As counter-intuitive as it may seem, most of the companies that push us into the next technological revolution deliver poor investment returns. Today we look at current and historical data to show why this is the case but first, we chat about the top financial news of the week. Borrowing heavily from Carlota Perez’s Technological Revolutions and Financial Capital, we then explore how the links between tech revolutions and investing adhere to a consistent model. Following this model, we discuss how our current information-led revolution is as impactful as revolutions experienced in previous generations. We touch on the factors that lead to innovation, historical perspectives of technology companies, and the many investing phases resulting from tech revolutions. Despite making for poor returns, we talk about why the frenzy of investing that accompanies innovation is good for that industry and leads to a golden age of tech adoption and growth. A key takeaway, we dive into how investors are paying too much for the expected growth of new companies and that there is little to no link between massive growth and high stock returns. From guessing the next IPO winner, we move to our planning topic of the week — how to be a successful household CFO. We close this episode with our bad financial advice of the week. There’s a lot of pressure in the market to invest in tech. Despite that, tune in to hear why you shouldn’t invest in the next technological revolution.
Key Points From This Episode:
Hear about host Benjamin Felix’s burgeoning 3D printing addiction. [0:0:06]
Sharing listener feedback and messages from the Rational Reminder community. [0:02:02]
Robinhood and why users are treated as the product, not the customer. [0:04:33]
News on what might be the largest cash raise in IPO history. [0:07:25]
How most ETF assets are in products that were launched prior to 2015. [0:09:24]
Benjamin shares details about his project exploring the value of investing in tech revolutions. [0:11:05]
Modelling the consistent sequences that technological revolutions follow. [0:14:38]
Why current tech revolutions are as powerful as those experienced in previous generations. [0:16:55]
Which common factors lead to tech revolutions. [0:18:31]
Looking at historical examples of innovations and the performance of tech companies. [0:20:35]
Why innovative big companies become unable to lead the next tech revolution. [0:23:18]
How explosive growth and a frenzy of investment is common during early tech breakthroughs. [0:29:30]
Signs that our current tech bubble has begun to pop. [0:34:45]
The benefits of investment frenzy phases for tech industries and society as a whole. [0:36:15]
Exploring what happens after phases of investment frenzy. b
Evidence showing that investors pay too much for the expected growth of new companies. [0:42:42]
Why there is no link between massive industry growth and stock returns. [0:50:00]
Applying lessons from our discussion to our current investing environment. [0:52:03]
Why you probably shouldn’t put your money in the technological revolution. [0:58:04]
How people operate as unofficial CFOs within their households. [01:02:45]
The many tasks that household CFOs need to perform. [01:05:20]
Bad advice of the week; swap your bonds for dividend-paying stocks. [01:10:42]
Why increasing inflation may be a key post-pandemic government strategy. [01:15:40]
Read the Transcript:
Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision making for Canadians. We're hosted by me, Benjamin Felix and Cameron Passmore.
Cameron Passmore: Okay, so off the top, those of you watching on YouTube, you'll notice over Ben's right shoulder, this incredible mesmerizing 3D printer. So, this is something we had to kick out at work. He gets on a teams call and we're all watching what's printing in the background. So you have to tell us what are you printing?
Ben Felix: Well, I wasn't printing anything, but because you had in your notes a question about what I'm printing, I decided to print. I decided to print another body for this bot here, that if you're on YouTube you can see. This is my current project. It's actually done now, the blade spins. It's pretty dangerous.
Cameron Passmore: So you made the whole thing on the ...
Ben Felix: So 3D printing was pretty fun when we got it. Finding cool stuff online and printing it, kids can play with the stuff, whatever, that's kind of fun. I guess about two weeks ago, probably around after we recorded our last episode, I got into using Fusion 360, which is a software from Autodesk, like a 3D CAD software. And they've got a free a version for non-commercial use. So I started playing with that, and got proficient enough that I can actually design my own components. That bot that I just showed you, that's every single component, including the gearbox inside, which has bearings in it. It's so cool. You can print the hole exactly the size to fit a bearing in. So I designed and printed every single component.
That difference between just printing stuff and actually making the components to print, it took the hobby from kind of fun to absolutely addictive.
Cameron Passmore: Amazing.
Ben Felix: I'm printing another like this base, there's three components, one, two, three, and there's gearbox inside, so I'm printing another one, one of those. In yellow this time, instead of that gray color.
Cameron Passmore: So if you want to see what Ben is building, you're going to have to go check him out on YouTube or check out this podcast on YouTube. Anyways, we got some great reviews a past couple of weeks. One from Young Investor YQR, Bruce with an @ sign, and Jacob who kindly wrote in his review as a title, this should be mandatory material for Canadian advisors. And this has more meaning once you hear Ben's bad advice of the week at the end.
Over on the Rational Reminder website, oh my god, I am blown away by the quantity and quality of engagement. It is absolutely jaw dropping. The people that are coming and the effort and the interest and the thoughtful writing is incredible.
Ben Felix: It is absolutely incredible. I think it was Jim Stanford a while back in one of our episodes that talked about how, I can't remember what I'm thinking now, but not all work is paid work. And the amount of work that is going into, just people with, what is the incentive? Just to interact with other people I guess. But the amount of work that is going into the posts on there from smart, thoughtful people, and I'm not talking about us.
Cameron Passmore: And also people that know episodes, we reference something and they go back and link it to that, is like, whoa, people are really paying attention. Also on that site too, we have our swag shop open of course. We decided to open it up to international shipping. So we just went with a $15 flat shipping fee internationally. Actually shipped off a hoodie to some in Malta last week. So we're happy to be part of that charge for sure just for the community. And also, I don't think I told you this, but Fred Vettese reached out to me last week and asked us to mention that he just released the second edition of his book, The Retirement Income for Life, which is a book we talked about on his masterclass episode with us back in Episode 104. So the book is available Kindle or paperback. I downloaded my Kindle copy last week. I haven't dug into it yet but I read some reviews last week from other bloggers and gets great reviews of course. So happy to pass that recommendation along.
Ben Felix: I just realized, if anyone wants the STL files for the bot components so that they can make their own bot, I'm happy to share.
Cameron Passmore: There you go, you can have [crosstalk 00:04:30]
Ben Felix: I'm not going to battle my own. Someone's got to make their own bot design for me to battle. It's no fun to battle my own.
Cameron Passmore: Right. Otherwise no real battle.
Ben Felix: That's it.
Cameron Passmore: All right, here you go. All right, so I kicked it off with Scott Galloway's podcast from last week.
Ben Felix: Let's do it.
Cameron Passmore: I don't know if you caught it or not, but the Prof G Show, Scott talked about something that he's actually riffed on many times in the past that really got me thinking. He talked about the Robinhood story where an account holder had their account hacked, share were resold, and money was taken from his account. Horrible story of course. So the individual went on to try to contact Robinhood. And there's no one 800 number, and had a real tough time getting through to Robinhood to let them know that his account had been hacked. And Prof G or Scott Galloway's point was, if you're not paying, you're not the client, you are the product. He said, here's a perfect example proving that. There is no customer service line to reach out to them. The person had to take to Twitter I believe. He said, what do you expect? You weren't paying, you're not the client, you are the product.
And he's made the same reference in prior podcasts about Facebook and other social media sites, again, that are free, you're the product, you're not the customer. We talked about this on past shows where these platforms make their money is off either the interest rate spread on cash or on the paying for order flow. So that's why Robinhood wants your accounts to be able to make money off your accounts by selling your order flow. Again, you're not the client.
