tag:blogger.com,1999:blog-87548044952922345382024-02-20T13:18:56.361-07:00Retire ReadyLon Jefferies, a Certified Financial Planner™ (CFP), is a fee-only financial advisor and trusted fiduciary at Net Worth Advisory Group in Salt Lake City, Utah. He is dedicated to providing comprehensive financial planning and investment management on a fee-only basis.Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.comBlogger329125tag:blogger.com,1999:blog-8754804495292234538.post-56464576545638313382015-11-23T11:57:00.000-07:002015-11-30T14:01:08.584-07:00Deception in the Financial Service IndustryTo be blunt, there is deception all around us. The primary presidential elections are a perfect example – whether it is Republicans debating with Republicans, Democrats questioning other Democrats, or Republicans and Democrats fighting each other, there is so many half-facts and conflicting information that it is impossible for everything said to be true.<br />
<br />
There is an equal amount of deception in the financial service industry. Whether you are watching CNBC, reading Forbes Magazine, or listening to a local salesperson promote his financial product, it is hard to believe we are ever getting the complete story from an unbiased perspective regarding any personal finance issue.<br />
<br />
Deception is frequently used to strengthen one’s agenda. An agenda can be supported by drawing attention to specific facts, or reinforced by drawing attention away from less desirable facts.<br />
<br />
<b>Hiding Good News in Deceit </b><br />
<br />
The reality is there are always some parties that don’t want us to know the good news happening around us. For example, financial television mediums are dependent on constant viewers in order for their business plan to succeed. Frankly, they can’t go on the air and tell viewers that there is nothing to worry about and that their time would be better spent outside on a bike or with friends and family. Instead, they must consistently remind viewers of all possible downsides to insert a fear that at any moment something could happen that would restrict our ability to meet our financial goals. This is an example of utilizing deceit to take attention away from the good news that is more reflective of our environment.<br />
<br />
Another example of using excessive information to conceal good news is the emergence of ultra-responsive investment strategies. Study after study has concluded that the best way to make money investing in the market is to buy and hold long-term positions. That is great news because it is fairly simple and can potentially be accomplished by anyone (at least in principle). However, this great news is frequently concealed by investment institutions who offer a responsive solution to every possible market scenario. Even though research suggests that an investor is better off not reacting to variables impacting the daily market, some financial institutions still promote such a strategy so they can charge higher fees due to a more frequent level of involvement.<br />
<b><br />Hiding Bad News in Deceit</b><br />
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In some situations, some parties may hide the bad news within their agenda amongst an abundance of less relevant information. As you might have noticed, most annuities are overly complex and not easily understood. The contracts accompanying these products are commonly the size of a book and written in such a manner that even the most experienced financial planners have a hard time comprehending. Meanwhile, the excessive fees and outlandish surrender periods of these products are something that are frequently not discussed by the advisor promoting the product. This is an example of using BS to make something overly complicated to conceal their negative features.<br />
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A second example of burying bad news in deceit is the way non-publicly traded REITs (real estate investment trusts) are sold. As millions of investors have learned over the last 20 years, non-publicly traded REITs are not a liquid investment, and if an investor wants to quickly sell their holding they frequently need to do so at a steep discount (commonly less than 50% of the purchase price). Clearly, this is bad news. However, the financial salespeople offering these investments claim that not listing the product on a public exchange enables the product to endure less volatility because investors can never get online and see their investment’s value go down. Of course, just because investors can’t see the daily fluctuations in their investment’s value doesn’t mean that the price of the investment will be stable when the investor wants to sell, and most owners of non-publicly traded REITs ultimately eat their shirts.<br />
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<b>The Best Solution Available</b><br />
<br />
In all aspects of life, it is useful to question one’s agenda and examine the use of deception to achieve that agenda. This is as true in the financial service industry as it is anywhere else. Simply looking for scenarios where the use of excessive or non-relevant information might be used to conceal facts that are either good or bad for you is likely to sharpen your decision making skills.<br />
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Further, I’d suggest that working with a fee-only financial advisor is likely to minimize situations where someone else’s agenda might conflict with what is in your best interest. Fee-only financial planners are restricted from recommending financial products that reward them for doing so. Further, fee-only financial planners are held to a fiduciary standard, which means they are required by law to make recommendations that are in your best interest. These two factors are likely to limit the amount of deceit you’ll need to sort through.Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com28tag:blogger.com,1999:blog-8754804495292234538.post-39291594000808294432015-11-11T12:48:00.000-07:002015-11-11T12:48:05.715-07:00Why Constantly Updating Retirement Projections is VitalNew retirement projections should consistently be created to reflect changing circumstances. While short-term fluctuations in retirement plan outcomes should be anticipated and not cause an over-reaction, long-term implications should receive attention and be addressed.<br />
<br /><b>Base Scenario</b><br />
<br />Consider a 65-year old retiree who would like to withdraw the inflation-adjusted equivalent of $20,000 of after-tax dollars per year from his investment account until age 90. This individual’s nest egg consists of a $500,000 IRA, and his financial plan estimates an average annual investment return of 6%, an effective tax rate of 18%, and an inflation rate of 3%. According to these assumptions, the individual’s financial plan indicates a high probability of success. A Monte Carlo analysis, which accounts for varying sequences of returns (because a flat 6% return isn’t achieved every year but rather achieved on average over time), calculates a success rate of 85%.<br />
<br /><b>Impact of the 2000’s</b><br />
<br />Now, consider this same individual with one adjustment – that it is the year 2000 and we are about to enter what is now looked at as the “Lost Decade.” During the next 10 years, the S&P 500 averaged an annual return of less than 1%. Let’s assume the investor had a diversified portfolio, which would have generated superior returns to a 100% large cap stock portfolio, and achieved an average annual return of 2% during the decade. Of course, the individual would have still been withdrawing the inflation-adjusted equivalent of $20,000 of after-tax dollars per year during this time period.<br />
<br />At the end of the decade and when the investor is 75 years of age, his nest egg would have been depleted to $301,784. By contrast, if the investor had achieved the anticipated annual return of 6%, his nest egg actually would have increased in value over this time period, ending the decade at a value of $521,185. Unfortunately, the unexpected lower rate of return has severally reduced the success rate of the individual’s retirement plan to an unacceptable 39%.<br />
<br />Note that in this situation, the investor didn’t do anything wrong. With the benefit of retrospect, we can see that an extended period of essentially no growth in the stock market was unavoidable. This illustrates the importance of paying more attention to variables that we can impact (such as spending) and less attention to factors that are out of our control (such as short-term market returns).<br />
<br /><b>Benefit of Plan Updates</b><br />
<br />Without adjustments, this individual now has a high probability of outliving his money – the ultimate failure of retirement planning. For this reason, updates need to be made to the individual’s financial plan so these issues can be identified and addressed. An analysis of the investor’s new circumstance at age 75 can discover that if annual portfolio withdrawals are reduced to an inflation-adjusted equivalent of $17,700 of after-tax dollars, the financial plan’s success rate bounces back up to 85%. While spending less than the investor’s goal is not ideal, it is certainly better than running out of money.<br />
<br />It is also worth noting that the 6% long-term investment return anticipated by the investor’s financial plan at age 65 may still very well come to fruition, even after enduring a 10-year period with such a low growth rate. Just as it was possible for returns to be unusually low for the “Lost Decade,” it is equally possible that returns will be above average for an extended period of time in the future. In fact, this scenario has actually played out as the S&P 500 is already up over 100% since 2010. Consequently, it is possible that our hypothetical investor would have only needed to reduce spending for a short period of time and that the quick market recovery would have enabled him to return to his previous withdrawal goals relatively quickly. Of course, frequently retirement plan updates would identify when the individual would be able to return to his more comfortable level of spending.<br />
<br /><b>Frequent Updates are Preferable</b><br />
<br />Lastly, it is important to note that even a quick market recovery can’t save an investment plan if there is no money left in the portfolio to experience the bounce. For this reason, it would be better if our hypothetical investor actually reduced spending during the period of slow market growth as opposed to after the extended period of lackluster returns. This is exactly why I’d recommend updating your financial plan at least annually – so issues can be identified quickly and adjustments can be made efficiently and when they have the most impact.<br />
<br />Unanticipated factors that affect retirement planning occur frequently. These variables range from market declines, to higher inflation rates, to changes in the tax structure, to surprise healthcare expenses, to <a href="http://www.utahfinancialadvisor.blogspot.com/2015/11/major-changes-to-social-security-filing.html" target="_blank">new rules involving Social Security</a>. Frequently updating your financial plan will help identify some of these issues – which are frequently out of our control – and allow us to address shortcomings by focusing on factors that we can adjust.Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com8tag:blogger.com,1999:blog-8754804495292234538.post-465160694701158312015-11-02T10:45:00.002-07:002015-11-03T11:06:16.131-07:00Major Changes to Social Security Filing Strategies (Updated!)After the market crash of 2000, Congress passed the Senior Citizens
Freedom to Work Act. This law was intended to enable people who had
previously retired and claimed their Social Security benefit to stop
receiving their monthly check while they returned to work and continued
earning retirement credits. Doing so would enable the worker to earn
more income from employment while increasing their future Social
Security benefit.<br />
<br />
An unintended consequence of this adjustment was
that it enabled U.S. citizens to explore and take advantage of various
strategies to maximize their Social Security benefits that were outside
the intentions of the law. These strategies became known as the “file
and suspend” strategy and the “restricted application” strategy. This
morning President Obama and Congress passed the Bipartisan Budget Act of
2015, which is intended to prohibit people from utilizing these
strategies going forward.<br />
<br />
Let’s dive into the differences between
the “file and suspend” and the “restricted application” strategies as
well as the steps you may need to take if currently utilizing one of
these strategies.<br />
<br />
<b>File and Suspend</b><br />
<br />
The file
and suspend strategy is when Spouse 1 files for Social Security and
then immediately suspends the benefit. This can be beneficial because it
could possibly enable Spouse 2 to begin collecting a spousal benefit
based on Spouse 1’s work history. Further, it would enable Spouse 1 to
collect delayed retirement credits until age 70, getting an 8% per year
raise in monthly Social Security payments.<br />
<br />
The U.S. government has
concluded that this strategy is abusive of the Social Security system
in that it is essentially double dipping, as it allows a couple to begin
collecting a benefit based on one spouse’s work history while at the
same time collecting delayed retirement credits on the same work
history.<br />
<br />
At this time, it appears this strategy will no longer be
allowed after April 30, 2016 -- six months from the signing of the law.
However, couples who have begun this strategy within the six-month
deadline will be allowed to complete the process. By comparison, after April 30, 2016, couples will no longer be allowed to start collecting a
spousal benefit for Spouse 2 unless Spouse 1 is also collecting a
benefit.<br />
<br />
<b>Steps to Take If This is You</b><br />
<br />
Suppose
your spouse is currently collecting a spousal benefit based on your
work history, although you are not currently collecting your own Social
Security benefit. This would be a scenario resulting from the use of the
file and suspend strategy.<br />
<br />
If this is reflective of your current
situation, you will likely be grandfathered into the program and be
allowed to complete the process. Alternatively, if this situation is
representative of the Social Security strategy you intend to utilize in
the future, you will no longer be allowed to execute this approach
unless you start the process by April 30, 2016. Since you must be at
least full retirement age to suspend benefits, this option is only
available to people who will reach age 66 on or before April 30, 2016. If
age 66 is obtained after April 30, 2016, you will either need to start
claiming your own benefit in order for your spouse to receive their
spousal benefit, or your spouse will not be allowed to collect a spousal
benefit until you file to receive your own benefit.<br />
<br />
On the other
hand, some people who intend to take advantage of the “file and suspend”
approach can actually accelerate their implementation of the strategy
in order to begin the process before the six-month deadline arrives.<br />
<br />
<b>Restricted Application</b><br />
<br />
The
restricted application strategy is slightly different from the file and
suspend strategy in that Spouse 1 files for his own benefits and never
stops collecting that benefit. However, this may allow Spouse 2 the
opportunity to begin collecting a spousal benefit immediately while
delaying her own benefit until she reaches age 70. Again, this can be
beneficial in that it allows Spouse 2 to collect one form of Social
Security (the spousal benefit) as soon as Spouse 1 files but also allows
the same spouse to continue collecting delayed retirement credits on
her own work history. Upon reaching age 70, Spouse 2 can then switch
from collecting the spousal benefit, which was based on Spouse 1’s work
history, to collecting their own Social Security benefit which has been
building delayed retirement credits even during the years when a spousal
benefit was being collected.<br />
<br />
Again, with a file and suspend
strategy, Spouse 2 is collecting a spousal benefit even though Spouse 1
immediately suspended his benefit and is currently collecting delayed
retirement credits. With the restricted application strategy, Spouse 1
never needs to suspend the collection of his own benefit and Spouse 2
still gets to collect a spousal benefit while earning delayed retirement
credits on her own work history. Going forward, the U.S. government
would like to ensure that each spouse is either collecting a benefit
(either their own or a spousal benefit) <b>or</b> earning delaying retirement credits, <b>but not both</b>.<br />
<br />
However,
the restricted application strategy is being phased out over a
different time span than the file and suspend strategy. Quite simply, as
long as an individual reaches ages 62 before the end of 2015, they will
be allowed to utilize the restricted application strategy at any point
in the future. Conversely, people who will not reach age 62 before the
end of the year will have no opportunity to take advantage of the
restricted application strategy.<br />
<br />
<b>Steps to Take If This is You</b><br />
<br />
As
long as both spouses are at least age 62 before the year ends, then
your strategy will likely not be interrupted. However, if one spouse
isn’t age 62 before year-end, then your strategy will likely need to be
reconsidered.<br />
<br />
<b>Speak to Your Financial Planner</b><br />
<br />
If
you have any questions regarding how these changes will impact your
Social Security benefit, please speak to your financial advisor.<br />
<br />
During
every financial plan review over the next six months, I will be
examining your situation and determining whether these changes affect
you. If this law impacts you, I will be exploring any adjustments that
need to be made. In the meantime, please don’t hesitate to reach out to
