Financial Well-Being In The Time of Coronavirus

For better or worse, many of us have had more time than usual to engage in new or different pursuits in 2020. Even if you’re as busy as ever, you may well be revisiting routines you have long taken for granted. Let’s cover eight of the most and least effective ways to spend your time shoring up your financial well-being in the time of the coronavirus.

 

  1.  A Best Practice: Stay the Course

Your best investment habits remain the same ones we’ve been advising all along. Build a low-cost, globally diversified investment portfolio with the money you’ve got earmarked for future spending. Structure it to represent your best shot at achieving your financial goals by maintaining an appropriate balance between risks and expected returns. Stick with it, in good times and bad.

 

  1.  A Top Time-Waster: Market-Timing and Stock-Picking

Why have stock markets been ratcheting upward during socioeconomic turmoil? Market theory provides several rational explanations. Mostly, market prices continuously reset according to “What’s next?” expectations, while the economy is all about “What’s now?” realities. If you’re trying to keep up with the market’s manic moves … stop doing that. You’re wasting your time.

 

  1.  A Best Practice: Revisit Your Rainy-Day Fund

How is your rainy-day fund doing? Right now, you may be realizing how helpful it’s been to have one, and/or how unnerving it is to not have enough. Use this top-of-mind time to establish a disciplined process for replenishing or adding to your rainy-day fund. Set up an “auto-payment” to yourself, such as a monthly direct deposit from your paycheck into your cash reserves.

 

  1.  A Top Time-Waster: Stretching for Yield

Instead of focusing on establishing adequate cash reserves, some investors try to shift their “safety net” positions to holdings that promise higher yields for similar levels of risk. Unfortunately, this strategy ignores the overwhelming evidence that risk and expected return are closely related. Stretching for extra yield out of your stable holdings inevitably renders them riskier than intended for their role. As personal finance columnist Jason Zweig observes in a recent exposé about one such yield-stretching fund, “Whenever you hear an investment pitch that talks up returns and downplays risks, just say no.”

 

  1.  A Best Practice: Evidence-Based Portfolio Management

When it comes to investing, we suggest reserving your energy for harnessing the evidence-based strategies most likely to deliver the returns you seek, while minimizing the risks involved. This includes: Creating a mix of stock and bond asset classes that makes sense for you; periodically rebalancing your prescribed mix (or “asset allocation”) to keep it on target; and/or adjusting your allocations if your personal goals have changed. It also includes structuring your portfolio for tax efficiency, and identifying ideal holdings for achieving all of the above.

 

  1.  A Top Time-Waster: Playing the Market

Some individuals have instead been pursuing “get rich quick” schemes with active bets and speculative ventures. The Wall Street Journal has reported on young, do-it-yourself investors exhibiting increased interest in opportunistic day-trading, and alternatives such as stock options and volatility markets. Evidence suggests you’re better off patiently participating in efficient markets as described above, rather than trying to “beat” them through risky, concentrated bets. Over time, playing the market is expected to be a losing strategy for the core of your wealth.

 

  1.  A Best Practice: Plenty of Personalized Financial Planning

There is never a bad time to tend to your personal wealth, but it can be especially important – and comforting – when life has thrown you for a loop. Focus on strengthening your own financial well-being rather than fixating on the greater uncontrollable world around us. To name a few possibilities, we’ve continued to proactively assist clients this year with their portfolio management, retirement planning, tax-planning, stock options, business successions, estate plans and beneficiary designations, insurance coverage, college savings plans, and more.

 

  1.  A Top Time-Waster: Fleeing the Market

On the flip side of younger investors “playing” the market, retirees may be tempted to abandon it altogether. This move carries its own risks. If you’ve planned to augment your retirement income with inflation-busting market returns, the best way to expect to earn them is to stick to your plan. What about getting out until the coast seems clear? Unfortunately, many of the market’s best returns come when we’re least expecting them. This year’s strong rallies amidst gloomy economic news illustrates the point well. Plus, selling stock positions early in retirement adds an extra sequence risk drag on your future expected returns.

Could you use even more insights on how to effectively invest any extra time you may have these days? Please reach out to us any time. We’d be delighted to suggest additional best financial practices tailored to your particular circumstances.

 

Read More: Coronavirus Financial Perspective, Action Steps, and Resources

 

Coronavirus: Financial Perspective, Action Steps, and Resources

Evidence in the Face of Uncertainty

We continue to watch with concern the spread of the new coronavirus. The uncertainty is being felt around the globe, and it is unsettling on a human level as well as from the perspective of how markets respond.

It is a fundamental principle that markets are designed to handle uncertainty, processing information in real-time as it becomes available. We see this happening when markets decline sharply, as they have recently, as well as when they rise. Such declines can be distressing to any investor, but they are also a demonstration that the market is functioning as we would expect.

Market declines can occur when investors are forced to reassess expectations for the future. The market is clearly responding to new information as it becomes known, but the market is pricing in unknowns, too. As risk increases during a time of heightened uncertainty, so do the returns investors demand for bearing that risk, which pushes prices lower. Our investing approach is based on the principle that prices are set to deliver positive future expected returns for holding risky assets.

We can’t tell you when things will turn or by how much, but our expectation is that bearing today’s risk will be compensated with positive expected returns. That’s been a lesson of past health crises, such as the Ebola and swine-flu outbreaks earlier this century, and of market disruptions, such as the global financial crisis of 2008–2009. Additionally, history has shown no reliable way to identify a market peak or bottom. These beliefs argue against making market moves based on fear or speculation, even as difficult and traumatic events transpire.

Another way some investors might react to a falling market is jumping ship and selling out of stocks. The intuition may be that sitting out of the market for a period of time can help avoid further losses. However, the weight of evidence and data suggest this type of market timing may instead actually reduce investors’ gains over time.

