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Our guest on the podcast today is Brian Feroldi. Brian is the author of a new book called Why Does the Stock Market Go Up? He is also a writer and contributor to the Motley Fool, where he focuses on the technology and healthcare industries. In addition, Brian has a big presence on YouTube. The videos on his YouTube channel have hundreds of thousands of views. He received his bachelor’s degree from the University of Connecticut and his MBA from the University of Rhode Island.
Background
Brian Feroldi—Spread Financial Wellness YouTube channel
Individual Stock Investing
“10 Investing Lessons for Stock Market Beginners,” by Brian Feroldi, youtube.com, July 15, 2021.
“The Hardest Part About Picking Stocks for New Investors,” video with Brian Feroldi and Brian Withers, fool.com, Feb. 10, 2021.
“Opinion: ‘Time in the Stock Market Is More Important Than Timing the Market’ and More Critical Money and Investing Lessons I Wish My Younger Self Had Understood,” by Brian Feroldi, marketwatch.com, May 5, 2022.
“Brian Feroldi’s Stock Investing Checklist: A Step by Step Guide,” by Brian Feroldi, youtube.com, June 18, 2021.
Antifragile: Things That Gain From Disorder, by Nassim Taleb
“Good Reasons to Ignore Valuation,” by Brian Feroldi, MicroCap Leadership Summit 2021, microcapclub.com, Oct. 6, 2021.
“Interview With Tom Engle: Investing Legend,” with Chris Reining, chrisreining.com.
“GameStop: Squeezed to the Max|Brian Feroldi|EP 293,” choosefi.com, Feb. 4, 2021.
“The 5 Biggest Investing Mistakes I’ve Ever Made,” by Brian Feroldi, yahoo.com, Sept. 23, 2018.
Other
Invest Like the Best with Patrick O’Shaughnessy
Transcript
Christine Benz: Hi, and welcome to The Long View. I’m Christine Benz, director of personal finance and retirement planning for Morningstar.
Jeff Ptak: And I’m Jeff Ptak, chief ratings officer for Morningstar Research Services.
Benz: Our guest on the podcast today is Brian Feroldi. Brian is the author of a new book called Why Does The Stock Market Go Up? He is also a writer and contributor to the Motley Fool, where he focuses on the technology and healthcare industries. In addition, Brian has a big presence on YouTube. The videos on his YouTube channel have hundreds of thousands of views. He received his bachelor’s degree from the University of Connecticut and his MBA from the University of Rhode Island.
Brian, welcome to The Long View.
Brian Feroldi: Jeff and Christine, thanks so much for having me.
Benz: Well, thanks for being here. We wanted to talk about your new book Why Does The Stock Market Go Up? And you wrote that you wrote the book because you wished you had such a book when you were starting to learn about investing. Can you walk us through what types of investors you’re trying to address with this book?
Feroldi: I love everything about money and investing. I’m just a nerd for this stuff. So, I’ve read dozens of books about investing and money. It just is something that really appeals to me. When I meet new people in my life, and they’re like, “I want to get started investing,” I didn’t think that there was a really great introduction book for those people for me to hand to them, because I don’t think you need to know how to pick individual stocks to do well. I just think you need to know the extreme basics about what the stock market is, how it works, and why it goes up over time. And for years, I was frustrated that no such book existed. And I thought to myself, finally, about two years ago, well, maybe this means that I’m supposed to be the person that writes it.
So, when I was writing it, I very much had essentially my mom in mind. My mom is somebody that knows absolutely nothing about the stock market. It scares her in many ways. She doesn’t understand it. It was never explained to her what it was. And because of that, she has actually had her 401(k), which she has been diligently contributing to for decades, in cash the entire way up, because she just understands, and she feels comfortable with that. And I just thought, what would I need to tell my mom to make her comfortable with understanding what the stock market is, how it works, and why she should have confidence in investing it in the long term? But more importantly, there’s about 100 million Americans that have money in the markets in one way or the other. And I have no data to back up what I’m about to say, I just know it’s true. If you ask them, why does the stock market go up? I have a strong suspicion that you would get the wrong answer 99% of the time. So, my real target audience was anybody with money in the market that doesn’t know the answer to that title.
Ptak: I think as the conversation unfolds here, we’ll get into your answer to the question, why does the stock market go up? But before we do that, I wanted to talk about the way you structured the book. You structured it as a series of very short chapters, each of which imparts a very specific lesson. What was your thinking in organizing the book in that way?
