Archive for the ‘Security Selection & Market Timing’ Category
That was a message I got from a new client of mine. I must admit, it really bites. Yes, I sold his Apple stock. And yes, since then the price has gone up 15%. So of course, I can understand he’s upset and beginning to question whether I know what I am doing.
Having studied improvisational comedy, I’m aware that regardless of how I feel, it is wise to always validate others’ feelings. So I replied, “Yes, I should have asked you before I sold it.”
Afterward, I sent him some data to mull over.
Nasdaq just crawled its way back to 4000 a few days ago, and this time Apple is the biggest and hottest stock in the Nasdaq 100.
Last time when Nasdaq passed 4000, the top ten tech stocks (try saying that ten times fast) were, Microsoft, Cisco, Intel, Qualcom, Oracle, JDSU, Nextel, Sun Micro, Veritas and MCI Worldcom.
Since the last time Nasdaq passed 4000, Microsoft has gone down 34%, Cisco 59%, Intel 53%, Qualcomm, the only up stock in the group, has gone up 25%, Oracal has gone down 67%, JDSU 98% and the remaining four are no longer in business; they were either merged out of existence or end ignominiously.
It is exceedingly difficult for mutual funds to beat market indexes. For the past decade, Standard and Poor’s has methodologically documented returns by mutual funds and what they found is something those fund managers do not want you to know: the majority of mutual funds under-performed their respective indexes literally every single time.
Here is an infographic published by MoneySense, a Canadian financial magazine, that shows 90% of Canadian money managers under-performed the market index in 2012; I can assure you that US money managers are doing no better.
He is paying the advisor 1.6% in fees. First of all, this fee is quite exorbitant. For the size of his portfolio, he shouldn’t be paying more than 1% in advisor fees.
Adding insult to injury, for the fee that he is charging, this advisor puts his money into a collection of very expensive mutual funds like ODMAX.
It is very easy to check the expenses of a mutual fund. I just googled ODMAX and I found out it has a load of 5.75% and an expense ratio of 1.36%. (For those who don’t know, load is a one time charge to pay commision to the Ameriprise advisor who doubles as a broker. Expense ratio is an ongoing annual charge.)
ODMAX is a mutual fund that invests in emerging market stocks. If you use the low cost alternative, aka a Vanguard fund, you will pay no load and the expense ratio is only 0.33%, a saving of 1.06%.
Don’t ever underestimate these tiny savings. Because in ten years, the savings will be more than 10%, in twenty years, more than 20%. This businessman is in his 50s; he can easily live another 30 years. I asked him: “How would you like to be more than 30% poorer in retirement?” That is exactly what this financial advisor will make him.
One very very sharp reader of my blog sent an email to me, and here is what it said:
Aren’t these 2 philosophies opposites of each other? If the market prices correctly based on all available information, how can the stock price be different from the expected dividend? Aren’t these 2 prize winning economists speaking in opposites?
As far as investment philosophy is concerned, I am solidly in the camp of Nobel Prize winner Eugene Fama and Vanguard founder Jack Bogle. They both believe that the market is by and large efficient, and there is no point in picking stocks.
Most of my money is in broad-based passively managed asset class funds, but I do set aside 5% just to have some fun with and right now I only have three stocks in my fun account.
I bought SWY last November after going to the Chicago Booth Entrepreneur Advisory Meeting. From the meeting, I learned that big retailers routinely write off their inventory at a huge loss. The reason being that they can not control demands as they have little information about the needs of the individual consumer, though they can usually make a rough guess on aggregate needs.
I noticed my wife had been shopping at Safeway more and more. After a little digging, I found out Safeway had set up a technology system to track each individual’s needs and price sensitivities. Then it can make targeted offers to shoppers like my wife that unfailingly brought her back over and over. I recalled my earlier meeting and realized they would save tons of money just from better inventory management.
OK sure, I can understand his point. Why invest outside of the US when the US markets already account of 40% of world capitalization? “The U.S. market is so well-diversified already that combining it with global markets doesn’t really matter,” so said Fama.
However, I think it actually does matter ….
