risk management | Financial Planner | Retirement Planning | Korving & Company Suffolk & Virginia Beach

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.

Are you taking more risk than you should?

We often take risks without knowing it. There are some risks that are well known; things like texting while driving or not fastening your seat belt. But there are other risks that are less well publicized and that can hurt you.
As financial professionals we often meet people who are not aware of the financial risks they are taking. While there are countless books written about investing, most people don’t bother studying the subject. As a result, they get their information from articles in the press, advertising, or chatting with their friends.
Many people have told us they are “conservative” investors and then show us investments that have sky-high risks. This is because investment risks are either hiding in the fine print or not provided at all. No one tells you how much risk you are taking when you buy a stock, even of a major company like General Electric. GE is a huge, diversified global company, yet lost 90% of its value between 2000 and 2009. Norfolk Southern is another popular stock in this area. Do you know its “risk number?” You may be surprised.
We have analytical tools that can accurately quantify your risk tolerance and give you your personal “Risk Number.” We can then measure the risk you are taking with your investments. They should be similar. If not, you may find yourself unpleasantly surprised if the investment you thought was “safe” loses its value because you took too much risk.
We have no objection to daredevils who know the risk they are taking by jumping over the Grand Canyon on a motorcycle. But we would caution the weekend cyclist not to try the same thing. Contact us to find your personal “Risk Number” and then determine how much risk there is in your portfolio.

The most common investment mistake made by financial advisors

Bill Miller beat the S&P 500 index 15 years in a row as portfolio manager of Legg Mason Capital Management Value Trust (1991-2005), a record for diversified mutual fund managers. He was interviewed by WealthManagement.com about active vs. passive management.
We have written a number of articles about the mistakes individual investors make. But what about mistakes that financial advisors make? We are, after all, fallible and make errors of judgment. And like all mortals we cannot predict the future.
Here’s Bill Miller’s assessment about traps that financial advisors fall into:

One problem is how they deal with risk. There is a lot more action on perceived risks, exposing clients to risks they aren’t aware of. For example, since the financial crisis people have overweighted bonds and underweighted stocks. People react to market prices rather than understanding that’s a bad thing to do.
Most importantly, most advisors are too short-term oriented, because their clients are too short-term oriented. There’s a focus on market timing, and all of that is mostly useless. The equity market is all about time, not timing. It’s about staying at the table.
Think of the equity market like a casino, except you own it: You’re the house. You get an 8-9 percent annual return. Casinos operate on a lower margin than that and make money. Bad periods are to be expected. If anything, that’s when you want more tables.

We agree. That’s one of the reasons we are choosy about the clients we accept. One of the foremost regrets we have is taking on clients who hired us for the wrong reasons. One substantial client came to us as the tech market was heating up in the late 1990s. He asked us to create a portfolio of tech stocks so that he could participate in the growth of that sector. We accepted that challenge, but it was a mistake. When the tech bubble burst and his portfolio went down and we lost a client. But it taught us a valuable lesson: say no to clients who focus strictly on short-term portfolio performance. Our role is to invest our clients’ serious money for long term goals.
Like Bill Miller, we want to have the odds on our side. We want to be the “house,” not the gambler. The first rule of making money is not to lose it. The second rule is to always observe the first rule.
To determine client and portfolio risk we use sophisticated analytical programs for insight into prospective clients actual risk tolerance. That allows us to match our portfolios to a client’s individual risk tolerance. In times of market exuberance we remind our clients that trees don’t grow to the sky. And in times of market declines we encourage our clients to stay the course, knowing that time in the market is more important than timing the market.

The Biggest Myth About Index Investing

John Bogle has done a great job of “selling” index investing. He started the Vanguard group with the promise that you could invest in the stock market “on the cheap.” It’s the thing that made the Vanguard group the second biggest fund family in the country.

Selling things based on price is always popular with the public. It’s the key to the success of Wal Mart, Amazon, and a lot of “Big Box” stores.

But Bogle based his sales pitch not just on price, but also the promise that if you bought his funds you would do better than if you bought his competition. He cites statistics to show that the average mutual fund has under-performed the index, so why not buy the index?

The resulting popularity of index investing has had one big, unfortunate side-effect. It has created the myth that they are safe.