And Mike Lukitz talked about this on one of his podcasts last week. I think we actually mentioned this before where Schwab, the big custodian in the US, 60% of their revenue comes from the net interest rate spread and cash balances. He makes a point that they kind of do all his trading and account custody work just incidentally to capture the revenue off of the cash spreads.
Ben Felix: Yeah, it's unreal. The order routing one is interesting with Robinhood because, when we talked about this in the past too, it's not necessarily a bad thing. Robinhood's in this unique position where because they've positioned themselves with a generally younger audience who are trading smaller amounts of money, and therefore, smaller amounts of shares or odd lots, as they're known in industry speak, not 100 shares round lots, spreads are always wider, are usually wider on odd lots and on small numbers of shares. And the high frequency trading firms are willing to pay more money to Robinhood for those types of orders.
So it's actually to Robinhood's benefits to be processing all of these small orders because they're actually worth more from the perspective of order routing.
Cameron Passmore: And it's good for the account holder as well.
Ben Felix: Yeah, so it's not necessarily a bad thing, but it's still interesting.
Cameron Passmore: Another item that Prof G talked about that was actually in Barry Ritholtz's morning email this morning, was about the largest cash raise in IPO history is likely to go this week. The company is called the Ant Group, which is a massive Chinese FinTech. It is the world's largest mobile and online payments platform, and also owns a payments and lifestyle app Alipay. And get this, it has more than one billion active users. Isn't that wild?
Ben Felix: That's a lot of users.
Cameron Passmore: Ant is an affiliate of the Alibaba Group. So it operates a credit card company, has a stake in online bank, a wealth management platform, as well as a significant critical illness insurance platform. Get this, it's expected to raise $34 billion this week and have a valuation of over $300 billion, make it one of the 10 most valuable companies in the planet. But in this Wall Street Journal article that Barry linked in his email this morning, more than five million individual Chinese investors have place orders for over $2.8 trillion. The demand for shares by individuals at 870 times the amount allocated for individual investors. The demand is just unbelievable. So it's going public in Shanghai and Hong Kong, and it's not going public in the US.
And just for comparison's sake, it's the largest cash raise of all time. And the next largest IPO was Saudi Aramco with $29 billion, and Alibaba at $25 billion. This is 34 with a valuation over $300 billion, just massive.
Ben Felix: It's unreal. It's hard to keep context for how much a billion dollars is when we're talking about 25, 29, but a billion dollars is a lot of money.
Cameron Passmore: It's a lot of money.
Ben Felix: That's wild.
Cameron Passmore: So a couple of little news items I came across last week that I thought were interesting. Tweet I saw from Nate Geraci last week, had a cool stat. Nate is the president of the ETF Store, which is a Kansas City based investment advisory firm specializing in ETFs. 94% of ETF assets are in products launched prior to 2015. To me, that's incredible. And he goes on to show that over 1500 products have been launched since the beginning of 2015. So you had this massive product proliferation, yet 94% of all ETF assets are in products launched before 2015.
So I went back and looked into more of the research that Nate does. He contributes to the ETF Educator, which is full of all kinds of really interesting ETF intelligence. So for example, since 2010, actively managed US equity mutual funds have lost, have hemorrhaged over $2 trillion in assets. That's how much money has been net redeemed out of US equity mutual funds. However, total assets in US stock funds have doubled in the same time, due to the performance of the bull market in the US.
So, managed US equity mutual funds in the US have gone from basically three trillion to six trillion, even though there's been two trillion taken out over the past decade. Thought that's some pretty wild little data points.
Ben Felix: Absolutely.
Cameron Passmore: So shall we jump into your big recent thoughtful project?
Ben Felix: Yeah.
Cameron Passmore: I mean, this one's been cooking for a while, like all your subjects.
Ben Felix: I'm worried that I'm not quite done yet, but done enough to talk about it I think on the podcast. And I think I've got a little bit more work to do before I'm ready to push this out as a YouTube video. But yeah, like you said, I've been doing a lot of reading and thinking about this topic. People that are on the Rational Reminder community know that I've been thinking about this because I mentioned it a couple times, but it's the concept of investing in technological revolutions. I think a pretty interesting theoretical framework to talk about, which is the book, Technological Revolutions and Financial Capital. So the model from that book I'll talk a little bit about. I know you looked at that book too, Cameron. Didn't find it as exciting as the-
Cameron Passmore: It's a heavier read. I am reading it but it's not light and fluffy, shall we say.
Ben Felix: It is heavy. And honestly, until I sat down and started writing about it, the first time I read it, I didn't grasp a lot of it. I sat down, I started writing about it and started to get it. So kind of like the second time reading it but also writing about it. And then I wrote down the model, and it's like, oh, that's actually fairly simple when you think about it. But getting there wasn't necessarily easy.
I found some really interesting just empirical examples that support her model, and there's a couple of other little interesting anecdotes that I've found for this too. And then there's a big theoretical piece that I'm still missing. And maybe I'll talk about that on a future episode once I've finished wrapping my head around it. Just in terms of what causes the low realized returns, I'm about to give away the whole thing. What causes the low realized returns of the companies that are sort of leading current technological revolutions. That's sort of the empirical fact is that investing in technological revolutions, and here I am again, and giving away the thesis. But it tends to give really bad results.
The way that I'm going to frame it here and the way all this information is organized, is with the idea that people overpay for growth. But there's another really cool theoretical explanation for why we get this outcome of low realized returns, and that's the part that I'm going to have to follow up on in a future episode because I'm just not there yet to talk about. So anyway, with that long winded preamble, we can jump in.
So, obviously, we're talking about technological revolutions. And a technological revolution is not a new company. Even a new industry within an existing technological paradigm, that's not a revolution. A revolution is something that changes the full productive spectrum, changes all other industries. So at that point, we can call it a technological revolution. So, steel, electricity and automobiles and oil, the information technology revolution is the one that we're still living through today.
Now, all of these have been distinct, obviously, completely different from each other in the way that they affect the world.
Cameron Passmore: Absolutely. They all stand out totally uniquely.
Ben Felix: Yeah. You can draw some parallels, and we're going to talk about some of the parallels that you can draw, but the way that they've changed the world, it's just been really different. But the sequence, the pattern, and this is where the model from Carlota Perez comes in, the sequence that they have followed, the technological revolutions have followed in the past has been, I mean, remarkably consistent. And the relationship between that sequence and financial capital has also been remarkably consistent.
So that's kind of what we're going to try and talk about is that relationship between technological revolutions and financial capital. It's an intertwined relationship. And that's maybe an obvious thing to say but you can't separate technological revolutions from financial capital. It's important to note that even though we're today living in this age of information, and we think about technology as the internet and the cloud and sharing of information and all that kind of stuff, and electronics even, all these other revolutions have been technologies of their time, and they've changed the world in profound ways, considering the existing paradigm at the time.
Cameron Passmore: Does it matter the quantum of change? I think about information technology does affect, I think some would argue, every business on the planet, whereas railways may not. Does it matter how sweeping the change is?
Ben Felix: I think that the argument that we would have to discuss there is tell me why rail did not affect all industries. You look back at the other technological revolutions, at least the ones that Perez considers in her book, and there's the Industrial Revolution. I think that affected everything. The age of steam and railways, same kind of idea. I don't know what that didn't affect. And then steel, electricity and heavy engineering, same thing, that facilitated cities and big urban centers, skyscrapers and all that stuff. Oil, the automobile and mass production, same thing. I don't know how you can escape what those didn't affect.
