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Analyzing Investment Styles: Growth vs. Value

Growth or value—what’s your style? Growth investors look for stocks that will grow at a high rate for a relatively short period of time or mutual funds that focus on growth stock. Value investors look for stocks that are currently undervalued and are expected to increase to their true value over a longer time horizon or mutual funds that focus on value stock.

Growth Fundamentals

Growth investors seek companies that show consistent earnings and sales growth, usually 25% or more each year, for a three- to five-year period. Typically, the companies represented by these stocks are in rapidly expanding industries; they offer proprietary niche products or services; or they have well-known brand names, strong finances, and top management. They have superior profit margins and generally high (over 15%) return on shareholder equity. They seldom pay dividends, preferring, instead, to plow earnings back into the company.

Two key indicators of growth stocks are share price and earnings. Generally, the earnings growth rate is the more important of the two indicators for growth stock investors. It is the rate at which profits grow from year to year. Generally, growth stocks have an earnings growth rate over 25%. Consistency is also important. The market will not place as high a value on a company whose profits are up 40% one year and down 10% the next, as on a company that grows 25% year after year.

Another key indicator for growth investors is stock price relative to the earnings or price to earnings (P/E) ratio. The P/E ratio, which is determined by dividing the current share price by the earnings estimate, represents what the market is willing to pay for a share of the company’s earning power. Although a growth investor may be willing to buy a company sporting a high P/E ratio, some relative guidelines may also be considered. Ideally, the P/E should be lower than the earnings growth rate, such as a growth rate of 45% selling at a P/E of 30%. It is also a good idea to look at a stock’s P/E in relation to the average P/E for its industry and relative to the market as a whole.

Value Investing—Key Indicators

Unlike the growth investor, a value investor typically buys a stock that has a P/E ratio substantially below that of the general market, the relevant industry, and the earnings growth rate. Value investors look for companies that are cheap relative to their “book value.” Book value is the difference between a company’s assets and its liabilities. It is theoretically the value of the portion of the company represented by a share of stock. Book value divided by the current market price, or price to book, shows the multiple that the market is willing to pay for a portion of the company’s assets.

Generous dividend payments, or a high yield, are also important to value investors. Since dividends account for half of a stock market’s long-run total return, a stock that has a higher yield will give a value investor an edge over other investors. A value investor expects the price of a stock to rise to its true value, a predetermined target. When the target or the “appropriate” value is reached, a value investor may sell that stock and look for another selling at a discount.

While some investors favor growth investing and others favor value investing, there are those who use both styles in their portfolios. The best strategies for your situation will depend on your risk tolerance, time horizon, and investment objectives.

Note: Stock and mutual fund values will fluctuate due to market conditions; shares, when redeemed, may be worth more or less than their original investment. Profits and protection against losses due to declining markets are not guaranteed.

For Business Owners: Adapting to Changing Economic Times

When business is booming, many business owners don’t take the time to find out if their organization is running at maximum efficiency. Wasteful practices may abound but are seldom addressed in the rush to get the product out or job done. Yet, when business slows, the time is there to take stock of business operations, formulate new strategies, and find innovative resources to help improve the efficiency and economy of your business.
Here are some issues to consider when planning to improve your company’s chances of success in the face of changing economic times:

Where can I cut costs?

This may seem like an obvious question, but formulating the right solutions without impairing your operations is seldom easy. Look for large and small ways to economize, without changing vital areas. For example, it may be possible to reduce the number of vehicles used or to conserve energy by turning off equipment when not in use. Now may be a good time to revisit some of your agreements and possibly negotiate a temporary or long-term discount. Consider taking advantage of bargains by buying in bulk or locking in prices for the future.

Are my marketing strategies still relevant?

The marketing approaches your firm used in boom times may be less effective under tighter conditions. Clients may be more cautious about commissioning projects, and they may want greater reassurances that they are getting quality and value for their money. While it may be a struggle to increase your marketing budget, well-targeted advertising campaigns can go a long way toward bringing in new business. Stepping up your networking efforts, both in person and online, is a low-cost option for attracting new customers and staying in touch with existing clients.

Are my prices right?

