Ep. 71 | 4 Ways to Survive a Market Crash with Apollo Lupescu

War in the Middle East. Rising oil prices. Expensive markets. AI changing everything. With so much noise, what should investors actually do? In this episode of The Purposeful Investor, David Andrew and Aden Wilkins sit down with Apollo Lupescu from Dimensional Fund Advisors to answer the questions coming out of client meetings right now.

Apollo has a gift for making the complex simple, and in this conversation he draws on decades of market data to explain why the right response to uncertainty is almost always the same and what history proves about staying the course.

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Chapters:
(0:00) Introduction & Episode Preview
(1:00) Welcome & Guest Introduction: Apollo Lupescu
(2:00) Win of the Week
(5:00) Middle East Conflict and What It Means for Investors
(7:00) How Markets Process Geopolitical Events
(11:00) What World War II Teaches Us About Staying Invested
(16:00) Why Timing the Market Requires Two Perfect Decisions
(26:00) Building a Financial Plan That Survives the Bumps
(31:00) The Danger of Averages and Bear Markets Explained
(35:00) 4 Strategies to Shorten Your Recovery Time
(43:00) Valuation Explained: Tesla, Toyota and the Magnificent Seven
(52:00) Is It Different This Time? The Chess Board of Investing

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Recorded and produced by Podwave Studios https://podwavestudios.au/

The Purposeful Investor Podcast is a public service provided for Australian investors wanting to make smart decisions with their money, avoid costly mistakes, look after the people they care about, and, have a great life!

We draw on over 30 years of experience from David Andrew and the Capital Partners team.

For more information on Capital Partners' award winning team, visit capital-partners.com.au.

Have a question? Email us ask@capital-partners.com.au.

This episode provides general advice only. We do not consider your personal circumstances when we share this information. Always refer to your financial adviser for advice about your personal circumstances. 

Capital Partners Consulting Pty Ltd AFSL 227148 trading as Capital Partners Private Wealth Advisers ABN 27 086 670 788.

Transcript

The Big Question Up Front

SPEAKER_03 0:00

How will this conflict impact the potential of any one company to make money? Their primary point of difference is I can protect you from all the bad stuff. Yes. Tell us about that. When the market drops, you own exactly the same number of shares.

Aden 0:15

When you look at some of those big downturns and people say, well, how do I mitigate that seven-year or eight-year period will go down?

SPEAKER_03 0:21

If you have your feet in boiling water and your head is in the freezer, on average you're comfortable.

SPEAKER_00 0:28

The war in the Middle East, no one really knows how long it's gonna go. The last time we had really bad oil shocks was in the 1970s, and that was pretty bad. How should people be thinking about that?

SPEAKER_03 0:40

That's a long time to be on the water. So the question is like, okay, we eventually recovered, but what can you do about it? How can you shorten this time? And I would argue there are four things that you can do, and you're doing it for your clients.

Welcome And Wins Of The Week

Aden 0:51

Welcome to the Purposeful Investor Podcast. We're a podcast for successful families who want to make smart decisions about their money and their future and also avoid costly mistakes. We're here to make sure that you and the people you care about are okay no matter what, and also to set you up to live a great life. Welcome back to another episode of the Purposeful Investor Podcast. Today we're going to be talking about a few very good topical things in the world of investing and in the world in general. And joining me today, I've got Capital Partners founder, David Andrew. David, welcome to the podcast.

SPEAKER_00 1:25

Always good to be here, Aidan.

Aden 1:27

And we have a very special guest in the studio today, all the way from California on the other side of the world. We have got Apollo Lepescu, who's a PhD from Dimensional Fund Advisors. And it was put to me yesterday that the best way to describe him is he's the secretary of making the simple, sorry, the complex look very simple. So, Apollo, welcome to the podcast. Hey then, great to see you, David. Fantastic to be here. Thank you so much for the invitation.

SPEAKER_00 1:52

Thanks for joining us.

Aden 1:53

And so there is a lot going on in the world at the moment. So geopolitical conflict, there's lots of noise out there. And we're going to go into a few of the big questions that have been coming out of client meetings, in the headlines, and actually just unpacking them a little bit and understanding what is actually going on. But as our listeners know, we like to start the podcast off with our little win of the week. So something that you can reflect back on. In the last week, there was a little win, personal or professional. Since you're our guest, why don't you start us off with your little win, Apollo?

SPEAKER_03 2:22

Well, it would have to be the fact that I am back in Australia. It's uh it's uh it's been about a year, less than a year since I've been here. The fact that I get to see Perth and I get to interact with all of you in person, it's my biggest win. So I'm so glad to be here and to visit this amazing part of the uh of Australia.

Aden 2:41

So uh that's that's my win. How do the um beaches stack up against California on first view?

SPEAKER_03 2:47

Well, I wish I had seen the beaches. We're gonna get you back because I heard so much about the weekend. I have been uh trying to surf at home, so I heard that rumor has it that there's some great surfing here, and I look forward to doing it one day. It's just unfortunately this time around, uh, it just did not work out, but I'm so excited to come back.

SPEAKER_00 3:06

Work schmerk. We need to work. What about you, Dave? What is your well, this is really weird because when when we got the opportunity to um book Apollo or have the opportunity to have him uh present to a client event last night, all this mess in the Middle East hadn't broken out yet. So I was looking at the topics and we'd sent through some topics that we were going to talk about at the client event. Um, and then this broke out. And so it was just so timely to have a full room of our clients upstairs last night, some wine and so forth, just to just to share some a re bit of a reality check, I think. And so yeah, it was great. And um, that's why we thought we might repeat the conversation today so that we can get it get to a much wider audience. How about you, Aiden?

Aden 3:57

Uh mine's a professional one as well, but slightly uh slightly different. So I'm involved in the WA, the Western Australian chapter of the Financial Advisor Association of Australia. Um and as part of that, I'm involved with Curtin University here who offered the financial planning degree. And I just found out so there's 200 students enrolled in financial planning. To give you context, if we go back six years ago, there was 12 students in the whole airport.

SPEAKER_00 4:21

Yeah, and the year after that there was 25. Yeah, it's amazing.

Aden 4:25

So it was actually really nice that all the work we're doing, investing in the uni to get more people coming through, is uh finally starting to pay off. So that was pretty cool.