Ben Felix: So as much as we can say, and that's kind of the point I want to make, actually, to start this, is that it's easy for us to think that the companies that we today think of as innovative are changing the world in ways that no company has in the past, or no industry has in the past. And while that's true, I think that within the previous paradigm, so when the new technological revolutions are happening, the previous paradigm that they're disrupting, in that context, the past technological revolutions have been just as powerful as anything that we're living through or have lived through. Our revolution is in a later phase, it's not beginning now. But I think the changes within that context have been just as profound in the past as they have been today. And I think that's a really important piece of this whole topic.
Cameron Passmore: And it's easy to assume not because we weren't here when these revolutions happened.
Ben Felix: Yeah, and I don't remember them all, but I think it was in Perez's book or one of the things that I've been reading, it gave some anecdotes to show how powerful, like canals, for example, canals in Perez's book, actually, it's pre, industrial revolution is I think canals as well. But just the way that canal has affected the world was profound at the time. That's a really important piece of this is it's so easy to get caught up thinking how different and advanced everything today is. But compared to what existed at the time, past revolutions have been just as big in terms of the increases in production and economic growth.
Ben Felix: Perez's main argument in the book, or at least it starts with this, there's a constant availability of talent. There're always smart people that exist, there're always entrepreneurs. But innovation and technology has not followed a linear path throughout history. There's not this constant linear increase in technology and innovation. It happens in these big bursts. And her argument is that the reason that it happens in these bursts is the relationship between innovation and financial capital. So specifically, what she says is that the favorable conditions for the next technological revolution are created when the wealth creating potential of the previous one is exhausted.
And you think about it, just logically, within an existing technological paradigm, there's really no incentive to innovate outside of that because innovations outside of the existing paradigm don't fit with anything else. If you come up with an absolutely new, I mean, VR is maybe an example. I don't know if it's a good example or not, but VR is a really cool technology with lots of potential, but nobody has a VR headset. And so, it's hard for something like that to take off. Little innovations like that, in the book, Perez gives the example of the coal industry had railways to move coal. But it wasn't useful for anybody else because there was no rail infrastructure. And it's not until there's an incentive, an economic or a financial incentive to innovate outside of that existing paradigm. So when there's no more innovation to be had within the existing paradigm, it starts to make sense to innovate outside of it.
Ben Felix: So that relationship in itself is really important. That's in her model of why we see this lumpiness because no one's going to innovate outside of the current paradigm until it makes sense to do so. And she gives a couple of examples. One of them that stuck out to me was within a paradigm, so with electric kitchen appliances, somebody thought it made sense to innovate, to develop the electric can opener. And so she calls it the common sense of the paradigm. It's common sense. Of course it makes sense to have an electric can opener because you have every other electric appliance.
But eventually, stuff like the electric can opener or whatever equivalent in other technological paradigms, you start to reach the limits of productivity increases in growth. And that's what I was saying before starts to happen, where capital starts to look for new areas of growth.
Now, one of the really interesting pieces of this whole thing is that, and this is where the financial capital piece becomes important, the existing companies, and you think all through history, there have been these massive companies. We've talked on the podcast a few times about the idea, this winner take all concept, that there are winner take all companies today, and there are, and there have been. One of the important distinctions that we're going to make again today and we've made in the past is that a winner take all from the perspective of market dominance is very different from winner take all from the perspective of stock returns. Very different, couldn't be more different. Maybe even negatively correlated. And we're going to talk more about that in a minute too.
But you look back through history with rail, the Pennsylvania Railroad became the consolidated, the big railroad company, and one of the biggest companies in the world, or the biggest listed company in the world at the time I think. General Motors, Exxon, AT&T, IBM, Microsoft, we talked about a bunch of these in a episode not too long ago too. But this trajectory of consolidation and massive companies having continued success and being in this winner take all position, that's not new, that's just a normal part of capitalism I guess.
Ben Felix: And the fact that these companies end up in this position, in this monopoly or oligopoly position and tend to have cash to throw around, but also tend to have big fixed expenses. And that's important. And also, by the way, at this later phase, those big companies are probably starting to have their margins squeezed a little bit. And they don't have any more avenues for rapid growth and expansion like they've had in the past. So these big companies may start looking around at ways that they can innovate. But because they have big fixed costs tied to their infrastructure built for the previous paradigm, they're either going to be unwilling or unable, and not unable in the sense that they can't actually do it, but unable in the sense that they can't comprehend what they need to do to make that push to lead the next technological revolution.
So I've got a couple of examples. In the 1950s, IBM thought, and this is a quote from the leader of IBM at the time, they thought that just a few computers would be sufficient for all of the world's computing needs.
Cameron Passmore: We all remember that quote.
Ben Felix: That was the first time I'd read it, it's fascinating though. And then from Tim Wu's book, The Master Switch, which actually a podcast listener recommended to me a while ago, AT&t was pitched the idea of a packet network, which is a decentralized network that is the way that the internet works, the internet is a decentralized packet network. And AT&T was pitched this by somebody for multiple years. This guy in the story spent years of his life trying to pitch AT&T on this idea. But their whole business was structured around a centralized network that they controlled. And so the idea of a decentralized network, it just didn't compute. Like AT&T in the book, they talk about how AT&T did a whole seminar, it was like a two day seminar or something to try and convince this guy they had been trying to tell them why they need to do this, why they shouldn't do it and why it was even impossible for them to pull off. And there goes the internet, AT&T kind of, I guess they missed out in a way.
Cameron Passmore: Wow.
Ben Felix: And then there's another one where Time Warner, so a massive media company, when the internet started to become a thing, they were pitched by the journalists that started the first online magazine, which is slate.com.
Cameron Passmore: Didn't know that.
Ben Felix: This little anecdote is just unbelievable. So I can't remember the person's name that was at Time Warner sitting down with these journalists. But he listened to the pitch and all the feedback that the journalists were getting, and this is from their perspective of the stories being told. All of the feedback they were getting was about how they were going to use the long distance lines to fax physical copies of digital magazines to customers. It just didn't, it didn't compute that it was actually going to be on the computer. I think it's truly challenging for the existing companies in the existing paradigm to innovate outside of their paradigm. They have this sort of conflict of interest where they've got large fixed cost toed to their infrastructure. It's just hard to understand when you've built this whole enterprise within a paradigm, it's hard to see outside of that.
The one company that I've been thinking a lot about is Walmart, and it doesn't come up in any literature that I've been reading, but they seem like a company that's done a pretty good job of adapting to the new paradigm. But anyway, that's just a random thought I had.
Cameron Passmore: Certainly with curbside and online sales, for sure.
Ben Felix: Yeah, well, online logistics. They basically become a massive eCommerce business. It's not like you can't adapt, but historically, it seems like it's been difficult for big companies to make the total shift. One of the things that comes up in this is that a lot of the existing big companies will eventually adapt. And this is one of the things that leads to productivity and growth once the new paradigm starts to become installed, existing companies, using Walmart as the example, they will take the internet, and some of them will take the internet and deploy it and adapt to it and become better businesses. That makes the whole productive spectrum grow.
