Finance Professor Answers Investing Questions

I'm Cam Harvey,

professor of finance at Duke University.

I'm here today to answer your questions from the internet.

This is Investing Support.

[upbeat music]

A Reddit user asks,

Why doesn't everyone just stick with an Index Fund?

Well, that's actually reasonably good advice.

So it's really difficult

for an individual investor to actually pick stocks.

That takes a lot of effort,

a lot of time,

and you don't necessarily have access to the data.

So for most investors,

the easiest thing to do is to invest

in a low-cost exchange-traded fund

or an index fund that gives diversification

and you don't need to worry

about the individual stock that you're picking.

Civil_Employee_4736 asks,

Is holding individual stocks worth the stress anymore?

It is stressful,

especially if you're only holding a few stocks,

which is not advised.

However, I actually recommend holding out

a small amount of your portfolio,

let's say 10%,

to pick individual stocks.

You're gonna learn a lot from that,

and you should keep track record of your investments,

and it's also fun.

Yaadikillertje asks,

Why do so many people say

that gold is a bad investment,

while the returns are consistent

and sometimes better than the S&P 500?

Well, gold is a very interesting investment

in that it's the oldest investment in history.

We've held gold for millennia.

And gold has got this safe haven status.

So when there's market turmoil or economic turmoil,

it tends to hold its value over the long term.

But that said,

gold is volatile,

and most people don't realize

that gold is about as volatile as the S&P 500.

GirthFerguson69 asks,

If you had $20,000 today,

how would you invest it?

What I recommend is most of that investment goes

into a combination of equity,

meaning a diversified equity portfolio,

not just the US

but international as well as the US,

and then some portion to a money market fund

to earn the maximum yield,

so a smaller portion,

and then what I recommend is holding out some.

So hold out 5 to 10%.

And with that,

invest in stocks that you've researched.

Do the work, actually follow them,

collect information,

and make investments.

It is something that is valuable for you

in terms of learning what's important

for valuation of these stocks,

and it's also important for you

to measure the performance of your picks.

Firetyrant asked the question,

How much international allocation do you have

in your portfolio?

Most investors don't have enough international allocation,

that their portfolio's dominated by US investments.

And it turns out that historically they've done fine

because the US has done really well.

So if you think about today

in terms of the overall value of stock markets,

it's extraordinary that the US stocks are worth 50%

of the world value of all stocks.

And let me put that number in context of GDP.

So the US is only 15% of world GDP

yet 50% of the value of all stocks.

So, it's a good idea

to have some diversification

where you're buying stocks outside of the US.

So an exchange traded fund

that has allocation to the US

as well as other developed markets and emerging markets.

So the simple answer to the question

is 50% international, 50% US.

Olives82 asks,

What's the deal with the AI bubble?

What are the implications

and ramifications of an AI bubble burst?

The value of stocks

that are related to AI has exploded.

Indeed, most of the value creation

in the stock market over the last year

is due to stocks that are related to AI.

And it's a reasonable question.

What if the AI bubble bursts?

Is this 1999?

And that was the year

just before the tech bubble burst in 2000.

So I argue that today is definitely different.

And this talk of the AI bubble bursting,

there might be a correction,

but this time it's sufficiently different

that I think it's lower probability.

So in particular,

what are the differences?

So, number one,

the technological disruption of AI is far different

than the introduction of the internet in the 1990s.

Think of the internet as something that allows you

to collect information efficiently

and it allows you to socialize.

AI is completely different.

AI not just collects information.

It can be creative,

it can solve problems.

The implications for productivity are vast.

So number two difference.

The internet in the late 1990s

had really a differential effect.

Some companies were really impacted,

other companies were not.

Well, with AI today,

every company is impacted.

Indeed, even within a company,

there could be hundreds of different applications of AI.

So this disruption is much more diversified.

It touches everything.

Number three is this idea of self-disruption.

And this idea is a bit complex,

and that is that companies today are more than willing

to initiate projects

that destroy or weaken parts of their existing business.