SPEAKER_00 4:32

And that's not just us, of course, there's some some of the best firms in Perth are really leaning into this because Australians need good financial advice. And um you know, there used to be 30,000 advisors in Australia, there's now fifteen and a half thousand. Wow. Because they brought in the education standards. So that's fantastic news. Well done.

Aden 4:55

That was um a nice little surprise to you. Yeah, congratulations.

SPEAKER_00 4:58

Yeah, definitely.

War, Emotions, And Market Pricing

Aden 4:59

So off that note and onto the topic at hand, why don't we start by talking about what's going on in the world? So there's been a lot of headlines, news around geopolitical conflict, uh particularly in the Middle East. And one, what does it mean for investors, but also what does it mean in terms of should people be doing anything differently?

SPEAKER_00 5:18

I might just lead in and add to that. I I I find this whole thing, and I think lots of our listeners will find this whole conflict very distressing because there's such a big human element to it as well. I think not far below the surface, we're thinking, oh gee, I hope I'm gonna be okay. But I think our primary concern is for the people who are on the receiving end, whether they're Iranian or uh Israeli, it doesn't matter. There's a lot of humans involved in this, and and I think that's what is the first thing that's distressing. And then there's just below the surface of, oh gee, this is this is pretty scary.

SPEAKER_03 5:53

Right.

SPEAKER_00 5:53

Right.

SPEAKER_03 5:54

Well, I I think it's so important to to start with the human element because there's a lot of suffering and uh and people are uh dying and it's it's uh anytime you see conflict, I do think that it takes an emotional toll.

unknown 6:07

Yeah.

World War II Returns Surprise

SPEAKER_03 6:07

And it creates anxiety. We don't know where this is gonna go. And whenever there's war, it's just it's war. It's it's it's you know, we don't expect to see it. Like we thought that this civilization moved on and we're gonna be uh in a better place. And and it seems like every once in a while we go through some all these phases. And uh what's interesting too is that when it comes to the emotions associated with this, uh something that was fascinating to notice last night uh during the event, as well as in the US, very, very similar. Last night, uh talking to two of your clients, one of them was very uh anxious about the conflict, what's going on. The other one was excited in the sense, not excited that it's happening, excited, well, it's a good thing because this way perhaps they're not gonna have good weapons, they're gonna be a threat. So there are divergent opinions. I don't think there's a universal agreement that this is you know good or bad. And uh um, and and you know, I uh you wish there was a better communication on, but in other words, these emotions are real and they're all over the place, and I think we need to acknowledge them. Uh so the suffering, the emotions are real. Uh, what's interesting though, to Aiden's question is that us as investors, while we acknowledge these emotions, professionals need to disentangle them from investment decisions and make sure that when you invest somebody's money, the basis of the decision is not how you felt, but rather very pragmatically based on data and evidence. I think that's a fundamental premise of the market, is that you want to take away the emotion. People who do things emotionally tend to not make the right decision. Uh so in that respect, I have to start with uh this premise that that the function of the stock market is not to uh assess morality. That's just not it. I mean, I, you know, I there are other venues for that. What it is, in my opinion, is a way to assess uh how much is a business worth at any one moment in time. Because when you buy shares into, you know, whether it's Rio Tinto or Chevron or uh uh, you know, Newman Mining or Google or Facebook, you are buying a piece of a company and you have to pay for that privilege of partaking to the earnings of that company. That's exactly what the stock market allows us to do. So when a conflict like this happens, the fundamental question that the market participants are asking is how will this conflict impact the potential of any one company to make money? And what you saw the day after, so the bombing happened on a Saturday, when you looked at Monday, you look at companies in the US like American Airlines. Well, that stock went down because there are flights in the Middle East, and that is probably not gonna impact them positively. And that's exactly what I would expect. On the other hand, you had another stock like Lockheed Martin, which makes uh rockets and other defense um items for the government. Well, you'd expect that they're gonna buy more of those. So the stock price of Lockheed Martin went up. So every single stock will have a different reaction to these geopolitical events. And when you combine them all in the U.S. market, what's fascinating is that the Monday after the uh uh the attack, the stock market in the US was pretty much flat. Not that it didn't care about the conflict, but what it assessed is that to most companies, this conflict will not have a material impact. You know, if you look at Starbucks, how many Starbucks is there in Tehran? If you look at uh uh Apple, how many iPhones are they selling in Iran? Uh and what the markets kind of processed is that it's it's emotional, it's hard to see the suffering. At a pragmatic level, for most companies, it will not have an impact. Now, days later, everybody became a geography expert and uh straight up her moose and all that stuff, and all of a sudden you realize wait, there's a uh traffic jam of oil tankers and they can't get through there. Uh well, that's going to have an impact, and the market processed that. Uh, so I think that's the function of the market to be unemotional and process this idea of um how is this impacting the world? So, what does it ultimately mean for the for you as an investor? What we found looking at history is that over and over, the companies impacted, whether positive or negatively, uh, by any uh geopolitical or worldwide event, uh they tend to be very resilient because it gives them a chance to innovate and adapt. And quite often they might even come out stronger at the other end. So if you find that I'm relying too much on the Middle Eastern oil, well, that's what the U.S. found out in 1973-74 with the oil crisis. And what happened afterwards was you had this uh energy independence that allowed the U.S. to produce more and now be a net exporter. And that what I that's what I mean immediately might have been a little painful, but companies and economies, they do find a way to be resilient and innovate. And and I will have to take probably the worst conflict of modern history. And I was talking to my mother, and she's 91 years old, and when I asked her, because she seemed a little anxious about this as well, and asked her, Mom, you know, what was the worst geopolitical event that you confront in your life? And without blinking, she said, World War II. She lived in Europe and she said that was as bad as it got. Tens of millions of people dead, devastation all over the place. Uh, and and that kind of got me curious. Well, when you look at the history of the markets, what exactly happened uh to U.S. investors during that period of war? And this is where it gets so interesting because if you go back to September of 1939, and you're an investor, you see bombs coming and say, this is not good. This is not good. It's going to be a world conflict again, devastation over the place. And somehow you decided to stay invested in the U.S. stock market. And I'm reflecting on the U.S. market uh from 19 uh thirty-nine to nineteen forty-five, is because that's the only market where we have data. No other stock market in the world had data at that point in time. The UK came back later in 55 and so forth. But you can look at that six years of war, September of 39 to August of 1945, and you can look at the SP 500 index, which is a uh aggregation of the largest companies in the U.S. market, and you ask, well, how did investors fare during six years of war? And what's absolutely remarkable is that in those six years of war, one dollar invested at the beginning of the war would have pretty much doubled. Pretty much doubled.

