Archive for the ‘Investor Behavior’ Category
The S&P 500 closed the first quarter at a record high. Should that worry investors? The short answer is, No.
When the market was 30% below the high three years ago, I did some research. I categorized all market conditions into:
1. Breaking a new high.
2. Less than 10% below historical high.
3. Between 10% and 20% below historical high.
4. Between 20% and 30% below historical high.
5. Between 30% and 40% below historical high.
6. More than 40% below historical high.
Then I calculated the one year forward returns of the six conditions.
Recently, a client called to tell me that he had finally got the big boulder off his back, and it was such a relief for him.
The “big boulder” he referred to was his big house, with a swimming pool and a tennis court. The house had been costing him $100k a year in property taxes and upkeep, more than 50% of my client’s retirement income. No wonder he called it a big boulder on his back.
He bought the house 25 years ago for $2.2mm, and he just sold it for $2.1mm. After all the costs associated with selling the house, he took home $2mm and change.
Posted February 7, 2013on:
With the market up about 5% in January, a prospective client of mine called to let me know he is not going to invest in stocks at this time – in fact, he is going to pull all of his money out of the market.
This may not be the best course of action for him.
According to research done by Cooper and McConnell, what the market does in January has a strong predictive power for what the market will do for the rest of the year.
Using data since 1940, they found that if the market is up in January, it will rise an additional 14.8% for the rest of the year; if the market is down in January, it will rise only 2.92% for the rest of the year. This gives rise to a spread of almost 12%, a highly statistically significant number.
In the last month alone, I’ve gotten calls from two clients asking me if they should invest in tax advantaged oil and gas investments being pitched to them? Both of these clients are physicians.
The pitch is that oil and gas investments are like IRA accounts, but without the contribution limit. Whatever amount you invest can be written off right away.
The pitch is quite alluring to high-income professionals like physicians who are facing higher taxation. But it sounds too good to be true, so I did a study.
It turns out what is being pitched as “tax advantaged” is in fact the riskiest part of an oil and gas investment.
After working as a financial advisor for six years and after reading tons of research, I have developed a good sense about how the average investor loses money. As the New Year approaches, I think it’s good to share my insight so that readers can determine if they are making these mistakes.
Conflict of interest
I cannot emphasize this enough: Wall Street firms don’t work for you. If you have a Merrill Lynch or Morgan Stanley advisor, expect to give away 2.5% of your money every year – about half of it will be in explicit fees, the other half will be in hidden fees. If you invest through insurance products, expect to give up 3.5 percent of your money.
We call it stupid if someone takes a $55k job, even if he is offered the same job at $100k.
We call it market-timing when the same thing happens in the stock market. The long-term average annual market return is 10%, but the long-term average annual investor return is only about 5.5%. This is documented both by Dalbar’s study titled “Quantitative Analysis of Investor Behavior” and Morningstar’s research on fund returns and investor returns.
How could this possibly happen?
Here is a selection of the best wealth management articles around the web for September:
5 reasons your portfolio is too complicated, by Kyle Bumpus
Why analysts are scratching their heads over QE3, by Robert Wasilewski
Is rebalancing market timing?, by Mike Piper
Choosing a mutual fund – Avoid these 6 mistakes, by Roger Wohlner
Fidelity’s new retirement saving guidelines, by Barbara Friedberg
Can I consistently outperform the market? by Ken Faulkenberry
Dividend reinvestment plans (RIPS) and their benefits, by Dave Scott
Questions to ask when picking a financial advisor, by Carl Richards
Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.
I was in Denver attending the Financial Blogger Conference (FinCon12), and I was thrilled to meet Allan Roth there.
If you don’t know Allan Roth, for the sake of your financial wellbeing, you should.
Allan is an hourly fee-only financial advisor practicing in Colorado Spring. He also writes an investment column for CBS MoneyWatch. Recently, Jason Zweig invited him to write a column in the Wall Street Journal as well. Read the rest of this entry »
When talking to prospective clients, I am upfront about what I can and can not do. I can NOT beat the market.
