Tag: Asset allocation

What's a "Bubble?"

The word “bubble” has been thrown around a great deal with the Dow Jones Industrial Average (DJIA) at 16,000, the S&P 500 at 1800, and the Nasdaq Comp above 4000.  The term “bubble” is a scare word that makes people think of a repeat of the Tech Crash of 2000 or the real estate bubble that led to the financial crisis of 2008.

Cluifford Asness, whose firm manages $80 billion has a pet peeve and one of them is the loose use of the term “bubble.”

“The word “bubble,” even if you are not an efficient market fan (if you are, it should never be uttered outside the tub), is very overused. I stake out a middle ground between pure efficient markets, where the word is verboten, and the common overuse of the word that is my peeve. Whether a particular instance is a bubble will never be objective; we will always have disagreement ex ante and even ex post. But to have content, the term bubble should indicate a price that no reasonable future outcome can justify. I believe that tech stocks in early 2000 fit this description. I don’t think there were assumptions — short of them owning the GDP of the Earth — that justified their valuations. However, in the wake of 1999-2000 and 2007-20008, and with the prevalence of the use of the word “bubble” to describe these two instances, we have dumbed the word down and now use it too much. An asset or a security is often declared to be in a bubble when it is more accurate to describe it as “expensive” or possessing a “lower than normal expected return.” The descriptions “lower than normal expected return” and “bubble” are not the same thing.

Bloomberg columnist Barry Ritholtz comments:

“It would only take a small marginal improvement in the economy, or a small uptick in hiring, or heaven help us, even a modest increase in wages to increase revenues and drive profits significantly higher,”he current market valuations do not, in my opinion, have the characteristics of a “bubble.” “

Whether stocks, bonds or commodities are fairly valued, undervalued or overvalued will become apparent over time.   In the meantime, unless you are being paid to opine, it’s best to realize that fortune-telling is not the way to manage your portfolio.  Creating an all-weather portfolio with the asset allocation that will allow you to face any reasonable future is the best strategy.

 

5 Bad Ways to Pick a Mutual Fund

The Sunday Wall Street Journal has an article with the title “Bad Ways to Pick a Mutual Fund.”  We think it’s worth while examining this list and making a few comments.

1. Focusing on past returns

This may well be the biggest problem for people who pick their own mutual funds.  There is a good reason that funds mention that “past performance is no indicator of future results.”  There are all sorts of reasons that past performance may not predict how well a fund will do in the future.  Among them are management changes, style drift, and sector rotation.

2. Not looking under the hood

I am always amazed by the number of people who buy a fund without knowing what they do or how their money is being invested.   Going by an advertisement or an article in a financial magazine is no substitute for research.

3. False diversification

Buying multiple funds that all do the same thing is not diversification, its duplication.

4. Chasing headlines

I recall that dot.com stock funds were incredibly hot in 1999 and people losing their shirts when the tech bubble burst the next year.   The retail investor is never going to be ahead of the information curve.

5. Buying on ratings alone

Focusing on stars alone is as bad as buying based on what some magazine has deemed, say, the top five funds. In both cases, past performance plays too big a role.

The focus for serious investors is to look for a well diversified portfolio of funds that focuses on generating superior risk-adjusted returns.  To do that, serious investors get professional guidance.

How to Get Your 401(k) Ready for Retirement

In a recent Wall Street Journal article the writer gives those who are getting within 10 years of retirement six very useful ideas about getting their 401(k) plans prepared for the day they will actually leave work.

  1.  If you haven’t done it lately, review your 401(k) investment mix.: Typically after people enroll in employer-sponsored plans and make initial investment choices, they forget about how their money is allocated in the plan—sometimes for years.  Don’t let this happen to you.  It may mean that just as you should be getting more conservative you are actually increasing your risk.
  2. Beware of the rate sensitivity of fixed-income funds you own in your 401(k).:  Bonds traditionally were the safe-haven choice for near-retirees, but the bond market has changed and rising rates could result in losses just as retirement approaches.  Not all bond funds are created equal and caution is the watchword in today’s bond market.
  3. Look for greater variety within your 401(k).: When advisers construct portfolios for clients, they often include a mix of U.S. and international stocks, multiple types of bond exposure and, increasingly, “alternative” investments such as commodities and a variety of hedge-fund-like strategies.  So should you.
  4.  Use IRAs and other accounts to complement your 401(k).:  Too often people who change jobs leave their 401(k) behind at their previous employer.  When you leave, roll your 401(k) money into an IRA and don’t leave “orphan” accounts behind and unattended.
  5. Check whether your 401(k) plan includes a brokerage window, or self-directed account.: if your plan allows you to make your own investment decisions, you can often get greater variety and better asset allocation options than are offered in most 401(k) plans.
  6. Consider getting professional advice. : As you would expect we are 100{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} behind this recommendation.  In fact, if you want guidance with your 401(k), call us and see what we can do for you.

With rising interest rates, what to do about bonds.

With interest rates increasing investors are noticing that their bonds are not doing nearly as well as their stocks.  In fact many investors may have lost money on bonds this year.  For example, the typical tax exempt bond fund has lost between 4 – 5{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} year-to-date.  What should investors do about bonds when the likelihood of rising interest rates is high?

The October issue of Financial Planning magazine give us an insight into what happened in the past when interest rates rose.