me if you have any questions.Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com6tag:blogger.com,1999:blog-8754804495292234538.post-85754297711571123012015-10-30T10:04:00.001-06:002015-10-30T10:04:55.934-06:00Breaking News: Major Changes Coming to Social Security Filing StrategiesAfter the market crash of 2000, Congress passed the Senior Citizens Freedom to Work Act. This law was intended to enable people who had previously retired and claimed their Social Security benefit to stop receiving their monthly check while they returned to work and continued earning retirement credits. Doing so would enable the worker to earn more income while increasing their future Social Security benefit.<br />
<br />An unintended consequence of this adjustment was that it enabled U.S. citizens to explore and take advantage of various strategies to maximize their Social Security benefits that were outside the intentions of the law. These strategies became known as the “file and suspend” strategy, and the “restricted application” strategy.<br />
<br />
As part of the 2016 budget, President Obama and Congress intend to prohibit people from utilizing these strategies going forward. At the time of this publication, these proposed changes are not yet law. Although both the House of Representatives and the executive branch have signed off on these bills, they still need to be approved by the Senate before the laws go into effect. However, this is expected to occur with minimal modifications within the first week of November.<br />
<br />Let’s dive into the differences between the “file and suspend” and the “restricted application” strategies as well as the steps you may need to take if currently utilizing one of these strategies. <br /><br /><b>File and Suspend</b><br />
<b> </b><br />The file and suspend strategy is when Spouse 1 files for Social Security and then immediately suspends the benefit. This can be beneficial because it could possibly enable the individual’s spouse to begin collecting a spousal benefit based on Spouse 1’s work history. Further, it would enable Spouse 1 to collect delayed retirement credits until age 70, getting an 8% per year raise in monthly Social Security payments.<br />
<br />The U.S. government has concluded that this strategy is abusive of the Social Security system in that it is essentially double dipping as it allows a couple to begin collecting a benefit based on one spouse’s work history while at the same time collecting delayed retirement credits on the same work history.<br />
<br />At this time, it appears that this strategy will no longer be allowed beginning six-months from the date the law is passed. Further, it is currently unclear what action will be taken against those who have already utilized this strategy. It currently appears possible that couples who have already started this strategy will be allowed to complete the process. Alternatively, it is possible that couples who have started this process will no longer be entitled to the spousal benefit they are currently receiving until Spouse 1 begins claiming his Social Security benefit, at which time the spousal benefit for Spouse 2 would continue. In a worse-case scenario, it is possible that the U.S. government may attempt to recollect any benefits that are no longer allowed from couples who have already taken advantage of this strategy. (I believe this is the least likely result, as it would be hard to take money away from people who have already collected it.)<br />
<br /><b>Steps to Take If This is You</b><br />
<br />Suppose your spouse is currently collecting a spousal benefit based on your work history, although you are not currently collecting your own Social Security benefit. This would be a scenario resulting from the use of the file and suspend strategy.<br />
<br />If this is reflective of your situation, then significant adjustments might need to be made as this law becomes more concrete. It is possible that you will either need to start claiming your own benefit in order for your spouse to continue receiving their spousal benefit, or your spouse will need to stop collecting any benefit until you file to receive your own benefit. Again, these kind of adjustments will likely be implemented six months after the bill is finalized.<br />
<br />Alternatively, and depending on how the law is agreed upon, it is possible that some people who intend to take advantage of the “file and suspend” approach actually accelerate their implementation of the strategy in order to begin the process before the six-month deadline arrives.<br />
<br /><b>Restricted Application</b><br />
<br />The restricted application strategy is slightly different from the file and suspend strategy in that Spouse 1 files for his own benefits and never stops collecting that benefit. However, this may still be beneficial in that it allows Spouse 2 the opportunity to begin collecting a spousal benefit immediately while delaying her own benefit until she reaches age 70. Again, this can be beneficial in that it allows Spouse 2 to collect one form of Social Security (the spousal benefit) as soon as Spouse 1 files but also allows the same spouse to continue collecting delayed retirement credits on her own work history. Upon reaching age 70, Spouse 2 can then switch from collecting the spousal benefit, which was based on Spouse 1’s work history, to collecting their own Social Security benefit which has been building delayed retirement credits even during the years when a spousal benefit was being collected.<br />
<br />Again, with a file and suspend strategy, Spouse 2 is collecting a spousal benefit even though Spouse 1 immediately suspended his benefit and is currently collecting delayed retirement credits. With the restricted application strategy, Spouse 1 never needs to suspend the collection of his own benefit and Spouse 2 still gets to collect a spousal benefit while earning delayed retirement credits on her own work history. Going forward, the U.S. government would like to ensure that each spouse is either collecting a benefit (either their own or a spousal benefit) <i>or</i> earning delaying retirement credits, <i>but not both.</i><br />
<br />However, the restricted application strategy is being phased out over a different time span than the file and suspend strategy. Quite simply, as long as an individual reaches ages 62 before the end of 2015, they will be allowed to utilize the restricted application strategy. Conversely, people who will not reach age 62 before the end of the year will have no opportunity to take advantage of the restricted application strategy.<br />
<br /><b>Steps to Take If This is You</b><br />
<b> </b><br />As long as both spouses are at least age 62 before the year ends, then your strategy will likely not be interrupted. However, if one spouse isn’t age 62 before year-end, then your strategy will likely need to be reconsidered.<br />
<br /><b>Speak to Your Financial Planner</b><br />
<b> </b><br />If you have any questions regarding how these changes will impact your Social Security benefit, please speak to your financial advisor.<br />
<br />During every financial plan review over the next six months, I will be examining your situation and determining whether these changes affect you and exploring any adjustments that need to be made. In the meantime, please don’t hesitate to reach out to me if you have any questions.Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com4tag:blogger.com,1999:blog-8754804495292234538.post-82687716473433294882015-10-27T15:44:00.000-06:002015-10-27T15:44:21.085-06:00Who Are the Best Predictors of Stock Market Performance?Every day CNBC airs dozens of “financial professionals” making market forecasts. Similarly, every financial publication has multiple pieces regarding the future of the stock market. With so much information, how is it possible to determine who is worth listening to and what information to incorporate into your investment strategy?<br />
<br />
Without dropping any names, I’d suggest that the more confident a market pundit is about his or her prediction, the more you should question their advice.<br />
<br />
People who make strong, unwavering forecasts are interesting to watch and appear as intelligent, appealing leaders whose advice is worth following. Meanwhile, people who frequently say phrases such as “it depends,” “maybe,” or even “I don’t know” don’t seem to be adding much value and don’t appear to be any more knowledgeable than the average investor. Yet, I’d suggest you tune out the stanch forecaster pounding his fist on the table as he speaks and rather listen closely to the individual who is less willing to make firm predictions.<br />
<br />
Stock market performance is clearly not a result of any singular factor such as whether or not companies will generate more profits than expected. If this was the case, making market predictions would be easy – one could simply guess the answer to be yes or no and have a 50% chance of being correct. Rather, hitting profit targets is only point A on a long list of factors impacting stock market performance.<br />
<br />
Point B may be whether or not the Federal Reserve will raise interest rates during their next meeting. Again, our market forecaster could guess yes or no to this question and have a 50% chance of being correct. However, when considering both factors A and B, now our market forecaster has to be right twice on two issues where there is only a 50% probability of being correct on each. Simple math tells us there is only a 25% chance that this will occur (50% x 50% = 25%).<br />
<br />
Point C may be whether the republicans or the democrats win the 2016 election. Again, there is a 50% chance of either possibility. Now there are three factors in play, each with a 50% probability, so the probability that the market pundit will get all three factors correct is 12.5% (50% x 50% x 50% = 12.5%).<br />
<br />
Point D may be whether the US dollars strengthens or weakens when compared to other currencies. Again, there is a 50% chance of getting this right, so when we consider all four factors, there is now a 6.25% chance of getting it right (50% x 50% x 50% x 50% = 6.25%).<br />
<br />
There are hundreds of factors that go into this equation. Will Greece have another economic crisis? Will the price of oil go up or down? Will a war breakout with Russia? This is exactly why forecasting market performance is so difficult!<br />
<br />
For this reason, the people who make the best forecasters are people who say phrases such as “perhaps,” “however,” and “on the other hand” a lot. Doing so illustrates that the individual has looked at the situation from a lot of different perspectives and realizes that everything may not go according to plan. These types of people also tend to admit when they are wrong more willingly and update their analysis utilizing the latest information available, even if the new information doesn’t reflect what they previously anticipated. Their thought process is likely: “I got point A wrong, so I need to adjust my thinking on point B, which will have an impact on point C, so how does this change my perspective on point D.” We’ll call this a point-A-to-point-B-to-point-C-to-point-D mentality.<br />
<br />
By comparison, the forecaster who makes the strong prediction while staring into the camera likely utilizes more of a point-A-to-point-D mentality. They are less likely to admit that there are more factors affecting market performance than can be managed, and less likely to incorporate new information that doesn’t coincide with his previous prediction when making forward-looking forecasts. Their thought process is likely: “I may have gotten point A wrong, but that doesn’t matter. All that matters is point D and I believe I got that right when making my prediction.” This approach is obviously less logic-based than the approach taken by the forecaster who knows there are too many factors to enable an individual to make a confident prediction.<br />
<br />
While people who make confident predictions regarding market performance are entertaining to watch and provide advice that is simple to follow (he said buy, so I’ll buy), their advice is not likely to be any more accurate than other market pundits. In fact, if they are unwilling to admit when they get any potential factor concerning market performance wrong, their advice may be more damaging then useful. By comparison, market forecasters who utilize phrases such as “however,” “it is hard to say,” and “I’m not sure” provide advice that may come off as unhelpful or impossible to follow, but it is these people who provide logic-based nuggets of information that are likely to benefit your investment portfolio.Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com1tag:blogger.com,1999:blog-8754804495292234538.post-9774752199456340512015-09-21T15:45:00.000-06:002015-09-21T15:45:44.692-06:00Rethinking Diversification<!--[if !mso]>
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As a financial planner, one of my favorite words is
“diversification.” Diversifying a portfolio essentially ensures that we don’t
have all of our investment eggs in the same basket. A properly diversified
portfolio should experience fewer losses than a non-diversified portfolio as
well as benefit from a reduced downside when the market decreases in value. I
have a chart that I draw for clients in steps that help me illustrate the
purpose and benefits of diversification.</div>
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Step one of the chart is to communicate that given enough
time, the market has always produced positive returns. (The phrase “enough
time” is subjective and fluctuates, but the fact that the market is worth more
now than when you were born proves the point.)<span style="mso-spacerun: yes;">
</span>Thus, given enough time, the market will eventually move from point A to
point B:</div>
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Unfortunately, as we all know, the market doesn’t increase
in value at a constant pace. Rather, given enough time, it ebbs and flows while
moving in an upward manner:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgkFAHpBqg5LPwMmUn9nHfuSqZ_8LPgsOF1jXfdzosVsFq514pJiERoenMji7df9pdAjw__n6tjEIb814wyVO5Q1iUw8fesqrhgHQ9YjT2_QogxIQ5dF3cUTtABTViqfG9VK_xb9aXNIaGv/s1600/Investment+One+Return.JPG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="300" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgkFAHpBqg5LPwMmUn9nHfuSqZ_8LPgsOF1jXfdzosVsFq514pJiERoenMji7df9pdAjw__n6tjEIb814wyVO5Q1iUw8fesqrhgHQ9YjT2_QogxIQ5dF3cUTtABTViqfG9VK_xb9aXNIaGv/s400/Investment+One+Return.JPG" width="400" /></a></div>
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<br /></div>
<div align="center" class="MsoNormal" style="text-align: center;">
<span style="mso-no-proof: yes;"></span></div>
<div class="MsoNormal">
Armed with this information, what two investments would make
up the most consistently performing portfolio? Two assets that ebbed and flowed
in a perfectly opposite manner while they ultimately trend upward:</div>
<div class="MsoNormal">
<br /></div>
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBmtqau-Xju3l1h1I07f6PxlZ4nakkvH62uW1QTisoAEWWlfgqsc9dzuQpbjtv52_e3GJ2VvWY3oO7CbNUoQV2u0QGlcyGdPV27tX0EHr5cZRAFXzKxVeSJZvv6l6XYrRr5oanbUfuKVfL/s1600/Two+Investment+Return.JPG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="300" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBmtqau-Xju3l1h1I07f6PxlZ4nakkvH62uW1QTisoAEWWlfgqsc9dzuQpbjtv52_e3GJ2VvWY3oO7CbNUoQV2u0QGlcyGdPV27tX0EHr5cZRAFXzKxVeSJZvv6l6XYrRr5oanbUfuKVfL/s400/Two+Investment+Return.JPG" width="400" /></a></div>
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<br /></div>
<div align="center" class="MsoNormal" style="text-align: center;">
<span style="mso-no-proof: yes;"></span></div>
<div class="MsoNormal">
A portfolio of only these two perfectly inversely correlated
assets would lead to an incredibly stable and predictable rate of return with
virtually no volatility:</div>
<div class="MsoNormal">
<br /></div>
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgm4UTcSZStT3fLyO2yf33HE7GdKwboVL27Afs2dWK7fSNJsChelkqSs4OQF8rPQwl87E9GiaU_Xv9cS3zygP4-XUpfe9RLloSrz2UhL81Dbdfqucks-tPGW4qd__6MdgUKnTuj1ZA8wjlZ/s1600/Diversified+Portfolio+Return.JPG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="300" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgm4UTcSZStT3fLyO2yf33HE7GdKwboVL27Afs2dWK7fSNJsChelkqSs4OQF8rPQwl87E9GiaU_Xv9cS3zygP4-XUpfe9RLloSrz2UhL81Dbdfqucks-tPGW4qd__6MdgUKnTuj1ZA8wjlZ/s400/Diversified+Portfolio+Return.JPG" width="400" /></a></div>
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<br /></div>
<div align="center" class="MsoNormal" style="text-align: center;">
<span style="mso-no-proof: yes;"></span></div>
<div class="MsoNormal">
Unfortunately, these exact investments don’t exist. However,
certain asset categories sometimes (not always!) exhibit this characteristic.
For instance, when stocks experience a decline, bonds often benefit as
investors sell their equities while their prices are low and buy bonds in what
is called a flight to quality. The increased demand for bonds causes the price
of the asset to also increase. Thus, an investor who had half his money invested
in stocks and half in bonds would likely experience a decrease in the value of
the stock portion of his portfolio but an increase in the value of his bond
holdings. This would lead to a less dramatic loss when stocks go through a
rough patch. Similar relationships can also exist between other asset classes:</div>
<div class="MsoNormal">
<br /></div>
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqtVLVoH_A_aNNvHHZXnGB7UYzn7oXaYtALFhKc2IcX0IL_JuC92QHP5xuh9ua3pxzDUKXZwJMW6FOM6Hsn70hrLJXBik9jT5TWZgPYAgMhCog8Af5UCQ80gSbDm7UpK830EmTHYxwsfiq/s1600/Inverse+Asset+Categories.JPG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="300" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqtVLVoH_A_aNNvHHZXnGB7UYzn7oXaYtALFhKc2IcX0IL_JuC92QHP5xuh9ua3pxzDUKXZwJMW6FOM6Hsn70hrLJXBik9jT5TWZgPYAgMhCog8Af5UCQ80gSbDm7UpK830EmTHYxwsfiq/s400/Inverse+Asset+Categories.JPG" width="400" /></a></div>
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<br /></div>
<div align="center" class="MsoNormal" style="text-align: center;">
<span style="mso-no-proof: yes;"></span></div>
<div class="MsoNormal">
Obviously, the more inverse relationships that exist within
a portfolio, the less volatility it is likely to experience. This is the true
value of diversification.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
However, there is a factor that we must return to – that the
market and a diversified portfolio only make money when given sufficient time.