SPEAKER_00 12:31

And I bet most of our listeners are sitting there thinking, ah, it would have been terrible. It would have been a terrible outcome. Exactly. Because logically and emotionally emotionally, they cannot be good.

SPEAKER_03 12:41

Yeah. And and and you know, you can some uh somebody actually pointed out to me that they listen, the U.S. got involved in December of 41. So the U.S. was only in the war 42, 43, 44, 45. And what's amazing, uh, guys, is that if you look at those years, in every single year, the U.S. market was up at least twice the long-term average of about 10%. Uh every single year the market was positive in 42%, 43%, 44, and 45. And to me, does it mean that um the war is good for business? Not at all. Not at all. I don't I think that supply chain. No, that's not it. It goes back to what I just mentioned. I do believe that firms will innovate and they will find ways to navigate as well as long as they operate in free markets. Uh and if you go back to those days, uh, at some point I lived in Michigan, uh, and I would go with a uh a friend of mine, and on Sunday nights we would have dinner with elderly couples or individuals who were just alone, and they would tell us stories about the good old days. And one thing that that I recall, they're talking about you know how these companies navigated the war. And when I look back, I found some uh ads from back in those days, and you have a Cadillac. Cadillac, uh when they couldn't sell their cars, they put the engine into a tank and they sold it to the government. When Ford couldn't sell their cars, they were making airplanes the same way that Ford was making respirators during the pandemic.

SPEAKER_00 14:03

Crossler would have been making Jeeps. Exactly.

SPEAKER_03 14:06

In fact, Jeep was created. Jeep was created um uh in uh in uh in those days to provide military vehicles to the army. And that's we s they were still around after years.

SPEAKER_00 14:19

Because we were chatting last night and I was saying being the age I am, I've had nearly 40 years of investment experience. Right. And in the early years, when I had lesser amounts of money, which is true of all pretty much all investors, you build up over time. Um I would react to these sort of things. Right. And I would try and back my judgment, my best judgment. But certainly for the last 20 years, probably the last 30 years, I've just said I'm staying in the market no matter what. No, once the money's in, the money's in. It's staying in. And that has worked out for me to be an extraordinarily simple anchor that's made me a lot of money, frankly. And and it comes back to this idea that the the the American stock market, let's just say the broad American stock market, the S P 500, since 1926, so we're talking a hundred years, right, has it returned what, 9.6, I think? Just compounded. 90%. Yeah, yeah. Nearly 10%. Let's call it 10% just for the sake of the conversation. And all you had to do was turn up and not worry about all this geopolitical stuff that jumps in the way to try and derail us.

SPEAKER_03 15:35

And that's exactly right. And and you just have to be this you have to be there. The market gives you returns for the taken, and and the only way to miss is if you get out. And and the the notion that you can somehow protect yourself um is uh is not necessarily uh a a pragmatic one, but rather an emotional one.

unknown 15:54

Yeah.

The Trap Of Market Timing

SPEAKER_00 15:54

Because uh But there's a lot of market participants, of course. Fund advisors and managers and so forth who would tell you their primary point of difference is I can protect you from all the bad stuff. Yes. Tell us about that.

SPEAKER_03 16:07

Well, I mean, there there are two ways to think about it. The the first one is that if you want to protect somebody, uh in in the conventional Wall Street way, the idea was that you examine and hey, this is not a good time to be invested, things don't look good, get out of the market. The problem with that is is twofold. Uh the first problem with that is that when you decide that this is not a good time to invest, like for example, the pandemic, the market lost about a third of its value in a matter of weeks. And people were panicked, like this is different. This is unlike anything else we've seen. We need to get out because this there's no bottom to this. Um, and I think that that the uh you know, if you're an investor who says, okay, this makes sense, let's get out. The problem is that you have to make an equally important decision at exactly the same time, which is when do you get back in the market?

SPEAKER_02 16:53

Yeah.

SPEAKER_03 16:53

And that's the problem that a lot of folks in the US had. They got out of the market, they were scared, and then as the recovery happened and the market, in fact, went up about 18% for 2020 uh during the pandemic, they were still sitting and nursing those losses, and they will never recover them. They'll never recover them. See, the thing is like when the market drops, you own exactly the same number of shares. Their value is now lower, but you own the same number of shares. You are entitled to the same profit uh percentage of the profits of the company. That hasn't changed. What's changed is the value. But you know, it's like having a uh you know a house that that somehow every minute it tells you what the value of the house is. What are you gonna do? Like, okay, fine. I'm still gonna collect the rent. Like if you own uh, for example, uh a property and uh and you charge your tenants X amount of dollars. Well, it turns out that if the value of the property goes down, you're still collecting the same rent. Companies are still paying dividends and uh they might not make as much, but in the case of Yeah.

SPEAKER_00 17:57

And so I'm interested in your perspective on this, Aidan, because you're you're very much client-facing. I get the sense when I talk to people, not so much our clients, because they're really well educated, but just people I run into, they they have this view that when they're investing in the stock market, the share market, it's kind of gambling and that they're they're buying bits of paper almost. And you know, I just became so crystal clear on this a long, long time ago that I'm a part owner of BHP and I'm a part owner of Toyota Corporation of Japan, and I'm a part owner of NVIDIA. And and I just think if people could cross that one simple mental bridge and come to terms with the fact that they're not buying a piece of paper, they're buying you are an owner, okay. I I don't own very much of Toyota Corporation, right? But I own part of Toyota Corporation. So my mindset is no no no, these are operating companies that are paying me a dividend. And that's a really useful thing to be to be an owner of.

Aden 19:07

But I think it comes back to Apollo's point before. So to participate in the share market, the privilege is that you get to participate in the ownership of a company. And then fundamentally you've got to ask yourself the question if something's happened, what does that change about the fundamentals of the company? Good point. And like you said before, and I think this is what gives me the most optimism as an investor, is you're investing in human ingenuity. So when things go wrong, it gives the opportunity to innovate, to look at how to do things differently. And you mentioned a really good one last night, it's not quite geopolitical, but during COVID, like everyone we had all these face-to-face meetings, but it brought about Zoom and teams and efficiencies from that front, where as a business owner or as a collective group of um people within a business, you get to take a look and say, well, is there any weaknesses in the supply chain, or could we do be doing things differently? Um and I think that's the real there's obviously the human side of it, but it is the opportunity that comes out of conflict, whether it be conflict or even just disruptions in the market. Absolutely.