During the five-year period from 1977 through 1981, the federal discount rate rose to 13.42{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} from 5.46{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, an increase of nearly 800 basis points, or 145.8{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}. During that period, the five-year annualized return of U.S. T-bills was an impressive 9.84{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.  But T-bills are short-term bonds.

But bonds did not fare nearly as well. The Barclays one- to five-year government/credit index had a five-year annualized return of 6.61{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, while the intermediate government/credit index had a 5.63{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} annualized return. The long government/credit index got hammered amid the rising rates, and ended the five-year period with an annualized return of -0.77{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}. Finally, the aggregate bond index had a five-year annualized return of 3.05{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.

As every investor should know, bonds go down in price when interest rates go up but that decline is offset by the interest paid on the bonds.  If an investment manager knows what he is doing and protects his portfolios by avoiding exposure to long-dated government bonds the results will be acceptable. An annualized return of 5.63{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} is quite good when rates are increasing.

But one important note: It does not seem prudent to avoid bonds entirely during periods of rising interest rates. Bonds are a vitally important part of a diversified portfolio containing a wide variety of asset classes – during all times and seasons. Rather than trying to decide whether to be in or out of bonds, the more relevant issue would seem to be whether to use short-duration or long-duration bonds.

This, of course, is consistent with a strategic approach to portfolio design. Rather than completely remove an asset class from a portfolio, advisors and clients would be well advised to thoughtfully modify the components of an asset class. To use a nautical metaphor, rather than swapping boats, we simply trim the sails.

 

Stop worrying about the Federal Reserve

There are lots of people fixated on trying to figure out what the federal reserve is going to do with interest rates and when they are going to do it.  If you are a retail investor, you are not going to beat the professionals in that game, so stop trying.  Instead, let the pros handle it and relax by looking at the view from 30,000 feet.  Here’s what the bond experts at Oppenheimer are telling us in a messge titled Why Fed Watching Is Likely a Waste of Your Time

What to Remember for the Long Haul

For long-term investors, I believe there are essentially five important points to keep in mind.

1) Overall global economic growth is slow but most likely the worst is over. While there may be hiccups every so often, it is unlikely that we will revisit the financial abyss in the near-to-medium term.

2) Real interest rates are quite low. Over any reasonable investment horizon, they are going to go up. That is true irrespective of what the U.S. economy looks like this quarter or who the next Fed chair is.

3) Because interest rates are so low now, the likelihood that returns from any part of the bond market will get you to a comfortable retirement based on their real returns is virtually zero. You most likely have to have a significant portion of savings in assets that provide better real returns, albeit with greater risk.

4) That said, you can’t just put all your money in stocks. There will be future periods of equity underperformance. In order to make sure you don’t panic and go all cash at the worst point in the cycle, have some part of savings devoted to bond or bond-like instruments now. Even if they aren’t generating a lot of income, those investments may provide protection during equity downturns, which is as important.

5) Income, not price appreciation, is typically going to be a significant part of overall returns. Therefore, wherever you can, and whatever risks you are comfortable with, seek out income-generating investment options. As always, past performance does not guarantee future results.

Good advice.

The 401(ok) opportunity

One of the major problems with 401(k) and similar defined contribution plans is that the people who set them up are not really that interested in them.   Nobody runs a business for the purpose of having and managing a 401(k) plan.  Like insurance and other employee benefits, retirement plans are a side issue for employers, often a distraction from their job of running the business.  Besides that, the typical business owner may be good at running a dry cleaning business, a medical practice or an automobile dealership but he’s not an investment professional.

As a result, the typical 401(k) may have a selection of mediocre funds, high expenses and little or no guidance for the employees regarding their investment choices.

This is where  some innovative Registered Financial Advisors can make a huge difference.  Not only can they provide the business owner unbiased guidance with regard to the investment choices in the plan and help to reduce plan expenses, but also provide guidance to plan participants in creating a portfolio that’s right for them.

Korving & Company can help both the plan sponsor and the employee to maximize the benefit of their 401(k) and transform it into a 401(ok).

Why 401(k) Fees are Not the Primary Issue

A pair of university professors have once again tried to prove that the reason people get poor results in their 401(k) plans is because of high fees.  This is a perennial subject and will generate a lot of discussion without helping anyone.

The primary factors that determine how much money there is in a 401(k) plan at retirement are

  • How much money employees put into the plan
  • Whether the company provides a matching contribution
  • How well the money is invested

The fact is that people put too little into these plans, many employers do not put in a company match, and employees don’t know how to create an effective portfolio from the choices that are available.

Not knowing how best to invest the 401(k) is not the employees’ fault.  They are not investment professionals.  Information about the investment choices is limited.  Most people don’t have the time or inclination to do the research.  That is why we are beginning an initiative to help people who want to make intelligent choices in their 401(k) plan do a better job.

The focus on fees reminds us of the old story about a man who lost his car keys at night and kept searching for them under a street light because that’s where the light was better.  Fees are easy to measure while investor behavior is harder to quantify.  That’s why the fee focus is so misplaced.

Of course, all things being equal, low-cost funds are better than the same fund that charge higher fees.  In our business, we try to invest in the lowest cost class of funds that we wish to use.  But the focus on expenses can actually backfire.  For example, most foreign funds have higher fees than domestic funds.  Yet a properly diversified portfolio should be exposed to foreign markets.  If the investor is persuaded to invest in the funds with the lowest expenses he may forgo investing in the markets  that may make him the most money.

Free advice is usually worth what you pay for it.  In many cases it can be misleading.

 

©  Korving & Company, LLC