What happens to a diversified portfolio over shorter periods of time? Does
diversification still add value?</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
One of the implied assumptions in the charts above is that the
better performing asset makes more than the worst performing asset loses during
any given cycle. For instance, the best performing asset might make +15% while
the worst performing category might lose -5%. If this was the case, the
portfolio would average a +5% overall return. If this wasn’t the case and the
best category returned +10% while the worst asset lost -10%, the portfolio’s
performance as a whole would be flat (a return of 0%). Fortunately, investments
tend to both make money more frequently than lose money and also make more during
the years when they achieve a positive return then they lose during years when
they experience a loss.*</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Unfortunately, over short periods of time, this is not always
the case. In fact, the relationship could be the opposite – the worst
performing asset category may lose -15% while the best performing category may
only make +5%, resulting in an overall portfolio loss of -5%. As the above
charts assume a sufficient amount of time for the market to work, these
temporary period of market declines aren’t reflected in the diagrams.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
A chart consisting of only the potential disappointing
short-term returns of +5% for the best investment and -15% for the worst
investment would look something like this:</div>
<div class="MsoNormal">
<br /></div>
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgc_KjFAxfl56d62tIAHO8cnX3UJvuFfl3R4T3-5SHcot5FXYglvl9yUvWfDmxd9AcfR7MkE7-EICnJgJn9NKJ5ySZybboUITJpyIeXHwo3T1PnH13SEjiapbFWbfUQ6LYM54gEbTMUeUf7/s1600/Declining+Market.JPG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="300" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgc_KjFAxfl56d62tIAHO8cnX3UJvuFfl3R4T3-5SHcot5FXYglvl9yUvWfDmxd9AcfR7MkE7-EICnJgJn9NKJ5ySZybboUITJpyIeXHwo3T1PnH13SEjiapbFWbfUQ6LYM54gEbTMUeUf7/s400/Declining+Market.JPG" width="400" /></a></div>
<div class="MsoNormal">
<br /></div>
<div align="center" class="MsoNormal" style="text-align: center;">
<span style="mso-no-proof: yes;"></span></div>
<div class="MsoNormal">
While the negative short-term results aren’t particularly
exciting, the above chart illustrates that diversification adds value even
during a bear market. If we had a non-diversified portfolio during a market
correction (which would be represented by either the blue or the green line),
then there are periods when our portfolio would decrease in value at a much
more dramatic pace than our diversified portfolio (represented by the red line).</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
As this series of charts illustrates, while diversification
doesn’t prevent a portfolio from avoiding losses over short periods of time, it
does add value to a portfolio during environments of both increasing and
decreasing market values. Further, a diversified portfolio is likely to endure
both fewer and less drastic periods of short-term losses. All things
considered, a diversified portfolio is very likely to produce superior returns
over a non-diversified portfolio over an extended time frame.</div>
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<br /></div>
<div class="MsoNormal">
<br /></div>
<span style="font-family: "Calibri","sans-serif"; font-size: 11.0pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">* Virginia Retirement System <a href="http://henrico.us/pdfs/hr/benefits/vrs/vrs_marketreturns.pdf" target="_blank">study: S</a>ince 1926, in years when the S&P 500
increased in value, the average positive annual return was 21.47%. Meanwhile,
the average negative annual return in down years was only -14.29%. Further, the
market experienced a positive return in 73% of years, and a negative return in
only 27% of years.</span>Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com16tag:blogger.com,1999:blog-8754804495292234538.post-9186814025599444412015-09-18T11:17:00.000-06:002015-09-18T11:17:22.651-06:00Back to Basics: “Invest” Means Something Different to Everyone<!--[if gte mso 9]><xml>
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One day last week, I had two interactions that reminded me
that there is no common definition for the word “invest.”<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
First, I was completing an interview with Matt Gephardt from
KUTV news. During the discussion, Matt asked if it was a good time to invest.
Immediately, I assumed he was referring to the volatility that the stock market
has recently experienced and I provided my opinion that volatility was
ultimately a good thing because it penalized short-term speculators and
provided profitable opportunities for long-term investors. As I spend a lot of
energy encouraging clients to focus on achieving their long-term financial
goals and paying minimal attention to short-term market movements, I said I wouldn’t
hesitate to invest given the current market environment.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Further, as Matt is a young individual with several decades
before retirement, investing early and utilizing as much time as possible to
allow his portfolio to compound would clearly be beneficial. Investors with
such an extended investment time horizon will certainly experience their share
of market pullbacks, corrections, and even crashes. Yet, history strongly
suggests that the simplest way for young investors to achieve wealth is to get
invested dollars working for them as early as possible.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
It wasn’t until later that I realized Matt very well could
have been asking if it would be wise to invest money now after a market pullback
and hope to quickly profit from a bounce or a quick recovery. This would have
certainly been a fair question as such action would clearly fall within the
definition of investing. However, if I had interpreted the question in this
matter, my answer would have been completely different. I would have responded
that I have no idea what the market will do over the next week, month, or even
year, so if you are looking to make money over the short-term I can’t say that
investing now is an action that I would recommend.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
The second interaction involved an email exchange with a new
client who is about to transition into retirement. This individual has historically
been an extremely conservative investor, having his entire nest egg invested in
cash equivalents (CDs, money markets, and savings accounts) for the last
several years. However, he has recently recognized that such investments won’t
provide the income that he desires throughout his retirement.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
I’ve worked with this individual to produce a financial plan
and investment strategy that we are both comfortable with, so the next step is
to put the plan into action. However, the client expressed concern about
investing amid the recent volatility. While this is certainly a valid concern,
it made me realize that the client and I were using the term “invest” to mean
different things.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
I believe when the word “invest” was used, the client
logically concluded that the entire cash balance would be invested in the
market immediately. This would be a huge transition and could certainly be
scary.<span style="mso-spacerun: yes;"> </span>By comparison, to me “invest”
meant starting the process of slowly moving money out of his cash balance and
putting it to use in more assertive assets by dollar-cost-averaging over time.
This could take 12-24 months, dramatically reducing the client’s exposure to
short-term market movements.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Further, it became increasingly clear that although the
client and I had discussed and agreed upon an asset allocation that may consist
of only 30% stocks, the client hadn’t yet incorporated the mindset that only
30% of his portfolio would be subject to the volatility of the stock market.
Admittedly, if the market were to drop 10% immediately after investing your
life savings, that would be a frightening experience. However, if only 30% of
the portfolio was invested in stocks when the market declined by 10%, the
investor’s loss would have likely been only approximately 3%. While enduring a
loss is never pleasant, an immediately loss of 3% would be a lot more
manageable than a 10% portfolio reduction.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
With Matt, he and I may have interpreted “invest” as a way
to obtain completely different goals – profiting from the current market
environment vs. obtaining long-term financial goals. In my interaction with the
new client, our slightly different interpretation of the word “invest” was
leading us to envision scenarios with drastically different risk implications.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Of course, it is possible that both Matt and the client
could have meant various other things while discussing investing in today’s
market. The point is that the term “investing” is frequently not sufficient
when communicating with others. What are the goals you hope to achieve with the
investment? How long do you intend to hold the investment? What assets will you
actually be investing in?</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
While these may seem like basic principles, it is possible that
a commonly understood definition of the word “invest” may be lacking during
some communications, whether those discussions are taking place between
spouses, financial advisors and their clients, or between families and their
accountants and attorneys. Every once in a while, it is probably worth ensuring
that the people you work with possess an understanding of what the word
“invest” means to you.</div>
<br />
Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com0tag:blogger.com,1999:blog-8754804495292234538.post-9880886475666017042015-08-24T20:34:00.000-06:002015-08-24T20:34:51.672-06:00Tools For Navigating the Market Pullback<!--[if gte mso 9]><xml>
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<![endif]-->On August 24th, the Dow Jones Industrial Average opened the day decreasing in value by 1,000 points. One of the most volatile days in memory continued, with the DOW fighting back to nearly even by mid-day, down only 98 points. Unfortunately, the bounce couldn’t be maintained through the market close with the DOW ending the day down 588 points, off about -3.5%.<br />
<br />How are investors to deal with this level of uncertainty? First and foremost, remember that this is what diversification is for. It is easy to look at a major market index like the DOW or the S&P 500 and equate the performance of those assets to the performance of your portfolio. However, the first thing investors should remind themselves is that they don’t have a portfolio consisting of only large cap stocks, which is what is measured by both the DOW and S&P 500 index.<br />
<br />In fact, most investors don’t have a portfolio consisting of just stocks. Many investors who are nearing or enjoying retirement may have a portfolio that is closer to only 50% or 60% stocks. If an investor only has 50% of his portfolio invested in stocks, only 50% of the portfolio is invested in the asset that declined in value by -3.5% on August 24th, meaning the individual’s portfolio likely only decreased by about -1.75%. While a -1.75% decline is not pleasant, it is hardly catastrophic.<br />
<br />The next step is to remind ourselves that temporary sharp market declines are common. Morgan Housel, one of my favorite financial writers, <a href="https://twitter.com/TMFHousel/status/635799895203577857" target="_blank">noticed that</a> the correction the market is currently experiencing is currently about half as bad as the correction that took place near the beginning of 2011, which no one now remembers or cares about. These market pullbacks will always come and go, and the world will continue to turn.<br />
<br />Additionally, it is useful to acknowledge that while we tend to remember dramatic and shocking market decreases, stocks tends to be an efficient investment over time. As Ben Carlson <a href="http://awealthofcommonsense.com/crash-rules-everything-around-me/" target="_blank">pointed out in his blog</a>, when investors think of the ‘80s the first thing that comes to mind is usually the crash of ’87. However, U.S. stocks were up over 400% during the decade. Similarly, even though stocks are up 200% since March of 2009, many investors have spent the last five years trying to anticipate the next 10% - 20% correction. In retrospect, an investor would have clearly been better off riding the equities rollercoaster during both the good and bad times and ending with a 200% gain rather than being out of the market in an attempt to avoid a small temporary decline. Given a long enough investment time frame, this has always been true and will continue to be the case.<br />
<br />Finally, as <a href="http://www.utahfinancialadvisor.blogspot.com/2015/07/why-there-has-to-be-market-correction.html" target="_blank">I pointed out in a previous post</a>, it is useful to recall that market corrections are actually a good thing for long-term investors. Fear amongst investors is what creates the equity risk premium that enables stocks to produce superior investment results when compared to investments with no risk such as CDs and money markets, which essentially experience no growth after accounting for inflation. When investors forget that equities can go both up and down in value, everyone wants to invest their money in stocks. This excess demand inflates asset purchase prices to the point that owning equities is no longer profitable. Market declines reintroduce risk to the investing public, and it is the presence of risk that makes stocks an appreciating asset. Thus, for those who don’t intend to sell their investments for 10+ years, short periods of volatility are a positive because they recreate the equity risk premium which raises rates of return over time.<br />
<br />These are all logical steps for mentally dealing with market corrections. For those who need it, Josh Brown <a href="http://thereformedbroker.com/2015/08/24/my-little-trick-for-coping-with-a-correction/?utm_source=dlvr.it&utm_medium=twitter" target="_blank">proposes a less logical step for tricking your mind into embracing the market pullback</a>. During scary market environments, Mr. Brown proposes that you identify a couple of stocks you’ve always felt you missed out on. Have you always wished you got in earlier on Apple, Google, Netflix, Chipotle, etc? A market correction like we are experiencing might be the perfect opportunity to become an owner of a great stock at an attractive price. Why not set a number for each of these stocks – say, if they drop in value by 20% - and if those targets are met you commit to buying some shares?<br />
<br />This strategy truly enables you to use lemons to make lemonade. It provides an opportunity to buy shares of companies that you have always wanted without overpaying for them. This mental trick can actually cause you to hope that the market correction continues because you are now hoping for a chance to buy. Rooting for a further correction can certainly make volatile market periods more tolerable.<br />
<br />As I mentioned, this mentality isn’t completely logical because the rest of your portfolio will likely need to decline in value in order to afford you the opportunity to purchase those coveted stocks. However, implementing this strategy is a bit of a mental hedge that enables you to get something good out of whichever direction the market turns. Think of betting money against your favorite sports team – of course you don’t want your team to lose, but even if they do you still get something positive out of it.<br />
<br />I’m confident that most of my clients already know that selling in the middle of a market correction is not a good idea. Still, I acknowledge that doing nothing as the market seems to be collapsing around you can be nerve-racking – even though it is the appropriate response. Hopefully these mental strategies and tricks enable you to stick to your long-term buy-and-hold investment strategy which has always proved to be profitable given a long enough time frame.Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com0tag:blogger.com,1999:blog-8754804495292234538.post-68038842714269710182015-07-29T15:51:00.000-06:002015-08-24T16:54:35.936-06:00Why There Has To Be a Market CorrectionWhy do we invest in the stock market? To make money so we can improve our standard of living, right? Notice that we aren’t investing just to get our money back. If we simply wanted our money back, we would place the money in a savings account at a bank where we would likely be able to access it any time and know that we could redeem it at full value. However, making money is better than simply getting our invested dollars back, so there has to be a trade off for receiving that additional benefit.<br />
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Of course, the trade off is that investing in the market involves more risk than simply depositing money in a bank account. The additional return that is required by investors for investing in an asset that could potentially lose money is called the equity risk premium. There must be a potential downside in exchange for the larger reward that can be obtained by investing in the stock market. Otherwise, no one would ever deposit money into the more secure bank accounts and people would always invest in the stock market generating superior returns. Unfortunately, this would make things too easy, and as we have learned our whole lives, the easier a goal is the less reward we get for achieving that goal. That is why positions that can only be filled by a select few individuals with rare talents (CEOs, doctors, Lebron James) are handsomely compensated.<br />
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By now, most people know that over a sufficiently lengthy period of time, the stock market has historically produced returns of approximately 10% per year. This seems like a simple and easy way to make money, so why don’t all investors buy stocks and hold them for extended periods of time? The fact that we aren’t all rich suggests that buying stocks and allowing the market time to do its thing isn’t easy. This is because enduring risk and suffering losses creates negative emotions that get the best of many investors, causing them to sell at the wrong time and stop investing new dollars.<br />
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Yet, when we refer back to the concept that the tougher the task the greater the reward, we should be happy that buying and holding stocks isn’t easy because it makes the strategy more profitable. For this reason, the next time the market goes through a correction or even a crash, wise investors should be grateful. Market volatility causes unsuccessful investors to sell when prices are down and increases the rewards for those who can stick with their investment strategy by holding their assets or even buying new positions.<br />
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Supply and demand suggests that when the markets are decreasing in value, more people are selling assets than buying. The people who are selling their investments at a loss create an equity risk premium for those who can endure market volatility. This increases the reward for successful investors by both providing an opportunity to buy assets when they are inexpensive, and reminding the marketplace that investing in volatile positions is unpleasant. Of course, things that are unpleasant aren’t easy to accomplish, which means there is a large benefit for achieving those things.<br />
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Thus, market corrections are great for successful investors because it is volatility and easily-rattled buy-and-sell investors that enable buy-and-hold investors to make significant profits over the long term. In fact, it wouldn’t be possible for stock market investors to make money without periodic intervals of unpleasantness as it is this discomfort which causes some investors to sell and creates an equity risk premium for the rest of us.<br />
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It has been easy for investors to buy and hold for the last six years as the market has been nothing but accommodating since early 2009. However, when things get too easy, it reduces our reward for being a long-term investor because everyone can do it. For this reason, we need the market to experience a correction at some point to shake out the unsuccessful investors, causing them to sell assets and create an equity risk premium once more.<br />
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When the next correction occurs, you can either sell assets and create a risk premium for others, or you can stay invested and take advantage of the money unsuccessful investors leave on the table. Successful investors with a sufficiently lengthy investment time horizon remind themselves of this concept frequently so that when the market experiences a decline they are not overcome by fear but rather grateful for the opportunity provided by the short-sighted.<br />
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</xml><![endif]-->Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com2tag:blogger.com,1999:blog-8754804495292234538.post-62365794540571676902015-07-21T15:58:00.000-06:002015-07-21T15:58:12.756-06:00Fear of Missing Out: An Investor's Worst Enemy<!--[if gte mso 9]><xml>
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Fear of missing out (FOMO) is an increasingly powerful
emotion in our daily lives – so much so that FOMO was officially added to the
Oxford English Dictionary in 2013. Have you ever looked at your Facebook feed
and been jealous of someone’s picture from a beautiful viewpoint, or enviable
of a friend’s photo of their expensive dinner with a strategically placed
bottle of fancy wine in the background? That is FOMO – the fear that at any
given moment someone is doing something more appealing than what we are doing
at the time.</div>
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A fear of missing out has always been part of life, but it
has become more and more prevalent with the emergence of social media.