Feroldi: I don’t like dense books myself. And I really like Dan Brown. Dan Brown, the author of Angels & Demons and The Da Vinci Code. And one thing I really loved about his books was, there were tons of chapters, and each of them are three or four pages long, and that really made me feel good as a reader to know, yes, look how much progress I’m making as I’m going along. But more important than that is, if you’re a content creator on social media–and I am very active on Twitter–one thing that social media trains you to do is to get your point across as quickly and succinctly as possible. And I very much kept that in mind when I was writing the book. In fact, when I was editing myself, I constantly asked myself, how can I make this chapter shorter, shorter, shorter? I want people to be able to pick this up, breeze through the book for it to be enjoyable to read, and then for them to get on with their life.
Benz: I wanted to talk about a couple of things that the book doesn’t include. It doesn’t include a lot on personal finance or behavioral finance matters. And those have been key focuses in a lot of other top-selling money-related books recently. Why did you, for the most part, avoid those subjects?
Feroldi: Well, I think there has been so many wonderful books written on exactly those subjects. On the behavioral finance part, my friend Morgan Housel’s book The Psychology of Money is just phenomenal with explaining those topics to people. But you are right. Your personal finances and your behavior are extremely important topics for every investor to really know and master. However, when it comes to the behavior part, I think one reason why people naturally panic or feel panicked when the markets are declining, is that they don’t fundamentally understand what is happening and why it’s happening. I myself in years past, whenever I saw the market declining, I was like, well, that’s it, capitalism. We had a great run, but it’s 2008, the world’s falling apart; there’s no way the stock market is going to rebound from this. And obviously, within a matter of, what, 18 months, the stock market was back to hitting all-time highs again.
And that just intuitively did not make any sense to me at all. It doesn’t make any sense how there is this thing called the stock market that, yes, it declines very sharply sometimes, but it just always goes on to hit new highs. I firmly believe once you understand how the market works, the underlying forces that cause the market to hit new highs that you can actually invest with confidence, and that can help you to hold on to your stocks and continue to add when the market is declining. So, I didn’t tackle it directly. But I do think if you do understand the core structure of the stock market, you can positively impact your behavior.
Ptak: To go back to your question, why does the stock market go up, what’s the most succinct explanation you could offer someone for why the market goes up? You have someone like your mom, who maybe is fearful of the market, or just plain doesn’t understand it, but they do want to understand why does the market go up. How would you answer that?
Feroldi: I’ve been wrapping my head around that very topic. It’s a quite complex thing to try and explain to somebody. So, I broke it down by getting into the individual components, and I started by talking about a fictional coffee company in the book. I think if you start at the individual business level, and specifically the simplest business that I could think of, which is a coffee company, you can then scale it up into the stock market.
So, why does any business that has generated strong returns over long periods of time go up? We both know the answer to that question is the business behind that stock grows its revenue, expands its margins, and increases its profits dramatically. Take a look back at any of the best-performing stocks of all time–Apple, Microsoft, Amazon, Netflix, and so on–and ask yourself, why are these companies worth so much more today than they were 10 years ago, 20 years ago, 30 years ago? The answer is their businesses are many, many, many multiples bigger today than they were 10 and 20 years ago. I think that that concept is relatively straightforward to understand to somebody and you can make them understand why those stocks gradually went up over time as the businesses were succeeding.
So, I just take that very simple concept, explain briefly what the most simple valuation metric that I could get across, which was the price/earnings ratio, and then, I say, “So here’s how a business grows in value over time. The stock market works in the exact same way.” If you look at the long-term history of the S&P 500, it’s very clear that the price goes up over time. What’s often hidden from our view is that people don’t see the earnings of the S&P 500 and how that has trended over time. So, that’s what I tried to do in my book. I tried to just make the very basic connection between stock prices and business earnings and explain the bull case for why earnings have grown at the S&P 500 for more than 100 years and lay out the case why I think they will continue to grow for the next 100 years.
Benz: I wanted to ask about stock investing for individual investors. At The Motley Fool you write about individual stocks quite a bit and individual stock investing is a key focus of your book, too. Do you think buying and holding individual stocks is a reasonable path for small investors, especially when you consider all we know about the failings of professional money managers. The question is why would individual investors do any better with that activity?
Feroldi: If somebody comes up to me that I don’t know well, and they say, “What should I invest in?” My answer in the stock market is always the same: index funds. If the average person just dollar-cost-averaged into index funds for 10 or 20 years, I’m extremely confident that they will do very well with their money over long periods of time. So, I think that that is the right choice for 98% of the population. However, there is that 1% to 2% of the population that, for whatever reason, like myself, are just interested in business, are interested in stocks. And I think it is worthwhile for the people that have the time and the inclination to do the research and to buy individual stocks–I think that that is a viable strategy for building long-term wealth.
