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What Kind of Investor Are You?

  • August 24, 2017/
  • Posted By : admin/
  • 0 comments /
  • Under : Behavior, Seeking Prudent Advice

question-mark

What kind of investor are you?  According to author William Bernstein, there are three broad groups of investors segregated by behavior:

Group 1: The average small investor, who does not have a coherent asset-allocation strategy and who owns a chaotic mix of mutual funds and/or individual securities, often recommended to him or her by a broker or advisor. He or she tends to buy near bull market peaks and sell near bear market troughs.

Group 2: The more sophisticated investor, who does have a reasonable-seeming asset-allocation strategy and who will buy when prices fall a bit (“buying the dips”), but who falls victim to the aircraft simulator/actual crash paradigm, loses his or her nerve, and bails when real trouble roils the markets. You may not think you belong in this group, but unless you’ve tested yourself and passed during the 2008–2009 bear market, you really can’t tell.

Group 3: Those who do have a coherent strategy and can stick to it. Three things separate this group from Group 2: first, a realistic appraisal of their true, under-fire risk tolerance; second, an allocation to risky assets low enough, or a savings rate high enough, to allow them to financially and emotionally weather a severe downturn; and third, an appreciation of market history, particularly the carnage inflicted by the 1929–1932 bear market. In other words, this elite group possesses not only patience, cash, and courage, but also the historical knowledge informing them that at several points in their investing career, all three will prove necessary. Finally, they have the foresight to plan for those eventualities.

“Job one for the investor, then, is to learn as best she can, to ignore the day-to-day and year-to-year speculative return in order to earn the fundamental return.” – William Bernstein

Source: Rational Expectations: Asset Allocation for Investing Adults


Great Expectations

  • July 14, 2017/
  • Posted By : admin/
  • 0 comments /
  • Under : Behavior, Investing 101, Performance, Seeking Prudent Advice

Expectations are very important. If you know what to expect, you shouldn’t be surprised. And if you’re not surprised, you won’t panic.

Coaching clients on what to expect and how (not) to respond to extraneous events is our defining role as a trusted advisor. 

We invest in stocks because of their superior returns. Those historically higher returns are a reward for tolerating volatility (i.e., the “volatility premium”).  But what does stock volatility look like in the real world? What pattern of price variability should we expect?

Well, here it is in its most elegant of graphical forms (click image for a bigger view).

Here’s how to read this chart:

  • The intra-year decline versus the annual return of the S&P 500 are plotted vertically with years running horizontally from 1980 through year-to-date 2017.
  • The annual return (grey bars) show the calendar year price increase. For example, in 1980 stocks climbed 26% for the year.
  • The intra-year decline (red dots) is the largest market drop from peak to trough during that year.  For example, in 1980 we experienced a 17% drawdown.
  • Putting these together, in 1980 the stock market dipped 17% before closing up 26% by the end of the year.

It’s not hard to see that short, intra-year declines are the norm.

In fact, the average intra-year drop is 14.1%. But despite these temporary declines, the annual returns are positive in 28 of 37 years (76% of the time). During the charted time period 1980 to 2016 the average annual return was 8.5% This pattern is persistent.  If you look back to 1946, the average drawdown is a remarkably close 13.8%, and the price return was positive 50 of the 71 years (70% of the time).

History shows the declines are temporary, the advance is permanent.

Think about how the average person responds to these intra-year declines. The financial media is screaming about the crisis du jour which is consistently characterized as the end of the world (“I’ve lived through some terrible things in my life, some of which have actually happened.” — Mark Twain ).  Data shows the average investor, without the support of a caring, empathetic coach/advisor, consistently sells at the worst of times – i.e., during one of these perfectly normal and temporary pullbacks.

Volatility does not equal a financial loss unless you sell.

In our humble opinion, possessing an informed expectation, one that allows you to ignore short-term gyrations to capture long-term gains, is a Great Expectation.


Sir Isaac Newton: Monumental Scientist, Terrible Investor

  • July 6, 2017/
  • Posted By : admin/
  • 0 comments /
  • Under : Behavior, Seeking Prudent Advice

220px-GodfreyKneller-IsaacNewton-1689Most people recognize Sir Isaac Newton as one of the most influential scientists of all time, but did you know he was a horrible investor?

Newton’s experience with the South Sea Company vividly demonstrates the financial perils of chasing hot markets, getting caught up in investment bubbles, and not maintaining a diversified portfolio.

