Tag: Investment strategy

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.

How Great Advisors Search for Stand-Out Managers

In the bad old days, not that long ago, brokers for the “big box” stores recommended fund managers because

a) They were paid more or received benefits like trips or prizes.

b) They were trying to get their clients quantity discounts by using only one fund family.

c) They didn’t know any better.

So lots of unwary investors ended up with a hodge-podge of mutual funds, either all from the same fund family or a collection of funds that did not create a well diversified portfolio.  Many funds were not reviewed regularly and investors hung on to them for years because no one bothered to do any analysis.

Today a lot of the landscape still looks the same.  Even the “do it yourself” investor has a tendency to focus on things that may not really help them achieve their financial objectives.  For example, the focus on fees has a tendency to distract from issues that are more important.   Investors are constantly told that low expense index funds are the only way to go because they beat their actively managed cousins. Well, no, that’s not necessarily true.  Active managers can beat index funds, and have done so over long periods.  But managers need to be monitored.  A smart investor needs to keep track of how a manager is performing, be sure that he’s sticking to his discipline and, finally, make sure that he has not left the mutual fund to someone else to manage.

Well-chosen active funds can pull their weight during market downturns by cushioning portfolios from the full decline.  Since we can’t forecast the future with precision,  getting great returns on a risk-adjusted basis is the guiding principle for the selection of stand-out managers.  That’s why RIAs who are not part of one of the major firms and can give unbiased advice are so valuable.

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.


How our emotions hurt our investment decisions.

One of the things that differentiate investing from other financial decisions is bargain hunting.  When we buy things in stores, shop for cars or buy homes we have a tendency to look for bargains.  We may even negotiate for a lower price.  However, studies have shown that when it comes to investing, the more expensive a stock is, the higher the market rises, the more people want to buy.

It’s a common saying that the two emotions that most affect the typical investor are greed and fear.  Greed makes us buy stocks that have already gone up in price, hoping that we’re jumping on the train that is leaving the station.  Fear is what causes us to abandon the market just as it reaches the bottom.

Warren Buffett is quoted a saying: “Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

The urges or biases that control our behavior have little or nothing to do with our wealth, our education or age.  Some of these biases are

  • Overconfidence – we believe we know more than we really do and believe that the decisions we make are in our best interest.
  • Myopia – we are overly influenced by short term results.  However short-term results are often random or dependent on “headline” events that have no long-term meaningful effect.
  • Anchoring – predicting the future from the past.  For example, when we look at long term stock market returns we have tendency to project those average returns into the future, ignoring the volatility of the market over the long term.
  • The cat on a hot stove effect – if a cat jumps on a hot stove, he’ll quickly jump off, but he won’t jump on a cold stove either.  after investors experience a negative event such as the losses people suffered in 2000 and 2008, they often revert to a strategy that will reduce the probability of reaching their goals by, for example, investing only in CDs or savings accounts.
  • Regret aversion – not wanting to admit a mistake, investors may hold losing stocks to avoid experiencing regret over a bad decision.  Often investors will hold a losing stock for years, waiting to “get even.”

One of the biggest problems investors face today is not lack of information  but too much information.  Newspapers, magazines, TV and the Internet are bombarding the investor with information and advice: buy this, sell that, top ten funds of last year, cheapest to own, all delivered with intensity and conviction.  And many contradicting each other.

Investment advisors recognize what biases affect people and provide tremendous value to their clients by understanding and helping reduce their influence.  By education and hand-holding when greed or fear are influencing the investing public, they help their clients avoid what Warren Buffet calls their “urges” that get people into trouble.

10 Mistakes Gen Y Makes with Advisors

1. Not Having an Advisor Help with Big Financial Decisions

Keep in mind that you are dealing with a financial advisor, not a stock broker.  If you can’t tell the difference you’re dealing with the wrong person.  Big financial decisions affect your plan, your investments and your future.  The role of a financial advisor is to advise you on all the important financial decision you make.

2. Not having a spending plan in place

As Dave Ramsey is fond of saying: every dollar should have a name.

3. Not “paying themselves” first rule

First pay yourself by putting some money aside.  If it’s hard , have it done automatically so you don’t have to do it yourself every payday.

4. The Ones who Make Less Money Can be Less Receptive to Advice

Poor people are poor for a reason, and that reason is often that they don’t want to take advice.

5. Not Appreciating their Long Time Horizon in Investments

The biggest asset that a young person has it time.  They may not have much money but the magic of compounding turns a small amount into a big amount over time.

6. Itching to Get Ahead Professionally

It takes time and patience to get ahead.  An advanced degree does not necessarily let you skip rungs on the ladder of success.

7. The Budget Cliche

If you don’t know where you’re money’s going it’s impossible to know where to economize.  There are several good computer programs that can help you keep track of where your money is going.

8. This Generation Struggles with Insurance

It’s the young professional who is most in need of insurance and who is apt to put off getting it until it’s too late.

9. Working with “Old School” Advisers

The old school advisor is really a stock jockey who doesn’t bother to listen to your needs but promises to “beat the market.”  This person is not an advisor, he just wants to manage your money.

10. Planning too far out

Too often people get a lengthy, expensive “financial plan” that projects the future 40, 50 or 60 years out.  That’s nonsense and a waste of time and money.  Simple plans of a few pages are better and should be reviewed annually and updated with new information.  Keep in mid the old saying: the map is not the territory.

