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Monthly Archives: March 2014

The First Key to Successful Stock Investing is Understanding and Accepting Reality

26 Wednesday Mar 2014

Posted by wmosconi in business, Education, finance, financial planning, Individual Investing, investing, investment advice, investments, math, personal finance, portfolio, risk, statistics, stocks, volatility

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average stock returns, business, expected stock returns, finance, individual investing, investing, personal finance, risk tolerance, S&P 500, S&P 500 Index, stock returns, stocks, volatiltiy

The first key to successful stock investing has more to do with your emotions than a fundamental understanding of what causes stocks to move up or down. Emotions about money can be a powerful thing and cause people to behave in irrational ways. One of the most common phrases passed on to investors as a piece of wisdom is to “buy low and sell high”. However, study after study has shown that most individual investors fail to heed that advice. Why does this happen? Well, I would submit the real cause is behavioral and based upon incomplete information. Let’s dig into that statement a little further and reveal the key as well.

Most individual investors are told when they start investing in stocks via mutual funds and/or ETFs to expect an annual return of 8% to 9% per year. You will find that many financial calculators to help you plan for retirement on the Internet have that as one of the inputs to calculate the growth of your portfolio over time. While that information is not too far off the mark based upon historical returns of the S&P 500 stock index, the actual annual returns of stocks do not cooperate to the constant frustration of so many investors. That brings us to the first key to successful stock investing: The actual yearly returns of stocks very rarely equal the average expected. The most common term for this phenomenon is referred to as volatility. Stocks tend to bounce around quite a bit from year to year. Volatility combines with the natural instinct of people to extrapolate from the recent past, and investing becomes a very difficult task. I will get deeper into the numbers in a later post for those readers who like to more fully understand the concepts I discuss. I do need talk in general about annual stock returns at this point to expand upon the first key.

Below I have provided a chart of the annual returns of the S&P 500 index for every year in the 21st century:

Year

% Return

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%

2011

2.1%

2012

16.0%

2013

32.4%

 

What is the first thing you notice when looking at the yearly returns in the table? First, you might notice that they really jump around a lot. More importantly, none of the years has a return that is between 8% and 9%. The closest year is 2004 with a return of 10.9%. If the only piece of information you have is to expect the historical average over time, the lack of consistency can be extraordinarily frustrating and scary. In fact, individual investors (and sometimes professional investors too) commonly look back at the last couple of years and expect those actual returns to continue into the future. Therein lies the problem. Investors tend to be gleeful when returns have been really good and very fearful when returns have been very low. Since the average never comes around very often, investors will forget what returns to expect over the long run and will “buy high and sell low”. It is common to sell stocks after a prolonged downturn and wait until it is “safe” to buy stocks again which is how the sound advice gets turned around.

I will not get too heavy into math and statistics, but I wanted to provide you will some useful information to at least be prepared when you venture out to invest by yourself or by using a financial professional. I looked back at all the returns of the S&P 500 index since 1928 (note the index had lesser numbers of stocks in the past until 1957). The actual annual return of the index was between 7% and 11% only 5 out of the 86 years or 5.8%. That statistic means that your annual return in stocks will be around the average once every 17 years. The 50-year average annual return for the S&P 500 index (1964-2013) was approximately 9.8%. Actual returns were negative 24 out of 86 years (27.9% of the time) and greater than 15% 42 out of 86 years (48.8% of the time). How does relate to the first key of stock investing that I mentioned earlier (“The actual yearly returns of stocks very rarely equal the average expected”)?

Well, it should be much easier to see at this point. If you are investing in stocks to achieve the average return quoted in so many sources of 8% to 9%, it is definitely a long-term proposition and can be a bumpy ride. The average return works out in the end, but you need to have a solid plan, either by yourself or with the guidance financial professional, to ensure that you stick to the long-term financial plan to reach the financial goals that you have set. Knowing beforehand should greatly assist you in controlling your emotions. I recommend trying to anticipate what you will do when the actual return you achieve by investing in stocks is well below or quite high above the average in your portfolio. Having this information provides a much better way to truly understand and your risk tolerance when it comes to deciding what percentage of your monies to allocate to stocks in my opinion. I will readily admit it is not easy to do in practice during powerful bull or bear markets, but I think it helps to know upfront what actual stock returns look like and prepare yourself emotionally in additional to the intellectual side of investing. Now I always mention that statistics can be misleading, conveniently picked to make a point, or not indicative of the future. Nevertheless, I have tried to present the information fairly and in general terms.