Now, if you look at many of the studies that come out, especially on mutual fund managers, the data is very clear that most mutual funds underperformed the index over long periods of time. So, why the heck would an individual have any better luck at that? Well, I firmly believe that individual investors have a structural advantage over mutual fund managers. Namely, individual investors are investing their own capital. They don’t have to explain or justify their moves to anybody else. They have no career risk. They don’t have to explain why they own ABC stock, or why ABC stock is underperforming to anybody else. And because they’re investing their own capital, and they’re not going to fire themselves, they can truly focus on a three-, five-, 10-, and 20-year time horizon when they’re making an investment. And if you look back at any of the best-performing stocks of all time, all of them without exception went through periods when their stock went down dramatically. Amazon in the wake of the 2000 crash, peak to trough fell 92%. That is a whole lot of pain that Amazon put its investors through. And if you’re a professional money manager, and you’re having to hold through that, you can bet that your investors are going to be pointing at that and saying, “Why do you own this stinker?” And it’s a really hard thing to justify to other people why you own a stock. However, when you’re investing your own money, and you’re picking your own individual stocks, you can truly ignore that short-term viability and invest with the long-term in mind. So, while I don’t think the effort of picking your individual stocks is worthwhile for everybody, for a very small percent of the population, I think it’s a perfectly viable strategy.
Ptak: Besides patience and nerve, what do you think are the key characteristics or personality traits that someone should have if they’re aiming to be successful in individual stock investing? And on the flip side, who do you think should just avoid delving into individual stocks? It’s a large group. I think you said 98% of people should just be indexing. And so, what are the traits of the people that ought not to mess with individual stock-picking?
Feroldi: There’s a lot of skills that you need to develop if you’re going to go through the process of picking your own stocks. You need to study accounting, you need to study history, you need to be able to think through business models, you need to think through risks, you have to study your own psychology, you have to study your own behavior. And it’s worthwhile to look at some of the greatest investors of all time and really learn what they did. That is a whole lot of effort that people have to go through if they want to buy individual stocks and try and outperform over the long term.
So, the number-one characteristic that you need is interest in doing that, because that is a time-consuming process. And for most people, the idea of digging through a 10-K, or listening to a conference call would just bore them to tears. So, it’s not something that you can do a little bit. If you want to pick your own stocks, you do need to put the time and energy into learning how to do it correctly. So, to me, that’s the number-one thing. You have to be interested in it enough to do it more than you’d want to do any other activity.
Benz: In the book, you talk about how it’s a legitimate path to maybe thinking about owning a little bit of individual stock exposure alongside, say, an index fund or mutual fund portfolio. In practice, though, when I see that in people’s portfolios, it seems like they own a lot of large-cap stocks that largely duplicate the exposure in their index funds or in their mutual funds. So, should people be thoughtful about that to make sure that the individual stocks that they do pick somehow complement the other stuff in their portfolio?
Feroldi: Yes, that’s a perfectly fair question. Some of the most popular stocks that people buy are like Apple, Amazon, Microsoft. These are big, powerful names. And they might not realize that if they just own an S&P 500 index fund that they already have, say, 4% or 5% or 6% of their portfolio already invested in those names. However, I think it’s a perfectly fine strategy to buy those stocks. If the investor for whatever reason thinks that that company is set up to outperform–just take a look at Apple, for example. Apple was a gargantuan company three years ago, five years ago, and even 10 years ago, it was an absolutely huge business. And yet, it has dramatically outperformed the index over the last three, five, and 10 years as it’s grown to become more powerful. So, if that’s a company that sings to somebody and they want even more exposure beyond what they already have, I say, go for it. But you do bring up an excellent point. I don’t think people that crack open the index funds and components of theirs, so they might be over-allocated to some of the big tech names without even knowing it.
Ptak: Many stock investors repeat the old Peter Lynch mantra about investing in companies you know and love. In your opinion, is that a good starting point for investing, or not so much?
Feroldi: Peter Lynch is one of my favorite investors of all time. And as I said previously, if you’re going to pick individual stocks, the most important criteria to me is that you are interested in it. So, if you are naturally interested in some companies, even if they’re big, popular companies, I think that those are a great place for investors to look because they’re more likely to follow the company and want to learn about it if it’s a name that they know and they’re comfortable with. However, if you’re looking for long-term alpha, which you should be if you’re going to go through the process of picking individual stocks. More often than not, some of the highest returns are found from going down the market cap and looking at companies that are in the smaller market-cap range, let’s say, under $10 billion or $5 billion–that might not be companies that they know as well and are as familiar with. But I think investing in what you know is a great starting point.
