Why the Stock Market Should NOT Scare You (Even As It Crashes)

Mindy:
Welcome to the BiggerPockets Money podcast, show number 327, where we interview Brian Feroldi and talk about the stock market.

Brian:
Only information that most people get about the stock market is what? Price, that’s it. That’s the only information that people have access to. That’s the only thing that 99% of people look at and focus on when they’re talking about the stock market. What is hidden behind that, if you dig into the details a bit more, is that behind the stock market are those businesses and those businesses are generating profits. If you look over long stretches of time, the undeniable trend of those business profits are up and to the right. That is the reason why the stock market has always recovered from previous crashes, is that business profits eventually recover and that leads to higher prices.

Mindy:
Hello, hello, hello. My name is Mindy Jensen and joining me today is my every day is a party cohost, David Pere.

David:
I’m glad somebody thinks I’m an optimist. I feel like the world probably sees another side of me half the time, but I’d like to think I’m a eternal optimist and it probably bites me in the butt more than it helps anything.

Mindy:
Every day’s a party with David Pere. Hip hip Pere. David and I are here to make financial independence less scary, less just for somebody else. To introduce you to every money story, because we truly believe financial freedom is attainable for everyone, no matter when or where you are starting.

David:
Whether you want to retire and travel the world, go on to make big time investments in assets like real estate, or start your own business, we’ll help you reach your financial goals and get money out of the way so that you can launch yourself towards your dreams.

Mindy:
David, I am super excited to talk to Brian Feroldi today. He is the author of a new book called, Why Does The Stock Market Go Up? Everything You Should Have Been Taught About Investing In School, But Weren’t. You had a very funny joke at the end of our recording, after we hit stop, you said, “You should have named this, Why Doesn’t The Stock Market Go Down?” And he said, “Well, that’s because I’m bad at timing the market.”

David:
That’s very true.

Mindy:
And that’s exactly right. Nobody is good at timing the market. You should never try to time the market. Today, we learn about the market. We talk about what the stock market is, we talk about the multimillion dollar mistake that you could be making and not even be knowing it. We talk about earnings and P/E ratios, and we talk about valuations. We talk about a lot of fun things on this episode. Well, fun for us. If you’re listening to this show, you’re probably going to find it fun too.

David:
Yeah, no, this is a lot of fun. It’s funny because we had an issue there with the recording for a minute and so I asked him a question off the record, which ended up being a really good answer. I think we’re going to leave it on the record, about Tesla and P/E ratios and stuff. I even made the comment to you, I was like, “God, I love when we record and I’m learning stuff.” Not to sound like I’m this know-it-all, arrogant guy, but when we did the prenup recording, I thought I had an understanding and I knew nothing. I mean, it very quickly blew my mind on his gross income versus earnings, versus P/E, versus, blah, blah, blah, blah, blah. I was like, “Oh, okay. Yeah, this is not my realm and he’s all right.” Yeah, its a great episode, lots of fun.

Mindy:
The prenup episode actually changed my whole mind on prenups. Don’t tell my husband, but that was a really, really fun episode as well. I’m looking that up. That was episode 301 with Aaron Thomas. That was a great episode as well. But we’re not talking about prenups on this episode, we’re talking about the stock market. We change it up over here. It’s always related to money and this one’s fun. You’re going to learn a lot about the stock market, why it goes up, why it goes down, and what you can do to take advantage of it.
Brian Feroldi, welcome to the BiggerPockets Money podcast.

Brian:
Mindy, it is awesome to be here. Thanks for having me.

Mindy:
I’m so excited to talk to you today. Today, we’re talking to Brian Feroldi, author of the ChooseFi publishing book, Why Does The Stock Market Go Up? Everything You Should Have Been Taught About Investing In School, But Weren’t. Brian, this is going to be a really timely show given the first half of 2020, which if you’ve been paying attention to the stock market, you are feeling the pinch. Many people, this is their first experience with a prolonged down market. Our last bull run basically started in March of 2009, with lots of little dips and bumps, of course along the way, but has been basically up and to the right ever since then. With the exception of March of 2020, we had a big drop and then an almost immediate recovery, but this feels different.
It always feels different, but this feels super different. What would you tell someone who is freaking out about the current state of the economy, the current state of the stock market and the outlook for the future? All of the news stories are starting to say there’s a recession coming and the stock market’s going to keep crashing and then the sky is falling. It’s Chicken Little all over the place. What is your advice for people who are having a little bit of trepidation?

