How to Become a Successful Long-Term Investor – Summary

30 Monday Sep 2019

Posted by wmosconi in asset allocation, behavioral finance, correlation, correlation coefficient, Dot Com Bubble, Emotional Intelligence, EQ, financial advice, Financial Advisor, financial goals, financial markets, financial planning, financial services industry, historical returns, Individual Investing, individual investors, investing, investing advice, investing information, investing tips, investment advice, investments, market timing, math, personal finance, portfolio, risk, risk tolerance, risks of stocks, S&P 500, S&P 500 historical returns, S&P 500 Index, standard deviation, statistics, Stock Market Returns, stock prices, stocks, volatility

≈ Leave a comment

Tags

asset allocation, behavioral finance, education, finance, historical stock returns, investing, investments, math, mathematics, performance, performance monitoring, portfolio, portfolio management, S&P 500, S&P 500 historical returns, S&P 500 Index, statistics, stock returns, stocks, success, successful long term investing, trading, uncertainty

The discussion of how to become a successful long-term investor in my three-part series is now finished. However, the journey is an ongoing one that takes discipline, constant learning, and monitoring your emotional reactions to fluctuations in the financial markets. I discussed the history of stock market returns of the S&P 500 Index (dividends reinvested) from 1957-2018, the concept of risk, and also the futility of trying to engage in “market timing”. But you may be asking yourself, why didn’t you tell me what stocks, bonds, and other assets to buy to build my investment portfolio? That is a valid question, and there is an extremely important reason why that gets at the very heart of my overall discussion.

The best way to answer the question posed above is with an analogy. Now my international readers will have to indulge me with this example. My favorite sport is football which is the most popular sport in the world. Most people in the United States refer to it as soccer and only watch if the men’s or women’s teams are competing in the World Cup. I could tell you all about the reasons why football clubs rarely use a 4-4-2 formation. Or I could talk about how the 4-2-3-1 formation has evolved in the Bundesliga. We also could discuss why goalies now need to be good with their feet in order to pass from the backline. Finally, I might even be more specific and give my rationale for why Liverpool in the Premier League uses a 4-4-3 formation given their current squad for the 2019-2020 season.

My analogy above relates to long-term investing because I would argue that you should not invest a single dollar in the stock or bond markets without knowing about the history of returns, risks and volatility, and “market timing”. Most Financial Advisors (FAs), Certified Financial Planners (CFPs), and Registered Investment Advisors (RIAs) jump right into the discussion of how to build an investment portfolio taking into account your financial goals and risk tolerance. This conversation is directly related to the football analogy above. Without a firm understanding of investing at a high level (or the general way football is played first), you are likely to fail in your resolve to stick with a long-term focus while investing. For example, when you are asked if you can tolerate a 20% decline in the stock market, how should you answer? I would say that, if you do not have some grasp of historical returns and the level of risk, you cannot properly answer. Remember that we covered how often you will experience negative returns (including 20% declines) in the first article. You need to understand the “composition of the forest before deciding how to deal with the trees”.

Here are the links to the three articles to have an understanding of first prior to jumping into the mix of long-term investing strategy and building an actual portfolio of investments.

Part 1 – Understanding Historical Stock Market Returns:

https://latticeworkwealth.com/2019/09/23/successful-long-term-investing/

Part 2 – Understanding and Managing Risk:

https://latticeworkwealth.com/2019/09/25/successful-long-term-investor-risk/

Part 3 – Giving up on the Allure of “Market Timing”:

https://latticeworkwealth.com/2019/09/28/successful-long-term-investing-market-timing/

Once you have a firm grasp on these topics, you are ready to get your feet wet in the world of investing.

For those of you wanting a little bit of guidance because your intention is the manage your investments personally, I have written about this topic in the past. I wrote a two-part series on how to build an investment portfolio and monitor the performance returns of that investment portfolio. I have included the links below:

Part 1 – Building an Investment Portfolio:

https://latticeworkwealth.com/2013/07/16/how-to-create-an-investment-portfolio-and-properly-measure-your-performance-part-1-of-2/

Part 2 – Monitoring the Performance of an Investment Portfolio:

https://latticeworkwealth.com/2013/07/19/how-to-create-an-investment-portfolio-and-properly-measure-your-performance-part-2-of-2/

Those two articles above will provide you with some ways to go about creating your own investment portfolio without the assistance of a financial professional. While it does contain a lot of information and suggestions, individual investors who are complete novices may find it easier and less confusing to seek out someone to guide them with investment selection, measuring risk tolerance, and understanding the goals of their financial plan.

In summary, I appreciate you taking the time to read my thoughts in regard to successful long-term investing. As you can see successful investing has more to do with preparation, setting realistic expectations, and knowing how you personally respond to risk. These topics need to be studied prior to investing money yourself or before going to seek out investment advice from a financial professional. If you have any questions, comments, feedback, or disagreements, you can feel free to let me know.

Bonds Have Risks Other Than Rising Interest Rates. Dividend Stocks are not Substitutes for Bonds.

24 Sunday Jul 2016

Posted by wmosconi in academics, asset allocation, bond basics, bond market, Bond Mathematics, Bond Risks, bonds, Fabozzi, finance, finance theory, financial advice, Financial Advisor, financial goals, financial markets, Financial Media, financial planning, financial services industry, Fixed Income Mathematics, foreign currency, Frank Fabozzi, Individual Investing, individual investors, interest rates, investing, investing advice, investing information, investing tips, investment advice, investments, math, MBS, personal finance, rebalancing, rebalancing investment portfolio, rising interest rate environment, rising interest rates, risk, risks of bonds, Search for Yield, statistics, types of bonds, volatility, yield

≈ 1 Comment

Tags

asset allocation, bond basics, Bond Risks, bonds, dividend stocks, education, finance, financial advice, Financial Advisor, Financial Advisors, financial markets, financial planning, financial services, financial services industry, individual investing, interest rates, investing, investment advice, investments, mathematics, personal finance, portfolio, portfolio allocation, portfolio management, rising interest rates, risks of bonds, Search for Yield, statistics, types of bonds, volatility, yields

