberance.
Jayamanne: Ultimately, the two episodes looked at volatility in markets and how this can impact investor outcomes. But – the main lesson that we took from this is that valuation levels will change, prices will change, investor and market sentiment will change. It is important that as investors we have a framework and a plan that allows us to see past this noise – something that keeps us on track as this volatility is inevitable. It is the price that we pay for the returns that we get. Over the long term – investors have been rewarded for riding out this volatility.
LaMonica: The chance for us as investors to increase our success in the pursuit is that we truly understand what we are investing in to reach our goals, and how these assets behave. Reducing the nervousness that we, as humans, naturally will feel with volatile markets, comes with understanding this behaviour.
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Jayamanne: Okay – the ETF episodes. The first was about being able to build a portfolio with three ETFs and this looked at how you could diversify your portfolio and get exposure to the asset classes you need, with three trades.
LaMonica: And we can see how this is an appealing concept for many investors. Investing means that you are constantly exposed to choice. And the choices and information that investors are inundated with can be exhausting.
Jayamanne: A simplistic portfolio not only means that you spend less time on portfolio admin, but it also means that you are less likely to overtrade. And therefore, it is likely that your portfolio will have better results.
LaMonica: So the three ETFs that we picked were Vanguard MSCI International ETF with the ticker symbol VGS – so that was for international equity exposure.
VanEck Australian Equal Wt ETF with the ticker symbol MVW for domestic equity exposure.
And then finally the iShares Core Composite Bond ETF with the ticker symbol IAF. This was the choice for exposure to the Aussie fixed income market.
Jayamanne: And we won’t go through all the considerations for why we picked these particular ETFs – but the main reasons were fees, the underlying exposure that you get and liquidity that means less trading costs.
LaMonica: VGS - our analysts cite how cheap the fees are, the liquidity or the ease with which you can move into and out of the ETF, the diversification and the track record that Vanguard has of being able to match the index return. That is what earned it a Silver rating from our analysts.
Jayamanne: MVW – the domestic equity exposure. The reason we have selected this ETF is based on the unique attributes of the Aussie market. We talked a lot about the concentration in the top 10 holdings and particularly in BHP which makes up close to 10% of the index. That only tells part of the story. The Australian market is really narrow, which means that a handful of sectors and industries dominate, including financial services and mining. And we think in this situation you aren’t really getting adequate diversification. That is why we really like the equal weighted ETF from VanEck.
LaMonica: And we've seen this a little bit this year, although it is too short of a time period for any definitive conclusion, but the equal weighted index has outperformed the market cap weighted index by less than 2%, but still by something. And The last one – our fixed income exposure with IAF. It is cheap at .15% and has low tracking error so you are getting the index return. And that index in this case is the Bloomberg AusBond Composite index. The index is mostly made up of government bonds but it also has exposure to corporate bonds.
Jayamanne: We spoke about asset allocation as well. And asset allocation is important because it is one of the largest determinants of your returns.
LaMonica: And Aussie investors especially tend to gravitate away from traditional asset allocation targets, and this is because they have a strong sense of home bias. This strong sense of home bias means that Aussie domestic equity plays a large part in their portfolio.
Jayamanne: The second episode is why you shouldn’t invest in ETFs. And we laid out a couple of reasons – the first was behavioural.
LaMonica: A study done by UTS showed that investors who had ETF portfolios underperformed non-ETF portfolios by 2-3% per year and that’s huge.
Jayamanne: But this wasn’t because of the assets that they chose – the losses that they’ve realised mostly comes from buying ETFs at the wrong time.
LaMonica: But ETF portfolios outperformed when they were held for the long term. That means that adopting a buy and hold strategy helped in the long term, more so than the vehicle.
Jayamanne: The next was tax. The tax consequences for ETFs are very different than investing in direct equities. You don’t have any control of what is bought and sold at single security level. So, ETFs have mandates – both active and passive. And managers invest within that mandate.
LaMonica: For example, with a passive fund, let’s take the ASX/200, if a stock falls out of the 200, the new stock at 200 must be bought and the original stock must be sold. Same thing with equal weight indexes – it would need to be rebalanced at intervals to make sure that it remained equal weight.
Jayamanne: There’s no consideration of whether it is the best decision for the portfolio. Active management also faces similar issues – they’ll have large bands within which they’ll have to invest in most instances. For example – a fund may have a 10- 20% allocation to Australian equities. If Australian equities perform particularly well, they have to sell out of Aussie assets and into other assets – whether or not the investments have good prospects that are still unfulfilled.
LaMonica: And what we’re talking about is rebalancing. Rebalancing triggers tax consequences in almost all circumstances, and tax is part and parcel of investing and making money, but mitigating it protects the total performance of your portfolio.
