Mark does not hold these assets
This week's episode of Investing Compass looks at the investments that Mark deliberately excludes from his portfolio.
This week's Investing Compass episode focuses on assets Mark excludes from his portfolio. Sometimes investors obsess over what is contained in others' portfolios, but sometimes we find it even more insightful to explore what is deliberately excluded. He explains why what he chooses not to buy may be the most important financial decision that he makes.
You can find the full article here.
Listen on:
Shani Jayamanne: 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 consideration your personal situation, circumstances or needs. So Mark, you're back from holiday.
Mark LaMonica: I am. I was actually back a week ago, but I came back and immediately got sick.
Jayamanne: Tell us where you went.
LaMonica: I went to Korea, Hong Kong, and then a couple of spots in Thailand.
Jayamanne: And what was the highlight?
LaMonica: I really liked it. I've now been in Korea twice. In both times I've gone in December, which is a big mistake because now that I've moved to Australia, I'm soft and I can't take winter weather.
Jayamanne: You messaged me while you were there. You said you barely went out.
LaMonica: It was freezing. I mean, I would leave the hotel, go to a bar, go out for dinner.
Jayamanne: Did that not warm you up?
LaMonica: Oh, it did.
Jayamanne: It would be like the baker in the Titanic.
LaMonica: I don't know. I know that you watched the Titanic because you won't stop talking about it, and you were sending me memes from the Titanic last night.
Jayamanne: The baker in the Titanic drank a lot of booze and kept warm in the freezing water, and that's how he survived.
LaMonica: So this isn't like the Leo DiCaprio movie.
Jayamanne: I think he was in the movie anyway. We're off topic.
LaMonica: Okay, there you go.
Jayamanne: But if you want to have a little bit of Mark's holiday, you can go to his new column that he's launched. Do you want to talk about that?
LaMonica: Yes, it's called, what's it called?
Jayamanne: Unconventional wisdom.
LaMonica: Unconventional wisdom. It's available on Mondays, and I put two food shots in there.
Jayamanne: Yeah.
LaMonica: Two things that I ate.
Jayamanne: So you talk about the things that you eat, on holiday and not, I'm guessing.
LaMonica: Exactly. Well, unfortunately, I'm not allowed to go on holiday for like 90% of the year, which is what it would take.
Jayamanne: Okay.
LaMonica: All right. Should we get into this?
Jayamanne: Let's do it.
LaMonica: So we listen to a lot of investing podcasts, Shani. We read a lot of investing content, and you're always hearing about what investors have in their portfolios.
Jayamanne: And we've covered this before and talked about how we think they are generally unhelpful with some context, including the goals and strategy of the investor that holds them. But today, we're doing something a little different. We're going to talk about things that are not in your portfolio, Mark.
LaMonica: Right. And we can -- you want to go through all the jokes, like any winners.
Jayamanne: Oh, in your portfolio.
LaMonica: Yeah.
Jayamanne: Okay.
LaMonica: Anyway.
Jayamanne: Wasn't very good. So...
LaMonica: We're going to do large categories, though. We're obviously not going to do individual securities, large categories.
Jayamanne: Okay. Well, I'm glad we're focusing on large categories. We should do another episode where I just go through the ASX 300 and you say yes or no.
LaMonica: Do you think people would enjoy that?
Jayamanne: Compliance wouldn't, but...
LaMonica: It would just -- what would we title it? Like Kermit Reads 300 company names?
Jayamanne: Yeah. I could just take the day off.
LaMonica: There we go. Well, luckily for you and our audience, we're not going to do that. Shani will be very much part of this episode. We're going to do a couple of disclaimers. I'll do a couple of disclaimers. That I will probably repeat multiple times as we go through this. But the things that are not in my portfolio are based on my own personal circumstances. That includes my investment strategy, my temperament, my overall financial position. Just because I wouldn't buy something now doesn't mean that I wouldn't in the future as I get older and my circumstances change.
Jayamanne: All right. So let's get into it as much as everybody likes disclaimers. The reason we think this exercise is helpful is because as investors, we do have an abundance of choice. Some, including us, would consider this an overabundance of choice. With all these different options out there, the product providers have to work extra hard to sell them. And that means more niche products, that it means more marketing, and it means more appealing to our base emotions. So this all means that eliminating large categories makes your life a lot easier as an investor.
LaMonica: And the issue is that with all these choices and these slick marketing campaigns, investors are constantly tempted to switch investments. And there's been a huge increase in trading and turnover in people's portfolios. And as you've heard multiple times on here, that generally does not work out well for investors.
