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Stop Worrying… Embrace the Security Freeze

The recent cybersecurity attack that hit the credit reporting agency Equifax has been called the worst data breach in the history of the modern era.  While this may be true, it’s likely your data was stolen long before the Equifax fiasco.    

A majority of Americans (64%) had already experienced at least one type of data theft, before the Equifax breach was reported, according to Pew Research Center.  Most are unaware.  

If you ever used Yahoo mail, you were likely part of the Yahoo data breach, announced in 2016, that impacted an estimated 1 billion user accounts.  Or perhaps you had your health insurance with Anthem, who reported in 2015 that as many as 80 million current and former customers had been impacted.

Earlier this year the U.S. Office of Personnel Management announced that data on 4 million government employees was compromised.  A few weeks later, Sally Beauty, a nationwide retailer, announced that they found their customer information available for sale on a Russian website.  It was the same website that offered stolen credit card data in the wake of the massive data breaches at Home Depot and Target.   

Cleaning up after your identity is stolen can be a nightmare.  My suggestion is that you use the recent Equifax disclosure as a wake-up call.  Get out in front of this problem before discovering that someone opened a new credit card or filed for a phony tax refund in your name.    

If your response is to do what each of the breached organizations suggest — to take them up on one or two years’ worth of free credit monitoring services — you might sleep better at night but you will probably not be any more protected against crooks stealing your identity.  Credit monitoring services aren’t really built to prevent ID theft.  The most you can hope for from a credit monitoring service is that they give you a heads up when ID theft does happen, and then help you through the excruciating process of getting the credit bureaus and/or creditors to remove the fraudulent activity and to fix your credit score.

In short, if you have already been victimized by identity theft (fraud involving existing credit or debit cards is not identity theft), it might be worth paying for these credit monitoring and repair services or sign up for any free services offered by the offenders.  If you are not offered free monitoring and would prefer not to pay monthly fees for the rest of your life to LifeLock or a similar service, and don’t mind putting up with a myriad of ads, there is a free alternative.  Go to CreditKarma.com to sign up for a free account and you’ll get access to free credit monitoring. If they notice any suspicious activity, you’ll get an alert.  Plus, Credit Karma also gives you free access to your credit scores and reports, as well as tips on what factors are impacting your credit.

If you want to be more proactive, a monitoring service is simply not enough.  I strongly advise you to consider freezing your credit file at the major credit bureaus. 

There is shockingly little public knowledge or education about the benefits of a security freeze, also known as a “credit freeze.” Also, there is a great deal of misinformation and/or bad information about security freezes available online.  As such, I thought it best to approach this subject in the form of a Q&A, which is the most direct method I know how to impart knowledge about a subject in way that is easy for readers to digest.


Q:  What is a security freeze?

A:  A security freeze essentially blocks any potential creditors from being able to view or “pull” your credit file, unless you affirmatively unfreeze or thaw your file beforehand.  With a freeze in place on your credit file, ID thieves can apply for credit in your name all they want, but they will not succeed in getting new lines of credit in your name because few if any creditors will extend that credit without viewing your credit file first.  And because each credit inquiry caused by a creditor has the potential to lower your credit score, the freeze also helps protect your score, which is what most lenders use to decide whether to grant you credit when you truly do want it and apply for it. 

 

Q:  What’s involved in freezing my credit file?

A:  Freezing your credit involves notifying each of the major credit bureaus that you wish to place a freeze on your credit file.  This can usually be done online, but in certain circumstances you may need to contact one or more credit bureaus by phone or in writing.  Once you complete the application process, each bureau will provide a unique personal identification number (PIN) that you can use to unfreeze or “thaw” your credit file should you need to apply for new credit in the future.  Depending on your state of residence and your circumstances, you may also have to pay a small fee to place a freeze at each bureau.  There are four consumer credit bureaus, including Equifax, Experian, Innovis and Trans Union When you do a credit freeze, it is imperative that you freeze your credit with all three bureaus.

 

Q:  How much is the fee, and how can I know whether I have to pay it?

A:  The fee ranges from $0 to $15 per bureau, meaning that it can cost upwards of $60 to place a freeze at all four credit bureaus (recommended).  However, in most states, consumers can freeze their credit file for free at each of the major credit bureaus if they also supply a copy of a police report and in some cases an affidavit stating that the filer believes he/she is or is likely to be the victim of identity theft.  In many states, that police report can be filed and obtained online.  The fee covers a freeze as long as the consumer keeps it in place.  Equifax has a decent breakdown of the state laws and freeze fees/requirements.  Also, if you were subject to the recent Equifax breach, Equifax will waive their freeze fee for the first year.

 

Q:  What’s involved in unfreezing my file?

A:  The easiest way to unfreeze your file for the purposes of gaining new credit is to spend a few minutes on the phone with the company from which you hope to gain the line of credit to see which credit bureau they rely upon for credit checks.  It will most likely be one of the major bureaus.  Once you know which bureau the creditor uses, contact that bureau either via phone or online and supply the PIN they gave you when you froze your credit file with them.  The thawing process should not take more than 24 hours.

 

Q:  I’ve heard about something called a fraud alert. What’s the difference between a security freeze and a fraud alert on my credit file?

A:  With a fraud alert on your credit file, lenders or service providers should not grant credit in your name without first contacting you to obtain your approval — by phone or whatever other method you specify when you apply for the fraud alert.  To place a fraud alert, merely contact one of the credit bureaus via phone or online, fill out a short form, and answer a handful of multiple-choice, out-of-wallet questions about your credit history.  Assuming the application goes through, the bureau you filed the alert with must by law share that alert with the other bureaus.  Consumers also can get an extended fraud alert, which remains on your credit report for seven years. Like the free freeze, an extended fraud alert requires a police report or other official record showing that you’ve been the victim of identity theft.

 

Q:  Why would I pay for a security freeze when a fraud alert is free?

A:  Fraud alerts only last for 90 days, although you can renew them as often as you like. More importantly, while lenders and service providers are supposed to seek and obtain your approval before granting credit in your name if you have a fraud alert on your file, they’re not legally required to do this.

 

Q:  If I thaw my credit file after freezing it so that I can apply for new lines of credit, won’t I have to pay to refreeze my file at the credit bureau where I thawed it?

A:  It depends on your state. Some states allow bureaus to charge $5 for a temporary thaw or a lift on a freeze. However, even if you have to do this once or twice a year, the cost of doing so is almost certainly less than paying for a year’s worth of credit monitoring services. The Consumers Union has a handy state-by-state guide listing the freeze and unfreeze fees.

 

Q:  Is there anything I should do in addition to placing a freeze that would help me get the upper hand on ID thieves?

A:  Yes; periodically order a free copy of your credit report. By law, each of the three major credit reporting bureaus must provide a free copy of your credit report each year — via a government-mandated site: annualcreditreport.com. The best way to take advantage of this right is to make a notation in your calendar to request a copy of your report every 120 days, to review the report and to report any inaccuracies or questionable entries when and if you spot them.

 

Q:  I’ve heard that tax refund fraud is a big deal now. Would having a fraud alert or security freeze prevent thieves from filing phony tax refund requests in my name with the states and with the Internal Revenue Service?