The main reason why Financial Advisors are recommending that individual investors sell bonds is that interest rates are likely to rise over the next 3-5 years or more. Although those sentiments have been a familiar refrain over the last 3-5 years though. Well, I would tend to agree that interest rates are poised to rise at some point toward the end of this decade. However, interest rate risk is only one of the risks of bonds. In fact, the size of the bond market dwarfs the stock market. When Financial Advisors are talking about bonds, they tend to be referring only to US Treasury bonds, corporate bonds, and municipal bonds. Interest rate risk greatly affects these bonds indeed. With that being said, they tend to conflate the interest rate risk of these bonds with the entire bond market. Remember that interest rates have dropped from 16.30% on the 1-month US Treasury bill back in 1981 to roughly 0.25% today. Therefore, bond prices have been rising for over 35 years and most financial professionals outside of the fixed income markets have forgotten (or if they are younger than 50) how bonds normally work, especially in a rising interest rate environment.But does it even matter really? Yes. Here is an urgent note to all individual investors: “Beware of financial professionals that recommend dividend stocks or other equities as replacements for your fixed income allocation”. What I mean by this is that the volatility of stocks is far greater than bonds historically. Yields may be very low in money market funds, US Treasuries, and in bond mutual funds now. However, your risk tolerance must be taken into account at all times. While it is true that many dividend-paying stocks offer yields of 3% or more with the possibility of capital appreciation, there also is significant downside risk. For example, as most people are aware, the S&P 500 index (which represents most of the biggest companies in America) was down over 35% in 2008. Many of those stocks are included in the push to have individual investors buy dividend payers. With that being said, stock market declines of 10%-20% in a single quarter are not that uncommon. If you handle the volatility of the stock market well, there is no need to be concerned. However, a decline of 10% for a stock paying a 3% dividend will wipe out a little more than 3 years of yield. Individual investors need to realize that swapping traditional bonds or bond mutual funds is not a “riskless” transaction, meaning a one-for-one swap. The volatility and riskiness of your portfolio will go up commensurately with your added exposure to equities. Sometimes financial professionals portray the search for yield by jumping into stocks as the only option given the low interest rate environment. While your situation might warrant that movement in your portfolio allocation, you need to be able to accept that the value of those stocks is likely to drop by 10% or more in the future just taking into account normal volatility in the stock market historically (every 36 months or so in any given quarter). Are you able to handle that volatility when looking at your risk tolerance, financial goals, and age?The purpose of this blog post is to discuss the risk factors associated with bonds in greater detail. Most bonds, such as Treasury notes and bonds, corporate bonds, and municipal bonds, will go down in value when interest rates go up. Conversely, they will go up in value when interest rates decrease. This characteristic of these types of bonds is called an inverse relationship. For a primer on how most bonds function normally, I have posted supplementary material alongside this post. You can refer to it to brush back up on bonds and how they work, and I also provide a historical look at interest rates over the last 35 years. Here is the link to that prior blog post:https://latticeworkwealth.com/2014/01/02/a-bond-is-a-bond-is-a-bond-right-should-you-sell-bonds-to-buy-stocks-supplementary-information-on-how-bonds-work/There are many risk factors associated with investments in bonds. A great overview of those risks can be found in Fixed Income Mathematics the Fourth Edition by Dr. Frank Fabozzi who teaches at Yale University’s School of Management. Most fixed income traders, portfolio managers, and risk managers use his Handbook of Fixed Income Securities as their general guidebook for approaching dealing with the trading, investing, and portfolio/risk management of owning fixed income securities. Suffice it to say that he is regarded as one of the experts when it comes to the bond markets. Dr. Fabozzi summarizes the risks inherent in bonds on page 109 of the first text referenced above. The risks are as follows:

Interest-rate risk;
Credit risk;
Liquidity risk;
Call or prepayment risk;
Exchange-rate risk.

Most of fixed income folks and myself would add inflation risk, basis risk, and separate credit risk into two components. Bonds have two types of risk as it relates to payment of principal and interest. The first risk is more commonly thought of and referred to as default risk. Default risk is simply whether or not the company will pay you back in full and with timely interest payments. Credit risk also can be thought of as the financial strength of the company. If a company starts to see a reduction in profits, much higher expenses, and drains of cash, the rating agencies may downgrade their debt. A downgrade just means that the company is less likely to pay back the bondholder.Here is an example to illustrate the difference more fully: a company may have a AA+ rating from Standard & Poor’s at the beginning of the year, but, due to events that transpire during the year, the company may get downgraded to A- with a Negative Outlook. Now the company is still very likely to pay back principal and interest on the bonds, but the probability of default has gone up. As a point of reference, AAA is the highest and BBB- is the lowest Standard & Poor’s ratings to be considered investment grade. You will note that the hypothetical company would need to be downgraded four more times (BBB+, BBB, BBB- to BB+) to be considered non-investment grade or a “junk” bond. Bond market participants though will react to the downgrade though because new potential buyers see more risk of default given the same coupon. So even though the company may not default eventually on the actual bond, the price of the bond goes up to compensate for the interest rate required by the marketplace on similarly rated bonds to attract buyers.Now I will address the full list of risks affecting bonds outlined by Dr. Fabozzi above. Any bond is simply an agreement between two parties in which one party agrees to pay back money to the other party at a later date with interest. All bonds have what is referred to as credit (default portion) risk. Credit risk in general is simply the risk one runs that the party who owes you the money will not pay you back (i.e. default). What is lesser known or thought about by individual investors is interest-rate risk and inflation risk. These two risks are usually missed because investors tend to think that bonds are “safe”. Interest-rate risk relates to the fact that interest rates may rise, while you hold the bonds (spoken about at length in the beginning of this blog post). When financial pundits make blanket statements about selling bonds, they are referring to this one risk factor normally. Inflation risk means that inflation may increase to a level higher than your interest rate on the bond. Thus, if the interest rate on your bond is less than inflation or closer to inflation from when you bought the bond, your purchasing power goes down. The prices of goods and services go up faster than the interest you earn on the bond. Call risk refers to instances where some companies have the option to redeem your bonds in the future at an agreed upon price. This is normally done only when interest rates fall. Prepayment risk is a more specialized case of call risk and refers to people paying their mortgages (or credit cards, home equity loans, student loans, etc.) back sooner than expected. Most people group these two risks into a category called reinvestment risk. Think about the concept in this manner: many people refinanced their mortgages because interest rates went down. They did so because they could lower their total mortgage payment. Well, companies do the same thing if they have the option. Companies can redeem bonds at higher interests and issue new bonds at lower interest rates. Chances are that, if you are the owner of the redeemed bonds, you will be unable to find as high of an interest payment currently if you want to buy a bond with similar characteristics of the company issuing the bonds you own before.The other three risks I mentioned above are less commonly discussed and not quite as important. Exchange-rate risk exists because sometimes a company issues bonds in a currency other than its own. For example, you will sometimes hear the terms Yankee bonds or Samurai bonds. Since the company is paying you interest and principal in a foreign currency that money may be worth more or less depending on what happens in foreign exchange markets in the future. Liquidity risk refers to the phenomenon that there are certain crisis times in the market where very few, if any bond market participants, are willing to buy the bonds you are trying to sell. Therefore, you might have to take a bigger loss in order to entice someone to buy the bonds given the current macro environment. Basis risk is a more obtuse type of risk that institutions deal with. Basis risk essentially refers to anytime when interest rates on your bond are pegged to another interest rate that is different but normally behaves in a certain way (referred to as correlation). Now most of the time, the behavior will follow the historical pattern. However, during times of stress like a liquidity and/or credit crisis, the correlations tend to break down. Meaning you can think you are “hedged” but, if the historical relationship does not hold up, your end return will be nothing like what you had expected. These two risks are not something that individual investors need to focus on for the most part, since these types of bonds are not normally owned by them.I will admit that this list is quite lengthy and, quite possibly, a bit too detailed and/or complicated. However, I wanted to lay them all out for you. Why? When you hear Financial Advisors recommend that you sell a large portion of your bonds, and/or hear the same investment advice from the financial media, they normally are really only referring to interest-rate risk primarily and secondarily inflation risk as well. As you can see from the description above, the bond market is far more complex than that to make a blanket statement.Now, as I usually say, I would never advise individual investors to take a certain course of action in terms of selecting specific bonds or not selling bonds to move into more stocks. However, I am saying that you should feel comfortable enough to ask your Financial Advisor why he/she recommends that you sell a portion of your bonds. If the answer relates only to interest-rate risk, I would probe the recommendation further. You can explain that you know that is the case for Treasury notes/bonds, municipal bonds, and corporate bonds. However, there are a whole host of other fixed income securities with different characteristics and risks. Now I am not referring solely to Mortgage Backed Securities (MBS), although the residential and commercial markets for these are in the trillions of dollars. There are bonds and notes that have floating interest rates which means that as interest rates go up, the interest rate you receive on that security goes up. Not to mention that different countries are experiencing different interest rate cycles than the US (stable or downward even).The complete list is too in-depth to cover in a single blog post. My goal was to provide you with enough information to at least ask the question(s). Your risk tolerance and financial goals might make a move from bonds to stocks the best course of action. With that being said, you also have the option of selling bonds and keeping the money in cash or investing in the different types of bonds offered in the fixed income markets while keeping your total allocation to fixed income nearly the same. Thinking holistically about your portfolio, you may be increasing the riskiness of your portfolio beyond your risk tolerance or more than you are aware unbeknownst to you by moving from bonds into stocks. This is something you definitely want to avoid. It can turn out to be a rude awakening and hard lesson to learn one or two years from now.