Lowering your prices may be a painful but necessary measure in a declining economy. Even if you don’t reduce prices across the board, you may offer discounts or incentives to attract and retain customers. If your customers agree to adjustments in the scope of the work or types of materials used, it may be possible to lower your prices while still maintaining profit margins.

Can I trim my payroll without losing key employees?

Some companies start laying people off at the first signs of an economic slowdown. However, this can prove to be a dangerous overreaction, especially if your business ends up losing its most valuable employees. If you need to reduce payroll costs, consider viable options for doing so without letting good people go, such as offering flexible schedules, time off for training, or reduced hours for employees who want them. If necessary, consider trimming the size of retirement and health benefits, with assurances to employees that benefits will be restored as business improves.

How can I maximize my cash flow?

When funds are tight, keeping track of cash flow becomes especially important. Check that your invoicing processes are operating efficiently, and that outstanding accounts are managed quickly. As obtaining credit becomes more difficult, meet with your accountant and your banking representative to discuss your credit lines, ways to improve your company’s credit score, and the options available in case of emergency.

Is it time to try new technologies? Implementing new software and other information technologies, and integrating these programs into your business operations, is a complex and sometimes arduous process. A slower pace can provide your firm’s staff with the time they need to familiarize themselves with IT solutions that can help your business operate more efficiently. When better times return, your firm will continue to benefit from the productivity enhancements. Review your website, ensuring that the information is up-to-date and professionally presented. Investing time in enhancing your online presence will likely pay off during the downturn and as the economy improves.

Adapting to change is never easy. But, neither is running a business. Rather than focusing on the recession, focus on emerging leaner and more competitive than ever. After all, when the going gets tough, the tough get going.

Avoiding Financial Scams and Identity Theft Scams

Young or old, wealthy or poor, online or in person … Nobody is immune from financial scams and identity theft slams. No matter who you are or how well-informed you may be, the bad guys are out there, daily devising new tricks for every fraud we fix.

Who Are They? Fraudsters and Thieves

What Do They Want? Your Money and Your Life

Some of your most treasured personal information includes:

How Will They Get It? However They Can!

Criminals come in all shapes and sizes, and will use anything and everything that might work:

What Should You Look For? Ten Red Flags

Criminal techniques may be new-fangled, but the tactics – the red flags to look for – are mostly unchanged. Whether online, in the mail, on the phone or in person, be on extra alert whenever:

  1. An offer sounds too good to be true.
  2. A stranger wants to be your real or virtual best friend.
  3. Someone you know is behaving oddly, especially via email or phone. (This may mean it’s an identity thief, posing as someone you know.)
  4. Someone claiming to represent a government agency, financial or legal firm, police department or other authority contacts you out of the blue, demanding money or information.
  5. You’re feeling pressured or tricked into responding RIGHT AWAY to a threat, a temptation or a curiosity.
  6. You’re prioritizing easy access over solid security (weak or absent locks and passwords).
  7. You’re sharing personal information in a public venue (including social media).
  8. Facts or figures aren’t adding up; bank statements, reports or other info is missing entirely.
  9. Your defenses are down: You’re ill, injured, grieving, experiencing dementia or feeling blue.
  10. Your gut feel is warning you: Something seems off.

An Action Plan (Hint: It’s a Lot Like Evidence-Based Investing)

The more of these sorts of alarm bells are sounding off, the more suspicious you should be. What then? The hardest part may be deciding where to begin. We recommend approaching your personal security the same way you approach investing: Instead of feeling you must immediately chase every defensive action out there, start with a plan.

What Else Can You Do? Quite a Lot!

While criminals are forever finding new ways to foil our defenses, there are still plenty of sensible steps you can take to protect yourself and your money.

Online Protection

Suspicious Phone Calls

Credit and Records Management

Personal Security

What If They Succeed? Act Promptly

If you believe you’ve been exposed to identity theft or financial fraud, time is of the essence.

An Index Overview Part IV: Index Investing – Opportunities and Obstacles

Legend has it, a pharmacist named John Pemberton was searching for a headache cure when he tried blending Coca leaves with Cola nuts. Who knew his recipe was destined to become such a smashing success, even if Coca-Cola® never did become the medicine Pemberton had in mind?

