question is indexing, okay, which index? And then in what allocations? And then how often and when do you rebalance these indexes? And then just understanding what the risks are associated.
So the risk being the downside volatility in difficult times because we know and research has shown and our experience has shown that the best investment program for someone is one that they can stick to. Welcome to Keenan retirement, a show dedicated to helping you thrive before and during your retirement years. If you are looking to grow and protect your wealth and want to get the second half of your life, the best half, then listen in as well as advisor Bill Keenan and his host sort through the key issues that you need to know in a lively and candid way. Hello everybody and welcome back to Keenan retirement.
I'm your co-host Steve Sandusky and here with me on this chilly day is Bill Keenan, Matt Wilson. Hey guys, how you doing today? We're good today Steve. How are you doing?
Fantastic. It's always good to chat with you guys on a new episode of Keenan retirement. So we've got another fun topic here today. But Matt, do you have something you're going to challenge us with here as we get started?
You know, I do. I'm always a fan of history. We had something very exciting happen in January 10 years ago. Any guesses?
I'll give you some kind of light open. Maybe you can give me some high level guesses. We'll narrow it down from there. What do we get a hint is what I would ask?
I got to think of a hint that doesn't give it away. How about Bill and I each get to ask you two questions and you can say yes or no? Okay. My first question is, is it financial related?
No. Is it politics related? No. Is it geopolitical related?
It is not. Does it have to do with the birth of something or someone? No. I don't think those questions are very complicated.
So here's the hint. I guess we're not good at that game. Yeah. No.
This hint, maybe it's still a little bit vague. It has to do with aviation. Oh, okay. Well, that's right up your angle there.
Oh, yeah. I started taking flight lessons. Yeah. 2010.
So that's probably not it. I don't think that would have made the website. Nobody's really that's stated in that. Okay.
Yeah. So here it is. Wait, hold on. Okay.
Does it have to do with the Hudson? It does. Sully Sullenberger. Yeah.
US Airways Flight 1549. It was the most successful ditching in aviation history called the Miracle on the Hudson mid-January 2009. It's interesting you bring that up because multiple times we talked about how fast time goes by. Yeah.
10 years. Since Sully successfully ditched in the Hudson. It's amazing how quickly time passes. But wow, what a story.
Yeah. Interesting. I mean, you know, flying into that flock of beasts and losing all power. Both engines.
Yeah. Amazing. You know, we saw him speak, didn't we Matt? We did.
Probably what a couple years after it happened. Maybe five or six years after it was at the actual Smithsonian Aviation Museum. Or we saw him speak. Yeah.
They play the radio call and everything. Oh, sure. Yeah. Sure.
The movie on that, but it speaks to training. It speaks to pre-commitment to what happens when things don't go your way. I know that he's been a lot of time on the simulators, but they tried to tell him that the computers said that the airplane should have been able to make it back, I believe, to the airport. And he said, you have to give a human a couple of seconds to troubleshoot and determine what the next best action would be.
And it was those couple of seconds that would have not allowed them to make it back to the airport. And even the aviation board that investigated it said that it wasn't going to be possible after the fact. They said it wouldn't have been possible for really to go back. Okay.
So, you know, based on that analysis, I would say they probably did the best, absolute best thing they could have done because if they tried to go back, I'm sure they would have blamed it on the ground. Right. Oh, for sure. Yeah.
Wouldn't have been the city landing. Yeah. Probably as we like to say. So, you know, and I think what's interesting too, talking about checklists and aviation and following a set of rules, because that's really what the checklist is.
It's just written down in front of you. And you know, recently, the founder of Vanguard passed away. That was John Vogel. And you know, he is credited with inventing the first index fund.
And you know, we're going to talk about that today. What is an index fund? But really, you know, from the highest level, an index fund is just a rules-based approach to investing. That's all it is.
Sure. There are many indexes out there in existence, but he is credited with starting the very first index fund. And he was 89, I believe, when he passed. And it was just a couple weeks ago.
Yeah. He was considered probably one of the best investors of all times, really one of the true innovators, I think, in the industry as well. Yeah. He started the Vanguard, you know, a company in 1974.
