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Before You Take Any Investment Advice, Consider the Source – Version 2.0

18 Wednesday Sep 2019

Posted by wmosconi in asset allocation, Average Returns, behavioral finance, bonds, Charlie Munger, confirmation bias, Consumer Finance, emerging markets, Fama, finance, financial advice, Financial Advisor, financial goals, financial markets, Financial Media, Financial News, financial planning, financial services industry, Geometric Returns, Individual Investing, individual investors, interest rates, Internet Bubble, investing, investing advice, investing, investments, stocks, bonds, asset allocation, portfolio, investment advice, investments, Markowitz, Modern Portfolio Theory, MPT, personal finance, portfolio, risk, risk tolerance, stock market, Stock Market Returns, Stock Market Valuation, stock prices, stocks, Uncategorized, Valuation, volatility, Warren Buffett

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academics, anchoring, behavioral economics, behavioral finance, Ben Graham, Bill Ruane, Capital Asset Pricing Model, CAPM, Charlie Munger, cognitive bias, Common Stocks and Uncommon Profits, David Dodd, economics, economy, Efficient Market Hypothesis, EMT, finance, invest, investing, investments, mathematics, Modern Portfolio Theory, MPT, performance, Phil Fisher, portfolio, portfolio management, Security Analysis, stocks, uncertainty, Warren Buffett

I originally wrote about this topic five years ago.  However, I think that it may even be more relevant today.  You may have heard about behavioral finance/economics and how cognitive biases plagued individual investors when making financial and investing decisions especially during volatility times in the financial markets.

Sometimes an overlooked topic is the fact that whomever provides you with financial advice will invariably be affected by those same biases.  Yes, even the professionals cannot escape them.  One of the most prevalent and insidious cognitive biases is called “anchoring”.

In layman’s terms, “anchoring” describes the tendency of people to form a particular belief and then stick with it unless there is an incredible amount of evidence to the contrary.  It is just part of human nature; we generally do not want to admit that we were mistaken or flat out wrong.

Now when I am talking about considering the source, I am not referring to the person’s qualifications such as having a Chartered Financial Analyst (CFA), Certified Financial Planner (CFP), or Chartered Market Technician (CMT) designation.  I am referring to the person’s investing paradigm. 

For the most part, financial professionals are influenced greatly by the time period in which they first start out in the financial services industry.  The first several of years have an outsized impact on their investing recommendations throughout the rest of their careers. 

I will give you an example in life, and then I will talk about Warren Buffett and even myself.  Take special note that I am including myself in this “anchoring” cognitive bias within the context of investing.

There have been many studies that show that the kind of music you listen to most during your teen years becomes your preferred type of music.  For example, there are many people in their early 40’s that love 80’s rock.  They would prefer to listen to that over any type of new music.  My parents are in their seventies now, and they love to listen to Peter, Paul, & Mary, the Beach Boys, Neil Diamond, Motown, and lots of one-hit wonders from the 50’s and 60’s. 

Think about your own taste in music.  Does this ring a bell?  Most people fall into this category, and it is almost subconscious.  You like a certain genre of music best, and it sticks with you.  Did you have a family member that was really into music and had a collection of records?  Sometimes you get introduced to music at an even younger age, and you are drawn to it.  You listened to it during your formative years.  The same goes for investing in a rather similar way.

If we take a look at Warren Buffett, he was definitely influenced by the time period in which he started learning about investing seriously.  Buffett read Security Analysis by Benjamin Graham and David Dodd, and he knew right away that he wanted to go to Columbia to get his MS in Economics.  The themes in the book seemed to resonate with him.  I have heard stories that the value investing class with Ben Graham and Warren Buffett was really a conversation between the two of them.  The rest of the classmates just sat back and enjoyed the “show”. 

Warren Buffett also learned a lot from a lesser known gentleman, Phil Fisher.  Phil Fisher wrote the classic treatise on “scuttlebutt” called Common Stocks and Uncommon Profits.  “Scuttlebutt” is essentially trying to gain every last piece of information you can about a company prior to investing.  This technique includes, not only speaking to management and reading annual reports, but talking to competitors, suppliers, current employees, past employees, and several other sources.

Warren Buffett remarked in the past that he was “15% Fisher and 85% Graham” in terms of his investing style.  Most experts on the career of Buffett would say that the percentage has shifted toward Fisher quite a bit, especially with the massive size of Berkshire Hathaway now.

I did not pick Warren Buffett because of his long-term track record of stellar performance.  I only picked him because many individuals are familiar with Warren Buffett.  Warren started out working for Graham in the early 50’s after he graduated from Columbia in 1951.  If you look back at this time in history, the stock market had finally gained back its losses from the great crash of October 1929.  The baby boom was in full swing, and the US economy was on overdrive in terms of growth.  The Securities and Exchange Commission (SEC) was set up back in 1933 after the crash once an investigation was done regarding the causes of this debacle. 

There were two important promulgations from the SEC in 1934 and 1940 that were issued in order to ensure that company information was available to the public and not fraudulent.  Well, there were still scams, but they were harder to pull off.  (As an aside, the Investment Advisor Act of 1940 did not stop Bernie Madoff from stealing billions of dollars several years ago).  Buffett and Graham (and Graham’s partner, Newman) loved to get their hands on any piece of information they could.  In fact, Buffett used to read entire books on every single public company. 

During that time period, information was so disjointed and hard to get.  However, it was now available to the public and professional investors who could do much more thorough analyses.  The financial markets had far more inefficiencies back then. 

This time period was before the dawn of Modern Portfolio Theory (MPT), the Capital Asset Pricing Model (CAPM), and the Efficient Market Hypothesis (EMT).  Thus, there was a great deal of opportunities for individuals like Buffett who soaked up all the information he could find.

Buffett started his own investment partnership in the mid 50’s.  It was essentially a hedge fund in most respects.  Without getting into too much of the details, Buffett was able to earn 20% more on average than the Down Jones Average annually until 1969.  The stock market at this time seemed to be overpriced in his estimation, so Buffett disbanded the partnership.  He referred his partners to Bill Ruane of the famed Sequoia Fund.  Bill was a former classmate of Warren, and he amassed quite a record himself.

So if we look at Buffett’s beginning career, he saw how doing your homework really paid off.  In fact, there are even stories that Ben Graham would use examples in his lectures about companies he was going to buy.  After class let out, all the students rushed to call, or see directly, their stock brokers to buy the companies Graham presented on. 

Buffett learned from Graham the importance of valuing a company based upon verifiable evidence and not market sentiment.  Fisher’s lessons showed him the benefit of accumulating information from different sources in order to truly understand a business prior to investing.  These formative years are still with Buffett. 

Now Charlie Munger, Buffett’s Vice Chairman at Berkshire Hathaway, has been an influence as well.  What is little known is that they grew up together in Omaha, Nebraska, and they were able to meet during this same time period.  This introduction to investing left an indelible mark on Warren Buffett that permeates his investing career today.

Obviously I am no Warren Buffett, but I started investing in mutual funds at age 13 in November 1987.  What got me so interested in the stock market?  Obviously Black Monday on October 19, 1987 really caught my attention.  It was not really the crash that really piqued my interest though.  My father told me that the market drop of 508 points on that day was an overreaction (down over 20% amazed me).  I did not know much about stocks, but it seemed to me like the world was ending.  At least that was how the nightly news portrayed things.  My father said watch the market over the next several days. 

To my absolute amazement, the Dow Jones Industrial Average (DJIA) went up almost 290 points in the next two trading sessions.  Wow!  This turn of events was really weird to me.  How could stocks move around in value so greatly?

I thought that all the big money investors in the stock market really knew what they were doing.  However, most everyone was caught by surprise by Black Monday.  The other interesting thing for me was that 1987 turned out to be a positive year for the DJIA.  If you want to get your friend’s attention, you can ask them what the return of the DJIA was for 1987 (positive return) and 1988 (negative return).  Most people will get it wrong.

Well, these events left a mark on me.  When I learned more about investing and was exposed to Modern Portfolio Theory (MPT) and the Efficient Market Hypothesis (EMT), I really did not think it was true given my start in investing back in the latter portion of 1987.  How could the value of the entire U.S. economy be worth 20% less after one day of trading? 

Now, the stock market is normally efficient and stock prices are correct, but I knew that there were inflection points in the stock market where rationality was thrown out the door.  Therefore, when I learned about Mr. Market and the vicissitudes and vagaries of the stock market from Ben Graham’s books, I liked that metaphor and way to characterize volatility in the stock market. 

For better or worse, I really do not care for the academic, ivory tower analysis of behavior in the stock market.  I cling more to focus investing, value investing, and seeing the financial markets as complex adaptive systems.  I would fall into the camp of Warren Buffett and the great hedge fund investor, George Soros.  Both men have said that they would never be able to pass the Chartered Financial Analyst (CFA) exam. 

The CFA is now the standard designation for all portfolio managers of stocks and bonds.  I tried studying for it, but a lot of it made little sense to me.  I guess that is why I think it is funny when Buffett says he wants to gift money to universities to install permanent chairs in business schools to teach Modern Portfolio Theory forever.

Most of the financial professionals you meet will range in age from twenties to sixties.  You should always ask them when they started investing or their career as a Financial Advisor.  Here are the ten major events that will cover those individuals:

  • The 1973-1974 severe bear market;
  • The Death of Equities article from Business Week magazine in 1979;
  • Black Monday in October 1987;
  • The Bond Bubble Bursting in 1994;
  • The Asian Contagion and Long Term Capital Management (LTCM) incidents in 1997-1998;
  • The Barron’s article in December 1999 that questioned the relevance of the Oracle of Omaha, Warren Buffett;
  • The Bursting of the Internet Bubble in April 2001;
  • The Financial Crisis and ensuing Great Recession of 2008-2009;
  • The “Lost Decade” of Returns from the S&P 500 from 2001-2010 when stocks averaged approximately 2% annually.
  • Managing Money is Easy. Look at my investing record over the past 10 years (2009-2018).  Note that the annualized return of the S&P 500 index over that period was 13.13%.

These major inflection points in the financial markets will have a great effect on your financial professional’s recommendations for investment portfolio allocation.  In fact, I met a Financial Advisor that tells his clients that they can expect to earn 12% annually from stocks over the long term.  He uses this return for modeling how much clients need to invest for retirement.  He was introduced to investing around 1996 which is when the stock market went gangbusters. 

I know another Financial Advisor that tells his clients to never put more than 50% of their money in common stocks.  He tells this to all of his clients, even if they are in their thirties and have 30+ years until retirement.  He started advising clients in 2007, and he lost a great many clients in 2008.  Therefore, he wants to have limited downside risk for two reasons. 

First, he has seen how much the stock market can drop in one year.  Second, this gentleman wants to ensure that his clients do not close accounts and flee to other financial professionals because the stocks in their portfolio go down 30-40% in a single year.

The importance today of the long, extended bull market of the past 10 years is extremely important to take into account for all individual investors.  A recent stretch of 13.13% annualized stock returns makes it seem that investing systematically over the long term is the correct investment strategy.  I would not disagree with that thought. 

However, Financial Advisors with 10 years of experience or less will only tell clients what they would do hypothetically in the event of a major market decline in the stock and bond markets.  Hypotheticals and backtesting are all well and good. 

But it has been my experience, that there is no substitute for actually investing during periods of extreme volatility and major stock market declines (20% or more).  For example, what was the best stock investment strategy right after the Internet Bubble implosion in terms of the asset class?  The best performing asset class for the next decade was to have a larger than normal allocation to emerging market stocks (think Ticker Symbol EEM or VWO).  Do you think that your Financial Advisor would have the stomach to recommend this investment to you after seeing the NASDAQ index fall by over 50%?