In similar vein, when Charles Dow launched the Dow Jones Industrial Average (the Dow), his aim was to better assess stock prices and market trends, hoping to determine when the market’s tides had turned by measuring the equivalent of its incoming and outgoing “waves.” He chose industrials (mostly railroads) because, as he proposed in 1882, “The industrial market is destined to be the great speculative market of the United States.”

While the actively minded Dow never did achieve market-timing clairvoyance (and neither has anyone else we’re aware of), he did devise the world’s first index. We’d like to think his creation turned into something even greater than what he’d intended – especially when Vanguard founder John Bogle and other pioneers leveraged Dow’s early work to create among the most passive ways to invest in today’s markets: the index fund.

Bogle launched the first publicly available index fund in 1976. Initially dismissed by many as “Bogle’s folly,” its modern-day rendition, the Vanguard 500 Index Fund, remains among the most familiar funds of any type.

Index Investing Is Born

In defense of Dow’s quest to forecast market movements, it’s worth remembering that his was a world in which electronic ticker tape was the latest technology, there were no open-ended mutual funds or fee-only financial advisors, and safeguards and regulations were few and far between. Essentially, speculating was the only way one could invest in late-nineteenth century markets.

Compared to actively managed funds that seek to “beat” the market by engaging in these now-outdated speculative strategies, passively managed index funds offer a more solid solution for sensibly capturing available market returns. As the name implies, an index fund buys and holds the securities tracked by a particular index, which is seeking to represent the performance of a particular slice of the market. For example, the Vanguard 500 Index Fund tracks the popular S&P 500 Index, which in turn approximately tracks the asset class of U.S. large-company stocks.

Compared to actively managed solutions, index funds lend themselves well to helping investors more efficiently and effectively target these three pillars of sensible investing:

  1. Asset allocation – How you allocate your portfolio across various market asset classes plays a far greater role in varying your long-term portfolio performance than does the individual securities you hold.
  2. Global diversification – Through broad and deep diversification, the sum of your whole risk can actually be lower than its individual parts.
  3. Cost control – The less you spend implementing a strategy, the more you get to keep.

Index Investing: Room for Improvement

As we’ve described throughout this series, indexes weren’t specifically devised to be invested in. There’s often a lot going on underneath their seemingly simple structures that can lead to inefficiencies by those trying to retrofit their investment products on top of popular indexes.

Index Dependence – Whenever an index “reconstitutes” by changing the underlying stocks it is following, any funds tracking that index must change its holdings as well – and relatively quickly if it’s to remain true to its stated goals. In a classic display of supply-and-demand pricing, this can generate a “buy high, sell low” environment as index fund managers hurry to sell stocks that have been removed from the index and buy stocks that have been added.

Compromised Composition – Asset allocation is based on the premise that particular market asset classes exhibit particular risk and return characteristics over time. That’s why your investment “pie” should be carefully managed to include the right asset class “slices” for your financial goals and risk tolerances. As we described in Part III of this series, if you’re invested in an index fund and you aren’t sure what its underlying index is precisely tracking, you may end up with off-sized pieces of pie. For example, the S&P 500 and the Russell 3000 are both positioned as U.S. stock market indexes, but both also track some real estate. If you don’t factor that into your plans, you can end up with a bigger helping of real estate than you had in mind.

Introducing Evidence-Based Investing

So, yes, index investing has its advantages … It also has inherent challenges. No wonder academically minded innovators from around the globe soon sought to improve on index investing’s best traits and minimize its weaknesses. In fact, many of these thought leaders were the same early adapters who introduced index fund investing to begin with. Building on index investing, they devised evidence-based investment funds, to offer several more advantages:

Index-independence – Instead of tracking an index that tracks an asset class … why not just directly capture the asset class itself as effectively as possible? Evidence-based fund managers have freed themselves from tracking popular indexes by establishing their own parameters for cost-effectively investing in most of the securities within the asset classes being targeted. This reduces the need to place unnecessary trades at inopportune times simply to track an index. It also allows more patient trading strategies and scales of economy to achieve better pricing.

Improved Concentration – Untethering themselves from popular indexes also enables evidence-based fund managers to more aggressively pursue targeted risk factors; for example, an evidence-based small-cap value fund often has more flexibility to hold smaller and more value-tilted holdings than a comparable index fund. This provides more refined control for building your personal investment portfolio according to your unique risk/return goals.

