June 24, 2015

Why You Need to Rebalance

Credit: worradmu at FreeDigitalPhotos.net
Suppose you invested $100,000 on January 1st, 1995. You invested $50,000 in the Barclays U.S. Aggregate Bond Index and $50,000 in the S&P 500 (U.S. stocks). Between January 1st, 1995 and December 31st, 2002, you were in for quite a ride as the Dotcom Bubble expanded and eventually popped. Your bonds would have offered annual returns of 18.46%, 3.64%, 9.64%, 8.70%, -0.82%, 11.63%, 8.43%, and 10.26%. Your stocks would have offered annual returns of 37.58%, 22.96%, 33.36%, 28.58%, 21.04%, -9.11%, -11.89%, and -22.10%. Declining interest rates and the mania surrounding Internet-based companies fueled some really good returns during that period. In fact, if you didn’t touch your $100,000 portfolio at all during that period, I’d estimate you would have had around $206,000 by the end of 2002.

Do you notice how the last three years of S&P 500 returns from 2000 – 2002 were negative as the bubble popped and a recession began? Wouldn’t it have been nice to have liquidated your portfolio on December 31, 1999 and missed the stock market pullback? If you had, your portfolio would have been around $248,000 on December 31, 1999; $42,000 better than it would have been worth three years later!

By now I hope you know me well enough to know I’m not the type to ever advise you going all in or all out of the market. When it comes to market timing like that, I’m just not that smart, and I don’t think anyone else is, either. I believe in calculated tactical adjustments to a portfolio if you see a medium to long-term trend, but I do not believe in ultra-short-term trading and all-in / all-out investing. There's just too much uncertainty!

Some of you that were investing back in the late 1990s and early 2000s may be able to remember how hard it would have been to sell out of your high-flying stock portfolio on December 31, 1999. That was a time (like many times before) where the sky felt like the limit.

Great, Tom. You’ve told me this story about how I would have been better off selling my January 1st, 1995 portfolio on December 31st, 1999 versus holding it until December 31st, 2002, but then you told me no one can know exactly what the future holds and not to invest all-in or all-out. What can I do? You can rebalance.

Rebalancing your portfolio is something you should periodically do to bring your portfolio strategy back in line with your initial investment strategy. Sure, it can be a hassle, it can generate some capital gains taxes, and it can generate some trading fees, but oftentimes, it’s worth it. Hopping back to our 50% bonds and 50% stocks January 1st, 1995 portfolio example, did you know that by December 31st, 1999 your portfolio would have only had 29% bonds and would have swelled to 71% stocks? Would you be happy if the portfolio strategy you agreed to in 1995 drifted that much? I don’t know many investors who would be pleased with a divergence from their investment strategy of that magnitude. That’s why in the spirit of trying to more closely maintain your investment strategy and hedge your bets on the markets continuing to roar upward vs. correct downward, periodically rebalancing your portfolio is the way to go. Excluding taxes and fees, if you would have rebalanced your January 1st, 1995 portfolio at the end of every year back to a 50% bonds and 50% stocks portfolio, your portfolio would have had around $216,000 by then end of 2002; $10,000 better than if you had done nothing at all. Rebalancing your portfolio can generate taxes and transaction costs, but it also, and more importantly, allows you to not drift too far from your investment strategy. Rebalancing is a prudent way to hedge your bets on the market going up or down in the future.

I don’t often trade a portfolio, but when I do, I prefer to rebalance. Does that make me the most interesting wealth advisor in the world?


June 16, 2015

Diversifying Your Life

Credit: pakorn at FreeDigitalPhotos.net
Do you know what I do when I’ve had a crappy day at work? I smile as I drive home.

Do you know what I do when one of my friends rubs me the wrong way? I get together with another one of my buddies.

Do you know what I do when my golf swing starts launching balls further to the right than straight ahead? I pick up my tennis racquet.

Why am I telling you all of this? Because since I’ve been in the financial services industry I’ve noticed a surprising and profound pattern. Diversification is good for your portfolio, and it is also good for you.

Unless you’re luckier than I am, it’s pretty rare for everything to be going well at once. I mean I’ve been very blessed, and compared to many in this world, I have absolutely nothing to complain about, but, even so, there is usually at least one area of my life that could be a little bit better. I think many of you feel the same way. From what I’ve heard from countless friends, family members, and clients, I think it’s pretty common for a spouse to occasionally get under your skin, a friendship to cool off, or a family member to make you seriously consider DNA testing. It’s fairly normal for a boss to act like a “Michael Scott,” a co-worker to make you over-utilize a stress ball, or to occasionally have a bad day at work due to your own actions or lack thereof. There are times when the beach is more fun than the mountains, when you are more excited about learning to play the guitar than your softball league, and when Atlanta Hawks games are more entertaining to you than Atlanta Braves games. None of these occurrences should make or break your life if they are part of your life. What is important is that they are part of your life.