Jayamanne: And we all need to remember that our financial outcomes are likely more of a result of what we choose not to buy than what we choose to buy.
LaMonica: Well, that's like very profound, Shani. I know. I found a quote though. So Barry Schwartz, he was made famous by, he wrote the book, A Paradox of Choice. He said, learning to choose is hard. Learning to choose well is harder. And learning to choose well in a world of unlimited possibilities is harder still, perhaps too hard.
Jayamanne: All right. So why don't we move on to your first category, Mark, of what you don't invest in?
LaMonica: Bonds. That's not enough.
Jayamanne: Yeah. You're really starting out with a niche part of the investing universe where we have, you know, 60-40 portfolio.
LaMonica: Yeah. And it's like the bond market is much bigger than the stock market. So it's actually, I've eliminated most of what's out there.
Jayamanne: So it leaves you with shares and cash. But you should probably explain why you've eliminated bonds.
LaMonica: Okay. So there are four reasons that I don't invest in bonds. I will get to those in a second. But they're all based on three very important facts and they are facts about me. So this is like Mark Trivia, something that nobody wants to play. First, I'm 45, and despite what Shani says, I still have a fairly long time until retirement. So that's fact one. Fact two, I think there's a pretty low probability that I will panic during a market downturn. And I'm saying that because I didn't panic during these other market downturns in my life. So at least there's some sort of evidence there.
Jayamanne: Do you know, I was going to ask you, what do you panic over? And then I realized I had an answer to your question. Do you remember during COVID where we were in lockdown? And I sent you a message because it was going around on social media that the liquor stores are closing down.
LaMonica: Oh, I spent like $4,000. I just take like eight trips back from the, and then of course it wasn't true.
Jayamanne: But you were very well stocked.
LaMonica: Well, it was COVID. What else are you supposed to do? Like you didn't drink during COVID. All right. Fact three. So that is what I panic over. Fact three is that my portfolio is mostly invested in shares. But as Shani likes to point out, I am a boring guy. I'm an income investor. I own boring shares. They pay dividends are generally big multinational companies. They skew towards non-cyclical industries like consumer defensive and infrastructure companies and healthcare. So traditionally, my portfolio has been a lot less volatile than the market. So those are the three facts about me, a bonus fact about me during COVID. So I guess now we can go through those four reasons. I don't own bonds.
Jayamanne: I feel like you're building a lot of suspense here. And bonds are really boring. So this is good. Keep going.
LaMonica: Yeah, exactly. Okay. So here are my four reasons for not owning bonds. So volatility is not how most investors should think about risk over the long term. The real risk is not earning a high enough real or inflation adjusted return to meet your goal. So that's one. Number two. The trade-off for getting lower volatility is meaningfully lower long term returns. So this significantly impacts that risk of not achieving your goal. Three. Bonds lower volatility, but have significantly higher inflation risk when compared to shares. The risk of inflation destroying the purchasing power of your portfolios is one of the biggest risks that I face and likely you face as an investor. While volatility is not a risk most long term investors face, it does cause people to make bad decisions, which of course, I pointed out, I don't think that's going to happen to me. But we do need to remember that that does impact long term returns.
Jayamanne: So let's dive into some of those points that you made. And each of those points mentioned volatility. And as you said, bonds lower volatility, but they don't eliminate it. Bonds still exhibit volatility, but it's just less than shares. Sometimes bonds are negatively correlated to shares, meaning their price moves in the opposite direction as share prices. Sometimes they're positively correlated, which means they move in the same direction. It all depends on the economic environment, but bonds still go down in price. The recent environment in the last couple of years of increasing interest rates is illustrative of this risk. So my question for you, Mark, is this, you said you don't really care about volatility too much, but do you care at all?
LaMonica: Well, Shani, I do a little bit because of course, I need cash sometimes. And there may of course be unexpected situations that come up where I need cash. Because let's face it, every time I open my mouth, Shani, as you tell me, I get a little bit closer to losing my job. But there's one asset that of course has no volatility. And that is cash. So if you put $100 in the bank, then it will be there when you want to get it out and it will grow. The growth will be less than bonds. But I think we have to put that within context. So over the past 30 years, cash has delivered returns of 4.2% a year according to Vanguard. Now, bonds have grown 5.5% a year. Those are Aussie bonds. And like bonds, inflation of course is a large risk to holding cash. It may not have volatility, but the money you put in the bank will also lose purchasing power over time. So if we take inflation into account, over the last 30 years, cash has delivered real returns of 1.5% a year versus 2.8% a year for bonds. So inflation of course is a risk to achieving my goals. It's an outsized risk to both bonds and cash. I still think cash is preferable in a period of high inflation.
