The Global Marketplace

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Map2

 

The World At Your Fingertips

As investors, we have the entire global marketplace available to us.  The image above shows the global capital market (the markets available for investment around the world). Like an atlas, the image is laid out loosely in the shape of the continents and countries.  Instead of national borders, however, each country’s outline is based on the size of its capital market relative to the entire global market.   The markets are then identified by their percentage size, and in color by the type of market, developed, emerging, and frontier.  Developed markets are in countries with stable political and economic atmospheres, and have transparent systems for accounting and regulation.  Emerging Markets are in countries that fall short in some way, whether it is the political regime or lack of market transparency.  Frontier Markets fall short in multiple ways, and are generally too risky for individual investment.

 

Capital Markets Vs. Economies

As you view the ‘map’ you will notice the relative size of the United States capital market, and in particular, the relative size of the Chinese market.  While China is the second largest economy (after the United States) by most measures, because of their political structure and their non-transparent systems for accounting and regulation, the actual size of their capital markets is relatively small and emerging.

 

How to Own the Global Market?

As investors, we want to participate in the growth of all of the meaningful global capital markets in approximate proportion to their overall composition (See: Diversification a Complete Meal).  By owning thousands and thousands of different types of companies around the globe through low-cost mutual fund investments, it is possible as an investor to take advantage of the constantly shifting flows of growth in a highly diversified and meaningful way.

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

Diversification: A Complete Meal

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What single action can you take to simultaneously dampen your exposure to a number of investment risks while potentially improving your overall expected returns? Diversification.

While it may seem almost magical, the benefits of diversification have been well-documented and widely explained by some 60 years of academic inquiry. Its powers are both evidence-based and robust.

 

Global Diversification: Quantity AND Quality

What is diversification? In a general sense, it’s about spreading your risks around. In investing, that means that it’s more than just ensuring you have many holdings, it’s also about having many different kinds of holdings. If we compare this to the adage about not putting all your eggs in one basket, an apt comparison would be to ensure that you’re multiple baskets contain not only eggs but also a bounty of fruits, vegetables, grains, meats and cheese.

 

While this may make intuitive sense, many investors come to us believing they are well-diversified when they are not. They may own a large number of stocks or stock funds across numerous accounts. But upon closer analysis, we find that the bulk of their holdings are concentrated in large-company U.S. stocks.

 

In future installments of our series, we’ll explore what we mean by different kinds of investments. But for now, think of a concentrated portfolio as the undiversified equivalent of baskets full of plain, white eggs. Over-exposure to what should be only one ingredient among many in your financial diet is not only unappetizing, it can be detrimental to your financial health. Lack of diversification can:

 

  1. Increase your vulnerability to specific, avoidable risks
  2. Create a bumpier, less reliable overall investment experience
  3. Make you more susceptible to second-guessing your investment decisions

 

Combined, these three strikes tend to generate unnecessary costs, lowered expected returns and, perhaps most important of all, increased anxiety. You’re back to trying to beat instead of play along with a powerful market.

 

A World of Opportunities

Instead, consider that there is a wide world of investment opportunities available these days from tightly managed mutual funds intentionally designed to facilitate meaningful diversification. They offer efficient, low-cost exposure to capital markets found all around the globe.

 

 

Your Take-Home

To best capture the full benefits that global diversification has to offer, we advise turning to the sorts of fund managers who focus their energies – and yours – on efficiently capturing diversified dimensions of global returns.

 

In our last piece, we described why brokers or fund managers who are instead fixated on trying to beat the market are likely wasting their time and your money on fruitless activities. You may still be able to achieve diversification, but your experience will be hampered by unnecessary efforts, extraneous costs and irritating distractions to your resolve as a long-term investor. Who needs that, when diversification alone can help you have your cake and eat it too?

 

In our next post, we’ll explore in more detail why diversification is sometimes referred to as one of the only “free lunches” in investing.

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.

 

Financial Gurus and Other Unicorns

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Do Financial Gurus exist? Yes.

Do Lottery Winners exist? Yes.

Do you want to invest your savings in lottery tickets? No.

 

While Financial Gurus (experts at identifying mispriced investments) do exist; the overwhelming evidence shows that these gurus are few and far between; or as Morningstar strategist Samuel Lee has described, managers who have persistently outperformed their benchmarks are “rarer than rare.”

As investors we are better served letting the market serve us, rather than attempting to outsmart the collective knowledge of all other investors.

 

Group Intelligence Wins Again

As we covered in “You, the Market and the Prices You Pay,” independently thinking groups (like capital markets) are better at arriving at accurate answers than even the smartest individuals in the group. That’s in part because their wisdom is already bundled into prices, which adjust with fierce speed and relative accuracy to any new, unanticipated news.

 

Thus, even experts who specialize in analyzing business, economic, geopolitical or any other market-related information face the same challenges you do if they try to beat the market by successfully predicting an uncertain reaction to unexpected news that is not yet known. For them too, particularly after costs, group intelligence remains a prohibitively tall hurdle to overcome.

 

The Proof Is in the Pudding

But maybe you know of an extraordinary stock broker or fund manager or TV personality who strikes you as being among the elite few who can make the leap. Maybe they have a stellar track record, impeccable credentials, a secret sauce or brand-name recognition. Should you turn to them for the latest market tips, instead of settling for “average” returns?

 

Let’s set aside market theory for a moment and consider what has actually been working. Bottom line, if investors who did their homework were able to depend on outperforming experts, we should expect to see credible evidence of it.

 

Not only is such data lacking, the body of evidence to the contrary is overwhelming. Star performers – “active managers” – often fail to survive, let alone persistently beat comparable market returns. A 2013 Vanguard Group analysis found that only about half of some 1,500 actively managed funds available in 1998 still existed by the end of 2012, and only 18% had outperformed their benchmarks.

 

Across the decades and around the world, a multitude of academic studies have scrutinized active manager performance and consistently found it lacking.

  • Among the earliest such studies is Michael Jensen’s 1967 paper, “The Performance of Mutual Funds in the Period 1945–1964.” He concluded, there was “very little evidence that any individual fund was able to do significantly better than that which we expected from mere random chance.”
  • A more recent landmark study is Eugene Fama’s and Kenneth French’s 2009, “Luck Versus Skill in the Cross Section of Mutual Fund Returns.” They demonstrated that “the high costs of active management show up intact as lower returns to investors.”
  • In the decades between, there have been as many as 100 similar studies published by a Who’s Who list of academic luminaries, echoing Jensen, Fama and French. In 2011, the Netherlands Authority for the Financial Markets (AFM) scrutinized this body of research and concluded: “Selecting active funds in advance that will achieve outperformance after deduction of costs is therefore exceptionally difficult.”

 

Lest you think hedge fund managers and similar experts can fare better in their more rarified environments, the evidence dispels that notion as well. For example, a March 2014 Barron’s column took a look at hedge fund survivorship. The author reported that nearly 10% of hedge funds existing at the beginning of 2013 had closed by year-end, and nearly half of the hedge funds available five years prior were no longer available (presumably due to poor performance).

 

Your Take-Home

So far, we’ve been assessing some of the investment foes you face. The good news is, there is a way to invest that enables you to nimbly sidestep rather than face such formidable foes, and simply let the market do what it does best on your behalf. In our next installment, we’ll begin to introduce you to the strategies involved, and your many financial friends. First up, an exploration of what some have called the closest you’ll find to an investment free lunch: Diversification.

 

Evidence-Based Investment Series #4: Diversification: A Complete Meal

 

Woodstone Financial, LLC is a fee-only financial planning and investment management firm located in Asheville, North Carolina.   Contact us to learn more about our services.