Financial downturns are unpleasant for all market participants. Investors can reduce exacerbating the experience by adhering to core principles. Two such principles supported by a long history of research are broad diversification and maintaining a consistent asset allocation. Investors who deviate from these principles by pursuing stock picking or market timing may undermine their ability to achieve their investment goals.

Action Steps That May Be Appropriate

 

What can we do while we hunker down at home, and wait for better days. As always, our specific advice and actions will vary, depending on circumstance and needs. Here are a few other areas of interest we’re keeping an eye on:

  • Tax planning and money management: Helping optimize new tax breaks, loans, grants, unemployment benefits, and similar relief measures for individuals and businesses

 

  • Financial life planning (pre-retirement, retirement, and everywhere in between): Deliberately assessing the impact of the current market on the overall financial plan. to the opportunities and challenges specific to your near- and long-term interests and concerns. What opportunities and challenges are now presented with the current market.
    • For younger investors (or any investor with a decades long timeframe), current market conditions can actually benefit you greatly. You can buy equities now while prices are low (or at the very least not abandon the ones you already hold), and watch their expected growth compound over time. Especially if you can do this in a tax-sheltered account like a 401(k), traditional IRA, or Roth IRA, you can build even more long-term wealth, even more dramatically.
    • If you are in or near retirement, with a significant (but appropriate) need for portfolio income, the truth is, the current market is not ideal for you. You might face what are known as sequence of return risks if you must sell depressed stock holdings to fund your current spending needs. Essentially, selling stocks at a loss early in retirement inflicts a double-whammy on your portfolio’s future growth potential. Detailed withdrawal strategies for managing sequence risk is beyond the scope of this piece. But best practices do exist. This is one critical reason we are glad to be here as your advisor, to help you weigh the challenges and possibilities ahead of you, and proceed in an informed manner.
  • Investment management:
    • Rebalancing, and maintaining structure in portfolio target allocations – a systematic, objective, and consistent way to buy low and sell high
    • Creating beneficial tax-losses, and making other prudent moves to best position your portfolio for future expected growth
  • Bringing to light the long-term perspective: Looking at the evidence, data, and reality of the crisis, and putting this into a long-term perspective. Avoiding fixating on daily returns or reacting rashly to scary market news
    • We need remain informed about the evolving financial landscape – especially about changes that might directly impact life plans. The structure of the plans and investments should always be built in anticipation of periodic bear markets like the one we’re seeing now.
    • Essentially, among the most important things we can currently do is to largely look past all the market’s mayhem, and focus instead on making the most of your life. Try to “set your egg timer to six months,” as this moving piece by Contrarian Edge’s Vitaliy Katsenelson suggests. Consider his advice (emphasis ours):
      • “We have been given a very unique opportunity to divorce ourselves from material things and spend time with our family. To really spend time with them. We have been given the rare opportunity to prioritize what is most important to us without guilt. The material world is on pause, at least for a few weeks. Try to make the most of it while you can.”

CARES Act Overview

With much of the country in self-isolation, perhaps you’ve got time to read the entire H.R. 748 Coronavirus Aid, Relief, and Economic Security Act, or CARES Act. If you’d prefer, here is a summary of many of the key provisions we expect to be discussing with you in person (virtually), depending on which ones apply to you.

In General

  • Direct payments/recovery rebates: Most Americans can expect to receive rebates from Uncle Sam. Depending on your household income, expect up to $1,200 per adult and $500 per dependent child. To calculate your payment, the Federal government will look at your 2019 Adjusted Gross Income (AGI) if it’s available, or your 2018 AGI if it’s not. However, you’ll receive an extra 2020 tax credit if your 2020 AGI ends up lower than the figure used to calculate your rebate. This Nerd’s Eye View illustration offers a great overview:
  • Retirement account distributions for coronavirus-related needs: You can tap into your retirement account ahead of time in 2020 for a coronavirus-related distribution of up to $100,000, without incurring the usual 10% penalty or mandatory 20% Federal withholding. You’ll still owe income tax on the distributions, but you can prorate the payment across 3 years. You also can repay distributions to your account within 3 years to avoid paying income taxes, or to claim a refund on taxes paid.
  • Various healthcare-related incentives: For example, certain over-the-counter medical expenses previously disallowed under some healthcare plans now qualify for coverage. Also, Medicare restrictions have been relaxed for covering telehealth and other services (such as COVID-19 vaccinations, once they’re available). Other details apply.

For Retirees (and Retirement Account Beneficiaries)

  • RMD relief: Required Minimum Distributions (RMDs) go on a holiday in 2020 for retirees, as well as beneficiaries with inherited retirement accounts. If you’ve not yet taken your 2020 RMD, don’t! If you have, please be in touch with us to explore potential remedies.

 For Charitable Donors

  • “Above-the-line” charitable deductions: Deduct up to $300 in 2020 qualified charitable contributions (excluding Donor Advised Funds), even if you are taking a standard deduction.
  • Donate all of your 2020 AGI: You can effectively eliminate 2020 taxes owed, and then some, by donating up to, or beyond your AGI. If you donate more than your AGI, you can carry forward the excess up to 5 years. Donor Advised Fund contributions are excluded.