Benz: So, if that’s the starting point, then what types of due diligence should come after that? Because I’m guessing you would say that that’s not a good ending point, like, “I love Lululemon, therefore, it’s probably a good stock to hold in my portfolio.” What are the other things that someone should be attuned to?
Feroldi: If you’re going to go through the process of individual stock investing, what I suggest everybody do is a very simple process. Step one is to get a piece of paper, an Excel spreadsheet or whatever, and write down every business attribute that would make a company appealing to you to invest in. So, I’ve done this process for myself, and I came up with things like: I want a strong balance sheet; I want positive free cash flow; I want high returns on capital; I want a business with a moat that is wide and expanding; I want a founder-led business; I want happy employees; and I want a stock that’s already beaten the market, and so on. So, I have like 25 criteria that if a company has that attribute, I’m attracted to it.
Conversely, I made another list, which is, what are the attributes that I don’t want to see in a business that I invest in? And I came up with things like, I don’t like accounting problems. If I can’t trust the numbers, how can I possibly trust anything else about the business? I don’t like it when a business gets an outsize portion of its revenue from just a small number of customers. I don’t like it when a company relies on interest rates, or commodity prices, or a strong stock market to succeed. I don’t like it when there’s high levels of dilution through stock-based compensation, and so on and so on. So, I made these two lists for myself: the positive attributes and the negative attributes. And then, I forced myself to rank them from most important to least important. From there, I assigned a very simple weighing system, so that now after I went through this process, any business that I come across, I can run through my investing checklist of the good one and the bad one, and I can come up with a simple scoring system for myself that tells me how strong of a match is this company for my investing needs. So, I think that that process right there is worthwhile to do for everybody who is interested in individual stocks. And I made my checklist freely available, and you can download it right from my website. And I encourage people to do that, and then change the criteria to be whatever metrics sing to them. But I just really think that process of writing things down, a good list and a bad list, and then weighing them will really dramatically simplify investing decision-making.
Ptak: I want to turn to business quality. I think you said that you believe that business quality, and what you call anti-fragility are characteristics of great equity investments. First question is, how are those two things different? And then, secondly, can you talk about how to assess businesses through those lenses, maybe providing an example or two?
Feroldi: Sure. So, on my YouTube channel, my business partner and I, Brian Stoffel, we have our investing checklist that we made. So, mine is called the Feroldi Quality Score, and it mimics the exact checklist that I said before. My business partner Brian, he invests with an anti-fragile mentality. That term is stolen from Nassim Taleb in his wonderful book, Antifragile. And his thought process is rather than investing in businesses and trying to predict the future, he wants to invest in businesses that he thinks are best positioned to withstand economic shocks and a best position to expand during times of distress. Largely, when we run companies through both of our frameworks, more often than not our checklist decisions do align with each other. But every now and then we do find a company that scores really well on my system but poorly on his and vice versa. But those are just two examples of checklists and weighing systems that investors can use. And it highlights just how one company, the same company with the same business attributes, can be a fit for one style of investing, but a bad fit for another.
Benz: I wanted to talk about how valuation fits into this. You’ve described yourself as a natural value investor. But you’ve also noted that earlier in your investment career, you missed the boat because you sold too early, or maybe you avoided stocks altogether due to their high valuations. Can you talk about how valuation should fit into stock investors’ analysis and how investors can ensure that they’re not overpaying for those good-quality or anti-fragile businesses?
Feroldi: Valuation is one of the trickiest things about investing. And to your point, my natural inclination as just a human being is to seek out value. If I’m going to the grocery store or shopping for clothes, the thing that my eye is naturally attracted toward is things that are on sale. So, when I first started investing, and I read books by Warren Buffett, Charlie Munger, and some of the famous value investors, that style of investing just immediately attracted me–yes, what I’m trying to do in investing is find dollars that are trading for $0.70 and buy those stocks at a discount. And one of the first stocks that I came across–this was back in 2006–the company I was working for at the time adopted a new software product called Salesforce.com. And I, as the employee of this company, immediately realized the power of this software. The business that I was working for almost instantaneously became completely dependent on this software.
And I was learning about investing at the time. And I said, “I wonder if this company is publicly traded.” Well, I went on and lucky enough, it was publicly traded. The company was worth about $3 billion at the time. And then I looked down to that price/earnings ratio and found that it was trading at 100 times earnings. And I immediately said, “Nope, pass, can’t buy that.” One hundred times earnings. How on earth could that be a good investment? Way too overvalued. Well, you can probably guess what happened next to that stock; me passing on that stock. I missed out on buying a multi, multi, multi-bagger. It’s up at least 20 times since I passed on that investment. So, slowly, over time, after having experiences like that, and learning from some investors that I deeply respect, I’ve learned the hard way that you should deemphasize valuation if a company has tremendous long-term potential. On the flip side of that, if a company has limited long-term potential, you should really emphasize valuation.