As previously mentioned, I will be writing another related blog post that will discuss the numbers in more detail with math and statistics.  I have separated these discussions so that those intimidated by math or who do not want to get into all the details can skip that part.  However, I will be providing some advice on how to use the information I have provided to assist you in moving past the first key to successful stock investing.

Is There a Way to Discern Whether or Not a Prospective Financial Advisor Will Provide You with Top-Notch Service? Short Answer is Yes.

06 Thursday Mar 2014

Posted by wmosconi in asset allocation, bonds, business, Consumer Finance, Education, finance, financial advisor fees, financial planning, Individual Investing, investing, investment advice, investment advisory fees, investments, personal finance, portfolio, reasonable fees, reasonable fees for financial advisor, reasonable fees for investment advice, statistics, Suitability

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asset allocation, AUM, AUM fees, business, CFP, education, finance, Financial Advisor, investment advisor, investment advisory fees, investments, portfolio, reasonable fees, reasonable fees for financial advice, retirement, RIA, selecting a Finnacial Advisor

Most individual investors rely primarily on trust and the ability to develop a long-term relationship primarily to determine whether or not a prospective financial professional is the right choice.  Turning over the management of your investments to someone else is a major decision that has many implications.  Your current lifestyle in retirement or future lifestyle in retirement and meeting your other financial goals along the way are of paramount importance.  The assessment of your personal risk tolerance and understanding of how the financial markets work is inextricably linked.  With so many choices out there in terms of whose investment advice to value, it can be extremely challenging to decide who to pick or what firm offers the best investment, financial planning, and tax/legal advice.  With that being said, there is a critical step that I wanted to share with you that can limit the possibility that you might end up with a financial professional or firm that will not work as hard as you would like to ensure that your financial future is secure.

The answer to this question lies in the compensation to the financial professional as a result of taking on your business.  Now keep in mind that not all financial professionals will fall into this generalized group.  However, financial incentives and time constraints make this a significant factor in the servicing of your account.  The single most important question you can ask a prospective financial advisor, as it relates to this topic, is how much the average value of a client account is.  Why is this so important?  The reason it is so important is that any financial professional has a number of client accounts to service, and time is limited and constrained of course.  From the financial professional’s perspective, the ideal would be to acquire new clients that offer the most potential revenue.  Let’s go over some of the specifics of the financial services industry to illustrate the importance of this average account size bogey.

Most full-service financial services firms will categorize the client accounts of a financial professional in various tiers.  There are normally tier one, tier two, tier three, and other clients.  Tier one clients are those who offer the most revenue potential.  These clients tend to have the largest amount of assets.  Tier two clients are clients that have less assets than tier one but offer the promise of moving into tier one in the near future.  Tier three clients have below average assets in comparison to the other tiers and show no immediate promise for a lucrative revenue opportunity in the coming years.  There are then all other accounts that really should be transitioned to another financial services firm.  When the firm considers all the costs associated with maintaining that client account, it does not make economic sense.  It is far better for the financial professional to recommend that the client picks another financial services firm and professional most always does so via a referral.  Note that different firms have different terms to describe these classifications.  However, the general concept holds across the entire industry.

Here is the key component as it relates to individual investors specifically.  Tier one clients tend to be the top 20% clients in terms of account size for a financial professional.  Typically a certain relationship holds in these cases.  This tier of clients usually will yield roughly 80% of the overall revenue for financial professional.  Oddly enough, it follows very closely with the famed Pareto Principle.  The tier two clients fall below that top tier, but they show promise for the future.  Many times these individuals have investment accounts at other financial firms or will be coming into a good deal of new monies in the future.  They might be converted to tier one status.  These accounts tend to fall into the 21%-50% of clients managed by the financial professional.  The tier three clients are the bottom half of the accounts managed by that financial professional.  There also are “legacy” accounts that really offer little to no revenue and sometimes are unprofitable under certain circumstances.