For Business Owners (and Certain Not-for-Profits)

  • Paycheck Protection Program loans (potentially forgivable): The Small Business Administration (SBA) Paycheck Protection Program (PPP) is making loans available for qualified businesses and not-for-profits (typically under 500 employees), sole proprietors, and independent contractors. Loans for up to 2.5x monthly payroll, up to $10 million, 2-year maturity, interest rate 1%. Payments are deferred and, if certain employment retention and other requirements are met, the loan may be forgiven.
  • Economic Injury Disaster Loans (with forgivable advance): In coordination with your state, SBA disaster assistance also offers Economic Injury Disaster Loans (EIDLs) of up to $2 million to qualified small businesses and non-profits, “to help overcome the temporary loss of revenue they are experiencing.” Interest rates are under 4%, with potential repayment terms of up to 30 years. Applicants also are eligible for an advance on the loan of up to $10,000. The advance will not need to be repaid, even if the loan is denied.
  • Payroll tax credits and deferrals: For qualified businesses who are not taking a loan.
  • Employee retention credit: An additional employee retention credit (as a payroll tax credit), “equal to 50 percent of the qualified wages with respect to each employee of such employer for such calendar quarter.” Excludes businesses receiving PPP loans, and may exclude those who have taken the EIDL loans.
  • Net Operating Loss rules relaxed: Carry back 2018–2020 losses up to five years, on up to 100% of taxable income from these same years.
  • Immediate expensing for qualified improvements: Section 168 of the Internal Revenue Code of 1986 is amended to allow immediate expensing rather than multi-year depreciation.
  • Dollars set aside for industry-specific relief: Please be in touch for a more detailed discussion if your entity may be eligible for industry-specific relief (e.g., airlines, hospitals and state/local governments).

For Employees/Plan Participants

  • Retirement plan loans and distributions: Maximum amount increased to $100,000 on up to the entire vested amount for coronavirus-related loans. Delay repayment up to a year for loans taken from March 27–year-end 2020. Distributions described above in In General.
  • Paid sick leave: Paid sick leave benefits for COVID-19 victims are described in the separate, March 18 R. 6201 Families First Coronavirus Response Act, and are above and beyond any benefits received through the CARES Act. Whether in your role as an employer or an employee, we’re happy to discuss the details with you upon request.

For Employers/Plan Sponsors

  • Relief for funding defined benefit plans: Due date for 2020 funding is extended to Jan. 1, 2021. Also, the funding percentage (AFTAP) can be calculated based on your 2019 status.
  • Relief for facilitating pre-retirement plan distributions and expanded loans: As described above for Employees/Plan Participants, employers “may rely on an employee’s certification that the employee satisfies the conditions” to be eligible for relief. The participant is required to self-certify in writing that they or a direct dependent have been diagnosed, or they have been financially impacted by the pandemic. No additional evidence (such as a doctor’s release) is required.
  • Potential extension for filing Form 5500: While the Dept. of Labor (DOL) has not yet granted an extension, the CARES Act permits the DOL to postpone this filing deadline.
  • Exclude student loan pay-down compensation: Through year-end, employers can help employees pay off current educational expenses and/or student loan balances, and exclude up to $5,250 of either kind of payment from their income.

For Unemployed/Laid Off Americans

  • Increased unemployment compensation: Federal funding increases standard unemployment compensation by $600/week, and coverage is extended 13 weeks.
  • Federal funding covers first week of unemployment: The one-week waiting period to start collecting benefits is waived.
  • Pandemic unemployment assistance: Unemployment coverage is extended to self-employed individuals for up to 39 weeks. Plus, the Act offers incentives for states to establish “short-time compensation programs” for semi-employed individuals.

For Students

  • Student loan payments deferred to Sept. 30, 2020: No interest will accrue either. Important: Voluntary payments will continue unless you explicitly pause them. Plus, the deferral period will still count toward any loan forgiveness program you’re in. So, be sure to pause payments if this applies to you, lest you pay on debt that will ultimately be forgiven.
  • Delinquent debt collection suspended through Sept. 30, 2020: Including wage, tax refund, and other Federal benefit garnishments.
  • Employer-paid student loan repayments excluded from 2020 income: From the date of the CARES Act enactment through year-end, your employer can pay up to $5,250 toward your student debt or your current education without it counting as taxable income to you.
  • Pell Grant relief: There are several clauses that ease Pell Grant limits, while not eliminating them. It would be best if we go over these with you in person if they may apply to you.

For Estates/Beneficiaries

  • A break for “non-designated” beneficiaries: 2020 can be ignored when applying the 5-year rule for “non-designated” beneficiaries with inherited retirement accounts. The 5-Year Rule effectively ends up becoming a 6-Year Rule for current non-designated beneficiaries.

As such, before proceeding, please consult with us and other appropriate professionals, such as your accountant, and/or estate planning attorney on any details specific to you. Please don’t hesitate to reach out to us with your questions and comments. It’s what we’re here for.

 

 

Reference Materials:

 

Tuning Out The Noise

As you consider the results from the past quarter (Quarterly Market Review Here) – It can be easy to feel overwhelmed by the relentless stream of news about markets. Being bombarded with data and headlines presented as impactful to your financial well-being can evoke strong emotional responses from even the most experienced investors. Headlines from the “lost decade”1 can help illustrate several periods that may have led market participants to question their approach..

May 1999:
Dow Jones Industrial Average Closes Above 11,000 for the First Time

March 2000:
Nasdaq Stock Exchange Index Reaches an All‑Time High of 5,048

April 2000:
In Less Than a Month, Nearly a Trillion Dollars of Stock Value Evaporates

October 2002:
Nasdaq Hits a Bear-Market Low of 1,114

September 2005:
Home Prices Post Record Gains

September 2008:
Lehman Files for Bankruptcy, Merrill Is Sold

While these events are now a decade or more behind us, they can still serve as an important reminder for investors today. For many, feelings of elation or despair can accompany headlines like these. We should remember that markets can be volatile and recognize that, in the moment, doing nothing may feel paralyzing. Throughout these ups and downs, however, if one had hypothetically invested $10,000 in US stocks in May 1999 and stayed invested, that investment would be worth approximately $28,000 today.2

When faced with short-term noise, it is easy to lose sight of the potential long-term benefits of staying invested. While no one has a crystal ball, adopting a long-term perspective can help change how investors view market volatility and help them look beyond the headlines.

