You Have to let it Simmer

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One of the questions I get most often is why investment advisors don’t jump in and out of the market. Most recently I was asked “Why don’t investment advisors drastically change their portfolios when something bad has clearly happened?”

The answer you have probably heard, and maybe even from me, is because frequently trading your portfolio begins to cease looking like investing and begins to resemble gambling. How many people do you know that often come back from Vegas with more money than they left with? You don’t jump in and out of the market because to do so effectively you have to correctly time the market twice; you have to have the insight to know when to sell high when most investors will be pouring in money in a euphoria and you have to have the insight to know when to buy low when most investors will be sprinting for the exits in temporary fear. Even if you do somehow manage to time the market correctly, you’ll be burdened with more transaction fees and taxes as a result of your more frequent trading. That’s why most professional investment advisors don’t jump in and out of the market, and as far as jumping in and out of the market after something bad has clearly happened, professional investment advisors don’t do that because the "bad event" has already occurred and some of the market’s biggest gains often come on the heels of something less than ideal.

After 9/11 did you want to be invested? Think back to 2008-2009 right after Lehman Brothers collapsed and the Great Recession began. Did you really want to be invested? What about in 2011 after the credit rating of the United States was downgraded? Did you want to be invested then? At the time of those events, my answer would have been no. When events like that happen in the future, my answer will be no again, but it has to be yes. You have to stay invested.

Check out the link below to visuals from Putnam Investments. I found these incredible statistics as I was researching and working on my correspondence with the individual who most recently inquired about market timing.

https://www.putnam.com/literature/pdf/II508.pdf

Two of the Dow Jones Industrial Average’s biggest days occurred within eleven months of 9/11! Seven of the Dow’s best days since 2001 occurred between October 2008 and March 2009! One of the Dow Jones’ biggest days in the last 15 years occurred within a week of the unprecedented US credit downgrade! If you had invested $10,000 in the Dow at the beginning of 2002 and stayed invested, you would have had around $28,700 by the end of 2016 and have averaged an investment return of around 7.3% per year. If you had jumped in and out of the market and missed those ten best days I just mentioned that were relatively right after 9/11, the Great Recession, and the US credit downgrade just happened, you would have only had around $14,700 by the end of 2016 and averaged an investment return of around 2.6% per year! If, instead of the ten best days, you missed the twenty best days, you would have only had $9,600. You would have lost money over a fifteen year period due to missing twenty days!

I love to cook. One of my specialties is spaghetti with a homemade meat sauce. It’s ground beef slowly cooked with salt, pepper, Worcestershire sauce, and hamburger seasoning. I carefully dry the cooked meat on some paper towels on top of a plate. The meat then joins my pot of tomato sauce and I add in garlic salt, pepper, and Italian seasonings. I then slowly melt in some parmesan cheese to make the sauce richer and a little thicker. Like my mother taught me, I always taste with a clean spoon, but I keep sampling and throwing in a little more of this and that until it’s just about right. Then I put a lid on the pot and let it simmer. It’s only after simmering with an occasional stirring that all the ingredients truly come together and I end up with my desired result. Long-term investing is similar. Add the proper ingredients, tweak a little as needed to taste, and prudently monitor, but you’ll only get your desired result if you let it simmer.

-Tom

Is Your Investment Advisor Doing the Hokey Pokey?

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Over the last few months I have had numerous conversations with people regarding their investment advisor’s dance moves. It seems that over the past year there has been a lot of “dancing” going on in some people’s portfolios. Something along the lines of you put your money in the market, you pull your money out of the market, you put your money in the market and move your investment strategy all about. If that has been your investment advisor’s tune or you self-manage your investments and that’s your typical jam, I have one word for you: stop.

A strategy largely based on putting your money in and out of the market is essentially a market timing strategy, and imperfect timing is a very common cause of poor investment performance. The truth is, no one is smart enough or consistent enough to successfully invest with a money in and money out approach over a long period of time. Sure, you can be lucky and look brilliant over a short period of time, but, even so, the transaction fees and short term capital gains taxes generated by jumping in and out of the market time and time again will also diminish your investment returns.

