IFB105: Q&A: Is Acorns Worth it? Should I Buy Small Cap Stocks?

Announcer:                        00:00                     You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners led by Andrew Sather and Dave Ahern. To decode industry jargon, silence crippling confusion and help you overcome emotions by looking at the numbers, your path to financial freedom starts now.

Dave:                                    00:37                     All right folks, welcome to Investing for Beginners podcast. This is episode 105, tonight. Andrew and I are going to read some listener questions and we’ll go ahead to answer those on the air and we’ll have our usual banter and witty, witty comments from each other as we go forward with all this. So I’m going to go ahead and read the first question. Andrew, would you like to say hello?

Andrew:                              00:58                     Hello.

Dave:                                    01:00                     Excellent. Good job. All right, moving on. Hello. I have been following your podcast for months and just recently signed up for your service. I noticed you’re using your Roth IRA for your stock recommendations and tracking your 40 year portfolio. I understand the benefits of using a Roth to avoid taxes but is absolutely unnecessary for the goal of your slash our investing. My Roth is being utilized with an advisor service from vanguard. So it was not available for individual stocks. I’m using a separate, separate taxable brokerage account for my stock picking. Would this still be beneficial in the long run with having to pay taxes yearly on dividends and capital gains are selling if in a taxable brokerage? Thank you Jared. Andrew, what are your thoughts on this?

Andrew:                              01:43                     So we were kind of talking about this off the air before I’m heading record. I think like, like what you mentioned Dave, obviously, um, you can have multiple Ross, so he talks about how he has an advisor who’s handling one of his, you know, his Roth account. You can open a second one and use that for your stock picking instead of doing it with a taxable brokerage account. So just as a quick overview refresher, maybe if you’re not well versed in all this stuff, the individual brokerage account, um, it gets taxed. And so like he said in the question, you get taxed on dividends, you get tax on capital gains. What’s key to understand is even if you’re doing a drip, like a dividend reinvestment, you’re still going to get tax on those dividends. So let’s say you’re reinvesting all of your dividends and the given year, let’s say you had like $1,000 in dividends and you invested all of them, um, you’re still going to get a bill come tax time.

Andrew:                              02:41                     So you should have some money saved to pay for those taxes on those dividends you received. Obviously we like to take advantage of all the tax shelters we can as investors. And so that’s why a Roth IRA or a regular IRA is something that we from the onset recommend you can go back to our personal finance series and and hear all about that. But you know, with a Roth, they’re not going to tax you on those dividends. So as an example, if I’m getting $200 in dividends this year for my Roth a, I’m not going to get taxed on any of that so I don’t have to save any money and I can just reinvest those dividends and let that grow over time. Now we’ll say one way to mitigate this. So obviously you can open the second Roth that kind of solves that problem. Uh, another reason why somebody might not be able to use a Roth is there’s income limits on Roth.

Andrew:                              03:37                     So if you make a certain amount of money, um, obviously you’re fortunate, but you’re not able to take advantage of some of the tax shelters like a Roth, particularly if you make a lot a lot of money. So what you can do instead is instead of, instead of like reinvesting your whole portfolio, you can maybe let’s say pick half of your stocks to, to do a drip and then automatic reinvestment and maybe the other half you’re going to collect those dividends and let them sit. And then you can, um, have, have a cash balance and you can take that out when tax time happens and use that to pay your taxes. Um, so, so you can do some calculations on that. You can be clever and smart, however you want to do that. You can set your whole account to not ran best and then just kind of reinvest manually, right?

Andrew:                              04:27                     So you have a pile of, of, of, of cash from your dividends and you buy more stocks manually instead of having them do automatically. And again, you can be smart with calculations and make sure you don’t buy too much stock so you have enough for taxes. So those are all kind of options we can do. Um, because my eli there does a Roth Ira, I don’t have to worry about taxes. And so those decisions and those stocks, elections are happening in that environment, in that context. So that also would like, because a tax benefit buying and holding a stock for a long, long time as a tax benefit in theory in my Roth, you know, I could be trading in and out and not have to pay any capital gains taxes. And so that could encourage trading activity. Obviously. Um, I like to hold longer in spite of that. But, um, that’s another way to mitigate taxes is at least not on the dividend side, but on the capital gain side. Um, well I think Warren Buffet, some of these, some investor quoted how that’s one of the best, the most tax efficient things to do is just to hold your stocks because you’re not having to pay capital gains tax every time you sell. So that’s another kind of idea or strategy you can take if you’re in the fortunate position to have so much money that you can’t have these Roth contributions.