Brian:
Well, what we’re going through right now is a great example of the difference between being able to handle volatility in theory, and being able to handle volatility in real time when you’re living through it minute by minute. If anybody’s looked back at historic returns of the S&P 500, it pretty much looks like a squiggly line that just goes bottom left to upper right. And if you’ve done any sort of compound annual growth calculator on it, you know that a little bit of money put into that produces massive amounts of money when judged over the appropriate period of time, which is measured in decades. Not months, not weeks, not years, it’s measured in decades. But there’s a huge difference between understanding that in theory and understanding that in reality.
Jason Zweig has a wonderful thought process about that. It’s like when you’re meeting with your investment advisor, it’s like, “How much risk can you handle in theory?” It’s like showing you a picture of a snake and saying, “Does this look scary?” And then it’s like saying, “All right, let’s actually live through this,” and he takes a live snake and throws it on your lap and saying, ‘How do you feel right now?'” I mean, that is truly the difference between understanding volatility in theory, and living through it day by day in your portfolio.
The most important thing that people that are investing in the stock market right now need to understand is that declines are perfectly normal, perfectly normal. It is a completely healthy thing for the stock market to decline over various periods of time. Every decline rhymes with previous decline and every decline really feels like that’s it, capitalism is over. We had a great run, but now, now things are really taking off and are permanently going to go down the tube.
Especially if you watch the news and there’s talk about… Let’s see, what’s in the news? Supply chains concerns, there’s inflation, there’s recession on the horizon. There’s a war that could potentially escalate. There is an endless amount of negative news that’s out there. However, if you look back at the long term returns of the stock market, it has survived and thrived in all kinds of environments. We’ve survived recessions, depressions, we’ve survived pandemics, we’ve survived terrorist attack, presidential assassinations, massive world wars, huge debts. And yet the result is that the stock market eventually bottoms and continues to push higher. So my advice to people that are worried right now is to look at the long term chart of the S&P 500 and just keep zooming out.

David:
I love that and I love that you said decades. Whole life insurance may not necessarily be my favorite thing in the world, but I love when they argue, “Well, imagine if you had put all your life savings in 2007 into the stock market, and then you retired in 2009?” I’m like, “Yes, and imagine if you backed that out 100 years and actually did the math, because it’s a whole different story.” I told someone just last week like, “Hey, if you had invested on the peak of 1929 or whatever, when the market tanked and then just let it sit for the next 100 years, you wouldn’t be upset about it.” Long term, you’re not going to be upset, that’s the beauty of, I’m sure we’re going to talk dollar cost averaging and different things throughout, but just staying consistent. It’s great, it works long term.

Brian:
Very, very much so. But I will tell you the thing that always confused me about the stock market was it’s not hard to realize why the stock market goes down. I feel like that is relatively intuitive, even if you know nothing about the stock market. It went down in 2000, 2001 terrorist attacks, right? That’s an easy explanation. Went down in 2007 to 2009, housing crisis, great depression part two. It went down in 2020, COVID. More recently it’s gone down because of potential nuclear war, supply. It’s not hard to understand why the stock market goes down. What always confused me was why the stock market ever went up in the first place.

Mindy:
Why does the stock market go up, Brian?

Brian:
That’s a semi complicated question, but the ultimate answer, the ultimate reason that the stock market goes up over time is that business profits go up over time. But let me dig into that a little bit further. First, let’s answer the question, what is the stock market? That term’s thrown around all around the time. Generally when people refer to the stock market in the United States, what they’re referring to is either the S&P 500 or the Dow Jones Industrial Average. Both of those are simply indices that contain collection of companies. In the Dow’s case, it’s a collection of 30 of the largest and most profitable companies in America. In the S&P 500’s case, it’s a collection of 500 of the largest and most profitable companies in America. Those indices track the overall performance of those companies on any given day, week, month, or year.
However, what people don’t see is the profits that those companies are actually producing. The only information that most people get about the stock market is what? Price, that’s it. That’s the only information that people have access to. What happened to the price of this index today? What happened to the price of this stock today? That’s the only thing that 99% of people look at and focus on when they’re talking about the stock market. What is hidden behind that, if you dig into details a bit more, is that behind the stock market are those businesses and those businesses are generating profits. If you look over long stretches of time, the undeniable trend of those business profits are up and to the right. That is the reason why the stock market has always recovered from previous crashes, is that business profits eventually recover and that leads to higher prices.

