Tag: speculation

The lure and risks of “alternative investments.”

The financial world has been deluged marketing offers from investment firms offering “alternative investments.” “Alts” are non-traditional investments.  They include non-traded REITs, hedge funds and private equity.

The lure of “alts” is summarized in a quote from Financial IQ:

“The 2008 financial crisis scarred investors enough that they’re still seeking new ways to diversify out of stocks and bonds. Meanwhile, investors also are hungry for yield amid persistently low interest rates.”

The problem with “alts” is that they are not well understood.

Many are not liquid – in other words they cannot be sold at a moment’s notice.

In addition, most are not transparent – you can’t always tell what you own because the “alts” managers are secretive, unwilling to reveal their strategy in detail.

Third, the fees charged by “alts” managers are often much higher than those charged by traditional managers.

Many of the “alts” use derivatives which are difficult to understand and can lead to risks that are not obvious. An example are the “guaranteed” structured notes created prior to 2008. When Lehman Brothers collapsed it was revealed that the “guaranteed” notes issued by Lehman were backed by the claims paying ability of a bankrupt company.  People lost millions and learned a painful lesson.

Our philosophy is to invest our money in securities we understand. We always want to know: what’s the worst thing that can happen? If we don’t understand the risk, we don’t invest.  It’s a lesson learned over the years as we keep in mind the first rule of making money:  don’t lose it.

Benchmarking Inverts the Basics of Investing

The problem with “benchmarking”  – that is measuring your investment performance against market indexes (known as “benchmarks”) – is that it often leads to buying into asset bubbles.

During the tech boom of the last 20th century, billions of dollars went into internet stocks whose values became wildly inflated.  People who participated in this as a way of reaching for high rates of return, found that no one rang a bell when the party was over.  Many lost their retirement savings and saw their 401(k)s devastated.

Certain stocks become wildly popular, industries become wildly popular and investing styles become wildly popular, all of which leads to wildly inflated values.  This almost inevitably leads to financial pain.

But this does not only happen in the stock market.  In the first decade of the 21st century, real estate seemed to be a way of making outsized profits.  Of course, when the housing bubble collapsed, many not only lost money, but their homes.

The focus of serious investors is to align your portfolio with your personal objectives.  The focus should be on long-term – multi-year – performance.  The only benchmark that should concern you is the one you set for yourself.

At Korving & Company we keep our clients grounded and work with them to meet their personal benchmarks.  Contact us to do the same for you.

Market Myth #2: It’s all about beating the market.

For many amateur investors the object is to beat the market.  They are abetted in this belief by the many magazines and newsletters that make the market the benchmark of what a successful investor should emulate.  People spend hours scouring the media looking for stock tips and investing ideas as if investing was a sport, like horse race, where the object is to beat the others to the finish line.

The fact is that “beating the market” does not address any individual’s actual financial goals.  It’s a meaningless statistic.  And it’s dangerous.

The fact is that most professional investors don’t beat the market on a consistent basis.  Even index funds, designed to replicate the market, don’t actually beat the market.  At best they provide market rates of return minus a fee.  Attempting to beat the market exposes the investor to more risk than is prudent.

Your portfolio should be built around your needs and consistent with your risk tolerance.

What does this mean?  Your portfolio should provide a return that’s keeping you ahead of the cost of living, that allows you to retire in comfort, and is conservative enough that you will not be scared out of the market during the inevitable corrections.

Want to create a portfolio that’s right for you?  Contact us.

Market myth #1: the stock market can make you rich.

This is one of a series of posts about common market myths that can be dangerous to your wealth.

The market is rarely the place where fortunes are made.  Real people get rich by creating and running great companies.  Bill Gates became the richest man by building and running Microsoft.  Steve Jobs the same way.  The Walton Family, ditto.

In the less rarefied world of multi-millionaires, millionaires and semi-millionaires the same thing is true.  People get rich (or well-to-do) by starting a business, studying and becoming a professional or just working for a living and saving part of what they earn.

This is not to disparage the market as a  tool for protecting  wealth, maintaining purchasing power, living well in retirement and getting a fair rate of return on your money.  But the idea that you can get rich by trading stocks is a myth that can actually destroy your financial well-being.

One of the best ways of avoiding the temptation to use the market as a “casino,” a place where you can “win the lottery” is to turn to a professional investment advisor.  Someone who knows what’s possible and what’s not.  Someone who is in the business of getting you a fair rate of return on your money while minimizing the risk that you will lose it.  An independent, fee only RIA is someone who will not try to sell you one the latest investment fad that the  wire-houses are selling, but who will act in your best interest, because that’s in his best interest.