Dave:                                    06:01                     That was an excellent answer and I guess the only thing that I would tag on with what Andrew was saying was just to kind of I guess double tap they the the hammer on the reducing the taxes. You have to think of taxes as something we all have to pay obviously and we can get into all the different ramifications of that and we won’t because that’s not our kind of show. But anything that’s going to reduce how much you can reinvest into your wealth for your future is going to have an impact in the long run. And so if you’re paying taxes yearly on dividends that you’re going to reinvest back into the company, that will affect the long term compounding because you’re going to be reducing the amount that you’re actually putting into the account to reinvest. And so that’s why I would recommend that you investigate other options to help you reduce the impact that taxes can have on your investments.

Dave:                                    06:58                     Because regardless of whether you’re a 29 or 49 when we’re investing, we want a long time horizon because that’s how we’re going to build the wealth is not by hitting a home run, by picking Amazon when it first comes out as $12 a share and now it’s you know, a couple thousand or whatever it is. It’s, it’s by having you know, gradual compounding interest over a long period of time and just continuing to grow as Andrew likes to say, continue to grow, all those streams of income and anything that’s going to interrupt that or impede that is something that you want to try to avoid if at all possible because it will have an impact. Even if it’s, you know, the taxes maybe knocks off half a percent of what you’re reinvesting, that’s a half a percent. You can’t have to invest so it’s, you know, it behooves you to run, not walk to find what the options would be to help you reduce that if any way possible. I love hearing something I wrote in the daily email earlier and here your reference now on the podcast today. That was great. I told you I do read them. All right, well why don’t we move onto the next question. Okay. So, hi Andrew. I’ve been following your stuff for a couple of weeks now and just purchase the value type indicator. Buck was spreadsheet.

Andrew:                              08:15                     I’m really enjoying the material and easy to understand the answer you’re making everything. I had a question about market cap and picking stocks. I’m from Australia, so I assumed our small, mid and large cap stocks would be of different value to America. However, I seem to get the same valuations when I do a search with MCAP being anything over 2 billion. I want to know the potential downside to buying small cap stocks. I’ve ran a screen in a found a few small cap stocks in Australia that massive ETF for by, but I wasn’t sure about executing because they’re small cap. Look forward to your response. Nicholas, what’s your thoughts?

Dave:                                    08:48                     My thoughts are to try to avoid small cap stocks if you can, for one very, very large reason, volatility, when you’re dealing with small cap stocks, you’re going to deal with a great ton more volatility than you will with mid or even large cap, especially just because of the nature of how the market works. Small cap stocks can have a large amount of volatility based on the good news or bad news that happens with the stock market. And because they’re so small that there can be wild fluctuations in the price and as a longterm investor, you want something that’s going to be calmer and just generally go up. But small cap stocks can rush up really, really fast because they’re the fat of the day. And then all of a sudden some, a bit of bad news comes out. Everybody pulls their money out and it crashes like a bomb. And that’s how you can lose a lot of money in the stock market is by playing in that field. Uh, if that’s something that you could comfortable with the risk of dealing with that and, and the stress of seeing those things go up and down and up and down, up and down, then maybe that’s something do you want to consider. But for me personally, that, that is a big reason why I steer clear of small cap stocks. Andrew, what are your thoughts?

Andrew:                              10:07                     Yeah, I agree. Um, I think we should be clear to the way people define small cap is going to be different. So some websites will say a small cap stock is from the 2 billion to $20 billion range, which I love buying those. Some websites will call small cap stocks under $2 billion, which is a what Nicholas was referring to here. And I think Finn is CAC categorizes it the same way. Uh, and those are the ones that I would avoid. The reasons why I think that there’s so much volatility with the stocks. If we think about fundamentally why they are that size, you’ll have a, a few things in a few factors to consider. So when a stock is that size, generally it’s because the industry hasn’t matured as much. And so you might have, it could be one of two things or both. Really. You could have, um, a lot of players and the in the market where not one as has been dominant.