So, we're at the point where it's hard for the production capitalist, what Perez refers it to, production capital being the current producers, the current businesses, it's hard for them to kick off the next revolution, even though some of the ideas are out there, like IBM knew that computers were a thing, but they didn't think they were going to be a big deal. There's another one with Edison with the phonograph. He thought it would be useful for people to record their wills on their bedside when they were dying but didn't see the other applications.
So this is where financial capital starts to become critically important to technological revolutions. So it's got to be investors who are not tied to production capital. So investors with liquid wealth.
Cameron Passmore: Is it about the money or is it about the ideas, about the idea generation.
Ben Felix: This is the interesting thing is that the ideas are there all along. When you look back through the historical technological revolutions, it's never been like this technology, boom, it exists and then there's a revolution that happens right after it. It's like all of the pieces necessary for technology had been incrementally developed. And in a lot of cases, the technology even exists. It hasn't been socially accepted and integrated into the economy. And so it can't really be used.
Cameron Passmore: This is the aspiration for the vision to really drive it forward to societal change must be what's going on. To commit the dollars, you have to have the motivation to put the dollars on the table, perhaps?
Ben Felix: Yeah. Well, I think it also has to become economically viable. So when a technology becomes cheap enough to use or cheaper than what else is out there and it starts to have real potential to increase productivity, that seems to be one of the things that happens like Perez talks about. There is a big bang, there is an event for each technological revolution, that you can kind of pinpoint and say, here's where it starts, like the first test of a working steam engine that kicked off technological revolution, the opening of the Bessemer steel plant, that you can go back and say that kicked off that technological revolution. Intel's first microprocessor. You can go back and say that kicked off the technological revolution. But there's a lot that happened leading up to that.
Cameron Passmore: Yup, for sure.
Ben Felix: And the technology had to be cheap enough to actually be usable by other businesses. And even then, it takes a long time for that whole transition to happen to the new technological paradigm. And there has to be financial capital to support it. And that's the main thing that we're talking about here.
So after that big event, whatever it happens to be for the given technological revolution, there does tend to be a phase of explosive growth. And when you think about explosive growth, it's tons of new companies, tons of experimentation, lots of IPOs, and a lot of continued innovation using this new technology. Microprocessors are a good one. Like okay, we've got microprocessors, now what? Think about all the innovation that's happened since then to now. And financial capital in that phase is extremely important because if IPOs are happening and new businesses are starting, someone's got to be putting up the money to invest in them.
And once that really gets going, Perez calls the next phase, a frenzy. And it's really, the way that she describes it in economic terms is that it's a phase where production capital, so the actual output of the businesses that are starting, becomes decoupled from financial capital. So another way you could say that is that there's a bubble. And then you can say in a different way that I mentioned earlier, I haven't quite wrapped my head around yet. But however you want to explain it, prices get really high. Prices grow faster than the fundamentals of the underlying businesses. Theoretical explanation, you can pick what you want I guess.
And it's not always one big bubble, and it's probably even hard for us to go back in historical instances and say that there was multiple bubbles or one bubble. It's easy to go back and look at the railway stocks and call it one bubble. But I don't know, maybe there were a whole bunch of bubbles over three years. I think it's just hard to get that level of granularity in the data. In the current technological paradigm, we can see obviously the dotcom bubble, there is the tronics boom that was before the microprocessor anyway in the 60s. And we've got some pretty high prices now. Who knows, but anyway.
There's an instance or multiple instances of the prices of the companies in this new paradigm, the ones that are pushing forward the new technology. Their prices get pretty high. And in a lot of cases, they get really high. And it's not like, I gave a couple examples of rail and internet stocks, but it happened with canals, where you got, there's one really successful canal, I can't remember which one it was, the first canal. And then there are a bunch more companies raising capital to make more canals. And it just turns into this frenzy where people were not properly planning out canals, they're just digging canals wherever. And investors are putting money into it. So, if you want to call it a bubble, it sure looked like one. And then a bunch of people lost money. And canals are actually an interesting one because that revolution happened, and within fairly short order, railways took over. And railways basically made canals obsolete pretty quickly.
Cameron Passmore: Really?
Ben Felix: Yeah. So a lot of people in the canal example lost a lot of money. But same as railways. It's the same thing, where there's all these new rail companies that are building tracks, and there's a different book I read a while ago< I can't remember what it was. It might have been about the Vanderbilt family, I can't remember the name of the book now, but just talking about the stories of all the railway companies and one railway company would build a track literally beside another one in hopes that they would get acquired by them just to make the competition go away. It was the same idea, just massive new issuance, massive capital being raised. And the railway one was interesting too because they used something called scrip. Or that was the nickname, I don't know if that was the actual name or slang, but it was scrip that was used to raise money and scrip was effectively a leveraged tool, kind of an option sort of.
So all these people are massively leveraged investing in the railway stock. Same deal, companies get super valuable, more companies raise capital because money is cheap, or it's easy to raise, however you want to describe it. And same thing, a bunch of people get burned. And then eventually is consolidation, and so on, and so forth.
And then in the 1920s, same kind of idea where, roaring 20s, the economy is just taking off, mass production, automobiles, everything's kind of hitting its stride. And stock prices start shooting up, people start borrowing tons of money to invest in stocks. Same deal. And then we had the internet bubble, obviously. But this pattern of frenzy, it's easy to dismiss Perez's model, but it's actually not so easy to dismiss this relationship between new industries, new revolutionary technologies, and financial bubbles. It's actually really hard to separate in the historical data.
Ben Felix: And then the next phase in Perez's model is that there's a turning point. And the turning point tends to happen around a recession or after a recession. The prices of those new technology companies that were previously high come back to Earth. So the bubble pops, if you want to frame it as a bubble. And then after this point, and this is really interesting to think about in the context of what's happening in the world right now with the antitrust stuff that we're starting to see with Google. There's a recession, and leading up to this too, there's a lot of social unrest, and this is where a lot of the populist movements in the past have come from, because the new technology whatever is is displacing a big portion of the population's productive capacity. And there's no regulation in place to deal with that new technology.
If you think about automobiles. When people started making cars, there were no roads, no traffic lights, no laws, no driver's licenses, no insurance. There's just no regulation. And then at some point, regulation catches up. We're maybe seeing that now with the technology companies, I don't know. So after this recession, and obviously this is all, you can't go and pinpoint exact dates for when this has happened historically, it's just a general model. So there's a turning point, a recession turning point, and then after that, there's institutional acceptance of this new technology. Regulations start catching up. It becomes socially accepted. And at that point forward in Perez's model, is what she refers to as a golden age.
Ben Felix: So at this point, in the frenzy phase, the installation of the new technology infrastructure happens when all this cheap money is flying around. When you think about it, with the telecoms, massive money went into laying cable, like communications cable, fiber optic cable. There's a quote in, I think it was in Perez's book, or it might have been in The Master Switch, about how only 2% of the fiber optic cable that was laid in the telecom boom actually ever ended up getting used. And most of it ended up having to be just written off as losses. But the cheap capital, the profit hungry investors willing to supply capital in the hopes of profits facilitated that. So it's kind of weird because from an economic perspective, that frenzy phase is actually kind of a good thing. It facilitates the infrastructure. You can think about cannabis too, that's another interesting one, where tons and tons of cheap money goes into building massive grow operations and stuff like that.
Most investors lost money. But from the perspective of the economy and the infrastructure for that industry, that phase is actually really important. But it's weird, right? Investors lose money, society and the economy and the the industry in question end up with these huge benefits from that frenzy phase or those those high profit expectations. Whether they materialize or not for investors, for the economy, it's a really good thing.