SPEAKER_03 20:08

And that that is the what you just said is that that's the true reason that I have faith in the markets and that what gives me optimism. It's not like some blind optimism. I I really believe in human ingenuity, as you said, and the resilience that people have. And because people are resilient, companies are resilient. Companies are resilient, markets are resilient. Uh and to me that that is what what gives me uh optimism for the future.

SPEAKER_00 20:32

That's a s that's a very interesting we talk about these little mental bridges. Right. Humans are resilient, therefore ultimately that will trickle through to markets because it's part of our survival. Exactly right. But when you think about investing in government bonds, is there any ingenuity associated with that? Is there any ingenuity associated with investing in gold? Right. You know, the stock market is a unique way to invest.

SPEAKER_03 21:01

And not only that, but there's one other leap that maybe I can make is that um investing in the stock market, it gives us all a stake in free markets. And and if I can say capitalism, it's just not hopefully not a bad word, but I think it gets a bad rap. Yeah, but but but the idea of it it gives us in free markets and the fact that that we participate in the same exact companies that we use. You know, when you buy a Toyota, would it be nice that you know you partake into the earnings of that company? Uh if you if you put gasoline in your car, hey, you know, I have a bit of Chevron in there. Uh so it it is interesting to me that that that this democratizes in a way uh things, that that you don't have to be Bill Gates or Elon Musk uh to actually uh start a business and and be a business owner. Every single one of your clients is in fact a business owner. And in fact, not a single business owner, but the way that I understand you build portfolios, you have roughly about Exposure to 12,000 plus different companies in 40 plus uh countries, uh, which is pretty amazing. You you tap into the global productive capacity, uh, and uh uh and and that is an amazing thing that that investors can accomplish, particularly today, uh where fees have come down, uh, that he can do it in a most incredible efficient way, both in terms of cost and taxes.

SPEAKER_00 22:24

Absolutely. I'm interested just to come back to the Middle East briefly. Um, because we're seeing diesel prices this morning at$2.70 and lots of talk from politicians about the release of strategic reserves and the like. And so I think a lot of our listeners would be fairly thinking, okay, that's a that's a fair response. Companies will respond by innovating. But I I I suspect a lot of our listeners are thinking or feeling, feeling and thinking that there's quite a lot of layering of risks. So there's the war in the Middle East, no one really knows how long it's gonna go. The last time we had really bad oil shocks was in the 1970s, and that was pretty bad. And that led to a recession. And so how should people be thinking about that?

Building Buffers For Real Life

SPEAKER_03 23:16

Aaron Powell Well, I mean, the first thing is that that as you pointed out, there is uh an impact that this conflict is having very, very quickly and very directly on all of us uh because uh you know, gasoline and petrol prices are going up, which means that you know, likely other items are gonna go up because you have transportation costs, and if that goes up, uh you have airlines that that that are gonna increase prices for their tickets. So it's gonna have a direct just food in general, like for sure. I mean, so there's so it will be a direct impact on on consumers. Um and in that respect, uh the way that it will manifest is probably divergent from groups of people to groups of people. In other words, what we've seen, at least in the US, is that you have the uh white-collar jobs, the uh the folks who are the higher earners. And to them, if they have to pay a little bit more, the gas station, if they have you know, it's not the end of the world for them. Uh they can they can get through that without really feeling it that much. On the other hand, you have some folks who are not in the high income brackets. And I think that those are the folks who are gonna be most impacted by this. Uh so the the the impact of this uh on the society is gonna be probably more tilted towards the lower income because they will be the ones impacted the most. I I do think that if you look at the higher incomes, uh even when you had an 08-09, there's still a waiting list for Ferraris. I mean, like, you know, they they're nobody gonna really change big time their behavior, uh, maybe perception-wise, they wouldn't. But you know, in other words, the society um is a combination of different groups of people. And economically, I think that the the uh the higher net worth will be probably less impacted by this. But it will have potentially the longer it it takes, it might have other uh consequences that right now we can try to forecast what they might be. Um we you know, it could be good or bad. I mean, it could just be that all of a sudden there's a wake-up call for countries that, hey, you know, we need to reduce our reliance. Like in the pandemic, they realize that the supply chains are not as robust. Right now, the energy is certainly not a robust. So, what do we do to change that? Uh and and the the U.S. did have that moment uh back in 1973. And without a doubt, that was a very big moment because in 1973 uh we did have that that um that oil shock. And what you what you saw in 1973 are huge lines at a gasoline station where people didn't have enough uh uh fuel to to uh uh for their cars. And and that was like you know very, very bad. But it what it led to is this idea that we need to be energy independent. So the consequences, I think there are going to be some short-term consequences that are probably more painful to one group of people than another. Uh in the long term, it is quite possible that this might make the world and including Australia, the US, Europe stronger. Uh, because uh that's what happened in the US in the in the 70s, as painful as it was, uh it in long run, it was a benefit ultimately by having that energy independence.

SPEAKER_00 26:14

So interesting. Aidan, I've just had a thought, and I really like you, as the advisor in the room, to speak to how you think about these crises as far incorporating the idea of that every successful investor is always acting on a plan. So tell tell us about how you think about these sorts of events when you're constructing a financial plan for someone, for example, who's you know, handing over their retirement savings to your stewardship to to help them navigate an enjoyable retirement. Just step us through how you the the mechanics of how you think about that.

Aden 26:57

Well, I think that as a starting point when you're building out a plan, you can't think that it's gonna be a smooth road. So we when you're designing a plan, you're not saying to the client everything is going to be smooth sailing as we go through it. So immediately then you're thinking about, okay, well, we know that things happen in the world from time to time, the world changes, that's a given, but we know things always happen. So we need to factor in a buffer for safety or a margin for safety. We don't know when it's gonna happen, we don't know how prolonged it's gonna be, but we need to be prepared ultimately. So as a starting point, it's making sure that you build in that buffer for safety so that people we know that over the long term humans are inventive, we adapt, we change, but you need to have a buffer for safety. And how that comes into portfolio construction, the long-term plan, is actually thinking about okay, well, we know that roughly you wanna you wanna live like this, spend this much on annual expenditure, travel this much, do this for the kids. Let's be really clear on those things. And then when you're actually designing the portfolio, building the long-term plan, making sure you've got an adequate amount set aside in defensive assets, cash reserves to call upon when that bump in the road comes. Yeah. So because we know it's gonna come.