As you can see, the start of anyone’s investing career has an impact on their outlook for the financial markets and how to set up a portfolio properly.  I am not saying that any of this advice is “wrong” per se. 

My only point is that you need to probe your Financial Advisor a little bit to understand the framework he/she is working with.  Thus, you can refer to the aforementioned list of ten major events in the history of the financial markets.  These events really shape the investment paradigm of all of us.  And, of course, I will admit that I am no different.

With that being said, most investment strategies recommended by Financial Advisors are borne out of those individuals first few years with the financial markets.  Some financial professionals are more bullish than others.  Others focus on downside risk and limiting volatility in investment portfolios.  Still others utilize complicated mathematics to build investment portfolios that are optimized. 

Therefore, you need to understand your risk tolerance and financial goals very well.  You have your own personal experience with the market.  If your Financial Advisor is somewhat myopic and focused on the past repeating itself in the same way over and over, you need to be careful. 

History does repeat itself, but the repeating events will be caused by much different factors in most cases.  Unfortunately, the financial markets and market participants are always adapting to changing investment strategies, global economic GDP growth, interest rates, geopolitical events, stock price volatility, and a whole host of other things. 

You can learn from the past, but I urge you not to be “stuck” in the past with your Financial Advisor’s “anchoring” cognitive bias at the expense of setting up an investment portfolio that will allow you to reach your financial goals and match your risk tolerance.

Four Important Lessons for Individual Investors from the Brexit Vote

10 Sunday Jul 2016

Posted by wmosconi in Alan Greenspan, Black Swan, bond market, Brexit, Brexit Vote, Emotional Intelligence, EQ, EU, European Union, Fed, Federal Reserve, finance, finance theory, financial advice, Financial Advisor, financial goals, financial markets, Financial Media, Financial News, financial planning, financial services industry, Greenspan, Individual Investing, individual investors, Internet Bubble, investing, investing advice, investing information, investing tips, investment advice, investments, Irrational Exuberance, Nassim Taleb, personal finance, portfolio, Post Brexit, PostBrexit, rebalancing, rebalancing investment portfolio, risk, risk tolerance, stock market, Stock Market Returns, Stock Market Valuation, Taleb, Uncategorized, Valuation, volatility, Warren Buffett

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Alan Greenspan, asset allocation, Black Swan, bonds, Brexit, BrexitVote, EU, European Union, Fed, Federal Reserve, finance, financial advice, Financial Advisor, Financial Advisors, Financial Market History, financial markets, financial planning, financial services, financial services industry, Greenspan, individual investing, investing, InvestingLessons, investment advice, investments, Nassim Taleb, portfolio, portfolio allocation, portfolio management, Post Brexit, PostBrexit, stock market, stocks, Taleb, UK, uncertainty, volatility, volatiltiy, Warren Buffett

The vote by the United Kingdom (UK) to leave the European Union (EU) caught the majority of individual investors by surprise.  In fact, the so-called Brexit was not foreseen by many of the most sophisticated professional investors and money managers all around the world.  The election results sent shockwaves through the financial markets on the Friday and Monday following the Brexit vote.  The most notable effect was the devaluation of the pound to its lowest level since 1985.  Over the course of Tuesday through Friday, the US and European stock markets gained back nearly all their losses from the two days after the Brexit vote.  This fast-moving volatility has left individual investors feeling confused, frustrated, bewildered, and a bit scared.  However, the Brexit vote results offer individual investors a unique set of key lessons to learn and understand.

The four important lessons for individual investors from the Brexit vote are as follows:

  • 1)  There are very few seminal events in financial market history that affect the future path of stocks, bonds, and other assets.

 

The difficult thing to realize about the financial markets is that there are very few consequential events that make an inflection point or major change in the direction of the financial markets.  Even more frustrating than that, these consequential events are only known with the benefit of hindsight.  In other words, what seems like a monumental event today may or may not be considered one of those major events.  Given the fact that there are so few, there is a high probability that the seemingly major events of today will not fall into the seminal event category of financial market history.

What are some of the seminal events in financial market history?  Here is a list of some of the seminal events in chronological order:  the stock market crash in October 1987, the bursting of the bond bubble in 1994, the Asian contagion of 1997-1998, the bursting of the Internet bubble in March 2000, and the Great Recession of the financial crisis starting in September 2008.  There are many more examples previous to 1987, but these are events from recent financial market history that many individual investors will remember.  Keep in mind that in between all of these events are a string of other major events that turned out to be minor blips that caused only fleeting financial market volatility or none at all.

Furthermore, these seminal events are confusing to financial market participants in and of themselves.  For example, let’s take a closer look at the stock market crash of October 1987.  The US stock market dropped over 20% in one day, and things looked very dire.  If an individual investor with a portfolio of $100,000 had sold his/her stock mutual funds (primary investment vehicle used by individuals on the day of the crash, he/she would have a portfolio worth $80,000 approximately.  That type of individual investor was likely to be very fearful and stay out the of stock market for the remainder of 1987.  If an individual investor with a similar portfolio of $100,000 had keep his/her money in stocks on the day of the crash and for the rest of 1987, he/she would actually have roughly $102,000 at the end of 1987.  Why?  Well, there are not too many investors these days that remember how 1987 really turned out for the US stock market.  The S&P 500 index ended up about 2% for the year, so US stocks recovered all of the losses from the crash and a bit more.  Here’s a little fun exercise:  Ask your Financial Advisor or Financial Planner what the return of stocks was in 1987.  The vast majority will assume it was a horrible down year for performance returns.

Another excellent example is the bursting of the Internet bubble in March 2000.  The reason it is so interesting is that individual (and even professional) investors forget the history.  Alan Greenspan, the Chairman of the Federal Reserve during that time period, gave a famous speech where he coined the term, “irrational exuberance”.  Greenspan warned investors that the Internet and technology stocks were getting to valuations that were way out of line with historical norms for valuation of stocks.  What do individual investors forget?  Well, that famous speech was actually given in December 1996.  Yes, that is correct.  Greenspan warned of the Internet bubble, but it took nearly 3 ½ years before financial markets took a nosedive.  The main point here is that smart, rationale professional money managers and economists can know that financial market valuations are out of whack in terms of valuation at any given point in time.  (Note that this can also be stock market valuations that are too low).  However, these conditions can persist for far longer than anyone can imagine.  That is why individual investors should not be so quick to sell (or buy) major portions of their portfolio of stocks and bonds when these predictions or observations are make.

For a more in depth look at this concept, you can refer to a blog post I wrote three years ago on this very subject.  The link to that blog post is as follows:

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

  • 2)  Investors focus on valuations (no emotions) while traders and speculators focus on market sentiment (emotions) and valuation (no emotions).

The majority of professionals who talk to individual investors and provide advice will explain how important it is to keep emotions out of the equation when dealing with elevated market volatility.  When the financial markets are bouncing up and down by large amounts in the short term, it can be very difficult to keep a cool head and resist the urge to buy or sell stocks, bonds, or other assets.  The frenetic pace of market movements makes it seems as though an individual investor needs to do something, anything in response.  The standard advice is to keep one’s emotions in check focus on the long term, and stick to the financial plan.  What is usually missing from that advice is a more complete explanation why.

There are two general types of financial market participants:  investors and traders/speculators.  These two groups have vastly different goals and approaches to the financial markets.  Investors are focused on investing in stocks, bonds, and other assets in order to obtain returns over time from their investments.  The long term might be defined as five years.  Thus, day-to-day fluctuations in the financial markets mean very little to them.  On the flipside, traders/speculators are focused on making gains in stocks, bonds, and other assets in the short term in order to obtain returns.  The short term for this group might be hourly, the medium term might be daily, and the long term might be weekly.  With this particular group, they need to determine both the likely direction of the financial markets due to both market sentiment and valuation.

As you might imagine, the traders/speculators have to analyze emotions or the psychology of financial market participants.  Gauging market sentiment (general short term positioning of traders/speculators in stocks, bonds, and other assets in terms of their trend to buy or sell) is all about emotions.  Additionally, they must be able to combine that with proper valuations for stocks, bonds, and other assets.  Essentially they need to be correct twice.  On the other hand, investors are focused on the long term which corresponds to valuation.  Valuation over the long term is not driven by emotions.  There is a very famous saying by Ben Graham who taught one of the most well-known investors of all time, Warren Buffett.  Graham said, “In the short term the market is a voting machine, in the long term the market is a weighing machine.”  The takeaway from Graham’s quotation is that market sentiment (i.e. emotions) can drive the financial markets wildly over the short term.  However, after a period of years, financial markets always seem to follow the path back to what their true valuations are.  Since emotions are not part of that equation, individual investors should feel more comfortable ignoring or at least subduing their emotions whenever the financial markets exhibit high levels of volatility.

A related part of the story is the financial media (both TV and print) almost always provide information for traders/speculators.  To be perfectly honest, the financial media would not have much to talk about if long-term investing was the topic.  Essentially they would recommend analyzing one’s risk tolerance, define one’s financial goals, and then build a portfolio of financial assets to reach those goals over the long term.  Yes, true investing is very boring actually.  The financial media needs to have something more “exciting” to talk about in order to have viewers (readers) and the corresponding advertising dollars that come from that.  Therefore, the stories and article appearing in the financial media are geared toward traders/speculators.  Now if you are an investor, you can either ignore this bombardment of information or take it with the proverbial “grain of salt”.  Thus, you can keep your emotions in check when all the traders/speculators are wondering how to react to the market volatility right now each and every trading day or week.

For a more in depth discussion of managing one’s emotions as it relates to investors, you can refer to one of my older blog posts.  The link to that blog post is as follows:

https://latticeworkwealth.com/2015/06/11/two-steps-to-help-individual-investors-become-more-successful-at-investing/

  • 3)  The benefit of diversification can disappear or be reduced greatly whenever there are periods are elevated volatility.

The benefit of diversification is one of the hallmarks of the proper construction of an investment portfolio for individual investors.  The basic premise (which has been proven over very long periods of time) is that investing in different asset classes (e.g. stocks, bonds, real estate, precious metals, etc.) reduces the volatility in the value of an investment portfolio.  A closer look at diversification is necessary before relating the discussion back to the Brexit vote.  The benefit of diversification stems from correlations between asset classes.  What is correlation?  To keep things simple, a correlation of 1 means that two different assets are perfectly correlated.  So a correlation of 1 means that when one asset goes up, the other asset goes up too.  A correlation of -1 means that two assets are negatively correlated.  So a correlation of -1 means that when one asset goes up, the other asset goes down (exactly the opposite).  A correlation of 0 means that the two assets are not correlated at all.  So a correlation of 0 means that when one asset goes up, the other asset might go up, go down, or stay the same.  Having an investment portfolio that is properly diversified means that the investments in that portfolio have a combination of assets that have an array of correlations which dampens volatility.  Essentially the positively correlated assets can be balanced out by the negatively correlated assets over time which reduces the volatility of the balance in one’s brokerage statement or 401(k) plan.

What does all this correlation stuff have to do with the Brexit vote?  Surprisingly, it has quite a bit to do with the Brexit vote.  Note that this discussion also applies to any situation/event that causes the financial markets to exhibit high levels of volatility.  During extreme volatility like investors witnessed after the Brexit vote, the correlations of most asset classes started to increase to 1.  Unfortunately for individual investors, that meant that diversification broke down in the short term.  Most all domestic and international stock markets went down dramatically over the course of the two trading days following the Brexit vote.  Therefore, individuals who had their stock investments allocated to various different domestic and international stocks or value and growth stocks all lost money.  When correlations converge upon 1 during extreme market shocks, there is really nowhere to “hide” over the short term.  In fact, the only two asset classes that did very well during this period were gold and government bonds.

