EP. 136 More Knowledge, More Wealth: AM 590 Radio Show

Transcript:

Announcer:

This is More Knowledge, More Wealth, with your host, Gabriel Shahin. Gabriel is a certified financial planner and a registered investment advisor at Falcon Wealth Planning. This show is not intended to provide personalized investment advice through this broadcast and does not represent that the services or securities discussed, are suitable for any investor. Investors are advised not to rely on any information contained in the broadcast, in the process of making a full informed investment decision. More Knowledge, More Wealth, on AM 590 The Answer. Now here's your host, Gabriel Shahin.

Gabriel Shahin:

Good afternoon. This is Gabriel Shahin, certified financial planner and your host of More Knowledge, More Wealth here on every weekend, talk about all important topics of personal finance. Our goal is to give you the knowledge you need to increase your wealth. Now, to the listener, you can always reach out to myself or any one of our colleagues here at Falcon Wealth Planning. Our phone number's (855) 963-2526. That's (855) 96-FALCON, like the bird, where we can help relate this show to your specific situation.

Now, I'm a principal of Falcon Wealth Planning. We are a fee-only registered and investment advisory firm. We also manage money as well, but we really specialize in comprehensive planning. That can go over where you are today, how retirement looks like, talking about taxes, estate planning, insurance, investment folks, you name it. Anything that involves a dollar sign we can help you with. And we got offices all across California and we help people nationwide. Folks, give us a call yet again, if you want help relating this show to your specific situation. Our phone number is (855) 963-2526. That's That's (855) 96-FALCON, like the bird, or visit our website at FalconWealthPlanning.com. That's falconwp.com for short. We'll be happy to put together a personal assessment for you to really just help with all the questions that you may have.

Now, we have a lot to talk about out today. I typically ask people, what do you want to discuss with our time together? I've gotten a lot of questions about the market and really just trades in general. So today, I want to talk to you about a stock and ETF. The difference of what is a good one versus a not good one, and there are three attributing factors to that. One is liquidity, which I'll go into detail of the cost and then direct index. And the second part to that is talking about the difference of an ETF and a mutual fund. I think that's very important because a lot of people have this misconception of how they work, what's best for you, and the cost, so on and so forth. Because it got tricky with the new law that passed in 2019, that really changed the characteristic of an ETF. In my previous shows from years ago, back in 2015, you will notice that what I used to say is not the actual reality of how it works today. So we'll make sure we discuss that in great detail.

Now, I want to focus more on stocks and ETFs. The really important part of that is really just the bid and ask part, liquidity of the event. Okay? That is extremely important. Looking at how an ETF, the core characteristics of an ETF works, it's important to know that you're going to want liquidity, especially times of volatility. I think that's extremely important that a lot of people do not take into account. And then the cost of the index itself, and then taking a look at what imitates the index the best.

So we see a lot of people that don't go over that don't really care for that, that really don't even know the difference between the two. And let me explain. When you have an investment, there are times you need liquidity. Even when things go sour, you don't want to sell when the markets drops, but reality is, is when the markets drop like COVID and your business is shut down and you have no income to live off, you may need access to your money. And when everybody's selling, it's extremely difficult to get the price of what it says it's trading at in the stock market. There is something for every stock and ETF that's called a bid-ask. And they're never the same. They could be one penny off, they could be $1 off per share or more.

And so a bid is, when you see a bid-ask on a stock, the bid is how much you were to sell it for. That's the lower amount. When you want to sell something, you have to get a bid. The next part is the ask. That's the price that's typically higher of what you buy it for when you want to ask to buy something. And so this spread, depending on the liquidity of the investment, the index could be extremely wide versus maybe a company like Vanguard or BlackRock, or State Street, which has spiders, which are billions of dollars in these indices, which allows for high liquidity. These are important factors to make a decision on. And sometimes when you see people that sell when the markets drop, they are losing more than the index. The market says it's down for that day. And I'll give you an example.

If you were to sell on a day that dropped 10%, like it did I believe in late 2019, where there was days that it dropped ... Or excuse me, in 2020, during the COVID crash. The market said it was down 10%, but at the time, if you would've sold intraday, you could've lost 15, 20 plus percent, even though that's not what it said that it was losing in the stock market itself. Because of the liquidity and the supply and demand, there needs to be a buyer for what you are selling. A lot of people are not aware of this. They do not take this into consideration. So the more liquid your investment is, is represented in the bid-ask. This can be extremely important.

So a lot of people say, “Hey, I have indexes. I have my portfolio set up. I have my stock set up.” But what they don't know is there's a liquidity issue in their portfolio where they can't get their money if they actually needed it. So these are important factors. And when you tie that into an index that should be low cost, there are some indices out there that are charging north of 1%, and this is an index. How hard is it? You and I can choose the top 500 companies in S&P 500. That's easy for us to do. If you think about it, we know the top 500 companies in the S&P 500, and it's waiting.