So, today, if I came across a company that was trading for–its market cap was $1 billion–and I thought that if that company was successful, it could be worth $10 billion or $20 billion one day, I’m going to ignore valuation altogether; I’m just going to get that company into my portfolio. Conversely, if I was trying to pick up shares in Apple or Microsoft, or McCormick or some companies that are in the mature slow growth phase of their business lifecycle, I’m going to really emphasize valuation with my entry point. So, that’s broadly how I approach it today. The larger the potential, the more I downplay valuation; the smaller the potential, the more I up-play valuation. But valuation is one of the trickiest things for investors to figure out.
Ptak: You’ve noted before that your personal investment strategy involves adding your positions and what you consider to be good-quality businesses after they’ve sold off. Has the recent selloff in growth stocks afforded you opportunities to add to companies you like at more attractive prices?
Feroldi: Very much so, yes. Well, it never feels good when I see my portfolio take a pounding as it has over the last year or so at this point. My investing style is to slowly build positions in companies again and again and again. And I try and do so at better and better value points. This is something I learned from one of my favorite investors of all time, a guy named Tom Engle, who’s been living off his portfolio for more than 40 years now.
So, the style that I go today is, if I find a new company that I’m interested investing in, and it has really high potential, I take a position in that company immediately, but a small one. When I buy the stock for the first time, I’m going to write down at the time of my purchase, what’s the price/sales ratio, what’s the price/free cash flow ratio, what’s the P/E ratio. So, I’m going to jot down a couple of simple valuation metrics. Then, I’m going to follow the company, and if the company continues to execute against its plan over time, I’m going to look to add to that company at a better valuation than I bought the first time. So, if I first paid 20 times sales for a company, with my next purchase I’m going to try and pay 18 times sales or 16 times sales, or less. So, with each future purchase, I’m trying to buy at a better and better valuation, as I build my position.
Now, that’s not always possible to do. And in some cases, the companies flame out and I’m no longer attracted to the business. In that case, I stop buying. But broadly speaking, that’s like the best-case scenario for me. I find a business, I want to own it for five, 10, 15 years, and I buy that same business again, and again, and again on the way up or on the way down, always trying to pay a lower valuation than my previous purchase.
Benz: So, you’ve been emphasizing the importance of understanding the businesses that you’re invested in. During the pandemic, it seemed like many of the new investors in the market appeared to be using some version of the greater fool theory to help guide their investments. They’re basically speculating. What were you thinking as you watched the GameStop phenomenon unfold in the summer of 2020?
Feroldi: It was crazy to watch. And you can learn so much about investor psychology by studying what’s happened with GameStop and AMC. To your point, those businesses that became a meme stock, by and large, are companies that I am just not interested in as an investor. They are on the declining phase of their growth style. I don’t think their businesses offer very good long-term potential, or at least they didn’t before they went through that craze. That doesn’t mean that their stocks can’t go up. And we saw those companies absolutely skyrocket as Reddit got behind them, and they were being pumped like crazy on social media. So, I just thought that what was happening with those stocks was just fascinating to watch. But I in no way as an investor wanted to participate in it.
Ptak: It’s hard not to think of the elimination of trading costs as a positive. But do you think the removal of frictions like commissions has contributed in a way to the fast-trading mindset that you were just describing? And ultimately, that isn’t going to be good for investors?
Feroldi: I will tell you, I’m very much of two mindsets around that. On the one hand, I absolutely love what Robinhood has done for investors by bringing down commission costs to zero, to making it very easy to get started investing, to offering things like fractional shares. On the flip side, many, many years ago, when trading was so much more of a hassle and you had to pay $50 or $100 per transaction, and you had to buy in 100-share lots, and there was so much more friction to investing, there were some bigger, much bigger hurdles that were in place for investors to buy and sell. And I think by making it so easy and so convenient to buy and trade by doing it on your phone, you are doing investors some disservice because it makes it so easy to sell if something’s down or buy if you see something going up. So, generally, I am a huge fan of the fact that trading costs and commissions have been ground down to zero, but it would be foolish to think that there weren’t some potential negatives to that happening.
Benz: We want to talk a little bit about teaching young people about money and about life. You have a post on your blog contrasting what you’re teaching your own children about success with the things that you were taught as you were growing up. Can you talk about some of the key differences there?