What is the key takeaway for individual investors?  Individual investors need to realize that there is an enormous benefit to having a diversified portfolio.  However, diversification is associated with investing over the long term and thereby harnessing its benefit.  There are times of market stress, like the Brexit vote and aftermath, where diversification will not be present or helpful.  When those times come around, individual investors need to keep emotions out of the picture and stick to their long-term financial plans and investment portfolios.

  • 4)  The surprise Brexit vote provides the perfect opportunity for individual investors to evaluate their risk tolerances for exposure to various risky assets.

The two trading days after the surprise vote by the UK to leave the EU (Brexit) were very volatile and very tough to keep emotionally calm.  Individual investors were faced with a very unusual situation, and the urge to sell many, if not all of their investments was very real.  That reaction is perfectly understandable.  Now for the bad news, there will be another time when volatility is as great as or larger than the volatility that the Brexit vote just caused.  In fact, there will be many such periods over the coming years and decades for individual investors.  In spite of that bad news, the Brexit vote should be looked at as a learning experience and opportunity.  Since individual investors know that there will be another period of elevated volatility, they can revisit their personal risk tolerances.

It is extremely difficult to try to determine or capture one’s risk tolerance for downturns in the financial markets in the abstract or through hypothetical situations.  You or with the assistance of your financial professional normally asks the question of whether or not you would likely sell all of your stocks if the market went down 10%, 15%, 20%, or more.  How does an individual investor answer that question?  What is the right answer?  There is no right or wrong answer to that type of question.  Each individual investor is unique and has his/her own risk tolerance for fluctuations in his/her investment portfolio.  A better way to answer the question is to convert those percentages to actual dollar amounts.  For example, if an individual investor starts with $100,000, would he/she be okay with the investment portfolio decreasing to $90,000, $85,000, or $80,000 over the short term.  Note that the aforementioned dollar amounts sync up with the 10%, 15%, and 20% declines illustrated previously.

The opportunity from the Brexit vote is that individual investors have concrete examples of the volatility experienced in their investment portfolios.  It is far easier to analyze and determine one’s risk tolerance by looking at actual periods of market stress.  Depending on your stock investments, the total two-day losses might have been anywhere between 5% to 10%.  Let’s use a 10% decline for purposes of relating this actual volatility to one’s risk tolerance.  If an individual investor was invested 100% in stocks prior to the Brexit vote, he/she would have lost 10% in this scenario.  Let’s use hypothetical dollar amounts:  if the starting investment portfolio was $100,000, the ending investment portfolio was $90,000.  Now the vast majority of individuals do not have all of their money invested in stocks.  So let’s modify the example above to an individual investor who has 50% in stocks and 50% in cash.  In that particular scenario, the individual investor has $50,000 invested in stocks and $50,000 invested in cash.  If stocks go down by 10%, this individual investor will have an ending investment portfolio of $95,000.  Why?  The individual investor only losses 10% on $50,000 which is $5,000 not the full $10,000 loss experienced by the individual investor with a hypothetical portfolio of 100% in stocks.

The importance of the illustrations above and its relation to the Brexit vote is that one can quickly calculate the actual losses from a market decline with a good degree of accuracy.  So let’s say that you had 60% of your money invested in stocks prior to the Brexit vote.  If the overall stock market declines by 10%, your stock investments will only decline by 6% (60% * 10%) assuming the other 40% of your investment portfolio remained unchanged.  So let’s put this all together now.  If you look back at the stock market volatility caused by the Brexit vote, you need to adjust the overall stock market decline by the percentage amount you have invested in stocks.  That adjusted percentage loss will be close to the decline in your overall investment portfolio.  Now whatever that adjusted percentage amount is, ask yourself if you are comfortable with that percentage loss over the short term.  Or is that way too risky?  If the adjusted percentage is way too risky for you and makes you uncomfortable, that is perfectly fine.  The important piece of knowledge to learn is that you need to work with your financial professional or reexamine your investment portfolio yourself to reduce your exposure to stocks such that the adjusted percentage loss is reasonable for you to withstand.  Why?  Because there will be another market volatility event on the order of magnitude of the Brexit aftermath or even worse.

Keep in mind that I am not making a financial market prediction over the short term.  The important point is that the history of financial markets has shown that periods of elevated market volatility (i.e. lots of fluctuations up and down) keep occurring over time.  The Brexit vote provides a real-life example to determine if your risk tolerance is actually lower than you first imagined.  The next cause of market volatility may be a known market event similar to how the UK vote to leave the EU was.  The harder things to deal with are market volatility stemming from the unknown and unforeseeable.  These market volatility events are called “black swans” which is the term coined by Nassim Taleb in his book by the same name several years back.  A “black swan” can be a positive event for the market or a negative event for the market.  As it relates to individual investors and risk tolerance, the negative “black swan” is applicable.  Now the term “black swan” is improperly used today by many investment professionals.  A “black swan” is an event that by definition is unknown and cannot be predicted.  When it does occur though, there is a period of extreme market volatility afterward.  Thus, you can adjust your risk tolerance to be better prepared for future events that will cause market volatility, either known events like the Brexit vote or unforeseen events.  The Brexit vote aftermath should be embraced by individual investors as a golden opportunity to ensure that they are properly (or more precisely) measuring their risk tolerances.

Summary of Important Lessons for Individual Investor from the Brexit Vote:

  1.  There are very few monumental financial market events that should cause individual investors to feel inclined to immediately change their investment portfolios. Plus, they can only truly be identified by hindsight;
  2. Investors should focus on valuation of financial assets (no emotions here), traders/speculators worry about market sentiment (emotions) and valuation (no emotions here);
  3. The benefit of diversification can disappear or be greatly reduced during periods of extreme market volatility and financial market stress over the short term;
  4. The surprise Brexit vote offers individual investors a valuable opportunity to see if their risk tolerances are aligned with the possibilities of short-term market declines.  This real-life event can be used to redefine one’s risk tolerance to better withstand similar periods of market volatility that will inevitably occur in the future.

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

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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.

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 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

You Purchased a Stock: Now What?

27 Sunday Oct 2013

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

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$WU, asset allocation, bonds, business, Charlie Munger, equity, equity selection, finance, individual stocks, investing, investments, momentum stocks, portfolio, stock pickers market, stockpicking, stocks, value investing, Value Masters, Warren Buffett, Western Union

One of the questions that I have been asked is about individual stocks, and, more specifically, how to monitor developments after the purchase.  Now I have mentioned before that I strongly recommend that you do not start off trying to buy individual stocks.  ETFs and index mutual funds are a better way to start off investing and will generally garner you higher returns in the long-run.  Why?  Well, please continue reading, and you will see how I approach the decision to purchase a stock and when I decide to sell.  Now my method is strictly my own, but you will see it closely mirrors Warren Buffett’s style of investing.  There are many other market participants that use a variation of the Buffett and Graham paradigm.  Moreover, there are literally tens of thousands of portfolio managers, hedge fund investors, research analysts, and others that value stocks every second of every day in response to company, economic, and geopolitical news.  Once you see how much work it takes, I am hopeful that you do NOT try it to begin with.

Before delving into the process of following a stock after your purchase, I will go through the steps I take prior to a purchase.  I strive for a turnover of 15-20%.  Turnover measures how long an investor holds a particular stock.  A turnover of 100% means that an investor holds a stock for one year.  Thus, my turnover equates to a holding period of 5.0 to 7.5 years.  So if I am willing to hold a stock for that long, I better make sure I am confident that it is a good investment.  How do I start?  I have a list of stocks that I am interested in purchasing.  If I decide to possibly invest, I go through a lengthy process.  Now I am not recommending any security.  However, I want to put some meat surrounding the discussion.  Therefore, I will talk about my process in terms of my decision to purchase Western Union (WU).  Western Union is now my top holding.  Should you buy WU?  Maybe so.  Maybe not.  You must do your own homework and not take my word for it.  As a show of good faith, I encourage you to look at my Twitter account:  @NelsonThought.  I have been posting information about WU for several months, so I am not “cherry-picking” to make me look good.  Let’s begin.

Regardless of where I get my ideas of stocks to analyze, I start off my analysis by learning everything I can possibly get my hands on.  You would be amazed at how much information is out there.  Prior to deciding to even value WU, I took a number of steps.  First, I read the last three annual reports for WU.  What do I focus on?  The most important part of any annual report is a section called Management Discussion & Analysis (MD&A).  MD&A is indispensable because management has a chance to be open and honest with investors.  Now when you purchase a stock, you should view yourself as a fractional owner in the actual company.  You do not own a piece of paper that says you have x number of shares.  You own a claim to the future cash flows and dividends of that firm.  Contained within the MD&A is management’s discussion is a review of the most recent financial developments, their strategy, and what management thinks is the future direction of the company.  WU’s management team talks a great deal about emerging markets.  WU relies upon the wiring of money between individuals.  The most important, growing income stream comes from immigrants sending money back home to their families.  For example, did you know that 30% of the Gross Domestic Product of El Salvador comes in the form of these remittances?  Wow!  That fact always gets to me.  Obviously you can see that the emerging markets are a great way for WU to grow earnings.  Additionally, WU has a huge market share in the correctional system.  If family members or loved ones of prison inmates need money to purchase items behind bars, they can use WU to transfer money into their accounts to buy food, hygiene products, and even other items like TVs and radios.  WU’s management speaks at length about these opportunities, and they also focus on growing their network of facilities that provide their services.  There is a “network effect” for WU.  The more money transfer centers there are, the more people in general will use their services.  For instance, if a local WU outlet is right near your house, and you need to wire some money to an individual or business, you are more likely to use it.  Well, if you need to wire money to a friend, and the nearest WU outlet is 50 miles from that person, WU is probably not a good option for you.  Therefore, it makes sense for WU to provide good incentives to build up their network.

Now I really focus on MD&A going back in time because management is telling you what they intend to do in the future.  Think about it in these terms.  Have you ever had a friend who tells you that they are going to quit working and start a business?  I know that I have.  More often than not, when I see that person in several years, they tell me that they are still working but they are starting the business soon or they found a better business to start.  It is great to have ideas, but, unless you act upon them and do it, there really is no point.  Well, the same scenario happens very often with a business.  Management might describe great plans to grow the business back in 2010.  If they never speak about it again, or they have new and better ideas when you read the 2012 annual report, that should be a red flag for you.  Now changing strategy is sometimes warranted, but management should be transparent with you.  If a strategy is no longer relevant, or it did not work out, they should explain why.  It is only fair.  You own the stock; you own part of the company.  Always take the time to compare prior MD&A with current MD&A.  This technique can save you a lot of time.  Why value a stock if management does not seem to know what they are doing?

After you feel comfortable with management and still have strong beliefs that the business is well-positioned, you can look at the financial statements of the company.  Every publicly traded company is required to file financial statements with the Securities and Exchange Commission (SEC).  The reports are called 10-Ks on an annual basis and 10-Qs on a quarterly basis.  The SEC even has a website that you can go to when you look for them.  It is called the EDGAR system can be found here:  http://www.sec.gov/edgar.shtml.  The financial statements will include the income statement, balance sheet, and statement of cash flows.  Which part is most important to me?  Well, that is a trick question.  I go to the back of the financial statements and look at the notes to the financial statements.  Do not feel bad if you got the question wrong.  When I pose the question to undergraduate students during presentations that I give, I have never had a finance student give the correct answer.