Andrew:                              11:11                     So instead of like the soda industry where there’s Pepsi, Coke and Dr Pepper and um, and those are like the three kind of pillars of the industry. It could be a small industry where there’s like hundreds of players. It’s a, it’s in a very growth stage. The industry itself. I, I think of marijuana when I, when I think about an industry like that and so, so many, some of these small companies, so much competition, such a young industry. And so there’s going to be blood to, to, to um, finally reach a point where it’s more mature and there’s more stable players in there. Um, so it could be one of those two things, right? It could be a young industry or there be just so many players or it could just be a very, very small player in the bigger field. And so I think whether it’s any of those reasons, it’s not something that I would be comfortable buying.

Andrew:                              12:04                     There’s plenty of opportunities with stable companies. Like Dave was saying, a lot less volatility, not only in the stock price but also in the financials. And so why play lottery tickets when you can, you can go for something that’s a little bit more established in a little bit more safer. And another thing to consider too is I think you can have a lot more, not funny business, but like factors that you don’t really have to consider with really big companies. So I don’t know how many people know this, but when Warren Buffet was starting out, he was a very activist type investors. So if you think about those types of investors today, I think of like Bill Ackman, um, couple other names are escaping me at the moment, but basically these, these big investors who will, who will buy up large portions of a, of a company and then kind of use that power to make decisions themselves on how they want the company to go.

Andrew:                              13:08                     So that could be good or bad depending on the activist investor. So if the investor is kind of seems like a value opportunity and they want to close on that and then they want to get out of that position, once that value has been realized, then if you’re the type who really is trying to buy the stocks for the very long term, that might not work out for you. If they’re an activist investor who’s maybe trying to keep a long term stake, maybe that’s, that is good for you. So you can’t really know. But it’s the smaller market cap type stocks where there’ll be more likely to have a big player come in and kind of, they could change the whole story of the company within, you know, a few months. And so you don’t tend to see that with the larger market cap stocks because there’s not many people with billions of dollars laying around that can just go into these huge public corporations and just kind of demand their way. So those are all, I think additional reasons and factors and fundamentals to consider when it comes to these small cap stocks. Um, like I said, I don’t, I, I’ve, I’ve dipped in into like the 1 billion to $2 billion range and I, and sometimes I’ll buy into those still, but definitely anything under 1 billion is, is no go for me. And generally I try to stay above 2 billion in market cap.

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Dave:                                    14:46                     Excellent. Good answer. All right, let’s move on to the question.

Dave:                                    14:52                     Good morning, Mr Sather. Thank you for this peek into the growth of a dollar. Very informative and detailed explanation of compounding interest and growth. Out of curiosity, do you use at all use apps like acorns or Robin Hood and what is your opinion on their viability as investment vehicles and do you happen to know if there is a way to set up a drip on there? I apologize if you’ve already answered this question in the podcast, but I haven’t gotten there yet. I recently started at a small Robinhood investing account to force myself to pay attention to the market more than occasionally reading my quarterly 401k statements. Thank you very much for guidance making the vast world of than investing a little bit smaller for me. Best regards, Ryan,

Andrew:                              15:33                     I love that he’s, you know, it’s something I’ve talked about over and over again and I talked about it a lot when I first started. The blog is just get started, right? Just get your toes in the water and just, there’s something about having ownership in the stock that makes you look at the stock market different. It makes you pay attention even if it’s just like a couple dollars. Um, there’s something about having that ownership that really changes things and I think it accelerates your learning process. So I love that. Even though we’re not too fond of Robinhood. I love that he made one just so he could pay attention to the market. And it sounds like it’s working out for him as far as like thoughts on Robin Hood, other than us saying that, hey, we’re, we’re not, we’re not big fans of it. I would say you can go back in the archives and listen to week dedicated a whole episode two, um, it’s not coming up on my search here, but I do have a blog post on Robin hood. If you go on the blog, a investing for beginners.com you go into the search bar and you type in Robin Hood, uh, you can read thoughts on there. They don’t offer drip as of now this recording in the middle of 2019. So keep that in mind as far as acorn. So I’ve used acorns in the past, but just very sparingly. So the way acorns works is it’s this app that you can download, it’s totally free, you can hook it up to your bank account and then basically it’s like a keep the change, but for investing. So if I buy a candy bar for a dollar 75, um, they round up the change up to the next dollar amount and then they take that money and they invest it for you.