Proportionally, the US market is getting smaller. Right after the second world war, the US market accounted for 70% of world capitalization, now it only accounts for 40%. For a country that boasts only 5% of of the world’s population, this is still exceptionally high.
For the foreseeable future, there are better than even odds that the combined markets outside of the US will grow faster than the US market will do alone. Why forego those opportunities?
The diversification benefit you’d get is certainly not negligible either. During the so-called ‘lost decade’ of 2000 to 2009, the US market, as measured by the S&P 500, had a net loss of 9.1%, while international developed markets went up by an anemic 12.4%, but emerging markets went up by a whopping 154.3%.
It would have made a bog difference if you have a piece of emerging markets in your portfolio.
I jumped out of my chair in delight when I learned that Eugene Fama and Robert Shiller had won this year’s Nobel Prize in Economics. These are two economists that greatly influenced my investment philosophy and their works have been an integral part of how I help my clients build and preserve wealth.
Let me explain their contributions:
He accurately pointed out, “If I spent like that, I would be bankrupt in a few years.” He believes so strongly that the US is going the way of national bankruptcy that he has moved substantial amounts of his money overseas and has invested a great deal in gold.
I happen to believe that gold is the most unproductive of assets, since it does not generate dividends or interest and it actually costs money for upkeep in a safe in a Singapore bank.
On top of that, by throwing so much money into gold, one could over prepare for a disaster that is very unlikely to happen and thereby miss out on all the opportunities to grow wealth in this country.
But I still need to explain why the US won’t go bankrupt anytime soon. Here are two explanations:
Also see Top Ten in July.
1. ThinkAdvisor highlighted a Maryland study which showed that states which pay the highest fees to Wall Street (for managing pensions) have the lowest returns. That says it all about Wall Street. No wonder Rick Ferri wants you to steer clear of actively managed funds.
2. Reuters Money reported how Health Savings Accounts (HSAs) can be used as retirement savings accounts. This information is especially useful for small business owners and self-employed individuals who tend to neglect their retirement savings and face high deductibility in their health insurance. Here is the garden variety of ways they can save for retirement.
3. DIY Investor Robert Wasilewski encountered a bear while hiking. He survived to write about it, but he mused that the same reactions that kept him in the gene pool will surely “eliminate you from the investment pool.”
When I write a blog post, I like to drive home one and only one point at a time.
In my last blog post, the point I wanted to make was that cost matters. In case you didn’t notice, not only did I reduced my new client’s cost by 85 basis points, I also reduced the number of funds in her portfolio from 39 to 4.
With such a small numbers of funds, is the portfolio diverse enough?
Emphatically yes. In fact, it is much more diversified than the previous portfolio of 39 actively managed funds.
What I use are asset class funds; DFQTX holds all 5000+ stocks traded in the US equity market; DFTWX holds all foreign stocks; DFGEX holds all domestic and foreign REITs and of course VBTIX holds all bonds. With these four portfolios, you are holding all of the world’s productive assets. How much more diversified can you get?
Recently, I visited a prospective client in New Jersey. He is currently a client with Fisher Investments, and his advisor told him never to rebalance since that involves market timing.
I have to hand it to this financial advisor for recognizing that market timing is an unproductive endeavor, but he is so wrong about rebalancing that I am compelled to write this article.
Rebalancing is not a market timing activity, it is calendar-driven or condition-driven. For instance, you may decide that you will rebalance your portfolio on January 1st of each year or whenever an asset class allocation is off by 20%.
Recently, I got a call from a physician client of mine who asked a fantastic question. The Shiller PE of the S&P 500 index is at 24 now, much higher than the historical mean of 16 – is the market headed for a fall?
What is the Shiller PE?
This is a stock market metric invented by Yale Professor Robert Shiller. Basically, it is the average of the PE ratios of ten consecutive years. Because of that, Shiller PE is also called PE10.
Professor Shiller found it to be a reasonably good measure of valuation of the whole market: the higher the Shiller PE, the more expensive the market.
Back to my client’s question, I told him right away that I don’t know the answer. I don’t make investment decision based on opinion. I have to research historical data. After I hung up the phone, I asked my assistant to study the relationship between the Shiller PE and forward one-year and forward three-year returns.
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.
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.