 Why do I say the notes?  For one, I have an accounting undergraduate degree, so I am interested in them.  You can always get financial statement ratios and earnings expectations online, but they rarely incorporate information from the notes.  Now the notes to the financial statements tend to be boilerplate to begin with.  The accounting firm that audits the financial statements of a firm will explain that the company used generally accepted accounting principles (GAAP) and disclose the accounting methodology utilized when GAAP allows different choices.  After all these disclosures, you will find lesser known items.  The second reason why I look at the notes to the financial statements is to see if there is something I do not understand.  What do I mean by this?  You may remember the downfall of Enron.  The downfall of Enron was right in plain sight all along.  Enron had a disclosure “buried” in the notes that talked about Special Purpose Vehicles (SPVs).  What is a SPV?  I still really have a vague understanding, but here are the basics without getting too technical.  A SPV is a separate legal entity that is set up to own assets and incur liabilities.  It is really like a subsidiary of a company but, since it is a separate entity, the assets and liabilities of the SPV are not required to be reported on the company’s balance sheet.  What?  This phenomenon is called off-balance sheet reporting.  Essentially it is a way to not disclose liabilities.  Think about it in terms of the federal government.  The federal government does not consider future Social Security and Medicare benefits to be necessary to be reported in the current budget.  Thus, the $50+ billion of future payments of benefits is not reported; only think tanks talk about it periodically.  Now I do not want this to be a political discussion.  That is not my intent.  I simply bring it to your attention as a more familiar example of this topic.  Thus, Enron had liabilities that it had to repay in the future, but, if you only examined the financial statements, the future payments were not on the balance sheet.  The auditors did not look too closely.  Why?  I liken it to this.  No one wanted to raise his/her hand and say what is this SPV thing.  In general and in business, people do not want to look uninformed or “dumb”.  If you see something in the notes to the financial statements that you do not understand, I would suggest that you pass on the purchase of that stock.  When I look at the notes for WU, there is nothing that bothers me in particular.

After I look at the notes, I focus on the statement of cash flows, balance sheet, and then the income statement.  I look at them in that exact order.  Now I do not prepare a model at this point to value the company.  Rather, I do some calculations in my head.  Is the company actually generating cash from the operations of the business?  Does the company have enough assets to invest in the business?  Are earnings coming from sources that will either never occur again or have nothing to do with its core business?  These are very vital questions to ponder.  Why do you not value the company at this point?  Now I really have a number in mind for what the stock is worth, you still need to compare that to the sub-industry and industry that the company operates within.

As one reader commented, he was probably going to use this discussion to cure his insomnia ailment.  Hopefully you made it this far.  Are we having fun yet?  I promise we will get to the discussion of how to follow a stock after making a purchase, but I need to lay the foundation to ensure that my method makes sense.  Not that it is right, but the logic of the paradigm is plausible.  As it relates to the sub-industry and industry, I perform what is referred to as a SWOT analysis.  SWOT stands for Strengths, Weaknesses, Opportunities, and Threats.  Now I already know the S and W part from my review of MD&A and the review of the financial statements issued by the company.  The O and the T refer to the industry and competitors.  The main competitors in this space to WU are MoneyGram International and Euronet Worldwide.  How does WU match up against these two?  These two companies are smaller than WU, but bigger is not always better.  These two firms are constantly innovating and trying to make inroads into the niche of WU.  They are referred to as firms within the sub-industry.  The industry as a whole is the financial services industry.  Now WU is able to grow significantly in the emerging markets because the banking industry is not very developed in these countries.  It is easier at this point to simply pick up a wire transfer at a Western Union outlet than to open a checking accounting.  I can assure you that banks have noticed taking note.  Banks are trying to come up with ways to make it easier to open an account and simply have the money deposited there.  That is the most common way to look at the industry.  Now sometimes it is easier to ignore other developments, but I try to take everything into account.  Did you know that you can make wire transfers at most Wal-Mart stores now?  That development might be a game-changer.  Think about it this way.  Why should you go to WU when you can simply do your normal shopping at Wal-Mart and then send your wire transfer?  Remember that there are a plethora of Wal-Mart stores, so they already have a built in “network effect”.  They are a definite competitor even though they are technically in the retail industry.

After my entire analysis, I was confident that the purchase of WU would be a good investment.  How do I go about valuing any stock?  As I mentioned previously, I use a method that Warren Buffett has perfected over the years.  Trust me, I am no Warren Buffett.  If I were as good as Warren Buffett, I would not be writing this blog.  However, his method (coupled with Phil Fisher, David Dodd, Charlie Munger, Bill Ruane, and a few others) makes sense to me.  Think about stocks like bonds.  Bonds are much easier to value.  Why?  They are a promise to pay back money loaned to them.  The only return from a bond held to maturity comes from the coupon.  The coupon is simply the interest rate.  As an aside, you will hear coupon over and over again.  Where does the term come from?  Back in the older days, when you would purchase a bond, the company would give you a certificate that actually had coupons.  When a payment was due from the company, you would take the coupon to your local bank and get your money.  The bank would collect all the coupons and present them directly to the company.  This was prior to the introduction of computer systems to monitor who owned which bond.  That is why you will hear the term coupon.  Anyway, the interest rate of the bond does not vary over time.  A bond is worth a set amount that you will receive upon maturity and the periodic interest payments, but you need to remember that the payment is fixed.  What if interest rates fall?  If you purchased a bond that had a 6% coupon and the prevailing interest rate for the same type of bond rises to 8%, how are you able to sell the bond?  Why would I buy your bond if I can simply buy one with an 8% coupon?  You can sell me that bond by lowering the price.  A corporate bond is usually issued in $1,000 increments, so, if interest rates rise, you can simply lower the price to make its return equivalent to owning an 8% percent bond.  This is what is referred to as an inverse relationship.  It works the same way in reverse if interest rates fall.  If prevailing interest rates fall to 4%, you can afford to charge what is referred to as a premium because buyers in the marketplace cannot find a better opportunity with your 6% coupon.  Therefore, you can charge more than $1,000.  How does this relate to stocks?  Stocks are nothing more than bonds with variable cash flows.  Now if you ignore the fact that owning a bond makes you a creditor and holding a stock makes you an owner of the firm, you really need to value it in the same way.  However, it is infinitely more difficult.  Why?  You do not know how the company will fare in the long-term.  Will the strategies work out, will they be executed properly, will another competitor overtake the company, or will a new technology displace the service provided by the company?  I have already talked about the competitors of WU, banks knocking at the door, and the “invasion” of Wal-Mart into the space.  All of these elements cause the future earnings of WU to be unknown and variable.  I am still confident with the prospects of WU, so I move to valuing the company and approach it in the same manner as I would a bond.

To me (and many others), a stock is only worth what a company can earn in the future.  If you have a friend that has a business idea but you can see that it is unlikely to work, would you invest in the firm?  Probably not.  When I look at WU, I see that it is likely to earn money far into the future.  What are earnings?  You will hear many different terms because there are many different types of market participants and other stakeholders.  I focus on a concept called owner earnings.  Owner earnings are a combination of Free Cash Flow (FCF) and changes in Plant, Property, and Equipment (PP&E) and working capital.  FCF is simply the cash that comes from ongoing operations of the firm.  However, you need to remember that the firm needs to make future investments in technology and other items.  Thus, when you look at depreciation of PP&E which is only an accounting convention, the company may need to make more or less investments into the business in order to keep competing.  Additionally, the company needs cash to simply pay current bills that come due which relates to working capital.  If you calculate FCF and adjust for PP&E additions and working capital, you come up with owner earnings.  Once you calculate owner earnings, you know that the firm will be able to grow owner earnings over time.  If they cannot grow owner earners in the future, you probably would not be at this point in the analysis right now.  Well, you also need to remember that these earning will occur in the future.  Why is this important?  Think about loaning $100 to a friend for a year.  If he/she tells you that they will pay you the $100 back sometime next year, you will most likely want more than $100.  For one, you automatically know that under normal economic conditions, it will cost more than $100 to buy the same amount of products or services next year.  Additionally, you could have bought something else with the $100 and enjoyed it right away.  This is the concept of utility.  For example, you could have purchased 5 or 6 Blu-Ray discs and enjoyed watching these movies.  You are forgoing that consumption because you loaned out the money.  In order to make it worth your while, you might tell your friend that you will loan him/her $100, but you want them to pay you $110 next year.  This will compensate you for inflation and delaying your consumption.  The same economic principle applies to the purchase of stocks.  You could spend your money, or you could invest in another stock.  Therefore, you will only purchase a stock if the price will increase satisfactorily in the future such that you can make money.  You need to discount these future owner earnings.

How do you discount the owner earnings?  I come up with my financial model at this point.  I determine how much WU will earn over the next five years, the five years after that, and then for the rest of its existence.  Once you have calculated the next five years, you need to remember something.  If a certain company is earning what is referred to as “excess profits”, other firms will come into the market and try to do the same thing because it is lucrative.   Additionally, there might be other technological advances which make the wire transfer business of WU less attractive or obsolete, which is even worse.  Thus, I assume that WU will grow at a certain rate for five years, a lower rate for the next five years, and then a growth rate similar to the general economy forever.  The last part is somewhat of a plug figure.  Most stock analysts will say that WU (or any other company) cannot keep growing at high rates forever, it will eventually grow owner earnings very similar to GDP growth in perpetuity.  Now I use an assumed growth rate of 3.5% which is higher than the domestic economy because WU has a significant presence in the emerging markets which are growing at a faster clip.  Now that I have a stream of owner earnings, I need to discount them to the present.  The discount rate is a subject of much debate.  I use a rate of 7% or the equivalent of the yield on the 10-year US Treasury.  Other investors will use a higher rate.  I won’t get into a debate about the proper discount rate to use.  I simply follow the advice of Warren Buffett.  Here is a link to see his rationale:  http://www.sherlockinvesting.com/help/faq.htm.  If I discount that owner income stream back to the present at that discount rate, I come up with what is referred to as an intrinsic value.  Intrinsic value is a concept that was coined and explained at length by the father of value investing, Benjamin Graham.  The intrinsic value is what I think WU is worth right now given the current business environment and likely future prospect.  Now since I am fallible and the future is uncertain, I use the margin of safety concept also introduced by Benjamin Graham.  I take the intrinsic value figure and reduce it by a certain amount.  For WU, since it is in a somewhat stable industry and finance is my background, I use a margin of safety of 20%.  Therefore, I multiply my intrinsic value figure by 80% (100%-20%).  If the current stock price of WU is lower than my calculation, I am inclined to buy.  The intrinsic value I get for WU is significantly above the current stock price.  I purchased WU at $14.24 average cost, and it now trades at $18.36 as of August 9, 2013.  I still hold the largest portion of my portfolio in WU because I see the intrinsic value of WU as being higher than that presently.

As you might imagine, this entire process took me roughly 55-60 hours.  Surprisingly, there are many stock analysts that may say that I was not thorough enough.  An example would be the famed hedge fund investor Bill Ackman.  I am willing to bet that I spent more time prior to the purchase of WU than you will spend on financial planning over the course of your lifetime.  I do not mean this in a condescending manner.  I only point this out to simply show why the purchase of an individual stock is not right for everyone.  I tend to refer to myself as a “dork”.  I am passionate about investing, and I love to perform this type of analysis and calculations.  If you are not willing to put in that type of time to do your homework, I would stop at this point.  I will repeat again that ETFs and index mutual funds are much better choices for individual investors.  If you would like the chance to beat the index averages, I would rather see you invest in actively managed mutual funds or separate accounts than try your hand at selecting individual securities.  With that being said, I will now turn to what I promised to in the beginning.  Please forgive me for what might seem to be a circuitous route.

