Breaking Investor Mediocraty

I wanted to give some reflection on my experiences this week as a presenter at a local financial literacy/education event.  I have been presenting in this program for several years, and year after year I do tend to see the same faces.  The audience is predominantly made up of very educated and accomplished individuals.  While presenting at this event is enjoyable, it has taken a lot of work to prepare for.  Since the audience is mostly DIY investors, this, as you can image, is not a very good event for client recruitment. 

If we look at the Dalbar QAIB study, the state of the average investor is, well, sad.  Over the past 20 years, they calculate that the average investor has made less than half the return of the S&P 500.  So, even in my classes of highly educated people, there are probably some attendees that have done great, the other half have likely preformed poorly. (However, they would not admit to this).  Education and earning ability has no bearing on your investment success.

Making a change in one's investments is a huge undertaking, both mentally and even emotionally.  All sorts of emotions come into play.  And it's only a stronger emotional response that will spur change.  That is why I have starting writing a new class: "7 Reasons Why You Will Fail as an Investor, and 6 Reasons Why You Won't Fix it".  Here's a sample.

1) You are not diversified.  True diversification is rare.  And unless you can quantify it, you can't prove you are.

2) You use active management.  This flawed philosophy has been debunked by academia.  If you are not a stock picker, your mutual fund manager probably is.

3) You are not disciplined.  Most investors are not.

4) You are taking more risk than you realize.  Unless you can tell me the standard deviation of your portfolio, you don't even know how much risk you are taking.

5) You don't know your costs.  You have no idea what you are paying in the form of fees, commissions, or opportunity costs.

6) You don't know anything about the subject.  You lack even basic knowledge of investing, and are perfect prey for salesmen and women of financial "products".  OR this lack of knowledge paralyses you from making ANY decisions.

7) You don't even know if you are succeeding or failing.  You don't even know what you should be earning.  In your simple system, a positive year is a success, and a negative year is a failure.  You are failing more than you know. 


Why You Won't Fix It:

1) Your current advisor is your friend.  I get that.  If you choose relationships over results that is your choice.

2) You are penny wise and pound foolish.  You think that fees are the end all and be all of successful investing.  While important, I can show you a very bad, very cheap portfolio.

3) You lack the will to make the change. You don't have the energy to look into the situation.

4) You don't know who to trust.  That being said, you just remain in frozen in your current state.

5)  Your Ego.  You are smart.  You make a lot of money.  You don't want to pay an "advisor".

6) You have given up on the whole investing thing.  Too much money lost; and you are not playing the game anymore.

I know this may seem a little punchy, and I certainly don't want to offend anyone, but maybe it has to be that way for the message to hit home.  Do these lists resonate at all with you? While a good advisor can be a tremendous asset, ultimately your investment success is dependent on no one else but you.

Being Different Isn't Easy

It's a rainy afternoon on a Saturday, so I thought it would be a good opportunity to explain something that has certainly come to light in the past few weeks.

Sometimes it's not easy being different.  2014 is proving to be a great example of that. 

As of 10/3, the S&P 500 Index (a fairly good indicator of large US stock performance) is up a hair over 8%.  For the vast majority of the investing American public, they are experiencing a decent positive return on their fund's this year, simply because of the fact their portfolios very much track this index.  Retail US investors own mostly Large US Company Stocks.  This is not a prudent or diversified strategy.  However, as blind luck would have it, this area of the global stock market is doing comparatively better than many others in 2014. 

Take the Russell 2000 (a small cap stock index) for example.  That is down about 8% this year.  International stocks are also on the whole down a small percentage year to date.  That being the case, an investor that holds a diversified portfolio may feel some unease when comparing their portfolio to their neighbors', or to the popular stock indexes quoted daily on the news.  Their stock portfolio has likely declined this year.