A:  Neither would stop thieves from fraudulently requesting a refund in your name.  However, a freeze on your credit file would have prevented thieves from using the IRS’s own Web site to request a copy of your previous year’s tax transcript — a problem the IRS said led to tax fraud on 100,000 Americans this year and that prompted the agency to suspend online access to the information.  If you become the victim of identity theft outside of the tax system or believe you may be at risk due to a lost/stolen purse or wallet, questionable credit card activity or credit report, etc., the IRS recommends that you contact their Identity Protection Specialized Unit, toll-free at 1-800-908-4490 so that the IRS can take steps to further secure your account.

The IRS issues taxpayer-specific PINs for people that have had issues with identity theft.  If approved, the PIN is required on any tax return filed for that consumer before a return can be accepted. To start the process of applying for a tax return PIN from the IRS, check out the steps at this link.  You will almost certainly need to file an IRS form 14039 (PDF), and provide scanned or photocopied records, such a driver’s license or passport.  Understand, however, that the IRS does not approve all PIN requests, and the approval process seems to be quite delayed and haphazard at best.

 

Q:  Okay, I’ve got a security freeze on my file, what else should I do?

A:  It’s also a good idea to notify a company called ChexSystems to keep an eye out for fraud committed in your name. Thousands of banks rely on ChexSystems to verify customers that are requesting new checking and savings accounts, and ChexSystems lets consumers place a security alert on their credit data to make it more difficult for ID thieves to fraudulently obtain checking and savings accounts.  For more information on doing that with ChexSystems, see this link

 

Q: If I freeze my file, won’t I have trouble getting new credit going forward? 

A: If you’re in the habit of applying for a new credit card each time you see a 10 percent discount for shopping in a department store, a security freeze may cure you of that impulse. Other than that, as long as you already have existing lines of credit (credit cards, loans, etc) the credit bureaus should be able to continue to monitor and evaluate your creditworthiness should you decide at some point to take out a new loan or apply for a new line of credit.

 

Q:  How do I get started?

A:  Here are detailed instructions on how to freeze and thaw your credit with each agency:

EQUIFAX CREDIT FREEZE

  • Credit freezes may be done online or by certified mail – return receipt requested.
  • Check your state’s listing for the exact cost of your credit freeze and to see if there is a reduction in cost if you are a senior citizen.
  • Request your credit freeze by certified mail using this sample letter. Please note the attachments you must include.
  • If your PIN is late arriving, call 1-888-298-0045. They will ask you for some ID and arrange for your PIN to be sent to you in 4-7 days.
  • Unfreeze: Do a temporary thaw of your Equifax credit freeze by snail mail, online or by calling 1-800-685-1111 (N.Y. residents dial 1-800-349-9960).
  • Info on freezing a child’s credit with Equifax can be found here.
  • If requesting a freeze by mail, use the following address:
      • Equifax Security Freeze
        P.O. Box 105788
        Atlanta, GA. 30348

EXPERIAN CREDIT FREEZE

  • Credit freezes may be done online; by certified mail – return receipt requested; or by calling 1-888-EXPERIAN (1-888-397-3742). When calling, press 2 then follow prompts for security freeze.
  • Check your state’s listing for the exact cost of your credit freeze and to see if there is a reduction in cost if you are a senior citizen.
  • Request your credit freeze by certified mail using this sample letter. Please note the attachments you must include.
  • You can also freeze a child’s credit report. The information contained at this link is applicable for all three credit bureaus. You must first write a letter to each bureau to learn if your minor child has a credit report and if so, then you can proceed to freeze it.
  • Unfreeze: Do a temporary thaw of your Experian credit freeze online or by calling 1-888-397-3742.
  • Info on freezing a child’s credit with Experian can be found here.
  • If requesting a freeze by mail, use the following address:
    • Experian
      P.O. Box 9554
      Allen, TX. 75013

TRANSUNION CREDIT FREEZE

  • Credit freezes may be done online, by phone (1-888-909-8872) or by certified mail – return receipt requested.
  • Check your state’s listing for the exact cost of your credit freeze and to see if there is a reduction in cost if you are a senior citizen.
  • Request your credit freeze by certified mail using this sample letter. Please note the attachments you must include.
  • Unfreeze: Do a temporary thaw of your TransUnion credit freeze online or by calling 1-888-909-8872.
  • Info on freezing a child’s credit with TransUnion can be found here.
  • If requesting a freeze by mail, use the following address:
    • TransUnion LLC
      P.O. Box 2000
      Chester, PA 19016

 

Q:  Anything else?

A:  Beware of related phishing & other scams.  Criminals will use every tactic they’ve got to take advantage of this situation.  With so many Americans worried about whether their information was exposed and if they are at risk, crooks are going to tap into that fear in order to trick you into handing over your personal information.

If your information was not exposed, you still may receive a fake email, text or phone call from a criminal offering to help or asking for your information to either determine whether you were affected by the Equifax hack or to help you protect yourself.

But even if you fall for one of these scams, with a credit freeze in place, the criminals won’t be able to carry out fraud in your name.

With scams related to the hack expected to pop up everywhere, here are some tips to help you protect yourself, your money and your identity:

  • ID thieves like to intercept offers of new credit and insurance sent via postal mail, so it’s a good idea to opt out of pre-approved credit offers. If you decide that you don’t want to receive prescreened offers of credit and insurance, you have two choices: You can opt out of receiving them for five years or opt out of receiving them permanently.  To opt out for five years: Call toll-free 1-888-5-OPT-OUT (1-888-567-8688) or visit www.optoutprescreen.com. The phone number and website are operated by the major consumer reporting companies.To opt out permanently: You can begin the permanent Opt-Out process online at www.optoutprescreen.com. To complete your request, you must return the signed Permanent Opt-Out Election form, which will be provided after you initiate your online request. 
  • Be wary of unexpected emails containing links or attachments: If you receive an unexpected email claiming to be from your bank or other company that has your personal information, don’t click on any of the links or attachments. It could be a scam. Instead, log in to your account separately to check for any new notices.
  • Call the company directly: If you aren’t sure whether an email notice is legit, call the company directly about the information sent via email to find out if it is real and/or if there is any urgent information you should know about.
  • If you do end up on a website that asks for your personal information, make sure it is a secure website, which will have “https” at the beginning (“s” indicates secure).
  • Look out for grammar and spelling errors: Scam emails often contain typos and other errors — which is a big red flag that it probably didn’t come from a legitimate source.
  • Never respond to a text message from a number you don’t recognize: This could also make any information stored in your phone vulnerable to hackers. Do some research to find out who and where the text came from.
  • Don’t call back unknown numbers: If you get a missed call on your cell phone from a number you don’t recognize, don’t call it back. Here’s what you need to know about this phone scam.

If your questions weren’t answered here or you need additional guidance, give me a call or send an email.  I want to help.


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When is your Financial Independence Day?

On July 4, 1776, a small band of colonial leaders declared independence from the Kingdom of Great Britain.  The American Revolution changed the course of world history forever and launched a nation that no other has since rivaled. 

In the spirit of the heroes of the American Revolution, would you be willing to consider declaring your own revolution...your Declaration of Financial Independence? 

5 Stages of Wealth

To get where you want to go you need to know two things.  You need to know where you are and you need to know where you want to end up.  Let's set the context by describing what I call, the five stages of wealth.