Focusing on Innovative Evidence – Evidence-based investing shifts the emphasis from tracking an index, to continually improving our understanding of the market factors that contribute to the returns we are seeking. By building portfolios using fund managers who apply this same evidence to their funds, you can make best use of existing academic insights, while efficiently incorporating credible new ones as they emerge.

An Index Overview, Revisited

From describing an index’s basic functions, to exploring some of the intricacies of their construction, we’ve covered a lot of ground in this four-part series on indexing. To recap, indexes can help us explore what is going on in particular slices of our capital markets. In the right context, they also can help you compare your own investment performance against a common benchmark. Last but not least, you can invest in funds that track particular indexes.

Equally important, remember that indexes do not help us forecast what to expect next in the markets, nor do high-water markets such as “Dow 20,000” foretell whether it’s a good or bad time to buy, hold or sell your own market holdings. And, while low-cost, well-managed index funds may still play a role in your overall investment portfolio, it’s worth ensuring that you select them when they are the best fit for your evidence-based investment strategy, not simply because they are a popular choice at the time.

What else can we tell you about indexes or index investing? Let’s take a look at your unique financial goals, and see how indexing fits into your globally diversified world of investments.

An Index Overview Part II: A Few Points About Index Points

As we covered in our last piece, indexes have their uses. They can roughly gauge the mood of a market and its participants. If you’ve got an investment strategy that’s designed to capture that market, you can see how your strategy is doing in comparison … again, roughly. You can also invest in an index fund that tracks an index that tracks that market.

This may help explain why everyone seems to be forever watching, analyzing and talking about the most popular indexes and their every move. But you may still have questions about what they are and how they really work. For example, when the Dow Jones Industrial Average (the Dow) exceeded 20,000 points last January, what were those points even measuring?

An index’s total points represent a relative value for the market it is tracking, calculated by continually assessing that market’s “average” performance.

If that’s a little too technical for your tastes, think of it this way: Checking an index at any given time is like dipping your toe in the water to see how the ocean is doing. You may have good reasons to do that toe-check, but as with any approximation, be careful to not misinterpret what you’re measuring. Otherwise, you may succumb to misperceptions like: “The Dow is so high, it must be in for a fall. I’d better get out.”

With that in mind, when it comes to index points, we’d like to make a few points of our own.

Indexes Are Often Arbitrary

It helps to recognize how popular indexes become popular to begin with. In our free markets, competitive forces are free to introduce new and different structures, to see how they fly. In the same way that the markets “decided” that the iPhone would prevail over the Blackberry, popular appeal is effectively how the world accepts or rejects one index over another. Sometimes the best index wins and becomes an accepted reference. Sometimes not.

Measurements Vary

Different indexes can be structured very differently. That’s why the Dow recently topped 20,000, while the S&P 500 is hovering in the 2,000s, even though both are often used to gauge the same U.S. stock market. The Dow arrives at its overall average by adding up the price-weighted prices of the 30 securities it’s tracking and dividing the total by a proprietary “Dow divisor.” The S&P 500 also takes the sum of the approximately 500 securities it’s tracking … but weighted by market cap and divided by its own proprietary divisor.

With mysterious divisors, terms like “price-weighted” and “market cap,” and additional details we won’t go into here, this probably still doesn’t tell you exactly what index points are.

Think of index points as being like thermometer degrees. Most of us can’t explain exactly how a degree is calculated, but we know hot from cold. We also know that Fahrenheit and Celsius both tell us what the temperature is, in different ways.

Same thing with indexes. You can’t directly compare an S&P 500 point to a Dow point; it doesn’t compute. Moreover, neither index adjusts for inflation. So, while index values offer a relative sense of how “hot” or “cold” a market is feeling at the moment, they can’t necessarily tell you whether a market is too hot or too cold, or help you precisely predict when it’s time to buy or sell into or out of them. The “compared to what?” factor is missing from the equation. This brings us to our third point …

Models Are Approximate

There’s an important difference between hard sciences like thermodynamics and market measures like indexes. On a thermometer, a degree is a degree. With market indexes, those points are based on an approximation of actual market performance – in other words, on a model.