 

The Value of a Trusted Advisor

Part of being able to avoid giving in to emotion during periods of uncertainty is having an appropriate asset allocation that is aligned with an investor’s willingness and ability to bear risk. It also helps to remember that if returns were guaranteed, you would not expect to earn a premium. Creating a portfolio investors are comfortable with, understanding that uncertainty is a part of investing, and sticking to a plan may ultimately lead to a better investment experience.

However, as with many aspects of life, we can all benefit from a bit of help in reaching our goals. The best athletes in the world work closely with a coach to increase their odds of winning, and many successful professionals rely on the assistance of a mentor or career coach to help them manage the obstacles that arise during a career. Why? They understand that the wisdom of an experienced professional, combined with the discipline to forge ahead during challenging times, can keep them on the right track. The right financial advisor can play this vital role for an investor. A financial advisor can provide the expertise, perspective, and encouragement to keep you focused on your destination and in your seat when it matters most.

A recent survey conducted by Dimensional Fund Advisors (see Exhibit 1) found that, along with progress towards their goals, investors place a high value on the sense of security they receive from their relationship with a financial advisor.

EXHIBIT 1

How Do You Primarily Measure the Value Received from Your Advisor?

Top Four Responses

 

 

Having a strong relationship with an advisor can help you be better prepared to live your life through the ups and downs of the market. That’s the value of discipline, perspective, and calm. That’s the difference the right financial advisor makes.

OLLI Exploring Continuing Care Retirement Communities

We are proud to be a guest speaker at the Osher Lifelong Learning Institute’s Program

Exploring Continuing Care Retirement Communities: A Thorough Guide to Your Options

 

July 23 &30, August 6, 13, 20, & 27 and September 3 & 4 

 

 

OLLI Exploring CCRCs Interest List 2020

(Click link above to register for Retirement Planning Today through WCU’s website)

 

Contact Jake Sadler Here

(Click link above to contact us with any questions)

 

Course Description:
“Exploring Continuing Care Retirement Communities” will meet for eight sessions over the course of seven weeks. Three of the meetings will be held at the Reuter Center where we will set a context for better understanding the advantages and challenges of life in a CCRC. For the other meetings, participants will travel to representative communities to hear both from marketing directors and from residents to gain a clearer understanding of quality and character of individual communities. Informational sessions held at CCRCs will generally last from 10 a.m. to 2 p.m.; participants will have the option to eat lunch at each of the CCRCs.

$150 per person payable by Visa or MasterCard.

*OLLI membership for 2020/2021 membership year required to participate

Refund policy:

Refunds will be issued for the program fee, minus $25/person administrative charge, for cancellations made by 5 p.m. at least 10 days prior to the program start date. For cancellations made fewer than 10 days prior to the program start date, $75 will be refunded.  To cancel, notify Hannah Furgiuele by email hfurgiue@unca.edu

 

The ABCs of Behavioral Bias: H-O

There are so many investment-impacting behavioral biases, we could probably identify at least one for nearly every letter in the alphabet. Today, we’ll continue with the most significant ones by looking at: hindsight, loss aversion, mental accounting and outcome bias.

 

Hindsight

 

What is it? In “Thinking, Fast and Slow,” Daniel Kahneman credits Baruch Fischhoff for demonstrating hindsight bias – the “I knew it all along” effect – when he was still a student. Kahneman describes hindsight bias as a “robust cognitive illusion” that causes us to believe our memory is correct when it is not. For example, say you expected a candidate to lose, but she ended up winning. When asked afterward how strongly you predicted the actual outcome, you’re likely to recall giving it higher odds than you originally did. This seems like something straight out of a science fiction novel, but it really does happen!

 

When is it helpful? Similar to blind spot bias (one of the first biases we covered) hindsight bias helps us assume a more comforting, upbeat outlook in life. As “Why Smart People Make Big Money Mistakes” authors Gary Belsky and Thomas Gilovich describe it, “We humans have developed sneaky habits to look back on ourselves in pride.” Sometimes, this causes no harm, and may even help us move past prior setbacks.

 

When is it harmful? Hindsight bias is hazardous to investors, since your best financial decisions come from realistic assessments of market risks and rewards. As Kahneman explains, hindsight bias “leads observers to assess the quality of a decision not by whether the process was sound but by whether its outcome was good or bad.” If a high-risk investment happens to outperform, but you conveniently forget how risky it truly was, you may load up on too much of it and not be so lucky moving forward. On the flip side, you may too quickly abandon an underperforming holding, deceiving yourself into dismissing it as a bad bet to begin with.

 

Loss Aversion

 

What is it? “Loss aversion” is a fancy way of saying we often fear losing more than we crave winning, which leads to some interesting results when balancing risks and rewards. For example, in “Stumbling on Happiness,” Daniel Gilbert describes: “[M]ost of us would refuse a bet that gives us an 85 percent chance of doubling our life savings and a 15 percent chance of losing it.” Even though the odds favor a big win, imagining that slight chance that you might go broke leads most people to decide it’s just not worth the risk.

 

When is it helpful? To cite one illustration of when loss aversion plays in your favor, consider the home and auto insurance you buy every year. It’s unlikely your house will burn to the ground, your car will be stolen, or an act of negligence will cost you your life’s savings in court. But loss aversion reminds us that unlikely does not mean impossible. It still makes good sense to protect against worst-case scenarios when we know the recovery would be very painful indeed.