Wealth Stage 1.  Your cash flow (including your paycheck) is sufficient to pay all of your bills (on time!) plus consistently invest 10% of your gross income. This puts you on the pathway to financial independence. 

Wealth Stage 2.  Cash flow from your investments is equal to your earnings contributions (10% of gross pay).  I call this 'one to one'...where for each dollar you are contributing to your long-term investment program, the pot of money you've created is also projected to contribute (earn) a dollar.  For example, you're investing $10,000 per year and your investment portfolio of $120,000 is expected to have total average earnings of $10,000 per year (over the long term). 

Wealth Stage 3.  Expected cash flow from investments is equal to your paycheck.  Congratulations!  You are financially independent!  At this point, you would expect to be able to tap your investments each month for an amount that would cover your expenses (including inflation) indefinitely.  For example, if it takes $4,000 per month to pay your bills and you had a portfolio of stocks and bonds worth $1,200,000; using a 4% annual withdrawal rate you should be able to meet your current and future lifestyle expenses. 

Wealth Stage 4.  Cash flow from your investments is equal to two-times the income needed to pay your bills.  We define this as 'Wealthy'.  You now have enough cash flow from investments to pay all your bills with a substantial margin which allows you to raise your lifestyle, make charitable and family gifts, etc. 

Wealth Stage 5.  Cash flow from your investments is five-times or more what is needed to pay your bills.  We define this as 'Rich'.   

Which wealth stage best represents your situation?  When I was describing the 5 Stages of Wealth to one client, he said, "I'm not at stage one yet.  How would you describe that stage?"  "Financial stress," was my reply.  If you're having trouble paying your bills or are not saving and investing at least 10% of your gross income for the long term you're either in la-la land or feeling stressed out.

If you are not where you should be at this point in time, here are a few tips to get you started:

1.  Automate your investment program:  Ten percent of gross income is the minimum needed to put you on the path to financial independence so just do it!  Start with a a repetitive monthly contribution to a Roth IRA and your employer's retirement program, particularly if they match contributions. 

2.  Attack bad debt:  Bad debt is anything you borrow money to buy that is expected to go down in value.  First commit to avoid creating any new bad debt, then put in place a plan to automatically pay off your debt as fast as you can.

3.  Adjust your lifestyle:  Adjust your spending patterns to compensate for items number one and two above.

4.  Hire a coach:  Accelerate your success by hiring a coach, someone who has the experience to take you further, faster.  If you wanted to transform your fitness and physical appearance, hiring a nutritionist and personal trainer would be a good place to start.  In the financial world consider hiring a Certified Financial Planner™ practitioner

At the time, the idea of a small group of colonialists taking on the world's mightiest country would have seemed impossible.  They proved anything is possible to those with vision and an unwavering commitment to never give up until they achieved success. 

If you decide what you want, set in motion a plan to achieve it, and never give up until the deed is done, you, too, can create the life of your dreams!  Happy Fourth of July!

Bill

 

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Market Pullbacks May Not Be Worth Waiting For

By William Neubauer, CFP MBA, Comprehensive Money Management

I have noticed that many retail investors are currently sitting on cash and waiting for an opportunity to get back in the market. Many of these people either pulled their money out of the market after the Financial Crisis, or raised cash before or after significant political events like Brexit, or the US and European elections.

Psychologically, the degree of cash on the sidelines can cause an investor to join the ‘gloom and doom’ camp, where they no longer cheer for economic progress, but rather look forward to the next economic shortfall or political misstep to justify their bearish positioning.

Some in this camp may have felt their prayers were being answered on May 17, when the S&P 500 registered its steepest decline since September 9 and finally appeared to be taking in all the news coming out of Washington. However, those hopes for a more significant pullback were quickly dashed over the rest of the week as the S&P 500 recovered more than 50% of its decline, and MSCI EAFE made new multi-year highs.

With so much money on the sidelines or hiding in low-risk assets and a lack of market weakness, I think there are two questions worth asking: 1) Is a market pullback likely? and, 2) Is a pullback worth waiting for?

Is a pullback likely?

I believe with fairly high conviction that over the next 12-18 months, the market is likely to experience a pullback. However, I am skeptical that such a pullback will be at the time, to the degree, or for the reasons that many investors have been expecting. One reason I do not prefer significant cash holdings is that the next pullback may happen from higher levels and therefore not present an entry price that is any lower than where the market stands today. A second reason I think investors with cash could be disappointed is that I do not envision a pullback that will be deep enough to justify the decision many investors made when raising cash last summer or fall. That is because, in our view, the recent and significant improvements in economic data and political landscapes around the world have created greater unease for those with cash on the sidelines. Investors with high cash now appear more determined to get invested, leading to pullbacks that have been both shorter and shallower than normal, which can be seen in the two charts below

Finally, a pullback may not come for the reasons many investors expect. The old saying “a watched pot never boils” has an application to markets, in our view. Markets are most affected by the unexpected, and investors are becoming accustomed to Trump’s war with the media. With so much media attention currently focused on President Trump, the market is constantly assessing the likelihood of his administration achieving their economic agenda. For example, small-caps and material stocks, which were viewed as the obvious and disproportionate beneficiaries of Trump’s tax and infrastructure plans, have already retraced 80-100% of their relative post-election gains. In fact, we may have gotten close to the point that the bigger surprise to Wall Street would be the President’s economic agenda getting back on track.

Is a pullback worth waiting for?

I believe the answer is “no” for investors with time horizons beyond five years. That is because, for investors with longer time horizons, I believe successful timing of a market entry or exit level (market timing) can be difficult, costly, ultimately may not materially impact long-term returns, and may conflict with the efforts of an investment manager.

Market Timing is Difficult:  Market timing, which involves dramatic shifts in a portfolio’s asset allocation based on the price movements of a market, is notoriously hard. Professional market timers  regularly admit that only about half of their trades are profitable. I do not regard the tactical portion of our investment process as market timing, since our trades are typically smaller shifts and generally based on reasons that extend beyond simple price movements.

The experience of market timers is less predictable than that of long-term investors, who have historically benefitted from the fact that the US large-cap stocks have risen in value 62 months out of 100 since 1926 (source: CRSP). The odds have been even better for investors when market valuations are close to fair value when measured by our Price Matters® methodology, as they are now (Table 1). Given the different investment experiences of these two groups of investors, it begs the question, why would a long-term investor accept historically poorer odds by trying to time the market?

Table 1: Returns of Large-Cap Stocks When Valuations Are Close to Fair Value (plus or minus 10%) Using CMMS’s Price Matters® Methodology

Source: Riverfront Investment Group, calculated based on data from CRSP 1925 US Indices Database ©2017 Center for Research in Security Prices (CRSP), Booth School of Business, The University of Chicago. Data from Jan 1926 through March 2017.

Market Timing Can Be More Costly in Today’s Environment:  When an investor is being “paid to wait” as their cash is accumulating interest at the bank or yield on short-term bonds, the long-term costs of market timing can be less punitive. However, today’s low interest rate environment does not pay an investor to wait, and in fact, I believe it imposes somewhat of a penalty on money that remains on the sidelines. With short-term rates at less than 1% and inflation running over 2%, as measured by the Consumer Price Index (ex-food and energy), cash on the sidelines loses purchasing power every day it remains idle.