Personally, I can’t help but check my Twitter feed every hour or so to make
sure that I’m not missing out on an article published by one of my favorite
financial writers. Yet, social media has increased the power of FOMO more than
I realized. For example, I can honestly say that I have absolutely zero
interest in horse racing – frankly, I dislike the sport. However, due to all
the hype on Facebook and Twitter, I couldn’t help but watch the Belmont Stakes
out of fear of missing American Pharaoh become the first Triple Crown winner of
my lifetime.</div>
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FOMO is frequently a counter-productive emotion, leading to
jealousy of others, dissatisfaction with our own lives, and bad decision making
processes. Nowhere is the negative impact of FOMO more apparent than in some
individuals’ investment strategy. For years, no one has enjoyed going to the
neighborhood BBQ only to have to listen to their neighbor brag about
how his portfolio has outperformed the S&P 500 index over the last six
months. Not only is listening to the boasting annoying, it makes us discontent
with the return our own portfolio has achieved and makes us wonder if we should
adapt a different strategy (i.e. take more risk right after the market achieved
a new all-time high).</div>
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Social media has expanded the impact of FOMO on investment
strategies. For the last year, the internet has ensured we are aware that large
cap indexes like the S&P 500, Dow Jones Industrial Average, and NASDAQ are
at all-time highs and achieving appealing returns, and we wonder why our more
diversified portfolio isn’t behaving in a similar fashion. It is hard to be
content with our diversified strategy when every media outlet is constantly
reminding us how we are missing out on the stellar performance that could be
obtained if only we had a non-diversified portfolio that invested only in the
asset category that is currently in the middle of a hot streak.</div>
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When it comes to investing, FOMO is significantly impacted
by recency bias. Our fear of missing out becomes more and more intense after
the market has just experienced an uptick. If we take a couple of steps back,
it is clear why we maintain a diversified portfolio – it provides the most
appealing tradeoff between maximizing returns and minimizing risk. Yet, it is
hard to remind ourselves of this when it seems like everyone around us is taking
advantage of the latest market trends and we are missing out. Of course,
changing our portfolio to try and take advantage of a run that has already
taken place would be foolish, as we would be selling assets with prices that
have remained flat and may now be undervalued relative to the market in order
to buy assets that have recently experience significant growth and are likely
now expensive. These are the type of decisions that FOMO can cause and we would
be wise to avoid this type of thinking.</div>
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We have been in this position before. In the late 1990s,
people wanted to abandon their diversified portfolio and put a heavy focus on
the technology stocks that were making all their neighbors rich. In the mid
2000s, everyone wanted to borrow as much money as possible and utilize the
funds to buy and flip real estate. In the early 2010s, everyone was wondering
if they should sell their stocks before a double-dip recession began and use
the resulting funds to buy gold. In each of these scenarios we were hearing
individual stories of others who had implemented these strategies and were
doing better than we were. Of course, with the benefit of hindsight, we can see
that changing our long-term investment strategy due to a fear of missing out on
what was working for a short time period would have been a drastic
mistake.</div>
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<span style="font-family: "Calibri","sans-serif"; font-size: 11.0pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">After the market has done well, recency bias and
FOMO causes investors to be more afraid of missing a bull market than of
suffering large losses. However, in these times, we need to remember that we
chose a diversified investment strategy because it provides us with the highest
probability of obtaining our financial goals while exposing us to the least
amount of volatility possible. When the media and our acquaintances insist on
informing us how we would have been better off placing heavy bets on the asset
categories that have recently done well, we would be well served to remember
that a diversified portfolio strategy will almost certainly provide us with the
best chance to achieve long-term investment success.</span>Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com0tag:blogger.com,1999:blog-8754804495292234538.post-6796453131476204292015-06-18T10:20:00.000-06:002015-06-18T10:20:02.186-06:00How To Use Deposits and Withdrawals To Rebalance Your PortfolioThe benefits of rebalancing a portfolio are well documented. Constant rebalancing forces an investor to lighten the portfolio positions that have recently performed well and use the resulting funds to buy more shares of the assets in the portfolio that have remained flat or even declined in value. In other words, rebalancing causes the investor to sell high and buy low.<br />
<br />Most financial professionals recommend rebalancing your portfolio at least once a year (I rebalance my clients’ portfolios on a semi-annual basis). However, the tax status of an investment account can have a significant impact on a rebalancing strategy. While investments within a tax-advantaged account like a traditional or Roth IRA can be sold without tax implications, selling appreciated assets in a taxable investment accounts will create a capital gains liability. Consequently, while rebalancing within a tax-advantaged account should be a no-brainer, investors should carefully consider the tax implications that may result from rebalancing a normal investment account.<br />
<br />For this reason, investors should view every deposit to or withdrawal from a taxable investment account as a chance to rebalance. Depositing new money is a free opportunity to buy more of the positions in which the portfolio is underweight. For example, suppose an investment account of $100,000 has a target asset allocation of 50% stocks and 50% bonds ($50,000 invested in both). After a year in which stocks made 10% and bonds were flat, the portfolio would consist of $55,000 of stocks and $50,000 of bonds, for a total account balance of $105,000. If at this point the investor would like to invest an additional $5,000, the entire contribution should be placed in bonds, bringing the actual portfolio allocation back to 50% stocks and 50% bonds ($55,000 invested in each).<br />
<br />
Of course, this same strategy can be implemented regardless of the size of the additional contribution. If the investor wanted to contribute $10,000 in year two, the total account value would be $115,000 ($105k current balance + $10k new money). In order to get back to our 50% stock and 50% bond targets, we would want $57,500 in each position. With $55,000 already invested in stocks, we would only want to invest $2,500 of the new money into stocks and place the remaining $7,500 into bonds, bringing both portions of the portfolio up to their targets.<br />
<br />Taking withdrawals from a taxable investment account should also be viewed as an opportunity to rebalance. Rebalancing via withdrawals may not be free as it is when rebalancing is done when new funds are deposited because appreciated assets are likely sold, creating a tax liability. However, when a withdrawal is taken from a taxable account, it is still wise to sell overweight asset categories to produce the funds needed for the distribution.<br />
<br />Let’s return to our previous example of a 50% stock and 50% bond target portfolio that had grown to $55,000 of stock and $50,000 of bonds. If the investor then wanted to withdraw $10,000, he could take the entire distribution out of bonds which would allow him to free up the amount needed without creating a tax liability. However, the resulting portfolio would consist of $55,000 of stocks and $40,000 of bonds – a ratio of approximately 58% stocks and 42% bonds.<br />
<br />This is a significantly more volatile portfolio than the target 50% stock and 50% bond portfolio. For example, in 2008 a portfolio that consisted of 50% large cap stocks and 50% long term government bonds lost -7.16%. Meanwhile, a portfolio of 58% stocks and 42% bonds lost -11.93% over the same time period – a 66.6% increase in volatility.<br />
<br />Alternatively, I’d suggest using the $10,000 withdrawal to rebalance the portfolio, bringing the resulting $95,000 portfolio back to 50% stocks and 50% bonds ($47,500 in each). Of course, to do this, the investor would liquidate $7,500 of stocks and $2,500 of bonds. Although this could potentially create a small capital gains tax liability, this is a tax bill that will need to be paid at some point anyhow, and the investor will maintain a portfolio with the target amount of volatility.<br />
<br />
Further, remember that the long-term capital gains rate (which applies to any capital assets held for over a year) is a favorable tax rate. For single filers with a taxable income of less than $37,450 and joint filers with a taxable income of less than $74,900, the capital gains tax rate is actually 0%! Additionally, for single filers with a taxable income of between $37,450 and $406,750 and joint filers with a taxable income of between $74,900 and $457,600, the capital gains tax rate is only 15%. Consequently, the investor can likely rebalance the portfolio back to the target allocation via the withdrawal while incurring only a nominal tax bill.<br />
<br />While rebalancing provides a significant increase in investment return over long time periods, tax implications should be considered when determining whether or not to rebalance a taxable investment account. However, depositing money to or withdrawing money from these accounts provides a favorable opportunity to obtain the return premium rebalancing creates while minimizing tax implications.Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com2tag:blogger.com,1999:blog-8754804495292234538.post-27132375564712843762015-06-09T12:38:00.000-06:002015-06-09T12:38:10.743-06:00Investment Risk May Not Be What You ThinkA new logic has been surfacing amongst the top minds in the financial planning industry. Many of my favorite financial authors – Warren Buffett, Josh Brown, Nick Murray, Howard Marks, and others – have proposed the need to redefine the work “risk.”<br />
<br />Most investors and financial advisors tend to utilize the words “risk” and “volatility” interchangeably. We measure how risky a portfolio is by examining its potential downside performance. For example, we review how much a similar portfolio lost during 2008 or when the tech bubble popped in 2000-2002. When doing this, we are really talking about volatility rather than risk. Volatility – usually measured by standard deviation – reflects how much a portfolio is likely to increase or decrease in value when the market as a whole fluctuates. Risk, however, is quite different.<br />
<br />Josh Brown characterizes risk as the possibility of two threats:<br />
<ol>
<li>The possibility of not having enough money to fund a specific goal, which includes the possibility of outliving your money</li>
<li>The possibility of a permanent loss of capital.</li>
</ol>
In a dramatic example of how volatility is different from risk, consider a retiree with a $10 million portfolio who only spends $50,000 a year. Next, assume the investor experiences a two-year period in which during the first year his portfolio loses 50% of its value and in year two the portfolio earns a 100% return. Thus, after year one the portfolio would only be worth $5 million and after year two it would again be worth $10 million.<br />
<br />Clearly, this is a very volatile portfolio that is subject to a wide range of potential performance outcomes. However, is this portfolio truly risky to the investor? According to Mr. Brown’s first factor, the portfolio is not risky because the investor will have enough money to fund his $50k per year retirement regardless of whether his portfolio is valued at $10 million or $5 million. Additionally, the portfolio is also not risky according to the second factor in that the investor didn’t experience a permanent loss.<br />
<br />Investors tend to view stocks as risky assets because they have a large standard deviation of returns. Similarly, we tend to view money market equivalents such as CDs and savings accounts as very safe investments because they are not likely to experience a large loss. However, rather than considering stocks to be risky and cash equivalents to be safe, it would be more accurate to consider stocks an investment with high volatility and cash to be a holding with low volatility.<br />
<br />What is the difference? Suppose it is determined that you need an average rate of return of 6% over time to achieve your retirement goals. Historically, over a sufficiently significant period of time, stocks have returned an average of about 10% per year while cash equivalents have returned about 3% per year. Consequently, if these averages continue in the future, you actually have a very low chance of reaching your retirement goal of not outliving your money if you place money in the “safe” investment of a cash equivalent, while you would actually have a pretty high probability of reaching your retirement goal if you place money in a more volatile basket of stocks.<br />
<br />By this metric, cash is actually the more risky investment because investing in it would increase the probability of outliving your funds. Meanwhile a basket of stocks, if given enough time to achieve its historically average rate of return, is actually the safer investment as it gives you a higher probability of not outliving your nest egg. Thus, while a portfolio of stocks will almost certainly experience more short-term volatility, over an extended period of time it very well may be a safer investment for ensuring your retirement goals are met.<br />
<br />Warren Buffett recently addressed this issue in his annual letter to shareholders:<br />
<br /><i>Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.</i><br />
<br />Further, Josh Brown proposes that the muddying of definition between risk and volatility is something a portion of the financial service industry has done on purpose. Mr. Brown suggests that the easiest way to sell someone a product is to first convince them they have a need. If hedge fund managers, insurance agents, and annuity salesmen can make consumers believe that volatility is equal to risk, and that since their products minimize volatility they must also minimize risk, they can achieve more sales. However, even if an annuity can eliminate downside volatility, if it limits potential return to a figure that is insufficient to achieve the investor’s long-term goals, the investment is still likely more risky than an investment with more short-term volatility but a higher probability of long-term success.<br />
<br />Next time the market goes through a correction, remember that the drop in your portfolio’s value is a reflection of the potential volatility your portfolio is capable of experiencing. Yet, recall that as long as you don’t sell your assets and suffer a permanent loss of your investment capital, you can allow the market time to recover and achieve its historical rate of return. Doing so will ultimately make your investment strategy less risky than utilizing investment options that experience less volatility because it maximizes the probability you will eventually achieve your long-term financial goals.Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com1tag:blogger.com,1999:blog-8754804495292234538.post-15636938876912652032015-05-28T13:05:00.001-06:002015-06-01T15:13:31.393-06:001099 Income - A Potential Retirement SaviorYou have likely seen reports about how financially unprepared the average American is for retirement. According to the Federal Reserve, the <a href="http://www.fool.com/retirement/general/2015/01/10/the-typical-american-has-this-much-in-retirement-s.aspx" target="_blank">median balance of retirement accounts held by Americans who are saving for retirement totals less than $60,000</a>. The same report states that the median value of retirement accounts for families whose head of the household is between ages 55-64 is $103,200, while the median value of retirement accounts for families whose head of the household is between ages 65-74 is $148,900.<br />
<br />
Clearly, these median account balances are insufficient to fund a retirement. A 65-year old with a retirement account balance of $148,900 who is withdrawing 4% of that balance each year (a common withdrawal rate) is receiving less than $500 per month. Although most individuals will have Social Security and perhaps a pension to supplement this retirement income, it is likely that many people will need to significantly scale back their standard of living during retirement in order to not outlive their retirement savings.<br />
<br />
So what is the best way to give your retirement accounts a boost? Obviously, the basic answer is to save more. However, this is easier said than done for most people. First, many people simply don’t have money left to save after subtracting expenses from their income. Second, even those who have extra funds face a restriction on the amount of tax-advantaged money that can be saved each year because retirement accounts have contribution limits: individuals under the age of 50 can only contribute $5,500 per year into traditional or Roth IRA accounts (individuals over age 50 can save an additional $1,000). Similarly, employees under the age of 50 who have access to an employer-sponsored 401k plan can only contribute $18,000 to the plan each year (individuals over age 50 can contribute an additional $6,000). These 401k contribution amounts are in addition to any deposits made by the employer.<br />
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Due to both a lack of income and retirement account contribution limits, it may be hard for some people who feel behind on their retirement savings to get caught up. However, allow me to suggest a potential way to bump up your retirement account balances – 1099 income.<br />
<br />
Income from self-employment is classified as 1099 income. Self-employment income can come from sources ranging from consulting, to providing a service in which you possess a unique skill, to driving for Uber. It is frequently a perfect second source of income in that by definition, you can earn 1099 income on your own schedule. While an employer can require you to work at a certain time, you can literally earn 1099 income whenever your schedule allows. Of course, assuming your expenses remain constant, a second source of income would create more money that can be saved for retirement.<br />
