In this Rule Breaker Investing podcast, David Gardner brought some special guests to help him respond to his listeners' questions, including Tim Hanson, the creator of the Fool 100 Index; Jeff Fischer, head of Motley Fool Pro and Options; and -- for the second month in a row -- Motley Fool Asset Management Chief Investment Officer Bryan Hinmon.
They weigh in on subjects such as the history of the Fool 100 Index -- even before it existed, why the Fool 100 ETFs fees aren't lower, why the Fool so rarely makes recommendations that aren't stocks, why the Dow's returns appear to be stomping the FTSE, and more.
A full transcript follows the video.
This video was recorded on Feb. 28, 2018.
David Gardner: Welcome back to Rule Breaker Investing! A delight to have you with me this week.
It's our mailbag week. It's the final Wednesday of the month; therefore, I have a motley array of items in store for you. Yup, we're going to be talking about market drops, and potential, and how to act in those situations. We're going to be talking about some Fool Funds questions that some of you have had. I definitely will be reflecting on some of the notes and tweets I got about other episodes we did this month. All that and a lot more.
Now, let me mention next week's podcast. I'm very excited to have an external guest. It's Steven Pinker from Harvard University, the author of the recent book Enlightenment Now. He also, seven years ago, wrote The Better Angels of Our Nature, which some of you may have read. I'm very excited to have him and his positivity in the house for Rule Breaker Investing next week.
By the way, go right ahead and buy the book Enlightenment Now. I think it will challenge you. I think you'll find it really interesting and you can read ahead of my conversation with Dr. Pinker next week.
All right. I'm not even going to count Rule Breaker mailbag items this particular month. I'm just going to do them, and we're going to see how many we have. I know one thing. I have a number of external conversations. Some guest stars coming in to help me with some of your great questions. But I'm going to start this mailbag with -- I'll just call it our little "hot picks" section. These are often tweets or shorter bits from people reacting to Rule Breaker Investing podcasts of this month and maybe of the past as well.
Let me start it with Kurt Elia, @kurtElia on Twitter. He tweeted "@DavidGFool. I just listened to your Sept. 20th, 2017, edition of RBIPodcast and couldn't help but be struck by the fact that PYPL" --PayPal -- "seems to fit all five attributes of a potential takeover target by, let's say, Mastercard or Visa."
To summarize those five attributes of potential takeover targets, Kurt just put it this way. "If there's overlap, if there's a niche leader, if there's consolidation happening, if there's no big founder in charge, and if there's a big asset." Those were the five we covered on "How to Spot a Potential Buyout, Vol. II," which you can go back and listen from Sept. 20 of last year. And Kurt, I agree with you. I do think that it fits that pattern. You and I developing pattern recognition. That was the point of that particular episode.
We're rarely ever recommending stocks because we want them to be bought out. Usually great companies keep being great on their own and can get stronger as independents, but certainly it can be exciting to wake up one morning and find out that one of your stocks is up 30% because somebody else is buying them out. Maybe returning you your capital to invest in the next rule breaker. I wouldn't be surprised, at all, to see PayPal get bought out in the next three to five years, but I'm not investing for it.
All right, another hot take. This one from Brian Stoffel reacting to our "Five Stocks to Feed The Bear" review, a review of five stocks I picked two years ago to see how they've done since and they, good news, had done pretty well. However, I didn't do well enough. I blew one fact, and Brian Stoffel, my good friend, points it out.
"Awesome show and picks from two years ago. Wow! But Novo Nordisk's (NYSE:NVO) market cap is way below the $150 billion threshold, no? Thought I might be looking in the wrong place." And sure enough, I was talking about how the five stocks all were somewhere around $150 billion or more, and as it turns out, Novo Nordisk was more like $120 billion. So, Bryan, good catch. Thank you. I'm never going to get all my facts right, but I sure do like it when people help me and show me where I could have done it better. So, yes, it turns out Novo Nordisk which, by the way, is now up to about $132 billion market cap, so it's been a good couple of weeks for ticker symbol NVO.
Also reacting to that company was Claus Torp, who sometimes writes into this podcast. He said, "@RBIPodcast. David, listening to your recommendation of Novo Nordisk, I can say, your Danish is actually OK. Fool on! Torp, aka The Dane from Denmark." So, Claus, no doubt a Denmark native himself. I was attempting, on that show, to pronounce the location of Novo Nordisk's headquarters, which I'll keep going with Bagsveard, Denmark. That's B-A-G-S-V-A-E-R-D.
I should note, in passing, that we have a lot of Danish blood in the Gardner family. In fact, our Danish ancestor, way back when, changed -- anglicized -- as he immigrated to this country our name from Gartner to Gardner. So, Claus, I want you to know Danish show of brotherhood on this show with that tweet. Thank you very much, Bagsværd, Denmark.
And the last of our hot picks. This one coming in from @pixeldesk. That's a pretty good handle on Twitter -- @pixeldesk. "@RBIPodcast Thanks, DavidGFool for the lingo episode." That was last week's "Gotta Know the Lingo, Vol. III." "Listened to it right before I went over Shopify's conference call. On that, the chief operating officer uses both CAC and LTV in a single sentence and I can actually understand! By the way, that's #companytheworldneeds."
Well, that's awfully fun. Abi Malin came in and presented customer acquisition cost, or CAC, and LTV, lifetime value, and both of those were used in one sentence shortly after you heard the podcast. That's perfect.
Now, on to our first full mailbag item, and I'm really pleased to be joined by Tim Hanson of The Motley Fool.
Tim Hanson: Hey, David! Thank you.
Gardner: How you doing, Tim?
Hanson: Good, great!
Gardner: Good. Well, we've got a lot of interest in Fool Funds and specifically The Motley Fool 100 ETF that you've been so instrumental behind designing and then launching. So, just a couple of questions for you. In fact, a little later this podcast, I'm going to have Bryan Hinmon back from Fool Funds to answer a few others, because there are a lot of questions this month on Motley Fool Funds.
Hanson: Yes, I work on the index side, so Fool Funds use the index to run their ETF.
Gardner: Tim, briefly share that story of how you've built the index that has enabled us to have a Fool 100 Fund. What's going on with the Fool 100 Index?
