Category: Investment strategy

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Don’t Let These Worry Traps Discourage You From Investing

Have you ever noticed that most of the people who forecast what the stock market is going to do predict that it will either crash, or at least go down sharply? Even when the stock market’s going up there are people who predict the market’s next move is down and that it’s time to head to the sidelines. The fact is that fear sells, that’s why so many prognosticators emphasize the negative.

Of course they have something to sell that will “protect” you from the upcoming catastrophe. If they scare you witless they will sell you gold, annuities, structured products or their newsletters.

It’s easy to be fearful when markets go down and you see the value of your portfolio decline. If the decline is sharp, investors get frightened. If the headlines scream of financial doom, people can panic. To help you cope when fear hits, here’s a list of “worry traps” that you should recognize. Worry traps are phrases that you will recognize because you have heard most of them before. They are part of the playbook that doomsayers bring out to frighten you. Here are four examples:

  • The “sucker’s rally” trap. This never fails. Whenever the market turns down and there’s a move to the upside, any number of people will tell you that it’s a sucker rally. What they’re basically telling you is that if you buy stocks that have been reduced in price you’re a “sucker.” If you listen to them, buying stocks after a dip is foolish. Of course, the way to make money is to buy low and sell high and the only way to do that is to buy stocks when they’re “on sale.”
  • The “Bear Market Rally” trap. This is a variant on the “sucker rally” comment. The problem is that people can’t even agree on the definition of a Bear Market and nobody rings a bell when one ends. The people who use this term will never admit that a Bear Market is over so any recovery after a dip will be called a Bear Market Rally. Listening to this advice is sure to keep you from buying stocks when they’re cheap.
  • The “wise market” trap. Have you ever noticed that financial “experts” are always talking about what “the market is telling us?” The market isn’t an organism and it isn’t telling us anything. It’s a counting mechanism that allows people to participate in the financial affairs of a free market economy. In many cases it’s reacting to the news of the day, which is replaced by the news of tomorrow when the new day dawns. It often reacts to internal market dynamics which have nothing to do with the real world. This is especially true with computer-driven trading. From one day to the next the market is neither rational nor wise which means that investors must take the long view and look at economics as their guide.
  • The “laundry list” trap. This is a list of all the reasons why the market will go down. It’s a laundry list of problems: economic, financial, political, or military that make it hazardous to invest. These currently include slowing global economic growth, Fed policy, political uncertainty, trade issues, Brexit, commodity prices, and regional military conflicts. The problem is that there is always such a list. As problems are addressed, new worries pop up that replace the old. There’s another old Wall Street saying: “Bull markets climb a wall of worry.” Know problems are almost always discounted by the market. It’s the unknown surprises that represent danger.

Most people are psychologically drawn to these common traps. It’s scientifically shown that people withdraw money from their investments at market bottoms and buy at market tops – selling low and buying high. That’s where an experienced financial advisor is worth their weight in gold. They know these traps and how to avoid them.

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The Risks of Do-It-Yourself Retirement Plans

Do-It-Yourself Retirement Planning?

A report recently published by the Federal Reserve Bank on the economic well-being of U.S. households discusses what people have saved for retirement versus what they will actually need, commonly known as the “retirement gap.”  The survey found that only 47 percent of DIY investors were comfortable with handling their own 401(k)s, IRAs or other outside retirement accounts.

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Protecting and Growing Wealth when Nearing Retirement

This was a question asked by a visitor to Investopedia.
Several other advisors responded.  Here’s my contribution to the discussion.
 

You have gotten some good advice from the others who have responded.  The only advice I would add to theirs is that the years just prior to retirement and the first few years of retirement are the most critical years for you.  These are the years when significant investment losses have the biggest impact on your retirement assets.

That’s because of something referred to as “sequence of returns.”  “Sequence of returns” refers to the fact that market returns are never the same from year to year.  For example, here are the returns for the S&P 500 from 2000 to 2010.  That was a dangerous decade for retirees.