Have a question about the markets?  Ask us.

Avoiding the Housing Trap in Retirement

Homes are a money pit. This morning the HVAC repairman showed up to fix the broken attic fan. Painters are coming next week. The insurance bill on the home is due soon. The landscaping needs some work. Let’s not forget real estate taxes and the mortgage payment.

Many people think of their home as a financial asset. Most people thought real estate was a safe financial asset. People were flipping houses for fun and profit. Then 2008 came along and we learned a whole new set of terms, like “liar loans” and “short sale.”

What does this have to do with retirement? Just this: many people are over-spending on their dream home or holding on to costly vacation homes. There is a term for this: being “house poor.” It describes the homeowners who spend too much of their income on housing costs.  How much is too much?  If it’s nearing 40{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} it’s definitely too much.

We won’t go into the reasons for this; they are well-known. The answer is to either make more money or to get rid of the money pit. It may be a very difficult emotional decision, but over the long-term, the financial markets have done better than the housing market. Another benefit is that the financial markets are liquid while your home is not,  sometimes taking a year or more to sell.

We are big believers in home ownership. But in our experience a home is not a financial asset that is used in retirement. In most cases the home does not become a financial asset until the owner gets too old and has to move into a retirement community or a nursing home. By that time, retirement is nearing its end.

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.

What is an IPO?

An “IPO” or “initial public offering” is the first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the capital to expand, but can also be done by large privately owned companies looking to become publicly traded.

An example if the recent offering to the public of the common stock of Facebook.  This company was private until it decided to offer it shares to the general public and allow itself to be traded on a major exchange.  From Investopedia.

In an IPO, the issuer obtains the assistance of an underwriting firm, which helps it determine what type of security to issue (common or preferred), the best offering price and the time to bring it to market.

The benefit to the founders of the company is that it gives them the ability to sell part of their stake in the company to the public, often making them millionaires or even billionaires overnight.   It also provides the company with much more capital than it previously had for purposes of expansion and growth.

The benefit to the public is their ability to participate in the company’s growth alongside the founding shareholders.

IPOs should be viewed with a great deal of caution.

IPOs can be a risky investment. For the individual investor, it is tough to predict what the stock will do on its initial day of trading and in the near future because there is often little historical data with which to analyze the company. Also, most IPOs are of companies going through a transitory growth period, which are subject to additional uncertainty regarding their future values.

Investors in the IPO of Facebook found this out when the excitement and hype surrounding its initial offering resulted in such a demand for the stock that people were willing to pay much more for the stock than was warranted.

What is a short sale?

Today, people generally think of a “short sale” as a real estate transaction in which the home owner sells his property for less than the mortgage.   Before the housing crisis, “short sale” referred to a transaction in the stock market. So what does it mean when we sell a stock “short.”

Borrowing a security from a broker and selling it, with the understanding that it must later be bought back (hopefully at a lower price) and returned to the broker.

Short selling (or “selling short”) is a technique used by investors who try to profit from the falling price of a stock. For example, consider an investor who wants to sell short 100 shares of a company, believing it is overpriced and will fall. The investor’s broker will borrow the shares from someone who owns them with the promise that the investor will return them later. The investor immediately sells the borrowed shares at the current market price. If the price of the shares drops, he/she “covers the short position” by buying back the shares, and his/her broker returns them to the lender. The profit is the difference between the price at which the stock was sold and the cost to buy it back, minus commissions and expenses for borrowing the stock.

But if the price of the shares increase, the potential losses are unlimited. The company’s shares may go up and up, but at some point the investor has to replace the 100 shares he/she sold. In that case, the losses can mount without limit until the short position is covered. For this reason, short selling is a very risky technique.

What is an option?

An option is a contract to buy or sell a specific financial product officially known as the option’s underlying instrument or underlying interest. For equity options, the underlying instrument is a stock, exchange-traded fund (ETF), or similar product. The contract itself is very precise. It establishes a specific price, called the strike price, at which the contract may be exercised, or acted on. And it has an expiration date. When an option expires, it no longer has value and no longer exists.

Options come in two varieties, calls and puts, and you can buy or sell either type. You make those choices – whether to buy or sell and whether to choose a call or a put – based on what you want to achieve as an options investor.

Options can be used to generate added income from securities, like stocks that you already own. The most common of these are “covered call options.”   They can also be used as a temporary insurance policy against a decline in the price of a stock or the market as a whole.  The most common of these are known as “protective puts.”

Options are complex instruments that require a sophisticated understanding of securities, and while some options can be used to reduce risk, others can create large amounts of risk.

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