<br />
More importantly, 1099 income allows you access to unique retirement plans such as a Solo 401k or a SEP (simplified employee pension). These retirement plans enable you to save a tremendous amount in tax-advantaged retirement accounts – up to $53,000 in 2015! This is incredibly useful, particularly to individuals who don’t have access to employer-sponsored retirement plans like a 401k or 403b. In these instances, the amount that can be saved in tax-advantaged retirement accounts suddenly increases from $5,500 (the IRA contribution limit) to as much as $53,000 per year.<br />
<br />
A Solo 401k enables the person who generated the 1099 income to make a tax-deferred contribution to the retirement account as both an employee and an employer. Contributions as the employee are limited to the lesser of the amount of income earned by the individual or $18,000, the 401k contribution limit ($24,000 for people over age 50). Additionally, as the employer, the individual can contribute up to 25% of the employee’s compensation. Combined, the contributions as both the employee and the employer can’t exceed $53,000 in 2015.<br />
<br />
For example, consider a 55 year-old that can’t afford to save any of the income from his primary job but also generates an additional $30,000 of 1099 income. This individual would be able to contribute $24,000 of this income to a Solo 401k as the employee, and would be able to contribute the additional $6,000 to the plan as the employer (as $6,000 is less than 25% of $30,000, the employee’s compensation). Consequently, this individual would be able to save the entire $30,000 earned for retirement in a tax-deferred account, which would prevent their tax bill for the year from increasing.<br />
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It should be noted that the individual would still need to pay the payroll tax, which consists of both the Social Security and the Medicare tax. Further, as both the employer and the employee, the individual would have to pay the entire amount of both taxes, which totals 15.3%. However, the point remains the same – the additional 1099 income created a significant amount of extra money, of which an unusually high percentage could be saved in tax-advantaged retirement accounts.<br />
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For those not looking to save such a large additional amount, a SEP may be sufficient. While a SEP doesn’t allow you to make the $18,000 employee contribution (or $24,000 for workers over age 50), you still have the ability to make the employer contribution of 25% of income. A SEP is slightly more simple to create and maintain than a Solo 401k. Additionally, for individuals who already have the ability to contribute to a primary employer’s 401k plan, a SEP may be a better choice. Such an individual could make the full employee contribution of $18,000 ($24,000 for individuals over 50) to the primary employer’s retirement plan, but still make the 25% of 1099 income contribution to their private SEP plan.<br />
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If you are looking to ramp up your savings rate and increase your retirement account balances, creating 1099 income may be an ideal solution. Of course, most people would welcome the second source of income, but the fact that the income can be generated on your own schedule makes this option particularly viable. Further, the access that 1099 income grants to unique retirement plans like a Solo 401k or a SEP, which have unusually high retirement account contributions limits, makes this type of income particularly appealing.Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com0tag:blogger.com,1999:blog-8754804495292234538.post-17242250596762312692015-05-08T09:12:00.000-06:002015-05-08T09:12:41.214-06:00The Market Has Been Flat For Six Months -- Why This is Great NewsInvestors have experienced a very uneventful 2015. In fact, at market close on 5/7/15 the Dow Jones Industrial Average was at essentially the same value as it was on 12/5/14, up a total of just 0.72% over the six-month period. This lack of fluctuation has been even more pronounced over the last two months. As of the market close on 5/7/15, the <a href="https://finance.yahoo.com/q/hp?s=^GSPC+Historical+Prices" target="_blank">S&P 500 has closed between 2,040 and 2,120 for 66 days in a row</a>. Further, between 4/9/15 and market close on 5/6/15, the DOW hasn’t experienced a 1-month high OR low and has traded within a 2% range the entire time (always between -1% and 1%).<a href="http://jlfmi.tumblr.com/post/117268588835/home-in-the-range-a-rare-streak-for-the-dow"><br /></a><br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEidHnLOnAOmQNeYgwmVXgVOLBDVMjgR-4QsFeCIE1GA7T9DmfppGoFM63L3C-rkEHvxg7vtcRcExhVRft8nr75BAG7uLTUO9A_9nUblBpVVF6wJ28KOKexFGjF6ssDXtkNbW7v8N8S8rvvV/s1600/one-month-return.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="191" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEidHnLOnAOmQNeYgwmVXgVOLBDVMjgR-4QsFeCIE1GA7T9DmfppGoFM63L3C-rkEHvxg7vtcRcExhVRft8nr75BAG7uLTUO9A_9nUblBpVVF6wJ28KOKexFGjF6ssDXtkNbW7v8N8S8rvvV/s400/one-month-return.png" width="400" /></a></div>
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Believe it or not, this may be the best pattern possible for the U.S. stock market.
History tells us that the market is likely to increase in value over time. If we were to plot the market's value from the time the market first opened to the current day, a chart of those two points would illustrate a return as such:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgjdMRXXbq4BeuRk4U5n4mqPgDXoNUY52skfOBkcF5kZFokMtfH_B2LoRIpkOyQKI0GEJLfEtAkVU8YeFVetIQM2Gxo_Am8eZVrjxYi3AS5UrwpUfzVbg85ofUSceqLPkn0KUsUyQadWKzn/s1600/Trendline+Image.PNG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="250" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgjdMRXXbq4BeuRk4U5n4mqPgDXoNUY52skfOBkcF5kZFokMtfH_B2LoRIpkOyQKI0GEJLfEtAkVU8YeFVetIQM2Gxo_Am8eZVrjxYi3AS5UrwpUfzVbg85ofUSceqLPkn0KUsUyQadWKzn/s400/Trendline+Image.PNG" width="400" /></a></div>
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However, we all know that the market doesn’t provide a consistent return. On individual trading days, the market can either increase or decrease in value, and the range of potential gains or losses is wide. Over extended periods of time, the market’s actual value may be above or below the expected trend line. In fact, the market’s actual historical return may look more like:<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-bqK5G9Xh8Wg_iucKV2P8Us1iou_91K6wj7YnR6B1WHjuT0En8qSmETg1rG3tQNpR6VI6c-tl_4xU5i44Ap53Ian_0t7bBJnSq_Ln2XLKEe3z8fF2Qh79hCcD-l_l0ayhUZh-SL3H3z8C/s1600/Historical+vs+Trendline.PNG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="251" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-bqK5G9Xh8Wg_iucKV2P8Us1iou_91K6wj7YnR6B1WHjuT0En8qSmETg1rG3tQNpR6VI6c-tl_4xU5i44Ap53Ian_0t7bBJnSq_Ln2XLKEe3z8fF2Qh79hCcD-l_l0ayhUZh-SL3H3z8C/s400/Historical+vs+Trendline.PNG" width="400" /></a></div>
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Anyone who knows me or reads my blog is likely aware that I am not one to make market predictions. I have no idea whether the market is near a temporary top or is still experiencing an upward trend after hitting the bottom of an S curve in 2008. However, let’s assume the market has reached the top of an S curve and is currently above the trend line that would represent consistent growth (similar to the illustration above).<br />
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If that is the case, there are two ways the market could get back in line with the trend line representing consistent long-term growth. The first and most obvious way this could happen is for actual market performance to curve downwards towards the trend line. This would represent a market correction or even crash.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhTDEbZ_fPLFy3__zSmdmRMMWzp_u6Qv0-C-ZTFG5LqIX4YWtmoTtqdj5sGwGwY_SElzGxQgQf8ORwPVI46ZKtPtK8DEtDSMzsZLnhUeXm4quHyb6AxZKmX5mFGFjQokv9So9_B-LFqPDkS/s1600/crash.PNG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="248" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhTDEbZ_fPLFy3__zSmdmRMMWzp_u6Qv0-C-ZTFG5LqIX4YWtmoTtqdj5sGwGwY_SElzGxQgQf8ORwPVI46ZKtPtK8DEtDSMzsZLnhUeXm4quHyb6AxZKmX5mFGFjQokv9So9_B-LFqPDkS/s400/crash.PNG" width="400" /></a></div>
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The second, and perhaps less obvious way that actual returns could become aligned with the long-term trend line is for time to allow the trend line to catch up to the actual returns we have experienced since 2008. In this scenario, the market doesn’t slump but remains stable while time enables price-to-earnings ratios, valuations, and the economy a chance to catch up.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEidEr9MSVonKlvedJy7LCkXrwY6f7FXjb1hn55Bf-Tf0ipr2mzy-0y3VVog241KtMvIJ1wfrfKBUJ2zroErq9wWjO1wNlqrlW2Balb2I6j2shB-dQnv15l4aQP271UJMenAkiA0jQmd3xtm/s1600/Time+Catch+Up.PNG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="243" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEidEr9MSVonKlvedJy7LCkXrwY6f7FXjb1hn55Bf-Tf0ipr2mzy-0y3VVog241KtMvIJ1wfrfKBUJ2zroErq9wWjO1wNlqrlW2Balb2I6j2shB-dQnv15l4aQP271UJMenAkiA0jQmd3xtm/s400/Time+Catch+Up.PNG" width="400" /></a></div>
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Very few investors enjoy or take advantage of a market correction. In fact, most investors lose control of their emotions when the market experiences a drastic downturn, and do exactly the opposite of what they should do: they sell at market lows – hardly a profitable investment strategy. Consequently, if we are to avoid an over-heated market, it is likely better for most investors if the market realigns itself with the long-term growth rate by remaining flat for awhile and allowing the trend line time to catch up.<br />
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Allow me to reemphasize that I am not predicting that the market is in fact at a temporary high and above where it should be. I have no idea what the market will do tomorrow, over the next month, or over the next year. That is why I believe investors should have a well diversified portfolio that represents their risk tolerance and that they stick to through thick and thin.<br />
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However, let’s look at the other side of the coin and assume the market is still at the bottom of an S curve, below the long-term trend line, and needs to experience further growth in order to catch up. Even in this scenario, an extended period of flat market performance is hardly a bad thing – it would simply make the potential upside needed to get back to market norms all the greater.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-GG37aabh9SR1aUv39BSNhUqB3lOiIsjs_0EibYVQKcRC04S5wDlUB1pd_mMqj1qMQrAViVY1xLJzEBPppODSXJPd03faNs7YlhRfx2nQTiqUPmns_SyeCbG258zcP7mvxRyWvqiNngXR/s1600/Market+Under+Valued.PNG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="242" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-GG37aabh9SR1aUv39BSNhUqB3lOiIsjs_0EibYVQKcRC04S5wDlUB1pd_mMqj1qMQrAViVY1xLJzEBPppODSXJPd03faNs7YlhRfx2nQTiqUPmns_SyeCbG258zcP7mvxRyWvqiNngXR/s400/Market+Under+Valued.PNG" width="400" /></a></div>
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It turns out that an extended period of flat market performance may very well be a positive for investors in any environment, regardless of whether the market is currently over or under-valued.
Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com1tag:blogger.com,1999:blog-8754804495292234538.post-35813904607395010672015-04-24T12:26:00.001-06:002015-05-05T14:17:55.246-06:00Attention Investors: Don't Get Soft<!--[if gte mso 9]><xml>
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<br />
<div class="MsoNormal">
Do you realize how easy investors have had it lately? There
is almost always something happening in the world that can serve as
justification for selling investment positions or not investing new dollars. Yet,
there hasn’t been many spooky events impacting the markets during the last
several months. Let’s examine the investment environment we’ve recently enjoyed.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
There is almost always geopolitical current events that are
capable of scaring investment markets. While this generation will always have
concern about ISIS, North Korea, Iran, Afghanistan, and terrorism, we haven’t
recently experienced the kind of negative political event that has immediately
sent the stock market into a tailspin. Even stories regarding missile strikes
in Gaza have been few and far between. The most relevant international
political event of late is the United States’ increased cooperation with Raul
Castro and Cuba -- a positive event.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Global economic situations also have the ability to increase
volatility in the stock market. Yet, we haven’t recently been bombarded with
headlines about excessive debt in Argentina or other countries on the doorstep
of financial collapse. Actually, international markets are the big investment
story thus far in 2015, with Europe, Asia, and emerging markets outperforming
U.S. stocks.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Social tragedies also have the ability to move the markets.
I believe the most dominant story regarding social issues of late has been the
horrific stories of potential racism and excessive police violence. Of course,
these events are shocking and unfortunate, but they aren’t usually the type of
stories that impact investment markets. Fortunately, I’m not aware of any school
shootings, mass suicides, or broad violent attacks on U.S. soil that have
caused a national mourning in 2015. </div>
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<br /></div>
<div class="MsoNormal">
Further, there have been relatively few natural disasters
such as hurricanes, earthquakes, or tornados that have significantly set back a
geographic area or the nation as a whole. In fact, the Weather Channel
announced that <a href="http://www.nbcnews.com/news/us-news/2015-tornado-season-59-percent-quieter-normal-weather-channel-n341111" target="_blank">the tornado count is 59 percent below average year-to-date</a>. There
were some large snow storms in the North-East earlier this year, but they had a
nominal impact on the direction of the stock market.</div>
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<br /></div>
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Even the U.S. economy hasn’t produced any data that has been
particularly frightening to investors. It was all the way back in October that
the Federal Reserve announced the ending of its quantitative easing (QE)
program, which caused some to wonder if the economy would start to dry up (it
hasn’t…). The concern about potentially higher interest rates has been present
for so long that it is now old news, and people seem less and less convinced
that higher interest rates would significantly stall the economy. Meanwhile,
the unemployment rate continues to decline.</div>
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<br /></div>
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Lastly, the stock market itself has hardly provided reason
for heartburn. The total return of the S&P 500 has been positive every year
since 2008. The index hasn’t even had a temporary pullback of more than -7.27%
(9/18/14 – 10/16/14) since 2011, even though the market historically goes
through a -10% correction approximately once per year, on average. In fact, the
biggest investment concern of 2014 was that small cap and international stocks
didn’t make as much as large cap stocks, causing most diversified portfolios
to under-perform the larger market indexes such as the S&P 500 and Dow Jones
Industrial Average. If your largest investing disappointment is that every part
of your diversified portfolio didn’t perform as well as the best performing asset
category in the market, you should really focus less on your portfolio and more
on enjoying life as a whole.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
When we examine the factors that typically lead to
volatility in the market, we’ve had a relatively tame past couple of months. My
purpose in pointing out this fact is not to imply that the market is in a prime
position to continue to do well nor on the verge of dropping drastically when
the next sign of uncertainty appears. I simply hope to remind investors that
the stock market is not always such a smooth ride.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
The most counter-productive action an investor can take is
to liquidate their positions after the market drops. I believe the best way to
avoid this mistake is to constantly remind yourself that you are investing for
long-term results and that short-term (and potentially drastic) volatility is
certain to occur. Reminding yourself of this fact now, before the volatility
arrives, is likely to increase the probability that you will be able to stick
to your long-term investment strategy during both the good and bad periods of
market performance.</div>
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<br /></div>
<span style="font-family: "Calibri","sans-serif"; font-size: 11.0pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">As Carl Richards points out in his new book <i style="mso-bidi-font-style: normal;">The One-Page Financial Plan</i>, no skydiver
would try to figure out how a parachute works after jumping out of a plane. Sooner
or later, an unfortunate event that will negatively impact the stock market is
certain to occur. At that time, remember that just as it always has, the world
will continue to turn. Further, remember that the longer you allow the world to
turn, the more positive your investment results are likely to be. Don’t let
this unusually quiet investment period make you more susceptible to short-term
instability once it returns.</span>Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com1tag:blogger.com,1999:blog-8754804495292234538.post-42454937479245665852015-04-20T13:52:00.000-06:002015-04-20T13:58:45.094-06:00Living and Dying on Averages<!--[if gte mso 9]><xml>
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Never forget the six-foot tall man who drowned crossing the
stream that was five feet deep, on average.</div>
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<br /></div>
<div class="MsoNormal">
We want to abide by averages because they make our lives
simple and manageable. A couple on a date night assumes a movie will be an
average of two hours long so they know when to schedule dinner with friends. The
entrepreneur wants to think in terms of making an average profit of $100,000
per year so he has a guideline regarding the standard of living he can enjoy.