I intend to hold WU for a long time.  I have a set intrinsic value, and I am willing to stick to holding the stock through all the “visiccitudes and vagaries” of the stock market.  My emotional intelligence is higher than most investors.  I view investing as an intellectual exercise.  The money is secondary.  As soon as you start focusing on the money, you may be tempted to sell your stock if it falls in price significantly for what might seem like no apparent reason.  If I need to wait for 5-10 years for WU to reach its intrinsic value, I am willing to do so.  Does this sound like fun?  Well, it is to me.  Unfortunately, this has really nothing to do with what you read in most financial news publications or see on financial media.  However, you need to remember that I am an investor in the company and not trading pieces of paper.  I can confidently say that the way investing is portrayed in the financial media is much more akin to speculation.  My suggestion is to go to the casino if you want to try to double your money.  You will have more fun.  Investing in stocks to gain significant riches immediately is a fool’s game in my opinion.

What do I focus on after the purchase?  The first thing I do is to read all the earnings transcripts of the firm.  After each quarter, the company will file a 10-Q with the SEC and announce financial results to the public.  Management will then talk to analysts on an earnings call to recap the quarter and then answer questions from a selected group of research analysts.  I try to see if the earnings results match up with MD&A and if management uses any “excuses”.  An example of a typical excuse is the weather.  If a retail outlet has depressed earnings, they tend to use bad weather as an excuse at times.  It may be likely, but, more often than not, it is a way to hide poor execution by management.  Any particular quarter should not affect your intrinsic value calculation much.  In the short-term, there can be developments that affect earnings for a temporary time.  I do not worry about quarterly earnings, but I am interested in how the company is doing.

The second thing I do is to keep up with general economic conditions.  I visit the Bureau of Labor Statistics (BLS) website on a periodic basis.  The link is as follows:  http://www.bls.gov/.  The BLS is the agency of the government that monitors and releases economic statistics like GDP growth, new housing starts, the trade deficit, and a lengthy amount of others.  I focus on leading indicators, but I also am interested in the so-called lagging and coincident indicators released by the BLS.  Why do I pay attention to this?  I do so for one primary reason.  I am very confident in my calculations of future owner earnings for WU.  However, I usually extend that to include a three-part probability exercise.  For example, the likely path of owner earnings for WU is definitely affected by the current/future state of the economy.  I have a percentage for normal, boom, and bust scenarios.  The normal part gets the highest weight, and I then attribute different percentages to the other two.  Now I will admit that these are very subjective, but they are imperative.  How does the calculation work?  Well, I assume that WU will earn more money if the economy does better than expected or less money if the economy enters a recession.  Therefore, I multiply these scenarios by three different percentages.  For example, I currently weight my estimates of future owner earnings by 80% normal, 15% boom, and 5% bust.  Therefore, if the state of the economy changes or its future trajectory, I alter the percentages.  Since WU relies so much on remittances across borders, if global growth slows significantly, I need to weight the stream that assumes a recession much higher.  Using this approach, I do not have to recalculate owner earnings for WU again.  I simply use the three different scenarios and weight them differently.  Trust me, it saves a lot of time.

The next thing I do is to follow the developments of competitors.  I read the earnings transcripts of these firms, do a cursory review of financial statements, and look at how the industry is possibly changing (for better or for worse in terms of WU’s positioning).  It is extremely valuable to be constantly testing your investment thesis.  You need to be ready to admit that you made a mistake.  You can lose a lot of money otherwise.  I can attest to that via Best Buy (BBY) and Citigroup (C) stock holdings in the past.  With that being said though, you need to do that without referencing the case laid out by speculators.  If someone tells me that WU will have a bad third quarter, I really do not care.  I am willing to ride out stock price volatility because I know that WU is worth more than the current market price.  The advice from speculators relates to traders of stocks (owning pieces of paper) and not investors.

I also follow market developments.  Although I do read the Wall Street Journal and Financial Times, I try not to get too hung up on the current news of the day.  You can get in trouble that way by feeling itchy and pulling the proverbial trigger and selling in a panic.  I commented on this in more detail in a previous blog as it relates to the entire stock market.  The link is as follows:  https://latticeworkwealth.com/2013/08/04/todays-news-should-prompt-you-to-adjust-your-entire-investment-portfolio/.  I tend to put more weight in The Economist, Barron’s, Bloomberg Businessweek, and trade journals.  I even read a few publications that seem unrelated but can make all the difference.  One great source is the Harvard Business Review.  This magazine is technical and “heavy duty”, but it can be a great way to identify mistakes that WU management is making or how they are behind the curve when it relates to business strategy.  This information helps me to determine whether or not my calculation of future owner earnings is correct and will come to fruition.

My next technique is a little odd to some.  I have found that I can learn a great deal about investing from other disciplines.  In fact, I will devote an entire post to the name of my firm.  I use what Charlie Munger, whom I lovingly refer to as Warren Buffett’s sidekick, calls the latticework of mental models.  This approach is to acknowledge that ideas from other discipline are germane and pertain to investing.  A perfect example is psychology.  There has been an explosion of ideas in the disciplines of behavioral finance and behavioral economics.  These fields do not assume that market participants are rationale.  Humans have innate biases and make consistent mistakes.  As an investor, you can use this to your advantage.  The one adage along these lines comes from Warren Buffett:  “Be fearful when others are greedy and greedy when others are fearful”.  If everyone is telling me that WU is going to the moon, I start to question my investment thesis.  Now as a contrarian investor, if everyone is selling WU for reasons that are temporary or are related to general market selling, I perk up and even look to add to my position.  You can read more about the latticework of mental models in an excellent book by Robert Hagstrom called Latticework:  The New Investing.  I use the concept of complex adaptive systems from biology, and the concept of nature searching for equilibrium from physics all the time.  In fact, there is an entire website that you can learn a great deal from.  It is called the Sante Fe Institute.  This think tank is not devoted to investing at all, but they are looking for common themes among different disciplines.  Take a look; I promise you will not be disappointed:  http://www.santafe.edu/.  I now will turn to the little talked about decision to sell a stock.

I think about WU in these terms.  If I come across another investment opportunity that is better than WU, I will sell WU.  If management or the state of the economy changes, I will sell WU.  If you are in a tax-deferred account (401(k), 403(b), Roth IRA, etc), you do not need to worry about taxes.  However, my individual stocks are in a taxable account.  While taxes should not guide your sell decision, you must take them into account when deciding if another opportunity is truly better.  Why?  You should only care about terminal values.  If you sell WU and buy another stock, that purchase should increase the value of your portfolio in the future.  That makes sense intuitively.  However, your mind can play tricks on you.  What if I am expecting to earn 9% a year from WU and another stock comes along that I can earn 13%?  Should I sell WU and earn the 13%?  The answer is that it depends.  Here is a typical scenario.  Let’s say I now own $20,000 of WU and purchased WU with an original investment of $10,000.  Thus, I have a $10,000 capital gain that is now subject to a 20% capital gains tax.  If I decide to sell WU and receive $20,000, I have to pay $2,000 ($10,000 * 20%) to the federal government come tax time.  Let’s look at the scenario in terms of expected yearly results.  If I sell WU to earn 13% in another stock, I am really only investing $18,000.  If I decide to keep WU, I still earn the 9% and avoid a capital gains tax.  What happens at the end of the year?  If my scenario holds true, I will have $21,800 ($20,000 + $20,000 * 9%) in my brokerage account at the end of a year if I earn 9% from owning WU.  If I decide to sell WU and buy the other stock, I will have $ 20,340 ($18,000 + $18,000 * 9%).  Yes, I earned 13% on my new stock, but I have a lower amount in my brokerage account.  Why is this a common phenomenon?  Well, most people file their taxes and pay any capital gains tax from their checking account.  The money does not come out of the brokerage account directly.  Your net worth goes down overall, but your brokerage account “misleads” you into thinking you made a great selection because you earned an extra 4% by owning this other stock.  In fact, you would need to earn 21.1% in order to have $21,800 in my brokerage account by being able to pay the capital gains tax and then have the same terminal value as I would by simply holding WU and earning 9%.  If you ever wondered why Warren Buffett holds onto Coca-Cola (KO) and American Express (AXP), taxes factor in greatly.

Now for all of you readers that are not asleep, I appreciate you bearing with me.  As I mentioned before, investing is not meant to be fun or exciting.  It is only fun and exciting if you like the intellectual challenge.  For all of us “dorks”, we go through this analysis because it is truly fun to us.  For most people, they would much rather not spend 60 hours finding a stock to buy and then 20-25 hours per year following your stock after the purchase.  Luckily, you can own an ETF or index mutual fund and likely match my investment return in WU or even beat it over the long term.  For more information on the style of Warren Buffett, I refer you to the following series of books by Larry Hagstrom (mentioned him before):

1)       The Warren Buffett Way

2)       The Warren Buffett Portfolio

3)       The Essential Buffett

4)       Security Analysis by Benjamin Graham the sixth edition

You will note that my investing style is similar to Warren Buffett, but I have incorporated elements from other famous investors and from other disciplines.  I will never be another Warren Buffett.  However, I can strive to use a similar investing paradigm.  Hopefully this discussion was helpful in thinking about one possible way to monitor your stock purchases.  Yes, it is a great deal of work and time consuming.  You will have much better investment results though, if you know as much as you can about your stock.

When It Comes to Your Investments, Are You Smarter than a 14 year-old?

12 Saturday Oct 2013

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

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That is a great question.  I will save you the suspense and give you the answer.  You are as smart as a 14 year-old when it comes to your knowledge of your investments.  What 14 year-old teenager am I referring to?  I am referring to myself.  I started investing when I was 13 back in November 1987.  (If you do the math, you can figure out how old I am).  After spending a year studying the financial markets, I had amassed quite a bit of understanding.  How does this relate to you?  Well, if you have been following my blog, I have not revealed any information that I did not already know by then.  Now my writing style has improved and I have incorporated innovations introduced after 1988, the topics I have written about are not that complicated.  Before you continue reading, I would like to state at the outset that I was not some sort of child prodigy when it came to finance.  I was good at math and retained what I learned.  I am no genius and have no delusions of grandeur.  As I sometimes tell my friends, “If I really knew what I was talking about, I would be running a $10 billion hedge fund”.

With that being said, you also have the good fortune of learning from approximately 25 years of mistakes in investing and misunderstanding about the financial markets and the impacts of exogenous and endogenous events.  I could go on and on about my mistakes; however, I will mention a few here.  First, I had the opportunity to invest in two shares of Berskshire Hathaway Class A (BRK.A) stock back in 1991 when it traded a little above $8,700 per share.  Of course, Berkshire Hathaway is the company run by the famous investor Warren Buffett.  As of August 5, 2013, BRK.A’s closing stock price was $177,300 or a bit over $350,000 if I would have purchased those two shares back in 1991.  Why did I miss out on this opportunity?  I did learn everything I could about Warren Buffett once my economics teacher talked about him and his investing paradigm.  It really made sense to me from the start.  Unfortunately, I pass up on purchasing the shares because I would only be able to own those two shares and one other mutual fund.  As a young man, I was hyped and yearning to pick a number of different investment choices.  Best Buy is one of the best performing stocks in the financial markets and trades over $30 now.  I purchased Best Buy about 7 years ago and paid $42.  I did sell quite some time ago, but I took a huge capital loss.     Second, I wrote a paper during my MBA program that talked about the risk management procedures of Citigroup.  As I look back on that paper written in 2005, it is curious to note that, besides AIG, Citigroup went through the pain of learning the limits of risk management and it had a bailout of epic proportions.  I guess my paper was not the best in retrospect.  Finally, I had a terrible habit of picking the current “hot hand”.  I tended to switch my mutual fund holding way too often when I was in my teens.  It was really attractive to calculate how much money I could earn in a mutual fund that made 20% per year.  Wow, I could double my money in less than four years!  As you always see now, past performance is not indicative of future returns.  I really ignored that statement and invested many times based upon hopes and extrapolation instead of rational thought.  My emotions got the best of me.