David:
I have a question and I was debating whether it was worth asking this. Curious, as you’re digging, because you’re mentioning the things that actually go into businesses that drive the stock market, I have been debating, not even debating, but I’ve had a semi bleak outlook on Tesla since their P/E ratio went to 2000% or whatever, or 1000% or wherever crazy number it hit. But everybody tries to tell me that the reason is because they’re baking in all of his private companies into the valuation and what he can do in the future. I was just curious if I’m missing something that you might know, or if you smell as much bull as I do?

Brian:
The P/E ratio is a wonderful metric, but you have to know when it’s useful and when it’s not. On Tesla, it’s more useful today than it ever has been in history. However, when a company is focused exclusively on the top line, as Tesla primarily is, the P/E ratio is useless. The reason it’s useless is because the company is purposely investing in itself like crazy. It’s hiring engineers, it’s hiring R&D, it’s hiring sales people, it’s opening superchargers. It’s doing all of that to fund future growth. Because the company is focused on growing the top line and not the bottom line, the earnings power of the company are artificially depressed.
If the E, if the earnings are artificially depressed, then the P/E ratio is artificially overstated. Now once the company normalizes for profits, which by the way, it’s much closer today. In fact, in the most recent quarter, its net profit margin was 10%. For every dollar in sales, they kept 10 cents as profit. That’s insanely good for a auto company. The P/E ratio is more useful today. When it was 2000, it was not useful. The way to judge Tesla, value Tesla is first off, it’s really hard, but I would say the price to sales ratio and the price to gross profit ratio are much better metrics.

Mindy:
That Tesla piece is really interesting. As you know, if you listen to this show, you know my husband is obsessed with Tesla and he of course, had no qualms about that. As you started asking him questions, David, I was like, “You should just call up Carl. He’ll tell you all this stuff. He’ll give you all the Kool-Aid to swallow.”

Brian:
Do you guys have a Tesla?

Mindy:
We do not have a Tesla. Even though we have talked about getting a Tesla for years and years and years, and the girls want a Tesla. He keeps saying, “Oh, when Tesla gets up to X number of dollars per share, then we’ll buy one.” Then he keeps raising that.

Brian:
I bit the bullet just over a year ago. It’s my favorite purchase ever.

Mindy:
Carl, listen to this.

David:
Yeah, I don’t own one yet, but I love them. I’ve on multiple occasions have gotten very close to throwing the deposit on the Roadster, but I’m holding off.

Brian:
Oh, wow. Oh, wow. Oh, okay. Yeah, I bought a Model Y.

Mindy:
I would take the Roadster.

Brian:
I don’t know, the steering wheel looks a little weird. I definitely want to just floor it and just see what that feels like.

David:
I mean, you don’t drive them though, so.

Mindy:
If you’re not going to drive it, why do you buy it?

David:
I meant, it drives you.

Mindy:
Oh, okay. Okay, fine. Let’s talk about valuation. A stock is priced at X number of dollars, that’s what it’s worth, right?

Brian:
Is that a question?

Mindy:
Yeah, that’s what it’s worth. I’m trying to figure out how to phrase this question because that’s not what it’s worth. There’s different ways to come up with the valuation of the company.

Brian:
Correct.

Mindy:
It’s hard for me to explain this. I can look at this and be like, “I know what I’m talking about, but I don’t know how to explain it.”

Brian:
Want to use the example I use in my book about the coffee shop that I think simplifying things always make things easy?

Mindy:
Yes, yes. Let’s talk about valuing. How do you determine? Because a lot of people in the FIRE movement say, “Oh, just index funds. Just do index funds.” I think that’s great advice. I really do think that most people do not have the time and inclination to do the work to justify individual stock investing. In fact, you have a really great questionnaire in your book. It says, “If you’re thinking about buying individual stocks, ask yourself these questions. Do you enjoy the process of a researching individual companies? Are you an organized person? Are you willing to spend the time to develop a system that helps you identify good investments?” Those three questions are really, really, really important. It’s not a, oh, they had good earnings last month. I should invest in them. That’s actually a really terrible way to choose stocks and I think that’s how a lot of people choose stocks is, oh, they’re up today.
Do you remember the newspapers where you could read all of the stock reports? That’s a terrible way to pick stocks. You have to do research and I’m talking deep, deep, deep research. We do some individual stock investing and I say, we, because we’re married. He does individual stock investing and he is my husband, Carl. And he listens to every Tesla podcast that there is, he reads every bit of Tesla news that comes out. He knows more about Tesla than that guy, Elon. He is so obsessed with this company, but he is fascinatedly obsessed. He doesn’t think of it as a chore. I would never invest in Tesla if it was up to me because I don’t care. I don’t want to do the research. I would rather throw the money in the index funds because it’s easy, it’s set it and forget it and I don’t have to spend the time.
But I think that is a really important question, are you willing to spend the time to develop a system that helps you identify good investments? One of those things is determining the value of the company and where you think the company is going to go in the future. And just because the information is there doesn’t mean that that’s the information that you should… It takes some diving into, I guess. So how do you determine the value of a stock? You just went through Tesla, which I thought was very interesting.