But this is kind of year when disciplined and educated investors earn their increased returns.  "Average" investors, those that hold undiversified portfolios, make poor choices, and invest like 98% of other investors, earn about 3-4% a year over time according to Dalbar's yearly study of investor behavior.  It may be tempting to chase large cap stocks this year, but do you remember the "dead decade"?  The 2000s were horrible for large company stocks.  The truth is that every market segment will have its day in the sun- and its long stretches of underperformance.  Every year it's a new winner- and that winner is not knowable in advance. 

But you might think, "Doesn't spreading myself out reduce my returns?  After all, if all my winners are always wiped out by losers, I will never get ahead".  Well, that would be the case if the long term direction on all of the global stock markets were flat, or down, but it is our view that the long term direction on all developed stock markets is UP.  Some may go up more one year, and in some years some go up and some go down (like this year).  But by being more diversified, and owning more areas of the market, we tend to smooth out the long term volatility, versus placing all of our eggs in one proverbial basket. 

Costs: Important Yes, but not the Whole Story

It is fairly well known among savvy investors that costs are one of the main things that can drag down your portfolio's return over time.  Morningstar.com recently did a study that showed a fund's expense ratio, relatively to other funds, was a better predictor of performance than their own star system.

This leads many numbers minded people to go on a search for the cheapest, least expensive funds, and them pile them in to their portfolios.  Unfortunately, while this may save on cost, it likely will not bring the desired returns.
The issue that is missed in this scenario, is that the other ingredient necessary in a good portfolio is the right mix.  If investing were like baking, getting right measurements would be like getting low expenses.  Baking, unlike cooking, requires fairly accurate measurements.  So, in investing, being cost conscious is good, and we certainly want to eliminate any unnecessary costs.

However, to complete the analogy, picking the right ingredients (like baking powder vs flour) in baking is like picking the right "asset classes" or investments in your portfolio.  If I made cookies and was perfectly exact in my measurements, but, used salt instead of sugar, or cumin instead of cinnamon, my cookies are not going to be very tasty. That is just like a portfolio with low expenses, but the wrong amount of money in the wrong areas.

Just take the VINIX, the Vanguard S&P 500 Index Fund, Institutional Class.  It's expense ratio is only .04%.  Wow.  Almost nothing.  However, if you loaded up on that fund 15 years ago, you would have only enjoyed about a 4.62% return per year since then.  I don't even know if that is better than what bonds did over that time. 

Cheap doesn't always mean good.  It's important to understand all of the parts needed for a well diversified global portfolio.  Your portfolio's construction will override the effects of cost every time.

Who is a Right Fit Client?

One size does not fit all. 

In looking at what makes a successful long term client advisor relationship, a good long term fit is important.  Each firm, because of their own unique philosophies, views, and personalities, has an ideal "right fit" client.  To the extent a client is a right fit, the relationship should have all of the ingredients to be a benefit to all parties involved for many years.  If deep down the client and advisor are not a right fit, eventually down the line, the relationship will likely have some issues.  This article looks at what we look for in our "right fit clients".

*****

“One of the things Warren Buffet looks for is someone he enjoys spending time with.  How do we know as advisors, whether it is going to work out when we meet a new prospective client”?

                That’s a very interesting question.  Here’s what I know: there must be a good fit for long-term success.  While you are evaluating an advisor for a good fit, they should be evaluating you as well.

                We reviewed our most enduring relationships and have identified Seven Key Characteristics.

________________________

They Live Their Life by Principles

Principles like honesty integrity and hard work—to name just a few—are the foundation of everything that they do.  They do not sacrifice principles for results…the ends never justify the means.

They Know the Value of a Dollar

                A local small business owner said it best when he said, “Every dollar that I have is valuable to me.  It came by the sweat of my brow and I risked everything I owned to start this business and keep it running.  I don’t want to pay one more dollar in taxes than I am required.”

They have worked hard to earn, save and accumulate their money.  They want investments vehicles that work as hard for them as they did to make it.

They Believe Wealth is More than Money

                They know that True Wealth has many dimensions…including personal, social, spiritual, human, and intellectual capital.  They believe all wealth is worth preserving.