A government employee planning to retire in the near future asked this question in a forum:

“I plan to rollover my 457 deferred compensation plan into Vanguard index funds upon retirement in a few months. I currently have 50% in Vanguard Small Cap Index Funds and 50% in Vanguard Mid Cap Index Funds and think that these are somewhat aggressive, safe, and low cost.”

The problem with the Vanguard sales pitch is that it’s worked too well. The financial press has given index investing so much good press that people believe things about them that are not true.

Small and Mid-cap stock index funds are aggressive and low cost, but they are by no means “safe.” For some reason, there is a widespread misconception that investing in a stock index fund like the Vanguard 500 index fund or its siblings is low risk. It’s not.

But unless you get a copy of the prospectus and read it carefully, you have to bypass the emphasis on low cost before you get to this warning:

“An investment in the Fund could lose money over short or even long periods. You should expect the Fund’s share price and total return to fluctuate within a wide range.”

The fact is that investing in the stock market is never “safe.” Not when you buy a stock or when you buy stock via an index fund. There is no guarantee if any specific return. In fact, there is no guarantee that you will get your money back. Over the long term, investors in the stock market have done well if they stayed the course. But humans have emotions. They make bad decisions because of misconceptions and buy and sell based on greed and fear.

My concern about the soon-to-be-retired government employee is that he is going to invest all of his retirement nest-egg in high-risk funds while believing that they are “safe.” He may believe that the past 8 years can be projected into the future. The stock market has done well since the recovery began in 2009. We are eventually going to get a “Bear Market” and when that happens the unlucky retiree may find that has retirement account has declined as much as 50% (as the market did in 2008). At some point he will bail out and not know when to get back in, all because he was unaware of the risk he was taking.

Many professional investors use index funds as part of a well-designed diversified portfolio. But there should be no misconception that index investing is “safe.” Don’t be fooled by this myth.

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.

A reader asks: what’s the difference between risk tolerance and risk capacity?

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That’s an interesting question and it depends on who you ask. The investment industry measures risk in terms of volatility, taking the opportunity for both gains and losses into consideration.

I will answer with a focus on losses rather than gains because, for most people, risk implies the chance that they will lose money rather than make money.

Risk tolerance is your emotional capacity to withstand losses without panicking. For example, during the financial crisis of 2008 – 2009 people with a low or modest risk tolerance, who saw their investment portfolios decline by as much as 50% because they were heavily invested in stocks, sold out and did not recoup their losses when the stock market recovered. Their risk tolerance was not aligned with the risk they were taking in their portfolio. In many cases they were not aware of the risks they were taking because they had been lulled by the gains they had experienced in the prior years.

People who bought homes in the run-up to the real estate crash of 2008 were unaware of the risk they were taking because they believed that home prices would always go up. When prices plunged they were left with properties that were worth less than the mortgage they owed.

This exposed them to the issue of risk capacity.

Risk capacity is your ability to absorb losses without affecting your lifestyle. The wealthy have the capacity to lose thousands, millions, or even billions of dollars. Jeff Bezos, founder of Amazon, recently lost $6 billion dollars in a few hours when his company’s stock dropped dramatically. Despite this loss, he was still worth over $56 billion. His risk capacity is orders of magnitude greater than most people’s net worth.

The unlucky home buyer who bought a house at an inflated price using creative financing found out that the losses they faced exceeded their net worth. As a result many people lost their homes and many declared bankruptcy.

There are some new tools available to measure your risk tolerance and determine how well your portfolio is aligned with your risk number. Click HERE to get your risk number.

What’s Your Risk Number?

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Defining how much risk someone is willing to take can be difficult. But in the investment world it’s critical.

Fear of risk keeps a lot of people away from investing their money, leaving them at the mercy of the banks and the people at the Federal Reserve. The Fed has kept interest rates near zero for years, hoping that low rates will cause a rebound in the economy. The downside of this policy is that traditional savings methods (saving accounts, CDs, buy & hold Treasuries) yield almost no growth.

Investors who are unsure of their risk tolerance and those who completely misjudge it are never quite sure if they are properly invested. Fearing losses, they may put too much of their funds into “safe” investments, passing up chances to grow their money at more reasonable rates. Then, fearing that they’ll miss all the upside potential, they get back into more “risky” investments and wind up investing too aggressively. Then when the markets pull back, they end up pulling the plug, selling at market bottoms, locking in horrible losses, and sitting out the next market recovery until the market “feels safe” again to reinvest near the top and repeating the cycle.