What do You Risk by Foregoing Professional Financial Advice?

What’s the first thing people think about if they need a will?  Which lawyer should I call?  If they get sick or think they need a physical exam, do they ask their brother-in-law?  No, not unless the brother-in-law is a doctor.  Yet so many people handle their own investments, rather than use an advisor.  Why?  Did they or a family member have a bad experience?  Are there cost concerns? It appears that neither one is the answer for most do-it-yourselfers, according to a survey for the Deloitte Center for Financial Services.

Many have a “higher comfort level in handling retirement planning on their own” and a “belief that they don’t need professional advice.”

The survey of over 4,000 households found that nearly two-thirds don’t ask the advice of a professional investment advisor for their retirement needs. The younger you are the more apt you are to do it yourself.  According to the survey, 75{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} of those who were 15 years or more from retirement did not use an advisor.

Of those not getting professional advice only 13{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} mentioned they had a negative experience with an advisor and only 12{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} mentioned cost. The two leading reasons for self-managing personal finances were the comfort level people had doing it themselves and the belief that they didn’t need professional investment advice.  There are other factors at work.  Too many people have not bothered to put any money away for a “rainy day,” much less retirement.  Those who have begun saving for retirement often mistakenly believe they have too little money to interest a professional advisor.  I have had people come to me and ask if they qualify to be a client of mine since they “only have $100,000 to invest.”  While some advisors have minimums of as much as $1 million, most advisors are willing to work with people who don’t have that much. 

What these do-it-yourselfers don’t realize is that the old model of providing financial advice and investment management is broken.  Twenty years ago people looking for advice opened an account with one of the huge brokerage firms.  These firms made a lot of their money by encouraging their brokers to trade stocks, bonds and mutual funds in their clients’ accounts and to charge commissions on each transaction.  There was rarely much in the way of true “planning” offered; often it was nothing more than a stock idea by a firm’s analyst that got pushed to the broker’s customers.  Today, a whole new generation of advisors exists who have broken the old mold.  These are the Registered Investment Advisors (RIAs).  They are quite often experienced advisors and financial planners who have left the major firms and established their own advisory firms.  Their objective is to help their clients succeed in achieving their life goals.  They offer a range of services all the way from advice and guidance on investments held at other places, like 401(k) accounts, to complete active portfolio management.  For people who want to remain in control of their own finances, these advisors can act as facilitators, enabling them by providing the tools and experience that the typical individual investor does not have.  There is value in having expert advice, whether it’s dealing with the complexity of law, medicine or family finances.   

An advisor should bring more than expertise and experience; they should provide peace of mind.  According to the Deloitte survey, the people who get professional advice on managing their money were almost two times as likely to feel very secure about their retirement versus those who forego professional advice.

The chances are that if you work with an advisor, you will be much more likely to have a “flight plan” to guide you to a safe landing for a financially secure retirement.


A Deposit In A Bank Is Not A Riskless Form Of Saving

This is a good time to remind our readers of something.    Via ZeroHedge

Cyprus has reminded us of a couple of awkward truths:

  1. A deposit in a bank is not a riskless form of saving.We may not see eye to eye with the FT’s Martin Wolf on many aspects of modern economics and central banking in particular, but he described banks well last week:
    Banks are not vaults. They are thinly capitalised asset managers that make a promise– to return depositors’ money on demand and at par– that cannot always be kept without the assistance of a solvent state.”

  2. When states become insolvent, the piper must ultimately be paid. Fatal, embarrassing insolvency is not a problem that can be perpetually or painlessly deferred.

Why do we have FDIC?  Because banks can fail,, and when they do, without someone else like the FDIC, depositors can lose part or all of their money, which is what happened in the Great Depression of the 1930s.  For a lesson in banks, watch “It’s a Wonderful Life.”

And even if the bank does not fail, if the interest they pay does not exceed inflation after taxes, the money in the bank is worth less over time because you can’t buy as much with the money as you did in the past.  The simple truth is that there is no “safe” place for money, even under the mattress.  Whenever you have money there is risk of loss.  Cash can be stolen.  Banks can go bust and investments can lose money.  For serious money, get professional help.

Passive investing vs. Active Investing

Comment from Oppenheimer Funds.

 Indexing clusters investment assets in securities which represent past success, are widely owned, and often fully valued.  Investing is about the future.  Good active investors are adept at uncovering future success.   Compounded over a long time horizons, the difference in so called “terminal wealth” can be very large between passive approaches, average active approaches, and above average active approaches.    

Translation: Most indexes, like the S&P 500, represent the best performing stocks of the past, not necessarily the best ones to own in the future.

Working with Widows

Advisors who work with widows know that there is often a great deal of confusion after a spouse dies.  Widows are often told not to do anything for a year.  This is terrible advice.  First of all, assets held in joint name have to be transferred into the name of the surviving spouse.  Beneficiaries have to be updated on retirement accounts and insurance policies.   Trusts and wills have to be reviewed.  And investments that were made and understood by the deceased are often not appropriate for the survivor. 

The best advice for the widow is to find a trustworthy financial advisor, explain the situation and allow the advisor ro guide the widow through the process of getting on with life.  Of course, it’s easier if the has a copy of the Before I Go Workbook to help.

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