SPEAKER_00 28:11

Yeah, and and you don't know when, as you say, you don't know when and you don't know how bad. But you is it true to say your objective would be that a client would never have to sell any of their stock market allocation or holding their portfolio to see them through a downturn like that.

Aden 28:30

Yeah, the idea is that that the protections there, so you're not the oh what's the old you want to sell high by low. You don't want to do the inverse of that. So you don't want to sell any of your growth assets or your shares when the market has fallen um during a pullback. So it's making sure you've got that. But I think it's also useful, this is probably jumping back about 10 minutes. So I really liked how Apollo mentioned if you're trying to play that game of predicting when it's gonna come, it's not one decision you've got to get right. It's two, it's when do you get out, when do you get back in. And without um without putting names, there there was actually a very prominent fund manager close to home here in Western Australia similarly, they got that call right just before COVID, and it's like you bet your chest a little bit, you think how good are we? But did the exact same thing because it still seemed a very scary time to be investing and it wasn't they didn't get back in. And we all saw what happened with COVID, right? The recovery was so quick.

SPEAKER_00 29:23

And also what happens depending on your tax structure, if if if at the first sign of a wobble the fund manager that's looking after your money sells your portfolio, if you're in retirement and you're in a tax-free account, fine. But if you're in a taxable account, guess what? You get a big tax bill as well. Thank you. And no one likes a big tax bill. No one likes paying tax. Um it comes back again, just coming back a few minutes in the pod. Um, we're talking about that 10% return since 1926 on the stock market. You and I were chatting last night about I think was it only four or five years where the average return so the average return is 10%. There's only about four or five years where the where the actual individual annual return, January to December, has been anything like the 10%. So it's either been way more or way less. So if our if any of our listeners don't have a plan that sounds something like what Aidan's talking about, where you where you actually have some liability structuring to say, I know how much I need to live off for the next two years, and then I'd like a safety buffer on top of that. And I know I want to buy a new car and I know I want to do some other stuff. So let's make sure I have that money quarantined. So if it hits the fan, as it will inevitably at some point, I don't have to feel bad about not doing any of those things.

SPEAKER_03 30:51

I mean, as long as you can tell the client, what if this has no impact whatsoever on your livestock?

SPEAKER_00 30:57

Yeah.

SPEAKER_03 30:57

Whatever happens in the market this year, next year has no impact. And by the way, I love the idea of the bringing up the idea of averages and how to think about them because yes, the market average has been 10% per year. But averages are dangerous because if you have your feet in boiling water and your head is in the freezer, on average, you're comfortable. That's a good one. Yeah. And in fact, if you look at uh one thing that stuck with me is that um in Los Angeles, uh one of the players for the Lakers is LeBron James, and he played over a thousand games in the NBA. And last I looked, his lifetime average was 27 points per game, seven assists, seven rebounds. That's his lifetime average. In the entire career, a thousand plus games. In how many games do you think he scored 27 points, had seven assists and seven rebounds?

SPEAKER_00 31:48

I'm going with none.

Corrections, Bears, And Long Recoveries

SPEAKER_03 31:49

None. None. None. None. So you got to be so careful with averages. And to your point, when you create the plan, you basically account for the fact that we do have these downturns. And let's spend a minute maybe on the downturns, because that is uh an interesting thing that I've that I've kind of started looking lately because the last time that we had a prolonged downturn uh was almost 20 years ago in 2008. And we have some bumps here and there. Um, but somebody asked me recently, well, how do you think about market downturns? And it came to realize that there is no single market downturns. And I don't want to freak people out or anything, but just to acknowledge the reality of being invested in the stock market. What did it take for you to get the 10% per year that you're talking about? Uh and I'm born in 1969. So I took my lifetime. And in my lifetime, we're very close. Uh, in my lifetime, uh, there have been uh uh 28 of what is called a correction. And a correction is a 10% market drop. So it means that on average, every two years, there is a uh 10% drop in the market. And because it's not a big uh drop, it happens quite often. We're pretty desensitized, so it's not really such a big deal. Now, the real bear market, it's a 20% drop. And in my lifetime, there have been uh about eight of these, which means that every seven years we see these bear markets. And because they don't happen as often and they're a steeper drop, people get to get spooked. It's like, way, bear markets is not gonna, and it's real, like you lose 20% in the SP 500, that's not nice. Uh, but you know, it's it's still happening and we're still not panicked as much. What I found interesting is that there were periods when you have something that's even bigger than a bear market. So, what's bigger than a bear? A grizzly bear. So there have been in my lifetime three grizzly bear markets. And these are prolonged uh uh downturns uh with the market dropping at least 30%. And there have been three of those. So they're unusual, but not really unprecedented. Uh, and it's instructive to, as an investor, understand what happens and how do you manage your expectations when something like that happens. So the first one uh was in 19 uh seventy-three, and as you talk about the oil crisis, Nixon resigning, uh, we had the Fed that was not independent in the US, a lot of things that happened in the U.S. at the time, many, many factors. And what he saw is that um if you had invested a dollar uh in uh uh uh December of 1972, and I and I might ask you, w how long do you think it took for the market on the news to kind of come back to uh the same dollar? In other words, how long to recover? How many months do you think it would have taken? Let's go two years. Two years. 48 months, something like that. Well, a little drumrolled, the answer is 91 months. Wow. Seven and a half years when you would have been on the water.

SPEAKER_00 34:46

I kind of knew that.