Brian:
Yeah, figuring out what a company is worth is one of the most difficult exercises that’s out there. And in truth, there are many different ways to value a company and what a company is worth at any given time. If a company is publicly traded, what a company is worth at any given time is literally their current share price, times number of shares outstanding, plus the amount of debt that they have, minus the amount of cash. That’s a fancy way of saying a term called enterprise value, which is basically if I was to buy this thing outright right now, the entire company, how much money would I have to raise to do that? Enterprise value is one way of measuring the current value of a company. Another is called the market capitalization, which is that same calculation. It’s just the dollar price of one share, times number of shares that are outstanding and that gives you the current value of that company’s equity.
Both of those are valid ways of saying how much is this company worth right now? But the value of a company changes, public traded company, second by second, with every uptick and downtick of its stock. Even if you look at big, stable, predictable companies, like McDonald’s, like Coca-Cola, like Walmart, if you look at their stock price over any given year, the difference between the 52 week high and the 52 week low, can be 20%, 30%, or even 40%. Those are for big, stable, predictable, boring businesses. That’s the market’s way of telling you that we think this company is worth somewhere between this number and this number. Valuation, figuring out what the business is worth, is a very, very difficult exercise. If you ask 10 different people, what’s this thing worth, you’re going to get 10 different answers.
But let’s simplify things for a second. Mindy, let’s say that me and you, we start a coffee shop together. We both invest some money, we get this coffee shop off the ground. We invest $100,000 dollars combined in it. In the first year, our company makes $100,000 dollars in profit. It’s super, super successful. We now have this coffee shop that is producing every year, $100,000 dollars in profit. Then we go to David and we say, “All right, David. We have this asset, but both of us are tired running this coffee shop, we want to sell. What would you pay us for this company?” Well, let’s just throw some numbers out there. Let’s say David comes to us and says, “I’ll give you $100,000 dollars for your coffee shop.” We have no idea what we’re doing, so we say, “Okay, that’s fair.”
So we sell our coffee shop to David. He gives us $100,000 dollars. Now David has this asset that’s producing $100,000 dollars in profit every year. The price of that deal was $100,000 dollars, the earnings or the profits per year of that company was $100,000 dollars, that’s a P/E ratio of one. Well, is that a good deal? Well, David is now earning 100% return on his investment every year. That’s an outstanding deal for David. What do CD’s pay at the bank? One percent, maybe? He’s now getting 100% return on his investment. Mindy, you and I got screwed on that purchase price. It was way too low. A P/E ratio of one for our company is way too low.
Let’s take it to the other extreme. Let’s say we all agree that our business is worth $10 million dollars, $10 million dollars. David agrees, he gives us $10 million dollars. He has this asset that’s producing $100,000 dollars in cash every year. Well, what’s David’s return on investment now? Well, he just spent $10 million and he is only getting $100,000 dollars back every year. That’s a 1% return on his investment. Why would he go through the hassle of buying and running a coffee shop if he could buy a government bond and get 2% return on his investment? A P/E ratio of one, way too low, terrible deal for us, too good of a deal for him. A P/E ratio of 100, terrible deal for him, way too good of a deal for us.
Let’s split the difference and let’s say, “How about a P/E ratio of 10?” What would our company be worth if the price to earnings ratio of our business was 10? Well, we made $100,000 dollars in profit, multiply that by that P/E ratio of 10, our business is worth $1 million bucks. Let’s say we all agree to that. So we sell this asset for $1 million dollars, that’s what we get today. David, by contrast gives us $1 million dollars and he’s now earning a 10% return on his asset over any given year. Let’s say that’s a fair deal.
Bingo! We now know how to value this business. That’s an extremely overly simplified example of figuring out what a business is worth. But that same concept applies to the stock market as a whole. The S&P 500, that index of 500 companies that’s out there, also have a P/E ratio, a price to earnings ratio. That P/E ratio fluctuates up and down depending on the earnings of the companies in there and the value that investors by and large are willing to pay on the company. But broadly speaking, P/E ratio is one of the simplest and in many cases, overly simplified ways of valuing a business.