                “Relationships are more important than my money.  Of course, I want to have enough to secure my lifestyle, but I want to positively impact my family and my community.”

They Are Open to Learning about New Ideas & Abandoning Old

                They approach ideas with an open mind and can make hard choices. They may believe they have a reasonable plan and good advisor…yet, they want to move to the next level.

They Know Science & Sound, Strategy Trumps Marketing Glamour

                Their experience has taught them the value of strategy first: aim before you fire.  They also know that when a strategy is backed by sound academic research, it is most effective.  Even though this requires more time up front & personal investment, it pays off handsomely in the long run.

They avoid imprudent sales tactics and herd mentality.

They Know What They Do Well

                By implication, they know what they don’t do well.  “I tried the do-it-yourself route with my money.  What a disaster!  I know enough to be dangerous… besides, I can make more money with my time than it costs to delegate.” shared a business owner who recently converted the wealth in his business to cash.

 They Care about Value and Quality

                They agree with John Ruskin when he said “There is hardly anything in the world that some man cannot make a little worse and sell a little cheaper, and the people who consider price only are this man’s lawful prey.”

                They hire, respect and reward talented specialist…and desire win-win relationships with people they enjoy.

                These Seven Key Characteristics have been the foundation for every enduring relationship we have…and we look for them in everyone we work with…whether business owners, retired professionals or women on their own.

 

 

 

Is Volatility the Enemy?

From our upcoming newsletter:


After a few good years of market returns, it’s inevitable that the "c" word begins to be uttered throughout the investment world- and by that I mean "crash". From cable news, to newspapers and magazines, to emails, people predict doom & gloom.

But is market volatility, especially negative volatility, our real enemy? Let’s look at an example based on the re-turns S&P 500. John Q, Investor, started investing in 2000. He invested, like clockwork, $10,000 on the first trading day of every year until January of 2014. But un-like most investors, he was given a choice to invest in the real stock market, or a magical one, where the direction was always up! The market genie told John, "Both stock markets will close at the same price on January 2nd, 2014, but the magical market will never lose. It’ll be a smooth ride up, the same positive return every year!" Given the opportunity to never agonize through a down year, John chose this market, as opposed to the "real" world, which saw major swings between Jan 2000- Jan 2014.

So, did John make the right choice by eliminating all downside volatility? In John’s magical stock market, he ended up with $168,050. He made about $18,000 on his investment and he never lost money in any year. He wanted to compare his results with his copycat brother in law Tom. (Tom matched John’s investments exactly, only he invested in the real world market). Tom had $221,793 by January of 2014. This beat John’s returns by almost 25%! Why? While market corrections may be no fun to live through, they do provide a period of time when our investment dollars go further. With lower stock prices, investors can buy more shares.

So if volatility is not our enemy, who is? I like to borrow a famous literary quote that says "We have met the enemy, and he is us". Poor investor decision making (like John above), is the main cause of diluted portfolio re-turns.

Without risk, there is no reward.  Will the market "crash" again.  Most certainly.  It always has, and it will over and over again.  No one can predict with certainty when.  What matters is our response to it.  Wise investors will whether through them, and look at the bright side of the situation.  But this is not to say investing is without risk.  Each investor needs to answer the question, "how much market volatility am I willing to bear?"

Buffet vs the "Experts"

This post is largely taken from an article from NBC news, but I thought it would be worth commenting on it.  The article can be found at:

http://www.nbcnews.com/business/markets/buffett-has-big-lead-stock-bet-vs-experts-n23646

About six years ago, the famed Warren Buffet made a wager with a group of hedge fund managers.  Hedge fund managers are touted as the most sophisticated, nimble, and adept money managers on the planet.  They are not burden by the regulatory issues facing mutual funds, and they can employ a vast array of financial maneuvers.  Warren's ten year wager was that he could outperform a group of hedge fund managers using a simple low cost index fund; meaning that for all their flash and sizzle, the masters of the financial universe would be unable to beat the market due to the market's efficiency. 