So think of, I'll just give an example, Tesla.

Many people think that Tesla is a car company.

Tesla is not a car company,

it is a robotics company.

And they're more than willing to invest in technology

to disrupt the business lines that are making them money.

So, the last point

is the fundamentals of these companies.

If you look back in the 1990s,

people were betting on future earnings,

that the earnings were not really growing that much.

Whereas today, it's completely different.

These firms are massively profitable.

4westofthemoon4 asks,

Why does the P/E ratio matter to me as an investor?

So the P/E ratio is a very popular way

to think about the valuation of a stock.

So the P is the stock price,

and the E is the earnings per share.

There's often a second version of this,

where you divide the price

by the expected earnings

rather than the past earnings.

So both of these are common measures,

and this is a measure of valuation.

So the idea here is if the P/E is very high

compared to, let's say, the stock's history,

then there is a substantial probability

that the stock price will revert to its previous P/E.

So, stocks that have very high P/Es

are often called expensive,

and stocks with very low P/Es are often called cheap.

And we should be careful with these definitions,

because a stock might have a very low P/E

because it's in distress.

It's not cheap, it's just in distress.

But again, this is an indicator of valuation

and very popular.

Indeed, there is the P/E for the market as a whole.

And that P/E for the S&P 500 is very high.

And when you look historically at the P/E

and then look at returns

for not the next year

but the next number of years,

there is a very clear relationship.

So when the market has a very high P/E,

and this kinda makes sense,

because with a very high P/E,

this might indicate overvaluation or expensiveness,

and there'll be a reversion to what is more normal.

So the P/E is a very important indicator

for the market as a whole

and for individual securities.

User shananananananananan,

Anyone using AI tools for investing?

Well, there's a lot of people using AI tools for investing.

One key thing in using any tool

is to understand how it works.

Those that are using AI tools

are large institutional asset managers

that have a team of people that are trained

in artificial intelligence and machine learning.

They know exactly what these programs are doing,

they understand the implications,

and they fine-tune the applications to vast amount of data.

So this is an application of AI

that makes sense.

Typical_Broccoli_325 asks,

Can the stock market really keep returning 7% a year?

So 7% is the long-term average return

on the S&P 500.

And sometimes it's greater than 7%,

like last year,

and sometimes it's a lot less.

And this is the notion of volatility.

So the stock market is a volatile investment,

and the 7% is a longer-term average of performance.

So one mistake investors make is they invest in the market,

it goes down,

and then they bail out,

and then they wait for the market to go up

before buying in again.

So in order to get this 7% over the longer term,

you need to be in the market

and to ride out these episodes

where the stock market draws down.

And if you do that,

then this longer-term return is obtainable.

It's not guaranteed,

but it's obtainable.

And really what this return is is two components.

The 7% is composed of a real return

and an inflation compensation.

So if we think of inflation at 2%,

which is the Fed's target,

the return that you're getting,

the real return after inflation,

is about 5%.

Doomshallot asks,

What percentage of your portfolio should be in crypto?

So, number one,

crypto is a very broad category.

So there are cryptos like Bitcoin

that are not backed by anything.

They have value because people believe they have value.

And then there's another class of cryptos

that are actually backed by something.

So think of a stable coin that's backed by US dollars

or a tokenized version of gold.

In terms of your portfolio,

I would be careful.

It's a big mistake, in my opinion,

just to invest in crypto.

I'm okay having some exposure to crypto,

but this is not the type of investment that warrants,

for example, a 10% of your portfolio.

It's more on the side of like 2 to 4%.

And be careful when you do that.

So Successful_War5671 asks the question,

What's one investing mistake beginners always repeat?

That one's easy.

So, the biggest mistake that beginner investors make,

and, I hate to say, even non-beginners,

is this idea of buying high and selling low.

So let me unpack that.

The best strategy of course is to buy something

when the price is low

and then sell it when the price is high,

make a profit.

But it's often the case

that a stock goes up in value,

it attains a lofty valuation,

and then people buy it

because they've seen that the price has gone up.

