Best Practices Archives - Page 5 of 10 - NorthStar Capital Advisors

Chasing Past Performance is Expensive

A rigorous study from Vanguard demonstrates that chasing the hot mutual fund is an inferior investing strategy compared to good, old-fashioned buy and hold.

Vanguard analyzed a decade of data ending December 31, 2013 across nine asset classes. In every case the investor would have been significantly better off just sticking with the index. On average the indexes generated 50% higher returns than the performance-chasing strategy!

Buy and hold may not be perfect, but it can be a lot better than flitting from mutual fund to mutual fund.

Skin in the Game?

Would you eat at a restaurant where the chefs didn’t eat their own cooking? Would you have joined the Hair Club if the president weren’t also a client? Then why would you invest according to an advisor’s guidance if that advisor doesn’t follow his or her own advice?

Portfolio manager Mebane Faber suggests,

Next time you sit down with your advisor, ask him or her a simple question:

How do you invest your own money?

Don’t settle for a simple “well, uh, I have some stocks and bonds, and, umm, some CDs”…ask them specifically what their allocation percentages are, and what funds they use etc. Many find it very uncomfortable to disclose and many will refuse to do so!

As far as fund managers, many managers don’t even invest in their own funds. (Here are a few articles on how little managers invest in their own funds here, here, and here.)

In addition, many commentators are willing to provide you with plenty of advice but just try getting them to disclose how they invest their own money – impossible! How many commentators can you identify that invest in their own funds and are transparent with where they invest? They are happy to give you advice, but forbid they tell you how they invest!

We Eat Our Own Cooking!
The principals of NorthStar Capital Advisors place nearly all of their investable wealth in the same type of diversified stock and bond portfolios that we manage on behalf of our clients. We also inform and educate our clients on how we are cooking via this personal finance blog, quarterly performance reports, and around the clock access via phone and email.

So, next time you are talking with your advisor or broker, or hear someone giving lots of financial advice, ask them one simple question: “What do you do with your money?”

Inherited IRAs

Inheritances received via an IRA can be advantageous since you can choose to stretch the required distributions across your life expectancy, giving the assets more time to grow (plus taxes aren’t due until withdrawals are made). Here are key best practices to keep in mind:

When you inherit an IRA from anyone other than your spouse, you can’t roll it over into your own IRA
Instead, you have to retitle the IRA so it is clear the owner died and you are the beneficiary
If you move the account to a new custodian, make sure it is a “trustee to trustee” transfer”
If the check is mistakenly made out to you, the IRS will consider it a “total distribution” subject to tax and if you are anyone other than the surviving spouse, it would effectively end the IRA
Be aware there are deadlines for all of these actions
If the IRA owner dies after age 70 1/2 (when required withdrawals start) and didn’t yet take a withdrawal for the year, the heir has to do so by December 31
(if you miss the deadline, you are subject to a 50% penalty on the amount you should have withdrawn!)
If you are a nonspouse beneficiary, determine the required distribution by looking up your life expectancy on the single-life table in IRS publication 590
(most IRA custodians will calculate the required withdrawal amount for you but you need to make sure they are using the inherited IRA calculation)
Once you receive a 1099 form, confirm that the custodian properly indicated the distribution as a code “4”

Know More, Make More

A ground-breaking academic study finds that more financially knowledgeable people earn a higher return on their 401(k) retirement savings.

Dr Robert Clark (NC State University), Dr. Annamaria Lusardi (George Washington University), and Dr. Olivia Mitchell (University of Pennsylvania) analyzed a unique dataset that combined 401(k) performance data for 20,000 employees plus financial literacy data for the same workers.

Investors deemed to be more financially knowledgeable than peers enjoyed an estimated 1.3% higher annual return in their 401(k)s or other defined contribution plans than those with less knowledge.

According to the study’s authors:
“We show that more financially knowledgeable employees are also significantly more likely to hold stocks in their 401(k) plan portfolios. They can also anticipate significantly higher expected excess returns, which over a 30-year working career could build a retirement fund 25% larger than that of their less-knowledgeable peers.”

Financially savvy people tend to save more and are more likely to invest those savings in the stock market. But past studies haven’t clearly demonstrated that these people necessarily make better investment decisions. The authors look at patterns in 401(k) retirement accounts and find that more sophisticated investors do indeed get better returns on their savings.

Source: “Financial Knowledge and 401(k) Investment Performance”

Rebalancing is Important

An investment portfolio must be periodically rebalanced back to its original targets to maintain the intended risk level and asset allocations (i.e., mix of stocks and bonds).

Drifting Through Time
Say you started out with a portfolio of 50% stocks and 50% bonds at age 21. Stocks go up 2 out of 3 years on average. By the time you’re 50 your portfolio mix could drift to 90% stocks and 10% bonds. That’s quite out of balance!