SPEAKER_03 34:47

But I've month after month, quarter after quarter, you look and say, I'm underwater, I'm underwater. And and that's a terrifying, that's a long time to be on the water. So the question is like, okay, we eventually recovered, but what can you do about it? How can you shorten this time? And I would argue there are four things that you can do, and you're doing it for your clients. The first thing, as you kind of mentioned already, is that when the market drops, too many people are saying, I'm afraid to put money in the market. And in fact, that might be the better time to do it, to reinvest at a lower valuation, a better valuation. And the easiest way to do it is to take the dividends that a company pays and reinvest them in the market. And it turns out that the market on the news just thinks the dividends don't exist. So the question is, what if you just simply reinvest the dividends from these companies? And the amazing thing is that if you simply do that, instead of 91 months, you would recover back to uh even in about 42 months. So about three and a half years, half that, yeah, which is incredible. It all you have to do is just reinvest during that time. The second thing that he can do is realize that the SP 500 is a collection of the largest companies in the US, but within the US market, there's another group of smaller companies that are not part of the SP, and he can invest in those as well. So why what if we add a piece to that small companies, realize that they're Australian stocks and they're Japanese stocks? And what if you invest around the world uh and you have a global perspective to investing? And what if you balance everything with some bonds? And this is where it's the prototypical 60-40 portfolio, not because it's any better or worse, not because it's an ideal law, just be it's just something to reflect upon. So, what would be the experience of an investor in these grisly bear markets if you reinvest the dividends, if you have money in uh uh small international and bonds, uh and let's go back to 73, 74. We had the 91 months, and at the worst point, it was a drop of about 46%. That's the that's the worst drawdown you would have seen in the SP on the news. Now, if you had this uh reinvested dividends with small international and bonds, uh, you would have cut the recovery period to 37 months, three years. And that's the bucket that you're talking about. We have your reserves there. Uh and it three years you're back to even, not 91 months, 37 months. And at the worst point, it wasn't 46 down, but it was rather 26 down, which is a very big difference. You take the second grizzly bear market, which happened to be the dot-com bust, and that was uh in the in the uh 2001, 2003. Uh and if you go back to that, it the uh the the recovery time was 81 months, 81 months. And at the worst point, it was once again 46 percent down. Now, with this strategy that that we're kind of uh suggesting here, the recovery time would have been about 40 months, so half of that. Uh and at the worst point, the the loss would have been only about 20%.

SPEAKER_02 37:48

Yeah.

SPEAKER_03 37:48

So you've a much shorter uh uh recovery time, much lesser uh drop in value. And the last one was the GFC. And during the GFC, we saw the market on the news take about 65 months to recover. Uh, and at the worst point, it was a 53% drop, so more than half your money. With this strategy, you would have actually had 38 months to recover. And the worst point was uh 33%. So what's interesting is that you cannot avoid losses. We're not gonna say you can avoid loss. You can't. But what you can do is mitigate both the time to recovery and the magnitude of the losses. And in every every single grizzly bear market that we've seen in my lifetime, uh the this this worked uh uh quite well in mitigating both the magnitude and the time to recover.

SPEAKER_00 38:32

And I can tell you with confidence, Apollo, that um during that GFC period, we did not have one portfolio failure. Not a single client had a portfolio failure. Now, some got the wobbles and said, I have to take some money out of my portfolio and so forth. But but the structuring that Aidan talked about combined with just the the education and the peace of mind and the and the and the encouragement to discipline, the encouragement to it will be okay, this too will pass. Um not a single client had portfolio failure. And I'm really proud of that. That's amazing. That's congrats on that, yes. Yeah, well well, I think there's a lot of advisors like us who who believe in a in a structured evidence-based approach where, you know, yes, you have a split between your your growth-generating assets, predominantly share market investments, and your necessary liability matching assets, your defensive assets. But then within, you don't just go and invest in an index fund, or you don't just go and invest with a fund manager who says, I can beat the market for you. You you can take a very structured approach by, as you mentioned earlier, having an exposure to the market at very low cost, having an exposure to smaller companies, having an exposure exposure to less expensive companies, which which you know we would call value companies, and also having an exposure to more profitable companies. And and it's such a compelling argument to to follow.

SPEAKER_03 40:09

But it all hinges on one thing that he mentioned. You have to have a coach, you have to have an advisor who not only puts together this plan, you can have the greatest plan. If you cannot stick with the plan, and if you break the discipline when things get tough, uh it's it's never gonna pan out. That's when the failure happens. So to me, the value of an advisor is indispensable. Indispensable. And the fact that, you know, uh that that you are coaching your clients before emergencies happen. In other words, you know, i if if if we talk about these things uh uh afterwards, it sounds like an excuse. But we're gonna tell you right up front, you're gonna have an investment experience that's gonna include some bumps. And I want you to be aware that, and let's talk about them now while the markets are still calm because otherwise it's gonna sound crazy. Uh, you know, you don't want to prepare for an earthquake after the earthquake. No. And being from LA, you know all about it.

Valuation Fears And The Magnificent Seven

SPEAKER_00 41:07

Exactly right. And you said that to me. You said I live with the knowledge that I will have a major earthquake. I'll have to deal with that. Well, not will, but there's a there's a good chance probability that you're gonna have a major earthquake. So so if you have that knowledge and you do nothing with it, so you you you remain uninsured on your house, you don't do the necessary renovations, bolt to house the foundation, pay the shelter wall of the things you meant to do, then you're gonna cop it. Yeah. But if you do the things and you act, it's a bit like paying an expensive gym membership and not turning up to say the personal trainer. I do I do wanna just segue on this because it's a related topic. It come before this Middle East conflict started, there was a lot of talk. It sort of dissipated a bit, but there was a lot of talk about oh wow, the markets are so expensive. And we've got to be in for a a cropper, and you know, the the the headlines love talking about this stuff. And but if you look at traditional valuation methodologies like price to earnings ratios, the view is the market is expensive. And so so again, to our listeners, you know, it would be reasonable if you hear those sort of headlines on the on the news or or if you see it in the paper, for those of three of you who still read a newspaper. Um it's isn't it natural that people get concerned about that stuff and and how should they process it?