And when you buy high,

you're often disappointed,

because at that very high valuation,

that's the point where people are giving it a second thought

and there could be a correction.

Scrom-hulios asks,

Does the brokerage I use matter?

Brokerage definitely matters.

And it really depends upon the investor's needs.

So, for example,

if you're younger,

it's probably best to use a very low-cost broker.

For example, Robinhood or Schwab.

And this allows you access to stocks and trading

and different products, like exchange traded funds,

at extremely low fees.

However, for more mature investors

and, in particular,

investors that are older in age,

like me,

you go to a broker that is much more expensive

in terms of fees,

and they charge, let's say,

0.5% to 1% fixed per year,

but they offer other services.

So you might need some legal advice on an investment,

you might need advice for the planning of your estate,

and they provide services like this for you

as part of the deal.

And it turns out that that can be very valuable.

So Helpful-Raisin-5782 asks,

What's your process for researching a new stock

you might invest in?

So number one,

I recommend investing most of your funds

in a diversified index fund,

but I also advocate holding part of your portfolio

for individual stocks that you pick.

And let me describe my process.

So, number one,

I'm looking at the news very carefully,

but in particular,

a company and all of its news,

whether it's in the main media

or the information that it releases.

So look at its annual report,

its quarterly releases,

the 10-K filing with the SEC.

And what I also look at is analyst coverage

if that's available.

So there's many people out there commenting

on individual companies.

Collect that information.

And then one thing that I particularly like

is the quarterly earnings call.

So this is a situation

where the company announces its earnings

and takes unscripted questions from the audience.

So this is not responses

that are vetted by lawyers or anything like that.

And we know that all the official company materials,

like the 10 K,

have been very carefully vetted by a legal team.

The next thing is to look at the fundamentals

of the company.

So just because the company has gone up in value,

that's not a sufficient reason to invest in that company.

Indeed, it might be the opposite.

It might be that the price has gone up so dramatically

that you've missed the boat,

and you need to step back and exercise restraint

and avoid this company

until there's a correction in the value.

And when the value corrects,

then you actually enter and buy.

So Charming_Jury_8688 asked the question,

Is there a way for an average Joe like me

to participate in private equity companies?

I wish.

So, there are so many exciting companies out there

that are not available to the average investor.

Think of SpaceX for an example.

So you can't buy into that company.

You need to be what's known as a qualified investor.

So in the US,

to be a qualified investor,

you need to make a certain amount of money.

So even though you might be quite knowledgeable,

you might not be allowed to buy into the equity of companies

that are not listed on an exchange.

And that's the definition of non-public equity,

or sometimes people call it private equity.

So private companies,

they have equity.

So, often what happens with these private companies is,

at some point,

they do an initial public offering

and that private equity turns into public equity.

And this is unfortunate.

And let me give you a very tangible example.

You've got somebody

that has got an advanced degree in biology,

and they decided not to go to the university route

but they're a high school biology teacher.

And as a hobby,

they're an expert in biotech.

That's a flaw with our system.

It should change.

So, to be qualified in terms of the way I think about it,

you should be able to do your research

and pass a test or something like that

to be deemed qualified,

and these companies should be made available

to a broader set of investors.

It's just not fair

that only those that are rich get to invest

in these very exciting stocks.

User just_another_ [beep] boi

has got the following question,

Are people really making money with meme coins?

Okay, so meme coin is a type of cryptocurrency.

It's got no fundamental value,

meaning it's not backed by anything.

It's more traded for fun,

like trading cards and things like that.

These meme coins are extremely volatile.

So if you think the stock market is volatile,

these are 20 to 100 times more volatile

than the stock market.

So that means extreme moves up,

extreme moves down.

There's no evidence that I know

that a portfolio of meme coins makes any money.

So you might get lucky

and the meme coin that you buy

goes dramatically up in value,

but, more likely, you lose everything.

So if you're going to invest in a meme coin,

make sure when you put your money in

that you're fully prepared to lose 100% of those funds.