In rebalancing, we would sell the “excess” of stocks and use the proceeds to purchase bonds. In doing so, we ensure that we sell investments at a relatively high prices and buy investments at a low price.

Effects of Rebalancing
In a balanced portfolio of stocks and bonds, you will typically be selling stocks and buying bonds when you rebalance. You will be removing excess volatility from the outsized stock allocation and going back to your initial combination of stocks and bonds.

Quarterly or Annually — Which is better?
In a taxable account, there is a tax benefit for waiting more than a year to rebalance. In a non-taxable account, quarterly rebalancing can have some advantages. You probably don’t want to rebalance on shorter time periods because you need to give your strong-performing investments time to run and avoid the potential costs of excess transactions.

Easy Rebalancing
Is it possible to set up automatic rebalancing? One way is to work with a professional money manager like NorthStar. We do this for our clients. Big firms like Vanguard usually don’t have an automatic option, but they say they will spend 15 to 30 minutes on the phone with customers to help walk through the process and get rebalanced.

Class of 2017: Financial Advice That will CHANGE YOUR LIFE

The 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

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

4 Weeks Until an Important Deadline

Here’s an important reminder if you have an individual retirement account (IRA) or are considering opening an IRA. 2016 contributions to IRAs can still be made up through April 18, 2017.

[Tax day falls on April 18, 2017. Usually, April 15 is the day taxes and IRA contributions are due. But in 2017, that falls on a Saturday. On Monday, the District of Columbia celebrates Emancipation Day. That affects taxes the same way federal holidays do. Emancipation Day is normally April 16, but that’s a Sunday. Therefore, the tax deadline is pushed out to the following Tuesday, April 18.]

Make it a double? If you really want to make the most of the growth potential that retirement accounts offer, you should consider making a double contribution this year: a last-minute one for the 2016 tax year and an additional one for 2017, which you’ll claim on the tax return you file next year. That strategy can add much more to your retirement nest egg than you’d think.

2016/2017 Annual IRA Contribution Limits*

Traditional/IRA Rollover: $5,500 ($6,500 if you are 50 years old or older)
Roth IRA: $5,500 ($6,500 if you are 50 years old or older)
SIMPLE IRA: $12,500 ($15,500 if you are 50 years old or older)
SEP IRA: $53,000 (2016); $54,000 (2017)

*Note: The maximum contribution limit is affected by your taxable compensation for the year. Refer to IRS Publication 590 for full details.

The savings, tax deferral, and earnings opportunities of an IRA make good financial sense. The sooner you make your contributions, the more your money can grow.

If you have any questions or would like to make an IRA contribution give us a call at (704) 350-5028 or email info@nstarcaptical.com.

The (Alternative) Facts of Investing

How 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

Putting Clients Second (!?!)

Although the following makes reference to politicians and political decisions, it’s not meant to be political. The intent is to inform you and to help protect you and your family’s best interest.

Today the founder and former chief executive of Vanguard, John C. Bogle, penned an article in the New York Times. It starts off:

THE Trump administration recently announced that it intends to review, and presumably overturn, the Obama-era fiduciary duty rule that is scheduled to take effect in April. The administration’s case was articulated by Gary Cohn, the new director of the National Economic Council.

Mr. Cohn, most recently the president of Goldman Sachs, called it “a bad rule” and likened it to “putting only healthy food on the menu, because unhealthy food tastes good but you still shouldn’t eat it because you might die younger.” Comparing healthy and unhealthy food to healthy and unhealthy investments is an interesting analogy.

The now-endangered fiduciary rule is based on a simple — and seemingly unarguable — principle: that in giving advice to clients with retirement funds, stockbrokers, registered investment advisers and insurance agents must act in the best interests of their clients. Honestly, it seems counterproductive to go to war against such a fundamental principle. It simply doesn’t seem like a good business practice for Wall Street to tell its client-investors, “We put your interests second, after our firm’s, but it’s close.”

To learn more, see Mr. Bogle’s article and The Freedom To be Fleeced — How Donald Trump Made Financial Hustles Great Again

It’s easy to get lost in the details and let our minds glaze over, but what you should know is very simple:

An advisor that is a fiduciary has a legal obligation to put your best interests first, always.
Most people think that all or most advisors are fiduciaries (WRONG!).
Most purveyors of financial products and services are NOT fiduciaries. They comply with a much lower “suitability standard.”
To assure you and your family are getting the most trustworthy care, always ask your advisor or financial salesperson the following:
“Are you a fiduciary? Are you always acting in a fiduciary capacity when working with me?”

When we formed our advisory practice many years ago we purposefully chose to be a fiduciary because it’s the right thing to do. Incredibly that ethos is counter-cultural in financial services. It’s bemusing to watch the delicate public-relations dance and contortions that many big institutions are making around or in avoidance of doing the right thing.

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