Most people know they need to have a large portion of their assets invested to have a good shot at hitting their retirement goals and to protect their hard-earned assets against inflation. Investors need an overall investment strategy that is historically appropriate for their age and stage in life, withdrawal needs, and risk tolerance. Beyond that, it’s my professional opinion that relatively small tactical adjustments are appropriate when there are specific opportunities or risks in the market or world that you’re trying to navigate, but drastic investment strategy changes should be the exception - not the rule. Sometimes taking action and making a lot of changes in your portfolio can feel good, but “surgery by chainsaw” rarely works out best. Instead, considering things like the amount of U.S. versus international stocks, large cap versus small cap stocks, growth versus value stocks, corporate versus municipal bonds, and long-term versus short-term bonds can be a good idea. 

Consider this year for example. Who knew 2016 would get off to one of the worst starts for a calendar year in market history? What if you’d completely jumped out of the market in February because you thought it was the beginning of the next cyclical pullback and you missed the bounce back of March, April, and May and endured transaction fees and realized capital gains? How many people actually thought Great Britain would vote to leave the European Union? What if you’d completely jumped out of the market in June due to the surprise result, media barrage, and overreaction of other investors and you missed the swift recovery and positive market performance since then?

When investing you shouldn’t make too many one-way, all-in bets. You should view investing as a mechanism to give you a high probability of achieving your financial and life goals. Investing is a marathon, not a sprint. It’s not sexy and it’s not news, but I do firmly believe investing in a prudently diversified portfolio with a long-term outlook really does give you the best chance to accumulate and preserve wealth.

After all, isn’t that what it’s all about?

-Tom

Normal Investors – Overconfidence

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There I was at the starting line of the famous Peachtree Road Race. I was finally old enough to be a part of the 4th of July tradition I’d watched my dad do every year of my life. I was stoked. I was a soccer player and I ran after the ball for a full hour without stopping every Tuesday, Thursday, and Saturday, so this so called “10-k” was going to be a piece of cake! When our wave started, I took off. My dad stayed with me for the first bit and then he started telling me we needed to slow down to save some of our energy for the finish. What did he know? Besides, a few runners were actually passing us! I think that first mile may have been my only career eight minute mile, but boy, by the fifth mile of the race, twelve-year-old Tom knew his dad was right.

I like to think I was a pretty cool guy in high school. In some ways I was. In some ways I was probably not. Being an avid ultimate Frisbee player with some of my band buddies was probably not my coolest hour, but we sure did have fun. We were good, too. So good that word travelled and some friends on the cross country team challenged us to a game one Saturday. Cross country whatever! I was in great shape! For a solid week my band friends and I went over and over how bad we were going to destroy our cross country friends. I think that was the last day I enjoyed running…

Of course there was that accounting test my junior year in college. I was tired. I wanted to do something other than study. Besides, I had things under control. I usually did well on tests. My scholarly roommate and fellow accounting major urged me to go over that small little bit the professor glossed over about a couple of terrible things called deferred tax assets and deferred tax liabilities. I actually remember saying, “If he asks me about that on the exam, he can have it!” I cannot tell you how much I ate those words. Literally, my roommate waited for me to look up and make eye contact across the room so he could give me that told you so look. Yes, yes he did.

I like to think I’m a pretty self-effacing guy, but from time to time in my life, I’ve been overconfident. Most of the times when I’ve been overconfident, it hasn’t worked out too well. Most of the time when investors are overconfident, it doesn’t work out too well, either. Humble pie doesn’t taste so good!

What? You don’t think you’re ever overconfident? Well let’s see about that. Do you consider yourself an above-average driver? You might be, you might not be, but studies suggest as many as 95% of people think they are above-average drivers, and that’s just impossible. Statistically, 50% have to be above-average drivers and 50% have to be below-average drivers. In the Atlanta metro area, I dare say a lot of people are the latter! Either way, overconfidence is the fourth tendency that I would suggest many normal investors have.