Feroldi: I was taught the standard American playbook of success growing up. What are you supposed to do? You’re supposed to get good grades in school; you’re supposed to go to a safe and prestigious university; you’re supposed to use that to get a safe, secure job; you’re going to earn a good salary and your job is to climb the corporate ladder. That was the standard playbook for decades in this country. I’ve since learned that the way that people actually become successful, especially today, is to think about money differently. And the way that I’m teaching my own kids how to think about money is I’m going to instill in them the idea of always being an investor, so I’m going to teach them like crazy as best I can, about what investing is, how to invest successfully, how to think for the long term. Another thing I’m going to try and teach them is how to network with other successful people. This is something that I am naturally pretty bad at but is one of the wonderful reasons to be on social media platforms, especially like Twitter. If you share your thoughts openly, honestly, and connect with people, I think people in general are very willing to connect with you and to get to know you. And by networking with other people, it just opens up a tremendous amount of opportunities down the road.
And the final thing I want them to learn is how to think like an entrepreneur. I’m going to really encourage them to start their own business, especially when they’re young and can fail on it. But even if they don’t want to become entrepreneurs down the road, I still think it’s very important for them to think like an entrepreneur. If you’re going to be joining a company in their career, it’s great, I think, to think like an entrepreneur and say, “Should I join a startup? I might be giving up salary in the beginning to do so. But I might be getting options or stock in that company and what could the long-term ramifications of that be?” And when you train yourself to think like an entrepreneur, it’s hard not to see opportunities just everywhere in the world. If you’re a hustler, and you can go out and learn a skill, it’s never been easier than it is today to find ways to generate income for yourself and work for yourself. So, broadly speaking, what I’m trying to teach to do is how to invest, how to network, and how to think like an entrepreneur. I think that will set them up for long-term success.
Benz: Do you think some people, though, just aren’t cut out to be entrepreneurs–not even literally, but also just do not have that mindset, it’s not in their personality type?
Feroldi: Oh, yeah, I think most people shouldn’t be entrepreneurs. There’s a lot that goes into it. And you have to have a mindset, you have to certainly have appetite for risk-taking. Still, even if your plan is to just be a worker, be and work for companies your entire life, I still think there’s a lot of value you can get by studying entrepreneurs and business executives of the past just learning how they think. Even if you never act on that, I still think there’s lots of value that you can bring to your employer by thinking like an entrepreneur.
Ptak: Some schools use stock market games to teach young people about investing and to ignite their interest. Do you think that’s a good idea? Or do you think that’s ill advised?
Feroldi: This is something that I’m very much of two minds about. I know that historically if you look back at the way stock market games are presented to kids, it’s like “Let’s pick some stocks one day, and then one week, or maybe one month later.” And they’re like, “Let’s see how our stocks did.” And that’s, of course, purely gambling over the short term. But I can tell you that this is something that I’ve started with my own kids in their elementary school, partly because I want to teach them how to do it. So, my twist on this was I visited my kids’ elementary school at the start of the year, I taught them a little bit about investing, what a stock is, what a company behind the stock is, and so on. And I gave them stocks to pick. So, they all picked five stocks from a list of 25 companies that I thought that they would be interested in. Then, I go in at the end of the year–I give it almost a full year–and I show them the results. But the important thing for me is that I’ve repeated this process now every year for multiple years. And when I’m going in and reviewing with them how they have done, I’m also referring to the stock-picks that they made one year ago, two years ago, three years ago, and more. It’s truly my hope to continue this with my kids’ classes, all the way through seniors and high school, and at the time they graduate, I can say, well, let’s see how we’ve done with investing from when you were in 10th grade, eighth grade, fifth grade, third grade, all the way back to second grade.
So, I’m trying to make it a good process by making it a multiyear period. But even still, if you just do a simple stock market game, and it teaches them about what a stock is, and why stocks squiggle around, and it’s over a short period of time, I still think there’s value in that, just not as much value as there would be if you did it over a multiyear period.
Benz: Speaking about lessons, broader lessons about money, you’ve often written that having an adequate savings rate and avoiding debt are the most important contributors to financial success. You mentioned that throughout your book. So, why are those really mundane things so often overshadowed by investing and maybe even investing in individual stocks?
Feroldi: Well, investing and talking about individual stocks is fun. Everybody wants to know, everybody wants to click on the thing that says, “Here’s a stock that can go up 10x tomorrow.” That’s just a fun topic to talk about. In reality, my personal belief is that what you do with your personal finances is, in order of magnitude, more important than what you do with your investing finances. And it would be foolish to think that the two things were not linked. My career mission in life is to spread financial wellness. And as a part of that, I really think it’s important for most people, to start by focusing on their personal finances.