By the way, folks, if you're just joining us, you're listening to Gabriel Shahin, certified financial planner, your host of More Knowledge, More Wealth here on every weekend, talking about all important topics of personal finance. And today, we are fixating on just your holdings in general. You may have great holdings, you may be happy with the performance of those holdings, but what you don't know is there are liquidity issues with your current holdings. And if volatility were to happen, this could be a serious impact if you try to liquidate your money.

And so the first part is liquidation, the second part is just overall cost. If you're paying an unnecessary 1% over the normal asking price of an index, I mean, heck you have Vanguard, iShares that are charging less than 0.04% of an index. And for you to pay 1% over that, it can be massive on a million dollars. That's $10,000 a year. Over 10 years, that's $100,000, straight math. That's not even compounding missing, depending on market performance. So this could be crucial for you guys to understand the cost.

And the last thing is, if you're going to go into indexing, because there is a lot of supportive data that shows that there is very little evidence that people who actively choose stock can outperform the index, can out beat them. If you look over a 10-year period, 95% of active managers fail to beat the underlying index and equities. And if you stretch it over 30 years, it's 98% fail to beat the overall index. And the ones that beat it probably just chose Amazon, Apple and has outperformed the index. And how sustainable is something like that through large cap growth? Because that did happen in the ‘90s. After the tech crash, dot-com bubble in the early 2000, it took 14 years for NASDAQ to come back to its all time high. So everything goes in waves, and that's why staying diversified is crucial.

So by sticking with an index, we think that is very wise for you to do. That is important. We just don't see a lot of people doing that. We see people chasing the hot stock, we see people chasing the asset class like large cap growth. And when you start looking at the fundamentals of these things, it can be very expensive to do that. These things are trading at some of the highest multiples they ever had. Some of these companies are trading at infinity multiples, but the simple reason is they are not making money. Not every company can be like Tesla that loses billions of billions of billions on an annual basis. They keep losing, losing, losing, and all of a sudden they continue to be ... Or now become profitable and making a bunch of cars. So a lot of that has to do with just the genius and the sales ability of Elon Musk and his proven track record, but not a lot of companies are like that.

Folks, if you need help analyzing your portfolio, you may be thinking, “Hey, I'm fine. I'm in the VT, the Vanguard Total World Index.” But that thing has made nothing in over 10 years. There is no substitute for global diversification and making sure you're properly allocated and taking advantage of that. Because if not, you're just riding the wave, you're doing nothing, and it's sad, and that's the case. And I see intelligent people that are doing the right things, but are just trying to take shortcuts and do it themselves. And they're the end losers in this situation, especially if you're investing in the whole world index or Vanguard Total Stock Market Index, which are great indices, but you have to look over yes, 10, 20, 30 years, there could be periods of 10 plus years that it doesn't do anything. And so this is something you should look at.

If you need help with that, we can help. We are offering one to two hours, one to two meetings of our time at no cost to you, no obligation at all. It's our way to show you, to prove to you that we can add value to your situation. And more importantly, show what you do, whether you do it yourself, or you want to work with us, that's your prerogative. But we would love to be that sounding board. And one of the good guys in this industry. Give us a call, we would love to help. Our phone numbers. (855) 963-2526. That's (855) 96-FALCON, like the bird, where we can help put together assessment to tell you what you're doing, what's good, what's bad, what the liquidity is of your portfolio, and how close to the index it actually tracks. Because some of these things go rogue. You might think you have the S&P 500 fund, but some of them might cut the bottom 50% of it or excuse me, the top 50 or bottom 50, which means you're only invested in the top 450 of the 500.

Those bottom 50 might be some of the fastest rising companies. It's a lot easier to double a company from 30 billion to 60 billion versus a company that's worth 3 trillion to go to 6 trillion dollars, which is more than most countries are worth. So these are important items to take a look at in your situation. But it's also important to understand your core holdings and your portfolio because there is a hot wave that's coming through of ETFs, exchange-traded funds, which are a basket of stock, just like a mutual fund. And there's been billions upon billions of money that's been leaving mutual funds and going to ETFs. I want to explain to you the pro of that. There could be also a con to that as well, depending on how your money is managed, depending on how you do things and how active you are in your portfolio.

There are some pros and cons to that, and there's a lot of misleading ideas and facts of how ETFs work versus when they first came out. But folks, if you need help, if you want help relating this show to your specific situation, making sure you're doing what's right, give us a call. Our phone number is (855) 963-2526. That's (855) 96-FALCON, like the bird, or visit our website at FalconWealthPlanning.com. That's falconwp.com for short. We can help put a personal plan for you at no cost.