Are Stocks Currently Overvalued, Undervalued, or Fairly Valued? Answer: Yes.

10 Tuesday May 2016

Posted by wmosconi in academia, academics, asset allocation, Average Returns, business, CAPE, CAPE P/E Ratio, Consumer Finance, Cyclically Adjusted Price Earnings Ratio, Education, finance, finance theory, financial advice, financial goals, financial markets, Financial Media, Financial News, financial planning, financial services industry, Forward P/E Ratio, Individual Investing, individual investors, interest rates, investing, investing advice, investing information, investing tips, investment advice, investments, Nobel Prize, Nobel Prize in Economics, P/E Ratio, passive investing, personal finance, portfolio, risk, Robert Shiller, Schiller, Shiller P/E Ratio, statistics, stock market, Stock Market Returns, Stock Market Valuation, stock prices, stocks, Valuation, volatility

≈ 1 Comment

Tags

business, CAPE P/E Ratio, Cyclically Adjusted Price Earnings Ratio, economics, education, finance, financial advice, financial markets, Financial Media, Financial News, financial planning, financial services, financial services industry, individual investing, interest rates, investing, investment advice, investments, P/E Ratio, personal finance, portfolio, portfolio allocation, portfolio management, Robert Shiller, Shiller, statistics, stock market, Stock Market Valuation, stock valuation, stocks, Valuation, volatility

Confusing and frustrating as it may be, the answer about the current valuation of stocks will always be different depending on who you ask. Various economists, mutual fund portfolio managers, research analysts, financial news print and TV personalities, and other parties seem to disagree on this very important question. Financial professionals will offer a wide range of financial and economic statistics in support of these opinions on the current valuation of stocks. One of the most often cited statistics in support of a person’s opinion is the P/E ratio of the stock market at any given point in time. Many financial professionals use it as one of the easiest numbers to be able to formulate a viewpoint on stock valuation. However, when it comes to any statistic, one must always be skeptical in terms of both the way the number is calculated and its predictive value. Any time one number is used to describe the financial markets one must always be leery. A closer examination of the P/E ratio is necessary to show why its usage alone is a poor way to make a judgement in regard to the proper valuation of stocks.

The P/E ratio is short for Price/Earnings ratio. The value is calculated by taking the current stock price divided by the annual earnings of the company. When it is applied to an entire stock market index like the S&P 500 index, the value is calculated by taking the current value of the index divided by the sum of the annual earnings of the 500 companies included in the index. One of the very important things to be aware of is that the denominator of the equation may actually be different depending on who is using the P/E ratio. Some people will refer to the P/E ratio in terms of the last reported annual earnings for the company (index). Other people will refer to the P/E ratio in terms of the expected earnings for the company (index) over the next year. In this particular case, the P/E ratio is referred to as the Forward P/E ratio. Both ratios have a purpose. The traditional P/E ratio measures the reported accounting earnings of the firm (index). It is a known value. The Forward P/E ratio measures the profits that the firm (index) will create in the future. However, the future profits are only a forecast. Many analysts prefer to use the Forward P/E ratio because the value of any firm (or index of companies) is determined by its future ability to generate profits for its owners. The historical earnings are of lesser significance.

The P/E ratio is essentially a measure of how much investors value $1 worth of earnings and what they are willing to pay for it. For example, a firm might have a P/E ratio of 10, 20, 45, or even 100. In the case of a firm that is losing money, the P/E ratio does not apply. In general, investors are willing to pay more per each $1 in earnings if the company has the potential to grow a great deal in the future. Examples of this would be companies like Amazon (Ticker Symbol: AMZN) or Netflix (Ticker Symbol: NFLX) that have P/E ratios well over 100. Some companies are further along in their life cycle and offer less growth opportunities and tend to have lower P/E ratios. Examples of this would be General Motors or IBM that have P/E ratios in the single digits or low teens, respectively. Investors tend to pay more for companies that offer the promise of future growth than for companies that are in mature or declining industries.

When it comes to the entire stock market, the P/E ratio applied to a stock market index (such as the S&P 500 index) measures how much investors are willing to pay for the earnings of all the companies in that particular index. For purposes of discussion and illustration, I will refer to the S&P 500 index while discussing the P/E ratio. The average P/E ratio for the S&P 500 index over the last 40 years (1966-2015) was 18.77. When delivering an opinion on the valuation of the S&P 500 index, many financial professionals will cite this number and state that stocks are overvalued (undervalued) if the current P/E ratio of the S&P 500 index is above (below) that historical average. If the current P/E ratio of the S&P 500 index is roughly in line with that historical average, the term fairly valued will usually be used in relation to stocks. The rationale is that stocks are only worth what their earnings/profits are over time. There is evidence that the stock market can become far too highly priced (as in March 2000 or December 2007) or far too lowly priced (as in 1982) based upon the P/E ratio observed at that time. Unfortunately, the relative correlation between looking at the difference between the current P/E ratio of the stock market and the historical P/E ratio does not work perfectly. In fact, it is only under very extreme circumstances and with perfect hindsight that investors can see that stocks were overvalued or undervalued in relation to the P/E ratio at that time.