Market Timing May Not Materially Impact Returns of Long-Term Investors: In our view, the longer an investor’s time horizon, the less important market timing is. I believe the old Wall Street adage that “successful investing is not about timing, but about time in” holds merit for most long-term investors for two reasons. First, over long time horizons, the US stock market has generally recovered its losses, as evidenced this year with most broad US market indexes hitting all-time highs. Second, long-term investing gives the investor the benefit of experiencing what Albert Einstein called “one of the most powerful forces in the universe”: compound interest. Compound interest allows a $100 dollar investment growing at 10% annually to return more than 6.7 times an investor’s initial money after 20 years. Investors who employ market timing tend to be un-invested or underinvested more frequently and are thus unlikely to experience the full benefits of compound growth. Table 2 shows how missing out on the first 1, 2 or 3 years of a 20-year time horizon can impair potential long-term returns. In our view, the risks posed by a strategy focused solely on market timing are simply not worth the potential return for the long-term investor. If done successfully, the positive impact to the portfolio is unlikely to be significant; but, if done unsuccessfully, the negative repercussions could be substantial.

Table 2: Compound Interest: Investing early can make a big difference in long-term returns

Market Timing Can Conflict With the Efforts of an Investment Manager:  The motivation for waiting on the sidelines is often a result of investors feeling like they already missed out on a bull market. While it may be true that some markets can hit levels of overvaluation that make them poor investments, investment managers with broad mandates are paid to identify and seek to avoid those markets.  At CMMS, we have been reducing our exposure to US equities, recognizing that the US bull market is now 9 years old, and I have been buying equities in developed markets outside the US, such as Europe and Japan, where I believe valuations are still considerably cheaper than they are in the United States.

An Alternative Strategy to Market Timing

Long-term investing deserves entry and exit strategies that are consistent with the investor’s goals and objectives and are based on a sounder footing than one’s ability to forecast market movement over short periods of time. I believe the goal of a long-term investor should be to get invested as soon as possible, while minimizing the risk of committing all their capital prior to a significant market pullback.

There are a number of strategies that can be used to accomplish this goal, and the strategy I have devised blends what I believe to be the best ideas from several strategies and tailors them to the long-term investor. It is a three-pronged plan I describe as: Immediately, Opportunistically, and Eventually.

·        Immediately: Based on our view that the US market is around fair value and markets outside the US remain ‘cheap’, I prefer an approach of putting a portion of our cash to work immediately.

·        Opportunistically: After not experiencing a pullback of greater than 3% thus far in 2017,I believe there is probably a pullback on the horizon. Therefore, I am inclined to hold onto a portion of our cash for an opportunity to invest at lower levels. Considering the short and shallow nature of pullbacks over the past six months, I set modest pullback targets of 3-6%.

·        Eventually: For the final portion of cash, I often set a date or series of dates over the next 3 to 6 months to invest the remaining proceeds. Once the dates are selected, I believe it is important to adhere to the investment discipline regardless of the market levels at those times.

 

William Neubauer, CFP, MBA

Comprehensive Money Management Services LLC

Additional Sources: 

Doug Sandler, CFA at ETF Strategist Channel

Charts by Riverfront Capital 

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2017: Party Like It’s 1999?

…or… How I Learned to Stop Worrying and Love Volatility (with credit to Dr. Strangelove)

Why are we so diversified?  Why so many different asset classes?  Aren’t US stocks the best place to be?  Shouldn’t we be more aggressive?  These are a few of the questions I’ve fielded recently with ever greater frequency as the bull market in US stocks enters its ninth year----an unusually long period for any asset class to rise without a serious correction. 

The frequency of the questions reflects a degree of complacency in investor psychology that is typical of the final years of a bull market.  It may also reflect wavering conviction in the wisdom of broad diversification after a period when US stocks have performed much better than other asset classes as they have in recent years. 

We all have short memories. 

The more time that passes between market crashes, the less we remember the pain.  Continually rising markets and double digit increases begin to feel normal.  That sets the stage for greater risk taking and unhappy endings.  Ultimately the paradigm will shift and reality will hit hard.  The timing and the triggers are rarely guessed accurately in advance, but the likelihood that serious corrections will occur is nearly guaranteed.  Sh*t happens---roughly every 6 to 12 years throughout history.  In recent years we had drops averaging more than 40% in 1973, 1981, 1987, 2000, 2008.  The longer the period between serious corrections, the harder the fall.  We’re now entering year 9.

It’s not “different this time”.

This slogan was popularized in 1999 to justify extraordinarily high stock valuations.  It turned out not to be correct.  It’s never different this time.  High valuations reduce future returns, it’s as simple as that.  They also increase the risk of a major crash.  That is why we diversify.  Diversification acts as a shock absorber.  Most of the asset classes we own have long term “average expected returns” of 5% to 10% per year, each with its own degree of volatility.  Individually, they can provide a very rough ride.  Collectively the ride is much smoother. 

Diversification is a free lunch

Diversification allows you to decrease the risks you face in investing without decreasing your expected returns.  To see why, imagine you are considering two investments, both of which are expected to appreciate at 10% on average, but which have a 1 in 5 chance of going down in value by as much as 50%. If you buy just one of these investments, there is a 20% chance that you will lose half of your money.  But if you buy them both (assuming they are perfectly uncorrelated), the chance of losing half of your money falls to only 4%, while your expected return is still 10%.  Keep adding asset classes?   The more uncorrelated asset classes you add, the lower your chance of losing half your money.  Why?  Because only rarely do they all have bad years in the same year.  

Learn to love volatility

Volatility can add to long term returns when it is used to our advantage.  We follow a disciplined asset allocation and rebalancing strategy that forces us to consistently sell high and buy low, always returning to our original target percentages.  Volatility creates the opportunity to do just that.  Multitudes of studies demonstrate that this discipline adds between 1% and 3% annually to long term returns over long periods of time.  The more the volatility, the greater the excess return.  Most of these studies use rolling ten year periods as their definition of long term. 

Trust Data, Not "Predictions."

Many people approach investing as a series of "predictions”… like "I just have this feeling that the stock market is going to go up in the next six months." The problem with this is that even the so-called "experts" have a horrendous record at making these kinds of predictions about the direction of the market. To put it charitably, they are wrong more often than they are right. 

Suffice it to say that none of the evidence suggest that it is wise to pay too much attention to the average commentator's "feelings" about the stock market. 

Invest for 2017, not 1999. 

An alternative approach is to try to avoid making predictions and to invest based on what the data tells us and what we know to be true about the markets.  For instance, we know the kinds of portfolios that have performed the best in the past, we know that the returns we get from buying an asset in the future will be inversely related to the price we are paying to get it, and we know something about the way that markets work.  We can compile all of these "truths" and data into a framework that will let us make rational decisions about what to invest in without the need to make any hand-waving predictions.

Consider the Math.

The magic of compound interest is pretty impressive. If you can generate a 7% average return for 10 years, you will double your money. In 20 years your money will quadruple. In 30 years it will increase in value by a factor of 8.  In 40 years it will increase in value by a factor of 16. 

