Dentists Who Invest Podcast

Fact Or Fiction: Is The S&P500 The Best Index To Invest In? with Anick Sharma [CPD Available]

• Dr. James Martin • Season 3 • Episode 386

Share episode

If you’d like to discuss your finances with a professional, you can connect with Anick here: https://www.viderefinancial.com/contact

———————————————————————
Get your free verifiable CPD for this episode here >>>  https://www.dentistswhoinvest.com/videos/fact-or-fiction-is-the-sp500-the-best-index-to-invest-in-with-anick-sharma

———————————————————————
“Just put your money in the S&P 500” – it’s the internet’s favourite investing advice. But does it actually hold up? In this eye-opening episode, financial planner Anick Sharma joins us to unpack the truth behind this popular mantra.

We break down what the S&P 500 really is – not simply the 500 largest US companies, but only those that meet specific profitability and liquidity rules. This subtle detail has major implications for investors who assume they are getting full exposure to the US economy.

Anick shares compelling global data that shows how market leadership constantly shifts. The top-performing country one year often ends up among the worst the next. With the US making up about 61% of global market capitalisation, focusing solely on it means missing nearly 40% of global investment opportunities.

We also explore factor-based investing – a research-backed approach that focuses on value, profitability, and size. One strategy highlighted in this episode would have turned £10,000 into £151,000 from 1994 to 2023, outperforming traditional global portfolios.

For those preparing for retirement or major financial goals, Anick offers a three-part framework that balances returns, volatility, and emotional comfort – a refreshing alternative to one-size-fits-all investing.

Tune in now to learn why the smartest investors think beyond the S&P 500 and how you can too.

———————————————————————
Disclaimer: All content on this channel is for education purposes only and does not constitute an investment recommendation or individual financial advice. For that, you should speak to a regulated, independent professional. The value of investments and the income from them can go down as well as up, so you may get back less than you invest. The views expressed on this channel may no longer be current. The information provided is not a personal recommendation for any particular investment. Tax treatment depends on individual circumstances and all tax rules may change in the future. If you are unsure about the suitability of an investment, you should speak to a regulated, independent professional. Investment figures quoted refer to simulated past performance and that past performance is not a reliable indicator of future results/performance.

Send us a text

Dr James:

When we talk about investing, a lot of people say we should just put all of our money in the S&P 500. Well, that's not necessarily true, and that's why today we're joined by Mr Anick Sharma of Videre Financial Planning. Anick is a financial planner. We're going to be delving into the pros of the S&P 500, the cons of the S&P 500, when it works, when it doesn't, so that you can make informed investment decisions. And if you don't know what the S&P 500 is, we're going to cover that as well. So it's all good either way.

Dr James:

Looking forward to this one, I'm also happy to share that there is free verifiable CPD associated with this podcast episode. Whenever you finish the episode, all you have to do is click the link in the podcast description. It'll take you right through the Dentists Who Invest website. You'll be able to complete a short questionnaire and, once passed, you fill in your reflections and we'll go ahead and email over to you your verifiable CPD certificate, which is entirely free. What that means is this podcast episode will be able to contribute towards your verifiable CPD hours during this learning cycle, myth busting 101. We got to talk about this because the number of people I see out there, especially on internet forums like Reddit who have this misconception in their head.

Dr James:

Whenever it comes to the investing side of things, we really wanted to devote a whole entire webinar to it, and that is is the S&P 500 definitively the best place to put your money long-term? It certainly is, if you ask Reddit, but there's a little bit more to it than that, right, Anick, just a little bit more. Hi James, how are you today?

Anick:

I'm good. The sun is shining, life is good.

Dr James:

Hey, that's what we like to hear. Anick, there'll be some people on the webinar who know you and some people who've yet to meet you. For the benefit of the latter, maybe it might be a nice place to start to have a little bit of an intro, or a re-intro, shall we say yeah, sure.

Anick:

I'm a certified and chartered financial planner. I help people retire, live lives, set up investments and accounts to live fulfilled and meaningful lives. Essentially no thing or two about investing and what the S&P entails.

Dr James:

Nice one and maybe just to set the scene for tonight. What can everybody expect from this webinar this evening? What are we going to address?

Anick:

We're going to have a chat about some of the myths around the S&P 500 and even take a step back. What is the S&P 500 and what is an index? What are some of the things that make it up? Then we're going to have a bit of a chat about some of the tools needed to assess whether we should use an index or certain indices for investments and what makes up our investment mix.