Hanson: So, the Fool 100 Index we built to be something that tracks the universe of Motley Fool recommendations. These are universally stocks The Motley Fool likes. How did we build that universe? We tried to be very plain vanilla about it. It's our first index, so keep it simple so people could understand it.
So, the Fool 100. We take a universe of open recommendations that The Motley Fool has on companies: recommendations from Stock Advisor, Rule Breakers. The services people know and love. We add to that the top 150 stocks from our Fool IQ database just to give us a robust universe of stocks to pick from. We rank them by market cap, which is a very industry-standard way of building an index. And then we just take the 100 largest, market cap weight them, and you've got something that you can backtest the performance of and obviously will track the performance of the Fool universe over time.
Gardner: Tim, when did the index itself -- we're not talking about the fund here. When did the index itself formerly launch?
Hanson: The index itself began being officially published on Nov. 9, 2017, and we were able to backtest the performance of the index using that methodology I described to Dec. 29, 2006.
Gardner: OK, great. So, I've got a couple of questions for you. This one comes in from Nick Greco. Nick took the time to follow up, and I think he even spoke with you directly, so thank you very much for fielding a member question. I'm just going to air it right out here on the podcast, because I think it's a fair and good question. So thank you, Nick, for writing in.
"David, I'm a frequent visitor to Fool.com. A member of Stock Advisor and Rule Breakers with eyes on adding new services. I purchased the new Motley Fool ETF, the Fool 100" -- TMFC is the ticker -- "on day one; but noticed it posted amazing performance results on the Fool.com home page, even though it's brand new.
"After a brief Twitter exchange with Tim Hanson" -- who we have today -- "I was referred to the disclaimer that explained the performance on the Fool.com home page is 'not actual performance.' After some frustration with this" -- in his characterization "out-of-character move for the Fool" -- that's the way Nick puts it -- "I saw the 'since inception' posted performance of 227.85%. That's on the disclaimer page table. Now, if you read the disclaimer, it absolves the 'pre-inception' figures, but implies that the 'since inception' are real." Well, I hope that's not the case, but, Tim, you'll explain this in a sec.
He closes, "Tim explained to me that the results are based on the index." I won't read that, because you can speak to it here. He does close by saying, "For the record, I love the Fool. I am long TMFC and 40-plus other Stock Advisor and Rule Breakers recommendations. If this creative performance trick is a standard industry practice, please forgive my ignorance. I personally think the 'since inception' result should be true or relabeled. Regards, Nick Greco."
Hanson: It's a fair question, and a good question. And it's actually something my team and I have been learning a lot about -- the differences between indexes and index-linked products of which an ETF is a wrapper for an index-linked product. Index and ETFs are different. ETFs can be based on indexes, but they don't necessarily have to be. They're actively managed ETFs, ETFs that track other things.
An index, on the other hand, is a publishing product. It's simply a list of stocks, and anyone can license that list of stocks for use in an index-linked product like a mutual fund or an ETF. And so, what we were able to do with regard to the index is, as I said, we started publishing it formally in November of 2017, so that is public performance of the index in real time.
Hanson: But we were also able to backtest that performance using a consistent methodology with a third-party independent calculation agent. And so, what you're looking at on Fool.com isn't the performance of an ETF or index-linked product. It's the performance of the index, and what we're disclaiming, there, is that the performance we're showing is backtested performance.
If you were to go look up the performance of an ETF -- any ETF -- it would certainly report the performance from the day the ETF began trading; whereas, if you look up an index performance, it is kind of an industry-standard practice to backtest and to see how they would have performed in other markets, period, as long as you disclaim that and tell people that this is backtested performance. It's a thing.
Gardner: Right. So what we're trying to do is we're trying to show you, had this been around for five or 10 years, here's what it would have done, and now that's it's a real thing, as of last November, what it's doing counts every single day. I know you're following it, and any fund -- there is one link to it, and TMFC is the ticker symbol -- that corresponds to that index, we'll give that performance as well.
So, it's a question of what is real and what is imagined, and in this case imagined is something that is kind of a standard practice and something that people would want to know, probably, but we obviously don't want to make people think that this was up for real, because it didn't exist back then.
Hanson: No. There were no index-linked products at the Fool 100 before our sister company launched one, but if another company -- in Japan, let's say, hypothetically -- were to launch a Fool 100 ETF, they would track their performance from the day they launched, and it would be independently tracked from the Motley Fool 100, our sister company one...
Hanson: ... and it would be independent from the index performance, which began being published in November of 2017 and was backtested to 2006.
Gardner: Awesome. So, thank you, Tim, for clarifying that. Thank you, Nick, for writing in. I think it's a very fair question. We're certainly not trying to mislead anybody. I mean, at the heart of The Motley Fool is our belief in transparency and scoring, and so the aim, there, is to show you how that index has done had it been something over the last three, five, or 10 years. But going forward, of course, it's all in the game as of Nov. 9, the thing that you built, Tim, so thank you.
One other, before I let you go. This one comes from @Pfoolhart, Ken Hart, who writes in, "Is a Rule Breaker Investing ETF in the cards at all? Seems like a basket of the top, say, 20 or 50 or even 100 RBI picks might be a real winner and take the edge off the inherent risk of these riskier stocks."
Now, I know you're not working for the Motley Fool sister funds company, but is that something that you're thinking about tracking or have done? What's your take on that, Tim?
Hanson: That's a great question. From the index side... it's funny. At the recent Motley Fool ONE event in San Francisco, somebody came up and asked is there, in the works, a Motley Fool biotechnology index, because I love your biotechnology picks, but if I only buy a few, some of them are big winners. Some of them are big losers. I'd love to get them all in an easy format.
And the answer to that is we are working on creating lots of additional indices. We think there's lots of fun things you can do with The Motley Fool universe of stock ideas with regards to slicing and dicing it for people who might want our technology exposure or our consumer exposure about technology I mentioned. It's just a matter of doing the R&D work to make sure that what we're putting out there, into the world -- and backtesting is a part of that -- is something that we would be proud to put out in the world.
