Do you want a wealthy retirement without worrying about money? Welcome to “Retire in Texas”, where you will discover how to enjoy your faith, your family, and your freedom in the State of Texas—and, now, here's your host, financial advisor, author, and all-around good Texan, Darryl Lyons.
Darryl: Hey, this is Darryl Lyons, CEO and co-founder of PAX Financial Group, and you're listening to Retire in Texas—and as always, I need to give you the legal disclosure that this information is general in nature only. It is not intended to provide specific tax, investment, or legal advice. Visit PAXFinancialGroup.com for more information.
And I want to remind you to text the word “TEXAS” to the number 74868. You'll be able to speak with a financial advisor with the heart of a teacher, 15 minutes to see if they're a good fit, if we're a good fit for you and vice versa. So, that's our way of having a non-threatening introduction conversation with the team at PAX Financial Group. Text “TEXAS” to 74868. [01:13.6]
This show, we're going to talk about small-cap stocks. Look, don't check out. This is a good one. I say that. Of course, that's kind of like patting myself on the back, but I think that content is going to help you and I'm going to explain it in such a way that I think it's going to be applicable to your life, so let's jump in right now and talk about small-cap stocks.
First of all, stocks is ownership of a company. We know this already, right? You own a piece of a company, not enough ownership to go into a store and take what you want, although some people do that in some cities now. But, generally speaking, you have a small percentage of ownership with thousands of people across the country. If that company does well and sells a lot of their products, then you benefit because the price of the stock goes up. And, at times along the journey, the company may pay out some of those profits in the form of a dividend, and so you get those dividends. So, that's a stock, in general, ownership. [02:14.6]
Small is a smaller company, obviously, but to put this in perspective, the large companies are like the Apples and the Googles. The smaller companies are not taco stands. They're not really, really tiny. They're not just local automotive companies. They're very, very big companies. They're very big, but they're not typically global and they're not typically across state lines. I mean, again, this is generally speaking.
A lot of times they may have a niche market or they may have a smaller geographical footprint, maybe even if you think of H-E-B, which might be probably slightly bigger than a normal small-cap stock. H-E-B is a local grocery store in San Antonio. They've treated the community very well with fair pricing and fresh produce and all that. But they wouldn't be considered a large cap. If you go to Nashville, they don't know H-E-B. If you go to California, they don't know H-E-B. [03:13.8]
So, it's going to be more regional in nature, but you would look at H-E-B and you would say they're not a small company when they're a big company. So, when we think about small-cap stocks, we're talking about pretty large companies, but just not the big multinational names that you often see in most portfolios, like Google and Apple and Facebook. It's the smaller companies.
When you talk about cap, just to define that, just a nerd thing for a second, a cap is short for capitalization, and so that means if you take the price of all those stocks, of all the shares of that company—the price, let’s say, is $10—if you take that price and multiply it by all the shares outstanding, that would give you the capitalization, and so then they compare that to other companies. [04:02.0]
So, this small-cap space is very important for you to understand specifically right now. Let me tell you why. Let me make sure it's very clear. Coming out of recession, small-caps have killed it, oh my gosh. Now, this is not promissory, but you’ve just got to look at the history and I’ll put the research references in the show notes.
But in 1981, we had a recession. From the bottom, 12 months later, small-cap stocks were up 90%. And in July 1990, another recession. From the bottom, one year later, they were up 70%. The 2000s had a different story, so this is interesting. So, 2000, right? Uh-oh, Y2K, dotcoms. One year after the bottom, 24%, so not near as good as the other years, but two years later, they were up 67%. There's more data points to consider, but I think you get the point. Coming out of recessions, small-caps are a place you want to be. [05:12.0]
So, how do I know if I own any right now? How do I know if they're in my portfolio? Is my advisor on it? Is it on autopilot? Do I know? I mean, do I have any of these small companies in here? Because if we are in a recession or about to go into a recession, and you're telling me that history shows that these are some good types of companies to own coming out of a recession, then I need to make sure I have some in my portfolio.
Let me talk about that for just a second, because I think we can go a little deeper here. If you're younger—I'm going to define, anything younger than under 65. Okay, look, I know, I don't mean to offend anyone here, but just for the sake of making the show simple—then you're accumulating wealth. You're not distributing wealth to live off. [05:56.6]
In that case, the most that I would consider owning in that small-cap stock space would be 25%, and that stretches me. 20%, I could say is probably more comfortable, max, but I have seen as high as 25% in the small-cap space, while you're accumulating. The younger you are, the more comfortable I am at 25%. As you get closer to that 60–65 that, I start to taper that down.
But you should have some of that aggressive small-cap stock in your portfolio. Obviously, doing all those risk-tolerance questionnaires affirming them, that makes sense, but it's just good for you to have some in there. It's just good to have small companies. Small companies are good for you. Why? Because these are the innovators. These are the grinder companies, and these are the companies that give you an opportunity to enjoy some really nice returns.
I was looking at some small-company stocks the other day. There's a new company coming out doing online learning, using artificial intelligence, and they're actually going to all the major universities and introducing this artificial intelligence to improve their programs—and I was with a major university just recently, and they're struggling, because now they're competing. [07:11.8]
These brick-and-mortar campuses are competing with these alternative-education programs, so they're really struggling. So, you've got this third-party small company coming around saying, “Hey, I’ve got some solutions to make you relevant again.” So, that's a cool company.