I did have quite a few wins along the way.  For example, I was invested in the famous Fidelity Magellan mutual fund when it was run by Peter Lynch.  Peter Lynch is a legend among mutual fund managers.  At one point in time, Fidelity Magellan had more assets than any other mutual fund in the country.  Oddly enough, that was its eventual downfall.  Another example would be that I was able to learn how to successfully manage my father’s 401(k) portfolio from 1988 to the present.  I have seen many bull and bear markets and never had his eventual retirement portfolio take a significant hit in terms of poor returns.  My experience investing over the last 25 years has shown me that there will be many times when the financial pundits say this time is different, new industries are going to blow away the Old Economy, or that news events should cause investors to reallocate investment portfolios dramatically.  Even though I have been investing for 25 years, there have been very few seminal financial market events, the global economy may be different but the laws of finance and economics still hold (or they eventually bring prices back to earth), and new industries tend to bring more innovation and tools for existing, mature industries.  An illustration would be the early Internet companies lost money and burned through enormous amounts of cash.  However, the technologies they introduced allowed existing businesses to use the Internet in unique ways to either generate additional revenue or improve productivity.  A direct example would be how airplanes revolutionized leisure and business travel, but the airlines have been a wealth-destroying industry.  On the other hand, there are a myriad of business that used the services of airlines.

My overall point is that if you take one hour per week for about four months, you will be able to get through the five books I recommended on investing.  Additionally, you can spend another 30 minutes looking at a few financial websites just to increase your knowledge of investment products, finance terms, and keep abreast of news in general.  As a reminder, the list of five books can be found here:  https://latticeworkwealth.com/2013/07/23/spend-20-hours-learning-about-investments-to-prepare-20-years-of-retirement-2/ .  As another reminder, some recommended financial websites can be found here:  https://latticeworkwealth.com/2013/08/04/todays-news-should-prompt-you-to-adjust-your-entire-investment-portfolio/ .

My entire goal with this blog is to save you lots of time.  Rather than being bombarded by disparate information regarding the financial markets and how to approach investing, I am trying to give you a shortcut.  I am hopeful that, if you have a roadmap that is clear, you will be more motivated to learn about investments and eventually become more comfortable with the process of building an investment portfolio to meet your financial goals, while ensuring that your emotions do not get the best of you.  At the end of the day, many individual investors pay fees to financial professionals to save themselves from enemy #1.  Who?  I mean that sometimes individual investors act rashly and keep buying and selling stocks and bonds at inopportune times just because a bad news event comes along or via peer pressure.  Remember that, if you have read all my previous posts, you are more than likely in the 90th percentile of individuals understanding of how the financial markets work.  Keep in mind there have not been that many posts to my blog, so I hope you realize that it is not as painful as you might have once thought learning about managing your investment portfolio and the financial markets is.

As an aside, please feel free to reach out to me if you have a recommendation for a topic I can discuss.  Please remember that this is a website geared toward individual investors who are novices or have not been investing for too long.   Thus, I am not looking to discuss how one might use ARIMA modeling to understand how macroeconomic variables affect the financial markets or individual stocks/bonds.  I appreciate you keeping it relatively simple.  With that being said, if enough people contact me in regard to one specific topic, I will definitely take a closer look.  Thank you in advance for your participation and time thinking about what would be more useful to you.  Furthermore, I am hoping that I cover topics that apply to everyone.  If the collective investment intelligence of the group steps up a few notches, I will cover the topic.  Please send me an email:  latticeworkwealth@gmail.com

A New Paradigm for Investing Available on Amazon.com

11 Friday Oct 2013

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

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academia, academics, asset allocation, Ben Graham, Bernanke, bloomberg, bonds, BRK, BRK.A, BRK.B, BRK/A, BRK/B, Buffett, cnbc, cnbcfastmoney, cnbcworld, consumer finance, David Dodd, economics, economy, Fed, Fed taper, Federal Reserve, finance, financial advice, Govtshutdown, individual investing, investing, investments, Jim Cramer, madmoney, math, mathematics, MBT, Modern Portfolio Theory, personal finance, portfolio, retirement, Shutdown, statistics, stocks, value investing, Warren Buffett, Yellen

I am happy to announce that I have published another book on Amazon.com.  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

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 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

A New Paradigm for Investing Available on Amazon.com

06 Sunday Oct 2013

Posted by wmosconi in asset allocation, Bernanke, bonds, business, Charlie Munger, Consumer Finance, Education, Fed, Fed Taper, Fed Tapering, Federal Reserve, finance, financial planning, GIPS, GIPS2013, Individual Investing, interest rates, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investments, math, NailedIt, NASDAQ, personal finance, portfolio, risk, statistics, stock prices, stocks, volatility, Warren Buffett, Yellen

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asset allocation, bbc, bbcworld, bloomberg, bonds, budgeting, Buffett, Charlie Munger, cnbc, cnbcworld, consumer finance, economics, economist, Fed, Federal Reserve, Govtshutdown, investing, investments, Mungerisms, NailedIT, Naileditoftheday, NBCNightlyNews, personal finance, portfolio, retirement, Shutdown, stocks, theeconomist, Wall Street, Warren Buffett

I am happy to announce that I have published two books on Amazon.com that 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.   The books explain how to select a Financial Advisor, and I provide a list of five books which can help you learn more about investing, respectively. I explain issues about investing as an individual in plain language and without the jargon normally associated with the financial markets. Please feel free to contact me should you have any questions/comments/feedback. 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 a limited time at $7.99.  The other book is normally $2.99, but I dropped it down to $0.99 for the rest of October 2013.

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 Wealth Report @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

How Risky Are Stocks? Do You Understand Volatility? Part 2 of 2

20 Friday Sep 2013

Posted by wmosconi in asset allocation, bonds, business, Charlie Munger, Education, finance, financial planning, Individual Investing, interest rates, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investments, math, personal finance, portfolio, risk, statistics, stock prices, stocks, volatility, Warren Buffett

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asset allocation, bonds, business, Charlie Munger, education, Fed taper, finance, financial planning, investing, investments, long term investing, mathematics, Modern Portfolio Theory, MPT, portfolio, retirement, risk, statistics, stocks, Warren Buffett

In the first part of this discussion, I talked at length regarding the volatility of stock prices.  Most investors are fearful of stock prices jumping all around for seemingly random or unknown reasons.  Many times extreme volatility can be explained.  Other times different news sources will attribute these fluctuations to totally different or even opposite reasons.  No wonder it is frustrating for individual investors.  Now traders and speculators need volatility to make money.  Additionally, Wall Street trading desks generate purchase and sale orders if stock prices are constantly in flux.  However, if you have a longer timeframe for holding the underlying components of your portfolio, it is quite easy to get hung up in this daily “circus”.  It is hard to have what I term “intestinal fortitude”, which is a fancy way to say guts, in the face of this environment of information overload.

Most financial professionals will construct a portfolio and recommend purchases/sales based upon Modern Portfolio Theory (MPT).  If you have heard the terms beta, alpha, r-squared, and tracking error, you are already familiar with MPT.  I will not get into the history behind the construction of MPT, but it started over 50 years ago.  Harry Markowitz is credited with creating the outline of the theory, and there has been a plethora of academic work done since then by some of the greatest academicians of all time.  With that being said, coming up with an academic theory and applying it to the real world are two different stories.  In brief, MPT talks about how to create a portfolio on the efficient frontier which maximizes return and minimizes risk (where risk is defined as the volatility of stock prices).  The portfolio consists of a combination of the risk free asset (Treasury debt) and an additional percentage of stocks.  However, there are a number of assumptions which underlie the theory.  In order to get the mathematics to work, a number of simplifying assumptions need to be made.  Otherwise, the calculations are so difficult that only a handful of mathematicians and statisticians would be able to understand the theory.  For some background information on the issue of stock price volatility, I encourage you to reread the first part of this article:  https://latticeworkwealth.com/2013/09/08/how-risky-are-stocks-do-you-understand-volatility-part-1-of-2/.

Let’s take a look at the six key underlying assumptions of MPT as described by Dr. John C. Hull who is the Maple Financial Group Chair in Derivatives and Risk Management at the Joseph L. Rotman School of Management, University of Toronto in his book entitled Risk Management and Financial Institutions Third Edition.  As an aside, most students with an MBA in Finance or MS in Financial Engineering will recognize Dr. Hull’s name from his book on Options, Futures, and Other Derivatives, which is a standard text in most programs:  http://www.amazon.com/Options-Futures-Derivatives-DerivaGem-Package/dp/0132777428/ref=sr_1_1?ie=UTF8&qid=1379691849&sr=8-1&keywords=john+hull+options+futures+and+other+derivatives+9th .  Dr. Hull lays out the assumptions on pages 10-11 of the aforementioned book.  They are as follows:

1)       Investors only care about the expected returns and the standard deviation of their portfolios assuming the standard normal distribution (bell curve).  He admits that many academics and practitioners believe that the expected returns of stock prices are non-normal and exhibit skewness and excess kurtosis.  Without giving a formal definition of the two, suffice it to say that skewness depicts whether or not more observations are above or below the average.  Kurtosis is simply whether or not there are observations than the simple bell curve would not predict.  Investors are more concerned with extreme negative returns above and beyond what the bell curve would predict;

2)      The second assumption is that stock price changes are not correlated to each other.  However, think about the industry factors that affect Apple and Samsung.  It is likely to be that global demand for smartphones will affect both these stocks in similar ways;

3)      The time horizon for all investors is one period which is typical one calendar year;

4)      All investors can borrow and lend at the same risk free interest rate;

5)      All investors are taxed at the same rate in all locations;

6)      All investors make the same calculations about the estimated expected returns, standard deviations, and correlations between returns for all investments available to investors.

We can clearly see that these assumptions severely limit the practical application of MPT to constructing a portfolio of investments that will provide a satisfactory rate of return given ones risk tolerance and financial goals.  Why are these assumptions made?  Well, I can assure you that even with these assumptions the math gets quite complicated.  For example, ask your Financial Advisor how William Sharpe proved that you can eliminate the covariance between stocks in order to come up with portfolios that lie on the efficient frontier to “simplify” Markowitz’s original theory.  Note this is just one “easy” part of coming up with the expected return of a portfolio composed of percentages of the risk free asset and all stocks.  If your Financial Advisor can explain that concept to you, you need not read any further.  I would be quite impressed and listen more to what he/she says.  If not, I would urge you to continue reading.

If some or all of the six assumptions do not apply to you, why would you want a portfolio custom made for you that uses a 50 year-old theory?  Personally, I do not know either.  So let’s proceed with how it relates to individual investors.  I will concentrate on investors in or near retirement or saving for retirement in my discussion below.