And their very first product, so to speak, was a mutual fund that tracked the S&P 500. So prior to this fund being accepted, there was no way for, especially for an individual or what's commonly referred to as a retail investor to monitor or track the S&P 500, because there's 500 companies in there. And you'd have to own every single one of them and all the same weights and everything that the S&P index was calculated. So he created a fund to do that for you.
Well, for the small investor, it would have been impossible too. And so the whole mutual fund concept or this being able to buy into some sort of a pool of investment allowed the smaller investor to get started building wealth in the capital markets. Yeah. And you know, probably the big difference between what John set up was this index fund that tracked the S&P 500.
And you know, big difference between that American century was it was considered passive. It was not an actively managed fund in the sense that there was an investment team and an investment committee making buy and sell decisions within that fund. Instead, what the Vanguard fund did was it just followed the rules that the S&P index had used to create its index. So there was nobody that needed to actively manage it.
Now, talking about index funds and passive investing, that's the big example. You know, it's probably the 800 pound gorilla, the S&P 500. You know, it's easy to track and see the media here in the United States puts it in front of our faces basically every single day, especially the financial media. But you know, there's another index provider called the Dow Jones.
You know, they create the Dow Jones index. But the Dow Jones company has 130,000 indexes. I was just going to ask you that they've created when someone comes in and says we're considering indexing. The first question we would have and we're not against indexes and we can talk more about how we actually use these in our process.
But the question is indexing, okay, which index? And then in what allocations and then how often and when do you rebalance these indexes? Yeah. And then just understanding what the risks are associated.
So the risk being the downside volatility in difficult times because we know and research has shown and our experience has shown that the best investment program for someone is one that they can stick to. And we know that Steve, we're going to be having Dr. Daniel Crosby on the show here in a few episodes. He's a behavioral psychologist.
And I think it's so important we talk about the behavior and the psychology around investing because if you owned the S&P 500 and that was your entire investment back in 2001 and 2002 or 2008 and 2009, you saw half your money go away. And the news press telling you that that that was just getting started, right? It was going to go on down from there. And a lot of people that were implementing those types of strategies unfortunately sold out.
And they were seven figure mistakes. For someone who has the wherewithal to potentially just say we're going to go all in and leave it alone and not look at it, might work. What we found in the world of emotion and human behavior is diversity, rebalancing, understanding when you might need some of this money back. If you're living on the proceeds, it complicates things doesn't know what the perceived simplicity of owning an index as they said.
That's right. Yeah. And you know, the index funds, they have a set of rules that they follow and those rules can lead to overweighting in certain asset classes or certain sectors of the market. The S&P is made up of 10 sectors and those sectors represent the 500 largest companies in the United States.
They do business all over the world, but they're headquartered here in the United States and it weights the individual holdings by what's called their market capitalization. The market capitalization is just their share price times their shares outstanding. Rough way to say how big is the company? The bigger the company, the more from evaluation sampling, basically, the more of a percentage it will make up of the S&P 500 index.
So you know my next natural question is how much of the S&P 500 is Google, Amazon, Netflix, that kind of thing. We think we're into diversified portfolio and we realize we have what's the number idea. Well, it is diversified because it does have those 10 sectors. But again, yeah, weighted by the size of the company.
Now, one thing you might have caught on is I didn't say how profitable the companies are, how much revenue they make, what's their earnings per share. Those aren't part of the market cap waiting. Now, essentially, you might say that's part of the stock price, but it's just shares outstanding times the price of the stock. Right.
Are you saying the market might be irrational at times? Well, the index is going to factor that in because in the late 90s, this was the issue with the index funds as they were very heavy in the tech sector. Yes. And it was with those companies that were very large, but maybe didn't have very good earnings or any earnings.
Sure. And those companies took a big hit in the NASDAQ, which is another index that tracks more of the tech sector was down 80%. Yes, P500 because it is a little bit more diversified, was only down 50 in 2002, 50 to 60. And then it was 0.809.
It was almost 60% from the peak down of the trough. And again, that was part of just the overall market and everything that was happening there. But the weightings within the sectors can get out of whack. So technology, again, is the biggest sector.