Now you can look at the financial incentives from the financial professional’s prospective.  Let’s say that the financial professional earns a 1% fee on all assets under management (AUM) which is very common across the industry.  Therefore, if a client has $1,000,000, the annual fee is $10,000 ($1,000,000 * 1%).  A client with $250,000 at the same AUM fee will yield an annual fee of $2,500 ($250,000 * 1%).  Thus, it would take four of the latter clients to equal the revenue from the other single client.  Given that any financial professional has limited time to meet with clients, it makes perfect sense that he/she would prefer to have only one client since the compensation is the same.  The financial professional with the $1,000,000 client can service that account and look for another three clients to increase that revenue (i.e. similar time/effort expended overall).  The general key is to garner the most assets under management with the fewest amount of clients.  That allows the financial professional time manage his/her time most effectively and efficiently.

Here is the most important question you can ask any prospective financial professional:  What is the average account size of your clients?  If the average account size is higher than your investment portfolio, the chances are quite high that your account and relationship will receive much less attention than that financial professional’s larger account.  Now there can be extreme cases where a few large client accounts distort the average account size to the upside, but you can always ask the general range of client account size overall.  Two things will be at play in a situation where your investment account value is less than the average.  First, it makes more sense for the financial professional to spend more time with the tier one clients from a compensation perspective.  Other financial firms are constantly trying to “steal” these accounts to their firms by offering more services and additional financial product offerings.  Second, depending on the amount that your account size strays from the average, you will most likely receive customer service contact from a junior member on the team and/or a “cookie-cutter” investment portfolio recommendation.

I will expand a bit more on the last comments.  Most financial services firms use what is termed a “turn-key approach” for tier three clients.  There are set asset allocation models with a limited amount of components in the recommended portfolio.  The advice can be nearly identical to what you might find by simply going onto the websites of Vanguard, T Rowe Price, Fidelity, or Morningstar for free.  Now please do not infer that I am intimating that the asset allocation models of those websites are not valuable or match your particular risk tolerance and financial plan.  The point is why should you pay a financial professional to get a recommended asset allocation that is virtually identical to these offerings.  You would be better off not paying a fee whatsoever since you can replicate those portfolios for free and follow the ongoing changes to these model portfolios over time.  Note that the underlying investments in these model portfolios are quite transparent and regularly updated on the websites and in many cases come from regulatory filings to the SEC.

While it is true that some financial professionals provide the same level of service without regard to client account size, but these financial professionals predominantly tend to charge a flat-fee or hourly fee for investment advisory and financial planning services.  Financial professionals that are compensated with AUM fees or via commissions have a very tempting incentive to not only spend more time with larger client accounts to retain the client over time but concentrate on obtaining new clients with potential to be in the aforementioned tier one category.

To summarize at this point, the primary question to weed out the vast majority of potential financial professionals to manage your money is to ask “What is your average client account balance?”  If your account would be less than that average, there is a strong probability that the future attention to your account relationship will be less than the other client accounts.  If you have questions in the future, especially during volatile times in the global financial markets or major life changes, you may not be able to get a hold of your financial professional for guidance in a timeframe acceptable to you.  The other options you have are to find a financial professional where you are above the average or find a financial professional that charges a flat-fee or on an hourly basis.  At least in the latter option, you know that the financial profession spends more of an equal amount of time with each client.  Every client account tends to get the same amount of attention, and there is very little distinction in terms of importance.  Think of it this way, it is your hard-earned money and your future is on the line, you deserve to be one of the important clients of your financial professional.  Not just a name and account number.