Cameron Passmore: And for society.
Ben Felix: Yeah, yeah. For society. It seems like an inefficient use of capital but I don't have any better ideas. So once that's done, there's a frenzy the installation, after the regulatory changes and all that stuff starts to happen and the social acceptance of the technology, in that phase, it benefits from the fact the infrastructure is already in place. So, this is where Perez calls it a golden age because the existing economy is able to fully adopt and deploy this new technology because all the infrastructure has been put in place largely based on the cheap capital in the frenzy phase.
And in the final phase, all of these new growth opportunities start to slow down. And financial capital, again, starts searching for the next thing to finance. And that cycle has repeated itself, in Perez's book, it's repeated itself five times. It's a very similar concept in the two books. In The Master Switch, it takes the last technological revolution in Perez's book, and it breaks that down into a whole bunch of individual technological revolutions. From telephones, to telegram, telephone, cable, internet. Within each one of these revolutions, you can have a bunch of smaller revolutions. But that relationship between financial capital and the revolution is very similar.
Now, I mentioned that early on in the technological revolution, it can be pretty nasty and really bad for society as a whole, because when a new technological revolution begins, the old paradigm does not just disappear. These are 50 year cycles roughly in Perez's model, and that maps really well to history. And so as the new paradigm starts happening, there are these real societal and economic divisions between the old industries and the new ones. But also the regions that they reside in. It makes me think of Detroit. Detroit versus Silicon Valley. And the workers. There's this boom revolution, and there's this huge population of workers who are trained with skills to be successful in the previous paradigm. And all of a sudden, their skills start to become irrelevant.
So there's this big disparity in the way that the wealth is distributed at the start of a technological revolution. And that only gets worse as the technology starts to get more entrenched. But then in that golden age, so after the turning point, in the golden age, it starts to get better. Now, this is important, this may sound like we're getting off track as it relates to financial capital, but this piece is really important because those cultural divisions and societal divisions and economic divisions, they actually relate back to the cost of capital.
So these new industries in the new paradigm are really exciting and attractive. And the old ones, they look like they're on their way out. So all the money wants to get into these exciting new industries, and they're willing to pay high prices to invest in them. But we've got to tie all of this back to what a stock actually is. What is a share of stock? You're buying future profits. And if you pay a lot for those future profits, you've got a low expected return.
So in this situation where the whole kind of productive spectrum, the economy is divided between this sort of new economy and the old economy, everyone wants to invest in the new economy, no one wants to invest in the old economy, it's counterintuitive, but the result is that the expected returns on the old economy are actually higher, not lower. And this is where I think the empirical part becomes really important because everyone's going to hear that and say, well, Ben, I don't want to invest in shrinking industries, I'm not going to get good returns. But the reality, the empirical reality is the complete opposite.
So this part I think is really important. That was kind of the theoretical model, which maps really well to the historical experience. But I think getting into some specific empirical examples is, at least for me, it really drives the whole concept home.
Ben Felix: So one of the books that I read for this was Jeremy Siegel's book, Stocks for the long run. It was the most recent edition, I think it was from 2014 was the fifth edition of his book. It's a great, great book, really interesting stuff in there. So he in that book gives the example of the S&P 500 index. So obviously, the S&P changes the S&P 500 index to represent 500 leading US companies. So if an industry is becoming significant in the US market, they will update the holdings to reflect that.
So back in the 1950s, steel, chemical, vehicle manufacturers, oil companies dominated the index by capitalization. And then if you look today, it's information technology and healthcare by a wide margin. And this is the part that Siegel does in his book. He says, what if an investor had invested in the S&P 500 at its inception and never rebounds, never reconstituted based on the future changes to the index constituents. Just held the original 500. And I think the way that he actually does it is rebalances within the original 500 and reallocates if a company goes under, I guess remaining proceeds would be reinvested in the remaining companies. Or maybe that was for mergers or something, I can't remember the exact methodology.
The idea is you're keeping effectively the same original 500 companies. That portfolio would have outperformed the actual index that was reconstituted by S&P by more than 1% per year over the next 50 years. So that's counterintuitive I think. You'd expect the index that's being rebalanced to capture the newest industries would do better, but it actually did worse. And so, Siegel suggests in the book, basically what I've been kind of getting at, which is that the reason that you get this outcome is because investors paid too much for the expected growth of the new companies. I think that makes sense.
Cameron Passmore: So companies being added you would say might be large cap growth stocks?
Ben Felix: Large cap growth stocks, yes, for sure. And stocks that probably have recently had significant increases in their price. Like you look at Tesla being considered for the S&P 500. When did that happen? And they didn't end up making it in, but when did that happen? When the price is just right up whatever ridiculous amount that it did.
And this one I posted in the Rational Reminder community, so people might not find this one as exciting. It's still crazy though. So I got this from the Credit Suisse global returns yearbook from 2015. [inaudible 00:45:43] an article in there looked at the rail industry in the US from 1900 through 2015, and I updated the returns portion of this until 2019. So rail companies by capitalization went from 63% of the US market in 1900, the dominant industry, to less than 1% in 2019. It is the perfect example of a declining industry. Can't find a better one.
Now, over that time period, rail stocks outperformed the US market, they outperformed road transportation stocks, and they outperformed air transportation stocks. Crazy. And I updated it through 2019, like I said, and they've still outperformed. So from 1900 to 2019, rail stocks beat the market despite declining from 63% by capitalization to less than 1%.
Cameron Passmore: Wow.
Ben Felix: Yeah. I've got more too. So 1971 is in Perez's book, the approximate start of the age of information. So that's when Intel came out with the first microprocessor. From then to now, the software industry has grown more than any other industry. And this industry data is from Ken French's data series, which you can get from his website. So basically didn't exist in 1971. And now it's the largest industry by capitalization at the end of 2019. It's 15% of the US market value is software.
And oil basically did the opposite. So in 1971, oil was 15% of the US market or close to 15%, and at the end of 2019, it was about 3% of the US market. Over that time period, a $1 invested in the software index classification grew to $76, whereas a $1 invested in the oil industry classification grew to $134.
Cameron Passmore: What is going on here? Is it because the rest of the market is growing up around it that's causing these bizarre percentage of overall allocation?
Ben Felix: Yeah. Other industries are probably getting bigger. I didn't look into exactly what describes the change in capitalization but I would imagine a lot of it as the other industries growing up around it, and these industries either maybe getting a little smaller or just not growing a whole lot in terms of capitalization.
The other big one I think is that where a lot of the growth comes from, when we're talking about capitalization, is like when we say industry is growing up around existing industries, a lot of that is coming from new issues. And new issues don't increase returns. So if an industry grows from all new issues, it could still have very low returns despite adding capitalization, because returns come from increases in earnings per share.
Cameron Passmore: That's it.
Ben Felix: And if you add new companies, your earnings per share is not increasing. And we talked about this when we talked about the stock market versus the economy a while ago. So when you get a bunch of new recapitalisation happening. I don't have this in my notes, but it is interesting. So if an industry is growing and you're getting a bunch of new listings, that doesn't lead to higher returns, it can actually lead to lower returns.
