Investment

Breaking Investor Mediocraty

I wanted to give some reflection on my experiences this week as a presenter at a local financial literacy/education event.  I have been presenting in this program for several years, and year after year I do tend to see the same faces.  The audience is predominantly made up of very educated and accomplished individuals.  While presenting at this event is enjoyable, it has taken a lot of work to prepare for. 

If we look at the Dalbar QAIB study (a study that looks at investor behavior and returns), the state of the average investor is, well, sad.  Over the past 20 years, they calculate that the average investor has made less than half the return of the S&P 500.  So, even in my classes of highly educated people, there are probably some attendees that have done great, the other half have likely preformed poorly. (However, they would not admit to this).  Education and earning ability has no bearing on your investment success.

Making a change in one’s investments is a huge undertaking, both mentally and even emotionally.  All sorts of emotions come into play.  Below are a few issues that may be present in they way you are currently invested. These issues keep many investors trapped in mediocrity.

1) You are not diversified.  True diversification is rare.  And unless you can quantify it, you can’t prove you are. Can you?

2) You use active management.  This flawed philosophy has been debunked by academia.  If you are not a stock picker, your mutual fund manager probably is. Have you decided on what your Investment Philosophy is?

3) You are not disciplined.  Most investors are not. This is not a flaw! It’s part of the human condition. An advisor can help keep you focused.

4) You are taking more risk than you realize.  Unless you can tell me the standard deviation of your portfolio, you don’t even know how much risk you are taking!

5) You don’t know your costs.  You have no idea what you are paying in the form of fees, commissions, or opportunity costs.

6) You don’t know anything about the subject.  You lack even basic knowledge of investing, and are perfect prey for salesmen and women of financial “products”.  OR this lack of knowledge paralyses you from making ANY decisions. We believe an educated investor will always fare best in the end.

7) You don’t even know if you are succeeding or failing.  You don’t even know what you should be earning.  In your simple system, a positive year is a success, and a negative year is a failure.  You are failing more than you know.

If you are ready, or thinking about making a change, there are always reasons why people don’t.

1) Your current advisor is your friend.  I get that.  If you choose relationships over results that is your choice.

2) Being penny wise and pound foolish.  You think that fees are the end all and be all of successful investing.  While important, I can show you a very bad, very cheap portfolio. Cheap isn’t always everything.

3) You lack the will to make the change. You don’t have the energy to look into the situation. I know. Life can be exhausting.

4) You don’t know who to trust.  That being said, you just remain in frozen in your current state. Thankfully, there are some things we believe you can look for in an advisor to narrow down the search.

5) You have given up on the whole investing thing.  Too much money lost; and you are not playing the game anymore. While tragic, the crashes of 02 and 08 really took it’s toll on some investors.

Do these lists resonate at all with you? While a good advisor can be a tremendous asset, ultimately your investment success is dependent on no one else but you.

Being Different Isn’t Easy

It’s a rainy afternoon on a Saturday, so I thought it would be a good opportunity to explain something that has certainly come to light in the past few weeks.

Sometimes it’s not easy being different.  2014 is proving to be a great example of that.

As of 10/3, the S&P 500 Index (a fairly good indicator of large US stock performance) is up a hair over 8%.  For the vast majority of the investing American public, they are experiencing a decent positive return on their fund’s this year, simply because of the fact their portfolios very much track this index.  Retail US investors own mostly Large US Company Stocks.  This is not a prudent or diversified strategy.  However, as blind luck would have it, this area of the global stock market is doing comparatively better than many others in 2014.

Take the Russell 2000 (a small cap stock index) for example.  That is down about 8% this year.  International stocks are also on the whole down a small percentage year to date.  That being the case, an investor that holds a diversified portfolio may feel some unease when comparing their portfolio to their neighbors’, or to the popular stock indexes quoted daily on the news.  Their stock portfolio has likely declined this year.

But this is kind of year when disciplined and educated investors earn their increased returns.  “Average” investors, those that hold undiversified portfolios, make poor choices, and invest like 98% of other investors, earn about 3-4% a year over time according to Dalbar’s yearly study of investor behavior.  It may be tempting to chase large cap stocks this year, but do you remember the “dead decade”?  The 2000s were horrible for large company stocks.  The truth is that every market segment will have its day in the sun- and its long stretches of underperformance.  Every year it’s a new winner- and that winner is not knowable in advance.

But you might think, “Doesn’t spreading myself out reduce my returns?  After all, if all my winners are always wiped out by losers, I will never get ahead”.  Well, that would be the case if the long term direction on all of the global stock markets were flat, or down, but it is our view that the long term direction on all developed stock markets is UP.  Some may go up more one year, and in some years some go up and some go down (like this year).  But by being more diversified, and owning more areas of the market, we tend to smooth out the long term volatility, versus placing all of our eggs in one proverbial basket.