Dr James:

essentially, you know what? Use the I word index just then. I think that's a great place to start right, Because, even though that's one of the fundamentals of investing, I feel that sometimes people have a few misconceptions around what an index actually is.

Anick:

Yeah, so essentially it's a list of companies. Now what that list is will depend on so many different criteria and you get so many different lists. So let's start with the S&P. The S&P is the 500 biggest companies in America. Now, it's actually not quite as simple as that, because what a lot of people don't realize is it's the 500 biggest companies that meet the S&P criteria. So S&P are a company. They create a list of 500 companies and these are the companies that fit their list. I think it was about last year. There was a really good bit of research. That said, of the typical S&P, 73 companies should have been in the top 500 and those 73 companies represented about 2.1 trillion, which is about 25% of the Australian stock market. But because they didn't fit the S&P criteria for profitability and various other metrics, they're not actually included in the traditional S&P 500, which is quite interesting, I think, because everyone assumes it's the 500 biggest. But it's the 500 biggest and that meet the criteria.

Dr James:

Well, it's interesting because Tesla wasn't in it, for it is now, but it wasn't in it for a long time, even though it was this massive company. So, yeah, it's good to just articulate that a lot of people believe it's the 500 biggest, but not necessarily all these indexes. They're all somewhat arbitrary, right like there's no, they're, yes, they're, they're certain companies from certain, you know, from certain countries, depending on the index, whatever you look at. But people always ask me they're like why do indexes continue to grow? And it's like they only continue to grow because they have the same set of companies, roughly speaking, relative to a certain period of time last year, and, generally speaking, the companies go up. There's no magical properties about it, it's just because they keep using the same yardstick, which I always find quite fascinating. But anyway, not to interrupt um.

Anick:

So then one question people might have is why stick my money in an index? Or what even is investing? When we talk about index investing? So to strip this back to the ground level, we as investors want to put our money into things that hopefully grow over time. Why? Well, people want a return. People want to try and mitigate against inflation when it comes to financial planning in the future.

Anick:

Inflation is probably the biggest risk we have. So a quick analogy if we think back to 1920, back in the day, um, eight pence bought you four pints of milk. By 1970, eight pence already bought you four glasses of milk. Fast forward to today, and eight pence buys you 11 teaspoons of milk. The point there is our money gets eroded by inflation. As inflation increases, the cost of everything becomes more and more expensive. So then that leads to the question what can we do to try and mitigate it? And one thing we can do is invest, because when you look at data sets over long periods of time, you typically would expect to see that investing, or stock market investing specifically, to be a great hedge against inflation.

Anick:

Now, when we put our money into things, what should we do it? What should we put them into, Sorry, and this is where we break down the asset classes and to cut a massive list of screening criteria down. We essentially want to put our money into things that gives the future expected cash flow. Now, when we apply that filter, we're left with four main things. The first is publicly traded companies, so the big companies you mentioned Tesla before, Microsoft, Nvidia, and, and, and, and. As investors, we expect to receive a future expected cash flow in the terms of dividends, typically when they make a profit or pay it out or some sort of capital appreciation. The other three, for people who are interested, are fixed interest, bonds, property and cash. But I'm going to focus on the equity piece in a moment. So if we're putting our money into a single company, well, that's quite risky, not very well diversified. I'll come on to some points about that in a moment. So, rather than putting all of our eggs in one basket, for example, we can put it into an index, a list of these companies, to try and spread our risk around. So if company A has a stinker and performance or the share price plummets, we are mitigated against that, essentially.

Anick:

Now to expand a bit more on that. Why do these indices matter to investors? Well, when we think about what investing is, there are two main ways of doing it. The first is active investing. So if I'm an active investment manager, I say, James, you give me your money, I'm going to predict the next Tesla or Nvidia and because I have an army of PhD analysts, we're going to predict when they're going to go to the moon, buy it when it's cheap and sell it when it's super expensive and make a tidy profit. Sounds great in theory, but because of their perceived expertise, the fees are actually incredibly expensive. And when you look at the data, given how data-driven we are, once you deduct fees, there's very, very few active investment managers who actually manage to beat the market as a whole. The other way of doing it is trying to predict a market crash. So again, if I'm an active investment manager and, James, you give me your money to manage, I might say there's a market crash. That's going to happen tomorrow. Let's move to cash and when the market starts to pick up again, we'll invest. And because of my army of PhD analysts the brightest minds in the world we can predict when that's going to happen.