That's what Rob Arnott and Bernstein wrote about this in a paper called The 2% Earnings Dilution or something like that, where they showed this difference between economic growth, GDP growth and stock market returns or earnings growth. And it's because a lot of the GDP growth is coming from new companies being listed. And whenever you recapitalize like that, you're spreading the same amount of earnings across more companies. So it's increasing GDP but it's definitely a part of it. Yeah. That probably plays into this too.
Ben Felix: They give the example of war torn countries after I think World War II, where they had massive economic growth but bad stock market returns because the whole market had to be recapitalized. So yeah, there's definitely some of that going on here too with all of the new issues. So we tried to dig into whether or not there's a consistently reliable relationship between industry growth and stock returns. So Braden helped me look at this data, and there was no relationship. I think there were maybe seven industries where there was a statistically reliable relationship out of 49 in the Ken French data. So I would call that not a reliable relationship.
But that also means that you can have industry growth and positive stock returns. So one that had that, a statistically reliable relationship was alcoholic beverages. It grew as an industry and beat the market from 1926 to 2019. But it also wasn't the same kind of like massive industry growth we've been talking about. Alcohol grew from .08% by capitalization to 2.85% between 26 and 2019. So, not the massive software growth that we were talking about, but still interesting.
But overall, it's kind of a seemingly random relationship. Which makes sense when you think about where the stock returns are coming from. If you invest in an industry based on your expectations and it delivers on those expectations, you're going to get the expected return. But a given industry, it's not going to do what you expect. There's going to be some industry specific factors that end up affecting it, so you wouldn't expect to get your expected return, you'd expect to get something unexpected plus or minus based on how things actually end up going relative to how investors expected them to go.
Ben Felix: So now this takes us to where we are today. I want to try and give a little bit of commentary on with the big tech stocks that have had their big run up in price recently. And I mentioned earlier, the winner take all companies, not being anything new. This is a thing that's happened many times. And actually, the winner take all companies today are relatively small compared to the historical experience at least in the US market.
I think there's always going to be a narrative for why this time is different. We've talked about why these businesses are better than anything we've seen in the past. And I think I have a good example that people have probably heard of, to put some color to why they're not that much different. They're different in the way that they're conducting their business, but their market dominance relative to historical paradigms is not that exciting.
Now, all of this interestingly kind of culminates in a discussion about value and growth, which is, we can talk about valuing growth, although it's more exciting to talk about technological innovation and industries. But it ends up being basically a value and growth story. And when you look at the market right now, for the last 36 months, ending September, in the US market, values trailed growth by 24% per year for the last three years. That's awful.
Cameron Passmore: Historically unique I think you could say.
Ben Felix: Oh, it is, yeah. You've seen that chart, I was just playing with the data a minute ago. It is at the, if you rank the returns in value, so three year value returns from best to worst, left to right, if you rank those and chart them, this three year period ending September is the worst by 7% per year. The next worst is -17% per year in March 1940, ending March 1940. That's ugly.
Now, I don't know if it's fair to call that a bubble or not, but it just seems like an easy way to think about it. Robert Shiller describes a bubble as a positive feedback loop where a group of stocks begin to rise and then there's a narrative around it. And then more people hear the story, the stocks continue to rise. And then people start reading about it on Reddit, media is talking about it, whatever, whatever. It keeps on going. The other effect that that has is it makes capital easily accessible to similar companies. And maybe that's got something to do with all the IPOs we've seen this year. I read a couple papers on that too, like when companies go public. They do it when the cost of capital is low.
Cameron Passmore: That's right. Give up less of the company, or get more cash.
Ben Felix: Yeah, get more cash. And then the implication for investors that expected future returns are then lower, which is one of the explanations for why IPOs have performed pretty badly. So, the parallel that I want to draw between history and the current companies is with the Nifty 50. So these were 50 companies in the late 60s, early 70s. They were the essence of that technological revolution. This is the age of oil, the automobile and mass production. And these companies were manufacturing retail, but big strong companies with really good underlying businesses just like the big huge companies that we have today that have had their prices run up.
10 years before the Nifty 50 became a thing, there was the tronics boom, which I briefly mentioned earlier. And that was, I mean, I don't know a ton about the tronics boom, but it sounds a lot like our little internet bubble that we had in 2000. It was like any company that had the name tronics in it or electronics in it just got a massive boost in its price, and its price multiple. And there was a bunch of fraud and companies that have no real businesses going public. It sounds really similar.
Cameron Passmore: I'm sure some people might disagree with you calling it a little internet bubble, but we'll go with that.
Ben Felix: That's fair. If you look at 2000 and like a global index stock of return series, it's actually not that bad. If you're in tech, it was really bad. That's why I guess I thought about it as little, it wasn't little, that's probably not fair to say.
So, the narrative here is that investors at the time had been burned by all these these fake companies or companies with no real business models 10 years previously. So they got really interested in investing in good, solid businesses that were at the leading edge of, at that time, the technological paradigm. And what happened was the prices of those companies, and this is a narrative, who knows why the price has actually increased but let's go with a narrative. The price of these companies got really high. And not quite as bad as today, but for the 36 months ending July 1972 when the Nifty 50 had their big run, value had trailed growth by 7% per year.
And you got to think, the mindset must have been somewhat similar. All those people call them one decision companies. Just invest in that one stock and you're going to be good forever. But the Nifty 50 did not deliver that result. There is a big drop. Some of them lost 85, 90% of their value. Long term, the companies in the Nifty 50, I think they still did fine, but they didn't end up being one decision market beating stocks.
And then there's the data point that we talked about in a recent episode, where for each decade starting 1930, 1940, 1950, and so on, all the way through 2010, each decade starting, so ending 2020, the 10 largest companies that started each decade have trailed the market by an annualized 1.51% on average for the decade that followed. And those 10 largest companies tend to be the ones at the leading edge of whatever paradigm is existing at that time, mixed in with some of the older companies from previous paradigms that are still dominant, like Exxon has been around for a paradigm or two, being one of the largest companies. Although maybe not so much now.
Ben Felix: The big takeaways here are that industry bets, regardless of the industry, no matter how exciting it is, are risky. And you introduce industry specific risk. And investing in the newest and most exciting industry has historically given bad results, not good ones. And doing the opposite, investing in the boring, old or even declining industries has actually given significantly better results. And again, we've basically just arrived back at me saying that value beats growth long term, which isn't new, but framing it in from this perspective I think is important.
And the last piece, and I think this is just as important as anything else is that after all of what I just said, people might say, okay, well, I'm just going to invest in the next technological revolution. Find the next Apple or Google. That's even harder than I think people realize. We throw around positive skewness and stock returns. Most stocks do poorly and a few stocks do really well, and that drives all the returns. That's positive skewness.
Now, that's true for stocks as a whole, but within IPOs, which behave like small cap growth stocks, and within venture capital, the skewness is far more extreme than it is in the stock market as a whole. So that concept of identifying the next winner, that's hard to do in stocks, period. It's extra hard to do in small cap growth stocks, which IPOs tend to behave like. And it's then even harder to do in venture capital.
Someone in the Rational Reminder community posted that advertisement for the ark innovation ETF, and it was basically making fun of investing in industries like banking and rail and saying, why would you want to do that when you can invest in technological innovation. But it's actually the complete opposite, at least when you look at the historical data. And it makes perfect sense when you frame it in the lens that Perez lays out in her book.
So I have my concluding note is that, investing in technological innovation, and also, investing in the winner take all companies of a given technological paradigm, are time tested failures. And counter intuitively, it's investing in declining industries or value stocks, if we have to go there, that's produced better outcomes.