Higher inflation and higher interest rates cause bond prices to go down. Cash held in the savings account or shorter term, term deposit does not go down in value and adjust to the higher interest rates quicker. So I could buy short-term bonds either individually or in an ETF. However, in an upward sloping yield curve, so that means longer term bonds have higher interest rates than shorter term bonds. I just don't think that that trade-off is worth it. So the beauty of cash, of course, is that you can reduce volatility in your portfolio by the same amount as holding bonds, but you need less cash. So that means you can hold more shares. So that was a long rant, as you would describe it, but I just feel like cash works better for my needs.
Will: I'm Will, the producer of Investing Compass. Each week I'll be bringing you highlights from our articles on Morningstar.com.au. Many of the stock market's biggest winners come from companies that manage to dominate an important emerging industry. Australia's CAR Group is one such company, yet its ascent is anything but likely. In the latest edition of his Bookworm column, Joseph taps Hamilton Helmer's seven powers framework to understand how CAR Group upset the odds.
The introduction of low-cost SMSF administrators means more and more investors are finding the control and freedom that self-managed super funds offer attractive. In her Future Focus weekly column, Shani looks at why an SMSF is not the right option for her now and what would need to change for her to consider one. No one contributes to the super thinking about the implications for their children's ultimate battle with the ATO. Sim explores the superannuation inheritance tax that children face upon the death of their parents. She examines free strategies to lighten the load of the tax bill. To find these articles and more, head over to Morningstar.com.au.
Jayamanne: All right, so one trade-off between cash and bonds is reinvestment risk. Your cash can of course sit in a savings account or if you want you can get a term deposit for a couple of years. But the issue of course is that when the term deposit matures, you have to reinvest at the prevailing interest rate. Now with a bond, you can of course go longer term, which means you can lock in a rate for longer. So does this trade-off worry you, Mark?
LaMonica: No.
Jayamanne: All right, turn off the mics.
LaMonica: It's over.
Jayamanne: Do you want to expand on that?
LaMonica: Yeah, exactly. I mean, I think how you access bonds matter. There are ways that you can go out there and buy individual bonds, but most people buy bonds using an ETF or a fund. So let's say I buy a longer term bond ETF. You still face reinvestment risk because a bond ETF, of course, is a portfolio of bonds. There is no maturity date on an ETF. So some bonds will mature in that portfolio. They'll get reinvested at whatever the prevailing interest rate will be. The point is that that scenario that you just described with reinvestment risk doesn't apply to ETFs or funds that hold bonds.
Jayamanne: So I'm going to play devil's advocate here a bit.
LaMonica: Which you love doing.
Jayamanne: I do.
LaMonica: You love pointing out if I ever send a Teams message to Shani and I spell something wrong, she immediately just corrects that word and sends it back.
Jayamanne: Do you not like that? Is that annoying?
LaMonica: I've been complaining about it for like four years now.
Jayamanne: I hear a lot of people say that they'd never invest in bonds and I can't help but think that's based on the current market environment. So I went back and looked at what the S&P 500 did over the last 15 years and we're talking US dollar returns here. So I removed any impact for an Aussie investor of currency changes. So that 15 year return is 13.5% a year, which is really high. So do you think people have been lulled into this false sense of security by those returns?
LaMonica: Oh, absolutely. I think most people would say that they won't invest in bonds, probably aren't that thoughtful about it. I think they aren't thoughtful about what their actual reaction will be during a bear market because it is easy to say you won't sell, but of course it's much harder to do in real life. So you haven't been through a bear market and a real bear market. I'm not counting the COVID thing. We blinked and that thing was over. One of those long grinding bear markets like the GFC, for example, I think that you need to acknowledge that you don't know how you'll react. And the second thing I guess I would say is, I'm personally, maybe I'm just very negative, but I'm personally ready and fully prepared for lower returns. So, as I've talked about on here, I am more concerned about income generated from my portfolio right now. So I can take a period of lower returns.
Jayamanne: All right. I'm going to call time on the discussion of bonds.
LaMonica: Okay. Because you declared them boring. And we don't want to keep to that. Okay. So the next thing you're probably going to disagree with me about, I don't invest in actively managed funds and ETFs. So let me come up with my rationale before you object. But part of developing investment strategies, we talk about a lot on here, is thinking about your edge or your competitive advantage over other investors. And this informs the approach you take and the types of investments that you consider for your portfolio. And I think one of my personal sources of edge is structural. So do you want to explain structural edge?