With four years remaining, Warren's simple index fund has a commanding lead, earning 43.8% vs 12.5% for the hedge funds (as of the time of the article).  What is more telling is that Warren chose an index fund to compete against them, not his own company's stock.

2013 Year In Review

It is likely that 2013 will go down in the books as a very good year for the markets.  As of December 13^th, the S&P 500 Index (a US market index) was up over 27%.  The international markets were also up, with the MSCI EAFE Index returning over 16%.  Most investors are pleased with these results.  However, it is at times like these that questions begin to be raised:

 

“What do you think the markets are going to do now?”

“Aren’t the markets really high?”

“When is the correction coming?”

 

It is impossible for anyone to tell what direction the market will go.  I can recall specific instances, even back in January of 2012, of people saying that they were going to stay out of the market because it was “too high”.  Those same people have missed out on the gains that have since occurred.  It is impossible for anyone to tell which direction the next 10, 20, 30 or even 40% move in the markets will go.  It could be up, it could be down. 

 

There has never been a 100% decline in the global stock market- and if it would occur, the state of your investments would (likely) not be your greatest concern.  After all, such an event would have to wipe out the entire value of all companies, all over the world.  By contrast, if we examine the historical record, 100% increases, over varying time intervals, have certainly occurred.

Remember that the day to day, week to week, and month to month market movements are largely  random.  In our world of instant gratification, investors need to learn to ignore the minute by minute market news given by media sources.  By weathering the volatility of the markets, long term investors who are disciplined ensure they are fully invested when the market makes a true and meaningful move upward. On the contrary, many undisciplined investors try in vain to time the market to avoid losses and lock in gains; but in reality the record shows this mostly leads to frustration, regret, and missed opportunities.  But like many things in life, the rules to successful investing are easy.  It's actually adhering to them that is difficult.

Reality Check

Over past few months, and even years, investors who have braved getting back into the market have enjoyed strong returns.  That is a fact.  However, in recent conversations, a few investors seem to be getting increasingly nervous about the pending "correction" coming.  In their view, the market is "too high" and has to come down.  And as such, they are shelving any long term investing decisions.  In fact, it wasn't just this year, but even in 2012.  Those investors have lost out on what was a prosperous 2013 thus far.

In one respect they are right.  The market will, as it always has, go down from time to time.  It is not a straight shot up.  The point to take from the question is, that even if they are right, what is the long term consequences?  I would argue, nothing.  A bear market is usually defined as a market decline of 20% or more.  If I look back at history, we have had a bear market, or worse, in every decade (including the 90s) in recent memory.  However, if you were a long term investor over those years, these bear markets were nothing more than a great buying opportunity, and were not a portfolio destroying event.  As long term investors, it is vitally important to keep a long term view, and not be influenced by the day to day hype.

Default: Nightmare on Wall St?

 

Nothing on the news this week seems to be encouraging.  There is gridlock in Washington, and there are dire warnings of financial meltdown if the US defaults on it's debt.  I am sure the memories of 2008 are still fresh in investor's minds, and on the whole they are terrified of going through that again just as many people have recovered their losses from the last correction.

As the debt ceiling showdown looms, I thought it would be a good idea to look at the possible effects of a US default on the financial markets- namely the US Stock markets.  To do that, we can look at the last global debt default. 

The last time a major world power defaulted on its debt was Russia in 1998.  The combination of the Asian financial crisis and falling natural resource prices put the Russian economy in dire straits.  By August of that year the Russian gov’t was no longer able to make good on its obligations.  From January to August of 1998, the Russian stock market declined about 75%.  The black line on the first chart below tracks the Russian stock market (the red line is the Dow Jones, just for comparison).