But compound interest has a downside as well. If you sit through a bear market and your portfolio takes a 50% decline, then you need a 100% increase to make up for this.  If your portfolio falls by 75%, then you need a 300% increase just to break even.  This could take decades.  But it could be worse.  If you invest 100% of your portfolio in the next Enron and lose everything, you will never break even.  You will never recover from a 100% loss. 

Manage Risk Above All Else. 

It is tempting to say then, that the first rule of investing is don't lose money. But of course, you have to be willing to accept the possibility of a short-term loss in exchange for a long-term gain. But it is essential to understand the size of the risks that you are taking and to actively manage your portfolio to avoid "falling off a cliff" at the wrong time. 

Your portfolios accomplish this in two ways.  First, it remains diversified at all times, since this increases the chance that something in a portfolio will do well no matter the external environment.  Second, we actively control the volatility (size of the swings from a day to day, week-to-week, and month-to-month basis) and make adjustments if this goes outside our expected range.  Managing risks prudently comes first; if we can do that right, the returns will follow. 

Thoughts are Fragile, Systems Last.

Many people, objectively speaking, "know" how to invest. The basics of the subject are not that difficult to understand, and anyone can buy good mutual funds or ETFs from a discount broker like Vanguard, E*Trade, or Charles Schwab.  Yet despite this, many of these same people achieve returns that fall far short of their potential.  Research from Dalbar shows the average investor in the stock market struggles to keep pace with inflation --- this in a market that has gone up an average of 7% a year over the last century. 

The reason most investors fail is simple: inability to execute

Two things tend to fall in the way of even the best-laid investment plans.  The first thing that trips up even well-informed investors is inattention. Many people have great intentions when it comes to investing.  And then life happens.  Kids come along, work heats up, other side-projects or hobbies come along that seem more interesting for a Saturday afternoon than re-balancing a portfolio.  The result is that too often people end up in undiversified portfolios that are in dire need of a rebalancing, or --- worse yet --- not even knowing what they are invested in or where to go to do anything about it. 

The second is psychological mistakes. The human brain came into its present form millennia ago in a hostile environment of lions, tigers, and warring tribes.  The "impulses" that we get through our intuitions may have worked very well in this kind of environment, but they frequently do us harm in the modern-day financial markets.  So in the time they do spend on their investments, individuals too often end up making decisions that cause them active harm, like pulling money out of the markets at a low in 2002 and putting it back in at a high in 2007. 

Luckily, there is a clear solution that makes it easy to execute: use a system. 

Taking a systematic approach to investing takes the emotions and impulses out of investing.  Our "thinking" is mostly at the time of creating the system, rather than in the heat of the moment when we are more likely to make a mistake. 

Our approach systematizes most of the key aspects of investing.  We have a clear plan, defined buy and sell criteria, and routine monitoring for rebalancing opportunities.  That takes emotions out of the process as much as possible.  Best of all, having a system allows you to relax and spend your Saturday afternoons doing things that are more interesting, knowing that someone else is monitoring the system and taking action for you when it is most needed and most effective. 

The challenge to adhering to any system is maintaining discipline and conviction.  

If you abandon a system based on short term disappointment, you don’t have a system at all.  Maintaining discipline and conviction is hard.  Helping you do that is an important part of my job.  Given the strength of the US stock market in recent years as compared to virtually every other asset class, the challenge of maintaining discipline and conviction in a system that requires broad diversification has been especially tough.     

 

Commonly asked Questions

Many of us have a heightened sense of risk as we head into 2017.  For better or worse, rapid political change is producing major uncertainty for the US and abroad.  This is a good time to review your investment strategy and ensure that your confidence and convictions are high enough to survive the volatile period that may be yet to come.  Part of that process is asking questions.  Some of the more common questions I’ve received lately have been addressed in a separate attachment.  I hope you’ll take the time to review them and ask more questions until you are strong and firm in your conviction that we have the right strategy to help you weather any coming storms.

Reading materials:

 

Part 2:  Conviction Building Q & A

Q:  Are we missing lost opportunities by not being more US centric? 

A:  Don’t be fooled by the fact that US stocks have recently had a good run.  Emerging market stocks had a great run 2004 to 2008.  Gold shined even more brightly from 2000 to 2011.  Every asset class eventually has its day in the sun.  Today’s winners become tomorrow’s losers.  The timing may be unpredictable, but the fact that every asset class will spend time at both the top and the bottom of the performance chart is baked in the cake.  Novice investors often fall into the trap of thinking that yesterday’s winners will always be winners, then invent stories to justify the increasingly lofty prices.  “It’s different this time” becomes the rallying cry.  Such investors often navigate through a rear view mirror oblivious to the dangers that lie ahead. 

Most investable asset classes have strong multi-year runs from time to time.  They are inevitably followed by steep declines.  We saw this with silver (1981-1984), US bonds (1981-1987), technology stocks (1997-2000), emerging market stocks (2004-2008), gold (2000-2011), and real estate (2003 to 2007).  All of these periods ended with major givebacks, some as much as 50% or more. 

Q:  I understand that US stocks go down at times (just like everything else) but at some point and historically they bounce right back to their original place and go beyond, right? 

A:  At some point?  True.  If you can patiently wait 10, 20 or even 30 years!  It took more than 25 years for US stocks to recover from the lows of the great depression.  After the crash of 1929 and 1930, US stocks didn’t get back to those same levels until 1957, a full 28 years later!  More recently, after the crash of 2000, it took 10 years for US stocks to get back to their former levels.   http://www.yardeni.com/pub/sp500corrbear.pdf

Q: I understand that 2008 was a trying times for stocks because of the financial meltdown, but when was the last time that happened, in 1930's?

A: Oh no!  Big corrections are the norm, not the exception.  Most individual asset classes, including US stocks tend to get over-extended and suffer a severe correction every 6 to 10 years, sometimes sooner.  For US stocks the corrections of 25% or more occurred in these years:

1929       -47%

1931       -83%

1933       -40%

1934       -32%

1937       -55%

1939       -32%

1942       -35%      

1946       -27%       

1962       -27%       

1968       -36%       

1970       -36%       

1973       -48%     

1981       -27%      8 years after the prior 25%+ correction

1987       -34%      6 years after the prior 25%+ correction

2000       -49%      12 years after the prior 25%+ correction

2008       -57%      8 years after the prior 25%+ correction

2017       ?             9 years and counting.  We’re due!!!

 

 

Given this history, is it any wonder why we choose to broadly diversify?

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Diversification, Discipline and Conviction: The Secret to Taming Fear and Greed

It is well understood in the field of behavioral economics that markets are built as much on human emotion as they are on fundamentals.  During periods of market euphoria, we become over-confident and prone to taking greater risk.  During periods of market gloom, we become despondent and head for the hills.  These behaviors of course are the exact opposite of what prudent investors should be doing.  Buying low and selling high sound very simple, but are nearly impossible to do, especially on a consistent basis.  Market timing holds great psychological appeal, but in the real world it rarely ends well.  Markets can defy logic and go on to become even more overpriced after you sell.  And nobody rings a bell to give the “all clear” sign when markets reach the bottom and let us know when to jump back in.  So given the artificial environment, and the nagging feeling that it won’t end well, what is a prudent investor to do?