The 65-year old retiree wants to assume he will live to the average age of 84.3
so he knows at what pace he can enjoy his nest egg.</div>
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<br /></div>
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However, when we rely too heavily on averages, our planning
can go awry. If the movie runs longer than two hours, the couple will be late
for their dinner date. If the entrepreneur has a slow year and earns less than
$100,000, he may end up taking out short term debt to pay his bills. If the
retiree lives past age 84.3, he may outlive his money.</div>
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<br /></div>
<div class="MsoNormal">
The use of averages is essential in financial planning. A
range of assumptions is required in the development of a financial plan – how
long will you live, how much will you spend each year, what rate of return will
your investments achieve, what tax rate will you pay, what will the rate of
inflation be, etc. Without these assumptions, retirement projections can’t be
constructed. Further, the best method for making these assumptions is to use
averages – an average life expectancy, an historical average rate of return, an
historical average inflation rate, etc.</div>
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<br /></div>
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So how do we prevent the use of averages from destroying us?
By allowing enough time and repetitions for the law of averages to come into
effect. Just because a basketball player shoots free throw shots at a 90%
success rate doesn’t mean he will necessarily make the next free throw shot he
takes. It does, however, mean that if he shoots 100 free throws he is likely to
make 90 of them.</div>
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<br /></div>
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A financial plan may assume you achieve an average annual
rate of return of 7% per year. Of course, this doesn’t mean it is impossible
that your portfolio will actually lose 10% over the next 12 months. It is
critical to remember that the financial plan assumes you achieve a 7% return
over the entirety of your retirement, which may be 30 years. Consequently, if a
loss of 10% occurs in the first year of retirement, your portfolio still has
another 29 years to achieve returns that average out to 7% per year. Thus, a
10% loss is far from catastrophic to your retirement projections.</div>
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<br /></div>
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In fact, the primary way a 10% loss could become
catastrophic to your portfolio is if it motivated you to make changes to your
investments that would prevent the law of averages from applying. If an
investor sold their portfolio after suffering the 10% loss, it would
essentially guarantee that the anticipated average rate of return won’t be
achieved, and consequently, the financial plan would be likely to fail.</div>
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<br /></div>
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For this reason, while it is true that over an extended
period of time the market has averaged an annual return of 10%, we should
always remember that there is a significant chance of the market taking a loss
during any given year (or three-year) period, and it is possible that the
market could endure a decade without any significant gains (similar to the 2000’s).
Still, if the financial plan requires an average investment return over an
extended period of time such as a 30-year retirement, even these setbacks are
far from certain to dislodge your secure retirement as long as time is granted
for the average to work itself out.</div>
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<br /></div>
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As famed writer and investor Howard Marks said, “We can’t
live by the averages. We can’t say ‘well, I’m happy to survive, on average.’ We
gotta survive on the bad days. If you’re a decision maker, you have to survive
long enough for the correctness of your decision to become evident. You can’t
count on it happening right away.” The use of averages has a purpose in
financial planning, and in other aspects of life. We simply need to be
confident that the figures we use for our averages are achievable over time,
and allow time the opportunity to prove us right.</div>
Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com0tag:blogger.com,1999:blog-8754804495292234538.post-81474010074256672332015-03-24T13:27:00.001-06:002015-03-24T13:33:24.830-06:00How To Make Your Family Line Rich<!--[if gte mso 9]><xml>
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Have you heard the story behind the invention of chess?</div>
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<br /></div>
<div class="MsoNormal">
The inventor brought the chess board to the emperor of
China, and the emperor was so impressed he said he would grant the inventor one
wish. The inventor had the simple wish of receiving one grain of rice for the
first square on the chess board, two grains for the second square, four grains
for the third square, eight grains for the fourth square, and so forth.
Sounding like a fair and modest proposal, the emperor agreed. However, it turns
out that filling the last 10 squares on the chess board would have required 35
quintillion grains of rice – more than enough to bury the entire planet.
Unamused, the emperor had the inventor beheaded.</div>
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<br /></div>
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Who knows whether the story is true, but the point is that
with compounding, grains seem small at first, modest in the middle, then
suddenly overwhelming. In the investment world, what enables compounding? Time.</div>
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<br /></div>
<div class="MsoNormal">
Let’s review the rule of 72. The rule of 72 states we can
divide the number 72 by the rate of return we achieve, and the resulting number
will tell you how many years it will take your money to double. For instance,
if we obtain a 9% rate of return, it will take eight years (72 / 9) for our
investment to double in value.</div>
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<br /></div>
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So what rate of return can we expect when we invest in the
market? From 1920 thru 2014, the S&P 500 (a typical measure of the stock
market) has returned an average annualized rate of return of <a href="http://www.moneychimp.com/features/market_cagr.htm" target="_blank">10.31%</a>.*
Coincidentally, 72 divided by 10.31 equals 6.9835. Thus, if we had invested in
the S&P 500 in 1920, our money would have doubled every 7 years.</div>
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<br /></div>
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What would happen if on the day your child, grandchild, or
great grandchild was born, you invested $1 in the S&P 500 but kept it a
secret. Assuming the infant lived to age 84, the dollar would be worth:</div>
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<br /></div>
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$2 at age 7<br />
$4 at age 14<br />
$8 at age 21<br />
$16 at age 28<br />
$32 at age 35<br />
$64 at age 42 (still not a big deal, right?)<br />
$128 at age 49<br />
$256 at age 56<br />
$512 at age 63<br />
$1,024 at age 70<br />
$2,048 at age 77<br />
$4,096 at age 84</div>
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<br /></div>
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Over one life span, $1 grew into $4,096. Impressive! Now
let’s add three zeros to all figures mentioned. In this scenario we invest
$1,000, and after 84 years of the child’s life, you would have $4,096,000 in
the investment account. Of course, I suppose you could invest $10,000 rather
than $1,000…</div>
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<br /></div>
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The key, of course, is time. The child will have many urges
to withdraw and spend the accumulated amount throughout his life. For this
reason, the chances of success for this project likely increase if you can find
a way to not tell the child for as long as possible.</div>
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<br /></div>
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How fun would this be? Imagine 84 years down the road, long
after you are gone, the young heirs in <span style="mso-spacerun: yes;"> </span>your
family line – who may have very ordinary finances at the time – suddenly get
such a massive infusion of assets that they could then use to maintain the
family’s stability for generations to come. All due to an amazing, mysterious
great, great grandparent with the incredible financial foresight to take
advantage of compounding. Now, imagine you stipulate that the heirs can have
access to the funds only if they take a fourth of the resulting investment
account and repeat the process!</div>
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<br /></div>
<span style="font-family: "Calibri","sans-serif"; font-size: 11.0pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">Think of compound interest as a bunch of tiny
personal employees that work extremely hard for you both day and night, and mate like crazy!</span>Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com1tag:blogger.com,1999:blog-8754804495292234538.post-32503942348120760932015-03-10T13:34:00.000-06:002015-03-10T13:34:05.799-06:00Is the Stock Market Rigged?<!--[if gte mso 9]><xml>
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I recently had dinner with a friend who abruptly asked “is
the stock market rigged?” As I attempted to fully understand his question and
address his concern, he ultimately said “if someone makes money by conducting a
trade he wins, and if someone wins, doesn’t someone have to lose?” This viewpoint
was preventing my friend from investing in his employer’s 401k plan or an
individual retirement account.</div>
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<br /></div>
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While I can see the logic in my friend’s viewpoint, I don’t
think it is accurate. Many people are reluctant to invest because they don’t
want to be on the losing side of an investment, opposite a more experienced and
skilled investor. This hesitancy likely stems from the fact that investing in the
market requires the purchase of an intangible asset. However, I believe the
same reasons that make purchasing a more tangible asset like a home worthwhile
also apply to investing in the market.</div>
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<br /></div>
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When an individual purchases a home, he does so for a reason
– he needs a place to live. For most people, the need to put a roof over his
head is more of a driving force to buy the home than because he believes the
current price is lower than the home’s actual value. The person only sells when
his needs are no longer matched by the home – perhaps because the individual
has retired and wants to move to a warmer climate or have a yard that doesn’t
require much maintenance. When he sells, assuming enough time has passed since
the house was purchased, the individual hopes to sell the home for more than he
paid for it.</div>
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<br /></div>
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Assuming the individual does sell the house for more than he
paid for it, does that make him the winner and the new purchaser of the home a
loser? Of course not. The new purchaser is buying the home to fill a need, just
as the original purchaser did. Similarly, assuming the new purchaser owns the
home for a long enough period, chances are pretty good that he too, one day,
will sell the home for a profit.</div>
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<br /></div>
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When we examine the purpose of investing in the market, it
is very similar to why we purchase a home. First, we invest in the market
because we have a need – to not outlive our assets. Again, for most people, the
need to save for retirement is the primary reason we invest, not because we
believe the market is particularly undervalued. Similarly, we only sell our
investment when it no longer matches our needs – perhaps because we need to
convert the asset to a more liquid and tangible asset (cash to buy a car), or
because the investment has become more risky than we are willing to tolerate
later in life. Just as the home provides a benefit (a place to live) while it
is owned and is later sold at a higher price after enough time elapses, our
investment in the market provides a benefit (dividends) while it is owned and
is later likely sold for a higher price after the passage of time.</div>
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<br /></div>
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Again, just because the selling market investor sold the
asset for more than he paid for it doesn’t make the purchasing investor a
loser. The purchasing investor will benefit from the same dividends the first
investor collected, and if he holds the investment long enough, will also likely
sell at a profit when the investment no longer meets his needs. When the market
continues to increase in value after the first investor sells, it doesn’t make
the seller a loser. He is still a winner in that he made a profit from
investing in the market and was later able to exchange the intangible
investment for a more tangible asset like a new car, an exotic vacation, or
simply the ability to not outlive his money.</div>
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<br /></div>
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There is, however, a factor that can potentially cause a
winner/loser scenario with both the purchase of a home and an investment in the
market – time. After buying a home, we are much less certain that the home’s value
will have increased after only a month as compared to ten years. The impact of
time is the same when investing in the stock market. We can be far from certain
that the market will increase in value after only a day, month, or even a year.
However, you’d be hard pressed to find a ten-year period when a diversified
investment portfolio didn’t increase in value to some degree. Consequently,
while both buying a home or investing in the stock market to make a quick
profit is far from certain, history tells us that doing either to fill a need
and with a long-term investment horizon is likely to yield a win-win situation.</div>
Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com1tag:blogger.com,1999:blog-8754804495292234538.post-59797542324659856712015-02-24T12:28:00.000-07:002015-02-24T12:28:09.618-07:00The Best Investment of the Last 50 Years<!--[if gte mso 9]><xml>
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One of my favorite writers, Morgan Housel, recently pointed
out the most profitable stock since 1968 in his article titled <a href="http://www.fool.com/investing/general/2015/02/13/the-extraordinary-story-of-americas-most-successfu.aspx" target="_blank">“The Extraordinary Story of America’s Most Successful Industry."</a> Any guesses what it
might be?</div>
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The company with the best performing stock must have
revolutionized the world in some way. The product must have been innovative,
like computers or a cure for a dreaded disease.<span style="mso-spacerun: yes;">
</span>Perhaps it was a small shop that became an international rage. Maybe it
was a company that has been on the cutting edge for the last five decades.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
As sound as those assumptions are, they are all incorrect.
The best performing stock since 1968 is Altria, the cigarette company. While $1
invested in the S&P 500 in 1968 would now be worth $87, $1 invested in
Altria at the same time would now be worth $6,638. That is an annual return of
20.6% for a 47 year period. Not bad!</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
I mention Altria not to discuss the impact of buying an
addictive substance or the role of ethics in investing, but as a perfect
example of the benefits of diversification. </div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
When thinking about the process of investing, it is human nature
to think of the factors mentioned in our guesses – the sexy ingredients to
success like technology or the garage shop going global. These are typical
descriptions of growth-style companies. Growth companies usually utilize their
profits to improve their systems, reach, or products. Further developing their
infrastructure and merchandise allows them to grow faster and generate more
revenue, and ultimately, more profits. This benefits investors in that the
price of the company’s stock increases as its ability to generate additional
profits increases.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Value-style companies are different. Value companies sell
products and services that no longer require significant ongoing innovation.
