Your Money This Week

In Your Money This Week, we’re seeing a rotation from large caps to small caps that should matter to investors and learning how to protect ourselves after a terrible story about a lottery winner who got fleeced by their advisor.

Small Caps Coming Up Big

There’s a rotation from large cap to small cap stocks going on now, and more specifically from large cap tech behemoths to small caps.

Large caps are stocks with a market cap (total dollar value of the company’s outstanding shares) of at least $10 billion, although they get significantly larger. The biggest company in the S&P 500, the U.S. large cap stock index, is Microsoft with a market cap over $3 trillion.

Small caps have market caps typically under $2 billion.

Historically, small cap stocks have done well compared to large caps and many evidence-based investors believe in a small cap premium, meaning higher expected returns for small caps than large caps. However, for the last three and a half years, large caps have trounced small caps.

Things changed after the June inflation report. We talked about that report here. It showed the first monthly inflation decline in four years and the lowest CPI number in three years.

Good news for those wanting Fed rate cuts and small cap investors, since small cap stocks are sensitive to interest rate expectations.

Why does this matter?

I don’t think the dominant run we’ve seen in U.S. large cap stocks driven by tech can continue unabated, which we’ve discussed many times (here, here, and here).

At some point, small caps will have their day. International stocks will too. You diversify to get exposure to all of them since predicting winners in advance doesn’t work. But right now owning only the S&P 500 has been so rewarding that too many investors aren’t diversified, and when market leadership changes, they’ll miss out.

This is the third decade of my career. In the first one, the S&P 500 lost almost 10% and suffered two vicious bear markets. By 2009, clients weren’t clamoring to only own the S&P 500. In the second decade’s back half, the S&P 500 outperformed and now it’s all anyone wants. If you are certain what the third decade and beyond will bring, then invest that way, but I’d recommend spreading things around to increase the odds you get the returns needed for your financial plan to work.

Protecting Yourself from Getting Fleeced

Last week The Wall Street Journal published A Couple Won the Powerball. Investing It Turned Into a Tragedy.

It’s worth reading in its entirety. The short version is a couple won the Powerball exactly five years after their granddaughter died of a rare illness and decided to create a nonprofit research foundation. They hired a financial adviser and insurance agent to manage their money. That adviser bought high fee variable annuities that paid him millions in commissions, and over a six-year period they lost money while the market doubled.

The biggest thing you can do to protect yourself is to work with a fiduciary, as they are obligated to act in your best interests and disclose conflicts of interest. Their compensation is typically fee-based, and they don’t sell commission-based products.

Brokers follow the lower suitability standard. For example, if you are a growth-oriented investor, a broker need only recommend appropriate growth-oriented investments. They don’t have to disclose if the investments are more expensive than alternatives. If they’re recommending it because it’s their company’s own product, that’s okay. If they are getting paid more to recommend it over others, they’re not required to disclose it.

Second, be skeptical about variable annuities.

The annuities in this case had fees up to 2% or more with commissions that could exceed 6%.

Annuities can provide tax benefits and features that investors find attractive, but a foundation doesn’t need those tax benefits and the features come with high costs that are typically not worth it. Here’s a great investor guide created by the SEC.

For comparison’s sake, I looked at a fiduciary wealth manager benchmarking study and found that the median fee for a $25 million account was .5% – at least 75% less than the variable annuity fees.

Third, research your advisor. Check out their public filings for any customer complaints or violations. The SEC’s investment advisor disclosure site (adviserinfo.sec.gov) provides the firm’s Form ADV and compliance history. You can research brokers through Broker Check provided by Finra (https://brokercheck.finra.org/).

Finding a Good Financial Advisor gets into a lot more detail about this topic.