Our best hope is to tame our emotions and ride out the ups and downs by building strong conviction around a sound investing discipline.  There is overwhelming evidence that diversification across a very broad spectrum of asset classes (including those that are currently out of favor) is the key.  Your individual asset allocation and return expectations should be based on both your financial and emotional ability to withstand market downturns.  Extreme diversification offers a degree of safety that, while not perfect, does offer some protection to shield us from market extremes.  That’s not a free lunch though.  Diversifying may offer some protection against short term stock markets declines, but it also comes at the cost of not fully benefiting from stock market runs on the upside.  For most of us that’s a small price to pay for greater consistency and increased peace of mind.  Moreover, study after study offer compelling evidence that this approach delivers stronger and more predictable long term returns. 

Yet the urge to fully participate in the euphoric action is too much for many of us to resist.  Many otherwise intelligent people jumped on the bandwagon in 1998-99 to board the tech stock rocket ship, or the second home craze in 2005-07, only to crash and burn. 

Likewise many otherwise intelligent people couldn’t resist the powerful urge to sell their underperforming emerging market stocks, international bonds, commodities and gold at recent market lows, only to lock in real losses, possibly just before the stage is set for another bull market run. 

Fear and greed are inescapable emotions for human beings.  Even intelligent individuals who are very knowledgeable and disciplined can become victims.  That’s why so many professional investment managers have other professional investment managers handle their personal portfolios rather than do it themselves.  They know how easy it is to succumb to these emotions when it is your own money at stake, and where a formal ‘investment policy statement’ no longer rules the day. 

Discipline is hard.  It requires not only a cerebral understanding of the ups and downs of markets and individual asset classes, but pre-emptive emotional preparation to remain calm and focused when markets or individual asset classes go to temporary extremes in either direction.  The secret may be to plan ahead, imagine those periods of extended euphoria or the feeling of the pit in your stomach during horrendous market declines, and rehearse in your mind how you will respond.  If you know that you won’t be able to handle it, take proactive action now by giving me a call to talk about adjusting your exposure to the equity markets.  We’ll discuss if the resulting change in long term return expectations will support or conflict with your long term goals and we’ll make changes if needed.

The Yale endowment philosophy that we follow is part of the solution.  I refer to this as a ‘philosophy” and not a “portfolio” as the approach refers to the practice of spreading your assets across a very wide variety of different asset classes in equal or relatively equal proportions, not to a particular asset allocation formula.  While it hasn’t always been wrapped in the “Yale wrapper”, this philosophy has been what we have followed since founding my firm more than thirteen years ago in 2002.  The philosophy is best known as a result of its successful implementation by David Swenson at Yale University and is now followed by most of the Ivy League university endowments and a growing number of professional investors worldwide.  Its popularity stems from the significant amount of empirical research that demonstrates that it outperforms all other investments models over time. 

This philosophy of extreme diversification over a wide variety of asset classes with relatively equal weighting and routine rebalancing takes advantage of the fact that every asset class eventually has its day in the sun.  It respects the fact that we can’t predict which asset class will take its turn next.  Rebalancing adds incremental return by forcing us to sell a little of the asset classes that are rising and becoming more expensive, and buy a little of those that are falling and becoming better values.  A wide body of independent research offers compelling evidence that this enhances long term returns by a significant sum. 

The practice of diversification, relatively equal weighting and routine rebalancing is widely respected in the academic world as the only reasonable way to participate in the modern investment markets.  Study after study demonstrates its superior long term performance, always beating all other approaches in any rolling 10 year period going back hundreds of years both in the U.S. and abroad.  The philosophy recognizes that none of us, no matter how gifted, can accurately predict the future much less get the timing right for entry and exits to markets or individual asset classes.  Not only is that impossible to get right consistently over time, but it is also unnecessary.  The disciplined approach we follow offers compelling risk adjusted returns for long term investors without all the angst and second guessing that goes into haphazard or trend based strategies that almost always underperform over long periods of time.

The chart below helps to illustrate the unpredictable nature of the markets and the wisdom of owning a little of everything.  You’ll notice that over time every asset class has it’s time near the top.  There is no predictability, only randomness. 

Intuitively you can see what empirical studies so clearly demonstrate; chasing performance by only investing in those things that have already reached the top (rear view mirror investing) is a loser’s game.  Successful investors own all the asset classes and remain patiently focused and disciplined.  They rebalance routinely, harvest losses for tax purposes occasionally, and patiently watch as each asset class eventually takes its place at or near the top.  Embrace the fact that none of us can pick tomorrow’s winners.  Better to own them all.  

Note:  As we face increasing economic and political uncertainty in the fall of 2016, you should take some comfort that we are the guys in white.  

 

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An Interview with Your Advisor

I get a lot of questions about our investment strategy, especially in times like these when a single asset class (US stocks) has been on a tear and virtually everything else has been lagging.  Here are a few of the most common questions and my responses:

Is our strategy working?

The goal of multi-asset diversification is first and foremost to avoid “the big loss” that tends to occur in any one asset class with some regularity every eight or ten years.  The US stock market fell more than 30% in 2000 and about 38% in 2008.  Some think we are now due.  It takes a 60% gain to recover from a 30% loss.  That’s just math.  Most of my clients would find such a loss devastating and don’t have the time or intestinal fortitude to wait out a multi-year recovery just to get back where they started.  Nor is that necessary.  We can achieve market returns with bond-like risk through multi-asset diversification.  Our strategy is working perfectly.  We’ve had average annual returns for the past ten years of 9% across all client portfolios.  The last two years have been light as money has flowed out of other asset classes and into US stocks making them now rather pricey.  No one knows if this will continue, but the longer it does, the more likely pain will follow.  We avoid that pain by maintaining a commitment and discipline to multi-asset diversification.

Is there a downside to multi-asset diversification?

Being diversified across the widest possible array of asset classes means that you’ll never have all of your money in the best performing asset class in any year (of course the reverse is also true!).  The past two years US stocks have had a phenomenal run.  At the same time, most other asset classes had modest single digit returns or were even negative.  Mitigating the risk of a big drop can come at a cost of lower short term performance from time to time, but in the end multi-asset diversification produces superior long term returns over rolling ten year period without the roller coaster ride of very high highs and very low lows from year to year. 

Is this what the Ivy Portfolio is about?

Yes.  David Swenson in his PhD dissertation thirty years ago performed long term studies that demonstrated that multi-asset diversification with routine rebalancing always outperforms all other strategies over any rolling ten year period.  His studies proved that this has remained true over time and all the way back to when records were first kept in 1880’s, both in the US markets and abroad.  His results were so impressive that Yale hired him right out of school to run their multi-billion endowment.  Thirty years later he is still at the helm and has become a legend in the investment world as the top performing investment manager of all time.  Harvard, Stanford and lots of other Ivy League universities now adhere to the discipline of multi-asset diversification, earning the strategy the nickname of “The Ivy Portfolio”. 

How has this strategy performed recently?