Here are the historical P/E ratios for the S&P 500 index from 1966-2015 as measured by the P/E ratio at the end of the year. Additionally, the annual return of the S&P index for that year is also shown.

Year	P/E Ratio	Annual Return
2015	22.17	1.30%
2014	20.02	13.81%
2013	18.15	32.43%
2012	17.03	15.88%
2011	14.87	2.07%
2010	16.30	14.87%
2009	20.70	27.11%
2008	70.91	-37.22%
2007	21.46	5.46%
2006	17.36	15.74%
2005	18.07	4.79%
2004	19.99	10.82%
2003	22.73	28.72%
2002	31.43	-22.27%
2001	46.17	-11.98%
2000	27.55	-9.11%
1999	29.04	21.11%
1998	32.92	28.73%
1997	24.29	33.67%
1996	19.53	23.06%
1995	18.08	38.02%
1994	14.89	1.19%
1993	21.34	10.17%
1992	22.50	7.60%
1991	25.93	30.95%
1990	15.35	-3.42%
1989	15.13	32.00%
1988	11.82	16.64%
1987	14.03	5.69%
1986	18.01	19.06%
1985	14.28	32.24%
1984	10.36	5.96%
1983	11.52	23.13%
1982	11.48	21.22%
1981	7.73	-5.33%
1980	9.02	32.76%
1979	7.39	18.69%
1978	7.88	6.41%
1977	8.28	-7.78%
1976	10.41	24.20%
1975	11.83	38.46%
1974	8.30	-26.95%
1973	11.68	-15.03%
1972	18.08	19.15%
1971	18.00	14.54%
1970	18.12	3.60%
1969	15.76	-8.63%
1968	17.65	11.03%
1967	17.70	24.45%
1966	15.30	-10.36%

Average 18.77

The P/E ratio for the S&P 500 index has varied widely from the single digits to values of 40 or above. The important thing to observe is that very high P/E ratios are not always followed by low or negative returns, nor are very low P/E ratios followed by very high returns. In terms of a baseline, the S&P 500 index returned approximately 9.5% over this 40-year period. As is immediately evident, the returns of stocks are quite varied which is what one would expect given the fact that stocks are known as assets that exhibit volatility (meaning that they fluctuate a lot because the future is never known with certainty). Thus, whenever a financial professional says that stocks are overvalued, undervalued, or fairly valued at any given point in time, that statement has very little significance. Whenever only one data point is utilized to give a forecast about the future direction of stocks, an individual investor needs to be extremely skeptical of that statement. The P/E ratio does hold a very important key for the future returns of stocks but only over long periods of time and certainly not over a short timeframe like a month, quarter, or even a year.

An improvement on the P/E ratio was developed by Dr. Robert J. Shiller, the Nobel Prize winner in Economics and current professor of Economics at Yale University. The P/E ratio that Dr. Shiller developed is referred to as the Shiller P/E ratio or the CAPE (Cyclically Adjusted Price Earnings) P/E ratio. This P/E ratio takes the current value of a stock or stock index and divides it by the average earnings of a firm or index components for a period of 10 years and also takes into account the level of inflation over that period. The general idea is that the long-term earnings of a firm or index determine its relative valuation. Thus, it does a far better job of measuring whether or not the stock market is fairly valued or not at any given point in time. However, another very important piece of the puzzle has to do with interest rates. Investors are generally willing to pay more for stocks when interest rates are low than when interest rates are high. Why? If it is assumed that the future earnings stream of the company remains the same, an investor would be willing to take more risk and invest in stocks over the safety of bonds. A quick example from everyday life is instructive. Imagine that your friend wants to borrow $500 for one year. How much interest will you charge your friend on the loan? Let’s say you want to earn 5% more than what you could earn by simply buying US Treasury Bills for one year. A one-year US Treasury Bill is risk free and, as of May 10, 2016 yields interest of 0.50%. Therefore, you might charge your friend 5.5% on the loan. Now back in the early 1980’s, one-year US Treasury Bills (and even savings accounts at banks) were 10% or higher. If you were to have provided the loan to your friend then, you would not charge 5.5% because you could simply deposit the $500 in the bank. You might charge your friend 15.5% on the loan assuming that the relative risk of your friend not paying you back is the same in both time periods. It is very similar when it comes to investing in stocks. Due to the fact that stocks are volatile and future profits are unknown, investors tend to prefer bonds over stocks as interest rates rise. This phenomenon causes the value of stocks to fall. Conversely, as interest rates fall, the preference for bonds decreases and investors will choose stocks more and prices go up. Now this assumes that the future earnings of the company or index constituents stay the same in either scenario.

With that information in mind, a better way to gauge the relative valuation of stocks in terms of being overvalued, undervalued, or fairly valued, would be to look at the Shiller P/E ratio in combination with interest rates. It is most common for investors to utilize the 10-year US Treasury note as a proxy for interest rates. Here are the historical values for the Shiller P/E ratio and the 10-year US Treasury note over the same 40-year period (1966-2015) as before:

Year	CAPE Ratio	10-Year Yield
2015	24.21	2.27%
2014	26.49	2.17%
2013	24.86	3.04%
2012	21.90	1.78%
2011	21.21	1.89%
2010	22.98	3.30%
2009	20.53	3.85%
2008	15.17	2.25%
2007	24.02	4.04%
2006	27.21	4.71%
2005	26.47	4.39%
2004	26.59	4.24%
2003	27.66	4.27%
2002	22.90	3.83%
2001	30.28	5.07%
2000	36.98	5.12%
1999	43.77	6.45%
1998	40.57	4.65%
1997	32.86	5.75%
1996	28.33	6.43%
1995	24.76	5.58%
1994	20.22	7.84%
1993	21.41	5.83%
1992	20.32	6.70%
1991	19.77	6.71%
1990	15.61	8.08%
1989	17.05	7.93%
1988	15.09	9.14%
1987	13.90	8.83%
1986	14.92	7.23%
1985	11.72	9.00%
1984	10.00	11.55%
1983	9.89	11.82%
1982	8.76	10.36%
1981	7.39	13.98%
1980	9.26	12.43%
1979	8.85	10.33%
1978	9.26	9.15%
1977	9.24	7.78%
1976	11.44	6.81%
1975	11.19	7.76%
1974	8.92	7.40%
1973	13.53	6.90%
1972	18.71	6.41%
1971	17.26	5.89%
1970	16.46	6.50%
1969	17.09	7.88%
1968	21.19	6.16%
1967	21.51	5.70%
1966	20.43	4.64%