Jayamanne: Yeah. So structural edge refers to the external factors that influence the way an investor acts. This is largely an issue for professional investors. And there are lots of factors that influence professionals. So there's career considerations, dealing with investor inflows and outflows, and pressure to not let short-term performance dip below and index. So none of these issues impact individual investors.
LaMonica: Yeah, exactly. And so I can just focus on the long-term and my objectives. And structural edge is something that impacts the average active manager, which is one reason that there's such high turnover in those portfolios. And this is, of course, a generalization. However, active managers also charge higher fees, which are tracked from the income generated, which of course is my goal for investing. That high turnover generates poor tax outcomes compared to passive products, also a bit of a generalization, but mostly true. And of course, there's no full disclosure of holding. So it's very hard for me to find managers that are adhering to my standards. So when you combine all of this with the fact that most active managers underperform, it's enough for me to exclude active management. So people may disagree, including you, Shani, but I'm okay with that because I don't believe this decision will impact my ability to achieve my goals.
Jayamanne: So you've annoyed people that invest in bonds and active managers. Is your ultimate enemy an active bond manager?
LaMonica: I mean, it's like the supervillain. I mean, maybe. But we have more groups we can go after. Not that I think anyone out there cares what I don't buy.
Jayamanne: We'll see how many people listen to this podcast.
LaMonica: At this rate, it might be pretty few. Maybe some people will start, but then that long bond discussion drove most of them away.
Jayamanne: Okay, who are you going to annoy next?
LaMonica: Growth investors. So I don't own shares that don't pay dividends.
Jayamanne: So before you start, I want to point out that this really isn't true. Do you remember the Christmas gift that you bought me?
LaMonica: Of course I do, Shani.
Jayamanne: Scienjoy Holding, SJ.
LaMonica: SJ.
Jayamanne: That doesn't pay dividend.
LaMonica: That's true. And for long-term listeners, I of course remember this. For people that have listened, we do exchange Christmas gifts for each other, to each other. And I bought that stock for Shani because the ticker symbol is SJ, which of course are Shani's initials. And sometimes when you want to do something for somebody, you do something you wouldn't normally do. Do you agree with that?
Jayamanne: That's true. It's like when Warren Buffett paid that one dividend to Berkshire Hathaway. And he said he was in the bathroom when they decided that.
LaMonica: You know what another example is? Jack Bogle, captain passive investing, his son works at an actively managed fund and he invested in that because he's like…
Jayamanne: It's my son.
LaMonica: Yeah, what am I going to do? You ordered a fish once and you don't really like seafood. Do you remember we went to that Sri Lankan? We went to that Sri Lankan Gleeb. And you ordered like, it was very early in our friendship. You ordered like every dish on the menu because you were excited.
Jayamanne: You have to try everything.
LaMonica: And you wanted me to try everything. And so I'm like stuffed by the end of this thing. And then the waiter comes over with like a whole fish. I don't remember what that dish was, but I did remember that I had to eat it.
Jayamanne: You did. You did well.
LaMonica: I try. So should we get back to these non-dividends?
Jayamanne: Yeah, tell me about the non-dividend paying shares.
LaMonica: Okay. Well, first of all, I obviously want to start out and say there's nothing wrong with shares that don't pay dividends. Many people point out to me when I make that statement that I, or they ask me if I'm going to miss out on shares that are going to have great performances. And the answer, of course, is yes. My guess is that I'll miss out on the top performing shares over the next 20 years. That would be my guess. So I acknowledge all that. I only invest in shares that pay dividends because of course I've talked about before how I spend some of the income from my portfolio for things I want to do now. That's, of course, a fine reason to pick a dividend paying share, but it's only part of the reason. I also only invest in dividend paying shares because that is the investing approach that resonates with me. That's the approach that I know I'll stick with over the long run. I know that investing in dividend shares is the right approach for me just because I know myself. And the secret to investing is, of course, time in the market and consistency. And that's how I do it.
Jayamanne: Now, I'm really surprised that we've missed a few things from this list. And I think a big one is crypto.
LaMonica: Okay. Well, I pissed everyone else off. I don't want to piss Will off. And like, honestly, after what crypto has done last year, what I'm going to, it's going to be like another old man rant about crypto while the people owning crypto are just like counting their money. So we can't do that, right? So I did, I did leave that off. But I thought three were enough. We're going to do one with you sometime. Things Shani does not own. Something to look forward to. But anyway, thank you guys very much for listening. Really, really appreciate it. If anyone has any questions or wants to ask Shani what she doesn't own, send me an email. My email address is in the show notes. And we really appreciate you taking the time to listen.
(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)