In the early 18th century the South Sea Company was established and given a monopoly on trade in the South Seas in return for assuming England’s war debt.  Investors liked the idea of that monopoly and the company’s stock began to take off.

Newton hear the siren call of the South Sea Company, invested his cash in early 1720 and managed to turn a nice profit.  But then the stock kept soaring after he had gotten out. So Newton jumped back into the stock with a lot more money than his original investment.

Newton subsequently lost 20,000 pounds, almost all of his life savings!  From this terrible outcome, Newton supposedly decreed, “I can calculate the movement of the stars, but not the madness of men.”

No warning on Earth can save people determined to grow suddenly rich.
— Lord Overstone

newton-investsSource: Sovereign Man

 

 


Code Red! 8 Ways to Permanently Wipe Out Your Retirement Savings

  • June 8, 2017/
  • Posted By : admin/
  • 0 comments /
  • Under : Behavior, Personal Finance, Retirement, Saving Money, Scams & Schemes, Seeking Prudent Advice

code-redDana Anspach at MarketWatch wrote about 8 financially devastating mistakes (aka “Code Reds”) that must be avoided:

1. Believe in a stock
The company you work for is doing well. You understand the potential of the business. You should own a lot of company stock. After all, it shows your level of commitment, right? 
WRONG! CODE RED!
You can lock in lifestyle by taking risk off the table. If trusted advisers are telling you to reduce risk, listen. You can’t take your “belief” in your company stock to the bank. Owning a lot of company stock doesn’t demonstrate a commitment to your company; it demonstrates a lack of commitment to your own personal financial planning.

2. Get reeled into real estate
Rental real estate is a good way to build wealth with someone else’s money, isn’t it? I mean, that’s what the infomercials say.
WRONG! CODE RED!
Investing in real estate is a profession in and of itself. With real estate prices on the rise again, don’t get reeled in with the lure of easy passive income. It isn’t as easy as it looks.

3. Follow a Tip
An opportunity to double your money is an investment opportunity worth pursuing. It could change your life, right?
WRONG! CODE RED!
Tips are great for your waiter or waitress. But where you family’s future is concerned, avoid the tips, and stick with a disciplined and diversified approach.

4. Change lanes — every year
Smart investors watch the market and frequently move money into the latest high performing investment, right?
WRONG! CODE RED!
You’ve probably noticed if you constantly changes lanes on a backed up highway, always trying to inch ahead, you usually end up farther behind. Driving this way isn’t effective; investing this way isn’t effective either. Pick a disciplined strategy and stick to it. Jumping from investment to investment is only going to slow you down.

5. Play the currency cards
Experts can deliver higher returns, right? Find someone who knows how to trade, and you’ll be set.
WRONG! CODE RED!
If experts could generate such high returns, why would they need your business? Don’t play the currency cards, the expert cards, or fall for any kind of outlandish promises. I’ve yet to see one of these programs work the way it was marketed.

6. Follow your ego
Better investments are available to those with more money, right? If you get the opportunity to participate in something exclusive, it is likely to deliver better returns.
WRONG! CODE RED!
If someone appeals to your ego, walk away. When it comes to investing, the only thing I’ve seen egos do is help someone lose money.

7. Follow their ego
You can trust prestigious people in your community. That’s why you should do business with them, right?
WRONG! CODE RED!
Checks and balances are good in government and in investing. One way to make sure checks and balances are in place is to work with an investment adviser that uses a third party custodian. The third party custodian sends account statements directly to you. The investment adviser can make changes in your account, but the transactions are reported to you directly by the custodian, who isn’t and should not be affiliated with the investment adviser.

8. Leverage up
Borrowing at low interest rates and investing in high growth assets is an excellent way to accumulate wealth, isn’t it?
WRONG! CODE RED!
Think twice before borrowing to invest. It causes ruin more often than it causes riches.

Visit MarketWatch to read Anspach’s full article.


Class of 2017: Financial Advice That will CHANGE YOUR LIFE

  • June 1, 2017/
  • Posted By : admin/
  • 0 comments /
  • Under : Behavior, Best Practices, Personal Finance, Saving Money

PDS-CommencementThe following is a brief excerpt from the commencement address by Dr. Chris Mullis to the graduating class of Providence Day School on May 31, 2013. The full text of Dr. Mullis’ speech, that includes career advice, financial guidance, and a few pearls of wisdom, can be found here.

At my investment advisory firm, we developed complex computer algorithms and use them to manage our clients’ investment portfolios. But the basic steps you need to take to manage your own money well are deceptively simple. First, live within your means and avoid being caught up in rapid lifestyle inflation. You will not live like your parents when you first start out. Second, save and invest your money wisely. Let me elaborate on this point.