Anick:

Now let's for one moment assume that I get this right. I essentially have a 50-50 chance of getting the call correct or not. Either there's going to be a market crash or there's not Now. At some point in the future I'm going to have to invest back into the market Again. There's a 50-50 chance of getting that right. Either it was the right decision or the wrong decision. Across those two events, my 50-50 chance and 50-50 chance essentially becomes 0.25. Now, over our investment lifetime and when we financial plan, we assume you live until age 100. Statistically that's not likely. So it's better to overball it than underball it. No one wants to run out of money in retirement.

Dr James:

The likelihood is, you're not going to get there.

Anick:

So, across such a long time horizon, the chance of an active investment manager continuously getting those calls right, the probability, becomes next to nothing. Don't get me wrong there will be some active investment managers who are truly, truly brilliant. The difficulty is we don't know whether that's skill or luck, and by the time we have a data set long enough to evaluate, they're in the Bahamas, they're enjoying their retirement, someone else has come in and we've missed our window of opportunity. So that leads us to what eventually became indexed investing. So people started to realize that it's incredibly difficult to consistently beat the market. So what about just owning the entire market? And this is where various indices around the world were born. So the FTSE 100, the 100 biggest companies in the UK, for example, or the S&P 500, as I was mentioning before.

Anick:

Different indices, different lists of companies around the world and people realize that by investing our money into these indexes and people realize that by investing our money into these indexes that we can actually, on average, outperform active investment managers because the fees to replicate an index are actually really really small Within the investment piece as well. So it can often be quite doom and gloomy. Some of the challenges I get of why we invest or against investing at that. Look at the news right now. It's filled, full of a load of doom and gloom, essentially. So people might turn around and say I don't quite want to invest just yet. I want to wait until things calm down. I'm just going to share my screen a second and jump into this, sure?

Dr James:

what it might be nice to do, annick, as well. Uh, just whilst you're getting that up on your screen, it might be nice to cover the difference between an index and a fund, right, because people use they often equate the two terms, but there's actually a distinction there and I feel this confuses people. But I'm sure you'll come on to that at some stage.

Anick:

Yes, I actually have a bit about this in the moment amazing, and then what we'll do is.

Dr James:

The next segue is to talk specifically about why people get so excited about the s&p, the pros, and then, obviously, the cons and the things to know and look out for which we'll come on to so let me just share this. Sure.

Anick:

Hopefully you're getting this?

Anick:

Yeah, it's coming through Let me just move myself out of the way. This is a headline around COVID. Billions wiped off the stock market, the worst financial crash since 2008. Loads of doom and gloom in the news. I think, from memory, this headline was around the 18th or 19th of March 2020. I think the bottom of the COVID crash was around the 26th, 27th, somewhere around there. Fast forward about eight months or so and the markets went to all-time highs, but there's no headline. This is from the Guardian. Actually, there's no headline to say billions wiped onto the stock market.

Anick:

It's so easy to get caught up in the hysteria over the stock market and what's happening in global economies. When it comes to us as individual investors, these are things that are so far out of our control and for most of us, it's not really going to make an impact to our investment portfolios. This is a really interesting chart. Let me just move this bar out of the way. What you're looking at here is essentially 1926 on the left hand side and 2022 on the right, but we're looking at bull and bear years. A bull year is essentially it's a bit of jargon, but it means periods in which we've had a prolonged up period, and the bear years are periods in which we've had a downturn. Essentially Now, before we even dive into it, the takeaway for me is the up years are so much more than the down years. Anytime we have a negative period, relatively compared to history it doesn't last for that long and the downturn compared to the rally we have after it is, you can't really compare it.

Anick:

Look what happened here. This was the Great Depression 80% down in 27 months. Imagine right now if the S&P or the global stock market dropped by 80%. Imagine the headlines. Yet when you consider the averages across time, the stock market here, which is actually the S&P in this example, has still done about 10% on average. Even considering this period in time. We've never had a period in which we've had a negative with no recovery. There's always been a recovery. Now, if I go on to the next page here, what we're looking at and it's zoomed out, I know, but from 1970 on the far left until 2023, and there's various worldwide catastrophes and global events COVID's over here, 2008 crash here, the dot-com crash here. Yet despite all of this, this market's still at about 12%. So people say to me but this time it's different.

Dr James:

But is it?