David:
Curious, just for clarification, I’m mainly a real estate guy and when I’m a stock market guy, I’m an index fund guy because of the piece that you said about wanting to spend time researching. I don’t. But I’m curious on the earning side, when you’re talking about this valuation. In real estate, it’s net operating income, which is total income, minus expenses, exclusive of debt service. Is that the same here? If the company has debt, you don’t factor that against the earnings, or would that be factored in as well?

Brian:
There’s lots of ways that you can calculate it and the P/E ratio is an overly simplified one. But in the earnings that we used, we assumed the earnings of the business was $100,000 dollars and that is accounting for all costs. All costs, including debt services. You can get much fancier than that by excluding debt, any interest expense, you can exclude the tax rate that you pay. You can exclude fancy accounting terms like depreciation and amortization. There’s lots of different metrics that you can use. It’s just the P/E ratio is the simplest one.

David:
Perfect, appreciate it.

Brian:
Okay, by your comments, you just said that 10 is the best P/E ratio out there, right? One is terrible and 100 is awesome and 10 is perfect. What is a good P/E ratio in the stock market right now?
Well, if you look at the historic P/E ratio of the S&P 500, you get numbers that are all over the map. I mean, truly. In 1949, 1950, somewhere around there, the P/E ratio of the S&P 500 got as low as six or seven. And in the 2000 boom, at the peak of the dot com craziness, the P/E ratio of the S&P 500 went as high as 43. That is a enormously wide range that the P/E ratio of the S&P 500 has swung in between. There’s a lot of factors that influence what is the current P/E ratio of the market. One of them is the current prevailing interest rates that are out there. By and large, the historic returns of the S&P 500 are somewhere around 10% annualized return. If you look back at long term historic data, that’s what the market normalizes towards. If you subtract inflation from that number to get a real return, it’s somewhere around 6% to 7%.
Well, if you were looking at bond prices today, if you’re going to make an investment in bonds today, what kind of interest rates could you get? Two percent, 3%, maybe 4%. By comparison, the 10% return that you get on the S&P 500 or the stock market, looks very, very, very attractive.
Now reverse that to the 1980s. Back then, which was when my parents were buying their house, the prevailing interest rates at the time were in the teens. They were 12%, 13%, 14%, 15% at the time. You could buy a government bond and earn a 15% return on your money. Why would you want to invest in the stock market if you had this guaranteed thing out there? So to compensate for that extreme interest rate that was out there, that you could get essentially “risk free” by investing in bonds, the price to earning ratio of the market had to fall dramatically so that the earnings yields of the buyer could compete effectively with the prevailing bond prices.
The interest rate that’s out there, the inflation rate that’s out there, the general mood of investors, the amount of liquidity that’s out there, what’s happening with the world globally, all of these factors, and many, many, many other influence what the current price to earnings ratio is of the S&P 500 at any given time. This is why stock prices bounce around so much and it drives people absolutely crazy. If you don’t know that there is this thing called the P/E ratio, and you don’t know that there’s a thing called earnings behind the scenes, stock prices just look random because on any given day, week, month, or year, they are random. On any given day, I think the S&P 500 historically, is up 51% of the time and it’s down 49% of the time. It is literally a coin flip what’s going to happen in the stock market on any given day.
But the longer the time period you measure the S&P 500, the more and more those odds tilt in favor of up days versus down days. In fact, my favorite statistic about the S&P 500 ever is that over every single 20 year period in US stock market history, you have earned a positive real return. Let me say that again, 100% of the time over every rolling 20 year period in the US stock market history, you have earned a positive, real return after accounting for inflation. That includes investing at the absolute peak in 1921, investing at the absolute peak of the dot com craze, investing at the worst possible days, the [inaudible 00:28:02] global highs, you have made money 100% of the time when measured over 20 year periods. This is why I constantly say the stock market actually isn’t risky. What’s risky is holding stocks for a shorter duration than their intended holding period.

Mindy:
What is their intended hold period?

Brian:
Well, if you listen to a lot of people such as myself, the stock market is a great place for long term capital. You shouldn’t put any money into the market that you know you’re going to need over the next one, three, or even five years. If you look at the five year returns of the S&P 500, I believe the number is something like you have a positive return over five year periods about 80% of the time. Over 10 year periods, it’s towards the 90% of the time. But that still means either 20% or 10% of the time, if you invest and wait five years, you’re going to have less money in five or 10 years than you had today. So it really depends on your risk tolerance.
But this is why the stock market is such a wonderful place for long term capital. That’s why it’s such a good place for retirement funds to go in there. If you have a multi-year and a multi-decade, even better time horizon, you should want essentially 100% of that capital in the stock market, because that’s the thing that historically has driven the highest return. Any shorter period than that, any shorter time period than five years, you’re really taking on a whole bunch of market risk, and you might not be able to buy the thing that you’re hoping in that time period.