Most investors diversify their portfolios because it reduces the overall risk of their portfolio. Everyday translation: by having your eggs in more than one basket, there’s less of a chance of them all breaking at once. By not being frighteningly obsessed with your job, by having friends outside of your spouse and kids, and by having more hobbies and interests than your weekly poker game with the same foursome, there’s less of a chance that all parts of your life will be going poorly at the same time! If you’re not happy at work, maybe you’re happy at home. If you’re not happy at home, maybe you’re happy at work. If you’re married to your job and are more of a father figure to your subordinates than your own children, and you don’t have a good day at work, what could possibly make you happy at home? If 100% of your friends seem to hang out with you Monday through Friday from about 9:00 – 5:00, who will your friends be when you or they stop working at the same company? If your hobbies are answering work e-mails after work or leaving voicemails at strange hours, what are you going to do when you retire? You know that most companies take your computer and disconnect your phone number when they take your key card, right?

As good as diversification can be for improving an investment portfolio’s risk-adjusted performance, diversification also follows the law of diminishing returns. What I mean is there comes a point after your portfolio is diversified where adding another position or fund in the mix really doesn’t add that much value anymore. To some extent, your investments can become so spread out that you can’t really be in something enough for a gain or loss to significantly move the needle. I think this holds true for life, too. You can be involved in too much. There can come a point where you are spread so thin with your own activities and social obligations that you really can’t take the time to excel in the activity or enjoy the obligation before you have to move on to the next one. Having too many acquaintances can prevent you from having genuine friends. Having too many time-consuming hobbies can hurt your family.

In the investment advisory arena there is a document called an Investment Policy Statement (IPS) that is often drafted between an advisor and a client. In essence, this document provides the general goals and objectives of a client and specifically states ranges of acceptable investment allocation (ex: % allowed in stocks vs. bonds). This allows the advisor to know how much he or she can change the makeup of the portfolio and gives the client the comfort of knowing there are limits to how much the makeup of a portfolio can be changed. Here again, based on my experiences as a normal, everyday person, I think it might be a good idea to apply the IPS mindset to our families, friends, and careers. If you have a busy week ahead at work and you need to rebalance your time to spend more hours at work than usual, that’s fine, but don’t adjust the allocation of work/life balance beyond the amount that is acceptable to your family. If your family is keeping you busy and you need to disappear from your friends for several weeks to do what you have to do, that’s fine, but don’t leave the allocation to your friends below what they expect for too long. If your new stamp collecting hobby has encroached on some of the allocation of your time normally set aside for your wife, that may be fine for a while, but it might not be the best long-term strategic allocation if you know what I mean.

Earlier in this post I said that there was usually at least one area of my life that could be a little better. That’s still true. However, it’s also true that there is usually at least one area or my life that is going pretty well. By diversifying my life, I can focus on what’s going well in the midst of whatever could be a little bit better, and I believe that makes me an overall happier person. On a given day I may not be as happy as an obsessed bird watcher who finally spots some sort of rare finch, but I also won’t ever be quite as sad as a total workaholic whose proposal wasn’t well received. Diversification can help your long term investment returns, but it can also help your return on life!


June 11, 2015

Your Sunny Day Fund

Credit: foto76 at FreeDigitalPhotos.net
One of the terms you have most frequently seen in my 146 (now 147) blog posts since 2012 is “rainy day fund.” It’s an unhappy term, but a necessary pillar of financial security. Cars break, houses fall apart, people get sick, and people lose their jobs. If people don’t have enough money saved up to get them through their unique personal thunderstorms, things don’t usually go so well. You need enough cash to be able to get through dark financial times. It’s as simple as that. I haven’t met many people who disagree with me on that premise, and I can tell you from experience that it usually doesn’t take very long for someone who is serious about financial security to build up a reasonable rainy day fund.

After someone has a rainy day fund, I frequently recommend that they work on saving more and investing more for things like the next car, the second home, and most importantly, retirement. I’ve found that there are some highly motivated, goal-driven people who go after hitting their savings and investing goals with the same vigor with which they built a rainy day fund, but I’ve also observed that a lot of people seem to lose “steam” or momentum. Why is that? I think it may be because saving for future wants and needs requires a little more self-control. It also lacks a catchy name.

So today, I’d like to throw out a happier term that I first heard on the radio as part of an advertisement for a national bank. I’d like to start calling the brokerage accounts, 401(k)s, and IRAs that you are saving into for your future your “sunny day fund.” Doesn’t that have a nice, warm glow to it? Doesn’t it have a better ring than some of the hideous titles bestowed upon employee savings vehicles? I think so!

As I’ve often said, my greatest concern for current workers, and particularly those of my generation and younger, is that the rules of the game are changing. Retirees once had pensions, Social Security benefits, and their savings to get them through the rest of their lives, but today’s workers will have to rely much more heavily, if not entirely, on their savings to get them through the rest of their lives. Sadly, I believe this means the days of being able to save very little and still retire with a reasonable income are numbered.

Saving and investing for your future are critical. It’s more fun to spend now, there’s no question, but I hear it’s also nice not to have to work until the day you die. Working towards that dream car, that vacation home, and those annual family trips by saving and investing now can be fun, too! Maybe it doesn’t feel as fun in a brokerage account, 401(k), IRA, or another type of account, but I really think it can be fun if you tweak your perspective just a little bit and decide that you are saving and investing to accumulate enough assets to propel yourself through the golden years. The bigger your sunny day fund becomes, the brighter your future could be.