Andrew:                              17:17                     So, you know, that candy bar we’ll take, instead of a dollar 75, I’ll take a $2 debit out of my account and those 25 cents will go into your acorns account. So it’s, I think it’s a cool way that gets started and it’s, it’s a very visually appealing platform. It’s very aesthetic, um, fun to look at. Uh, and that’s kind of cool to see that growth of your portfolio over time and you know, it’s, it’s something that’s automated, so that can be useful. I, I think it can be a cool thing, but it’s, uh, the, the way I’ll say it like this, like it would be like, it should not replace a good standard and lesson plan. Something like what we talk about with a $150 a month. The progress you’ll make on that is very, very slow unless your, um, a huge spender, which if you’re trying to build wealth that’s probably hurting you.

Andrew:                              18:21                     So you might think, oh, well my, now my good spending, you know, all this big spending them doing is helping my wealth as thought it. That’s going to be fractions of, of savings versus if you would have actually just save the money and investigate yourself. So I think it’s a variety of like credit card rewards. Um, you can, there’s people that certainly are good with them and you can kind of use that to your advantage to get nice little boosts here or there. But in the grand scheme of things, we’re talking about little small percentages versus La. Um, you know, we’re, we’re talking on different scales. So one to 2% versus 100% you know, uh, is a credit card rewards making you spend an extra $200 because you think the extra $2 is going to be free to you. You’re talking about 1% of if fuel just save the $200.

Andrew:                              19:16                     Now that’s I hope you get where I’m going with this. So acorns is cool. The way they do is they will give you like a portfolio of ETFs and um, you can choose your risk tolerance. They go conservative, moderately conservative mother. It my lady aggressive and aggressive and they’re going to large, large cap stocks, small cap stocks and, and just like a mix. I just remember the, the performance for it in the time when I had it and I was checking the performance. It was terrible. And definitely investing on my own had much better results. Not to mention the fact that you cannot really drip as far as I’m aware. And even if you are dripping, you’re not, that they’re buying fractional shares for you and in these huge, large portions of these, different ETFs that they’re getting you into. So you’re talking about fractions of fractions, of shares of it. It’s just you’re spreading your money so thin and it’s kind of dumb. So I, I just, I would say it’s a cool thing to have, but I would definitely not use it as a main, um, vehicle for saving for your retirement, saving for your future or thinking that you’re building any sort of wealth with the, it’s, it’s, it’s not really gonna do much.

Dave:                                    20:42                     I like the answer that was, I think that was good. I, uh, I personally don’t use acorns or Robin Hood and I Kinda, I guess my thoughts are very similar to Erin to Andrew, so I don’t really have anything to add to that. All right, I’ll do that. I’ll do one more question here. Okay. Uh, Mr Sather. I haven’t been following your news on there for a couple of months now and really enjoy reading your email leathers. I have another question asks you about investing. I understand value investing in that as your niche investing style. However, have you ever thought about monthly dividend stocks? I’ve listened to all your podcasts from past to present one of them ever talk about monthly dividend stocks. Who would be nice to hear your thoughts on them? It would also be nice to know a few have ever invest your money into any of them. Hope the best for you and your family and all your future endeavors. Thank you Robert.

Dave:                                    21:32                     I would like to hear your thoughts on that, Andrew, cause I be honest with you, I don’t know much about monthly dividend stocks and since you’re the, you’re the, you, the drip king, I think that would be appropriate for you.

Andrew:                              21:43                     So they definitely exist. Um, you can go on Google and you can find the list quite easily of monthly dividend stocks. So I get the appeal of it. You know, you’re, you have an income stream every month. So if you picture your somebody who’s close to retirement or actually in retirement, I think that’s where the draw is for a lot of people because they can kind of replace a paycheck as you’re getting these, these um, these checks, these dividend checks to you every month and it’s consistent, reliable. So that’s a cool feature. I wouldn’t buy a stock just because of that. You can kind of structure your portfolio to hit a lot of months or you could even effectively have it do the same.