2000 -9.1%
2001 -11.9%
2002 -22.1%
2003 28.7%
2004 10.9%
2005 4.9%
2006 15.8%
2007 5.5%
2008 -37.0%
2009 26.5%
2010 15.1%

When you are accumulating assets, the sequence of returns has no impact on the amount of money you end up with.  But when you are taking money out, the sequence becomes very important.  That’s because taking money out of an account exaggerates the effect of a market decline.

If you retired in the year 2000 with $100,000 and took out 4% ($4000) to live on each year, by 2010 your account would have shrunk to about $66,200 and, if you continued to withdraw the same amount each year you would now be taking out 6%.  If you have another 30 years in retirement, that rate of withdrawal may not be sustainable.

For that reason, most financial advisors recommend creating a portfolio that can cushion the effect of poor market performance near your retirement date.

Once you sell out, when do you get back in?

I recently heard about a 62-year-old who was scared out of the market following the dot.com crash in 2000.  For the last 17 years his money has been in cash and CDs, earning a fraction of one percent.  Now, with the market reaching record highs, he wants to know if this is the right time to get back in.  Should he invest now or is it too late?

Here is what one advisor told him:

My first piece of advice to you is to fundamentally think about investing differently. Right now, it appears to me that you think of investing in terms of what you experience over a short period of time, say a few years. But investing is not about what returns we can generate in one, three, or even 10 years. It’s about what results we generate over 20+ years. What happens to your money within that 20-year period is sometimes exalting and sometimes downright scary. But frankly, that’s what investing is.

Real investing is about the long term, anything else is speculating.   If we constantly try to buy when the market is going up and going to cash when it goes down we playing a loser’s game.  It’s the classic mistake that people make.  It’s the reason that the average investor in a mutual fund does not get the same return as the fund does.   It leads to buying high and selling low.  No one can time the market consistently.  The only way to win is to stay the course.

But staying the course is psychologically difficult.  Emotions take over when we see our investments decline in value.  To avoid having our emotions control our actions we need a well-thought-out plan.   Knowing from the start that we can’t predict the short-term future, we need to know how much risk we are willing to take and stick to it.  Amateur investors generally lack the tools to do this properly.  This is where the real value is in working with a professional investment manager.

The most successful investors, in my view, are the ones who determine to establish a long-term plan and stick to it, through good times and bad. That means enduring down cycles like the dot com bust and the 2008 financial crisis, where you can sometimes see your portfolio decline.  But, it also means being invested during the recoveries, which have occurred in every instance! It means participating in the over 250%+ gains the S&P 500 has experience since the end of the financial crisis in March 2009.

The answer to the question raised by the person who has been in cash since 2000 is to meet with a Registered Investment Advisor (RIA).  This is a fiduciary who is obligated to will evaluate his situation, his needs, his goals and his risk tolerance.  And RIA is someone who can prepare a financial plan that the client can agree to; one that he can follow into retirement and beyond.  By taking this step the investor will remove his emotions, fears and gut instincts from interfering with his financial future.

What does planning mean for you?

Financial planning is about more than assets, investments and net worth.  It’s about what you want to do with your money and why.  It’s about identifying your concerns, expectations and goals.  It’s about how you feel and what you want.

Financial planning helps address common fears and concerns such as health care costs, outliving your money and the best time to file for Social Security benefits.

The “Confidence Meter” helps you gauge how likely you are to reach your goals and whether you are on track instead of focusing on headlines.

Financial planning takes your risk tolerance into account.  You will get a “Risk Number” that guides you to the kind of investment you should have.

Learn more about how financial planning can help you by contacting us at Korving & Company today.

Why Your Home is a Poor Investment

Image result for homes

A couple we know moved to a new house recently.  They sold their old for a little more than twice the price they originally paid.  Doubling your money sounds like a great deal, right?

Not so fast.

To determine if the house was a good investment we need to make some calculations.  They originally bought their old home about 33 years ago.  That means that the return on their investment was just 2.4% per year.  To put it in perspective, 33 years ago CD rates were around 10%.  Viewed strictly from an investment perspective, they could have made a better return on their money if they had bought a CD.  And that’s to say nothing of maintenance and upkeep, costs not associated with CDs.