Anick:

really Throughout history we've had issues and challenges with investing and markets still continue to reward long-term discipline. For most people, the best advice will be do nothing, sit tight, stick to a long-term strategy. Volatility and when markets go down, is a function of the markets themselves. It's not a bug Before we do dive into S&P. It's just very useful to remind ourselves of this before we get caught up in some of the noise that happens. Let me just stop sharing my screen a sec. So, coming into what the S&P is, then there's been a move away from this passive terminology in recent time.

Anick:

James, you mentioned about the index terminology right at the start. Passive investing would assume that we are truly passive. There's no intervention being made and for the most part that's not true. So my example at the start of the S&P only being the 500 biggest companies that fit the criteria. You could argue that by having a criteria in the first place, that's not really passive. Is it Because there's a decision in there?

Anick:

Now the criteria of what makes up the S&P. It's driven by market capitalization. That's again a bit of jargon, but if you times the amount of shares by the share price, it gives you a very large number of a single company. Now that's essentially the market capitalization, or it can be a metric of what the company's worth. Now, if you list all of those in the top 500 that fit the criteria, that gives us the index. Other levels of other criteria profitability they'll look at liquidity and for the S&P, it has to be a US company.

Anick:

Now some argue that, given globalization, it doesn't really matter if someone's in the US. The world is interconnecting, which is quite an interesting take. Now, I mentioned market cap weighted, but because of that, it means we can have a disproportionate impact on the index as a whole. Some of you may have heard of terminology called the Magnificent Seven, which are Microsoft, invisio, Tesla, apple and a couple others, which make up essentially a third of the weighting. And because of that, if Microsoft has a bad day at the office, the index as a whole will drop massively because it has such a large impact. It has such a large impact and because of that as well, we see sectors such as tech having a huge, huge drag on the overall index. Typically, when we do look at the S&P, it's quite cyclical as well, so as new innovations come to the market and new companies are created to fulfill that need of society. Really, these companies grow bigger and we see a changing in what's happening, and at the moment that's tech. Previously it has been healthcare, finance, et cetera. Now, when we consider why we should invest in S&P 500, well, if you want to invest in companies to try and at least beat inflation, you're getting diversification within US large cap stocks, us large cap companies.

Anick:

Historically the S&P has been strong. That old cliche stick it in the S&P. James mentioned Reddit before Now. This is actually an incredibly interesting point. So the US they are incredibly proud and because of that, you see loads of people in forums say believe in US companies. We have a stellar track record. Now, where this has actually come from is a load of books and literature have always been focused on the US. Why the US specifically? Well, the US data the S&P actually goes back until 1926. And we don't have a stock market data set longer than that. So quite often we will use the US stock market data as a proxy for global data. Now, because of that data set being available, more and more US authors started writing a lot more about what was happening in the US, so we've had a massive amount of literature that's been relevant towards the US and the S&P and because of that and given how it's gone, um it the, the people in the reddit forums are constantly banging on about the s&p and why we should put money in the s&p essentially now within that as well.

Anick:

It's. It's incredibly accessible. There's low barriers for participation. Most people now can log onto the phone and invest in an S&P fund. It's incredibly liquid. So when we think about property investing, for example, which I'm sure many of you have experience with, the buying and selling process is so slow and so painful and you can't just sell off a wall of a house or a roof to try and liquidate your money Because there are so many trades constantly going on in the S&P index itself. There's constantly inflows and outflows of money, which means if you want to try and take some money out, it's actually super easy, and when we compare it to back in the day paper trades, it was difficult. Innovation and tech has removed barriers for for investing, which means we can all do it sat in, sat on our sofas at home really it's the uh liquidity, I believe, is the term right exactly James et etfs exchange traded funds, whereas once upon a time they were mutual funds, weren't they?

Dr James:

so you had to go through the broker and there was so much more.

Anick:

Uh, friction there, shall we say, and people forget that only happened in the last 15 years, yeah um tech and the, the birth etfs, um have have come on massively within the last few years and it's quite exciting to think about what it's going to move to in the future. The question before what's the difference between a fund and a index? So an index is literally just a list of companies, so you don't directly invest in an index itself. But let's say you have the S&P index, you will have a fund manager, the big players in the world Vanguard, blackrock, etc. Which I'm sure you've probably heard of they will try and create an S&P fund. So they will buy masses of shares in the S&P 500, and they will get investors such as you and I to buy units within this fund. And when we buy units, we're essentially buying part of that index in whatever amount we decide to do it. Now, the fund manager will apply fees, and this is one of the costs that are associated with investing and something we need to be mindful of.