 There are two things I’d like to draw from the below chart.  The first is that Russia’s default, and most other sovereign debt defaults, are the end result of some other drastic economic effect.  As you can see below, the Russian markets were falling long before the actual default later in 1998- serious trouble had surfaced before then.  There were real economic and financial reasons why the country was unable to pay its debt service, and eventually they had to accept default.  Our current situation is nothing like that.  Instead of economic reasons, the only reason we would have a default is through a self-inflicted wound due to the total failure of our government.  It’s unclear how the markets would react to a default with this unique set of circumstances.  After all, if a default were to occur, it would be surprising if it was anything but very short.  This fact alone would make our “voluntary” default somewhat novel.

 The other thing you can observe from the chart below, is that the Russian markets did in fact recover.  It was not fun to be an investor there in 1998, however, two years later in 2000 the markets had recovered, and then some.  In fact, from 1998 to 2008, while the Dow Jones made almost no gain, the Russian market would have grown by a factor of at least four even AFTER the 08 crash (second chart).  So in short, a default on sovereign debt, as we have seen elsewhere, is temporarily disruptive, but in the long run not the portfolio destroying event it is hyped up to be. 

 

 

 I have to credit www.tradingeconomics.com for these graphs.  The site is a wealth of statistics and charts.

 

 

Horse Sense

Horse Sense

by Margaret Wittkopp, President

 

Do you have “horse sense”?  Having good horse sense means you know how to handle yourself, have common sense and are a prudent person.  A person without “horse sense” is not considered to have much common sense.  Maybe you have horse sense when you are around your horses…but do you have the same horse sense when it comes to your financial life?   

There are many commonalities between good horse sense and good financial sense, especially when it comes to investing. Here are a few examples:

Patience:   It takes patience to train a horse, gain their confidence and get them to do what you want them to do.  Some have used abusive and brutal techniques to get a horse to behave, but anyone with horse sense knows that is not an effective way to train horses.   

It also takes patience to be a good investor: knowing your risk tolerance and structuring your investment according to your objectives, riding out the ups and downs of the markets, prudently re-balancing and avoiding the pitfalls of the quick fix.

Discipline:  Having the discipline to work your horse regularly and with consistent cues is hard work and necessary for good results with your horse. 

Discipline is also a necessary ingredient to financial success.  Avoiding the pitfalls that so many investors fall into like: track record investing, market timing, and speculative investments among other deadly practices.

Soundness:  A sound horse is a healthy horse, and a sound investment/financial plan is based on sound science, is academically proven, and verifiable.  Before I buy a horse I want it checked out by a veterinarian I trust.  A sound Investment plan should undergo the same scrutiny.

VERITAS Financial Services, LLC 506 East Mill Street Suite 101 Plymouth, WI 53073 920-893-5262   923 South Main Street Suite E Oshkosh, WI 54902 920-251-4862 www.veritasinvesting.com www.facebook.com/veritasinvesting

Courage:  It takes courage to ride a 1000 lb animal.  No matter how they act on the ground, under saddle anything can happen.  We all know that, and still the desire to ride overcomes our fear.

To be financially successful it is important to “bridle” the forces of the market to our advantage.  We do this through investing in the market.  When done in a prudent and cost effective way we can, and generally will, experience the rewards of the market.  To get the rewards of the market we must have the courage to seek the truth about investing and implement it.

Everyone needs a COACH/Trainer:   A good trainer is invaluable, from braking out a horse to knowing how to ride the horse to ...well you name it.  To have a great experience with our horse we need coaching along the way.

A Coach, (not a salesperson disguised as an “advisor” “planner” "wealth manager” etc.)  helps you understand markets, structure your investments prudently,  according to your personal needs and objectives.   And most importantly a Coach tells you want you need to know…. not what you want to hear, to keep you moving toward your goals and helping you have a successful financial life.

Confidence:  This is the reward we receive from our discipline, patience and the courage we develop from working with our horse. 

Confidence is also what we gain when we know how to answer the: “20 Must Answer Questions for Financial Peace of Mind”.  See the attached quiz and find out how you are as an investor.  Answers must be 100% sure to count as a yes…and only you will benefit from knowing.