Wealth accumulation depends on three factors: how much you save, the rate at which your money grows, and how long you save. That last factor, time, is very, very important. There’s an urban legend that Albert Einstein once said that compounding interest is the most powerful force in the Universe. That quote is likely misattributed but the message is spot on. If you save $5,000 a year for 40 years and earn 8% annually, you will eventually have $1.3M. But if you delay starting for merely 5 years, your results after 35 years will be only $860k. That 5-year delay preserved $25k of short-term capital but ultimately cost you >$400k in the long run. Time is the most powerful lever in the machinery of investing. Nothing else comes close to it.

So what do you need to do? Start saving and investing right out of high school regardless of how hard you think it hurts or how unpleasant the tradeoffs. Even if you set aside only 5% of your paycheck starting out, do it to get into the habit of saving. Delaying getting serious about investing until my 30s was a significant financial mistake on my part. No one ever sat me down and explained how important it is to start investing early. Now that we’ve had this little talk, you’ll never be able to say that no one told you.


Investors are Still Their Own Worst Enemy

  • May 12, 2017/
  • Posted By : admin/
  • 0 comments /
  • Under : Behavior, Best Practices, Mutual Funds

Our core belief is that the dominant factor in long-term, real-life financial outcomes is not investment performance, it is investor behavior.  Therefore, our true value as a trusted advisor lies in establishing and guiding our clients’ investor behavior, not in managing investment performance.

This philosophy of advice is data driven as many academic and industry studies demonstrate a perennial pattern that investors on average fail to capture the returns that their own investments offer, largely because of behavior.

In the recently released DALBAR study for the 30-year period ending December 30, 2016, the S&P 500 stock index produced an excellent annual return of 10.2%, while the average stock fund investor earned only 4.0%, a gap of 6.2%.  Bond investors did not fare any better. During the same 30-year period, the Barclays Bond Index yielded an annual return of 6.0%, while the average bond fund investor earned just 0.6%. Note these three decades include the crash of 1987, the tech boom-bust of 2000, the Great Recession crash of 2008, and the current bull market run — in other words a very fair sampling of good and bad times.

These results, illustrated above, reflect the fact that we experience powerful emotions when markets move up and down that cause us to make investment decisions that are not in our best interests (e.g., panic selling, euphoric buying, performance chasing, etc.).  This is a profound observation of the “behavior gap” that exists between investment and investor returns.  Investors are more often than not their own worst enemy when it comes to investing.

When we welcome new client families to our firm, we hand them a card.  The front consists of a bear market chart designed to prepare them for the fact that the market pulls back on average about every five years or so and not to panic.  The back of the card is a summary of What We Do / How We Earn our Fee:

  • 20% — Quantifying goals, crafting a long-term plan, funding the plan with a long-term portfolio
  • 80% — Coaching clients to continue working the plan through all the cycles of the economy, and all the fads and fears of the market
  • 0% — Analyzing/interpreting the economy and current events
  • 0% — Timing the market, calling tops and bottoms
  • 0% — Identify consistently top-performing investments

 

 


“You need to judge us over a full cycle”

  • April 13, 2017/
  • Posted By : admin/
  • 0 comments /
  • Under : Behavior, Investing 101, Performance

The standard argument that active investment managers make when challenged by their clients on why their portfolios underperformed the market is, “you need to judge us over a full cycle.”

Robust results published in today’s Wall Street Journal blow a hole through active managers’ favorite defense.  Over the 15 years that ended in December 2016, 82% of all U.S. funds trailed their respective benchmarks.  That long time period is more than enough to encompass the active managers’ “full cycle”, boom-bust-boom argument.  The findings are noteworthy because it’s the first time 15-year results have become available for this very comprehensive analysis.

The results are even worse when you looks at popular assets classes:

  • 92.2% of U.S. large-cap active funds trailed their respective benchmarks
  • 93.2% of U.S. small-cap active funds trailed their respective benchmarks
  • 95.4% of U.S. mid-cap active funds trailed their respective benchmarks

That elusive 8% of all U.S. fund managers that did beat the market 2002-2016 is a slippery target for investors.  Most of them did not persistently outperform throughout those 15 years.  So you can’t just take today’s top performers and go with them.  Said another way, the likelihood of you finding one of these funds ahead of time is very, very small.

You have a key decision — a choice that will materially impact your future life.  How will you choose to invest the bulk of your portfolio?  Will you go with the 92% odds in your favor (passive management), or the 8% odds in your favor (active management)?