Recently, that straightforwardness caused me to lose a prospective client to a major Wall Street firm. Apparently, the financial advisor from that firm was able to convince him that with their exclusive location, expensive brochure, and nice Armani suits, they could beat the market.
This led me to do a mental exercise.
Back on April 9, Mark Zuckerberg announced that Facebook had agreed to acquire Instagram for a jaw dropping $1b.
What is Instagram? It is an iPhone app that allows people to swap photos with friends. The one and a half year old company has about 16 employees and its revenue is a cool zero.
Most commentators said that Zuck was either trying to pre-empt a potential competitor or to expand in the mobile market where Facebook is weak. There is nothing Instagram does that Facebook cannot replicate, make available to its 900 million users, and instantly kill Instagram. Why pay $1b for something that is essentially worthless?
While reading USA Today at Panera Bread, I came across an article with a headline that blared: “Managed commodities can counter volatility.” You should have seen the chagrin on my face; you would have thought I was a facial contortionist.
How could such an uninformed article ever get published by a major newspaper? Just imagine the large number of people who will be misled by this article to put money into a financial product they don’t understand.
The claim of this article is based on a comparison of a managed futures index and the S&P 500 index. The managed futures index was compiled by a private firm called Barclay Hedge, basically a marketing arm of the managed futures industry. Read the rest of this entry »
This is a client communication letter I wrote on June 1st. One week after i wrote this, the market closed out its best week in 2012.
As I am writing this, the markets are falling like a rock. The Dow has entered negative territory for the first time this year; Nasdaq, which was up 20% a mere two months ago, is up only 5% for the year. The S&P 500 has lost close to 10% of its value since its April 1 peak.
I wrote the above paragraph using typical financial press lingo. This type of language has the tendency to cause amygdala hijack.
The amygdala is a part of our brain that processes threats. When we perceive a threat, the amygdala takes over the whole brain. fMRI scans show that blood supplies are literally commandeered from other parts of the brain for the amygdale. The amygdala is not sophisticated; it only knows three responses: fight, flight, or freeze.
Two months ago, I got a call from client of mine, who asked my opinion about an opportunity to invest in pre-IPO Facebook shares. He explained that he and his business partner were offered the opportunity to invest in a private fund that will hold Facebook shares.
I know nothing about these funds, but I told my client to stay away. As a general principle, I always steer my clients away from private funds unless they run the funds themselves. The reason is very simple: these are unregulated vehicles where there is no government oversight and there is no transparency whatever. You don’t know what monkey business they do with your money. Most business people intuitively grasp that if the private deal is about starting a restaurant; but once the deal is about buying Facebook shares, many of them throw caution to the wind.
Believe it or not, you are a stranger to yourself. That’s the finding of Hal Ersner-Hershfield et al. in their published research detailed in Social Cognitive and Affective Neural Science.
This unconscious assumption of a different self in the future is demonstrated graphically by brain scans. In their study, Ersner-Hershfield et al. found that when people think about their future selves, the same brain region lights up as when they think about strangers. The implication for saving behavior? Saving for the future instinctively feels like giving money away to a stranger. No wonder only 9% of Americans are saving enough for their retirement.
I am not a big fan of IPO shares. Research has shown that IPO shares usually underperform seasoned shares by about 2% a year. Business owners tend to time their IPOs at the optimal time for them, not for the future shareholders.
With Facebook (FB), there are so many people chasing so few shares that the IPO will create a “Winner’s Curse” effect – whoever wins the shares will end up overpaying for them.
According to Shlomo Benartzi, a University of Chicago economic professor, 50% of Americans don’t save for retirement. Of the other 50% who do save, only 11% save enough, according to their own estimates, which are probably optimistic.
This is not surprising to this financial advisor. For nearly all of my clients, I have created a savings and investment plan for them. The plan is designed so that they can live the lifestyle they desire in retirement. They are all committed to the plan. But while the commitment is there, the will power is not. When it comes time to implement the plan, they can always find important spending that justifies putting off saving to another day.
My clients are all very educated and highly intelligent. Why do even they have a hard time saving enough for a secure retirement? It all boils down to two words: instant gratification.