Doubleaplusron has got the question,

My company gave me stock options.

How do they work?

So, options provide the awardee,

the employee,

the right to buy the stock in the future

at a particular price.

So, this is a call option,

and it's very long-dated.

So think of the following situation

where the stock is trading at $90,

and then the employee gets some options

to buy the stock in five years at the price of 400.

So the price today is 90.

It's way, way lower than the 400,

but you never know what happens in the five years.

So, maybe the price of the stock

goes up to $1,000.

So now the employee's got the right

to buy stock for 400,

and then they can sell it immediately for 1,000.

So that's worth $600.

Companies do this.

It's a way to compensate employees.

It's also a way to retain employees,

where your stock that you've got the right to buy,

you need to be, like, an employee to actually do it.

So people tend to stick around.

So this is a popular way to retain employees,

and it's also kind of cheap for the company

in terms of cash flow.

So again, this is popular,

it aligns incentives.

So the employee actually wants to do everything possible

to make sure the stock is worth as much as possible,

ideally the thousand dollars,

because that's when they're gonna get the big payday.

Electronic_docter asks,

Potentially obvious question

but is mad money just insider trading?

Well, insider trading's got a very specific meaning,

and, obviously, you should do everything possible

to avoid being tempted by insider trading.

So insider trading is when

you've got some non-public information.

So somebody has tipped you

about a big deal that the company is making

or you've got somebody that tips you

about results of a clinical trial.

This is not stuff used for training.

It's unfair, unethical, and illegal.

However, stuff that's on TV

or video or on the internet,

that's public information.

So they could be talking up a stock,

and sometimes people take that advice,

buy the stock,

and the price goes up because people are buying.

This is especially the case with very small stocks,

where there's not that much trading,

and a sufficient number of buyers

could dramatically drive the price up for a while.

So just taking advice from some pundit or,

you know, on the internet and in forums,

stuff like that is fine.

It's where you get information

from an insider of the company

and trade upon that,

that will get you into trouble.

So SistedWister asks,

Why is day-trading considered so hard?

So, day trading is hard to make money off of

for the average investor.

So day trading is essentially buying

and selling the stocks every day,

trying to capitalize on trends or things like that.

And it's really hard to make money

because there are competitors that are doing this

at institutional-grade scale.

So these are the hedge funds,

the high-frequency traders

that have massive computing resources,

data feeds that are incredibly fast,

software that they've developed on their own

with their team of engineers.

This is very difficult to trade against,

and that's your competition.

So the day traders don't make money because,

effectively, they're trading against

these high-powered institutional traders.

So day trading is something I definitely do not recommend.

So JanaDD126 asks,

What exactly is a hedge fund?

And what does a hedge fund manager do?

So, there are many different types of hedge funds,

different styles.

Let me describe the most common style.

And this is an equity hedge fund

that has got part of their portfolio where they buy stocks

and another part of their portfolio

where they short or sell a group of stocks.

So this is different than our portfolios,

where we're just buying and holding.

So they've got that also,

but they're buying the stocks they think will be winners

and then they're selling,

which means if the stock goes down in value, they profit,

the stocks that they think will be losers.

And it's called a hedge fund

because they are hedged against market-wide movements.

So let me give you an example.

Suppose the market drops by 20%.

And if we're just in our index fund,

we're gonna lose 20%.

So for this hedge fund,

they've got a long portion,

the stocks that they buy,

and suppose that those stocks lost 20%,

so just like the market.

And then the stocks that they're selling,

suppose those stocks dropped by 30%.

Well, with the short side,

it means the hedge fund profited plus 30%.

So on one side of the portfolio,

they lost 20,

the other side, they gained 30,

so overall, they're up 10.

So even though the market tanked by 20%,

this hedging of having both a long side and a short side,

they make money.

So relatively immune to overall market movements.

Thank you for all the questions.

I really appreciated them.

Keep them coming.

Until next time,

I'm Cam Harvey.

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