Anick:

So there is a difference between an index itself, the list of companies and the fund which looks to try and replicate the index. There will be a difference between the two and we call that tracking error Again, a bit of jargon, but tracking error is the difference between the index return and the fund return. A good fund manager will have a very low tracking error or a small amount of tracking between the two, and typically that will be their costs. Now, if there's a big difference between it, I'd be asking questions. So one of the things you should be looking at if you decide index investing is for you, how close are they to the index itself? How close is the fund manager to the index itself? Because if they're miles off, then close are they to the index itself? How close is the fund manager to the index itself? Because if they're miles off, then what are they doing? It doesn't seem like they are really index investing to me, which is what we want to be doing, because active investment doesn't really work.

Dr James:

And can I just jump on that for two seconds, because again, it's another flaw in the wisdom that is espoused and thrown around. Where you can just invest in the S&P, I mean, yes, you do. You invest in something that replicates the index. That's what you're doing, right? So, to be more correct there, well, you know, obviously this would constitute financial advice. We're not going to do this tonight, but someone should be really specific and say the fund, like what fund, actually mimics the S&P to the greatest level of detail, because not all S&P funds are created equal. There's actually tracking error there we were talking about a second ago, and I believe you can find this information out in the KID document, right, the key investor information document. That's with every fund, but a lot of times people don't know how to decipher it.

Anick:

Yeah. So if you look at at it, it can be very overwhelming. But read through it a couple of times. So the key investor information document, the fact sheets between the two. They'll give various metrics over investment, what their charges are really important and we're getting more and more what I call closet tracker funds. So take ESG investing or green investing Quite often, this way of investing will promote themselves as only investing in socially responsible companies and companies that do good things for the world.

Anick:

Now, when you look underneath what they actually invest in, most of them are actually just investing in some sort of index, but slapping a very high fee on.

Anick:

So it's something to be very careful of. Now, just coming back a moment to some of the other implications of the S&P, it's important to realize what the limitations are as well. So I alluded to it before. But that market capitalization a handful of companies having the biggest voices essentially is such a big concentration risk. So, for example, as of March 2025 this year, the MAG-7 was down 12%, ie negative 12%. The other 493 was only down about minus 0.5%. So it's a huge difference because of a handful of companies. The other thing to remember with an S&P fund or S&P 500 index is that there's lack of exposure to other types of stocks, so there's no small cap, mid cap, international or emerging markets and because of that it's so concentrated on the US, which limits diversification. In my world, we think of diversification as the closest thing to a free lunch, and it's something we should be shouting about. We don't want to put all of our eggs into one basket.

Dr James:

let me just share my screen again for a second yeah, sure, and just while you're doing that, just to add to what you're saying, you know, if someone has all of their money in the s&p 500, which is companies that are primarily based in america, well, companies that are based in america, they do business all over the world, right? But you're basically backing america to continue not just thrive but outpace the rest of the world in terms of economic growth, right? But if you think about that for two seconds, like, america is already what? Like 50% of the global economy, something along those lines. So in order for it to get bigger proportionally, it has to continue to grow relative to the rest of the world, right? So you're basically saying, I think that America is going to become 51% or 52% or 53%, right, and past a certain point, the odds just kind of shrink, don't they? You know what I mean. You've literally got all your money on the fortune and fate of one country, and that, for me, is one of the biggest reasons why I get the heebie-jeebies whenever I see people just blindly espousing that logic, which relates to what you were saying a second ago.

Anick:

Absolutely. And I challenge people and say where's the evidence that the US continues to smash out of the park year on year and is top of the tree? Because if the evidence suggests that's the best way to invest, then there's an argument for it, but there's no evidence for it at all. So let me just share this is that on the screen? It is so hopefully you should have a very colorful chart um showing yeah, by the way, are we?

Dr James:

I don't know if you're intending this or not. Are we supposed to be able to see what those little boxes say, because you might need to zoom in more if not? Or is it more just a general picture we're looking at?

Anick:

more, just a general picture. Okay, I can zoom in a bit more if it's a bit better, hopefully. Hopefully, that might be somewhat better. Yeah, what we're looking at here 2005 on the left-hand side, highest returns per country and at the bottom, the lowest returns, and this goes all the way to 2024. Now, every single time I do this, I take a completely different path.