Jayamanne: So the lesson to take from this is that ETFs are simply a vehicle to invest through. Their underlying assets are what matter. However, certain investment products may suit you more that others. ETFs are popular with investors because they are easy to access, there’s no extra paperwork if you’ve already got a brokerage account and they allow for easy diversification and access to asset classes.
LaMonica: But no investment product is perfect. This case against ETFs episode was there to display there are downsides to investing through this investment vehicle, and investors should be wary of the pros and cons before deciding to invest.
Jayamanne: The last of the five most popular episodes was passive income. And in this episode, we looked at Mark’s approach to passive income.
Jayamanne: So we also talked about why Mark was obsessed with dividends. Mark – do you want to tell us again?
LaMonica: Yeah I think obsessed is too strong of a word but when I first started investing, the concept just seemed really great to me, so I own a company and a portion of what that company makes gets given to me. So I thought that if I could just grow that income enough over time, I could just live. Off of it. So I got out Excel and started trying to figure out how I could grow that income and what the different levers were that impacted that.
Jayamanne: And you also spoke about three ways to grow your income.
LaMonica: I started concentrating on the three ways I could grow my income. Increases in dividends, reinvesting dividends and new contributions I made to my account where I bought more shares. So I became really focused on growing my income. Thinking about the three ways it happened. And it occurred to me as the market was recovering from the .com bust that two out of the three of those sources of increases in income – the market dropping was a good thing. And that was because I was really focused on the yield of the new shares I bought – either through contributions or automaticity through a DRIP.
Jayamanne: There were a few other themes in there – such as compounding your passive income to grow it, and providing examples on how passive investing reduces behavioural risk in his portfolio. And this was an interesting concept – Mark had trained himself to be positive about falls in the price of shares he owned.
LaMonica: That’s right Shani – By focusing on income – and I'm so negative on anything else that happens so. It is a little bit surprising, right?
Jayamanne: Exactly. Yeah.
LaMonica: But by focusing on income, I wasn’t only just ignoring the value of my portfolio I was actually fairly pleased when it went down. And when it went down, I could get more yield or income for every investment I made I tried to put more money in and when the market was really high there was less incentive to invest more because the yield was low.
Jayamanne: So let’s explain this concept - the yield of a dividend paying share moves inversely to the price of the share. If the share goes up the yield goes down – and vice versa. So if you are investing $1000 a month into dividend paying shares on a company that pays $1 a year in dividends, and whose share price is $100 a share, you would increase your income by $10 each purchase. If the share price went up to $120 a share the income you would generate from that $1000 would drop to $8.30 because you would buy less shares. If it fell to $80 a share you would get $12.5.
LaMonica: I think the reason this episode was popular was because passive income is a goal for a lot of investors. There is going to be a time in our lives where we don’t want to, or can’t, continue to work. But passive income also allows you to fund goals and replace income at other stages in your life. It gives you the freedom to travel, to pull back from work – to achieve any number of goals that require an income stream.
Jayamanne: So all of these episodes have very different themes but ultimately there is some commonality between them all. When looking at things happening in markets and how you construct a portfolio and choosing what type and which instruments to buy, the one theme is that none of these decisions can be made in isolation. They need to be based on what you are trying to achieve.
LaMonica: And all we hear about in investing is returns – how can you earn the highest return. And we totally get that. We certainly aren’t trying to minimise that. But if you wake up everyday as an investor obsessed with returns and what will provide you with the best return, you are very likely going to make a lot of mistakes.
Jayamanne: That’s right. You are going to try and react to every movement in the market. Your time frame is going to get shorter and shorter because someone – your friends or a market commentator – is going to make a convincing argument that there is something you should do right now is the best way at earning the highest return.
LaMonica: But whoever you are getting this information from is not going to be there with you every day over the long-term supporting you in making the right decision for you. And that is because they won’t know what your goals are or what your financial situation is. Only you can do that. So everyday your focus should be on what is the best way to achieve your goals. And most days – probably 99% of the days – probably 99% of the days when you are investing over the long-term the best decision to achieve your goals is to do nothing.
Jayamanne: And some great life advice as well as investing advice is to have the serenity to accept things that you cannot change. And when it comes to investing, the thing you can’t change is the fact that there will be times – perhaps long periods of time - when the thing that you can’t change is the fact that you will underperform the market. Certain investments you purchase will not work out and you will always wish that you had purchased other investments.
LaMonica: So we hope that through the first 150 episodes of investing compass you have come to realise and accept that. And the way to minimise regret and the negative it impact it has on your decision making is through education and self-awareness of what you trying to accomplish. Thank you so much for supporting us through the first 150 episodes.
So Shani, Will and I are incredibly grateful that we get to do this and put out this content and as always, we want to keep making this better, so please send an email to my email address in the episode notes if there's any particular episode you'd like to hear, or if there's any suggestions for improvement. And once again, thank you so much for supporting us.