On the other hand, you can’t live in a CD.

How about investing that money in the stock market?  Over that same period the S&P 500 grew 8.5% annually.  That means that every $100 invested in the market 33 years ago would have grown to $1476!

The reason that so many people think that their home is their best investment is that they don’t sell their home very often.  As a result, they look at what they paid and what they sold it for.  If they held it for many years, it usually looks like a big number, and it is. But when viewed strictly as an investment, the annual growth rate is small compared to the alternatives.

As we alluded to earlier, home ownership also involves many other expenses.  There are property taxes and insurance.  Homeowners know that repairs and maintenance are expensive and never ending.  After all of the expenses are taken into account, the real return on home ownership may be even less that our earlier calculation.

But a home is much more than an investment.  It’s a place to live, a place to raise a family, a place to call your own.  A home is a refuge from the rest of the world.  The alternative is renting, wherein you often have more flexibility and are not on the hook for all of the repairs and maintenance.  But it also means that your monthly payment to your landlord is not going into equity that home ownership provides.

We are homeowners and advocates of home ownership.  The point of evaluating the true value of the home as an investment is to bring reality to the financial aspects of home ownership. It’s also a warning against investing too much of our resources in the family home, making many people “home poor.”

What does “diversification” mean?

To many retail investors “diversification” means owning a collection of stocks, bonds, mutual funds or Exchange Traded Funds (ETFs).  But that’s really not what diversification is all about.

What’s the big deal about diversification anyhow?

Diversification means that you are spreading the risk of loss by putting your investment assets in several different categories of investments.  Examples include stocks, bonds, money market instruments, commodities, and real estate.  Within each of these categories you can slice even finer.  For example, stocks can be classified as large cap (big companies), mid cap (medium sized companies), small cap (smaller companies), domestic (U.S. companies), and foreign (non-U.S. companies).

And within each of these categories you can look for industry diversification.  Many people lost their savings in 2000 when the “Tech Bubble” burst because they owned too many technology-oriented stocks.  Others lost big when the real estate market crashed in late 2007 because they focused too much of their portfolio in bank stocks.

The idea behind owning a variety of asset classes is that different asset classes will go in different directions independent of each other.  Theoretically, if one goes down, another may go up or hold it’s value.  There is a term for this: “correlation.”  Investment assets that have a high correlation tend to move in the same direction, those with a low correlation do not.  These assumptions do not always hold true, but they are true often enough that proper diversification is a valuable tool to control risk.

Many investors believe that if they own a number of different mutual funds they are diversified.  They are, of course, more diversified than someone who owns only a single stock.  But many funds own the same stocks.  We have to look within the fund, to the things they own, and their investment styles, to find out if your funds are merely duplicates of each other or if you are properly diversified.

You need to look at a “portfolio x-ray” which will show you how much overlap there is between two or more mutual funds.

Only by looking at your portfolio with this view of diversification can you determine if you are diversified or if you have accidentally concentrated your portfolio without realizing it.

Negative Interest Rates – Searching for Meaning

We have mentioned negative interest rates in the past.  Let’s take a look at what it means to you.

Central banks lower interest rates to encourage economic activity.  The theory is that low interest rates allow companies to borrow money at lower costs, encouraging them to expand, invest in and grow their business.  It also encourages consumers to borrow money for things like new homes, cars, furniture and all the other things for which people borrow money.

It’s the reason the Federal Reserve has lowered rates to practically zero and kept them there for years.  It’s also why the Fed has not raised rates; they’re afraid that doing so will reduce the current slow rate of growth even more.

But if low rates are good for the economy, would negative interest rates be even better?  Some governments seem to think so.

Negative interest rates in Japan mean that if you buy a Japanese government bond due in 10 years you will lose 0.275% per year.  If you buy a 10 year German government bond today  your interest rate is negative 0.16%.   Why would you lend your money to someone if they guaranteed you that you would get less than the full amount back?  Good question.  Perhaps the answer is that you have little choice or are even more afraid of the alternative.