The past two years have been all about the US stock market.  The performance of every asset class has paled in comparison.  The period reminds me a lot of 1998 and 1999 when everyone and his brother was concentrating their wealth in US stocks and in US tech stocks in particular.  The words “it’s different this time” ruled the day as US stocks were bid to unsustainable levels.  In 2014, when newscasters announced that “the U.S. stock market hit another new high today”, consider that meant it was just getting back to its former level last reach 15 years earlier!  For those who invested their money in the year 2000, it took 15 years to get back to breakeven!  For those invested heavily in US stocks back in 1998 and 1999, it felt good at the time, but we all know how that ended.  It takes a lot of discipline to avoid the temptation to over-emphasize any one asset class in an investment portfolio.  Succumbing to the temptation to “chase performance” by doubling down on yesterday’s winners almost always ends badly.  Our multi-asset investment discipline provides equity-like returns but with bond-like risk.  It’s the closest thing that we have to a “free lunch” in the investment world.

What happened in the second half of 2014 after starting the year so strong?

Two unexpected and seismic events occurred in late 2014 that were temporary setbacks.  First oil prices fell more than 50% after having been stable for many years.  We own oil in the commodities category of our allocations and also own oil companies in the natural resource category.  Second, the US dollar recorded its largest and fastest gains in recorded history against virtually every currency in the world.  The Euro was at about $1.35 to the dollar and now hovers around $1.09.  That was more than a 20% drop in the Euro versus the US Dollar in just a few months.  The same was true of the Japanese Yen and all other currencies around the world.  So what does that mean to us?  Even if valuations of European and Asian companies remain unchanged in their home currencies, they fell when measured in US dollars.  We own international stocks, bonds, real estate, infrastructure and other assets.  As the dollar rises, the values of these assets fall when measured in US dollars.  Normally currency moves are small and gradual, but the move in 2014 was largest and fastest in our lifetimes.  The big drop in oil prices and the big rise in the dollar combined to erase the double digit returns recorded earlier in the year.  We ended the year with a modest 1% to 2% gain.  The good news is that it is unlikely that this is a continuing and forever trend.  A snapback or reversion to the mean is possible in 2015 or 2016 since big moves in either direction are often overdone.

Commodities and gold have performed poorly recently.  Why are they in our portfolio?

Disciplined multi-asset investing requires a meaningful commitment to non-correlated and negatively correlated asset classes, even those that are currently out of favor.  Including assets that are negatively correlated with the growth assets in our portfolio protects our downside when the winds change.  We have to be prepared for all scenarios.  Commodities and gold are negatively correlated with stocks.  As the US stock market propelled to new highs, commodities and gold moved in the opposite direction.  Yet, despite several years of under-performance, gold remains the best performing asset class over the past fifteen years.  From 2000 to 2010 US stocks were flat, with a return averaging less than 1% per year.  Gold and some commodities recorded annual double digit returns during that same period.  Gold more than tripled over this time span.  None of us know when or if this will occur again.  Trends only become obvious after they are firmly established…  And then they can come to an abrupt end.  By the time inflation starts to show up again, real assets such as real estate, commodities and gold will have already soared to new highs while equities will have rolled over.  We maintain disciplined allocations to all asset classes to maximize upside opportunity and minimize downside risk.  This enhances long term returns, but (by definition) it means that we won’t have everything or most everything in the top performing asset class each year.  The opposite is also true.  We won’t lose big when the winds shift unexpectedly as they always do given enough time, often when valuations are already stretched, making the fall quite painful. 

Is inflation really a concern?

Not at the moment.  In fact deflation seems to be most likely scenario, leading central banks all over the world into “currency wars” to depreciate their currency.  They perform this experiment in an attempt to stimulate their economies, create inflation and gain short term advantage over others.  But this is a zero sum game, with gains in exports achieved by some coming at the expense of reduced exports for others.  Many fear that this one-upsmanship will end badly with rapidly rising prices as people lose faith in paper currencies.  There may be a tipping point when all of this has gone too far.  For that reason, we maintain a healthy 40% commitment to “real assets” that would hold their own when inflation unexpectedly returns or paper money drops in value. 

Most well designed retirement plans can withstand a lower rate of return than originally projected, but very few can withstand much higher inflation.  No rate of return is adequate if prices are rising exponentially.  Unexpected inflation is the most serious and potentially devastating risk for retirees.  We protect against that risk by maintaining a healthy commitment to real assets in your portfolio.

What are “real assets”?

Real assets include things that have intrinsic value like food, water, energy and other basic necessities of life.  They include domestic and foreign real estate, global infrastructure, energy and food commodities, and traditional stores of value such as silver and gold.  Some people also include inflation-protected bonds and natural resource companies under the classification of “real assets”.  We have a healthy amount of all of these things in our multi-asset diversified portfolios.  Unfortunately, a few of them such as oil and gas commodities, natural resource companies and precious metals have been taking it on the chin for a while.  That will change at some point.  Our discipline of not straying from prudent allocations will be what protects us from the sizeable losses that other investors who are more US stock-centric will experience from time to time.    

What are you doing to actively manage my portfolio, add value, and enhance long term returns?

Routine rebalancing, typically once per year, has been proven over and again to add to long term returns.  We sell a little of what has been going up and buy more of what has been going down.  Eventually trends reverse and you are better off now owning more shares than if the volatility had never occurred.  Even more importantly, I regularly perform “tax loss harvesting” to capture taxable losses by selling assets while they are down and replacing them with similar investments that will have similar gains when the rebound occurs.  In the meantime we receive a “free lunch” in the form of a capital loss that reduces your taxable income.  This doesn’t show up in quarterly returns, but often adds more value to your net worth you than you would ever achieve from investment returns alone.

Ultimately though, the most important way I can add value is to help you avoid “the big loss”.  That comes with helping you maintain the discipline of multi-asset diversification even when the powerful human emotions of fear and greed tempt us to deviate from our well designed plan.  Most investors can’t resist this temptation.  They can’t help but compare themselves to their less diversified neighbors who might have a good run every now and then.  They are always selling asset classes when they are down, abandoning well designed strategies when they are temporarily under-performing or changing advisors every time the wind blows in the wrong direction.  This is a sure-fire way to underperform all investors as a group over the long term.  Many people never learn these lessons, always thinking that they just have bad luck or a cloud hovering over them, when in fact they are the ones that seal their own fate.  Trust in the logic and proven history of diversified multi-asset diversification if you want to win the game over time.  Always chasing yesterday’s winners is a losing strategy and the mark of inexperience, lack of knowledge and inability to control our all too human impulses.  None of us can predict the future and none of us can tell which asset class will be next in taking its turn at the top.  Disciplined investing means sticking with a well-crafted plan and routinely rebalancing even when you feel like shaking things up from time to time.  Patience and discipline are always rewarded in the investment world.  Constantly searching for greener pastures is a losing strategy and a sure-fire way to underperform. 

Sometimes a picture is worth a thousand words.  Notice the unpredictability, randomness and extreme moves of individual asset classes.  Relative performance of one to the other can’t be predicted, only explained in retrospect.  Would you rather pick one or two and take a roller coaster ride or maintain a disciplined allocation to them all, making the ride as smooth and predictable as possible?  Your portfolio is very close to the “Asset Class Blend” in white.