Average 19.80 6.44%

These two data points provide a much better gauge of whether or not stocks are currently overvalued or undervalued. For example, take a look at the Shiller P/E ratio in the late 1970’s and early 1980’s. The value of the Shiller ratio is in the single digits during this time period because interest rates were higher than 10%. Lately interest rates have been right around 2.0%-2.5% for the past several years. Therefore, one would expect that the Shiller P/E ratio would be higher. Now the historical average for the Shiller P/E ratio was 19.80 over this period. The Shiller P/E ratio was in the neighborhood of 40 during 1998-2000 which preceded the bursting of the Internet Bubble in March 2000. The Shiller P/E ratio was at its two lowest levels of 7 and 8 in 1981 and 1982, respectively which is when the great bull market began. However, while this Shiller P/E and interest rates are better than simply the traditional P/E ratio, there are flaws. The Shiller P/E in 2007 was 24.02 right (and interest rates were around 4.0% which is on the low side historically) before the huge market drop of the Great Recession between September 2008 and March 2009. In fact, the S&P 500 index was down over 37% in 2008, and the Shiller P/E did not provide an imminent warning of any such severe downturn. Therefore, even looking at these two measures is imperfect but better than the normal P/E ratio in isolation.

To summarize the discussion, individual investors will always be told on a daily basis by various sources that the stock market is currently overvalued, undervalued, and fairly valued at the same time. One of the most commonly used rationales is a reference to the current P/E ratio in relation to the historical P/E ratio. As we have seen, this one data point is a very poor indicator of the future direction and relative value of stocks at any given period of time, especially for short periods of time (one year or less). The commentary and opinions provided by financial “experts” to individual investors when the P/E ratio is mentioned normally relates to the short term. By looking back at the historical data, it is clear that this one data point is really only relevant over very long periods of time. The Shiller P/E ratio in combination with current interest rates is a great improvement over the traditional P/E ratio, but it is even imperfect when it comes to forecasting the future returns of the stock market. There are two general rules for individual investors to take away from this discussion. Whenever a comment is made about the current value of stocks and only one statistic is provided, the opinion should be taken with a “grain of salt” and weighed only as one piece of information in determining investment decisions that individual investors may or may not make. Additionally, and equally as important, if a financial professional cites a statistic about stock valuation that you do not understand (even after doing some research of your own), you should always discard that opinion in most every case. Individual investors should not make major investment decisions in terms of altering large portions of their investment portfolios of stocks, bonds, and other financial assets utilizing information that they do not understand. It sounds like common sense, but, in the sometimes irrational world of investing, this occurrence is far more common than you imagine.

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

≈ Leave a comment

Tags

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

≈ Leave a comment

Tags

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

Not all Index Mutual Funds and ETFs are Created Equal: Part 2 of 2

12 Wednesday Feb 2014

Posted by wmosconi in active investing, active versus passive debate, asset allocation, bonds, business, Consumer Finance, Education, enhanced indexing, finance, financial planning, Individual Investing, investing, investments, passive investing, personal finance, portfolio, risk, stocks, volatility

≈ Leave a comment

Tags

active investing, active versus passive, active versus passive investing debate, asset allocation, bonds, business, education, enhanced indexing, ETF, ETFs, finance, financial planning, individual investing, individual investor, investing, investments, passive investing, portfolio, portfolio management, stocks

The exponential growth of passive investment vehicles over the past ten years has been astonishing since the infancy of index investing that Vanguard made so famous back in the early 1980s. In the first part of this discussion, I spoke at length about the need to really read the prospectus or fact sheet of an Exchange Traded Fund (ETF) or an index mutual fund. Two similarly sounding investments may actually have quite different underlying components. I utilized two different emerging market stock ETFs to demonstrate the difference, and they were the iShares MSCI Emerging Markets Stock ETF (Ticker Symbol: EEM) and the Vanguard FTSE Emerging Markets Stock ETF (Ticker Symbol: VWO), respectively to show why this is true. The main issue in this case was that one considers South Korea to be a developing economy (EEM), and the other (VWO) does not. Therefore, a large component of your investment allocation in your portfolio to emerging market stocks may be more heavily weighted toward South Korea than you at first thought (over 15% in fact). For the details of the discussion, you can click on this link:

https://latticeworkwealth.com/2014/01/28/not-all-index-mutual-funds-and-etfs-are-created-equal-part-1-of-2/

The second issue that I hinted at in part 1 relates to the definition of passive investing. The active management versus passive investing debate has been raging on for over 30 years with proponents on both sides of the fence. In its most general form, passive investing is choosing to invest in all stocks or bonds tied to a particular index, such as the S&P 500 Index, Russell 2000 Index, MSCI EAFE Index, or the Barclays Aggregate Bond Index. The investor in this case decides that he/she would rather participate in the investment performance of all the components of the index rather than picking the best stocks or bonds themselves. Active managers strive to beat the investment performance of a particular index by scouring the quantitative and qualitative data about each particular stock or bond. These professionals believe that they have the ability to make superior investment choices and do better than average (i.e. just settling for the investment returns of the index less the expenses of the ETF or index mutual fund). I spoke at length about active and passive investing in one of my earliest blog posts. Here is the link to that more involved discussion to get further detail:

https://latticeworkwealth.com/2013/07/05/difference-between-active-and-passive-investing/

A new type of investment vehicle has sprung up during the development of the ETF industry, and it is referred to as “enhanced indexing”. The idea is that you can approach the debate by using a hybrid view of sorts. Enhanced indexing is investing in a particular index but not investing in all the stocks or bonds or choosing to weight the stocks or bonds differently than the index does. These ETFs offer the ability to use the asset manager’s proprietary strategy to pick the “best” members in the index. There are many managers that do this, and two of the most popular are offered by the WisdomTree company and Dimensional Fund Advisors. The ETF and mutual funds offered by these companies follow a similar philosophy with different approaches. However, each company strives to outperform the index that their portfolio managers select.

There is nothing wrong with any of the offering of these companies. In fact, many of their investment vehicles have had superb performance over the years. This salient point is that they are really “blurring” the line between active and passive investment philosophies. Using a more strict definition of passive investing, the investor knows at the outset that they will underperform the index by the amount of fees (and “tracking error” – a concept I will not go into specifically in this post) assessed to the ETF or index mutual fund. However, they will not significantly underperform because all the components of the index are always held. An active investment vehicle has the ability to outperform or underperform an index after fees are assessed each year. Investors in enhanced indexed ETFs or mutual funds fall into the latter category. Once the asset manager makes a decision to pick the “best” components of a particular index, they are moving into the realm of active management. One of the appeals of this investing strategy to individual investors is that you can still beat the index. With that being said though, you are taking the chance that the investment will underperform what the passive ETF or index mutual fund delivers in terms of investment returns.