Costs: Important Yes, but not the Whole Story

It is fairly well known among savvy investors that costs are one of the main things that can drag down your portfolio’s return over time.  Morningstar.com recently did a study that showed a fund’s expense ratio, relatively to other funds, was a better predictor of performance than their own star system.

This leads many numbers minded people to go on a search for the cheapest, least expensive funds, and them pile them in to their portfolios.  Unfortunately, while this may save on cost, it likely will not bring the desired returns.

The issue that is missed in this scenario, is that the other ingredient necessary in a good portfolio is the right mix.  If investing were like baking, getting right measurements would be like getting low expenses.  Baking, unlike cooking, requires fairly accurate measurements.  So, in investing, being cost conscious is good, and we certainly want to eliminate any unnecessary costs.

However, to complete the analogy, picking the right ingredients (like baking powder vs flour) in baking is like picking the right “asset classes” or investments in your portfolio.  If I made cookies and was perfectly exact in my measurements, but, used salt instead of sugar, or cumin instead of cinnamon, my cookies are not going to be very tasty. That is just like a portfolio with low expenses, but the wrong amount of money in the wrong areas.

Just take the VINIX, the Vanguard S&P 500 Index Fund, Institutional Class.  It’s expense ratio is only .04%.  Wow.  Almost nothing.  However, if you loaded up on that fund 15 years ago, you would have only enjoyed about a 4.62% return per year since then.  I don’t even know if that is better than what bonds did over that time.

Cheap doesn’t always mean good.  It’s important to understand all of the parts needed for a well diversified global portfolio.  Your portfolio’s construction will override the effects of cost every time.

Is Volatility the Enemy?

From our upcoming newsletter:


After a few good years of market returns, it’s inevitable that the “c” word begins to be uttered throughout the investment world- and by that I mean “crash”. From cable news, to newspapers and magazines, to emails, people predict doom & gloom.

But is market volatility, especially negative volatility, our real enemy? Let’s look at an example based on the re-turns S&P 500. John Q, Investor, started investing in 2000. He invested, like clockwork, $10,000 on the first trading day of every year until January of 2014. But un-like most investors, he was given a choice to invest in the real stock market, or a magical one, where the direction was always up! The market genie told John, “Both stock markets will close at the same price on January 2nd, 2014, but the magical market will never lose. It’ll be a smooth ride up, the same positive return every year!” Given the opportunity to never agonize through a down year, John chose this market, as opposed to the “real” world, which saw major swings between Jan 2000- Jan 2014.

So, did John make the right choice by eliminating all downside volatility? In John’s magical stock market, he ended up with $168,050. He made about $18,000 on his investment and he never lost money in any year. He wanted to compare his results with his copycat brother in law Tom. (Tom matched John’s investments exactly, only he invested in the real world market). Tom had $221,793 by January of 2014. This beat John’s returns by almost 25%! Why? While market corrections may be no fun to live through, they do provide a period of time when our investment dollars go further. With lower stock prices, investors can buy more shares.

So if volatility is not our enemy, who is? I like to borrow a famous literary quote that says “We have met the enemy, and he is us”. Poor investor decision making (like John above), is the main cause of diluted portfolio re-turns.

Without risk, there is no reward.  Will the market “crash” again.  Most certainly.  It always has, and it will over and over again.  No one can predict with certainty when.  What matters is our response to it.  Wise investors will whether through them, and look at the bright side of the situation.  But this is not to say investing is without risk.  Each investor needs to answer the question, “how much market volatility am I willing to bear?”

Buffet vs the “Experts”

This post is largely taken from an article from NBC news, but I thought it would be worth commenting on it.  The article can be found at:

http://www.nbcnews.com/business/markets/buffett-has-big-lead-stock-bet-vs-experts-n23646

About six years ago, the famed Warren Buffet made a wager with a group of hedge fund managers.  Hedge fund managers are touted as the most sophisticated, nimble, and adept money managers on the planet.  They are not burden by the regulatory issues facing mutual funds, and they can employ a vast array of financial maneuvers.  Warren’s ten year wager was that he could outperform a group of hedge fund managers using a simple low cost index fund; meaning that for all their flash and sizzle, the masters of the financial universe would be unable to beat the market due to the market’s efficiency.

With four years remaining, Warren’s simple index fund has a commanding lead, earning 43.8% vs 12.5% for the hedge funds (as of the time of the article).  What is more telling is that Warren chose an index fund to compete against them, not his own company’s stock.