You don't backtest to manipulate it to make it look good in history, but you want to make sure that the methodology that you're putting forward in the future is one that would have stood the test of time and one that you can be proud of putting out as an index and then also something that is possible to be used as an index-linked product would have to meet certain liquidity thresholds and things of that nature to make it tangible, like that. But it's a great idea and one we're certainly excited to look into.
Gardner: Well, I know you and the team are having a lot of fun tinkering with things. As you depart, but before you quite walk out of the studio, Tim, could you just tell briefly the story of EPIQ-AI?
Hanson: Sure. We have a lot of fun tinkering with data and looking at different trends in the universe and implementations of it, and your brother, Tom, came to us after watching the movie AlphaGo, which is about the artificial intelligence program that Google built to play the game of Go and eventually beat the nine times world champion Go player. And at the culmination of that movie he says, "Even though I can't beat the AI program anymore, playing against it is maybe so much better that I'm now better than any human Go player in history."
Tom came to us and said, after seeing the movie, "Hey, could you build a robot that I could compete against to help make me a better investor?" So we put together a little learning program called EPIQ-AI. It's very rudimentary, but it's fun and it's something for Tom to compete against in the Everlasting Portfolio. It's basically a program that picks our favorite highest-conviction stock ideas from the Fool IQ database that I mentioned. Then it allocated a portfolio based on what we call "fundamental size," which is a metric that adds together revenue with a couple of other things to give you the economic footprint of a business. So it's a little bit different from market cap, but a little bit more stable. And then in ongoing rounds, where Tom buys things for the EP, EPIQ-AI will also buy something, or five things, and it will pick the favorite ideas from the database that also have good relative strength, which is a momentum metric that we found adds value to the database over time.
A little update. It's been running for 14 days and it's beating your brother by about 200 basis points already.
Gardner: All right. That's very exciting and a lot of fun. Tim, thanks!
Hanson: Thank you, David!
Gardner: All right. Our next Rule Breaker mailbag item. By the way, if you miss me numbering these... If numbering the Rule Breaker mailbag items was an important thing for you, write me and let me know for next month. Or, if it was distracting -- admittedly for me, it's a little less work not to number them -- and you're OK with that, then let me know that, too. Because I am nothing if not driven by the vox populi.
Speaking of the vox populi, here's a really nice note from Rich Smith. I'm just going to share this, and then welcome my next guest to talk Fool Funds. But first, let's call this Feel Good Item No. 1. We've got a few this podcast. So thank you for this note, Rich Smith.
"David, I want to start off by thanking your dad by giving both you and your brother, Tom, the upbringing which ultimately led to the creation of The Motley Fool." Well, a quick insert. Our dad, who's still living very much, but isn't so much a podcast listener, probably won't ever hear that, but I really appreciate you saying that. As a dad myself, I'd love for somebody one day to say that about me from what my kids have done, but thank you, Rich. That's really gracious of you.
You go on. "I've benefited greatly from all the podcasts to which I've been listening ever since November of 2015, for that was when I paid a visit to the Fool, during a business trip of mine, upon which Amy Dykstra," one of our wonderful employees here, "greeted me and was kind enough to encourage me to start listening to the podcast. I mention all this to share with you that the other day I was reviewing my brokerage statement, and I noticed that the first share of Amazon (NASDAQ:AMZN) I bought had appreciated in value by 114%." That's, I guess, since presumably around November of 2015.
"While I had purchased a couple of more shares since then, this first share was the one that achieved two-bagger status. Yes, I'm still far off from spiffy-popping my way around, but I was extremely excited for my first two-bagger and wanted to share the excitement with you and the Fool family. Thank you for the education, amusement, and enrichment. I look forward to spreading the investment lessons to my family, friends, and co-workers. Really, to anyone who will listen. Many thanks for all you all do at the Fool. Keep up the great work. Fool on! Rich Smith." Thank you, Rich!
Well, he always brings a disclaimer with him, and I'm assuming Bryan Hinmon of Fool Funds fame will be doing so, today. Last time we had some polka music played to the longest disclaimer ever read on air. Bryan, I know it's not going to be as long this time, but I wanted to have you back because (a) you did a great job last time and (b) I've got two questions for you from Rule Breaker Investing listeners.
Bryan Hinmon: It's a pleasure, and I can't wait.
Gardner: Thank you. Would you like to say something first?
Hinmon: Thanks so much. "My appearance today reflects my personal beliefs, not those of my employer, Motley Fool Asset Management. Motley Fool Asset Management is a separate sister company of The Motley Fool, LLC. Motley Fool Asset Management launched the Fool 100 exchange traded fund and its inception date is Jan. 30, 2018. In addition to normal risks associated with investing in equity securities, investments in the fund are subject to those risks specific to ETFs. Unlike other funds managed by MFAM, the fund is not actively managed, and we do not attempt to take defensive positions in any market conditions, including adverse markets. Likewise, we would not sell shares due to current or projected underperformance of a security, industry, or sector unless that security is removed from the index or the selling of the shares of that security is otherwise required upon a reconstitution of the index. As with all index funds, the performance of the fund and its index may differ from each other for a variety of reasons, including the operating expenses of the portfolio -- transaction costs not incurred by the index. In addition, the fund may not be fully invested in the securities of the index at all times or may hold securities not included in the index. Finally, fund shares may trade at a material discount to NAV, and the risk is heightened in times of market volatility or periods of steep market declines. For more information on the Fool 100 ETF, please visit Fool100ETF.com."
Gardner: Thank you, Bryan! Well done. Love it. You've got your laptop in hand. You kind of bring it up to your nose, almost, and just jam through those words as quickly; but, they're meaningful. They're important. We need to do that, so you did that very well once again. Thank you, sir!
So, two questions for you. The first one comes from my friend Ahmed Awami. Ahmed writes, "Also loved the release of Fool's ETF," which we've also talked about a little bit this podcast, "but I was disappointed by its expense ratio. 50 basis points is kind of high in its category of U.S. large-cap blend." Now, just to make sure we're defining our terms -- because not everybody knows what an expense ratio is -- Bryan, what is an expense ratio?
Hinmon: An expense ratio is the cost of managing the investment product, and so it includes a management fee and it includes, maybe any distribution costs or costs that we pay to third parties to help manage the assets in the fund.