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Take the Emotion Out of Investing for Better Returns

What do we know about the basics of investing? Buy low sell high. Diversify.  Invest for the long-term. Sounds easy, but it’s not. Every day I talk to investors who understand these concepts, and yet have difficulty executing them.  For many, this knowledge of what they should do vs what they are able to do on their own is the main reason they seek out a NAPFA-Registered “fee-only” investment advisor to manage their money based on a well-designed long term plan.

The problem with investing starts with our natural inclination to want to own what has done well recently.  It makes us feel better.  It makes for a good story at the cocktail party to say we made a big bet on the latest-greatest investment.  However, recency bias doesn’t make for a good long-term investment strategy.

We also know we need to diversify, but what does that really mean?  It means owning a variety of asset classes, including those that are out of favor.  It means buying some more of these asset classes when they don’t do well.  Investments are cyclical so that today’s must have is tomorrow’s has been.  In other words, a good portfolio has assets that have a negative correlation – when one part of the portfolio goes up another tends to go down.  If everything in your portfolio is going up you’re not diversified.  How else can you buy low and sell high if nothing’s down when something else is up?  It’s no fun watching parts of your portfolio going down, but having the discipline to rebalance with your long-term goals in mind will help drive long-term results.

b2ap3_thumbnail_investing-cycle-of-emotion.png

 

 

Successful long-term investing means not chasing results or trying to time your entry/exit into the market.  The above graphic is a good illustration of what usually happens when we try and do either.  Again, the counterpoint to emotional investing is having a long-term goal and a strategy in place to meet it.  There will be ups and downs along the way, but your goals remain clear.

Unfortunately, our brains are wired to want to chase results and make emotional decisions.  We know we are supposed to buy low and sell high but we’d rather buy into the hot investment (buying high) and then sell it when it doesn’t work out (selling low).  That’s why the average investor will consistently underperform a basic market index.

 

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Source: 2012 DALBAR QAIB Study

Don’t think that professionally managed funds are any better.  87% of large-cap active managers underperformed their benchmark over the prior 60 months.  The same problems that individuals run into when they let their emotions take control and they chase results, occurs when professionals try it as well.  On top of paying higher fees for this ‘professional’ management you’re still likely to get sub-par results.

Certainly sounds appealing then to go to a discount broker and do it yourself.  However, this supermarket approach of picking a few stocks and funds that look appealing to us isn’t much better.  Despite the best of our intentions our cognitive biases, like wanting to follow the crowd and seeking out information that conforms to our beliefs, will come into play.  It is nearly impossible for an individual to be devoid of these emotional biases that inevitably lead to poor investment decisions. At least when you suffer poor performance with a discount broker you’ll be saving on fees.

Emotion-Free Investing Is Hard But Possible

The right approach for investors is to have an advisor manage their money who will focus on a sound long-term investment strategy without chasing short-term results.  Investors need to work with a company that is a fiduciary – that the investor’s best interest will always come first.  Investing in a brokerage house that has an incentive to put your money in their products or products from which they get a kick back is not in your best interest.  Investing with a discount broker that allows you to pick from a buffet of investment choices is not doing you any favors.

And for some peace of mind, turn off the 30-second stock market updates on your phone.  Paying too much attention to the short-term noise in the markets can cause us to make knee-jerk decisions that will be detrimental to our long-term performance.  Better to understand the long-term benefits and strategy of your portfolio and ignore the short-term ups and downs. Coming up with a sound long-term investment strategy – and then keeping your emotions in check and sticking to it – is the best thing you can do to achieve your long-term financial goals.

 

Bill

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Investment Management is Simple, But Not Easy

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The smartest people on Wall Street understand four wonderfully powerful truths about investing.  We could all benefit enormously by adhering to these four great truths:

1.  The dominating reality is that the most important decision is your long-term mix of assets: how much in stocks, real estate, bonds, or cash.

2.  Diversify within each asset class—and between asset classes.  Bad things do happen—usually as surprises.

3.  Resist the temptation to “tinker” with your plan too often.  The discipline to stick with a well-crafted asset allocation plan is often even more important than picking the “right” plan.  Market sentiments change quickly and every dog will eventually have its day.  Selling an asset class at a recent low and increasing your investment in another asset class that has hit new highs is a surefire way to underperform over the long term.  Allow disciplined rebalancing to do the work for you.  Don’t abandon a prudent long term strategy based on short term disappointment, or based on the bravado of friends who had a better year.  They likely are taking too much risk, are insufficiently diversified and will quiet down after their next big loss.  They are also likely underperforming versus you over longer periods of time.

4.  Be patient and persistent. Good things come in spurts—usually when least expected—and fidgety investors fare badly. “Plan your play and play your plan,” say the great coaches. “Stay the course” is also wise. So setting the right course is crucial—which takes you back to number 1.

Curiously, most active investors—who all say they are trying to get “better performance”—do themselves and their portfolios real harm by going against one or all of these truths. They pay higher fees, more costs of change, and more taxes; they spend hours of time and lots of emotional energy; and accumulate “loss leaks” that drain away the results they could have had from their investments if they had only taken the time and care to understand their own investment realities, develop a sensible long-term program most likely to achieve their goals, and stay with it. 

Less experienced investors tend to abandon well-crafted strategies when they are temporarily down, and become over-exuberant and over-confident when they are up.  These emotions are self-defeating in the investment world.

Trying to time the market is the biggest mistake investors make. They sell at the bottom and buy at the top. They get out of stocks when everyone is pessimistic and panic is in the air, and they get in or double down when everyone is optimistic about what is going to happen.  They also make a big mistake by constantly trying to pick those stocks that will outperform.  Few if any are able to do this consistently. 

We are all better off sticking to a disciplined plan based on a broad array of index funds.  The goal is to mirror the world’s financial markets without making any big bets for or against any one of them.  An even better reason for individuals to index is that they are then free to devote their time and energy to the one role where they have a decisive advantage: knowing themselves and accepting markets as they are—just as we accept weather as it is—designing a long-term portfolio structure or mix of assets that meet two important tests:

1.  You can maintain the discipline and live with it through thick and thin.

2.  The long-term “expected results” are likely to achieve your long term goals.  

Changing managers—firing one after a period of short term underperformance and hiring another who has had some recent success—is also self-defeating.  Strategies and tactics that fare well in one short term period typically do poorly in the next.  In the industry this known as “dating” and is widely recognized as an expensive waste of time and energy that should be avoided by all serious investors.

So the great advantage of investors who are wisely concentrating on asset mix decisions is that it helps them avoid the “snipe hunt” of a vain search for “performance” and concentrates their attention on the most important decision in investing—long-term asset mix to minimize the odds of unacceptable outcomes caused by avoidable mistakes and maximize the chances of achieving their investment objectives.

If, as the pundits say, “success is getting what you want and happiness is wanting what you get,” investors—by concentrating on asset mix—can be both successful and happy with their investments by living with and investing by the four simple truths—so investments really do work for and serve them.

Of course, as all experienced investors also know, most individual investors take many, many years, make many mistakes, and have many unhappy experiences to learn these “simple but never easy” truths.

 

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Comprehensive Money Management Services LLC (“CMMS”) is a Registered Investment Adviser located in Coral Gables, Florida. The firm is registered with the State of Florida Office of Financial Regulation. CMMS and its representatives are in compliance with the current filing requirements imposed upon Florida-registered investment advisers and by those states in which CMMS maintains clients.

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