I saw one that's doing commercial real estate. They're using the markets and people's money to buy commercial real estate, so that could work out real well, if you're in the right space, probably apartments more than office.
There's a small company that's coming out that they've never done this before, but now kids need vaping treatments to get off their addictions, a small company.
A company that's using artificial intelligence to reduce inventory, because inventory, if you have too much inventory, you will find yourself not having enough cash flow.
I say all that because all these innovative, smart companies, a lot of them are in this small-company space, and so I want you to own those if you're accumulating money. [08:04.6]
Now, if you're distributing money at age 65 that you're living off, then the game plan changes, but it's kind of fun, still. Let me tell you why. You can own small companies. You can. You just have to be intentional about how you own it. You say, “My risk profile doesn't . . . I need . . . I don't have that kind of risk.” You can own small companies, even if you're older. You can.
Here's how you do it. You do your financial plan. You’ve got to crunch the numbers. Working with one of our advisors is the way we do that. Crunch the numbers, and some of you, not all of you, some of you will click the buttons and your advisors say, “You've got some extra money. You're not going to run out of money. You've got some extra.”
It could be 5,000, it could be 500,000, but that extra money is going to be inherited by somebody, and if it's going to be inherited by somebody, then let's look at life expectancy. If you're 65, let's say you live 20 years to 85. We've just identified the time horizon in which you're going to leave that extra money to the next generation, and it's 20 years. [09:11.2]
And because we've identified a time horizon, why not take advantage of a very interesting investment opportunity and call it your legacy bucket of money, carve that aside and let that grow, compounded growth in a little bit more aggressive way because the time horizon is 20 years? It's a legacy position, and I’ve mapped this out all in the book 18 to 80. I go through the process thoroughly. I'm on Pivot planning. Our advisors know how to do it. But in your legacy bucket, that's where you can put some of these small-cap companies.
Now, okay, a couple other things to talk about here and then I’ll wrap this thing up. How do you own these small-cap companies? Do you just buy the individual stocks? And if so, how do you find these stocks? [09:55.5]
What's cool about small-cap companies is that they're not covered by the nerds, also called Wall Street analysts, as much, so you do find anomalies within the-- I say anomalies. You do find opportunities for advantage by doing some healthy research on small companies, so if you are a trader yourself, I think you're going to have a lot of fun researching small companies. The research isn't as prevalent, so it's a really fun space to find kind of the diamond in the rough definitely. I’ve looked at a lot of small-company stocks over the years and there's just some cool stories there.
Two things really matter when it comes to small companies, management and cash, so those are considerations. As the lending environment changes, those companies that are depending upon lending a lot are going to struggle, no doubt, and that's part of the risk of small companies. It’s that they're smaller, so their ability to borrow money is restricted, because they don't have the scope as a Bank of America or an Apple. So, that's a challenge and that's why the risk-reward of a small-cap stock basket is there. [11:01.6]
And so, how do you own them? Do you buy the individual stocks? You can individually, but you just have to have the time, the emotional fortitude, and the tools to be able to do it individually. A lot of people like to buy them through indexes. Just, an index, as you know, is also called an ETF. I'm kind of making this as simple as possible, but it's a basket of small-cap stocks that are put together by a computer and they're not traded very often. So, you can do it that way and that's fine.
You can also do it through a mutual fund, which mutual funds have been around a long time, but find a mutual fund that buys small-caps and focuses on that. I kind of liked the mutual funds, because the manager of those funds can go and do that research and find the good ones. So, what you have to do is, you have to identify the cost of owning a small-cap mutual fund. Is it worth it? Because the index is going to be cheap. The mutual funds are going to be more expensive, and you look at the history and say, “Did the manager . . .? Have they done a better job?” [12:02.2]
I’ll tell you what we like to do at PAX is we like to use individual stocks, and the reason we do that is because some of these managers get too big or the ETFs get too big and then they can't buy a small-cap company anymore, because they would control the company. So, as these funds get bigger, bigger and bigger, and they want to own XYZ company, they keep buying more of it, and then they own more than 10% of the company and then that's too much risk. So, if we can not own it through a fund and own the individual stocks, then we feel that we can get a little bit of advantage.
At PAX, we like to do it that way, if we can. We can always do it that way, but it's a preferred way. There's just some challenges and minimums, and things like that. But, regardless, even if you can't own the stocks, the mutual funds or the exchange-traded funds are a good way for you to get some exposure to those small-company spaces. [12:55.2]
Again, if you're accumulating money, I really like the idea of the maximum 25%, and if you're distributing money and living off it, then I would like for you to carve out some of your legacy money and consider it in the small-cap space. Of course, as always, check with your advisor to make sure that it makes sense for your planning. But I really hope this helps you, because if we do hit this recession and come out of this recession, you may want to take inventory of your small-cap portfolio and see where the opportunities are.
I hope that helps you today, a lot of deep content in the economic world, and appreciate you hanging in with me. Again, if you need an advisor, text the word “TEXAS” to 74868. That's “TEXAS”, 74868. And as always, I want to remind you, you think different when you think long-term. Have a great day. [13:45.0]
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