Mindy:
Okay, let’s pivot to the 4% rule because the FIRE movement is predicated on the 4% rule, Bill Bengen’s brilliant analysis of past performance of the stock market. However, past performance is not indicative of future gains. What is your opinion of the 4% rule, because this is a long term play with the 4% rule. He’s not suggesting that you invest today, to start pulling out tomorrow. He’s suggesting that you invest for a while, to pull out over the course of 30 years. Which plays into your excitement of the stock market, which I agree with, by the way. I’m not just saying it’s your excitement, it’s our shared excitement of the stock market. But what is your opinion of the 4% rule?

Brian:
I love the 4% rule. I love simple rules of thumb that dramatically simplify things and simplify decision makings. As far as rules of thumbs go, the 4% rule is a pretty darn good one. The figuring out how am I going to pay for and handle retirement is one of the most complex math problems that just exists out there. You are taking so many potential variables into play. How much income am I going to have? What are inflation rates going to be? What’s prevailing interest rates going to be at the time? What are my health needs? What are my vacation preferences? What’s my lifestyle going to be? What major life events can I look forward to? All of those are massive unknowns, so if you can just take that and simplify that and say the 4% rule, AKA 25 times your annual spending rate and use that as a goal post, I think that is a fantastic starting point.
Personally, I’m on the journey towards 5% myself and I am just a conservative person by nature. I have always had it in my mind, “Oh, I’m going to get to the 3% rule. I want to get 33 times my spending and really go super worst case scenario.” But the more I’ve learned about it, the more I realize that my need for a 3% rule is ridiculous and it’s being way too conservative. Because you can always, as a person, adapt to changes that you see in the market. For example, if I saw that we’re going through a major bear market and my net worth declined by 30% or 40%, I guarantee you I would change my spending behavior. I would pull back on spending things. I would try and take lower cost vacations. I would perhaps not eat out as much. I would adjust my spending accordingly. Conversely, if we went through a 2020 style stock market boom, when everything went up, I would be more willing to pay for capital expenditures in my life, buy things that were more expensive or pay for fancy vacations.
None of that is really factored into the 4% rule. It just figures you’re going to spend a certain amount and increase your spending by every year. More over, it’s never been easier than it is today to pick up a part-time job that generates just a tiny little bit of income for yourself. It’s really not that hard to generate a few hundred or even a few thousand dollars in income for yourself “in retirement.” And if you can do that, then the 4% rule is way too conservative. But as far as rules of thumb go, I think the 4% rule is a fabulous starting point.

Mindy:
I like that you say rule of thumb. I think that it should be renamed to the 4% rule of thumb. It isn’t exactly on the dot. Although, if you look at Bill Bengen’s research ended in the ’90s, because that’s when his analysis was performed, Michael Kitces picked up where Bengen left off and he determined that the rule was even more valid than Bengen had originally thought. In a post that he made in January of 2022, and I’m going to give him a pass on this because it was January before the market started tumbling this year, he said, “In other words, 4% can be considered a floor for retirement spending, not a ceiling because anything less than a 4% initial withdrawal rate would virtually guarantee that there would be excess money left on the table after 30 years.” Now, this is 30 years and Bengen’s analysis was for retirement age based on a 30 year portfolio.
If you’re retiring early, if retiring when you’re 30, you’re probably going to need this for more than 30 years. But again, anything less than a 4% initial withdrawal weight would virtually guarantee that there would be excess money left on the table after 30 years. So you would have more money at the end of 30 years than you could spend. And he goes on to say, “In fact, retirees over the last 140 years who strictly followed the 4% rule, would have had only a 10% chance of finishing with anything less than their initial portfolio value.” We’re not even talking about having zero, we’re talking about going below the initial portfolio value after 30 years. “And an equally likely chance of finishing with more than six times their starting principle.”
All of this is amazing to listen to, and it doesn’t help you at all when your portfolio drops 25% in six months after having gone on a tear for 12 years. Which leads me back to the very beginning of the show where I said, “Hey, what advice do you have for people?” But I love this rule of thumb and these smarter than me guys have figured it out. But it’s still so hard to get over your emotions. That’s another one of your individual stock questions. Are you good at managing your emotions? Anybody who’s ever listened to this show is like, “Nope, Mindy’s not good at imagining her emotions.”