 

When is it harmful? One way loss aversion plays against you is if you decide to sit in cash or bonds during bear markets – or even when all is well, but a correction feels overdue. The evidence demonstrates that you are expected to end up with higher long-term returns by at least staying put, if not bulking up on stocks when they are “cheap.” And yet, the potential for future loss can frighten us into abandoning our carefully planned course toward the likelihood of long-term returns.

 

Mental Accounting

 

What is it? If you’ve ever treated one dollar differently from another when assessing its worth, that’s mental accounting at play. For example, if you assume inherited money must be more responsibly managed than money you’ve won in a raffle, you’re engaging in mental accounting.

 

When is it helpful? In his early paper, “Mental Accounting Matters,” Richard Thaler (who is credited for having coined the term), describes how people use mental accounting “to keep trace of where their money is going, and to keep spending under control.” For example, say you set aside $250/month for a fun family outing. This does not actually obligate you to spend the money as planned or to stick to your budget. But by effectively assigning this function to that money, you’re better positioned to enjoy your leisure time, without overdoing it.

 

When is it harmful? While mental accounting can foster good saving and spending habits, it plays against you if you instead let it undermine your rational investing. Say, for example, you’re emotionally attached to a stock you inherited from a beloved aunt. You may be unwilling to unload it, even if reason dictates that you should. You’ve just mentally accounted your aunt’s bequest into a place that detracts from rather than contributes to your best financial interests.

 

Outcome Bias

 

What is it? Sometimes, good or bad outcomes are the result of good or bad decisions; other times (such as when you try to forecast future market movements), it’s just random luck. Outcome bias is when you mistake that luck as skill.

 

When is it helpful? This may be one bias that is never really helpful in the long run. If you’ve just experienced good or bad luck rather than made a smart or dumb decision, when wouldn’t you want to know the difference, so you can live and learn?

 

When is it harmful? As Kahneman describes in “Thinking, Fast and Slow,” outcome bias “makes it almost impossible to evaluate a decision properly – in terms of the beliefs that were reasonable when the decision was made.” It causes us to be overly critical of sound decisions if the results happen to disappoint. Conversely, it generates a “halo effect,” assigning undeserved credit “to irresponsible risk seekers …who took a crazy gamble and won.” In short, especially when it’s paired with hindsight bias, this is dangerous stuff in largely efficient markets. The more an individual happens to come out ahead on lucky bets, the more they may mistakenly believe there’s more than just luck at play.

 

We’ve got more behavioral biases to cover in upcoming installments, so stay tuned. Next, we’ll continue through the alphabet, introducing a few more of the most suspect financial behavioral biases.

To read about Behavioral Biases A-F click here

To read about Behavioral Biases F-H click here

 

The Uncommon Average

The US stock market has delivered an average annual return of around 10% since 1926.  But short-term results may vary, and in any given period stock returns can be positive, negative, or flat. When setting expectations, it’s helpful to see the range of outcomes experienced by investors historically. For example, how often have the stock market’s annual returns actually aligned with its long-term average?

Exhibit 1 shows calendar year returns for the S&P 500 Index since 1926. The shaded band marks the historical average of 10%, plus or minus 2 percentage points. The S&P 500 Index had a return within this range in only six of the past 93 calendar years. In most years, the index’s return was outside of the range—often above or below by a wide margin—with no obvious pattern. For investors, the data highlight the importance of looking beyond average returns and being aware of the range of potential outcomes.

 

TUNING IN TO DIFFERENT FREQUENCIES

Despite the year-to-year volatility, investors can potentially increase their chances of having a positive outcome by maintaining a long-term focus. Exhibit 2 documents the historical frequency of positive returns over rolling periods of one, five, and 10 years in the US market. The data show that, while positive performance is never assured, investors’ odds improve over longer time horizons.

Conclusion

While some investors might find it easy to stay the course in years with above average returns, periods of disappointing results may test an investor’s faith in equity markets. Being aware of the range of potential outcomes can help investors remain disciplined, which in the long term can increase the odds of a successful investment experience. What can help investors endure the ups and downs? While there is no silver bullet, understanding how markets work and trusting market prices are good starting points. An asset allocation that aligns with personal risk tolerances and investment goals is also valuable. By thoughtfully considering these and other issues, investors may be better prepared to stay focused on their long-term goals during different market environments.

 

To review our most recent market review for the 2nd Quarter 2019, Click Here 

 

Déjà Vu All Over Again

Investment fads are nothing new. When selecting strategies for their portfolios, investors are often tempted to seek out the latest and greatest investment opportunities.

Over the years, these approaches have sought to capitalize on developments such as the perceived relative strength of particular geographic regions, technological changes in the economy, or the popularity of different natural resources. But long-term investors should be aware that letting short-term trends influence their investment approach may be counterproductive. As Nobel laureate Eugene Fama said, “There’s one robust new idea in finance that has investment implications maybe every 10 or 15 years, but there’s a marketing idea every week.”

WHAT’S HOT BECOMES WHAT’S NOT

Looking back at some investment fads over recent decades can illustrate how often trendy investment themes come and go.

  • In the 1950s, the “Nifty Fifty” were all the rage.
  • In the 1960s, “go-go” stocks and funds piqued investor interest.
  • Later in the 20th century, growing belief in the emergence of a “new economy” led to the creation of funds poised to make the most of the rising importance of information technology and telecommunication services.
  • Early 1990’s: attention turned to the rising “Asian Tigers” of Hong Kong, Singapore, South Korea, and Taiwan. A decade later, much was written about the emergence of the “BRIC” countries of Brazil, Russia, India, and China and their new place in global markets. Similarly, funds targeting hot industries or trends have come into and fallen out of vogue.
  • During the 2000s, 130/30 funds, which used leverage to sell short certain stocks while going long others, became increasingly popular.
  • In the wake of the 2008 financial crisis, “Black Swan” funds, “tail-risk-hedging” strategies, and “liquid alternatives” abounded. As investors reached for yield in a low interest-rate environment in the following years, other funds sprang up that claimed to offer increased income generation, and new strategies like unconstrained bond funds proliferated.
  • More recently, strategies focused on peer-to-peer lending, cryptocurrencies, and even cannabis cultivation and private space exploration have become more fashionable. In this environment, so-called “FAANG” stocks and concentrated exchange-traded funds with catchy ticker symbols have also garnered attention among investors.