If your time horizon is longer than one year, you can make some modifications to MPT in order to fit your financial goals, risk aversion, and timeframe.  How?  Well, if you are an individual investor, you can choose to see the world in a different manner when it comes to investing.  The day-to-day and even quarterly fluctuations of stock prices should not concern you too much.  Yes, I realize it is easier said than done.  However, you can choose to make tactical and strategic decisions about the composition of your portfolio.  Most financial professionals would tell you to invest for the long term anyway, right?  Well, tactical decisions should be made in the context of an annual review of your portfolio.  Strategic decisions should be made with an outlook on the next five years or so.  This is probably what you have heard anyway.  Here is the twist though:  if you look at the stock price fluctuations of the S&P 500 index over the last 50 years, there will be some scary results.  If we take the period April 1, 1957 through June 28, 2013 and use MPT statistics, you can expect that 1 out of every 10 quarters your quarterly return from the S&P 500 index will be less than -11.5% or greater than 15.1%.  Note the returns are based upon quarterly fluctuations.  You can expect to experience a return in any given quarter which is less than -11.5% every 5 years or so.  Given your risk tolerance, how would you feel if your portfolio lost this amount in a single quarter?  Most investors, especially retirees, would have a difficult time accepting this volatility in expect returns.  Should you sell all your stocks at this point?  Well, I try never to give portfolio advice, but, if you are fearful of losing more than 10% of your money investors in stocks, I think you should strongly reconsider your risk tolerance.  That negative return is any given quarterly window is not too extraordinary in the real world.

I talked about the standard deviation of stocks on an annual basis at great length in the first part of this article.  How can we use the same statistical techniques to look at a portfolio over the long term?  Your Financial Advisor is used to speaking with you once a quarter and at the end of the year to review the performance of your portfolio.  What if you are wondering what you should do over the next five years? If you are 43 years old, why should you worry about daily stock price returns in 2014?  You should think about stock price returns but not to the extent of watching the stock market every single day, month, or quarter to try to glean magical insight into the future direction of stock prices.  I have been investing in the stock market since 1987, and the history of the stock market is littered with incorrect predictions about the stock market.  In fact, it can be dangerous to listen to some of the market prognosticators of “gloom and doom”.  For example, if you hear that you should buy gold because the entire financial system is going to collapse, I would ask you to perform a thought experiment.  If the financial system breaks down such that we are bartering for goods with gold and silver coins, ask yourself how long that money will last.   How long will it be until there is a scene out of NBC’s television show Revolution?  If there is an armed gang of thugs roaming the streets, I am pretty sure that your coins will not be in your possession for very long.  Note that is my personal opinion, but, if you construct your portfolio based upon extreme scenarios, you have to perform extreme scenarios to “stress” your portfolio.  I think it is a better use of time to think about uncertainty as being an ongoing component of investing.  There will never be 100% certainty about economic and financial events.

We can use the same statistics invoked by the academicians who created MPT to our advantage if the time horizon is extended to five year increments.  For example, over the time period 1961-2010, the average annual return for stocks in the S&P 500 index over each five-year period was 9.7% per year.  Now the minimum and maximum annual returns for each five-year increment were 0.5% (2001-2005) and 18.2% (1996-2000), respectively.  Now please observe that the annual returns of 1973, 1974, 1987 (as shown in part 1 of 2 was actually positive), 2001, and 2008 are included in that time series.  How does this occur?  The extreme increases and decreases of stock returns are smoothed out over a long period of time.  We had the Internet Bubble in 2001 which was preceded by the period of time in the late 1990’s which former Federal Reserve Chairman, Alan Greenspan termed irrational exuberance (note that this term was coined by him in December 1996; please refer to this link for Greenspan’s famous speech:  http://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm).  The fluctuation of stocks over a particular year can be quite volatile and can persist for much longer than expected by top-notch economists and asset managers.  However, if you look at these observed returns, you come up with much smoother results.  Your financial professional encourages you to invest for the long term, so why don’t you look at the expected returns over the long term for stocks when creating your portfolio?  If you are making tactical (medium term) and strategic (long term) changes to your portfolio, doesn’t it make sense to ignore the daily changes in stock prices?  To me, these are rhetorical questions.  Given the financial advice you receive or information you receive from the financial media now, does it sound like they consider these questions to be rhetorical?

The last point I will leave you with is a brief look at the annual returns you might expect over any five-year holding period in stocks.  Looking at the ten observations of five-year annual returns between 1961-2010 for the S&P 500 index, you can expect that 1 year in every 100 your five-year annual return will be outside -5.9% and 25.2%.  Therefore, every 200 years, there should be a five-year annual return less than -5.9% which is otherwise thought of as downside risk.  The worst five-year annual return for stocks since 1931 was 1936-1940 in which the average annual return was a bit less than -0.5%.  The five-year annual return for stocks between 1931-1935 was 2.2% which incorporated the height of the Great Depression.  Therefore, I would argue that you are thinking about investing as a long-term exercise in helping you reach your financial goals, stocks may be less risky than you think.  Or at the very least, you should ask your Financial Advisor why they do not use annual and five-year annualized (geometric basis of course) expected returns for stocks when recommending how you should position your portfolio.  It is a valid question if you are a long-term investor.  Note that I did not even include diversification in this discussion.  Since you are able to choose small cap stocks, international stocks, high yield bonds, and real estate, you can look at an individual portfolio in an even more positive light.

How Risky Are Stocks? Do You Understand Volatility? Part 1 of 2

08 Sunday Sep 2013

Posted by wmosconi in bonds, business, Education, finance, Individual Investing, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investments, math, statistics, stock prices, stocks, volatility, Warren Buffett

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Investors are told over and over that stocks are risky investments.  How true is that though?  If you watch the financial news each day, it seems like there is no reason why stocks go up, down, or remain unchanged at times.  For every financial pundit that gets the direction of the market correct, there are many others that predicted things incorrectly or have been saying that the “sky will fall” for the past five years.  I will admit that stocks are very risky on a daily basis.  However, if you are not running a hedge fund or are a trader on a Wall Street firm’s proprietary desk, the “vicissitudes and vagaries” of the daily moves in the stock market are of no concern to you.  In fact, being too concerned about daily/weekly/monthly/quarterly movements in stock prices will actually hurt your long-term performance.  Investing is not a sprint.  It is a marathon!  If it seems as though the professionals on Wall Street do better than you, please keep in mind that the financial media rarely interviews people that were totally wrong on the market.

I do not like to pick on anyone; however, I will provide one example just to make a point.  Mark Faber, a long-time fixture on Wall Street, predicted that the S&P 500 index would drop to the 1266 level back in November 2012.  Refer to http://moneymorning.com/2012/11/08/stock-market-today-why-marc-faber-predicts-a-20-slide/.   He was recently on CNBC in August 2013 and predicted that the S&P 500 index would by 20% this year.  So is he actually more bullish on his bearish prediction about one year later?  Who knows how to characterize that one?  It is important to learn about stock price movements which are termed volatility in the jargon of Wall Street.  Your Financial Advisor will refer to it over and over when he/she advises you on how to construct your portfolio.

Why does volatility matter to you?  Well, in the very short run, stocks are one of the riskiest investments.  I recently read that over the last 50 years stocks were up 53% of the time and down 47% of the time.  So your odds of being right about one day is essentially a bit better than calling a coin flip.  Now hopefully you are not a speculator.  If you are trying to double your money this year or in even a shorter period of time, you need not read any further.  However, if you would like to learn how volatility affects portfolio construction and portfolio performance over the long term, please read on.

I pulled down some annual returns from the S&P 500 for the period 1926-2012.  Note that the S&P 500 was preceded by a number of other indexes of smaller components, so it is unwise to use this data in full.  Whenever anyone uses statistics to make an argument (myself included), you always need to be very skeptical.  So do NOT make me an exception.  If you look at the S&P 500 index’s performance over the 50 year period from 1961-2010, the annualized performance is a bit less than 9.7%.  Wow, that sounds really good!  However, it seems counterintuitive because the S&P 500 was down over 36% in 2008.  Plus, you may have heard that the 2001-2010 period is often referred to as the “Lost Decade”.  Stocks earned basically nothing over that timeframe.  You need to remember that the 9.7% figure is composed of five decades with different characteristics.  For a primer on how compounding of returns works, you can refer to one of my earlier posts:  https://latticeworkwealth.com/2013/07/08/double-edged-sword-of-the-power-of-compounding/.  The aforementioned annualized return of the S&P 500 index over the last 50 years is composed of the following returns for each decade:  8.1% (1961-1970), 8.5% (1971-1980), 13.8% (1981-1990), 17.3% (1991-2000), and 1.4% (2001-2010).  You will most certainly remember the financial crisis of 2008 and the Internet Bubble of 2001.  These major events in the stock market took a huge toll on performance returns over the last decade in this series.  With that being said, Time magazine had a cover story in 1982 where they declared the de facto death of equities.  Oddly enough, it turned out to be the beginning of the strongest bull market in history.  Why is it important to decompose this data?

The importance lies in human nature.  An annualized return of 9.7% means that an investment in stocks should essentially double every five years.  Well, if your Financial Advisor invokes market history when building your portfolio, he/she may set your expectation that you can expect to double your money in stocks every 5 years.  What if it takes longer or you do not double your money after even a ten-year period like 2001-2010?  Humans tend to seek patterns and be risk averse.  Many of the great bubbles over time have come because financial professionals extrapolate from the past, be it with stock prices, corporate earnings, or housing prices more recently.  We look at the immediate past for a guide to the future.  This analysis is called ex post facto, and, as you can see above, it can get you into a lot of trouble.

Many investors used the 1980s and 1990s as a guide to what would happen in the 21st century.  In fact, there were books written and predictions of why the Dow Jones Industrial Average (Dow Jones) would reach 36,000 which is more than twice its current level as of September 2013.  I have met many investors that are still shying away from buying stocks because of the Internet Bubble of 2001 and the financial crisis of 2008.  Now I am not making a prediction about the future direction of the stock market, my only observation is that people tend to wait too long to get back into the market if they attempt to time the market properly.  Everyone wants to buy low and sell high.  Furthermore, they want to sell all their holding right when the market reaches its highs.  Buying stocks and holding them for the long term is not really all that much fun.  When I was 13 years old and buying stocks in the late 1980s, I know I wanted to double my money each year.  I got frustrated really quickly; however, I kept plugging away and investing more every month.

After the experience many had in the stock market from 1966-1982, they felt it was unwise to invest in stocks at all.  The Dow Jones was essentially unchanged during that period.  Very few Financial Advisors were recommending the purchase of stocks in the early 1980s.  Conversely, most every Financial Advisor was recommending the purchase of stocks throughout the late 1990s.  As humans, we tend to seek out patterns in history and, even subconsciously, think that the past will repeat itself.  You may think that you do not fall into that category, but I urge you to think about your experience with the stock market in 2001, 2002, and 2008.  Did you sell all your stocks, hold them, or buy more stocks during those years?  I can remember 2003 where it was very unfashionable to still invest in stocks.  It is easy to say that you will not succumb to the pressure to sell stocks, but, after the stock market fell over 35% in 2008, many investors just had enough.  Imagine you had $1,000,000 on January 1, 2008 and opened your brokerage statement on December 31, 2008 only to see the balance was $640,000.  Hard dollar figures are much more impactful than testing your risk tolerance by wondering if you would sell your stocks if the market went down 10%, 20%, or 30%.

Your Financial Advisor will talk to you about diversification and the benefit of holding securities in many different asset classes.  Moreover, you will be told over and over again that stock price volatility is bad and hurts your returns.  I will agree that stocks are volatile, but the assertion that Modern Portfolio Theory (MPT) makes about risk/return can lead to odd answers.  Here is a homework assignment.  Ask your Financial Advisor if he/she remembers how stocks performed during 1987.  Of course, everyone remember the huge crash in October, but very few remember that the stock market was actually up a bit over 2% that year (S&P 500 index).  Why does that even matter?