Brian:
Hey, know thyself. That’s an incredibly important attribute. This is why rules of thumb are helpful, but they don’t apply to everybody because everybody is personal. We all have our own personal needs. Personally, I tend to be hyper conservative with my finances, because I’m just a nervous person and I just want to have as many barriers between me and an awful life as I can possibly get. I have long kept a pretty sizeable cash position, even though financially I’d be better off today if I kept all that in the stock market. I just like knowing that it’s there in case everything goes wrong in my life, that I have a big cash cushion. I also am a big fan of having absolutely zero debt of any kind, including a mortgage.
I know that decision is suboptimally from a pure financial perspective, especially today. If you could lock in a mortgage rate of say 3% or something like that in the last year and now inflation is 7%, I mean, the mathematical gains on keeping that money invested are so much higher than you could earn by paying off your mortgage. For me personally, I don’t care. I still want my mortgage gone because I want to permanently lower my fixed cost to the lowest number possible, period. And by eliminating my mortgage, I have now permanently reduced my largest monthly expense. To me, that is worth the satisfaction I get. The psychological satisfaction I get is worth the lost potential upside. But this is why personal finances is always personal.

Mindy:
I like what you said, because it shows that you have thought it through. You didn’t just pay off your mortgage because that’s what Dave Ramsey said to do, so you did it. You thought about what it means, you took into account that it is mathematically not the most optimal choice and you said, “I will sleep better at night knowing that my mortgage is paid off, so that’s what I’m going to do. Having taken into consideration the different factors, I’m still going to do it.” As opposed to, “Eh, I’m just going to do it.” You’re thinking it through and you’re right, personal finance is personal, and you make the decisions for your specific situation based on mathematically what works best for you and also mentally what works best for you. I can sleep well at night having a mortgage. David’s got 100 mortgages, he can sleep just fine, too.

David:
I was about to say, I would say 75%, 80% of my net worth is in real estate. It’s all pretty highly leveraged. It cash flows, it covers itself, it’s whatever. And yet, ironically, my wife, who is very risk averse and doesn’t like how much debt we have out on a lot of these properties, I am trying to convince her to let me focus on paying off the primary residence mortgage. She’s like, “Well, I just assumed mortgage is a piece of life.” It’s funny when you flip it, because I’m like, “I agree with you. I’m all for all of this risk in my LLCs because it’s cash flowing, it’s doing whatever.” But in my primary I’m like, “Well, why don’t we just pay that off so we can spend more money on things we enjoy?”

Brian:
That’s right. There’s no right or wrong way to do it. But when I thought about that number myself, I stopped and said, “Well, what’s the point of money? What is the purpose of money? Is it to maximize the number on a spreadsheet? Is that the purpose of money? Or is it the purpose of money to allow ourselves to live the exact lifestyle that we want and minimize the amount of financial risk that we’re taking on?” When I viewed it from that lens, paying off my mortgage became not a no-brainer, but a much easier decision when I said, “What do I care what the ultimate value of my net worth is when I die, if paying this off now would make me live a better life today?” When viewed through that lens, paying off my mortgage became not a no-brainer, but a relatively easy decision.

Mindy:
That’s what you have to do, is think about it, think it through, make sure that you are doing what is right for you based on thoughtful consideration. One last thing I wanted to ask you about, you share a hot tip for investing that is simultaneously sad, heartbreakingly sad to me, common sense, and potentially completely unknown to a newer investor. You call it the multimillion dollar mistake.

Brian:
Now this is actually a sad one a little bit, but it’s just knowing the difference between what an IRA is and how an IRA works, or what a 401k is and how a 401k works. A lot of people, especially those that aren’t as fluent in finance as we are, think that the term Roth or the term IRA or the term 401k is in itself an investment. It’s something that you can go out there and put money into and that is itself an investment. The truth of the matter is that a 401k, an IRA, and a Roth IRA, and many other terms are just wrappers around accounts that give them designated tax purposes. One potentially really big mistake that people can make is they could go to Vanguard, they could open up an IRA, they could open up a Roth IRA, they could contribute money to it and that money goes into that account and sits in cash. It just sits there in cash account because they never took the next step of actually taking the money and investing it into some kind of fund.
A good analogy I heard was you think about those accounts like a gift card. It’s like you’re putting money into this account that’s a gift card and if it just stays in that gift card, well, that’s earning you nothing. You have to go out and spend the gift card in order to get some value out of it. This can literally be a multimillion dollar mistake that people can make if they’re just putting money into an account, but they’re not taking that money in the account and investing it into the Vanguard Total Stock Market index fund, or the Vanguard Total Bond Market index fund. If you are doing that, please go check your account and make sure that it’s not all sitting there in a money market account or a cash account, that you’re actually investing it the way that you intend to.