Consequently, rather than using profits to continue to expand, value companies
payout the majority of their profits in the form of dividends to shareholders. While
growth companies are new and exciting, value companies are frequently old and
quite boring. As you might imagine, cigarettes are essentially the same today
as they were 50 years ago.<span style="mso-spacerun: yes;"> </span>However, since
the tobacco industry hasn’t required a large expense to continually upgrade
their product, an unusually high proportion of revenues have been paid out to
owners of the stock. </div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Clearly, an exciting new product that everyone must have and
quickly generates tremendous profits makes a good growth company.<span style="mso-spacerun: yes;"> </span>A good value company, on the other hand, is a
company that earns mediocre profits for an extended period of time. Remember,
to be effective compound interest requires long holding periods. Thus, Altria
is a perfect example of a value-style company.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
So is investing in value stocks a more profitable strategy
than investing in growth companies? As always when investing, the answer is “it
depends.” As <a href="https://www.fidelity.com/learning-center/trading-investing/trading/value-investing-vs-growth-investing" target="_blank">Fidelity points out</a>, value stocks did in fact outperform growth
stock for the 30 year period ending in 2010, with large cap value earning an
average annual return of 11.66% while large cap growth earned 9.91% annually
over the same time period. Further, large cap value stocks endured less
volatility over this period, with a standard deviation of 15.78 as opposed to
the standard deviation of 21.89 for large cap growth stocks.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
However, since 1990, large cap growth has made more than 34%
during a calendar year six times, while large cap value has accomplished that
feat only once, and we don’t want to miss out on all those exciting growth
companies that are on the cusp of changing the world, right? Fortunately, the
point of diversification is to hold uncorrelated assets in our portfolio so
that when one asset category goes through rough times, other asset categories
might maintain or even increase in value. Investing in assets that respond
differently to various market events ultimately reduces volatility in our
portfolio as a whole, and thus, reduces risk. For this reason, growth stocks
are a wonderful compliment to value stocks.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
The Dow Jones US Large Company Growth Index has performed surprisingly
different from the Dow Jones US Large Company Value Index in various market
environments since 1990:</div>
<br />
<br />
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<b style="mso-bidi-font-weight: normal;">1990</b></div>
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<div class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;">
<b style="mso-bidi-font-weight: normal;">1991</b></div>
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<div class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;">
<b style="mso-bidi-font-weight: normal;">1992</b></div>
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<div class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;">
<b style="mso-bidi-font-weight: normal;">1993</b></div>
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<b style="mso-bidi-font-weight: normal;">1998</b></div>
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<b style="mso-bidi-font-weight: normal;">1999</b></div>
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<b style="mso-bidi-font-weight: normal;">2000</b></div>
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<b style="mso-bidi-font-weight: normal;">Large Growth</b></div>
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0%</div>
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47%</div>
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4%</div>
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3%</div>
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42%</div>
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35%</div>
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<span style="color: red;">-25%</span></div>
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<b style="mso-bidi-font-weight: normal;">Large Value</b></div>
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<span style="color: red;">-8%</span></div>
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26%</div>
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<div align="center" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: center;">
11%</div>
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<div align="center" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: center;">
17%</div>
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<div align="center" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: center;">
15%</div>
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8%</div>
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1% </div>
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<table border="1" cellpadding="0" cellspacing="0" class="MsoTableGrid" style="border-collapse: collapse; border: none; mso-border-alt: solid windowtext .5pt; mso-padding-alt: 0in 5.4pt 0in 5.4pt; mso-yfti-tbllook: 1184; width: 51%px;">
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<br /></div>
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<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 13.44%;" valign="top" width="13%">
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<b style="mso-bidi-font-weight: normal;">2001</b></div>
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<div class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;">
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6%</div>
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2%</div>
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9%</div>
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11%</div>
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37%</div>
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15%</div>
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12%</div>
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22%</div>
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2%</div>
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17%</div>
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<span style="font-family: "Calibri","sans-serif"; font-size: 11.0pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">While
investing in companies on the verge of changing the world is exciting and
worthwhile, don’t forget about the dull value companies with a tried-and-true
business model and established market for their products or services. Due to
lower expenses and higher dividend payout ratios, these value companies can be
just as lucrative as those sexy growth investments. Fortunately, the benefits
of diversification make holding both of these positions together more value
than owning either by itself. </span>Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com2tag:blogger.com,1999:blog-8754804495292234538.post-76958946823351081522015-02-17T16:57:00.000-07:002015-02-17T16:59:51.490-07:00How Recent Events Hinder Your Return<!--[if gte mso 9]><xml>
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<![endif]-->Investors should be conscious of the recency bias when
developing their portfolio. The recency bias is the habit to assume recent
trends in market activity will continue well into the future. For example, an
investor might have the tendency to overweight large cap stocks in 2015 just
because large cap stocks were the big winner in 2014, significantly
outperforming small cap and international equities.<span style="mso-spacerun: yes;"> </span>This is dangerous because purchasing the asset
category that has recently done well is frequently the equivalent of buying
something when it is overvalued rather than positioning yourself to benefit
from the market’s future movements.<br />
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<br /></div>
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In another example, Tony Robbins recently published a new
book titled <i style="mso-bidi-font-style: normal;">MONEY Master the Game: 7
Simple Steps to Financial Freedom</i> which falls prey to an increasingly
popular version of the recency bias. Mr. Robbins worked with famous hedge fund
manager Ray Dalio to create the so-called “All Weather” investment strategy.
The asset allocation for the strategy is:</div>
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<br /></div>
<div class="MsoListParagraphCxSpFirst" style="margin-left: 40.9pt; mso-add-space: auto; mso-list: l0 level1 lfo1; text-indent: -.25in;">
<span style="font-family: Symbol; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7.0pt "Times New Roman";">
</span></span></span>30% Stocks</div>
<div class="MsoListParagraphCxSpMiddle" style="margin-left: 40.9pt; mso-add-space: auto; mso-list: l0 level1 lfo1; text-indent: -.25in;">
<span style="font-family: Symbol; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7.0pt "Times New Roman";">
</span></span></span>40% Long-term Bonds</div>
<div class="MsoListParagraphCxSpMiddle" style="margin-left: 40.9pt; mso-add-space: auto; mso-list: l0 level1 lfo1; text-indent: -.25in;">
<span style="font-family: Symbol; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7.0pt "Times New Roman";">
</span></span></span>15% Intermediate-Term Bonds</div>
<div class="MsoListParagraphCxSpMiddle" style="margin-left: 40.9pt; mso-add-space: auto; mso-list: l0 level1 lfo1; text-indent: -.25in;">
<span style="font-family: Symbol; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7.0pt "Times New Roman";">
</span></span></span>7.5% Gold</div>
<div class="MsoListParagraphCxSpLast" style="margin-left: 40.9pt; mso-add-space: auto; mso-list: l0 level1 lfo1; text-indent: -.25in;">
<span style="font-family: Symbol; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7.0pt "Times New Roman";">
</span></span></span>7.5% Commodities</div>
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<br /></div>
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As Mr. Robins points out, the All Weather portfolio has
performed quite well during the last 30 years. From 1984 through 2013, this
portfolio averaged an annual return of 9.7%, achieved a positive return in 86%
of calendar years, and never suffered a loss worse than -3.9% during a calendar
year. Not bad!<br />
<br /></div>
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However, these backdated results create a significant error
due to the recency bias. Unfortunately, these investment results reflect only
the past 30 years, which happens to represent the strongest bond bull market in
history. Assuming bonds will have an equally strong 30-year period going
forward is questionable at best and destructive at worst. In fact, as
investment analyst Ben Carlson showed, the same All Weather portfolio only
returned 5.8% annually during the much longer time period of 1928 to 1983.</div>
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<br /></div>
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Of course, my point is not that Tony Robbins’ book isn’t
worthwhile, or that the All Weather portfolio is a poor investment.<span style="mso-spacerun: yes;"> </span>In fact, all of Mr. Robbins’ seven steps are
sound financial practices, such as learning to invest in your future, keeping
investment fees low, setting realistic rate of return goals, diversifying, and creating
a retirement plan. Additionally, the All Weather portfolio may actually be an
appropriate investment for investors who don’t need much return to achieve
their retirement goals and are most interested in minimizing risk.</div>
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<br /></div>
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My point, however, is that we should not let the recency
bias skew our expectations for our investment portfolios going forward. It
could be catastrophic if an investor assumed they would achieve a 9.7% annual
return during retirement utilizing the All Weather portfolio only to have the
historic rally in bonds fade out, making that rate of return unachievable.
Similarly, it would be equally damaging to assume a loss of more than -3.9%
isn’t possible, since examining results before 1983 tells us that this
portfolio has lost as much as -17.5% in a calendar year.</div>
<br />
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The recency bias can cause us to make unproductive
modifications to our portfolios based on recent market movements. Further, over-weighting recent investment results and trends can lead to unrealistic expectations
for our portfolios’ risk and return levels. These behaviors can be destructive
to an investment strategy. Always be aware of our tendency to overweight recent
market trends and resist the temptation to let them negatively impact your long-term
investment strategy.</div>
<br />Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com0tag:blogger.com,1999:blog-8754804495292234538.post-35045381432904159852015-02-04T11:47:00.000-07:002015-02-04T11:47:52.566-07:00Diversification Strikes Back<!--[if gte mso 9]><xml>
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<br />
<div class="MsoNormal">
Let’s revisit the investment year of 2014:</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<span style="mso-tab-count: 1;"> </span>-S&P
500 (large cap stocks): +13.69%<br />
<span style="mso-tab-count: 1;"> </span>-Russell 2000 (small cap
stocks): +4.89%<br />
<span style="mso-tab-count: 1;"> </span>-iShares MSCI EAFE
(international stocks): -7.09%</div>
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<br /></div>
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These returns caused a lot of confusion and frustration
among investors. A well diversified investor who allocated a third of their
portfolio into each of these asset categories achieved a return of only 3.83%
during the year. Meanwhile, most people use only large cap indexes such as the
Dow Jones Industrial Average, the NASDAQ, or the S&P 500 as a metric for
how markets are performing. Consequently, after hearing how these large cap
indexes obtained double digits returns during the year, it was challenging for
some investors to comprehend why their portfolios obtained returns of only a
fraction of what these well known indexes earned. In fact, some investors
started to wonder why they own any investments other than large cap U.S.
stocks.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Now let’s examine investment returns during the first month
of 2015 (thru January 29<sup>th</sup>):</div>
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<br /></div>
<div class="MsoNormal" style="text-indent: .5in;">
-S&P 500 (large cap stocks):
-1.73%<br />
<span style="mso-tab-count: 1;"> </span>-Russell 2000 (small cap
stocks): -1.16%<br />
<span style="mso-tab-count: 1;"> </span>-iShares MSCI EAFE
(international stocks): +2.38%</div>
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<br /></div>
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As you can see, 2015 asset category performance is
essentially inversely related to how the asset classes performed in 2014. Large
cap stocks, the best performing asset category in 2014, has so far been the
worst asset category in 2015, while international stocks, 2014’s biggest loser,
has been 2015’s biggest winner.</div>
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<br /></div>
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These figures provide a useful reminder of the value of
diversification. In January, while large cap stocks lost -1.73% a diversified
portfolio with a third of all funds invested in each asset category would have
only lost -0.17%. </div>
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<br /></div>
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For this exercise, let’s annualize January’s returns. In
this case, the large cap portfolio would suffer an annual loss of -20.76% while
a diversified portfolio with a third of all funds invested in each asset
category would have lost -2.04% during a full year. While this isn’t an
optimistic projection for 2015, it illustrates the value of both
diversification and investing for the long term.</div>
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<br /></div>
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The last step in our exercise is to examine the 2014-2015
investment period we have now created, in which our large cap portfolio earned
13.69% in 2014 and lost -20.76% in 2015 while our diversified portfolio made
only 3.83% in year one but lost only -2.04% in year two:</div>
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<br /></div>
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After 2014</div>
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After 2015</div>
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Invest $10,000 in Large Cap Stocks</div>
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$11,369</div>
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<b style="mso-bidi-font-weight: normal;">$9,008</b></div>
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Invest $10,000 in Equally Weighted Portfolio</div>
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$10,383</div>
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<b style="mso-bidi-font-weight: normal;">$10,171</b></div>
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<br /></div>
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<span style="mso-spacerun: yes;"></span>Assuming $10,000 were
invested in each of these strategies, at the end of our two-year period the
large cap portfolio would be worth $9,008.79 and the diversified portfolio
would be worth $10,171.19.</div>
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<br /></div>
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Of course, we have no idea whether large cap stocks will
continue to decline throughout the year, or if international stocks will
continue increasing in value, but that is the point! Our hypothetical scenario reminds
us that as investors, we should be investing with a focus on the long-term.
Consequently, our goal should never be to obtain the largest return over a
short time period, but rather to achieve the best investment performance
possible over an extended time period while minimizing the volatility of our
returns. Examining market history provides example after example concluding
that maintaining a well diversified portfolio is the best method to achieving
this goal.</div>
Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com0tag:blogger.com,1999:blog-8754804495292234538.post-74575675434518298142015-01-30T11:56:00.000-07:002015-01-30T11:59:24.311-07:00Fundamental Strategies for Saving Money<!--[if gte mso 9]><xml>
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I recently watched a movie titled <i style="mso-bidi-font-style: normal;">Living on One</i>, a documentary about four college students’ efforts
to spend a summer in Guatemala living on a dollar a day. (The movie is
available on Netflix and is worth an hour to view.) As 50% of the citizens of
Guatemala live on less than a dollar a day, the film explored the personal
finance habits of people who have a hard time earning enough money to live on,
much less save.</div>
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<br /></div>
<div class="MsoNormal">
My favorite segment of the film discussed the concept of
savings clubs, a popular strategy in less developed areas of the world. To
illustrate how a savings club might work, consider a group of 12 individuals
who each agree to save $12 every month. However, each member contributes their
$12 of savings to the group every month, and one of the twelve members keeps
the full sum of $144. The member taking the lump sum alternates each month, so
that consequently, every member of the club receives $144 once per year.</div>
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<br /></div>
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As you likely already see, the purpose of the savings club
is not to achieve investment growth. Each member contributes a total of $144 to
the club each year (12 contributions of $12), and every member receives $144
once per year in return. So what’s the point?</div>
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<br /></div>
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The point is that in the arena of personal finance, it is
often more beneficial to receive a large lump sum occasionally than to receive
a smaller amount more consistently. In Guatemala, a large lump sum can be used
to purchase a stove to cook food, while in more developed parts of the world a
lump sum might be used to purchase a car or as a down payment on a home. The
$144 lump sum is more valuable than simply saving $12 for 12 months because
humans find it difficult to save money they have access to. Having smaller
amounts of money available that can spontaneously be spent on nice dinners,
vacations, or other small ticket items can ultimately be a drag on a person’s
savings efforts.</div>
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<br /></div>
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Another benefit of the savings club is that they force
individuals to prioritize savings.<span style="mso-spacerun: yes;"> </span>If a
member of the club can’t contribute their $12 during any given month, they are
kicked out of the group and will not collect the $144 lump sum they have been
counting on. A factor that motivates savings is indescribably beneficial. Most
people earn a salary, pay bills and have fun with that salary, and intend to
save any funds that are leftover. Unfortunately, for most people very little is
left after maintaining their standard of living, so very little gets saved.