THE FUND GRAVEYARD

Unsurprisingly, however, numerous funds across the investment landscape were launched over the years only to subsequently close and fade from investor memory. While economic, demographic, technological, and environmental trends shape the world we live in, public markets aggregate a vast amount of dispersed information and drive it into security prices. Any individual trying to outguess the market by constantly trading in and out of what’s hot is competing against the extraordinary collective wisdom of millions of buyers and sellers around the world.

With the benefit of hindsight, it is easy to point out the fortune one could have amassed by making the right call on a specific industry, region, or individual security over a specific period. While these anecdotes can be entertaining, there is a wealth of compelling evidence that highlights the futility of attempting to identify mispricing in advance and profit from it.

It is important to remember that many investing fads, and indeed, most mutual funds, do not stand the test of time. A large proportion of funds fail to survive over the longer term. Of the 1,622 fixed income mutual funds in existence at the beginning of 2004, only 55% still existed at the end of 2018. Similarly, among equity mutual funds, only 51% of the 2,786 funds available to US-based investors at the beginning of 2004 endured.

 

WHAT AM I REALLY GETTING?

When confronted with choices about whether to add additional types of assets or strategies to a portfolio, it may be helpful to ask the following questions:

  1. What is this strategy claiming to provide that is not already in my portfolio?
  2. If it is not in my portfolio, can I reasonably expect that including it or focusing on it will increase expected returns, reduce expected volatility, or help me achieve my investment goal?
  3. Am I comfortable with the range of potential outcomes?

If investors are left with doubts after asking any of these questions, it may be wise to use caution before proceeding. Within equities, for example, a market portfolio offers the benefit of exposure to thousands of companies doing business around the world and broad diversification across industries, sectors, and countries. While there can be good reasons to deviate from a market portfolio, investors should understand the potential benefits and risks of
doing so.

In addition, there is no shortage of things investors can do to help contribute to a better investment experience. Working closely with a financial advisor can help individual investors create a plan that fits their needs and risk tolerance. Pursuing a globally diversified approach; managing expenses, turnover, and taxes; and staying disciplined through market volatility can help improve investors’ chances of achieving their long-term financial goals.

 

CONCLUSION

Fashionable investment approaches will come and go, but investors should remember that a long-term, disciplined investment approach based on robust research and implementation may be the most reliable path to success in the global capital markets.

Keep this in mind as you reflect on the past 12 months in the markets (shown below).

 

What Does 2018 Mean

What does 2018 mean to us…

Part One: General Principles

We neither forecast the economy, nor attempt to time the markets, nor predict which market sectors will “outperform” which others over the next block of time. In a sentence that always bears repeating: We are planners rather than a prognosticators.

Once a client family has a plan in place—and has funded it with what have historically been the most appropriate types of investments—we will hardly ever recommend changing the portfolio so long as your long-term goals haven’t changed.  As a general statement, we have found that the more often investors change their portfolios (in response to the market fears or fads of the moment), the worse their long-term results.

In sum, our essential principles of portfolio management are fourfold.

  • (1) The performance of a portfolio relative to a benchmark is largely irrelevant to long-term financial success.
  • (2) The only benchmark we should care about is the one that indicates whether you are on track to accomplish your financial goals.
  • (3) Risk should be measured as the probability that you won’t achieve your goals.
  • (4) Investing should have the exclusive objective of minimizing that risk.

Part Two: Current Observations

2018 was perhaps the strangest year we have experienced in our careers as financial advisors. Most importantly, it was one of the truly great years in the history of the American economy, and by far the best one since the global financial crisis of 10 years past. Paradoxically, it was also a year in which the equity market could not get out of its own way.

It is almost impossible to cite all the major metrics of the economy which blazed ahead in 2018. Worker productivity, which is the long-run key to economic growth and a higher standard of living, surged. Wage growth accelerated in response to a rapidly falling unemployment rate. Household net worth rose above $100 trillion for the first time, yet household debt relative to net worth remained historically low. Finally—and to me this sums up the entire remarkable year—for the first time in American history, the number of open job listings exceeded the number of people seeking employment.

Earnings of the S&P 500 companies, paced by robust GDP growth and significant corporate tax reform, leaped upward by more than 20%. Cash dividends set a new record; indeed total cash returned to shareholders from dividends and share repurchases since the trough of the Great Panic reached $7 trillion.

But the equity market had other things on its mind. Having gone straight up without a correction throughout 2017, the S&P 500 came roaring into 2018 at 2,674—probably somewhat ahead of itself, as it seemed to be discounting the entire future effect of corporate tax cuts in one gulp. There ensued in February a 10% correction, followed by several months of consolidation. The advance resumed as summer waned, with the Index reaching a new all-time high of 2,931 in late September. It then gave way to a second correction.

The major economic and market imponderable as the year turns is trade policy, which in the larger sense is an inquiry into the mind of President Trump. It is fair to say, as the economist Scott Grannis recently did, that “Trump has managed to reduce tax and regulatory burdens in impressive fashion, but his tweets and his tariff threats have created unnecessary distractions and unfortunate uncertainties, not to mention higher prices for an array of imported consumer goods.”