Gardner: Great. And ultimately, it's how we get paid, right? So, if Ahmed buys some of the fund, then we get -- he said 50 basis points. I'm not even sure if that is the exact number. You can say in a sec.
Hinmon: Yes, that is the number -- 50 basis points.
Gardner: OK, good. So that means 0.5% each year you're paying us and, of course, we're not getting all of that, unfortunately. We'd be a better, stronger company if we were, Bryan, but yes, we are paying others to make that possible.
Some people are used to ETFs that are 20 basis points. Maybe even 17 basis points or something like that. There are probably very few ETFs that would ever be 100 basis points. I'm not really sure of the world at large. Bryan, explain a little bit about the 50 basis points and how you think about that.
Hinmon: I'll give you a little bit of context. Ahmed is absolutely right that fees, in general, have been declining in our industry over time. That is a good thing and something that we're fully supportive of. For a little context, the average actively managed equity ETF actually has an expense ratio of 0.87%, and the average index equity ETF has an expense ratio of 0.52%. So we like where we are in terms of delivering value. What you hear about most of the time are the Vanguards and the Fidelities of the world who charge 9 basis points for pure index-like returns.
It's a great opportunity to remind everyone that the Motley Fool 100 ETF is not exactly that. We were excited to launch this because we feel that it harnesses the great investing talent at our sister company, The Motley Fool, and a publishing business, and the securities that underlie the index there are actively chosen by our great team of analysts at The Motley Fool.
Gardner: Before we go to the next one, so there is a distinction here between actively managed ETFs and then passively managed, and the passively managed, kind of robo-ETFs, buy the whole market. Vanguard's made themselves famous for having very low, cut-rate fees. Those are often cheaper, but you're pointing out that with The Fool 100 ETF, this is an actively managed fund. The stocks change, even from one month to the next. It's not just the same hundreds nailing it in every year.
Hinmon: That's correct. The index is reconstituted quarterly, and it's important to remember that the underlying securities in the index are active recommendations by Motley Fool newsletter services or high-conviction ideas of the analysts back there.
Gardner: Awesome! Thank you, Bryan. Thanks for that explanation, and thank you, Ahmed, for writing in.
The second one comes from Cliff Kaeda, and he asks a question -- well, one of the reasons I have my guest stars on the show is often I don't know a lot of things, as I hope any Rule Breaker Investing podcast dyed-in-the-wool listener already knows. Dave doesn't know a lot about the world at large, so he makes friends with people who know and then he has them on the show to explain, so I really like Cliff's question here.
He wrote in so many words, "Hi. Sorry, way behind in my podcast listening due to recent travels. Bryan Hinmon" -- who, by the way, is with me right now -- "talked about the small-mid cap growth funds," the last time you were on the podcast, Bryan. He said, "I have one question about this fund based on the name." Cliff writes, "If a holding becomes a large cap" -- i.e., let's just say it started as a small cap, did really well, and becomes a large cap -- "do they sell it? This might be in the prospectus." Cliff confesses he's too lazy to read it.
He adds a related question, this one similar but interesting. "I suppose you could ask the same about Emerging Markets Fund. What if China is no longer considered, at some point, emerging?" Let's say in the next five years. "Would a fund sell all its Chinese stocks?" What's your take?"
Hinmon: This is a great question by Cliff, and these are problems that we want to deal with. If a small cap grows up to be a large cap, we're happy to deal with that.
Hinmon: In the industry writ large, we have to write a prospectus which lays out the strategy and rules by which we will hold ourselves as we manage the portfolio. Specific to the Motley Fool Small-Mid Cap Growth Fund, we have wording in our prospectus that you can read at FoolFunds.com that says at least 80% of the fund's assets have to be invested in small- and mid-cap U.S. companies. So we have a 20% carveout, not so that we can invest in large cap companies, but so that we're not forced sellers, because we are absolutely buy-to-hold, long-term investors.
Gardner: You bet. And that's a great answer. Bryan Hinmon, I think we'll leave it right there.
Two fine answers to two excellent questions, and keep those questions coming. Now, I think a lot of people tune into Rule Breaker Investing, perhaps ironically, because they're not really that into funds. They love talking about stocks, directly, or strategies. That's what I'll be doing the rest of this podcast, but I have noticed with the launch of some of our funds that we're hearing more interest out there, in Podcastville, so we're more than happy to speak to it and having Tim Hanson and Bryan Hinmon on this show is really a special asset that I have, that I can bring these kinds of Fools on and help answer your questions. So great questions, great answers. Thank you, Bryan!
Hinmon: Always happy to be here, David.
Gardner: Bryan, is there an exit disclaimer that you either need to or would like to read? Anything you'd like to say as you leave?
Hinmon: I think the most appropriate thing would be just to have Rick play me off with some polka music.
Gardner: All right. Feel Good Item No. 2 on this month's mailbag and this one comes from Lee Patterson. "Dear David, I was listening to the latest Rule Breaker Investing podcast today" -- that's Feb. 1, Lee writes -- "and thought to myself that Rule Breakers, Rule Makers was one of my earliest Amazon purchases. I scrolled through my purchase history and found that, indeed, it was my very first purchase along with The Motley Fool Investment Workbook. These were ordered on Feb. 1, 1999, exactly 19 years ago to the day. Back then they estimated delivery at seven to 10 days and I had to pay for shipping." We do remember those days, don't we?
Lee goes on. "I considered how much I would have if instead of spending the $32 on Motley Fool books, I had purchased Amazon stock. I calculated that it would be about $780. That's a nice return on $32, but it's far exceeded by the value gained from the Rule Breakers that I've purchased over the last 19 years."
Thanks for sharing your knowledge, Lee Patterson. And Lee, you even included a gif. By the way, I'm the pro-gif camp. I don't say "jif." I don't think j-i-f is right. I'm just putting it out there, but you included a gift of the purchase order. So, lovely. Order No. 0028988303. Wow -- 51 -- it keeps going. I'm not going to read the whole number, but Amazon was even selling a lot of stuff back in 1999 with an order number that large, but hilarious. Thank you, Lee, for sharing.
All right, guest star No. 3. Brian Richards, it's a delight to have you on the show!
Brian Richards: Happy to be here, David!