Enhanced indexing may seem like a great way to “have your cake and eat it too”, but, at its core, active management (either by way of a proprietary computer algorithm, back tested studies, qualitative metrics, or some other method) nonetheless. Many individual investors fail to recognize that they are really choosing an active strategy, although some professionals would argue that it is more sophisticated than the approach of traditional active managers. As long as you are aware of this fact at the beginning, there is nothing wrong with that. In fact, many investment advisors use a combination of active and passive investment vehicles when building a portfolio for their clients. For example, it has been shown that there may still be inefficiencies in micro cap (normally stocks with a market capitalization below $1 billion) stocks because very few Wall Street analysts follow the companies and provide investment recommendations. On the other hand, there are a plethora of Wall Street analysts who follow the largest companies in the US, so it becomes much harder to know more than other investors. Thus, some financial professionals will advise a certain portfolio allocation to passive ETFs and another piece of the portfolio will go to active managers. This type of approach is a hybrid approach.

In the case of enhanced indexing (or “smart beta” funds – similar type of concept that I will not elaborate more on in this discussion), the individual investor is allowing the asset manager to make active selections which is much more akin to active investing. The key is to know that you run the risk of two things. First, the particular investment vehicle may do worse than the corollary strictly passive ETF or index mutual fund in terms of investment returns. Second, the asset manager may not always be fully invested in the index at all times as well. Therefore, you may have a higher allocation to cash than you initially wanted. Now if the asset manager sells stocks to raise cash before a downturn in stock prices, the individual investor will not lose as much as other market participants. The flipside is that the individual investor fails to participate fully in any stock market rally. This second part is emphasizing that the asset manager may lag the investment performance of the benchmark index even more so than the passive ETF or index mutual fund.

The important thing is to simply know up front that passive investing involves average underperformance at the outset. However, you are assured of at least capturing the lion’s share of the investment returns. Any other investment vehicle may do better or worse over the long term which is the main concern of an individual investor. If the enhanced indexing investment strategy yields lower long-term investment returns for your portfolio, you have paid money to “lose” money on a relative basis. What I mean by this is that, as an individual investor, you could have just invested in the entire index of stocks or bonds at a very low cost by doing absolutely nothing. If the enhanced index manager outperforms the index after fees are taken into account, that investment decision was a wise one. However, history has shown that active managers tend to lag their proper benchmark over the long term (usually defined as 5 years or more).

It may be enticing to try to combine the best features of the passive investing and active investing philosophies. With that being said, individual investors need to realize that any departure from the strict definition of passive investing increases the odds that the manager will have an investment return different than the index. If your investing time horizon is 5, 10, 15, 20 years or more, the active mangers (either in its pure form or via enhanced indexing) has a more difficult time outperforming the index year in and year out to provide the individual investor with performance above and beyond what the “stodgy”, old passive ETFs or index mutual funds offer. I would characterize this more as “buyer beware”. The main takeaway is not that these are “bad” investments at all; rather, it is a conscious choice to depart from the passive world of investing and move to the active side.

The Results are in for my January CNBC Experiment: It Proves Nothing and Everything. What?

07 Friday Feb 2014

Posted by wmosconi in asset allocation, beta, bonds, business, Consumer Finance, currency, Education, EM, emerging markets, Fed, Fed Taper, Fed Tapering, Federal Reserve, finance, financial planning, foreign currency, forex, fx, Individual Investing, interest rates, investing, investments, math, NailedIt, personal finance, portfolio, rising interest rate environment, rising interest rates, risk, statistics, stock prices, stocks, Suitability, volatility, Yellen

≈ 1 Comment

Tags

bonds, business, cnbc, currency, education, EM, emerging markets, finance, financial planning, forex, fx, individual investing, interest rate risk, interest rates, investing, personal finance, rising interest rates, stocks, thought experiment, volatility

Sometimes the most important lessons in the individual investing sphere are complicated and simple at the same time. At the very beginning of January, I recommended a little experiment that related to the financial market coverage on CNBC. The specific details of this “thought experiment” can be found in the original blog post from January 1st:

https://latticeworkwealth.com/2014/01/14/happy-new-year-beginning-thoughts-and-information-for-international-viewers-2/

The brief version of the exercise related to watching Monday and Friday coverage of the current events in the global financial markets during the month. The simple exercise was to watch CNBC’s Squwak Box every Monday during the course of the month. The second part was to watch the last hour of the Closing Bell segment. What was the logic? The Monday show is a three-hour program, and there are many current issues considered and opinions from various market participants (e.g. traders, money managers, economists, investment strategists, research analysts, etc.). Monday is critical due to the fact that the market participants cannot trade on Saturday and Sunday. You might think of it as “forced” time to think and/or reflect about how current events are affecting investment opportunities and risks. Friday’s reflections from the same market participants is focused more on trying to explain the “vagaries and vicissitudes” (i.e. volatility of the stock market and changing opinions) of the markets ups and downs over the course of the week. Furthermore, many commentators and guests try to explain why the predictions on Monday did not or did match up with the ideas expressed at the beginning of the week.

The overall point of this experiment was to “drive home” the fact that trying to time the market or predict its direction over the short term is extremely challenging and can seem hopeless. Toward the end of December, the general investment thesis for the majority of money managers was that the stock market was poised to have a very positive January due to the fact that the financial markets did not really dive after the Federal Reserve announced the reduction of the tapering program, commonly referred to as QE (quantitative easing). Additionally, the main belief was that bonds were one of the least attractive investments to own. Most people assumed that the 10-year US Treasury Note was headed up to the 3.0% level. Things seemed pretty simple and not too many headwinds in the near future. So what happened during January?

The main event that most people remember was the currency difficulties of a number of emerging market countries. The financial media focused a lot on the Turkish lira (TRY) and the Argentine peso (ARS). Turkey had political problems, and Argentina has a huge problem as it relates to political leadership (or the absence thereof) and dwindling currency reserves. There were other currencies that experienced trouble as well like the South African rand (ZAR). The other important development was that the Japanese yen (JPY) reversed its direction and strengthen versus the US dollar (USD). Oddly enough, the Argentine Merval stock index was one of the best performers over the course of the month. No one saw this coming to such an extent. You might term this an exogenous event as anything that occurs outside of your current model to build a portfolio or invest in individual stocks/bonds. It is largely unknown and hard to predict. (As an aside, this is NOT the same thing as a “black swan”. That term is overused and conflated with many other things. Refer to Dr. Nassim Taleb for a further definition of the termed that he famously coined years ago). These events tend to be unknowns and have a greater impact because the general level of the perception of risk changes almost instantly and affect market sentiment and momentum. Market participants need to alter their models rather quickly in order to account for the occurrence of these events.