SPEAKER_03 42:44

Well, absolutely. I mean, I think that's something that you ought to pay attention to uh because when you buy these stocks, um not all stocks are the same. And to the point that he made earlier, there's some smaller companies, for example, that have an opportunity to grow. Uh and at some point, NVIDIA was a small mid-cap stock, and over time it became the largest company in the world. Um and that process happened. So that's that's something that you can pay attention to. Do I want to just buy all the large, well-established stocks, or do I want to also pick up some of these smaller ones? Um there's a difference in price. And let's let's uh to that point of expensive or not expensive, how do you think as an investor at the concept of valuation and what does it mean and how do you deal with that? And the concept of valuation goes back to what we discussed earlier. When you buy a share of a company in the market, you partake in the ownership of that uh business. Uh and let's take a business that that is in the U.S. and it's well known and it's uh uh pulled a lot of fans either for or against it, and uh that's Tesla. Um Elon Musk is very uh polarizing, and some people you know think that he's absolutely a genius. Other people think that maybe he's kind of dabbling to things that he shouldn't have. So they're all over the place. But the reality is that Tesla is a very uh solid company and and And uh, you know, kudos to somebody who can uh have an idea to build a car company uh not long ago and somehow, you know, despite like you know, people probably like us, are you crazy? Look, there's a BMW, there's a Mercedes, and you know, it's astonishing. It's astonishing. I mean, it's astonishing. Yeah, so it is. I mean, but what do you like as political things? It is pretty remarkable. Now, the thing is that if you are somebody who wants to partake into the ownership of that company at the beginning of the year, uh, you could have picked up a a share of Tesla uh for a price of about$450. So if you had$450 laying around, this is US dollars. You could have gone and either had like a really nice weekend with your better half or uh go buy a share of Tesla. Now, what do you get for that share? As I said, you partake into the ownership of the business, you can uh partake into the earnings of that company. So if you look at the earnings associated with that one share at the time when it was roughly$450, those were$1.50 per share. So if you reframe this idea as like, look, um, we just spend$450. And at the current rate of earnings, Tesla will come and put, let's say, a buck fifty into your piggy bank based on the current level of earnings. So based on this current level of earnings, you spend$450, Tesla comes and puts a buck fifty per year. The question is, how many years will it take for you to recover the investment? You paid$4.50, you get$1.50 per year. The math is not that hard. It's about 300 years. That's what valuation reflects. So the intuition of price earnings is exactly that. What's your payback period? And in this case, you can say, well, that's fairly expensive. I paying, I'm paying a lot of money for the current level of earnings. Now, why would anybody do that? Because they expect that at some point the money gusher is gonna open for Tesla and they're gonna rake it in, they're gonna make money hand over fist, they're gonna blow it up. And it's worth paying$4.50 now because just you wait until they start making money. And it's absolutely possible that that's gonna happen.

SPEAKER_00 46:09

Trevor Burrus, Jr. Well, with the work he's doing with robotics and all this. Absolutely. So it's worth like it's likely.

SPEAKER_03 46:14

Exactly, exactly right. So let's own a share of Tesla. On the other hand, another company that he mentioned, Toyota, Toyota, at the time when uh Tesla was selling for$4.50, Toyota was at a price of less than half,$215 a share. And the earnings associated with that one share of ownership were not$1.50, but rather$20. So it's roughly about a 10-year payback period, uh, which is very different. So the question is at the current moment, which one seems like a better investment? The higher priced one or the lower priced one? And the answer is both. Because Tesla might be worth buying in case they actually open that money gusher down the road. So let's own a piece of that. At the same time, let's not ignore something that right now seems like a pretty good deal. And that's in a way the distinction that we talked about earlier, the idea of value growth. Value is the comp the are the companies that are relatively low priced, in this case, it would be like Toyota, you know, just intuitively, and then uh the more expensive one would be um uh Tesla. But what's fascinating is that if you look right now at the U.S. stock market, uh, and you kind of say, okay, the U.S. stock market, how do you think about the valuation of the U.S. stock market? Well, the U.S. stock market is an aggregation of different companies. And the way we look at the market is not applying equal weight, equal percentages to each company. Uh, the larger the company, the greater the emphasis that the market puts on that business. And in that respect, these magnificent seven are remarkable not only because they're large tech companies, but because they're the largest companies in the U.S. stock market, uh, some of the largest companies.

SPEAKER_00 47:58

So we're talking Amazon.

SPEAKER_03 47:59

And we're talking about Amazon, NVIDIA, Apple, Google, Facebook, uh, Microsoft, and uh uh um and uh Tesla. So when you look at these Magnificent Seven, they also leave a hole in the SP without them. Let's call it the SP 493. And what's amazing is that if you look at uh at these seven stocks, together they amount to roughly about 35% of the value of the entire SP of the US market. So they're a really a big chunk of the SP 500. And the reason that is meaningful is because when you look at these seven stocks and you look at their price earnings, which is the intuition behind what we just talked about, what you see is that Tesla is at 300, which is crazy. I mean, the long-term average in the market is roughly about in the 20s. That's in the 20s. So this is like way out the norm. Uh, but then you have other companies. You have uh uh Facebook, which is the only stock that is in the ballpark of the long-term average, set about 22, uh, 23 for the price earnings. And then you have Apple, you have Amazon, Microsoft, and Google are all about 50 percent above. They're in the mid-30s. And then NVIDIA is twice. It's uh it's over 45. So that valuation right now for these companies is quite high relative to the historical norms.

SPEAKER_00 49:19

Aaron Powell Relative to historical norms. But but in terms of their reach and their revenue generation and their potential.

SPEAKER_03 49:29

Trevor Burrus, Jr. Absolutely. What the market is pricing in the right. They might represent pretty good value. Exactly right. Just because they're expensive, that doesn't mean they're a bad investment. It's just you have to pay attention to that. Uh but just because they're they're just basically these magnificent seven are pricing in expectations of great profits coming down the road. Maybe not immediately, but coming down the road. And it's quite possible that's gonna happen. And because of that, it's worth having. On the other hand, what's also interesting is that if you look at these seven, uh on average their price earnings is 68 among the seven of them, which is quite high. But the rest of the stocks in the SP are, you know, the 493, the SP 493, it's a much more reasonable 28, much closer to the long-term average. So not every stock in the US market is priced with these fantastic expectations. Yes, these max neighbor and seven are, but the rest, there's plenty of other stocks that are not. They still have reasonable valuations. And within this uh US, we talked about small companies. And if you look at the price earnings for the small caps, uh, it's actually below the market's long-term average, so about 18. Uh, and within that, there is a value component, and that is roughly at about 12. Uh so in other words, not every part of the investment universe is so richly priced. And the richly priced doesn't mean it's a bad thing. It's just basically saying the earnings that I expect might not be immediate, but I will I'm willing to pay today a higher price for those future earnings. Uh, it's just that that at the same time, you can say if you diversify and if you you know cover all your bases, you're gonna have plenty of stocks that are not at this great expectation. But today, like a Toyota, they're still making good money and they're still um uh have uh uh good valuations. And so you can find those companies, and the best thing you can do is blend them all and not really place a bet.