Cameron Passmore: So basically, you're working on your killer lines for your YouTube video. You're testing out your material.
Ben Felix: I usually write these in a way that I can use them for YouTube as well. But like I mentioned earlier, there's still some stuff that I'm trying to wrap my head around. I do use the podcast as more of a platform to discuss these ideas, even if they're not quite ready for YouTube. And I always appreciate the feedback that we get because it makes it makes the whole process of writing and thinking about these things more fun, but also more productive, because a lot of the, The Master Switch is a book, I don't know if I ever would have found if a podcast listener hadn't mentioned it.
Cameron Passmore: Yeah, super interesting.
Ben Felix: This hasn't been as much as, quantitative easing almost killed me actually. This hasn't been as bad as that, but there's a lot of stuff to take from this. Yeah, a lot of hours for sure. It's such a big topic and it's so, it's not that counterintuitive. If you reduce it down to, well, stocks with high prices underperform. That's about as reductionist as I can get with it. But it also explains it, like it's true. If IPOs, if new listings tend to behave like small cap growth stocks, that kind of explains the whole phenomenon right there. But I think having the framework for Perez's four phases of technological revolutions and the historical context that her framework maps so well to the last five technological revolutions, I think that framework maybe helps to make sense of it.
Those empirical examples too, you really have to sit down and think. It's like the way you asked, how is that true that rail declined from 63% of the market to 1% but beat the market in terms of returns over the same period? You really have to sit down and think about why that happened. These are empirical facts, you can't deny the data.
Cameron Passmore: Great work. Planning topic this week. I just found this interesting article that follows up on our discussion two weeks ago that looked at how high individuals' investment knowledge was. Remember how poorly people did on average, and how people really self-assessed themselves to be much higher than they really were. So I came across an article in the financial planning review from July 13th this summer entitled The Household CFO: Using Job Analysis to Define Tasks Related to Personal Financial Management.
So just thinking about that discussion we had two weeks ago, and to come across this article that actually looked at what do you have to do, and what do you have to know how to do in order to be successful managing your finances at home? If you think about it, we all end up in this role, at least one of us in a typical household. It's a job that you're not necessarily were trained for, weren't recruited for, it's not considered part of your work related job. And it's this interesting mix of skills and math and values and attitudes and personality all meshed into whether or not you're going to be successful in this role.
And you think about the actual job, being a household chief financial officer, there's a ton that goes on, right when you actually sit down and write out what the tasks are, from cash management, to budgeting, spending, asset management, long range planning, risk management, insurance, home, vehicle, personal insurance, life insurance, taxes, state planning, elder care, education planning. The list goes on and on and on. But how good are you at it? How do you know? And that's what this article is about.
Ben Felix: That's crazy to think about because even within the things that you just listed, even within our team, nobody is great at all of those things. Everyone's good at them, and some of us have specific specialized knowledge in one or two of them. But nobody on a team of financial professionals who are able to provide financial advice to people, nobody is an expert in all of those things.
Cameron Passmore: [inaudible] dig into the list of tasks you have to do. It's pretty crazy. And what this paper did is they did a list of tasks, and looked at the word from industrial psychology perspective, which is the study of human behavior in the workplace, to explain what tasks and characteristics were there in those that were successful in their household CFO role. So it identified the critical tasks and how frequently these tasks were being performed.
So they came up with this list of 259 items. They came from various sources, including the books by Dr. Tom Stanley, and the Millionaire Next Door series. Have you read these books?
Ben Felix: No.
Cameron Passmore: I remember when they came out in 1996. They were great books. And then they also went through various Labor Department networks, as well as some academic research to come up with this final list of 259 items over the four categories of planning, financial responsibility, problem solving/decision making, and working with others. And the goal is to learn from two different groups. Those that were arguably successful and those that were less successful, to figure out how do you, to shrink this gap between being successful, not being successful in your role as household chief financial officer.
So what they did is they built one group of people that, somehow they they came up with these people that were followers of some of the things that Dr. Thomas Stanley talks about. So I remember, this is off the top of my head, when the books came out in the mid 90s, the things that identified the typical millionaire next door was, they're not flashy, they're first generation wealthy, they took a long time to amass their wealth, they got rick slowly, and they allocated serious time to financial plans. So what they did is they asked this one group out of these 259 tasks, rank them in terms of importance, rank them in terms of frequency. Then the researchers combined those two to come up with what they defined as the most critical tasks.
So most critical tasks, let's go through the top five. Number one, live well below your means. Pay bills on time. Spend less on expensive than your total income. Complete and file tax returns on time. And create an emergency fund in your budget. So those are the top five. Then they set up a second group and asked them the same questions. Tell me, out of the 259 items, which ones are most important, which ones are most frequent? And they could take a look at the most critical ones. Well, when they did that, they found that the only ones similar to the top five of group one, so the wealthier group, were two, paying bills on time and filing taxes on time. Not one of the other top five were even in the top 20 in that second group.
Ben Felix: Wow.
Cameron Passmore: Isn't it amazing?
Ben Felix: Yeah, it is.
Cameron Passmore: And they said in general, that second group, rather than focus on financial planning tasks that involved making trade offs, those in that second group spent more time on interpersonal tasks and activities such as discussing unplanned expenses, devoting time to strong relationship with spouse, ensure consensus pre-purchase, dispute inaccurate charges, and demonstrate respect for spouse regarding their level of financial skills, which is really interesting.
Ben Felix: This is really cool.
Cameron Passmore: Anyways, the list of 259 tasks is in the paper, we'll put the paper in the show notes. And they also put down industrial psychology, I don't profess to be an expert in that area, but they put down the knowledge, skills and abilities that are critical to success in this role. So if you take a look at the task area planning, it's important that you have record keeping skills, deductive reasoning, ability, and conscientiousness. No great surprise there. In financial responsibility, record keeping skills, again, and conscientiousness. In the task area of problem solving/decision making, financial literacy knowledge is important, complex problem solving skill, mathematical reasoning ability, and deductive reasoning ability. On the last task area, working with others, you have to be agreeable.
Ben Felix: Oh, wow.
Cameron Passmore: What is cool is they said is that if you did this properly and gauge your ability as if you were in your own job at work, you could identify weakness areas which would help you going back to comment about the team, identify an advisor that fits and complements where you're weak and strong.
Ben Felix: That is interesting.
Cameron Passmore: But the list of 259 items is-
Ben Felix: That's really cool.
Cameron Passmore: It's really cool and they did it deliberately so they don't overlap. I'll give you some other examples of items, make financial decisions based on household budget. Understand the nature of investments and likelihood of risk and return. Budget enough for basic needs. Invest in employer provided savings accounts. Focus financial management to become debt free. Pay entire credit card balance each month. So there's 259 of these things that you can go through and say, yes, I do it, I don't do it, and how often do I do them?
Ben Felix: 259.
Cameron Passmore: 259. They had over 1000, they boiled it down to 259. And they're all there.
Ben Felix: That'd be kind of cool for people to go through as a sort of checklist.
Cameron Passmore: On to bad advice of the week.
Ben Felix: Yeah. The one that you have posted in here is still worth talking about, a couple people sent it to me, but I've got another one as well.
Cameron Passmore: There's a lot coming in, I think people want these sweatshirts. Anyway, this one came from the Globe and Mail October 19, 2020, entitled, with low rates here to stay, it's time to rethink a balanced strategy and invest in your longtime favorite dividend stocks.