The other big event was the movement of the yield on the 10-year US Treasury note. Instead of following a general path of rising, the interest rate actually fell. The yield on this instrument drifted down roughly 40 basis points (0.4%) from the 3.0% level. What most people fail to realize is that interest rates go down if economic data turns out to be worse than expected normally (e.g. December jobs of 70,000 and the lowest labor force participation rate since the 1980s), but, more importantly, there is a “flight to quality” phenomenon that occurs over and over again. There tends to be a bit of a “mini panic” when unexpected and impactful events occur. If all else fails, institutional investors like hedge fund managers tend to buy US Treasury bills, notes, and bonds for safety. The additional demand causes bond prices to go up and, by definition, yields will go down.

The combination of bad economic data and dealing with the currency woes in the emerging markets causes many short-term traders and speculators to buy these risk-free assets and figure out how to trade later. It is sort of an example of reflexivity. The bottom line for individual investors is that many sold bonds and purchased dividend stocks instead. The exact opposite happened: bond yields went down and dividend stocks sold off. The worst short-term investing strategy was to search for yield in the stock market rather than the bond market due to rising interest rates. For more information you can refer to one of my former posts on how to look at the various risk factors associated with bonds. Trust me, there is a lot more to bonds than simply interest rate risk. Here is the link to a former blog post that addresses this very issue:

https://latticeworkwealth.com/2014/01/02/a-bond-is-a-bond-is-a-bond-right-should-you-sell-bonds-to-buy-stocks/

There were many other smaller events that happened over the course of the month that affected the general volatility experience in the financial markets. At the end of the day, even the “experts” had a monumental task trying to explain all the macroeconomic events, currency movements, and interest rate implications throughout January. If the task was so difficult for them, it is normally advisable for individual investors to not follow the market daily and get caught up in temporary “greed and fear” of traders and speculators. Investment ideas and predications can change from day to day and even minute to minute in the short term. It is much more important for individual investors to develop a long-term financial plan that will allow them to reach future financial goals. You then blend that with your risk tolerance. For example, how likely would you have been to sell the positions in your portfolio given the volatility experienced during the course of January? An outlook of five years is normally a great start for that plan. If you look out into the future with a longer timeframe like an annual basis in terms of adjusting the components of your asset allocation, you are less likely to constantly trade the securities in your personal portfolio. The frenetic pace of traders/speculators and the volatility of the stock and bonds markets makes it seem that you MUST do something, anything!

If you would like to learn a bit more about behavioral finance, you can refer to this blog post from last year (note context of examples referred to is from August 2013 when the piece was published):

https://latticeworkwealth.com/2013/08/04/todays-news-should-prompt-you-to-adjust-your-entire-investment-portfolio/

One of the most important things to learn in investing is how to control your emotions. It is easy to map out your investment strategy and risk tolerance on paper. Many asset managers who have experienced a multitude of secular bull and bear markets refer to this phenomenon as your EQ versus your IQ. Thus, when actual “money” is involved, volatility and uncertainty in the financial markets brings forth challenges that even the best money managers have a hard time keeping up their nerve. The other takeaway is that people’s investment recommendations can change on a dime. Market participants can be very hopeful on one day and think the sky is falling the next day. Trying to time the market is so difficult that you end up developing a portfolio allocation for your investments that assumes that general events with transpire. All the planning in the world cannot account for all possibilities of geopolitical and global events that might really cause the market to go down more than normal in a short time period.

The whole point of this “thought experiment” was to encourage you to take a long-term view of investing in the financial markets. It is a lot less stressful, less complicated, and tends to lead to better overall investment returns (i.e. you do not “sell low and buy high” as much because everyone tells you to). For more information on stepping back and thinking about the long term, I have included a final blog post. You always need to remember that your financial professional (or yourself if you manage your own investments) who advises you about investment decisions is forever impacted by the start of their investment career. They tend to be biased and make investment recommendations based upon how things used to be when they started in the business. It is very hard to separate your “biases” from the present day. Here is the link:

https://latticeworkwealth.com/2013/08/18/before-you-take-any-investment-advice-consider-the-source/

Well, I hope you learned a few things by participating in my experiment and maybe even had a little bit of fun. Please feel free to leave a comment or send me an email directly at latticeworkwealth@gmail.com with more specific feedback and/or questions. Sometimes you can learn a great deal just by being an observer of financial market volatility. What is the nothing part of this learning journey? The moral of the story is that everyday guests appearing on CNBC or other commentators will let you know that the stock market with either go up, go down, or stay unchanged. Obviously everyone knows that simple concept to begin with. Thus, it is hard to choose who to listen too because of so many divergent opinions. Lastly, you should realize that this same experiment would have worked with the other business networks and large financial news publications like the Wall Street Journal, Financial Times, Barron’s.

A New Paradigm for Investing: Can Your Financial Advisor Answer These Questions?

01 Wednesday Jan 2014

Posted by wmosconi in asset allocation, bonds, business, Consumer Finance, Education, Fed Taper, Fed Tapering, Federal Reserve, finance, financial advisor fees, financial planning, Individual Investing, investing, investment advisory fees, investments, math, Modern Portfolio Theory, MPT, Nobel Prize in Economics, personal finance, portfolio, rising interest rate environment, rising interest rates, risk, statistics, stock prices, stocks, Suitability, volatility

≈ Leave a comment

Tags

Amazon book deals, asset allocation, books, business, education, finance, Financial Advisors, financial planning, individual investing, investing, investment advsiory fees, Modern Portfolio Theory, MPT, reasonable investment advisory fees, retirement

Greetings to all my loyal readers of this blog. How would you like to start off the New Year of 2014 by reevaluating your investment portfolio and how you get investment advice? This book on Amazon.com is available for download onto a Kindle. Additionally, there is a Kindle app for iPhones and Android devices which is free to download. Please feel free to check out the titles below. I have provided links to make it easier. My email address is latticeworkwealth@gmail.com.

The link to the book is as follows:

A New Paradigm for Investing: Can Your Financial Advisor Answer These Questions?

http://www.amazon.com/New-Paradigm-Investing-Financial-Questions-ebook/dp/B00F3BDTHW/ref=sr_1_3?s=books&ie=UTF8&qid=1388595896&sr=1-3&keywords=a+new+paradigm+for+investing+by+william+nelson

The book listed is normally $9.99 but available but I am offering it for a lower price over the course of the next week. For most of the day today, the book is $3.99 which is 60% off. The price of the book will be gradually increasing during the course of that period.