There is a new tool available that help people define their personal “risk number.”

What is your risk number?

Your risk number defines how much risk you are prepared to take by walking you through several market scenarios, asking you to select which scenarios you are more comfortable with. Let’s say that you have a $100,000 portfolio and in one scenario it could decline to $80,000 in a Bear Market or grow to $130,000 in a Bull Market, in another scenario it could decline to $70,000 or grow to $140,000, and in the third scenario it could decline to $90,000 or grow to $110,000. Based on your responses, to the various scenarios, the system will generate your risk number.

How can you use that information?

If you are already an investor, you can determine whether you are taking an appropriate level of risk in your portfolio. If the risk in your portfolio is much greater than your risk number, you can adjust your portfolio to become more conservative. On the other hand, if you are more risk tolerant and you find that your portfolio is invested too conservatively, you can make adjustments to become less conservative.

Finding your risk number allows you to align your portfolio with your risk tolerance and achieve your personal financial goals.

To find out what your risk number is, click here .

Why Rebalance Portfolios?

The market rarely rings a bell when it’s time to buy or sell. The time to buy is often the time when people are most afraid. The time to sell is often when people are most optimistic about the market. This was true in 2000 and 2009.

Rather than trying to guess or consult your crystal ball, portfolio rebalancing lets your portfolio tell you when to sell and when to buy.

You begin by creating a diversified portfolio that reflects your risk tolerance. A “moderate” investor, neither too aggressive or too conservative, may have a portfolio that contains 40 – 60% stocks and a corresponding ratio of bonds.

Checking your portfolio periodically will tell you when you begin to deviate from your chosen asset allocation. During “bull” markets your stock portfolio will begin to grow out of the range you have set for it, triggering a need to rebalance back to your preferred allocation by selling from the stock portfolio and using the proceeds to buy more bonds. During “bear” markets your bond portfolio will grow out of its range. Rebalancing at this point will cause you to add to the stock portion of your portfolio, even as emotion is probably urging you in the opposite direction.

If properly implemented and regularly applied, this will allow you to do what every old Wall Street sage will tell you is the way to make money in investing: “Buy Low and Sell High.”

Four “Hidden” Ways We Help Our Clients Save Money

We often tell clients that our long term investment objective is to provide them with a fair rate of return over time while working to minimize the amount of risk they take. Part of that objective is achieved by finding ways to save them money.

Buying the right mutual funds can save clients a lot of money. Many mutual fund families offer the exact same fund in several different “share classes.” The primary difference between each share class is the expenses the fund charges the client. After deciding which fund we want to buy, we choose the least expensive version of that fund. This means that our clients keep a bigger share of the fund’s returns.

We also pay attention to the tax consequences of our investment strategy and work to minimize the taxes that our clients pay at the end of the year. Occasionally we will sell some losing investments to offset gains in other investments. At the end of the day, this allows our clients to keep more of their money.

We help clients understand how much they need to save for retirement.

For example, we might tell them that buying the new luxury car that they really want every three years will mean they have to work for another five years to meet their stated retirement goals. This helps them with their decision making.

Making sure our clients understand how much they can safely spend and where they should take the money for their goals is a key value-added service that we provide.

Are fees really the enemy?

The popular press puts a great deal of emphasis on the costs and expenses of mutual funds and investment advice. I am price conscious and shop around for many things. All things being equal, I prefer to pay less rather than more. However, all things are rarely equal. Hamburger is not steak. A Cadillac is not the same as a used Yugo.

The disadvantage facing most investors is that today’s investment market is not your father’s market. Those words are not even mine; they come from a doctor I was speaking to recently who uses an investment firm to manage his money. His portfolio represents his retirement, and it is very important to him. He knows his limitations and knows when to consult a professional. It’s not that he isn’t smart; it’s that he’s smart enough to realize that he doesn’t have the expertise or the time to do the job as well as an investment professional.

As Registered Investment Advisors, we are fiduciaries; we have the legal responsibility to abide by the prudence rule (as opposed to brokers, who only have to abide by a suitability rule). Some interpret our responsibility as meaning that we should choose investments that cost as little as possible, going for the cheapest option. But do you always purchase something exclusively on the lowest cost without taking features, quality, or your personal preferences into consideration?