Source: WSJ – Indexes Beat Stock Pickers Even Over 15 Years


10 Most Common Behavior Biases of Investors

  • April 6, 2017/
  • Posted By : admin/
  • 0 comments /
  • Under : Behavior, Seeking Prudent Advice

Robert Seawright with Madison Avenue Securities assembled this list of the ten most common behavioral biases that hinder investors:

  1. Confirmation bias – we gather facts and see those facts in a way that supports our pre-conceived conclusions
  2. Optimism bias – our confidence in our judgement is usually greater than our objective accuracy
  3. Loss aversion – the pain of losing $100 is at least twice as impactful as the pleasure of gaining $100 (causes investors to hold onto their losing stocks too long)
  4. Self-serving bias – the good stuff that happens is my doing while the bad stuff is somebody else’s fault
  5. Planning fallacy – overrate our own capacities and exaggerate our abilities to shape the future
  6. Choice paralysis – we are readily paralyzed when there are too many choices
  7. Herding – we run in herds, latching onto the group think and moving in lock step
  8. We Prefer Stories to Analysis – people love a good narrative and prefer to be swept up by the story rather than work through the definitive numbers
  9. Recency bias – we tend to extrapolate recent events into the future indefinitely
  10. Bias blind-spot – the inability to recognize that we suffer from the aforementioned cognitive distortions!

How Does the Stock Market Work?

  • March 9, 2017/
  • Posted By : admin/
  • 0 comments /
  • Under : Behavior

Real Life Adventures by Gary Wise and Lance Aldrich

This cartoon highlights how your behavior as an investor strongly influences your success. Investor behaviors that likely contribute to reducing your returns include:

  • The tendency for investors to sell underperforming investments and then replace them with others that performed well; a pattern of “buying high,” and “selling low.”
  • Emotionally driven decisions that may cause trading at inopportune times.
  • Investment activity motivated by media hype, financial news networks, or televised “experts.”
  • Poor market timing decisions resulting in missed opportunities.

Avoid being the subject of this cartoon! Great investors throughout history have understood that building long-term wealth requires the ability to control one’s emotions and avoid self-destructive investor behavior.


The (Alternative) Facts of Investing

  • February 23, 2017/
  • Posted By : admin/
  • 0 comments /
  • Under : Behavior, Best Practices

alternative-factsHow well do you know the “alternative facts” of investing?  Phil Huber, CIO at Huber Financial, recently penned a great piece where he laid out what can appropriately be interpreted as the investing equivalent of FAKE NEWS:

Past performance is indicative of future results. Period!

Risk and return are NOT related. Period!

There is a direct correlation between how much a fund manager charges and how skilled they are. Period!

Standard deviation is risk. Period!

Nothing bad will happen if you mix your politics and your portfolio. Period!

Price is what you get, value is what you pay. Period!

The United States is the only capital market in the world and any attempts at investing in international stocks and bonds for diversification should be met with ridicule. Period!

Some investments are so great that they should be bought at any price. Period!

Three years is a statistically appropriate timeframe to judge the performance of an investment. Period!

Be greedy when others are greedy and fearful when others are fearful. Period!

Your calls for hyperinflation and currency debasement were not wrong, they were just early. Period!

If you can predict the outcome of an event, surely you can also predict how millions of other people will react to said outcome. Period!

The Dow is an accurate representation of the entire stock market. Period!

Price returns matter more than total returns. Period!

You can remain solvent longer than the market can remain irrational. Period!

The time to buy is when there’s a party in the street. Period!

Timing the market is more important than time in the market. Period!

Hedge Funds are an asset class. Period!

The perfect portfolio exists. Period! 

It’s OK to let the tax tail wag the investment dog. Period!

It’s a stock picker’s market.  Really, I mean it this time. Period!

Markets are perfectly efficient. Period!

Markets are wildly inefficient. Period!

This time is different. Period!

Phil goes on to point out that in many cases, the opposite is a closer approximation of reality and good behavior.  He recommends the following ways to prevent “alternative facts” of investing from seeping into your portfolio:

  • Work with financial professionals that act as your fiduciary and put your interests ahead of their own.
  • Implement an investment philosophy that isn’t predicated on forecasting an unknowable future.
  • Have a written investment policy statement that governs how you or your advisor is going to manage your portfolio ahead of time.  Refer back to that document when the going gets tough.
  • Remember that the plural of anecdote isn’t data.

 

Source: B&P


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