A model is a fake copy of reality, with some copies rendered considerably better than others. Here’s what Nobel Laureate Eugene Fama has said about them: “No model is ever strictly true. The real criterion should be: Do I know more about markets when I’m finished than I did when I started?”

Your Take-Home

According to Professor Fama’s description of a model, indexes have long served as handy proxies to help us explore what is going on in particular slices of our capital markets. But, they also can do damage to your investment experience if you misinterpret what they mean.

For now, remember this: An index’s popular appeal is the result of often-arbitrary group consensus that can reflect both rational reasoning and random behavioral bias. Structures vary, and accuracy is (at best) approximate. Even the most familiar indexes can contain some surprising structural secrets. In our next post, we’ll unlock some of them for you.

2016 Year In Review Hiley Hunt Wealth Management

As we look back on a year filled with surprises (from its opening days onward), it’s natural to wonder what to expect in 2017. This is especially so, since most of those surprising events have yet to play out in full – from the political climate in the U.S., to the Brexit referendum in the U.K. to uncertainty in government bond and oil prices around the world.

We are reminded of a favorite quote from The Wall Street Journal personal financial columnist Jason Zweig, who once observed that “Wall Street often resembles a blindfolded person looking in a darkened closet for a pair of black shoes that isn’t there.”

Interestingly, Zweig made his comment back in October 2008, when we had yet to see the light at the end of a very dark financial tunnel. We think the sentiment fits nearly any global market and any market climate, including whatever 2017 has in store for us.

Instead of getting too hung up on the forecasts from pundits, prognosticators or politicians, let’s take a moment to pause and celebrate the truly remarkable life force that has long driven our financial markets: human enterprise.

Our capital markets are, at heart, a place for people to participate in the business of being human. We express our humanity in the ways we choose to invest and the investments we choose to make. We keep the beat alive by positioning ourselves to make the most of a future we cannot see. As individuals, we may win or lose. But based on the millennia of evidence to date, whenever we come together to invest in buildings and businesses, sales and services, hopes and dreams – we have collectively come out ahead.

Will 2017 bring surging markets, scary tumbles or an eclectic mix? Time will tell. In the meantime, don’t forget what’s behind the data points and the drama. Remember the millionaires and entrepreneurs, the men and women, the energetic youth and experienced veterans among us. Think of the billions of souls and their trillions of dollars, coming together as we speak to build innovative new services, sales and solutions; to participate in our global capital markets; and to invest in humanity – just like you are.

As 2017 unfolds, we hope you’ll continue to focus on the durability of human enterprise. We also hope you will turn to us for financial advice and personal inspiration. Last but not least, we hope you’ll remain invested in your own hopes and dreams – onward, into the future.

Tax-Loss Harvesting: Opportunities and Obstacles

So much of investing is beyond our control (picking stock prices, timing market movements and so on), it’s nice to know that there are still a number of “power tools” we can employ to potentially enhance your bottom line. Tax-loss harvesting is one such instrument … although the analogy holds true in a couple of other ways: It’s best used skillfully, and only when it is the right tool for the task.

The (Ideal) Logistics

When properly applied, tax-loss harvesting is the equivalent of turning your financial lemons into lemonade by converting market downturns into tangible tax savings. A successful tax-loss harvest lowers your tax bill, without substantially altering or impacting your long-term investment outcomes.

Tax Savings

If you sell all or part of a position in your taxable account when it is worth less than you paid for it, this generates a realized capital loss. You can use that loss to offset capital gains and other income in the year you realize it, or you can carry it forward into future years. We can realize losses on a holding’s original shares, its reinvested dividends, or both. (There are quite a few more caveats on how to report losses, gains and other income. A tax professional should be consulted, but that’s the general premise.)

 Your Greater Goals

When harvesting a loss, it’s imperative that you remain true to your existing investment plan as among the most important drivers in achieving your ultimate financial goals. To prevent a tax-loss harvest from knocking your carefully structured portfolio out of balance, we reinvest the proceeds of any tax-loss harvest sale into a similar position (but not one that is “substantially identical,” as defined by the IRS). Typically, we then return the proceeds to your original position no sooner than 31 days later (after the IRS’s “wash sale rule” period has passed).