Gardner: So, you're going to answer a question from Ben Stubbins writing in from the U.K. But Brian, first, usually we do sound checks here. Like when Tim and Bryan already came in earlier, we asked them to do or say something. What are you going to have for dinner tonight?
Richards: Umm, fish. Fish, because my mom and dad are coming up to make dinner for my family...
Gardner: That's great.
Richards: ... because my wife's 40th birthday is this weekend.
Gardner: That is tremendous!
Richards: And they're out of town, so they said we're going to come up tonight and bring fish, and cake, and ice cream. We won't eat those at the same time. They'll be staggered, but I'm excited about this.
Gardner: Outstanding sound check. Here's Ben Stubbins' question. "Hi, David. Most professional investing advisors recommend we spread our capital across different asset classes. Now, across the Fool, I only really ever come across recommendations for equities, and occasionally properties, usually via REITs" -- real estate investment trusts. "I assume commodities and bonds are out of the scope of your services, but do you have these as allocations in your own portfolios, and if not, what's your reasoning for not including these?"
Now, that's not really what I've asked Brian Richards from Fool International to speak to. It's a more interesting question coming up. But I'll just mention, briefly that yes, Ben, I agree. We're very equity-focused here at The Motley Fool. Now, we know that our members come from all walks of life and all places around the world, and our assumption is that if you're focused enough to be doing some self-direction -- that is, you're rolling up your sleeves as a fellow individual investor and making some of these decisions yourself -- that you can understand that we're giving you the equity advice.
Maybe you have your own real estate properties that we can't speak to. There are lots of asset classes, probably only more growing with cryptocurrencies and these sorts of things. We try to speak to them some, but we are admittedly, primarily focused on equities, and that's to your next question.
You say, "I live in the U.K. and I'm member of Motley Fool Share Advisor and Motley Fool Hidden Winners. I've been gradually buying more and more U.S. companies, though, mainly prompted by the great podcasts across the Fool. U.S. companies now account for about a third of my portfolio." Again, he's writing in from the United Kingdom.
"So, I've joined Stock Advisor, as well. Lots of membership fees, but they've been worth every penny so far. My U.S. shares include MercadoLibre, Match, NVIDIA, Amazon, Alphabet, Disney." Love all these companies. "Tesla, Mastercard, Visa, Square, and PayPal, mainly because there aren't really any U.K. equivalents of these companies, and they are truly global. One thing I'm noticing," Ben says, "is that my U.S. shares seem to be significantly outperforming my U.K. shares, and if I look back at long-term charts of the Dow," versus the index they use, which is the FTSE 100, "the Dow leaves the FTSE for dust," writes Ben. By the way, in a British accent that I'm not bothering to affect this particular time. He does say, "Since 1988, the Dow has returned 1,135%" -- again, that's since 1988, so it's 30 years of returns -- "against the FTSE's 317%, according to Google Finance."
Brian, what's your take on that? Let's assume, unless you have other numbers to bring, that those numbers are generally true. That's my assumption. What do you think about that, what's going on there, and how do we roll with that with our Motley Fool U.K. services?
Richards: It's a great question. I guess the first thing I would say is I don't disbelieve those numbers; however, Ben did indicate that dividends were not reinvested in those returns, and the U.K. tends to be more of a high-yield multinational-focused market...
Gardner: Ah, good point.
Richards: ... so I would say dividends being reinvested actually does matter. The second thing I would say is his time frame is since 1988, and if you think about the composition of the U.S. stock market since 1988, it almost, not quite, but almost overlaps with the rise of the internet and the top five companies in the U.S. today, by market cap, are -- I might get these wrong -- Apple, Amazon, Google or Alphabet, Microsoft, and Facebook, which are companies that either didn't exist or were, in the case of Microsoft, in their infancy in 1988. I think it had just come public or was soon going public.
And so, the returns of the U.S. market have really captured the public companies that have dominated the first wave of the internet revolution -- it's a little unfair to compare the U.S. market against that, whereas the U.K. market is focused more on commodity players and big multinationals. Ben mentioned Unilever, Shell, HSBC, British American Tobacco, etc. ARM Holdings is a notable exception, and it's talked a lot about in the U.K. It was actually a recommendation in our U.K. services for a while, before it was taken over.
Gardner: And if you don't mind, it was a recommendation of mine in Motley Fool Stock Advisor, where I recommended it probably somewhere around 2003-2004, waited on it for four or five years, sold at below cost, sort of gave up, and then it went up about 10 times in value.
Richards: Yes, exactly.
Gardner: It still hurts. In fact, I don't know if you knew that or not...
Richards: I did not know that.
Gardner: ... but by you bringing that company to this podcast angers the host. Why would you do that?
Richards: So, ARM Holdings is the exception in the U.K. market. Ben mentioned that he has about a third of his portfolio in American stocks. Actually, if he's looking at the total world stock market capitalization, it's actually underweight. The U.S. market, as of Dec. 31, 2017, represents 51% of total world stock market capitalization...
Richards: The U.K. is 6.1%. I think as a company that preaches being diversified, to our U.K. audience we recommend U.S. shares for that reason. You get things in the U.S. markets that you really can't get in the U.K. with just the breadth. There's so many public companies doing really interesting things.
We met with somebody a couple of weeks ago from the U.K., and they were saying just the advantage of the U.S. is that you've got a gigantic single market, whereas in the U.K., let's say you're a fried-chicken company. You hit it big with a store in London and you say, "OK, we're going to launch a second store in London, and a third, and a fourth." And then you're going to go to Newcastle, and you're going to go to Manchester.
Well, you're going to quickly run up against the U.K. population limitation, whereas the U.S. is 320 million people. It's very diverse. You've got many large cities, and it's a single economic, linguistic, currency, political union, and that's such an advantage that the U.S. has relative to just about any other place. Even though we think about Europe as a union, China and Japan would be the only real competitors there.
I will say one of my favorite bits of investment research is called the Credit Suisse Global Investment Returns Yearbook. The 2018 version just came out, and I actually tweeted this a little bit last week when it came out.
Gardner: I saw that, Brian. I didn't click on your tweet. I read the tweet, but is that a free resource that anybody can read?