This one comes from Gordon Pape, who is a longtime financial commentator. And we had him speak for our company back in the early 90s if you can believe. And small world story for you, he went to school with my mother. I think in Three Rivers Quebec, but that's another story. Anyways, he used to write the Buyer's Guide to Mutual Funds, and this was a must read book every year. I remember waiting for it back in the early 90s. It came up before the end of RSP season, we would just pour over it back in the active mutual fund days.
From the article, he says, "If you're hanging on waiting for GIC rates to get back to normal levels, get ready for the long haul. It's likely to be at least five years and maybe longer before you are able to find a five year guaranteed investment certificate paying more than three and a half percent. He goes on to talk about the fragile economy, possible shutdowns from the Coronavirus, massive government deficits and how rates are likely to remain low."
"So he continue, so what does this mean for your investments? At current GIC rates, you'd be lucky to break even after taking into account inflation which will almost certainly rise and taxes. Based on the rates offered on recent issues, bonds don't look like a good option for income oriented investors. So of course, this leaves the stock market. Dividend paying issues have tended to underperform in recent months, but high quality companies have maintained their payouts, and in some cases, even raise them. I've always been a proponent of a balanced portfolio, but those are the days when the world was sane. Now we need to rethink how we position our assets. It's time to reconsider the traditional 60-40 stock bond split and move a higher percentage of assets into low risk dividend paying stocks."
But let me be clear about the meaning of low risk. I'm suggesting securities that will fluctuate in market value in the coming years, but will maintain or increase their dividend and distributions. For income investors, that should be the main focus. Don't fret if the price of the stock temporarily goes down. The time to worry is if a company you own cuts its dividend."
Ben Felix: That's it.
Cameron Passmore: Good candidate for bad advice of the week?
Ben Felix: Yeah, I think so.
Cameron Passmore: Swap you bonds for dividend paying stocks.
Ben Felix: I mentioned this in the last episode where we had a bad advice section. I feel like it's important for us to talk briefly about why that's bad advice.
Cameron Passmore: Do we really need to talk about dividends again, though?
Ben Felix: No, just quickly because some people, if it's a new listener, for example, that's never heard us talk about dividends before, they might be wondering why it's bad advice. I think it's worth just briefly talking about it. Stocks, whether they pay dividends or not are risky investments. When a company pays a dividend, the value of the share drops by approximately the amount of the dividend paid.
Cameron Passmore: Dividends just repackaging of returns.
Ben Felix: Yup. A stock paying a dividend when it's down is the exact same thing as selling a few shares to get the same value when it's down.
Cameron Passmore: Except less tax efficient.
Ben Felix: Yeah, less tax efficient, in most cases. Individual stocks are never safe no matter how strong or stable the company is. We talked about skewness in the end of the technological revolutions piece. Skewness in stock returns is an absolute killer. Stock's not safe investments. And under no circumstances are stocks a replacement where a GIC would have otherwise been the sensible choice.
Cameron Passmore: I think back to Morgan Housel's book, The Psychology of Money. He talked about the benefit of having bonds in your portfolio so you can hang on to your stocks if things go south. And this doesn't help that at all.
Ben Felix: No.
Cameron Passmore: Great book. You got to read it. Morgan Housel's book.
Ben Felix: It's sitting on my shelf back there. I've been busy reading all these other ...
Cameron Passmore: So you have another bad advice you said?
Ben Felix: Yeah. I also just wanted to make a note on inflation. Our guest coming up next week, who I'm super excited for, Professor Lubos Pastor, one of the things that we're going to talk to him about is actually inflation. And I won't give away his whole talking points on this, he'll do a better job explaining it anyway, I don't think hearing it twice is a bad thing. But I'll just briefly say his idea around this is that the pandemic has disproportionately affected young people who are unable to work in a lot of cases, and not really affected old people who are on fixed incomes and have an easier time staying at home.
Ben Felix: So he believes, I think, I mean, this is me, paraphrasing what I think he's going to say based on what he's written about it, that from a transgenerational perspective, it will make sense for governments to allow higher than normal inflation because that shifts the sort of post-pandemic burden from younger people who are ultimately responsible for the government debt back onto older people, because younger people don't tend to be as affected by inflation because their incomes rise, whereas older people do get hit by inflation because they're generally on fixed incomes. We'll see what he says when we actually ask him the question, but based on what he's written about it, he believes that governments will push central banks to allow some inflation to help with that transgenerational wealth transfer. I thought that was a pretty interesting perspective.
So the other bad advice that I had just real quick is from, I'm not going to call out the actual course because I don't want to get in trouble. But a course that people take to get licensed to sell investments. Not naming any names here. The section on how to select a mutual fund. And you're not going to believe this. So there's three criteria here. Focus on the best long term performance. This is a course that people are required to take and pass in order to have a license to sell mutual funds in Canada. Focus on the best long term performance. So that's your first criteria, you want to find the mutual funds with the best long term performance. Keep in mind that people with no previous education may be taking this course and then going on to sell investments. So, best long term performance. Okay.
Once you've got the funds with the best long term performance, the way that you narrow it down further is by finding the funds with the best year to year performance. So the least variability in performance. Okay, so now I've got funds with good track records, relatively low standard deviations.
And the last one is that you want to focus on funds that have successful investment managers. So when you've got the funds with good performing funds with low volatility, you want to find the funds where you can attribute the success to the investment manager.
Cameron Passmore: Perfect.
Ben Felix: Because good performance can be a combination of luck and skill. So we want to find someone that's-
Cameron Passmore: So by doing that, you've eliminated the luck out of the equation. You know it's skill, because it's high, persistent, human driven performance. Got it.
Ben Felix: That's right.
Cameron Passmore: Okay.
Ben Felix: Yeah, so a fund with good performance over the long run. And the same manager in charge is what you want to find. You want to use alpha as well, make sure that the manager is-
Cameron Passmore: You want alpha of course.
Ben Felix: It looks like, at least by the way it's been described here, it looks like we're talking about single factor alpha. There's no mention of, yeah, we're just looking at beta here. Yeah, no, it's just beta. Single factor alpha, if the manager has that, then it's going to be a green light. That's unbelievable.
Cameron Passmore: Oh, it wouldn't be if that was 1985.
Ben Felix: Maybe that's the problem, maybe it hasn't been rewritten. I find that just absolutely staggering that people coming into the industry are being taught that. Of course the distribution of fund assets in Canada looks the way that it does. Yeah, okay, that's it. That's all I got.
Cameron Passmore: Okay, thanks for listening.
Books From Today’s Episode:
Technological Revolutions and Financial Capital — https://amzn.to/3m8Xiqy
The Millionaire Next Door — https://amzn.to/32FHCnd
Links From Today’s Episode:
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Benjamin on Twitter — https://twitter.com/benjaminwfelix
'Earnings Growth: The Two Percent Dilution' — https://www.researchaffiliates.com/documents/FAJ-2003-Two-Percent-Dilution.pdf
'The household CFO: Using job analysis to define tasks related to personal financial management' — https://onlinelibrary.wiley.com/doi/full/10.1002/cfp2.1089
'With low rates here to stay, it’s time to rethink a balanced strategy and invest in these dividend stocks' — https://www.theglobeandmail.com/investing/markets/inside-the-market/article-gordon-pape-with-low-rates-here-to-stay-its-time-to-ditch-a-balance/