These and other uncertainties—perhaps chief among them Fed policy and an aging expansion—were weighing heavily on investor psychology as the year drew to a close. For whatever it may be worth, our experience has been that negative investor sentiment—and the resulting equity price weakness—have usually presented the patient, disciplined long-term investor with enhanced opportunity. As the wise and witty Sage of Omaha wrote in his 1994 shareholder letter, “Fear is the foe of the faddist, but the friend of the fundamentalist.”

Part Three: Looking Forward

What is good about all of this?

Interest rates and mortgage rates remain relatively low, with energy prices trending down. All of these are good, both for businesses and consumers.

Volatility can be hard to experience, but it indicates a normal, functioning market. It also correlates strongly with expected returns. Where there is no volatility, there is also no return (consider a bank account). A carefully measured amount should be embraced.

What can you be doing?

First, keep your faith in the future. We urge you to read the 2018 Market Review as an antidote to any messages you may have heard or will hear in the months ahead.

2018 Market Review

 

Second, maintain your proactive behavior and discipline.

  • If you’ve committed to a saving plan, or to an IRA funding plan, keep at it. If not, now is the time to begin. Lower stock prices are good entry points; as the broad market falls, value rises. We don’t know when this decline (read: sale) will end, only that it WILL end.

 

  • If you’ve committed to a withdrawal plan, know that your portfolio is managed to reliably provide income regardless of market conditions. Most portfolios have nearly one decade of reserves before an extended market event would suggest consideration.

Without committing additional funds, you may still benefit from lower asset prices by converting some or all of an IRA to a Roth IRA. This action pays the government’s inevitable tax bill at a time when asset prices are lower, and so therefore is the tax bill. Furthermore, federal income tax brackets are historically low. Action guarantees a known tax rate today against an unknown future tax rate.

What are we doing?

Even if you do not act on the items previously mentioned, we are considering them for you. It helps us greatly in this regard to see your most current tax return and for you to promptly notify us if your income is expected to markedly rise or fall as compared to previous years.

In addition, we’ve spent much of the last few months capturing the opportunities this period presented. By harvesting available positions within taxable accounts we’ve created what amounts to a “coupon” against future tax liabilities to offset future gains and potentially, earned income.

Current volatility has also allowed us to rebalance most accounts in a classic exercise of buying low to sell high. Amongst the assets classes, and overall, we have largely been able to do so without triggering a tax bill. Even without the addition of new funds, the purpose-built stability of the income/bond side of your portfolio allowed the reinvestment of dividends, interest, and capital gains at lower entry points. This was a fleeting opportunity created by lower asset prices.

Through this period, we have been net buyers of the greatest businesses in the US and the World. Tomorrow may show this timing premature. Yet, we accept this uncertainty in the shorter-term in exchange for more certainty over time.

Where do we go from here?

Going forward, the only question that matters is the one we guard against the most: Will you outlive your money? If this concern resonates with you, our approach has been designed to minimize that risk.

If you are confident that you have enough, then the only question that matters is: Are you making the best and most intentional decisions to live your life as rewarding and as richly as possible? This is a much more difficult and involved answer. Working towards these answers with you is one of the main reasons we look forward to coming in each day.

We’re sure to have forgotten something or created other questions for you in this message. That’s okay for now; this is all a process and an ongoing conversation. Some questions are easily answered by email or phone, but some are not and require a discussion of options, research, or a face-to-face conversation. Everyone’s situation is a little different.

 

Please, let us know what is on your mind.

 

The ABCs of Behavioral Bias: F-H

Let’s continue our alphabetic tour of common behavioral biases (See A-F here) that distract otherwise rational investors from making best choices about their wealth. Today, we’ll tackle F-H: fear, framing, greed and herd mentality.

 

Fear

 

What is it? You know what fear is, but it may be less obvious how it works. As Jason Zweig describes in “Your Money & Your Brain,” if your brain perceives a threat, it spews chemicals like corticosterone that “flood your body with fear signals before you are consciously aware of being afraid.” Some suggest this isn’t really “fear,” since you don’t have time to think before you act. Call it what you will, this bias can heavily influence your next moves – for better or worse.

 

When is it helpful? Of course there are times you probably should be afraid, with no time for studious reflection about a life-saving act. If you are reading this today, it strongly suggests you and your ancestors have made good use of these sorts of survival instincts many times over.

 

When is it harmful? Zweig and others have described how our brain reacts to a plummeting market in the same way it responds to a physical threat like a rattlesnake. While you may be well-served to leap before you look at a snake, doing the same with your investments can bite you. Also, our financial fears are often misplaced. We tend to overcompensate for more memorable risks (like a flash crash), while ignoring more subtle ones that can be just as harmful or much easier to prevent (like inflation, eroding your spending power over time).

 

Framing

 

What is it? Thinking, Fast and Slow,” Nobel laureate Daniel Kahneman defines the effects of framing as follows: “Different ways of presenting the same information often evoke different emotions.” For example, he explains how consumers tend to prefer cold cuts labeled “90% fat-free” over those labeled “10% fat.” By narrowly framing the information (fat-free = good, fat = bad; never mind the rest), we fail to consider all the facts as a whole.

 

When is it helpful? Have you ever faced an enormous project or goal that left you feeling overwhelmed? Framing helps us take on seemingly insurmountable challenges by focusing on one step at a time until, over time, the job is done. In this context, it can be a helpful assistant.

 

When is it harmful? To achieve your personal financial goals, you’ve got to do more than score isolated victories in the market; you’ve got to “win the war.” As UCLA’s Shlomo Benartzi describes in a Wall Street Journal piece, this demands strategic planning and unified portfolio management, with individual holdings considered within the greater context. Investors who instead succumb to narrow framing often end up falling off-course and incurring unnecessary costs by chasing or fleeing isolated investments.