When we prioritize saving, we earn our salary, achieve our savings goal as soon
as income is received, and find a way to live off what is left. This tactic
ensures we are saving the amount required to meet our financial goals.</div>
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<br /></div>
<div class="MsoNormal">
So a savings club both enables individuals to save while
removing access to the funds that are put away, and forces members to
prioritize saving by imposing negative consequences if savings goals aren’t
met. Sound like any savings vehicles that you might use?</div>
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<br /></div>
<div class="MsoNormal">
Employer-sponsored retirement plans like 401ks, 403bs, and
457s create the same driving factors as savings clubs. For example, 401k plans
enable us to contribute relatively small sums of money to our savings
consistently while removing our access to those saved funds by charging us a
10% penalty if we withdraw the money early. Further, a 401k forces us to
prioritize saving by contributing to the savings before we even receive our
paycheck. By taking the 401k contribution out of our salary before we even
receive it, we are certain to save the percentage of our salary that we choose
as our goal. Of course, employer-sponsored retirement plans are superior to the
primitive savings clubs in that they allow us to invest in stocks and bonds, so
their goal is not only savings but growth on those savings.</div>
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<br /></div>
<div class="MsoNormal">
Still, I find these savings clubs fascinating because they
highlight the most important and basic strategies to successful saving.<span style="mso-spacerun: yes;"> </span>If you’re looking to ramp up your savings,
the best things you can do is eliminate your access to the funds you set aside
and create a motivation to place savings ahead of spending.</div>
Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com3tag:blogger.com,1999:blog-8754804495292234538.post-6690286521066120862014-12-31T12:28:00.001-07:002014-12-31T12:28:32.175-07:003 Wacky Stock Market Predictions for 2015<!--[if gte mso 9]><xml>
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To be clear, this article doesn’t contain any stock market
predictions. Rather, the point of the article is in its title. This time of
year, you’ll see many articles with similar titles and segments in the
financial media with comparable themes. As Josh Brown points out in his most
recent book, <i style="mso-bidi-font-style: normal;">Clash of the Financial
Pundits</i>, this concept is one of the most widely used tricks among market
forecasters.</div>
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<br /></div>
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Making a stock market prediction that comes true often turns
into a gold mine for the prognosticator. How often do you see a guest that
predicted the 2008 crash, or even the tech bubble bursting in 2000, as a guest
on CNBC or CNN? The financial media loves having guests who were once right on
their shows because they bring viewers. Even if the same analyst predicted
another crash every year between 2009 and 2014 and was completely wrong each
time, people still listen to their opinion on the market’s future because they are
promoted as the genius who accurately predicted the big crash. Of course, being
known as the person who predicted the 2008 market crash is good for business,
and these people will milk that singular accurate forecast for years.</div>
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<br /></div>
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So how do people who earn a living guessing the direction of
the market maintain their credibility even though they make many more inaccurate
predictions than forecasts that actually come true? They write articles or
appear on television segments with titles such as “10 Outrageous Market
Forecasts” or “Potential Surprises for 2015.” By making predictions through
this medium, if the guesses don’t work out the prognosticator can claim they
were all in good fun or potential surprises, not expectations. However, if the
predictions come to fruition the forecaster can claim he got everything right
and benefit from years of being known as the analyst who accurately predicted
the future. Essentially, making predictions this way creates a no-lose scenario
for the author.</div>
<div class="MsoNormal">
<br /></div>
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As Mr. Brown makes clear, the lesson is that clever market
pundits couch their predictions in outrageousness. The public will forgive
inaccuracy masked as wackiness while we’ll hypocritically be impressed by what
looks like foresight, even if it arrives packaged as a surprise.</div>
<div class="MsoNormal">
<br /></div>
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Another trick that market forecasters employ is the art of
disguising predictions as suggestions. For example, a prognosticator might say
“The Fed should cut interest rates by 25 basis points.” Of course, if the Fed
does cut rates, the forecaster can say it is exactly what he told investors to
expect. Meanwhile, if interest rates aren’t reduced, the pundit can always say
the economy would have been much better off if the Fed had done as he suggested
and cut rates.</div>
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<br /></div>
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Perhaps the most blatant trick is forecasters saying
something “could” happen. This morning I heard a pundit on CNBC say that Yelp
“could” go up 60% in 2015. Of course, Yelp “could” also go down 60% in 2015 and
if it does, the pundit will take no blame for pointing investors in the wrong
direction because he only pointed out that it was possible Yelp could have a
good year. On the other hand, if Yelp does well in 2015 the forecaster will be
promoted as the sage who predicted the big move.</div>
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<br /></div>
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Virtually every market analyst who made an accurate
prediction has declared twice as many prophesies that didn’t come true.
However, they’ve learned and utilized tricks that enable them to take credit
for the minority of forecasts that become correct while avoiding responsibility
for the majority of predictions that are inaccurate. Watch for people who use
these techniques and give them no credence.</div>
Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com0tag:blogger.com,1999:blog-8754804495292234538.post-66872513583870850692014-12-01T12:13:00.000-07:002014-12-01T12:13:38.247-07:00Have a Taxable Investment Account? Time to Harvest<!--[if gte mso 9]><xml>
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<br />
<div class="MsoNormal">
Tax harvesting is the process of selling assets for the
purpose of creating either long-term capital gains or losses to minimize your
tax bill. This procedure is usually conducted near the end of a calendar year. While
many people are familiar with the concept of tax loss harvesting, fewer people
are familiar with the more recently developed<span style="mso-spacerun: yes;">
</span>process of tax gain harvesting. Between these two procedures, virtually
everyone with a taxable (not tax-advantaged) investment account should make
adjustments to their portfolio before the year ends.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<b style="mso-bidi-font-weight: normal;">Why Qualifies For the
0% Capital Gains Rate?</b></div>
<div class="MsoNormal">
<br /></div>
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First, it is important to understand that capital gains (the
growth on investments within a taxable, non retirement investment account) are
taxed differently than ordinary income (wages, pensions, Social Security, IRA
distributions, etc.). While short-term capital gains (recognized on the sale of
assets held less than a year) are essentially considered ordinary income, long
term capital gains, or recognized gains on assets held more than a year, are
taxed at advantageous tax rates. While ordinary income tax rates range from 10%
to 39.6%, capital gains tax rates range from 0% to 20%.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Second, it is crucial to understand what enables a taxpayer
to qualify for the 0% capital gains rate. If a taxpayer is in the 10% or 15%
ordinary income tax bracket, they qualify for the 0% long-term capital gains
rate. For a married couple filing jointly, the 15% tax bracket ends at $73,800
of taxable income ($36,900 for single taxpayers). Thus, if a married taxpayer
has a taxable income (which includes long-term capital gains but is also after
deductions and exemptions) of less than $73,800, all their long-term capital
gains will be tax free. If the taxpayer is in a tax bracket anywhere between
25% and 35% (taxable income of $73,800 and $457,600, or between $36,900 and
$406,750 for single tax filers), they will pay long-term capital gains taxes at
15%. Only those in the top tax bracket of 39.6% (married taxpayers with a
taxable income over $457,600 and single taxpayers with taxable income over
$406,750) will pay capital gains taxes at 20%.</div>
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<br /></div>
<div class="MsoNormal">
<b style="mso-bidi-font-weight: normal;">Tax Loss Harvesting</b></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
During the calendar year, assets have been purchased and
sold in most taxable investments accounts. The sale of an asset creates a net
gain or loss, both having tax implications. Investors should have an
understanding of what their long-term capital gains tax rate will be so they
can determine whether a taxable gain or loss is preferable.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
For instance, an individual who does not qualify for the 0%
capital gains tax rate may wish to minimize the amount of taxable gains they
recognize during the course of the year, which would reduce their tax bill. If
the investor currently has a net long-term capital gain (which is probable
after the strong year the market had in 2013), then it is likely worthwhile to sell
any assets in the portfolio that are currently worth less than the investor’s
purchase price. This tax loss harvesting would reduce the net gain recognized during
the year and lower the investor’s tax bill.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
In some cases, by taking advantage of all potential losses
within a portfolio an investor has the ability to negate all capital gains
created during the year, completely eliminating their capital gains tax bill.
Further, the IRS will allow investors to recognize a net capital loss of up to
a -$3,000 per year. This -$3,000 loss can be used to lower the taxpayers ordinary
income. This is particularly advantageous in that the capital loss reduces a
type of income that is taxed at higher tax rates.</div>
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<br /></div>
<div class="MsoNormal">
<b style="mso-bidi-font-weight: normal;">Harvesting Gains</b></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Harvesting gains from a taxable portfolio is a more recently
developed concept. Once the 0% long-term capital gains tax rate became a
permanent part of the tax code with the passing of the American Taxpayer Relief
Act of 2012 (signed January 2<sup>nd</sup>, 2013), in some scenarios it began
making sense to recognize long-term capital gains on purpose to potentially
avoid a larger tax bill in the future.</div>
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<br /></div>
<div class="MsoNormal">
Suppose a taxpayer’s taxable income is consistently $65,000
a year. Additionally, suppose our hypothetical taxpayer won’t withdraw funds
from his taxable account during the next few years, but may need a large lump
sum distribution five years down the road. Recall that the 0% capital gains
rate ends when a married taxpayer’s taxable income (which includes long-term
capital gains) exceeds $73,800. Consequently, this hypothetical taxpayer has
the ability to recognize $8,800 ($73,800 - $65,000) in long-term capital gains
every year without increasing his tax bill. If this $8,800 in gains is
recognized every year by simply selling and immediately repurchasing
appreciated assets, he would raise the cost basis of his investment by $44,000
($8,800 gain recognized annually for five straight years). He could then sell
and withdraw that $44,000 without creating a tax liability.</div>
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<br /></div>
<div class="MsoNormal">
Alternatively, if the investor does not harvest gains during
the years when no distributions are taken, withdrawing $44,000 of gains five
years down the road would create a sizable tax bill. He would still be able to
recognize $8,800 of gains tax free in the year of distribution, but the
remaining $35,200 of gains would cause his taxable income to be over the
$73,800 limit, eliminating access to the 0% capital gains rate. <span style="mso-spacerun: yes;"> </span>That $35,200 would be taxed at the 15% capital
gains rate, creating a federal tax bill of $5,280. With proper planning, this
significant tax bill can be avoided. </div>
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<br /></div>
<div class="MsoNormal">
<b style="mso-bidi-font-weight: normal;">The Bottom Line</b></div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Tax harvesting has no purpose in tax-advantaged retirement accounts
such as IRAs and 401ks because all distributions from these accounts are taxed
as ordinary income. However, taxable individual or trust investment accounts
can almost certainly benefit from tax harvesting. Speak to your accountant and financial
planner to understand whether capital gains or losses are desirable for you
this year and determine the amount of taxable gains already recognized. This
will help you determine what type of harvesting should take place.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Tax harvesting can be a difficult and confusing concept.
However, a competent financial planner who utilizes this procedure within your
taxable investment account can significantly lower your tax bill. Speak to your
adviser to ensure you are reaping the tax benefits available to you.</div>
Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com10tag:blogger.com,1999:blog-8754804495292234538.post-16239214781407603742014-11-24T13:56:00.000-07:002014-11-24T13:56:01.904-07:00My 2015 Market Forecast: All Forecasts Will be Wrong<!--[if gte mso 9]><xml>
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<br />
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<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; mso-fareast-font-family: "Times New Roman";">The investment media is a rare
industry in which professionals are rewarded for making bold projections but
never punished for being wrong. The more outlandish a pundit’s forecast the
more attention it receives. Yet, surprisingly little consideration is given to
how accurate the prediction turns out to be.</span></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; mso-fareast-font-family: "Times New Roman";">At the beginning of 2014, there were
some widely-accepted expectations regarding the investment environment. Let’s review
those predictions and analyze how precise they really were.</span></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; mso-fareast-font-family: "Times New Roman";">Interest Rates</span></b></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; mso-fareast-font-family: "Times New Roman";">In a study conducted by Bloomberg at
the beginning of the year, all 72 economists surveyed predicted higher interest
rates and falling bonds prices in 2014. Consequently, investors were
questioning whether they should reduce or eliminate the bond portion of their
portfolios until the rate increase occurred.</span></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; mso-fareast-font-family: "Times New Roman";">So have we experienced this rise in
interest rates? On January 1st, 2014, the yield on the 10-year Treasury note
was 3 percent. On November 13th, the yield on the same note was 2.35 percent.
That's right -- interest rates actually decreased significantly during the year.
As a result, intermediate U.S. government bonds (ticker - IEF) produced a
return of 7.38% during the year. Not bad for the conservative portion of your
portfolio!</span></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; mso-fareast-font-family: "Times New Roman";">Quantitative Easing</span></b></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; mso-fareast-font-family: "Times New Roman";">The most widely promoted fear among
forecasters was that the phasing out of the Federal Reserve’s quantitative easing
(QE) program would diminish stock returns. Prognosticators worried that the Fed
would lower the amount of loans the government would buy from commercial banks,
thus reducing the amount of money available for new businesses to borrow leading
to less innovation and the creation of fewer jobs.</span></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; mso-fareast-font-family: "Times New Roman";">So was the reduction of quantitative
easing a legitimate fear? In fact, this possibility came to fruition. In
December of 2013, the Federal Reserve was buying $85 billion of financial
assets from commercial banks each month. The Fed reduced this amount during
every meeting it held this year, finally eliminating the action completely in
October.</span></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; mso-fareast-font-family: "Times New Roman";">However, the elimination of
Quantitative Easing did not have a negative impact on the unemployment rate,
which declined from 6.7% in January to 5.8% in October. Further, the S&P
500 has gained 12.31% year-to-date (as of 11/13/14). </span><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt;">Clearly, fading
out the Quantitative Easing program didn’t have the negative impact on stocks
that many pundits expected.</span></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt;">Increased
Volatility</span></b></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt;">Another
widely held viewpoint at the beginning of the year was that 2014 was likely to
be more volatile than anything experienced in 2012 or 2013. There was talk
about valuations and P/E ratios being too high, concern about the war in
Ukraine (ISIS wasn’t even in the headlines yet), and endless noise about
unfavorable weather patterns impacting the market.</span></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt;">So
has 2014 been a wild ride? Since 1929, the S&P 500 has experienced either a
rise or a decline of more than 1% during 23% of trading days. In 2014, the
S&P 500 moved more than 1% only 15% of the time. Less movement equates to
less volatility, so again forecasters were inaccurate.</span></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt;">2015 Forecasts</span></b></div>
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<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt;">Bloomberg
News recently published a story titled <i style="mso-bidi-font-style: normal;">Predictors
of ’29 Crash See 65% Chance of 2015 Recession, </i>in which the grandson of a
prognosticator who luckily forecasted the Great Depression is still getting
attention for a guess his grandfather made 85 years ago. If giving credence to
forecasters isn’t ridiculous enough, suggesting there is a gene for forecasting
is insane!</span></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt;">The
article doesn’t mention that the same grandson made similar headlines with the
same forecast in both 2010 and 2012; of course, those predictions did not work
out so well. You will start hearing many 2015 projections soon, so pay no heed. </span></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<b style="mso-bidi-font-weight: normal;"><span style="font-family: "Times New Roman","serif"; font-size: 12.0pt;">Ignore the
Pundits</span></b></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt;">The
most significant lesson inherent in these numbers is that market expectations
are essentially useless. Despite their abysmal track record, the news media
loves forecasters because they capture attention and fill space. Unfortunately,
pundits making projections are rarely held to their inaccurate forecasts and
are allowed to continue making a living showing they have no greater knowledge
than the average investor. </span></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<br /></div>
<div class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto;">
<span style="font-family: "Times New Roman","serif"; font-size: 12.0pt; mso-fareast-font-family: "Times New Roman";">Of course, this is not to say that
interest rates will never rise, that bond values will never decline, and that
the market won't return to the roller coaster it is. In fact, all those things
are certain to happen. Unfortunately, anyone who contends to know “when” likely
doesn't actually know anymore than you or me. For this reason, having and
sticking to a diversified investment strategy that coincides with a detailed
financial plan is the most probable path to financial success.</span></div>
Anonymoushttp://www.blogger.com/profile/10939823763782896284noreply@blogger.com0