Anick:

So let's start with Denmark 2015, top of the tree. So the end of 2015, they returned 31%, smashed it out of the park, did better than everyone else. So if I'm an investor, I'm thinking, you know what Danish stocks are the place to be. I'm going to put all of my money into Denmark. What happens? 2016? They're literally bottom of the tree. Austria, 2017, again top of the tree 45% in a single calendar year, which is ridiculous. It's huge. 2018, what happens? Bottom of the tree, minus 23. Ireland, 2019, 32% very good. Ireland 2019 32% very good. To be fair, the midway through 11.5% for 2020. Finland, 2018 top of the tree. 2019 bottom of the tree.

Anick:

This is a very colorful chart to illustrate my point. Yes, but it's actually being put through statistical analysis. There's no pattern between which country comes out on top and which comes out on bottom. So by putting all of our money into the US stock market, we're taking an active bet on what's going to happen. Now, this is one for another webinar, but markets are incredibly efficient, and what that means is all new information is priced in. So if someone has information that I don't know the US stock market is going to tank for whatever reason, then we're going to see that reflected in the price.

Anick:

Now, if you're actively choosing to invest in the US stock market the S&P, in isolation, you're essentially saying that you know more than the collective participants of the market, which is a lot, a lot of people. We can't predict what's going to happen, so why limit ourselves just to the US? And this probably brings me on to my next point. There's a world of opportunities out there when it comes to investing. Capitalism is the mechanism in which bright ideas come to the market and people find funding to get their companies off the ground, and whilst that's the case across the world, it means there's an entire global set of companies to invest in, and we can see that here. If I come on to the next slide, James, I think you mentioned 50 odd, but we've got US here at 61%.

Dr James:

Okay, wow, there we go. Even bigger than I thought.

Anick:

Yeah, so this is literally the global stock market in relative proportion. So the US stock market makes up about 61% of the world. This little square here the UK makes up 4%. Now, to put some context on those numbers, this box here, Apple, also represents 4%. I'll put it another way. That is crazy.

Dr James:

Apple is the same size as the UK stock market, which is that is crazy.

Anick:

Yeah, it is crazy. Yeah, it is crazy. So we're missing out on 40% of the world and I've got some charts at the moment to explain what that diversification impact can be. So we're essentially cutting ourselves short from the rest of the world by limiting ourselves to the US stock market the other thing as well the US by only investing in the S&P 500, we're missing out on factor-based investing. Now, again, this is an entire webinar what factor-based investing is.

Anick:

But with Vidaire Financial Planning, our firm, we adopt an evidence-based investment philosophy. So all of our investment decisions are based on the academic, peer-reviewed literature we have today, not on speculations or finger in the air approaches. And there's an overwhelming body of evidence to say that if we invest in companies with certain characteristics so smaller companies and value companies and profitable companies we can actually get a higher expected return than the market itself, which is it is great because we're taking the principles of index investing with the idea of doing better than the market, but we're not speculating on it. Now, by only narrowing on the S&P 500, we're cutting ourselves from higher expected returns, which is it's not logical. We can see this here. So when we talk about factor-based investing, we're looking at the growth of 10 000 pounds from 1994, um until 2023 is when the data set went on to. So, for example, the grey line represents a global stock market, so even more diversified than the S&P 500. And across this time, 10,000 grows to 110,000. But by having a factor-based portfolio. So those three factors I mentioned before to give a high expected return, underpinned by Nobel Prize winning research, that 10,000 pounds over the same period actually grows to £151,000. And that's only on that £10,000 chunk. It doesn't account for ongoing money into it. So that's a ginormous difference just off that chunk there. Now the bars in the middle show the annual differences and we can see it's a bit more of a bumpy ride, which we would expect. Risk and return are related after all. We can't expect a higher return without taking on more volatility, essentially, um. So again it we're selling ourselves short if we're limiting ourselves to just the s&p 500 now.

Anick:

The other point I mentioned before is diversification. Being diversified during downturns can really protect us. Let me just zoom out. Hopefully that's showing fine what we're looking at here. So the green line is the S&P 500 between 2000 and 2010. And we can see the dot-com crash here and the 2008 financial crash. Here the US in particular got hit very, very hard, given what happened over there and their subprime mortgages and how they were packaged up. Because of that, if you invested concentrated in the S&P 500, you were hit quite hard.