And as it was back in the late 90s. Now, one big difference today is the tech sector is way more profitable today than it was back then. Not to say that being overweight, the tech sector is a good thing, but there is at least a lot more rationale behind those weightings, at least in terms of the investing public, because these companies are very profitable. So, Matt, I think one of the interesting things about a market capitalization weighted index, like the S&P 500, is that companies that are really large, companies like Apple and Microsoft and Amazon, that they make up a significant percentage of the value of the index.
And so, even though it's just a small number of companies, they have a disproportionate impact on the return of the index. Do you happen to have any of those numbers at your fingertips that kind of show the disparity there? I do. The top three stocks in the S&P 500 make up nearly 10% of the weighting of the portfolio.
Did you say three? Three stocks. And that's Microsoft, Apple, and Amazon. So, those are going to have a disproportionate weighting or impact on the value of the index, based on what their performance is over short periods of time.
Now, over long periods of time, they will, assuming nothing changes. Now, what happens over time is, yes, other companies become larger, and they knock down some of these companies like Microsoft. As we mentioned, one of our previous podcasts, biggest companies in the world in the late 90s, drop 60%. And other companies replace it like GE at one point.
So, it does cycle from in and out of favor. Now, if you look at the top, 25 holdings, that makes up 35% of the index. So, another way to look at that then is you may think that you're getting the performance of 500 stocks, which technically you are, but a very small percentage of the biggest companies account for a substantial percentage of the return of the S&P 500. So, they're not equally weighted, which would be the alternative.
Everyone accounts for the same percentage in the index. That's right. Yeah. And there's been a lot of expansion among these types of just indexes in general.
This is a traditional market cap weighted index with the S&P 500. And then, there's been a big explosion of indexes that are, some of them are what we call evidence-based. So, they're using factors like value, which does take into consideration what the company earns. Let's weight the index based on earnings, or let's weight them based on dividends, or even as Steve, you just mentioned, let's equal weight all 500 of them.
There's an equal weight S&P 500 index. That's basically active management. Then, that's exactly... You're still having the same rules-based approach, but you're now shifting from just this pure passive in that sense of what the traditional S&P 500 is.
And even us at Keen Wealth, we do believe there's a balance between the active and passive components to a portfolio, because owning the S&P 500 is going to be good at times and other times it's not going to be as well as other asset classes. And so, you want to own that maybe in the component of a diversified portfolio, but also there's international indexes. There's emerging market indexes. There's small cap indexes, mid-cap indexes.
There's indexes that by fixed income. But you also, when you own the index, like the S&P 500, you own good companies and maybe bad companies, however you wanted to find that. We would say companies that maybe aren't as shareholder friendly. They don't have as high quality earnings as other companies.
They're not good capital allocators. They might be actually destroying shareholder value by issuing a lot of shares and issuing a lot of debt, which the index doesn't screen for. It just owns them all. We like to take an active approach in that sense, where we want to focus on companies that are more shareholder friendly, that are doing things that are in someone's best interest, like paying a dividend, buying back shares, reducing debt, not issuing a bunch of shares, not purchasing a bunch of other companies.
And we feel that that adds value to the portfolios over time. And then there's even the process of actively managing the passive indexes. And that process, as you alluded to earlier, that's, okay, which asset classes do we own? According to Dow Jones, they've got over 130,000 indexes.
So which ones of those do we own? Then there's what weights then. Okay, now we've narrowed it down. Let's say we've narrowed it down to 20.
Now, what percentage do we put in each one? That can be unique to each individual based on their risk tolerance and how much income do they need from the portfolio. When do they need this money back? I mean, that's all going to factor in the weightings and also taking into consideration volatility too.
Because as you said, the best investment strategy is the one you can stick to. And we go over this chart in our meetings where we look at just maybe the top 10 asset classes and look back at how they did the last 15 years. And the number one performing asset class is also the most volatile. Right.
Mergy markets, right? Actually, this year is real estate. Mergy markets number two. So you don't want to put all our money in those.
So I'm going to get the best, right? If you had the ability to one know what was going to happen in the future and then never look at your statement for 15 years, yeah, that can work. But since we don't know the future and not recommending that. No, we are not.