Well, stock price volatility is measured by statistics.  Think of the bell curve in your days in school.  The bell curve has been used in education which basically states that most of the students will be average and get a grade of C.  There will be other students that get B’s and D’s as well.  Of course, there will be a small group of students that fail a class or exam or do extremely well and get an A.  MPT tells investors that volatility is bad.  It is bad in terms of the decisions you might make, but there are many odd answers given by the theory.  For example, the average daily return of stocks in was roughly 0.03%.  The main measure of volatility is standard deviation, and you do not need to worry how to calculate it.  Standard deviation simply measures how far from the average a series of numbers in a population is like daily stock returns.  The standard deviation for daily returns was about 2.0%.  The annualized standard deviation was 31.8% (just so you know standard deviation is not additive in nature, so it takes some mathematical manipulation to get to that answer).  Why did I present these numbers?  I presented them to make another observation.  In 1973 and 1974, the S&P 500 index was down 14% and 26%, respectively.  However, the annualized standard deviation for each of those years was 15.6% in 1973 and 21.6% in 1974.  Thus, those years were less volatile than 1987, but an investor would have lost a large amount of money in each year.  Would you rather make money during the course of a year or lose money over the course of the year with less volatility?  If you are a long-term investor, daily fluctuations in the stock market should not guide your decisions.  Otherwise, you will end up selling all your stocks just because prices are going up and down a lot.  The most important thing is the terminal value.  The terminal value just means what the return will be at the end of the period without regard to the volatility over the course of the year.

The validity or, more aptly usefulness, of MPT becomes more apparent when we look at daily returns.  MPT makes a lot of assumptions, one of which is that stock prices will follow the normal distribution.  That is just a fancy way of saying the bell curve.  Now if you know about statistics, you can make predictions about a set of data based upon the historical experience of that data.  I downloaded the daily returns of the S&P 500 from 1957-2012 because I had some extra time on my hands and was bored.  The average daily return of the index was 0.03% with a standard deviation of 0.98%.  If you assume the normal distribution holds, you can make the assertion that 99% of all observations should be within a low daily return of -2.25% and a high daily return of 2.31% (Formula is average – standard deviation * 2.33 and average + standard deviation * 2.33).  You might ask if that is really true.  This way to express the data means that the daily return for the stock market should be equal to or between those two figures 99 out of every 100 trading days.  In statistical terms, it is referred to as a 99% confidence interval.  What about the market crash in 1987?  The S&P 500 index dropped 20.5% on October 19, 1987.  How would you express that statistically?  In order to have a daily return that far away from the average, it equates to approximately 21 standard deviations from the average.  How likely is that?  It is pretty much the same odds of flipping a coin 20 times and having it come up heads each time.  Keep in mind that this date was not the only big drop over this period.  For example, there were over 20 times when the S&P 500 index dropped by 5% or more in a day during that period.  The likelihood of that happening over the course of 55 years (1957-2012) is infinitesimal.  If you would like to learn more about this type of odd result, I would encourage you to read the book, The (Mis)Behavior of Markets, http://www.amazon.com/The-Misbehavior-of-Markets/dp/B008A0LNBM/ref=sr_1_2?ie=UTF8&qid=1378664066&sr=8-2&keywords=The+Misbehavior+of+markets.

Suffice it to say that the path of stock prices does not follow the normal distribution.  Now academics will admit that is the case and have made modifications to MPT.  Additionally, most academics will use the lognormal distribution or other distributions to explain the volatility of stock prices.  However, the mathematics becomes exponentially more difficult and challenging.  With that being said, the financial advice given to you from your Financial Advisor is likely to be taken from the first iteration of MPT.  If you have heard your financial professional talk about beta, alpha, sigma, mean, r-squared, and the like, he/she is constructing your portfolio by making reference to the ideas laid out by MPT.  Now I will not go so far as to say MPT is incorrect.  Much smarter folks than me developed it.; believe me!  However, the great Warren Buffett gave a speech back in 1984 that encapsulated why MPT he does not subscribe its tenants.  To see a transcription of the speech, refer to:  http://www.bestinver.es/pdf/articulos_value/The%20Superinvestors%20of%20Graham%20and%20Doddsville%20by%20Warren%20Buffett.pdf.

In the next part of this discussion, I will attempt to show you how to look at the volatility of stock prices in the context of your portfolio.  If you do not need to withdraw money from your portfolio on a short-term basis, MPT has less and less applicability for you.  MPT assumes that all investors have a one-year time horizon.  Therefore, if you do not plan on needed to withdraw money over the course of a 12-month period, this discussion definitely will apply to you.  You should be looking at your portfolio in terms of one-year and five-year increments.

Quick and Effective Way to Learn about Investing in Stocks and Bonds

21 Wednesday Aug 2013

Posted by wmosconi in bonds, business, Education, finance, interest rates, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investments, stocks, Warren Buffett

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With the advent of the Internet and a plethora of financial news publications and television networks, there is an amazing amount of information available on investing and investments.  With that being said and obvious, why would you even read this?  Well, as I have said before, knowledge is power!  Now take a look at that cliché again but more closely.  Could you substitute the word information for knowledge?  Would it mean the same thing?  I am hoping you say that the answer is a resounding No.  Having access to information and having a lot of facts can be a detriment in some respects actually.  Is that how it feels with individual investing from your perspective?  You could spend months searching terms on the web, going to mutual fund websites, reading academic studies, keeping up with the current market moving news, and researching individual companies.  Would that really help you?  If you are waiting for someone to divine some wisdom for you in terms of when to invest and what to invest in, you will be waiting for many, many years.  Knowledge is taking information and constructing a framework that is actionable.

My recommendation to you is to read the following information in pieces.  Pick one or two items off the list to read per day. You can feel free to skip certain numbers if you are familiar with the concept already.  Let’s begin our discussion.

1)      How the Current News Affects Your Investments:

 

Learning how to invest in the financial markets can feel very overwhelming. Especially when you are retired or going to retire soon.  If you need to live on your “nest egg” and do not want to work again, where do you even begin?  I suggest that you never make rash decisions and adjust your entire portfolio based upon one day’s news.  For more information about that concept, please refer to this link:  https://latticeworkwealth.com/2013/08/04/todays-news-should-prompt-you-to-adjust-your-entire-investment-portfolio/.

 

2)      Do I Even Have Enough Money to Make Investing Worthwhile?:

 

The short answer is YES.  The funny thing is that if you leave these decisions in the hands of a financial professional you will be spending hundreds of thousands of dollars.  If you have a 401(k) or 403(b) retirement plan, this matters to you as well.  For information on how investment advisory and asset management fees add up, please refer to the following link:  https://latticeworkwealth.com/2013/07/11/is-learning-about-investing-worth-it-how-about-224000-or-320000-worth/.

 

3)      Learning About How to Create a Simple Model Investment Portfolio:

 

How should you allocate your investments?  Which asset classes or sectors are the best to choose from?  Before you can tackle that issue, you should look at more general portfolio construction concepts.  You can find the link here:  https://latticeworkwealth.com/2013/07/16/how-to-create-an-investment-portfolio-and-properly-measure-your-performance-part-1-of-2/.

 

4)      You Need to Properly Assess Your Risk Tolerance:

 

 If the stock market goes down 10% and you are so nervous that you sell, you probably should not invest in stocks at all.  You have a very low risk tolerance and will not sleep well.  The most important thing to learn here is that gain and losses are not proportional.  In fact, if you view the financial markets in that way, you probably should NEVER have more than 50% of your portfolio in stocks.  If you are worried about a bear market occurring (bear market is defined as a 20% or more drop), you probably should either not have any stocks or invest NO more than 20% of your money in the stock market.  For more information about how stock market fluctuations affect your investment portfolio, please go to this link:  https://latticeworkwealth.com/2013/07/08/double-edged-sword-of-the-power-of-compounding/.

 

5)      Differences Between Active and Passive Investing:

 

Once you understand how different annual returns affect the value of your portfolio, you can start learning about how well you are doing and how to set a realistic target return for your portfolio.  The first thing to do is to learn about the difference between active and passive investing.  There is a third, emerging category which too many say is passive investing.  It is called enhanced indexing.  For a longer discussion of the difference between active and passive investing, you can refer to the following:  https://latticeworkwealth.com/2013/07/05/difference-between-active-and-passive-investing/.

 

6)      Measuring How Well Your Investment Portfolio is Performing:

 

I would never assert that active or passive investing is better. However, I will say that you need to ensure that your chosen investing approach is working.  If you are choosing an active approach, your investment portfolio should be beating the market over the long run.  If it does not, why would you spend all the time searching for ways to beat the market? Refer to this link to understand more about how to properly measure the investment performance of your portfolio:  https://latticeworkwealth.com/2013/07/19/how-to-create-an-investment-portfolio-and-properly-measure-your-performance-part-2-of-2/.

 

7)      Investing in Individual Stocks and Bonds Should Be Left to Professionals:

 

If investing is starting to sound boring, it can be in a certain sense.  If you are looking to make 100% per year by buying stocks, you are going to be sorely disappointed.  It can seem so easy when you watch TV shows.  You also can lose a lot of money though.  The real pros spend hours upon hours learning about a particular company prior to buying the stock.  How much time?  Probably more than you would imagine.  Refer to this article:  https://latticeworkwealth.com/2013/08/09/you-purchased-a-stock-now-what/.

 

8)      Does Hiring a Financial Professional Make Sense:

 

After reading all this information, it may seem like it is better to let a financial professional manage your money.  If you are going to a financial professional to seek advice, you should know why you are going.  What can’t you do yourself?  Here is a unique way to think about this topic:  https://latticeworkwealth.com/2013/08/07/are-your-financial-advisors-fees-reasonable-here-is-a-unique-way-to-look-at-what-clients-pay-for/.

 

9)      List of Questions to Ask Any Financial Professional:

 

If you still think that going to a financial professional is the best option for you, I will not fault you for that.  What types of questions should you ask?  Here is a suggested list of questions:  https://latticeworkwealth.com/2013/08/12/important-list-of-questions-to-ask-when-selecting-a-financial-advisor/.

 

10)   Learn How a Financial Professionals Start in Investing Field Can Bias Them:

 

You will find that most financial professionals are biased based upon the time when they first started the profession.  Therefore, their advice might be “stuck in time” so to speak and not apply to your situation.  For a more detail explanation of this idea, you can refer to this post:  https://latticeworkwealth.com/2013/08/18/before-you-take-any-investment-advice-consider-the-source/.

 

 

11)   Understanding Why You Have Some Advantages over Institutional Investors:

 

You have different experiences and expertise in everyday life.  You can be more objective when it comes to investing and how the financial markets work.  Want to learn more:  https://latticeworkwealth.com/2013/08/11/why-did-i-choose-to-include-latticework-in-my-investment-firms-name-well-because-of-charlie-munger-of-course/.

 

12)   Learn That You Can Survive as an Individual Investor as Interest Rates Rise:

 

Do you keep hearing that higher interest rates are going to wreak havoc on the financial markets now and for years to come?  Should you not start investing until interest rates stabilize?  What if interest rates are going to continue to rise?  These are important questions, and I try to answer this question in the following post:  https://latticeworkwealth.com/2013/08/14/what-can-investors-do-in-a-rising-interest-rate-environment/.

You have finally reached the end of the list.  Do you feel smarter?  I sure hope you do.  My goal was to provide you with a framework to start your quest.  If you would like to learn more, I have a recommended reading list.  It will most likely take you 20 hours or so to read these books.  However, if you can save hundreds of thousands of dollars, would you say it is worth it?  Remember you are likely to live for over 20 years during your retirement years.  Here is the list:  https://latticeworkwealth.com/2013/07/23/spend-20-hours-learning-about-investments-to-prepare-20-years-of-retirement-2/.

Please feel free to send me your comments or other questions at latticeworkwealth@gmail.com.  You can post them directly on my blog as well.

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