Richards: It's a totally free resource. It's a downloadable PDF, and it looks at stock market returns across 26 or 28 developed markets around the world, and it compares the returns of stocks against bonds and against cash. And in all of the markets, stocks beat bonds, and bonds beat cash over the long term.
One of the charts I tweeted last week was about the U.K. market, in particular, and these returns are not also including inflation, but since 1955 -- so 1955 to 2017, which is much longer than Ben's time horizon -- U.K. large caps have returned 12% a year, mid caps 14%, small caps 15%, and micro caps 18%. So the U.K. market has actually been a good place for long-term-focused investors, even though it doesn't quite compare to the U.S. market since 1988 or over longer stretches.
Gardner: Awesome. Brian, thank you for joining with me. You're helping head up, with Randy Coon, Fool International. You're reaching lots more Fools worldwide than we certainly were at the start of our company which was not 1988, but 1993. But we had a fun launch last week. Could you just speak to that before you go?
Richards: We've been in the U.K. since the late 1990s. David, you probably know this better than I do.
Gardner: I did go out and help open it up...
Richards: All right, yeah...
Gardner: ... and loved the team.
Richards: And we are also in Australia, Canada, Germany, Singapore, and last week we were celebrating the launch of Motley Fool Hong Kong, which is something that we're very excited about. It is a focus of mine at the moment. We're hoping to bring the same sort of Foolish long-term, business-focused investing strategies to the Hong Kong population.
One of our first bits of published research, which I'm very excited about, is coming soon, from employee No. 1 of Motley Fool Hong Kong, and it's a look at the long-term returns of stocks versus property. Everybody knows the Hong Kong property market is one of the world's...
Richards: ... most expensive. It might even be the most expensive. And everybody's trying to buy property. The property story is quite popular. And we have a piece coming soon that shows that the long-run returns of the S&P 500 equivalent of Hong Kong, the Hang Seng Index, actually outperformed the property market in Hong Kong.
Gardner: Wow! Which the conventional wisdom would suggest not even possible, because we're talking about Hong Kong real estate.
Gardner: Well, that's pretty cool. Thank you, Brian! I really appreciate you joining, and before you go, could you just mention again the full title. I'm sure you've interested some people with the Credit Suisse report, so I don't have to hit rewind on my podcast when I'm driving, let's say. What do I google to find that?
Richards: If you google "Credit Suisse Global Investment Returns Yearbook," there will be a link to a downloadable PDF version. It's a really good resource of long-term returns across asset classes and across specific countries.
Gardner: Thank you. I guess I'd like to just close up. Ben did write one final paragraph in his email, and yeah, why not. It's time to trot out my British accent. Let's do this. Here's how Ben closed it out.
"I listen to every single RBI podcast. I have to admit I was skeptical, at first, as I used to be a 'value' investor and could never understand the justification for investing in overvalued companies, but within a handful of podcasts you convinced me to look at companies in a different light, and I've never looked back. It took a large amount of courage to buy Amazon two years ago at a P/E in the hundreds, but since then, I've pretty much stopped looking at such metrics for these types of companies. At no stage in its history has Amazon looked cheap, even at $3. Thank you for helping me understand how to truly value a company. I've just hit my first double with Amazon and hope there's plenty more to come with my other investments. Keep up the great work. Ben in the U.K." Thank you, Ben!
All right, we're getting near the end of our hour, but boy, am I psyched to be joined by my good friend and longtime business partner Jeff Fischer, one of the best-known Fools. Head of Motley Fool Pro and Options. Jeff is shortly going to be speaking to market drops, which is a topic of concern and probably more so in 2018 than it was three years ago, when I first started the podcast.
So the question I'm going to share with you, Jeff, comes right after this story I'm about to share, but I'd love for you to hear this and just maybe react to it. You're hearing it for the first time.
Jeff Fischer: Great. Thank you, David!
Gardner: Now this comes from Kishore, and Kishore has written a number of times. I haven't had an opportunity yet to share on the podcast, but this is an interesting perspective, and it's kind of about mindset, Jeff. I really appreciate the honesty here, and what he shares about his investment journey. My guess is that English is not Kishore's first language, and it's written with sequential numbers in a way I can't quite reproduce, so I'm just going to do my best to read some of it and get the gist of it, and then let's think about it briefly together.
"Hi, David. I am a Fool from more than 10 or 12 years and want to be a Fool for the rest of my life, though not so sure greed and fear will again overtake my actions and my discipline may be broken. The last week has, again, reiterated the facts that The Motley Fool has been advocating. The below story may resonate with many common stock investors."
Kishore starts, "I started the Stock Advisor service. Began investing in stocks, though I was doubtful at some of the recommendations. Marvel? Why the heck does he like comic book stock? Or Apple iPods." This is, of course, back in the day. "Or Electronic Arts. Note I was also following some other newsletters, which were recommending solid companies like Boeing or Raytheon, and I was like, 'David really is a' -- small-"F" -- fool.'
"Gradually, I started understanding the thinking behind the recommendations, though, and I was like, 'OK, yeah, they're not fools,' and I became an exclusive Fool recommendation follower. But then, I couldn't understand why the Gardner brothers don't sell. I'm smarter than them. I started selling stock when it went up. Netflix up 25%. Locked. So happy I exited before the Qwikster disaster happened and the stock crashed. And then, Amazon, yeah. Yeah, man, I made 35% and the stock drops. Ha ha ha! I was so happy.
"But then I started keeping track. The Motley scorecard was a great help. I realized if I just hold them with discipline and reduce my fear and greed, the returns would be the same or better. When Netflix crashed, why didn't I buy more?" Etc. "Then the Supernova service came in." I'm skipping ahead. Kishore is putting away $1,000 every week into these kinds of stocks. "Years later, this disciplined approach just made my portfolio into something I never imagined. Thank you so much.
"However, then greed starts coming in. Rally starts. News channels only talking about the Dow. Dow up 200 points again. Dow up 1,000 points in a week. News channels making a fanfare out of it. Analysis. Interviews. All-around positivity toward equities. My portfolio adds, like, 10% in a single month. 'Wow,' I think. So, what if I added a booster to it? What if I leveraged?