I said in believe it's freshman level investment course or economics course in college 30 years ago. And we talked about, we started learning about passive investments like we're talking about with indexing and active versus active. We also talked about technical analysis versus fundamental analysis. And it was interesting, it was almost like politics.
Right. There were hard line folks on either side of those aisles. It was either passive or active. It was either fundamental analysis or technical analysis.
And even back then, very inexperienced, although I had been trading in the markets since I was in high school. I had a Schwab account in 1985. My parents had to be on it with me. I was not 18 yet.
Did you talk to Chuck directly? I tried to reach him. But he was pretty busy back then. So now that we have a relationship with Schwab here at King, well, we still haven't been able to reach him.
We've got pretty high up the leverage. But I remember trading options or derivative securities on IBM back when I was in high school, a sophomore in high school, under just understanding it wasn't a lot of money involved. But it was giving me a really interesting understanding of how the capital markets worked and the derivative securities and leverage and those kind of things back then. But I remember the crash of 87.
And now I'm preparing our talk here. But I remember where I was at evening on the campus as a freshman, October of 87. And I was trying to get a hold of Schwab to place an order for my not very large account. But I think it was four digits.
I think I had over 1,000 in there. And I was trying to get a hold of them. I knew the market was probably going to open way up or way down. And guess what happened when I tried to reach them?
Couldn't get a hold of them. I was busy, Steve. Back in the payphone days? Yeah.
Well, things were a little different back then for sure. I was called over the landline. But to land this point, so to speak, it's understanding that in my common sense of view of things, it doesn't have to be all technical or fundamental. It can be both.
Why don't we look at things technically and also fundamentally? Does it have to be all passive or all active? Why don't we look at both? Why don't we say let's use the best of both and put that into play in a way that can make sense?
They both have an active process and a passive process. Both have very good qualities. And if putting them together helps the portfolio to be more diversified, help reduce volatility, that's exactly what we want. And going back to that chart, I mentioned that we look at the top asset classes.
Well, one thing that we also look at is what a diversified portfolio does. And with an active management wrapper around it of rebalancing the portfolio on an annual basis, and it gives us what's the free lunch, so to speak, and investing, where we're able to increase the rate of return and reduce the risk, to reduce the volatility. And the purpose of a diversified portfolio is never to be the best performer that year, but it's also to not be the worst performer. The diversified portfolio will never be the best in any given year compared to any one asset class.
We know that for sure, but to your point, it's not going to blow somebody's retirement up. That's right. Bill, I want to go back to something you said here just a minute ago. And you said that why be all passive or why be all active?
You want to take the best of both? And I think that's a really important point because what I see out there is that you've got some people who are just totally dogmatic and they say it has to be 100% passive or it has to be 100% active and they let their ego get in the way. Instead of what you guys do, which is you look at the information, you look at the research, you look at history, and then you decide what is going to work best. And so you take the best of both.
So it's not an either or it's an and. And so I think it's great that you're able to get the ego out of there and do what you think is best based on what the research says and what is best for clients. So I think that's an important point that we need to make here. Well, thank you, Stephen.
I can speak from now 27 years of actual doing this in real world with real clients and assets, my own experience. And it says what's going to get the job done for folks with attempting to have the least amount of stress and strain and anxiety. And then how do we employ a process and a strategy that's disciplined, that's repeatable, and that folks can understand why they're doing what they're doing. I think that's a huge part of it because we always come back to this behavioral side of things too.
There's like this dance between what is technically the quote best investment and then what is the investment that gets a family to their destination. And I just believe that for a client to be successful belong to them. We don't have to make them financial planners or charter financial analysts or CPAs or any of those things, but I do believe they have to understand why we're doing what we're doing. And that's why the planning process is so important because today we're just talking about the engine to the plan, the investments.
But in most of our podcast, we talk about the why and the why is the plan. And it's around taxes, it's around spending levels, it's around making sure that health care, coverage is provided, it's all those things, wills and trusts that go into the plan and really understanding someone's why the investment part of it is just the engine to the plan. I always like to go back to that. And we do believe, don't we, man, that indexes, we use probably over 20 different indexes in our portfolios, but we also use individual securities.