Anick:

Now this blue line is our VFP 100% equity portfolio, globally diversified essentially, but the same asset allocation to 100% stocks. And we can see here that 2000s, at the financial crash, it wasn't as bad. Granted, it was relatively close. But particularly over 2008 and beyond, there's quite a bit of a difference there and there's a lot of that diversification impact because the portfolio wasn't just invested in US stocks. There's actually quite a bit of a difference between the two and as investors, our money would have been, wouldn't have been subjected to some of that volatility we've seen Now.

Anick:

I appreciate that was a little while ago, but this is essentially the same sort of chart, but year-to-date data. So the orange line here, d, represents the S&P, and A, b and C are our VFP 100 to 100% equity portfolio, the 80% equity portfolio and the 60% portfolio. So the 100's in blue, the 80% equity portfolio and the 60% portfolio. So the hundreds in blue. The red is the 80% and the green is the 60%. So those percentages represent how much is allocated to stocks and shares.

Anick:

And we can see because we decide to take a global market capitalisation as our foundation because, as we've just seen from the colorful chart with the countries, we can't predict what country is going to come out on top and we're not in the business of making active speculations because that gets us nowhere. But by yes, the stock market returns over the last six months haven't been the best compared to what we've seen in recent years, but by being globally diversified we're actually a lot better off than if we just stuck our money into S&P, and diversification is so important to get, to get these things right for our money, especially if someone's about to retire or before some life events. If we don't have our portfolio set up rightly or before some sort of business exit or selling the practice, then we could potentially set we could be potentially setting ourselves up for failure.

Dr James:

Let me just stop sharing that yeah, so I mean it, just it. I think it just serves to drive home the fact that you know it's. I guess one of the biggest things that people say about the S&P 500 is the returns right are well, as you were pointing out a second ago, uh, that can actually well what the data would suggest. We need to be careful about offering uh, you know, you know suggesting that someone will, something will continue to grow prospectively. It's not really how it works. We can only really say, we can only really make predictions on the data that we have retrospectively right, but that data is as good as it gets. That's all we have to make those predictions right. So if we have that and that's certainly suggesting that something will outpace something else well, there's your odds right there, or there's your likelihood right there, right in front of you. So I I mean I guess that is one important thing to highlight and factor-based investing when has that become a thing and like when? When did that uh began begin to appear as an investment solution?

Anick:

So there's been various iterations of it. The original person who brought it to the market, who actually wrote about it in scientific literature, was a guy called Harry Markowitz. Now, I think his paper was released in 1951. It was in the 50s anyway. Wow, and he eventually got a nobel peace prize 20 years later. Um, because it was one of those things, no one really paid attention to it. But after he won the nobel peace prize and more and more research started being conducted around it and people realize it's actually a a very efficient way of investing Guy called Ken French, gene Farmer, rob Merton these were people who were all at the University of Chicago in the US and they sort of came up with each other and bounced all the research off each other in the 80s and 90s and between them they have so many Nobel Peace Prizes for their contribution to finance as a whole and they've changed how we invest in our thoughts of investing.

Anick:

Within the modern day it's probably still not used that often. To be honest, it's something that's massively overlooked, and I've got an academic background myself. I have my own published research paper but when you look at the evidence it's massively overwhelming and we should be asking ourselves why are we investing in this way? It's yeah, I absolutely love it, and I go to town because I'm a bunch of fun and read papers in my spare time. But that's just me.

Dr James:

Well, I guess I think part of the reason why maybe other solutions aren't talked about as much is because you've got these books that are the all-time classics on investing and I I know this for fact because they're over there behind this whiteboard on that bookshelf and you've got like way of the turtle and one up on wall street and even books that warren buffett warren buffett has written, and a lot of these books were all written in the 60s and 70s and people just didn't notice stuff. Yet we still circulate them today as these all-time classics, whereas the world has moved on right.

Anick:

Yeah, it has. The world has massively moved on and I guess for some people they like the premise of index investing. It's accessible.

Anick:

Factor-based investing isn't always available to people. It can be, depending on how it's implemented, but it can be quite hard. And it can be, depending on how it's implemented, but it can be quite hard and it can take quite a bit to get your head around, and I hope I've given a high level overview. That's understandable, but when you break it down into what those companies and what those factors actually are, it does get quite complicated. So for some people being perfectly content with a market-like return, less fund manager fees is acceptable and that's fine and it might well get them to a good retirement outcome or a good life outcome, um. But for some, factor-based investing might just be that, that thing that wants to chase or go after that high expected return, or might be the difference between potentially retiring a bit earlier. Um, not everyone has has content or the access to it and, like you say, the world's moved on massively and literature content et cetera, hasn't really caught up to it. Quite often any sources of content still reference old books from the 60s, exactly as you say, though.