Per the Wall Street Journal:

There is now $13 trillion of global negative-yielding debt, according to Bank of America Merrill Lynch. That compares with $11 trillion before the
Brexit vote, and barely none with a negative yield in mid-2014.
In Switzerland, government bonds through the longest maturity, a bond due in nearly half a century, are now yielding below zero. Nearly 80% of Japanese and German government bonds have negative yields, according to Citigroup.

This leaves investors are searching the world for securities that have a positive yield.  That includes stocks that pay dividends and bonds like U.S. Treasuries that still have a positive yield: currently 1.4% for ten years.  However, the search for yield also leads investors to more risky investments like emerging market debt and junk bonds.  The effect is that all of these alternatives are being bid up in price, which has the effect of reducing their yield.

The yield on Lithuania’s 10-year government debt has more than halved this year to around 0.5%, according to Tradeweb. The yield on Taiwan’s 10-year bonds has fallen to about 0.7% from about 1% this year, according to Thomson Reuters.
Elsewhere in the developed world, New Zealand’s 10-year-bond yields have fallen to about 2.3% from 3.6% as investors cast their nets across the globe.
Rashique Rahman, head of emerging markets at Invesco, said his firm has been getting consistent inflows from institutional clients in Western Europe and Asia interested in buying investment-grade emerging-market debt to “mimic the yield they used to get” from their home markets.
Clients don’t care if it is Mexico or Poland or South Korea, he said, “they just want a higher yield.” ….
Ricky Liu, a high-yield-bond portfolio manager at HSBC Global Asset Management, said his firm has clients from Asia who are willing for the first time to invest in portfolios that include the highest-rated junk bonds.

How and where this will end is anybody’s guess.  In our view, negative interest rates are an indication that central bankers are wandering into uncharted territory.  We’re not convinced that they really know how things will turn out.  We remain cautiously optimistic about the U.S. economy and are staying the course, but we are not chasing yield.

Pink Piggy Bank at the Center of Queation Mark Coins

What’s the Difference Between an IRA and a Roth IRA

A questioner on Investopedia.com asks:

I contribute about 10% to my 401k. I want to know more about Roth IRAs. I have one with my company, but haven’t contributed any percentage yet as I am not sure how much I should contribute. What exactly is a Roth IRA? Additionally, what is the ideal contribution to a 401k for someone making $48K a year?

Here was my reply:

A Roth IRA is a retirement account.  It differs from a regular IRA in two important aspects.  First the negative: you do not get a tax deduction for contributing to a Roth IRA.  But there is a big positive: you do not have to pay taxes on money you take out during retirement.  And, like a regular IRA, your money grows sheltered from taxes.  There’s also another bonus to Roth IRAs: unlike regular IRAs, there are no rules requiring you to take annual required minimum distributions (RMDs) from your Roth IRA, even after you reach age 70 1/2.

In general, the tax benefits of being able to get money out of a Roth IRA outweigh the advantages of the immediate tax deduction you get from making a contribution to a regular IRA.  The younger you are and the lower your tax bracket, the bigger the benefit of a Roth IRA.

There is no “ideal” contribution to a 401k plan unless there is a company match.  You should always take full advantage of a company match because it is  essentially “free money” that the company gives you.

Questions to ask when interviewing a financial advisor

A previous post referred to an excellent article on CNBC about financial advisors .  You first have to consider what kind of financial advice you want or need.

Once you determine the kind of advice you’re looking for, here are some key questions to ask when interviewing the financial advisor.

  • What are the services I am hiring you to perform?

  • What are your conflicts of interest?

  • Identify for me all of the ways you or your firm are compensated by me or by any other party in connection with services rendered to me or my assets.

  • Do you have a fiduciary duty to act in my best interests?

  • Describe your insurance coverage.

We’ll add a few more of our own:

  • What is your investment philosophy?
  • Do you do your own investing or do you use outside firms?
  • What kind of experience do you have?
  • Are your other clients similar to me?

If you don’t get straight-forward answers to these questions, go on to your next candidate.

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