We don't just default to outsourcing the money management to mutual fund managers and hoping it works out. We have a very disciplined, repeatable process that we're able to say what indexes should a client be in, and then what securities typically surround 50 securities, individual securities as well, if someone has the asset base to be able to diversify appropriately. To tie back to John Bogle, the founder of Vanguard, he also believed in active management. Today, two thirds of Vanguard's funds are actively managed.
So the creator of the index fund, the father of passive investing, so to speak, has two thirds of his company actively managing investments. So maybe he thought that best of both worlds exist as well. That's right. It's not an either or but a both hand.
That's right. And it's always easy for folks that either aren't doing this for real, that are just making comments about it online or making on a drive on Fox Business or something to look backwards and say, oh my goodness, look, this thing did the best last 10 years. And this is where you should have been. It's such a fantasy.
That's right. Especially when you take it out of context. How did that investment get to where it's at? How volatile was it?
And part of that graphic that I keep mentioning is we point out to people, yes, some of these best asset classes are also the ones that will be the best one year and the very worst the next year. And it's easy to look back and say you would have stuck with it, but I can tell you're living through those things. There's very few people that can actually stick to that volatility of those swings when they happen. Well, guys, I just want you to put me in the top asset class each year.
Okay. Can you do that for me? You have an inside line to it here. There's some program we can offer you.
Yeah, we're only that easy, right? We're getting our DeLorean and get our go back with Martin McFly. What was it? What was it?
It's kind of like that old saying that I think it's attributed to Will Rogers. He said something to the effect of, yeah, I just want to invest in things that are going to go up. If they don't go up, then I'm not going to invest in them. Excellent.
Sounds like a good strategy. That's right. Vanguard did come out with a piece a couple years ago and did say that they believe that by working with an advisor that is helping you with a number of different things that it could add up to 3% net return. They call it total potential value added.
Here are the places where advisors help clients. Suitable asset allocation using broadly diversified investments, rebalancing. Understanding we mentioned that earlier, knowing what sectors are going to be going to be going to rebalancing. Asset allocation in general, how much in stocks and how much in bonds and then all the asset classes, Matt mentioned.
Spending strategy, so coaching on the order and the places to take money from first, which would also be a tax strategy as well. Total return versus income investing, and then behavioral coaching. This is from Vanguard. Now, this isn't me.
This is Vanguard, finally cost effective implementation. Maybe not just using high price mutual funds and folks charging a fee on top of that or somebody charging commissions and investors charges, that kind of thing. But all that combined Vanguard themselves comes out and says that could, potential value added could be 3% a year for those services from a qualified advisor and I would say fiduciary advisor. Yeah, that might be an episode on by itself down the road as well.
What is the value that a financial advisor offers? We've got a lot of good things we could talk about there. Well, hey guys, let me just quickly wrap here. What I gathered today, basically three things, that when it comes to all of our listeners who want to get their financial situation in good order, three things we need to do.
One is we need to have the right investments. We've talked about those today. Could be passive, could be active, could be individual securities. Of course, we want everything to be diversified as well.
Second is we need to get the right plan. The importance of the financial planning process. And then third is the right behavior. We'll have an episode coming up here, as you mentioned earlier, Bill, with Daniel Crosby, one of the country's foremost experts on behavioral psychology as it relates to financial investing.
Any final words that either of you want to add as we wrap up today? I know we've talked a lot today about different indexes and maybe some things that were a little more technical, but at the end of the day, we just want to provide an environment where folks can learn and have the best opportunity to manage a successful life all the way out through retirement. So, appreciate you taking the time again today, Steve. Always enjoy the episodes and I look forward to our next one.
Matt, thank you. Okay, thank you. Well, thanks guys. And for all the information we've talked about today and all the past episodes, you can go to keenonretirement.com.
That's K-E-E-N on retirement.com. Guys, look forward to the next conversation. And between now and then, stay warm. You too.
The opinions expressed in this podcast are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security. It is only intended to provide education about the financial industry. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. Any past performance discussed during this program is no guarantee of future results.
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