"CFDs. Futures. My banker assigns me a trader and overnight I divert 5% of my portfolio." So, Kishore takes one-twentieth of the portfolio and gives it off to the trader. "First week, the returns are like 3% in a day. Again, 2% the next week. Hey, not a bad thing. I'm not saying no to Fools, but just making their approach better. What follows is addiction. Charts, technical, Fibonacci. Man, I started speaking like traders. Staying awake late nights. Checking the charts on the go. I fund the account more. Now 10% of my portfolio. Maybe this isn't bad," Kishore says. "Then comes this week." And I assume we mean the recent volatility, Jeff, is the reference I think we're talking about here.
Kishore says, "I'm leaving for my vacation. I have one open position. Just put in, take profit, and should be done. Five hours before the flight, the trader calls in. 'Hey, buddy, the market's down, but don't worry. It will be back up tomorrow. We can make more money. Let's buy more.'
"Oh, yes, I say, without realizing the risk. I'm leveraged. Three hours before the flight, trader says, 'Hey, this is not going the way you want.'" Notice the change of "we" into "you."
Fischer: Not good.
Gardner: Which was all caps in this note. "I get panicky. I check the account on the phone -- 50% down. What? The Dow was down only 2%. First day of vacation ruined. Second day, worried. Third day, tense. Fear, fear, fear. Holiday ruined. Mentally became a manic, checking phone all time. Charts. Hedging to cut the agony. Short five days. Just wiped the account."
Fischer: All 5%.
Gardner: Although I think Kishore had ratcheted it up to 10%, but I realize there's a flurry of facts here. So that's the story. It closes with, "I am a" -- small-"F" -- "fool. No matter how you see it, still can't get over it," and that's how it ends.
Now, it feels like kind of a sad ending. A lesson learned. The good news, I think, is that it was with a real minority of Kishore's portfolio. Jeff, before I go to the actual question I have for you, what are your thoughts about that?
Fischer: So many great thoughts, David. I love the honesty. I love the self-awareness. And we have to recognize that we all have learning experiences that make us better in life and as investors. Almost everyone, initially, that I have known has thought that they could do better by trading in and out. That once a stock goes up a little bit they should sell it and take their gain. And it's only through the perspective of time that we realize if you hold something, like an Amazon, and it does well over many years, you're going to be rewarded by such an enormous degree greater than you would have by taking that 20% gain.
But don't beat yourself up about it for having taken it in the past, because you didn't have that experience to begin with. It's only through time that we can now say, "Look at Stock Advisor. It's 15 or 16 years and look at these returns." We can point members to them and say this is how it works. Without having that to show them, we can tell them but that's two different things.
Gardner: A really good point.
Fischer: That's one thought. The second thought is that the trading bug -- I think everybody has been afflicted by that at one point or another, and in my experience it's usually when you're quite young, or it's right when you start investing, whatever age that is. You think, "I can use some leverage. I'm smarter than everybody else." But if it worked consistently, you would hear of people who are successful investors because of leverage. Well, you don't hear about those people, ever. You hear about the Warren Buffetts, the relatively few, who have bought and held on for decades.
So, you have to keep in mind there's nobody else out there doing this that you have heard of and that has succeeded, and there's a reason for that. I'm glad they only risked 5% and then 10%...
Gardner: While Kishore says, While I am a small-"F" fool, it was actually pretty wise to -- if you're going to speculate, just make sure it's with a real small slice of your nest egg.
Fischer: Right. And that's still a lot. If you still have the bug to speculate -- I don't think you will, anymore, but just 1%-2% should be enough, because you're using leverage, after all.
A final quick thought just on greed and fear, in general. The ideal for a stock investor is to eliminate those two emotions by only owning companies that you truly want to own. They're almost a part of you. You cannot imagine selling them anytime soon, and by that, I mean for years, so that even when the stock falls, when the market falls, selling doesn't even enter your mindset. It takes a while to get to a portfolio that is made up that way, but you can get there, and it's through learning experience.
Now, every year you may find some losers that you want to sell at year end for taxes, or you just may buy something and realize you're not quite comfortable with it. What I do is I start each new position generally small, add to it as it succeeds, so that it grows, and I add to my favorite winners; and what ends up dominating the portfolio are things that I really have no inclination to sell anytime soon.
Gardner: Really good organic thinking. It's built out of your own experience, and it accords with mine too, Jeff. I pretty much do the same thing. So, to close Kishore, thank you very much. It was my pleasure to read your story. We appreciate your honesty. I think that you're in a good place, and Jeff's point about feeling good about the companies or investments that you own, and gaining greater knowledge in them, and then just getting greater wisdom along of that. Forget about the actual names of the stocks or companies. What's your approach to investing? How do you react when the market goes up or down? Those are really important aspects of becoming a better investor. So, thank you for sharing.
Jeff, I've got something to share with you. This is actually a quick tweet, but it's a conversation I wanted to have...
Gardner: ... in brief with you. This one comes from @TeddyBeingTeddy who sometimes writes into this podcast. "@RBIPodcast. If, hypothetically, you thought there was going to be a big drop in the stock market this year, what specifically would you invest in to hedge that risk? Vanguard bond funds, real estate, cash, utilities, war stocks, other? Help us preppers prep for a cold winter!" I think that all fits in one tweet.
I have a quick initial response I'm going to give, but I really wanted to have Jeff in, because he thinks about these things. My quick, initial response is I don't spend a lot of time thinking about that myself. That's why in some ways, I can be very helpful to some listeners of this podcast, because they're also in it for the long haul. I know you are, too, Jeff. So, I expect market drops. I don't worry about them. I'm not changing up my allocation in reaction to that.
However, there are also a lot of people listening to this podcast, and other Motley Fool podcasts, for whom a big drop could hurt if they're retiring this year, or they're near the end of their life and they're living off of the capital that they're invested in. I don't necessarily want you just to speak to that mentality, Jeff, but how do you think about that? Because you're somebody who is our expert here at The Motley Fool thinking about hedging in some cases. Or doing well even in flat markets. What's your take on Teddy's question?
Fischer: A great question, and so many of us have that question. Like you, David, I don't try to guess where the market will go, but the ideal is to have a portfolio that you are comfortable with if the market does fall. In essence, you're always prepared for the market to fall.