The Tax-Loss Harvest Round Trip

In short, once the dust has settled, our goal is to have generated a substantive capital loss to report on your tax returns, without dramatically altering your market positions during or after the event. Here’s a three-step summary of the round trip typically involved:

  1. Sell all or part of a position in your portfolio when it is worth less than you paid for it.
  2. Reinvest the proceeds in a similar (not “substantially identical”) position.
  3. Return the proceeds to the original position no sooner than 31 days later.

Practical Caveats

An effective tax-loss harvest can contribute to your net worth by lowering your tax bills. That’s why we keep a year-round eye on potential harvesting opportunities, so we are ready to spring into action whenever market conditions and your best interests warrant it.

That said, there are several reasons that not every loss can or should be harvested. Here are a few of the most common caveats to bear in mind.

Trading costs – You shouldn’t execute a tax-loss harvest unless it is expected to generate more than enough tax savings to offset the trading costs involved. As described above, a typical tax-loss harvest calls for four trades: There’s one trade to sell the original holding and another to stay invested in the market during the waiting period dictated by the IRS’s wash sale rule. After that, there are two more trades to sell the interim holding and buy back the original position.

Market volatility – When the time comes to sell the interim holding and repurchase your original position, you ideally want to sell it for no more than it cost, lest it generate a short-term taxable gain that can negate the benefits of the harvest. We may avoid initiating a tax-loss harvest in highly volatile markets, especially if your overall investment plans might be harmed if we are unable to cost-effectively repurchase your original position when advisable.

Tax planning – While a successful tax-loss harvest shouldn’t have any impact on your long-term investment strategy, it can lower the basis of your holdings once it’s completed, which can generate higher capital gains taxes for you later on. As such, we want to carefully manage any tax-loss harvesting opportunities in concert with your larger tax-planning needs.

Asset location – Holdings in your tax-sheltered accounts (such as your IRA) don’t generate taxable gains or realized losses when sold, so we can only harvest losses from assets held in your taxable accounts.

Adding Value with Tax-Loss Harvesting

It’s never fun to endure market downturns, but they are an inherent part of nearly every investor’s journey toward accumulating new wealth. When they occur, we can sometimes soften the sting by leveraging losses to your advantage. Determining when and how to seize a tax-loss harvesting opportunity, while avoiding the obstacles involved, is one more way we seek to add value to your end returns and to your advisory relationship with us. Let us know if we can ever answer any questions about this or other tax-planning strategies you may have in mind.

Quarter-End Update

Is it just us, or did the fourth quarter arrive even faster than usual this year? Maybe it was the summer’s relative calm. There were the usual, never-ending newsfeeds whispering bitter nothings into investors’ ears, but global markets mostly snoozed through the white noise. We even celebrated a few milestones.

In the U.S.: The triumvirate of major stock indexes (the Dow, the S&P and Nasdaq) set new, simultaneous records for closing at all-time highs in August… twice in the same week.

In the U.K.: Investors kept a nervous calm and carried on in the aftermath of the Brexit vote. While there was the usual reactionary flight from stocks to bonds, there also were relatively strong August inflows into lower-cost “tracker” (index) funds – an encouraging sign.

Speaking of index funds: The world’s first publicly traded index mutual fund, the Vanguard 500 – turned 40 on August 31. “Happy birthday, index funds,” wrote Wall Street Journal columnist Jason Zweig. “[W]e should all celebrate an innovation that has cut the cost of investing by more than 90% and radically democratized the financial markets.”

More on cutting costs: The European Commission’s Valdis Dombrovskis called for EU regulators to investigate retail fund fees, performance and transparency – another good sign of an increased appreciation for how cost management contributes to investors’ end returns.

Now, think back to where we were around this same time last year. Even if you remember that all heck had just broken lose, with market mayhem setting off alarms among the popular press, you’ve probably nearly forgotten what triggered the turmoil at the time. Similarly, last January, when various pundits were ringing in dire predictions for the New Year, it may have felt like the year’s unfortunate fate was already sealed. Not so.

As we swing into the fourth quarter, we expect to see continued plays on your emotions: gloomy and giddy predictions alike tempting your investment resolve. We’ve got the U.S. elections. We’ve got a newly announced Brexit timeline. We’ve got Canada’s central bank suggesting retirees should plan for continued low interest rates. We’ve got Deutsche Bank’s shenanigans.