A New Paradigm for Investing on 50 year-old Investment Advice Available on Amazon.com

01 Saturday Mar 2014

Posted by wmosconi in asset allocation, beta, business, Consumer Finance, Education, Fama, finance, financial planning, Free Book Promotion, Individual Investing, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investment advisory fees, investments, Markowitz, math, Modern Portfolio Theory, MPT, passive investing, personal finance, portfolio, risk, Sharpe, sigma, statistics, stock prices, stocks, volatility

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Amazon.com, business, economics, education, FA, finance, Financial Advisors, free books, individual investing, investing, investment advice, investments, mathematics, Modern Portfolio Theory, MPT, personal finance, statistics

I have decided to make my recently published book FREE for today only, March 1, 2014(it normally retails for $4.99).  The book is another installment in my A New Paradigm for Investing series.  In this particular book, I focus on the use of Modern Portfolio Theory (MPT) as the primary tool by Financial Advisors to recommend portfolio allocations.  The theory is over 50 years old, and most of its assumptions have been shown to be less and less useful.  I explore the reasons why in my text.  I have tried to write in such a manner that you do not need a degree in mathematics or statistics to understand its contents.  Moreover, you do not need to know about the intricacies of MPT in order to follow my logic.  You would find the same information in a college textbook but in a condensed format here.  It actually is quite surprising how little Financial Advisors know about MPT in general and how the ideas apply to individual investors.

Note that this book is available for download onto a Kindle.  Additionally, there is a Kindle app for iPhones and Android devices which is free to download.  Amazon.com Prime Members can borrow the book for FREE as well. I have provided a link below to make it easier.   My email address is latticeworkwealth@gmail.com should you have any questions/comments/feedback.

The book is:

1)      A New Paradigm for Investing:  Is Your Financial Advisor Creating Your Portfolio with a 50 Year-Old Theory?:

http://www.amazon.com/New-Paradigm-Investing-Financial-ebook/dp/B00FQQ0CKG/ref=sr_1_1?s=books&ie=UTF8&qid=1381520643&sr=1-1&keywords=a+New+paradigm+for+investing+by+William+Nelson

I would like to thank my international viewers as well of my blog that can be found at https://latticeworkwealth.com/.  I also wanted to especially thank some selected followers of my @NelsonThought and @LatticeworkWlth Twitter accounts (each of whom I would strongly recommend following for their content and insight):

Followers on @NelsonThought:

–  The Wall Street Journal Wealth Report @WSJwealthreport – #wsjexperts

–  Institutional Investor @iimag

–  The Royce Funds @RoyceFunds – Small Cap value investing asset manager

–  Research Magazine @Research_Mag – Latest industry information for wirehouses and ETFs

–  Barron’s Online @BarronsOnline – Weekly financial news magazine of Dow Jones

–  Cleveland Fed Research @ClevFedResearch

–  Euromoney.com @Euromoney

–  Pedro da Costa @pdacosta – Central banking and economics reporter at The Wall Street Journal

–  Muriel Siebert & Co. @SiebertCo

–  Roger Wohlner, CFP® @rwohlner

–  Ed Moldaver @emoldaver

–  Sylvia Maxfield @sylviamaxfield – Dean of the Providence College of Business

–  The Shut Up Show @theshutupshow

–  Berni Xiong (shUNG) @BerniXiong

Followers on @LatticeworkWlth:

–  Tracy Alloway @tracyalloway – US Financial Correspondent at Financial Times

–  Vanguard FA @Vanguard_FA – Vanguard’s ETF research and education

–  EU External Action @eu_eeas – Latest news from the European External Action Service (EEAS)

–  Direxion Alts @DirexionAlts

–  Charlie Wells @charliewwells – Editor at The Wall Street Journal

–  Jesse Colombo @TheBubbleBubble – Columnist at Forbes

–  Alastair Winter @AlastairWinter – Chief Economist at Daniel Stewart & Company

–  AbsoluteVerification @GIPStips

–  Investment Advisor @InvestAdvMag

–  Gary Oneil @GaryONeil2

–  MJ Gottlieb @MJGottlieb

–  Bob Burg @BobBurg

–  TheMichaelBrown @TheMichaelBrown

–  Phil Gerbyshak @PhilGerbyshak

– MuniCredit @MuniCredit

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