To me financial wellness means that you have multiple sources of income, that you have a high savings rate, that you eliminate your debt, that you build up a strong emergency fund. Only once you get that stuff done, do I really think you should start to focus on investing and investing in individual stocks. So, it’s really important to me that you take care of your personal finances first. I also think that if your personal finances are in a really good place, it makes you a better investor. If you have no debt, multiple sources of income, and you’re not worried about your day-to-day life at all, what your portfolio does on any day, week, month, or year really will have no impact at all on your actual life. It will impact your psychology, but it might not impact your life at all. For that reason, if your personal finances are rock-solid, not only can you invest more in the markets, but when a downturn comes, I think it gives you the mental clarity to be able to take a focus on the long-term and really continually invest even when the markets are heading in the wrong direction.
Ptak: I wanted to shift gears and talk about crypto, which I think you’ve been a skeptic on in the past. But if I’m not mistaken, maybe you own some crypto now. So, can you describe how your thinking on crypto has evolved? And what were the key things that might have changed your mind along the way?
Feroldi: I vividly remember like five years ago, some colleagues who knew I was into investing, were asking me, “Brian, what are your thoughts on bitcoin? What are your thoughts on ethereum?” And at the time, my thought was, one, those things don’t produce cash flow, they will never produce cash flow. So, I have no idea how to value them. And two, they’re just like digital gold. So, it’s going to be the greater fool theory with selling them to somebody else at a higher price. So, that was the beginning and end of my research on it.
I will say that slowly, over time, I’ve come to understand how crypto works more. And the real thing that caused me to flip from being a crypto skeptic to now owning a tiny little bit of crypto myself was I asked myself a question, which was, “Should there be a digital currency of the internet; should that thing exist?” The more I think about it, the more I think the right answer to that question is: yes. So, what is the leading contender to be that thing if you think that thing should exist? Well, right now, the leading contender is bitcoin. There’s no doubt that bitcoin is the top dog and first mover in potentially answering that question. And then, it was just educating myself about the topic with things like the Bankless podcast and having some crypto enthusiasts like Chris Dixon, and Balaji, listening to them on podcasts, such as the Tim Ferriss podcast. So, slowly, over time, I’ve come to be more accepting of it. I don’t think that investors should go whole hog and devote 50% of their portfolio to it or anything like that. However, I now see nothing wrong with putting say 1% to 10% of your portfolio in crypto.
Benz: I wanted to ask about the FIRE movement, the financial independence, retire early community. You consider yourself a part of that community or group. Can you talk about what you find so attractive about FIRE?
Feroldi: The first time I heard of FIRE, which is financial independence, retire early, I was just immediately attracted to the idea. I’ve always kind of craved independence for myself. I’m the type of person that doesn’t like when other people tell me what to do. And if you’ve worked a job or had a bad boss or anything like that, I’m sure you can relate to that. But what’s so fascinating about the FI movement, once you start to study it is, before I learned anything about it, I just thought that the whole “I” thing was impossible. How do you save up enough money so that you never have to “work” again? And how could you possibly do that in a lifetime? But once you start studying people in the FIRE movement, you see not only is it doable in a lifetime, I personally know people that have retired from their jobs, “retired” in their 50s, in their 40s, in their 30s, even in their late 20s. And the way that they did so was they made, they maximized their income, and they minimized their expenses, and they just saved 40%, 50%, 60%, 70% of their income for a long period of time. And by doing so, by lowering their costs so low, they afforded themselves the luxury of buying back their future time. So, I love the FIRE movement. I love studying people that are in the FIRE movement, because those are people that are interested in money, they’re interested in investing, they’re interested in optimizing their life. And those are topics that just immensely appeal to me.
Ptak: I wanted to shift gears and talk about avoiding big mistakes. You have a section in the book on avoiding mistakes. One mistake is gravitating to stocks with the highest dividend yields, which is something that retired investors often do. Why is that not such a great idea, in your opinion?
Feroldi: I learned this lesson the hard way. So, let me just say, when I first started investing, I had no idea what I was doing. I couldn’t tell you how to find a balance sheet, how to find an income statement, who was running the companies that I was investing, what their competitive advantage is, nothing. I did literally no research at the start. And after dabbling with penny stocks, which went as well as everyone else that I’ve heard of investing in penny stocks, mainly I lost money by trying to trade penny stocks. I said, OK these penny stock things, they’re not working out. Let me go to the exact opposite side of the risk spectrum, or so I thought, I’m just going to buy companies that have dividend yields of 5%, 10%, 15%, 20%, whatever it is, I’m just going to hold the stock, I’m going to click my 20% dividend yield, and I’m just going to accept that.