Mindy:
Yes, that’s a research opportunity for anybody listening. Go in and check the allocation of every one of your investment accounts right now. Stop the listening and go look at every single one of your accounts. If you’re like my husband, you’ve got a thousand places to check. If you’re a more normal person, you probably have one or two, maybe your post-tax and pre-tax, but check them and make sure that your money has been invested in something other than nothing. We’re not going to tell you where to put it, because this is not an investment show.
Okay, Brian, this was really, really helpful. I learned a lot about P/Es and valuations, and we need to come back and have a strictly, this is how you take and analyze a stock, because I think there is some value in individual stock investments. I encourage people to not invest in individual stocks, unless they are absolutely certain that they want to do all the work and ride that roller coaster, which it can be very, very volatile. Just look at Tesla, it goes like this all the time and when it goes down, we buy more because he has done all the research that he wanted to do to learn everything about that. But seriously, he listens to hours of Tesla podcasts every single day. I can’t believe there’s more than one, there’s tons. But if you’re not willing to do the work, then the index fund is right for you.
But I really appreciate your time today, Brian. Thank you so much for joining us. What is the book called and where can we get it?

Brian:
Thank you guys so much for having me, this has been a blast. I would absolutely love to come back and either talk valuation with you guys, or if you want to get really nerdy, how to dig into a 10-K, how to analyze a business. I love talking about that kind of stuff. The book is called, Why Does The Stock Market Go Up? It is very much geared at people that are brand new to investing, people that have zero financial knowledge and just want to figure out what is the stock market and how does it work? That’s very much the person that was in intended towards. You can find it at all major online resellers. So Barnes and Nobles, Amazon, or choosefi.com, et cetera.

Mindy:
And where can people find out more about you, Brian?

Brian:
The easiest way to connect with me is on Twitter. I’m very active on there. Just my name, @BrianFeroldi. If you’re interested in analyzing individual businesses, I have a YouTube channel where we do exactly that and I show you how me and my business partner do so. That’s also my name, Brian Feroldi.

Mindy:
Awesome, and we will include links to all of these in the show notes, which can be found at biggerpockets.com/moneyshow327.
All right, Brian, thank you so much and we’ll talk to you soon.

Brian:
Thanks Mindy, thanks, David. Great to be here.

Mindy:
All right, that was Brian Feroldi, author of Why Does The Stock Market Go Up? David, what’d you think of the show?

David:
That was great. I think he did a great job breaking down P/E ratios and I like that we discussed the 4% safe withdrawal rate and index funds. I always like when I get confirmation about my decisions and so I am an index fund guy. When he says things like, “You should invest in index funds if you’re too lazy or don’t want to do the research,” and that’s me, do not want to do the research. Do not want to wake up when the stock market opens and do what’s going on today. Nope, don’t want to deal with any of that. It’s really nice when I get the affirmation of you’re in the right place by just doing an index fund, to let someone else do the thinking.

Mindy:
Yep. We started off as individual stock investors, and we have moved to mainly index funds because a rising tide lifts all ships and all these cliches, but that’s so true. He’s got a statistic in his book, between 2004 and 2019 more than 89% of mutual funds underperformed the stock market as a whole. That is shocking. You’re not going to do better than the stock market as a whole, throw it into an index fund and be done. Set it and forget it. If you are unwilling to spend the time to develop a system that helps you identify good investments, if you do not enjoy the process of researching individual companies, if you’re not good at managing your emotions, individual stock picking is not the choice for you.

David:
At the risk of frustrating all real estate investors out there and with the announcement and the reminder that I am one of those real estate investors, I don’t think there’s a single investment out there that is more passive than an index fund. The only thing you need to do once you set up your account and set up the routing, is set how much you want to contribute and then leave it alone. I mean, that’s even more passive than an LP investor on syndications, because you still need to vet the deals before those happen every five to seven years. Whereas with index funds, you can literally just let it ride.

Mindy:
Yep. Yeah, no real estate can be passive-ish, it can be passive-esque, but it is not truly passive. My stocks never call me up in the middle of the night to tell me about a problem. In fact, my stocks never call me up. My index funds never call me, ever, and that’s okay.

David:
Yep, I love it.

Mindy:
Okay, David, should we get out of here?

David:
We should.

Mindy:
From episode 327 of the BiggerPockets Money podcast, he is David Pere, from the Military to Millionaire group. I am Mindy Jensen saying, may the force be with you.