SPEAKER_00 51:22

And this is where diversification really is your by owning I I just want people to keep anchoring back to this idea that over the last hundred years, if you turned up in the S P 500 and stayed there, you got about a 10% per annum return. You do not have to do anything that's super, super clever to get that return. You do have to keep your costs low, you do have to rebalance your portfolio, you do have to use what we uh term portfolio hygiene. Yeah. We want you to good have have good, good, you know, it's a bit like having good, you know, table manners. You know, you've got to have good portfolio hygiene. That's funny. And and keep your portfolio neat and tidy. And and and it's not that hard.

Is This Time Different The Chessboard

Aden 52:07

And it was part of that as well, like as a polar talk to when you look at some of those big downturns and people say, well, how do I mitigate that seven-year or eight-year period will go down? It's about having like appropriate diversification across asset classes. And as anyone who's been involved in markets for a period knows, every asset class or subclass has their day in the sun. It's just very difficult to know when it's gonna happen. Absolutely, that's the importance of diversification. I do have a question for you though, Apollo. So we've we've talked a lot about everything that's going on in the world, and with that, the world is changing, and we sometimes get the question but is this time different? Yeah. So I'm I'm gonna ask you the question given AI and everything that's going on. Yeah, is it a little bit different this time?

SPEAKER_03 52:50

A hundred percent it is different. It is unlike anything else that I have seen in my life. This particular confluence of events is so unique, uh, whether it's the war, whether it's the you know, the politics in the US, or whether it's you name it, there's so many things that make this situation unique that to say that it's not different, it would be disingenuous. Like it Corey, we're kidding. Like it is different.

SPEAKER_00 53:13

But hang on, can I challenge you on that? Of course. Having the GFC, I remember we went to the brink of the of systemic. You know, the system was really in distress. Absolutely.

SPEAKER_03 53:26

And that was different is different. Okay. I get you. So that's my point. It is different. And and and uh, you know, David, to visualize this, during the pandemic, and uh remember those days, there was a a show on Netflix, a streaming service, uh that that was called the Queen's Gambit. I think that's a good idea. And you remember the show. It was a great show, and I ended up watching it and and uh I picked up an app and I started playing uh chess. And for folks who haven't seen it, it has to do with chess. Uh and uh one thing that that struck me is that you know, I'm not a good player, but I keep persevering. In all the games that I've played, it's never happened that I end up in exactly the same position. It's always different. There's always a different, you know, uh end game there. So to me, what was interesting to think about is that perhaps that, you know, the GFC is different than what happened today, the what happened in the pandemic, the same way that every game of chess ends up in a different position, a different situation. It's never the same, it's always different. And yet in chess, there's a fundamental premise that stays the same. It doesn't change from game to game. You have a uh chess board, there's 64 squares, 16 pieces on each side, and that doesn't change. Uh so in that respect, what would be interesting to explore is that even as this confluence of events is different, what is the chessboard of investing, the fundamental premise that has not changed, even as this particular confluence of events is different. And to me, I become a firm believer that there is a chessboard of investing, and that is the fact that companies operate in free markets. And as long as companies operate in free markets, they will find a way to navigate whatever is put in front of them, without a doubt. You've got tariffs, great, we're not gonna make it in China, we'll make it in India. Uh, you know, you get the uh pandemic, great, we're not gonna have face-to-face meeting, we'll do Zoom. Every single time something happens, human ingenuity that you're talking about in and and and resilience come back. Uh, and that is what happens in free markets. As long as we have free markets, that is the chess of investing. Companies will find a way to make money. They will find a way to navigate. Um, and and as I said, sometimes they'll come out stronger at the other end.

SPEAKER_00 55:42

And it and it really does come back down to the most basic um rules of humanity, and that is the human desire to survive. Yeah, and then thrive. And I suspect because our communities are made up of individuals and our companies are made up of communities of humans, right? That's that survival thrive instinct is exactly the same in a in a company.

SPEAKER_03 56:08

Absolutely.

SPEAKER_00 56:09

And some will prosper and some will fail. And and and that's okay. You know, that's that's that's why you diversify. That's incredible. Amazing link.

Aden 56:18

On that as well, I will just give a little plug for a book. I'm sure you're familiar with Morgan Hauser, who's the author of The Psychology of Money, his second book. Okay. It was called The Same As Ever. And it's all about the principles of what are the things that remain the same, what's the chessboard, both in life and investing, that you can sort of always lean back on these principles. And it was a really, really good read in typical Morgan Hauser style, short chapters, easy to digest, but it's all about that same principle.

SPEAKER_03 56:43

I mean, what do you uh what do you keep the same and what do you adapt? Yeah. And that's kind of you know, some things stay the same, others change, and it's okay. Uh, but I think in investing in um it it's it's it's a fundamental premise that that that free markets uh will help uh investors navigate whatever times, and it's not gonna be pleasant every minute. I just have uh great faith in in uh human ingenuity.

SPEAKER_00 57:07

Well, on that note, um Apollo, it's been fantastic chatting with you. I think our listeners, I think our listeners are gonna love it. And I'll hand back to you, Aiden.

Aden 57:17

Yeah, so thank you, Apollo, for joining us in the studio. We're very lucky to have someone of your capability to talk through so many complex issues when there's lots of noise going on in the world. As our listeners know, we love it when you send us a question, leave a review, share it with a friend, share it with anyone in your network. Um, if you've got any specific topics that you would like us to explore in further detail, send them through to myself, David, or the podcast email, which is ask at capitalhyphenpartners.com.au. And make sure you subscribe to our new YouTube channel so you never miss an episode. Apollo, David, thanks for joining me.

SPEAKER_00 57:52

Been a pleasure.

Aden 57:53

Great to be here. Thanks for joining us on another episode of the Purposeful Investor Podcast. Be sure to subscribe so that you never miss an episode. We also love it when you send through any feedback, comments, or questions through to the podcast, and be sure to share it with friends, family members, or colleagues who you think would benefit from a listen. Both Aidan Wilkins and David Andrews are authorised representatives of Capital Partners Consulting Proprietary Limited. We operate it under the Australian Financial Services Licence of 227 148.