I would like to thank my international viewers as well. I also wanted to especially thank some selected followers of my @NelsonThought and @LatticeworkWlth Twitter accounts (each of whom I would recommend following for the content and insight):

Followers on @NelsonThought:

The Wall Street Journal Wealth Report @WSJwealthreport – #wsjexperts

The Royce Funds @RoyceFunds

Research Magazine @Research_Mag

Barron’s Online @BarronsOnline

Vanguard FA @Vanguard_FA

Cleveland Fed Research @ClevFedResearch

Chloe Cho – @chloecnbc – CNBC Asia Anchor for Capital Connection show

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:

Euro-banks @EuroBanks

Direxion Alts @DirexionAlts

Charlie Wells @charliewwells – Editor at The Wall Street Journal

AbsoluteVerification @GIPStips

Investment Advisor @InvestAdvMag

Gary Oneil @GaryONeil2

MJ Gottlieb @MJGottlieb

Bob Burg @BobBurg

Melody Campbell @SmBizGuru

TheMichaelBrown @TheMichaelBrown

Phil Gerbyshak @PhilGerbyshak

MuniCredit @MuniCredit

D.J. Rob-Ski @DJRobSki

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

03 Tuesday Dec 2013

Posted by wmosconi in alpha, asset allocation, Bernanke, beta, bonds, business, Consumer Finance, Education, Fama, Fed, Fed Taper, Fed Tapering, Federal Reserve, finance, financial advisor fees, financial planning, Individual Investing, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investment advisory fees, investments, Markowitz, math, Modern Portfolio Theory, MPT, Nobel Prize, Nobel Prize in Economics, portfolio, rising interest rate environment, rising interest rates, risk, Schiller, Sharpe, sigma, statistics, stock prices, stocks, volatility, Yellen

≈ 1 Comment

Tags

alpha, asset allocation, Bernanke, beta, bonds, business, consumer finance, economics, education, Fama, Fed, Fed taper, Fed Tapering, Federal Reserve, finance, investing, investments, math, Modern Portfolio Theory, MPT, Nobel Prize, Nobel Prize in Economics, personal finance, portfolio, portfolio management, Schiller, Shiller, statistics, stocks, volatility, Yellen

I am happy to announce that I have published another book on Amazon.com. I have decided to make it FREE for the rest of the week through Saturday, December 7^th(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. Futhermore, 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.

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. 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

Followers on @NelsonThought:

The Wealth Report @wsjexperts – Wall Street Journal #wsjexperts

The Royce Funds @RoyceFunds

Research Magazine @Research_Mag

Barron’s Online @BarronsOnline

Vanguard FA @Vanguard_FA

Cleveland Fed Research @ClevFedResearch

Pedro da Costa @pdacosta

Muriel Siebert & Co. @SiebertCo

Roger Wohlner, CFP® @rwohlner

Ed Moldaver @emoldaver

Sylvia Maxfield @sylviamaxfield

The Shut Up Show @theshutupshow

Berni Xiong (shUNG) @BerniXiong

Followers on @LatticeworkWlth:

Euro-banks @EuroBanks

Direxion Alts @DirexionAlts

Charlie Wells @charliewwells

AbsoluteVerification @GIPStips

Investment Advisor @InvestAdvMag

Gary Oneil @GaryONeil2

MJ Gottlieb @MJGottlieb

Bob Burg @BobBurg

Melody Campbell @SmBizGuru

TheMichaelBrown @TheMichaelBrown

Phil Gerbyshak @PhilGerbyshak

MuniCredit @MuniCredit

D.J. Rob-Ski @DJRobSki

A New Paradigm for Investing Available on Amazon.com – FREE for Thanksgiving Holiday

27 Wednesday Nov 2013

Posted by wmosconi in asset allocation, Bernanke, bonds, business, Charlie Munger, Consumer Finance, Education, Fed, Fed Taper, Fed Tapering, Federal Reserve, finance, financial advisor fees, financial planning, GIPS, GIPS2013, Individual Investing, interest rates, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investment advisory fees, investments, math, Modern Portfolio Theory, MPT, personal finance, portfolio, risk, statistics, stock prices, stocks, Suitability, volatility, Warren Buffett, Yellen

≈ 1 Comment

Tags

bonds, Charlie Munger, consumer finance, economics, education, Fed, Fed taper, finance, financial advisor fees, Financial Advisors, financial planning, financial services, free books, interest rates, investing, investment advisory fees, investments, retirement, stocks, volatility, Warren Buffett

Greetings to all my loyal readers of this blog. In keeping with the Thanksgiving spirit, I have decided to make my first two books absolutely FREE for the rest of the week. These two books on Amazon.com are available for download onto a Kindle. Additionally, there is a Kindle app for iPhones and Android devices which is free to download. Please feel free to check out the titles below. I have provided links to make it easier. My email address is latticeworkwealth@gmail.com.

The books are as follows:

1) A New Paradigm for Investing: Can Your Financial Advisor Answer These Questions?:

http://www.amazon.com/New-Paradigm-Investing-Financial-ebook/dp/B00F3BDTHW/ref=sr_1_1?s=books&ie=UTF8&qid=1381107823&sr=1-1&keywords=A+New+Paradigm+for+Investing+by+William+Nelson

2) Spend 20 Hours Learning About Investing to Prepare for 20+ Years in Retirement

http://www.amazon.com/Learning-Investments-Prepare-Retirement-ebook/dp/B00F3KW9T2/ref=sr_1_1?s=books&ie=UTF8&qid=1379183661&sr=1-1&keywords=William+Nelson+Spend+20+Hours

The first book listed is normally $9.99 but available for FREE until November 30th. The other book is normally $2.99, but it is also FREE for the same time period.

Followers on @NelsonThought:

The Wealth Report @wsjexperts – #wsjexperts

The Royce Funds @RoyceFunds

Research Magazine @Research_Mag

Barron’s Online @BarronsOnline

Vanguard FA @Vanguard_FA

Cleveland Fed Research @ClevFedResearch

Pedro da Costa @pdacosta

Muriel Siebert & Co. @SiebertCo

Roger Wohlner, CFP® @rwohlner

Ed Moldaver @emoldaver

Sylvia Maxfield @sylviamaxfield

The Shut Up Show @theshutupshow

Berni Xiong (shUNG) @BerniXiong

Followers on @LatticeworkWlth:

Euro-banks @EuroBanks

Direxion Alts @DirexionAlts

Charlie Wells @charliewwells

AbsoluteVerification @GIPStips

Investment Advisor @InvestAdvMag

Gary Oneil @GaryONeil2

MJ Gottlieb @MJGottlieb

Bob Burg @BobBurg

Melody Campbell @SmBizGuru

TheMichaelBrown @TheMichaelBrown

Phil Gerbyshak @PhilGerbyshak

MuniCredit @MuniCredit

D.J. Rob-Ski @DJRobSki

Latticework Wealth Management, LLC

~ Information for Individual Investors

Tag Archives: education

How to Become a Successful Long-Term Investor – Summary

Bonds Have Risks Other Than Rising Interest Rates. Dividend Stocks are not Substitutes for Bonds.

Are Stocks Currently Overvalued, Undervalued, or Fairly Valued? Answer: Yes.

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

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

Not all Index Mutual Funds and ETFs are Created Equal: Part 2 of 2

The Results are in for my January CNBC Experiment: It Proves Nothing and Everything. What?

A New Paradigm for Investing: Can Your Financial Advisor Answer These Questions?

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

A New Paradigm for Investing Available on Amazon.com – FREE for Thanksgiving Holiday