As I drive to work each day, I pass an auto dealership featuring a new car with a price tag of $9,999 prominently displayed. I’m never tempted to stop in and buy this car, despite its low price. It does not meet my needs nor does it have the features that I’m looking for in a new car. Why would an investment be any different? Too many investors believe that there is no difference between various stocks, mutual funds or investment advisors. They focus exclusively on price and ignore risk, diversification, asset allocation and quality. People who go to great lengths to check out the features on the cars they buy often don’t know what’s in the mutual funds they own. Yet these are the things that often determine how well they will live in retirement. It’s this knowledge that professional investment managers bring to the table.

People who would never diagnose their own illness or write their own will are too often persuaded to roll the dice on their retirement. Don’t make that same mistake with your investments.

4 Reasons Why You Need a Good Financial Advisor Now

A good financial advisor has a number of roles: planner, investment manager, educator who is willing to teach you about investing, and sounding board with whom you can share your fears and aspirations.

Why is a Registered Investment Advisor (RIA), a fiduciary who puts your interests ahead of his own, so important now? People often get over-confident during a Bull Market. It’s when the market gets scary that financial professionals really prove their worth.

We have all heard the old sayings about being diversified, buy low and sell high, and stay the course. That’s often harder to do than it looks, especially in trying times such as these, when investor psychology overtakes reason. A financial advisor’s job sometimes involves protecting investors from themselves. And to protect them from all the bad advice that’s out there and from the bad actors in the industry.

The first thing that a fiduciary does is tell their clients that despite what you hear, no one can time the market. There may be some people who are exceptionally good at stock picking, but those rare individuals are not giving away their advice to you on TV, in Money Magazine, or in newsletters; I don’t care what they claim. If they exist at all, they are managing their own portfolios on an island in the Caribbean.
The retail financial services industry has an incentive to sell you expensive products as often as possible. And they are very good at it. Don’t get caught in the frequent trading trap; it’s not to your benefit. A fee-only RIA does not have an incentive to sell you investments to earn a commission.
Investors typically allow their portfolios to get too risky during the good times. When the stock market is going up, it’s too easy to get caught up in the excitement and ignore asset allocation guidelines. A good investment manager will rebalance your portfolio regularly to keep you from running into a Bear Market with a portfolio overloaded with risky stocks.
A fee-only RIA works for you. Stockbrokers, insurance agents, even mutual fund managers, work for the companies that pay them. They are legally required to work in the best interest of their employers, not their clients. Some of them do try to work in their clients’ best interests, but there can be large financial incentives to do otherwise. A fee-only RIA works only for you. We act in your best interest and use our expertise to allow you to take advantage of opportunities in good markets and weather the bad ones.

During volatile markets, we focus on the important things that really matter, not the daily chatter. We keep open lines of communication with our clients, helping them make sense of what’s going on, providing perspective, and helping them distinguish between what’s just noise and what’s a genuine trend. We work hard to control risk and manage portfolios to help our clients maintain confidence in their financial future.

If you want to receive our weekly commentary, view our latest guides, or get a free download of the first three chapters of our book “Before I Go”, or just find out about us, visit us at www.korvingco.com.

Setting Realistic Financial Goals

How realistic are your goals? Some people work hard and exceeded the goals they had when they were young. Others find their goals forever out of reach. For example, most people want to retire in their mid-sixties. That’s a goal, but is it realistic? Are they going to have a pension when they retire and, if so, how much is it? When are they going to apply for Social Security, and how much are they going to get? Will they need a retirement nest egg, and how much will be in it?

Career choices will have a big impact on these answers. A financial plan will also provide many of these answers. But a plan is only as good as the assumptions we put into it. As the old saying goes: “Garbage in, garbage out.”

The rate of return you get on the money you put aside has a huge impact on whether you reach your goals. Studies have shown that many people have an unrealistic expectation of the returns they can expect on their savings and investments. With interest rates near zero percent, putting your money in the bank is actually a losing proposition after taxes and inflation. Investing in the stock and bond markets may lead to higher returns. But the long-term returns that many people assume they can get often leads to taking unreasonable risks.

There is nothing wrong with having high goals. The best way to check to see if your goals are high, but attainable, is to talk to a fee only financial advisor. Preferably one that is a CERTIFIED FINANCIAL PLANNER™. They have the experience and the expertise to let you know if your goals are reasonable and what you can do to reach them.

Category: risk management