Well, it turns out that that investing style has a whole another set of risks. And really, you have to understand as an investor, well, what is a dividend? A dividend is when a company takes a portion of its profits, and it gives them back to its investor base. And if you look at companies like Apple and Microsoft today, those are big, strong, growing companies and their dividend yields are often 1% or 2% or so. So, why would there be companies out there that trade at dividend yields of 5%, 8%, 10%, even 15%? Well, that’s typically the market’s way of telling you that the dividend is not sustainable, and that the business that’s backing, that’s paying for that dividend, is in trouble.
So, I can tell you that when I first started investing in very high-dividend-yielding stocks, I again was doing very little research, was just focused on the yield. It turned out that the businesses behind those companies were crumbling. And when your business is crumbling and your profits are declining, you can’t afford to pay your dividend for so long. So, eventually, some of those companies slashed their dividend, which caused their stock price to fall. So, not only was I not collecting my 20% dividend yield, but the stock that I bought was down, too. So, broadly speaking, dividend stocks are very attractive, and there are some high-yielding companies out there that can afford to continuously pay them. But more often than not, if you see a dividend yield that’s more than 2 times the market, your first thought should be warning sign, not opportunity.
Benz: So, you referenced, Brian, the mistake of gravitating to penny stocks. Can you expand on that? Why are they not a great idea, even though you can assemble a basket of a lot of stocks with very little money to start?
Feroldi: Again, when I first started investing, I had no idea what I was doing. And I only had a few hundred dollars to invest at the time, and I just naturally thought to myself, well, I’m going to focus on stocks that trade below $5 per share, because it’s so much easier for a company that’s trading at $1 to go to $2 than it is for a company trading at $50 to go to $100. That’s a natural thing for new investors to think to themselves because in every other area of our life price tells you something about what you’re paying for. However, that’s not how investing works. The price of one share of stock is a meaningless figure and really tells you nothing about the underlying quality of the business. And broadly speaking, good companies do not—repeat—do not want their share price trading below $5 per share. If their stock is there, the odds are good is that it deserves to be there because the underlying business backing that company is not good, and that won’t be a good investment. So, that is again something I had to learn the hard way. Penny stocks are priced that way for a reason. Now, I own far more companies in my portfolio that trade way over $100 per share than I do than those trading under $20 per share. But again, that’s a counterintuitive lesson that I kind of had to learn the hard way.
Ptak: What are some of your go-to blogs and podcasts each week? What’s in your rotation?
Feroldi: I’m a money and investing nerd, and I probably have a rotation of 20 or 30 podcasts that I go to. A couple that I’ll call out about money that I really like The Motley Fool. I really like ChooseFI, that’s about financial independence. I like Afford Anything, another podcast about money and financial independence. I like a newer podcast by Chris Hutchins called All the Hacks, Invest Like the Best with Patrick O’Shaughnessy, the Rule Breaker Investing by David Gardner. I mean, truly, we are blessed today with so many high-quality podcasts out there. It’s never been easier for investors to get great information about investing.
Benz: I wanted to close by asking you about how you stay engaged. You have a well-articulated investment philosophy and you focused on the technology and biotech areas for a while now. So, how do you avoid complacency in your work and stay energized?
Feroldi: That’s a really fantastic question. For whatever reason, I was just born to be interested in money and finance and investing. And I think investing is like the ultimate strategy game. There’s always new companies coming public, the business news cycle is always changing. There’s always companies that are on the rise. There’s always companies that are on the fall. And I just think that it’s tremendous fun to sift through all that noise and look for companies that are good investments. Because if I do that well, then I can actually dramatically grow my wealth over time. So, I just so enjoy everything about stocks and investing. And so far, I haven’t become complacent in that. But I think that’s one of the positive about investing. There’s always new companies coming public. There’s always emerging technologies to learn about. So, I just find everything about researching them tremendous fun.
Benz: Well, Brian, this has been a really fun conversation. We really appreciate you taking time out of your schedule to be with us today.
Feroldi: Jeff and Christine, thank you so much for having me on. This is tremendous fun for me, too.
Ptak: Thanks again.
Benz: Thank you for joining us on The Long View. If you could, please take a moment to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.
You can follow us on Twitter @Christine_Benz.
Ptak: And @Syouth1, which is, S-Y-O-U-T-H and the number 1.
Benz: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.
Finally, we’d love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.
(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis, or opinions, or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)