Dr James:

You know, another interesting thing to highlight is and I know that you mentioned this earlier, but just to recap it, a lot of this logic, whether it's a factor based in uh, 100% equities portfolio, or it's the s&p, it's all precluded on the fact that 100% equities is suitable, right? Because that is another thing that we just need to throw into the mix. As you get closer and closer to retirement. It doesn't matter whether, whatever index you're trying to mimic, if it's 100% equities, because it's way too risky, right.

Anick:

Yeah, so this is a really interesting point. There's been a lot of literature about this. What do we define as risk? Now? Some people would say it's volatility. Some people would say it's the uncertainty of outcome. Now, depending on where you slice the maths, you can argue a case. If markets go down, then the higher equity allocation will give us enough punch to try and recover, but it means a more bouncy rise, and if you're in retirement, is that something you can stomach? If you can't, then there's no point in having the best portfolio design and spreadsheet. If if you're awake every night and you can't sleep because of what's happening in the worry, that that probably leads to a question we should be asking ourselves and what is the purpose of investing, though, or what's the end point? People who have listened to me before will know how much I speak about point b, defining that future life end point. Now, once we take time to find that, we can then take a step back and say is this way of investing, is this asset allocation, is this fund suitable as a tool to help get us there? And a a financial plan can be great to work backwards from this.

Anick:

We have a three-dimensional approach to portfolio selection, and it's the same for everyone, because the fundamentals are the fundamentals. The first is risk need, and that is what rate of returns do you need to achieve that point B? So if you need to grow your money by I don't know X percent per year, then that would lead to a portfolio or an investment of choice, a fund of choice. The second dimension is what we call risk capacity, and that's your ability to withstand short-term losses. So if you're a young associate putting money in your pension, you have such a long time horizon, it doesn't matter if the markets go down over a week, a month, a year when you're talking decades Now. If you're about to take out your entire pension as a retirement tomorrow and the markets crash by 20%, it's not a nice place to be. So that needs to be balanced up too. The third is what we call risk comfort.

Anick:

In the industry people might know it as attitude to risk, and this is essentially some sort of subjective questionnaire to understand how you feel about the volatility. Now I have a bit of a gripe with the profession as a whole here. As I'm sure you've probably seen, if you open up an investment portfolio, it'll ask you a question such as what sort of investor are you? And it'll throw out some sort of meaningless descriptors such as cautious, safe, balanced, aggressive, whatever that means. As a professional, I don't have a clue, so how does anyone else? But they're essentially attributing those meaningless descriptors to volatility. I how much the price goes up or down.

Anick:

So, by their definition, if we go for a safe fund and it's predominantly cash by the time we get to retirement because we've been safe, that means our money's safe right. That's not the case at all, because inflation would have ripped it a new one. And all of a sudden we're now in retirement, our money cannot fund our retirement, our peak earning years are gone and we're tricky. We're in a tricky situation. To me, that's risk, the uncertainty of outcome and what could happen in the future. So it's really important to balance those three dimensions of what means the most to you and what's relevant to your situation. Now, when it comes to building a portfolio, it's really important to build an asset allocation that's right for you. So, within the equity piece, look at international equities and, if it's relevant, look at blending this down or diluting it with various other assets I mentioned at the start. There, watch out for closet tracker funds. You don't want to be paying more fees in the investment piece than you need to.

Anick:

The other thing, which is super important have an objective, grounded investment strategy and beliefs. Without a doubt, throughout your investment journey, you're going to have downturns, market crashes, declines. We're human at the end of the day, which means when we see our money go down, we instantly think oh, I don't like this. What typically happens? Markets go up, people see it at the top and think this is great, I want a slice of this. The markets drop and people say I don't like this anymore, this is awful. So they sell and that cyclical behavior ruins wealth.

Anick:

Now, by being objective, having a rules-based, systematic approach to investing. It means when times get hairy and they will, without a doubt then we can go back to our rules and say we know this was going to happen and this is what we said we do. That helps steer the course for a good, successful outcome. And having high level principles our guiding north star. It is so important and it's something we bang on about to our clients our high level principles of what investing means to us. And if you go down that route, make sure you find someone who aligns with your investment philosophy and strategy, because that's really important as well. You want synergy across the board.

People on this episode

Head Shot

Dr. James Martin

Host