Folks, we're going to go on a little break. And when we come back, we're going to talk about the difference of ETF and mutual fund and what makes sense for you and how it should play in your overall situation. We'll be back after a few words.

Welcome back folks. This is Gabriel Shahin, certified financial planner and your host of More Knowledge, More Wealth here on every weekend, talking about all important topics of personal finance. And today, we are just talking about general indices markets, ETFs mutual funds, just making sure you're choosing the right one, because you do hear me preach about indices. You do hear me preach about making sure you have a properly put portfolio put together. And I am a big component and benefit of ETFs, exchange-traded funds, which I think can make a lot of sense in your portfolio. Just because for most of them out there, they do track the index the best and most economical and the easiest to access.

With that being said, there is also a lot of ETFs out there that are active managers, and they have high expenses to that because active managers have to do more work than an index. When you're just buying the 500 stocks in the S&P 500 and just buying and holding them, it's a lot easier to manage than somebody who feels they have a crystal ball and that can go ahead and try to out beat the market. And we've seen multiple research and data that suggests that, that's not possible, that nobody in the history of the world that's ever been able to do two things. Number one, time markets, no one to buy and no one to sell. Or number two, choose individual stock on a consistent basis. We just haven't seen anybody out there in the history of the world, including Warren Buffett, Peter Lynch, and so on that's been able to do that.

So why do I bring this up to you? Because there are different ways to invest. Some people do in fact, choose individual stock. And that's really great that you do that until by the way, it's not great. We see that quite often. We saw that with General Electric, remember them? They were massive. They're almost a mutual fund in itself. Well, how's that going right now? Exactly. You see that great with biotech until there's laws that had changed and then it stays stagnant for five, six years. You see that great with technology. I mean, the ‘90s and even recent years, but then there was 2000 and 2014 that it stayed flat. That was great with RadioShack, Toys“R”Us, Sears, Lehman Brothers, Barrett Stearns, Washington Mutual, WorldCom, Enron until they're not great.

So for that reason, because we're all bad losers and we hate losing money, guys. We don't like to lose money, do we? Of course, we don't. That's why most people out there for their safe money, their future money, their long term money, invest in baskets of stocks, whether in the form of mutual funds or exchange-traded funds.

So I want to talk to you about the difference between the two. Now, in ETF, used to be only passive index investing. Well, that law, that was a law that changed in 2019, where now you can have active managers inside an ETF. So you can no longer say that. And a mutual fund is the same situation. It could be both active or what's called passive management of a mutual fund. So that's very important to note because now with the law changes, they both are the same.

So what is the core difference between the two? It's very simple. They both have a basket of stock. The difference is an ETF changes and trades throughout the day, the price goes like this. It goes up, down, up, down, up, down, up down throughout the day. A mutual fund doesn't trade at all until the end of the day and settle a few hours after the market closes, because they have to calculate the price of every single one of those stocks.

So in ETF, trades as a stock. It looks like a stock, it feels like a stock, it smells like a stock, and it's a basket of companies. And it's more transparent with the ETF because they have to report their holdings on a daily basis versus a mutual fund that only has to do it on a quarterly basis. I've seen this a lot with a lot of very popular fund companies out there that hurry up, will sell their investments, and go ahead and buy Tesla so they can say, “Oh no, we've had Tesla this whole time.” As it's went up 200% this past quarter. Not this quarter, but historically speaking. So it's very also tricky and could be misleading with a mutual fund as well.

In addition to that, inside a mutual fund inherently has higher costs, higher fees, higher expenses inside of those. In addition, the liquidity of an ETF versus a mutual fund. You have to wait till the end of the day to sell it. And sometimes the markets continue to tank at the end of the day. You may have put the sell order at 10:00 AM, but the market doesn't close until a few hours later and you may have put the order in, and we've seen this recently where the market's up, but by the time the market closes, it's down many percentage points based on the news that comes out, like war and whatnot. This could be a very negative issue for those looking for instant liquidity.

By the way, folks, if you're just joining us, you're listening to Gabriel Shahin, certified financial planner and your host of More Knowledge, More Wealth here on every weekend, talking about all topics of personal finance. And today, we're just giving you the rundown on the characteristics of an ETF and a mutual fund. And if you need help with that, to see what makes sense for you, because what I won't talk about today because of time, and maybe I'll try to sneak it in there, is talking about the taxation of mutual funds versus ETFs and how it could be more advantageous from a tax point of view to have an ETF versus a mutual fund. So with that being said, if you need help relate this show to your specific situation, give us a call. Our phone number is (855) 963-2526. That's (855) 96-FALCON, like the bird, where we can help relate this to your specific situation.