 

Greed

 

What is it? Like fear, greed requires no formal introduction. In investing, the term usually refers to our tendency to (greedily) chase hot stocks, sectors or markets, hoping to score larger-than-life returns. In doing so, we ignore the oversized risks typically involved as well.

 

When is it helpful? In Oliver Stone’s Oscar-winning “Wall Street,” Gordon Gekko (based on the notorious real-life trader Ivan Boesky) makes a valid point … to a point: “[G]reed, for lack of a better word, is good. … Greed, in all of its forms; greed for life, for money, for love, knowledge has marked the upward surge of mankind.” In other words, there are times when a little greed – call it ambition – can inspire greater achievements.

 

When is it harmful? In our cut-throat markets (where you’re up against the Boeskys of the world), greed and fear become a two-sided coin that you flip at your own peril. Heads or tails, both are accompanied by chemical responses to stimuli we’re unaware of and have no control over. Overindulging in either extreme leads to unnecessary trading at inopportune times.

 

Herd Mentality

 

What is it? Mooove over, cows. You’ve got nothing on us humans, who instinctively recoil or rush headlong into excitement when we see others doing the same. “[T]he idea that people conform to the behavior of others is among the most accepted principles of psychology,” say Gary Belsky and Thomas Gilovich in “Why Smart People Make Big Money Mistakes.”

 

When is it helpful? If you’ve ever gone to a hot new restaurant, followed a fashion trend, or binged on a hit series, you’ve been influenced by herd mentality. “Mostly such conformity is a good thing, and it’s one of the reasons that societies are able to function,” say Belsky and Gilovich. It helps us create order out of chaos in traffic, legal and governmental systems alike.

 

When is it harmful? Whenever a piece of the market is on a hot run or in a cold plunge, herd mentality intensifies our greedy or fearful chain reaction to the random event that generated the excitement to begin with. Once the dust settles, those who have reacted to the near-term noise are usually the ones who end up overpaying for the “privilege” of chasing or fleeing temporary trends instead of staying the course toward their long-term goals. As Warren Buffett has famously said, “Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.”

Well said, Mr. Buffett!

 

We’ve got more behavioral biases to cover in upcoming installments, so stay tuned. Next, we’ll continue through the alphabet, introducing a few more of the most suspect financial behavioral biases.

To read about Behavioral Biases A-F click here

 

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.

Outcomes = Events + Response

Being an investor can be complicated, challenging, frustrating, and sometimes frightening. This is exactly why it is important to have an investment philosophy you can stick with, one that can help you stay the course, and respond rationally to unexpected events.

This simple idea highlights an important question: How can investors maintain discipline through bull markets, bear markets, political strife, economic instability, or whatever crisis du jour threatens progress towards their investment goals?

Over their lifetimes, investors face many decisions, prompted by events that  are both within and outside their control. Without an enduring philosophy to inform their choices, they can potentially suffer unnecessary anxiety, leading  to poor decisions and outcomes that are damaging to their long-term financial well-being.

When they don’t get the results they want, many investors blame things outside their control. They might point the finger at the government, central banks, markets, or the economy. Unfortunately, the majority will not do the things that might be more beneficial—evaluating and reflecting on their own responses to events and taking responsibility for their decisions.

Some people suggest that among the characteristics that separate highly successful people from the rest of us is a focus on influencing outcomes by controlling one’s reactions to events, rather than the events themselves. This relationship can be described in the following formula:

e + r = o (Event + Response = Outcome)

Simply put, this means an outcome—either positive or negative—is the result of how you respond to an event, not just the result of the event itself. Of course, events are important and influence outcomes, but not exclusively. If this were the case, everyone would have the same outcome regardless of their response.

Let’s think about this concept in a hypothetical investment context. Say a major political surprise, such as Brexit, causes a market to fall (event). In a panicked response, potentially fueled by gloomy media speculation of the resulting uncertainty, an investor sells some or all of his or her investment (response). Lacking a long-term perspective and reacting to the short-term news, our investor misses out on the subsequent market recovery and suffers anxiety about when, or if, to get back in, leading to suboptimal investment returns (outcome).

To see the same hypothetical example from a different perspective, a surprise event causes markets to fall suddenly (e). Based on his or her understanding of the long-term nature of returns and the short-term nature of volatility spikes around news events, an investor is able to control his or her emotions (r) and maintain investment discipline, leading to a higher chance of a successful long‑term outcome (o).

This example reveals why having an investment philosophy is so important. By understanding how markets work and maintaining a long-term perspective on past events, investors can focus on ensuring that their responses to events are consistent with their long-term plan.

An enduring investment philosophy is built on solid principles backed by decades of academic evidence. Examples of such principles might be: trusting that prices are set to provide a fair expected return (markets work); recognizing the difference between investing and speculating (long-term perspective); relying on the power of diversification to manage risk and increase the reliability of outcomes (Diversification); and benchmarking your progress against your own realistic long-term investment goals (monitoring progress).

Combined, these principles might help us react better to market events, even when those events are globally significant or when, as some might suggest, a paradigm shift has occurred, leading to claims that “it’s different this time.” Adhering to these principles can also help investors resist the siren calls of new investment fads or worse, outright scams.

It can be difficult for investors to develop a rational investment philosophy. And even the most self-aware find it hard to manage their own responses to events. Investing will always be both alluring and scary at times, but a view of how to approach investing combined with the guidance of a trusted professional can help people stay the course through challenging times. Keeping an objective view and separating emotions from investment decisions is incredibly difficult for most investors.  By building knowledge and confidence, however, we are better equipped to remain disciplined in our responses even to the most extreme market events.