Andrew:                              22:30                     I think just based on one of experience, I’ll get my dividends and waves. So I wish I looked this up before we were recording, but I think there’s a big, the way that these companies do their fiscal years, a lot of them tend to follow the same thing. And then a lot of, a lot of other companies will kind, Kinda do their fiscal year however they want. So they tend to pay dividends based on how their fiscal year schedule is. So I think it’s like the February may, um, every three months, like on that track kind of is a very common monthly dividend payout. So why you could build a portfolio based off of it? Um, it might be harder just because there is that one or two common, um, fiscal year structures that a lot of companies use. I would say, yeah, I get the draw of it. I, I get the idea that you want this consistent, reliable, um, easy to play him for income stream.

Andrew:                              23:34                     But I think the potential cons outweigh the potential benefits. You have to remember you’re, you’re doing these investments because you’re buying part ownership of a company. So the way I would see it as like, would you take, uh, a job that’s either lower pain or a job that just pisses you off because you get paid every week versus once a month? I certainly wouldn’t. And so I wouldn’t buy stocks in the same way because of all those reasons. So you should, if you’re planning to live off dividend income, you should structure your budgets. So you’re taking all of the dividend payouts and consideration. One of the stocks, that’s one of my favorites is Disney and they pay one, they’d do it biannually. So there’s only two dividend pay out payments and it’s a two times a year. So if you’re planning to live off dividends, you should take the whole portfolio into account and just try to budget for and make sure that the months where you’re not getting dividends you have, you have enough saved to cover those months. But yeah, kind of going back to the original question, I wouldn’t not buy them, but I haven’t found one yet that I wanted to buy and so I just haven’t bought one yet.

Dave:                                    24:50                     That was very interesting. I think one of the things that, I guess I would wonder about a company that’s doing a monthly dividend stock, um, are they, do they have like kinda higher payout ratios than normal companies and aren’t they kind of generally smaller cap stocks that are going to be doing this or are they larger cap stocks?

Andrew:                              25:15                     That’s a good question too. I, so I guess you know, there’s only so many earnings you can pay out, right? So whether the payout ratio is higher or not, I would imagine the parish are probably is higher. I think I’m like the MLPs master limited partnerships tend to, some of them tend to do monthly. So now, now that actually you mentioned it. Yeah, I did buy one of those in the past and then perform, you know, and it wasn’t like a, a much better stock from an income or performance perspective than, than any other stock I bought. Um, so yeah, I guess something to keep in mind too is that if they’re going to pay you monthly, it’s going to be a much lower dividend than the standard quarterly would be.

Dave:                                    26:02                     Yeah, that makes sense. And I guess you’re kind of exploring that a little bit more if they have a higher payout ratio, that means for those of you who don’t understand what I’m talking about, what were we talking about? A payout ratio. We’re talking about the money that the company is taking from their earnings and using that to pay out a dividend as opposed to share buybacks or reinvesting back in the company or just simply sitting on the money. And so the higher the payout ratio, that basically means if you have $100 in your account and you’re taking $80 of a two pay dividends, that we joined $20 to do anything else. And so the higher the payout ratio, generally there’s less margin for error. And I’ll obviously when we’re talking about this, there’s going to be exceptions to the rule and a company that springs to mind when I think about that as somebody like Coca Cola, uh, who’s been around for about a hundred thousand years and is very likely not going anywhere anytime soon and they have a elevated payout ratio, but they’re also at a stage where there are companies really kind of beyond growling at this point.

Dave:                                    27:09                     And so taking that money and giving it back to us investors as a dividend is a very wise way to go. But when we’re talking about all these other companies, the higher or the payout ratio, and especially if it’s a small cap that gives them the less margin of error for things. And so I think that’s one of the big risks that I would think would be involved in getting an vesting with a monthly dividend stock. Yeah, that’s a good insight.

Dave:                                    27:36                     All right folks, we’ll, that is going to wrap up our discussion for tonight. I hope you enjoyed our listener questions and our answers for them. There’s a lot of good nuggets in there and hopefully you find something that they can help you with your investing. So again, as always go out there and invest with a margin of safety emphasis on the safety. Have a great week and we’ll talk to you on that.

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