Now, taking a peak at other items of an ETF is you do have instant trading ability on your ETF. You can trade on it instantly, but the thing you have to be aware of, what I said earlier in the show was bid and ask pricing. So sometimes you have to put limit orders in. You don't get instant pricing. With the mutual fund, you can sell it and it settles at whatever it is at the end of the day. It's easier and more liquid. Depending on the execution of the mutual fund, of course, which is more institutional level conversation. But the point is ETF, you have to be careful. You can't just push sell because if there's no buyer on the other side, that could sell for much less than what you think it is.

In addition to that, with ETFs, you can also do option trading on there. We're not suggesting that you should, but it's a lot easier and it could make a lot of sense instead of just selling it a limit order, it may make sense doing what's called a covered call. We have a lot of clients that participate in something like this. Typically, it has to be more higher levels of income or I should say, assets to make you eligible for something like this, but it could make sense for you as well. And a mutual fund does not give you that option. You do not have that benefit.

Also, ETFs can be marginable as well. You can borrow on margin on it. We've seen some clients do that to avoid capital gain, so on and so forth. And some mutual funds, depending on the custodian is eligible or are not eligible for that, where most ETFs out there are. You also have to look at the other items of, we'll touch on taxation, which inside a mutual fund, they can buy and sell like crazy. And even if it's an index version that you could still pay taxes on capital gains inside of the mutual fund.

For example, if you have a mid cap mutual fund and it gets promoted to large cap and is sold at a gain, you have to pay the taxes on that. You inherit somebody else's cost basis when that happens. For an ETF, that's not the case, whatever you buy it at, that's your cost basis. And you don't have to worry about what happens inside of there in a passively managed ETF, where the mutual fund, you do. And I'll give you an example of that. This is where I didn't think I'd have enough time, but I'm squeezing it in there.

I had a client in the May of 2008. They became a client in 2009, but in May of 2008, they invested $100,000 in a mutual fund, in a large cap mutual fund. Now what happened in 2008 September, October, the market started crashing. So their 100,000 went to 70,000 by the end of the year, their luck, lost 30% at that time. So now, that's just bad timing, if you will. Well, what happened that following January is they get a 1099 from the IRS saying they made $42,000. They're like, “Excuse me, my $100,000 investment is only worth $70,000. I lost 30,000. You're here trying to say I made $42,000. Are you out of your mind?” And that is a realistic thing that happened at that time.

Now, why in God's name would that be the case? Well, when this individual bought their mutual fund in May of 2008, well, when the markets were crashing in September, October of that same year, people were selling their investments and wanting their money. Well, what the mutual fund manager had to do was sell their Microsoft they bought in the ‘80s at a very low cost. Sell the Walmarts they bought in the ‘90s. They had to the Apple they bought in the 2000s. And that realized a capital gain for the shareholders at the current present. Even though that investor did not hold the money at that time, they had to pay somebody else's taxes. Absolute. crazy So the IRS says, “You made, in this case situation, $42,000, even though you really lost 30,000.” 42,000, they had to pay $11,000 in additional tax of money they never made. They had to pay somebody else's capital gains bill.

Unfortunately, we see this often and this is a negative attribute of a mutual fund. And which is why I don't like mutual funds, especially in a taxable brokerage account, where you get a 1099-DIV on an annual basis. It could make sense in an IRA or Roth IRA, but not in a brokerage account. This is where I see some professionals, not caring, not being strategic, not being tax planners with how they invest your money. And that goes from you doing it yourself or a professional helping you. Most of the time, that professional say, “Please consult with a tax advisor.”

And we are the tax advisors. We can help with that. And taking a look at how your portfolio is constructed is crucial, folks. And we see people mess that up all the time, unfortunately. If you want a second opinion, if you want us to review, if you need help pointing you in the right direction, give us a call. Our phone number is (855) 963-2526. That's (855) 96-FALCON, like the bird, or visit our website at FalconWealthPlanning.com. That's falconwp.com for short. We can help put a personal assessment for you to let you know what you should be doing, where you are today, point you in the right directions, and explain to you the benefits that it will give. We don't see a lot of people doing that, folks, and we highly recommend that you take advantage of it.

Folks, that was a fast, fast show. I want to thank you for tuning in with us this weekend. You can always reach out to myself or any one of our colleagues here at Falcon Wealth Planning. Our phone number is (855) 963-2526. That's (855) 96-FALCON, like the bird. We'll be happy to put together a personal, confidential conversation, put that assessment together to help in your situation. Tune in every weekend and we go over all important topics of personal finance. Our goal is to give you the knowledge you need to increase your wealth. We want to thank you for tuning in. Have a great week and God bless.