And for everybody that's different. For some people near retirement, that means that they maybe do have a 60%-40% portfolio. 60% stock, 40% fixed income. But for those who have 100% stock and are worried about the market, they may learn to slowly increase their cash balance and carry one, typically, which I typically do as well. It ranges anywhere from 10%-25% cash at any given time. And I can get a lot of flak for that, because that money isn't invested and isn't earning returns, and will even lose to inflation.
Gardner: Did you mean you get a lot flak for that, or did you mean Slack, one of our advertisers and the regular app that we all use? You could get some Slack for that too, Jeff.
Fischer: I do mean flak, and it's also Slack in the portfolio. But that cash makes me feel comfortable with what I own, and when opportunities come along either in individual companies that I'm following, or the market as a whole declines, you have some cash to put to work.
So, in regard to the question. Do I buy real estate? Do I buy war stocks? Do I buy bonds? I would say no to all of those. Defense stocks -- you don't know if they'll do well when the market falls. Real estate -- the same thing. Bonds, right now, are not doing well as interest rates go up, so unless you hold them to maturity, you're looking at a loss. Even in your bonds, bonds have gotten clocked lately.
Of that list, I would say cash is the best hedge you can have. It's something you know will be there ready for you when you're ready to invest it. It gives you peace of mind. It will dampen the volatility in your portfolio. And it's available to use in life, as well, if you need it. So, it's a really simple way to hedge to raise some cash, selling things you don't like. Selling losers that you no longer want to own and raise some cash for a proverbial rainy day.
Gardner: Awesome. And that's something that you've done in Motley Fool Pro.
Fischer: Motley Fool Pro we've held, on average -- I should look it up -- but on average 15%-20% cash for many years, and yet we've outperformed the S&P despite that.
Gardner: Which is awesome, and I'm sure confounds a lot of experts which would think that's not even possible.
Fischer: So, if you're buying Foolish-type companies, David, as you know, like a Visa or in your case an Amazon or Netflix, those just crush the market over time, and that allows you to outperform the market even if you carry some cash for defense.
Gardner: Jeff, thank you very much!
Fischer: Thank you!
Gardner: All right. Ex-ante off the stage, my final guest star. Thank you to each of those Foolish voices, and we'll close this month with Feel Good Item No. 3. This one comes from Dr. B. Levy from Beth Israel, Newark. I think that's the medical center in Newark, N.J. Thank you for this lovely note!
"Dear David. First, I wanted to thank you for my first portfolio spiffy-pop. Yes, today's the day I've doubled my portfolio and it took about two-and-a-half years." Now before I go on, I do want to mention I think, here, Dr. Levy, you mean your first two-bagger or you've doubled your portfolio. The spiffy-pop, which you can google -- google "spiffy-pop" and you'll get to our page -- but a spiffy-pop is when you make more money in one day than you initially started out with. That probably will take a little bit more than two and a half years, but boy, will it be worth it.
And keep up the great work. That is a remarkable two-and-a-half-year run, and you and I should be pinching ourselves -- all of us, of course -- because the stock market has been so strong. It's going to be a rare two and a half years over the course of our lives where we could say that, but yes, we have lived through those years, and anybody who knows me as the market timer knows that I think the market is going up this year, for reasons I've explained in the past.
Anyway, you go on to say, "I've been a Stock Advisor follower for over a decade, but an active investor using Stock Advisor and Rule Breakers for only two and a half years. I'm so glad I've had the courage to listen to you and start investing, even when the market was up for a long time. I also wanted to thank you for your calm voice during volatile times, reminding us all to stay calm and think long term. Keep doing this. Much needed.
Second, I wanted to thank you for your podcasts. Not only a great resource for investing, but also day-to-day life, pearls of wisdom that have changed my life. Since starting listening to your podcasts," and here's a short list that just makes me smile. "I'm not wasting my time following the news daily. I'm less engaged in divisive political arguments. I bought some great board games to play with my wife and kids, and I've binged some great audio books, and more."
Dr. Levi goes on. "Now, a few questions for you. I hope you're going to address at least one of them." There are four, and we're really at the end of the time for this podcast. I'll briefly address one of them. They're all good. "Based on the little I know you, you would answer that if I enjoy investing, I should do it myself. If so, all in at once, or slow, gradual spread over the next couple of years trying to take advantage of market volatility?"
That's the heart of the question, and the heart of my answer, Dr. Levi, is that I think that you should be incremental. Don't put pressure on yourself. Don't make it a binary decision -- all in or not all in. I think the more you succeed with any approach that you're taking in life -- investing or other life approaches -- the more you should keep doing it and grow it. So, if you're having success as you have with your Motley Fool services, knowing that the market's been very strong, then sure, I think you could go ahead and allocate more to direct investing. Rolling up your sleeves with the rest of us as individual investors trying to beat the market. That's what we're doing in Fooldom and you know that very well.
So, yes, I think you could do more of that over time and some of us, like me for example. I'll raise my hand. I'm all invested in just stocks. And with Jeff Fischer, I tend to hold onto them, and I don't sell very often, so I'm 100% allocated to Motley Fool services, basically. But for some of us who are listening to this podcast, you haven't bought your first stock yet, and a lot of us are somewhere in between. I think my primary bit of advice, there, is be incremental.
You close by saying, "Thanks again for helping the world and me invest better and enjoy the process. Fool on! Dr. Levy."
Again, thank you. That was a delightful note to close on. And what I particularly appreciate about it is that it's not just about investing. That's never what this podcast has been about. I do love investing, and it is called Rule Breaker Investing, but to me investing is just one part of a life, a life well lived, and because I'm fascinated by other parts, I want to have guests, and I want to have conversations, and invite questions about those things, and we've done some of that.
We're always going to be focused on investing in Rule Breaker Investing and business, because those are such important things in our professional and financial lives, but the word that closed that phrase -- lives, life, thinking about how to live it better and me learning from you and you learning from me, I take particular joy in those shared sentiments. Thank you again, Dr. Levy!
Well, a reminder. Get your homework done. We're going to be talking to Steven Pinker, who wrote the book Enlightenment Now, which Bill Gates has called his "new favorite book of all time." Steven Pinker will be with me on this podcast next week. Read up. Fool on!
As always, people on this program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Learn more about Rule Breaker Investing at RBI.Fool.com.