I think overconfidence is a pretty natural thing. I think that people tend to value their own judgments and opinions over those of others, even if other people are “experts.” Think home projects, grilling, sports, parenting, politics, etc. In the investment management world I believe this is why many investors have a little trouble letting someone else professionally manage their portfolio. They value their own judgments and opinions, they want to be in control, and they want to see action in their portfolios. This leads to many "do-it-yourselfers" trading more in their portfolios than I would typically recommend, and that usually means more trading fees and expenses, more taxes, and a lower investment return over the long-term. Consider this chart presented by Saturna Capital that assumes a 7% annual return for ten years and a 23.8% tax rate:

Lower turnover (aka less trading) typically means higher portfolio values. Be an investor, not a trader!

Finally, I wanted to share an interesting study that I came upon done in 2001 by the Quarterly Journal of Economics. They studied portfolio turnover and the investments of male and female households and they found that single men trade the most, married men trade second most, married women trade the third most, and single women trade the least. Guys, based on what we learned from the chart above, I think that means the women are right again!

If you enjoy investing and you like the rush of trading, I encourage you to carve away a small portion of your assets and make it a hobby. It’s one thing to open a box with a zillion pieces, not completely read the instructions, watch a video online, and tell your wife you’ve got it under control - maybe you do, maybe you don’t. It’s another to be overconfident when it comes to your family’s nest egg!

-Tom

Next up: status quo

Questions You Should Be Asking Your Financial Advisor

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A friend of mine posed an interesting question to me the other day. His parents are beginning to think about retiring in the next few years, and they didn’t leave their recent meeting with their financial advisor feeling overly confident that they were in good hands, so he asked me what questions they should be asking. I may get tarred and feathered by others in my line of work for sharing this, but today I offer you some of the questions I think you should be asking your current or prospective financial advisor.

• Do you feel my investments are appropriate (particularly if it has been a while since you met or your investment accounts were rebalanced/reallocated)? If the response you get is only a “Yes,” you should follow up with “Why?” I really think that having a general understanding of why you are invested the way you are is important. It gives you confidence through the market's ups and downs, and it ensures that your advisor’s strategy is in line with your goals and your objectives.
• What fees have I paid you? An advisor may not be able to rattle this off on the spot, but if they can’t get you a clear answer pretty quickly, this may be a red flag. Contrary to how some practice in the industry, fees and expenses don’t have to be hidden. It also doesn’t hurt to ask an advisor how they get paid based on the investments they recommend. If you hear the word “commission,” you need to at least consider the possibility that your advisor could have a conflict of interest.
• What licenses and credentials do you hold? There is so much alphabet soup out there that I don’t even know what some of the acronyms stand for! That being said, some licenses and credentials are impressive and should be confidence-inspiring, but some, not so much. You’re looking for things like CFP®, CFA®, and CIMA® from an investment advisor in addition to advanced degrees from respected business schools.
• How can I access my funds and my information? In today’s world, you should have the ability to view your account any time and withdraw money within a few days. If you don’t, you may want to see if your advisor has booked a one-way trip to the Caribbean…
• Who is your typical client? What’s good for one type of client is often good for another, but not always. If your advisor is used to working with people with backgrounds, needs, and amounts of money drastically different than your profile, you may want to find an advisor better suited to work with you. You want to be your advisor’s "bread and butter" and a client that is right in their wheelhouse!

 

I’ve been asked lots of crazy questions from clients including why I couldn’t guarantee an 8% return every year, why a particular beverage wasn’t for sale in their local grocery store, and if I was dating anyone (because their granddaughter liked blondes), so my proposed questions should be softballs for your current advisor. If your advisor's answers leave a lot to be desired, I’d suggest you ask these very same questions when you are interviewing candidates to be your new advisor.

 

-Tom