Then again, we’ve also got a long history of the fourth quarter often delivering some of the markets’ best returns. As Bloomberg columnist Barry Ritholtz wrote (in a piece worth reading), “Since 1970, the fourth quarter usually has been the best for equity markets.”

Will this fourth quarter follow suit, or will it stumble or fall? That’s a trick question. If you’re participating in the market according to the evidence that suggests how to best manage its risks and earn its long-term rewards, the answer is: Who cares? That said, we understand that real market risk can generate very real concerns when it unfolds. As always, please let us know if we can answer any questions. In the months, quarters and years ahead, we remain here for you.

Wealth Management for Women: What Makes a Great Advisor? Part 1: Avoiding Confirmation Bias

Twice a week. Always twice a week.

Neither the oppressive heat nor the insufferable humidity hindered my mom from insisting that the lawn be mowed twice a week.

I had always assumed my mom had a good reason for wanting the lawn to be mowed that often. Perhaps it had something to do with the health of the grass. Maybe it was a strategy to ward off insects. Did it have something to do with water conservation? I was never brave enough to ask, but as I grew older, I figured that twice-weekly mowing made the grass healthy. After all, our yard always looked great!

Fast-forward to my mid 20’s, when I became a homeowner. I was so excited to begin my own twice-weekly mowing ritual for optimal lawn maintenance.

By this time, my parents lived in a villa-type neighborhood where lawn care was included in the monthly association fee. Apparently, the lawn wasn’t mowed twice a week there, because my father revealed to me that he still mowed. “You know how much Mom loves the lines in the grass,” he said.

All this time – all this time! – I had assumed that twice-weekly mowing was part of some larger program with some greater purpose, not something my father did just because my mom liked the lines in the grass! Indeed, I had been the victim of my own confirmation bias.

Confirmation bias is the natural tendency to use new information as confirmation of existing beliefs or theories. For more than 20 years, I thought I knew why lawns should be mowed twice a week. In fact, I had that idea only because I hadn’t asked the right questions and had never looked for information to the contrary.

Confirmation bias is at work in all our lives, and very often it colors the way we invest. We have a tendency to create a theory about an investment opportunity, and then we are drawn to content that confirms our theory.

In an article titled “A Behavioral View of How People Make Financial Decisions,” Keith Redhead explains that investors make financial decisions through a series of biases that shape our perceptions and motivations. Once we have a frame of reference for a decision – especially a decision that involves costs – we engage a part of our brain that encourages us to stay with the status quo. According to Redhead, even after we make a decision to move in a different direction – for example, to buy or sell an investment – we might not follow through with that decision because confirmation bias can lead our brains to overemphasize the case against change. This can be very costly for investors!

A great investment advisor will challenge your natural biases and present information that convinces you to consider the alternatives. But simply shedding light on a conflicting point of view is not enough. Once you have decided to make a change, the natural bias toward the status quo will fight against your motivation to implement the change. Your advisor should keep you accountable, ensuring that you carry out the change you decide to make. After all, a plan is only as good as its execution.

Hiley Hunt Wealth Management is a Registered Investment Advisor dedicated to serving women who are responsible for their household investment portfolio. We would love to connect with you to discuss how we can help you meet your financial goals. To learn more about how we work with our clients, please visit hileyhunt.com/what-to-expect.

What If Everyone Were a Passive Investor? (Is the Sky Really Falling?)

For as long as we’ve been in business, we have encouraged investors to adopt a patient, long-term approach to capturing the market’s expected returns. In industry parlance, some have categorized our approach as “passive,” versus active attempts to beat the market. We prefer to think of ourselves as evidence-based.

Call it what you will, all the while, a frequently asked question remains. Not unlike a favorite ghost story, its shape may shift, but the spirit remains the same:

What if everyone were a passive investor? Wouldn’t the markets collapse?

The question has resurfaced in a recent AllianceBernstein client note entitled “The Silent Road to Serfdom: Why Passive Investing is Worse Than Marxism.” Its authors reportedly proposed that a “supposedly capitalist economy where the only investment is passive is worse than either a centrally planned economy or an economy with active market led capital management.”[1]

If every investor embraced evidence-based investing, it is true that markets as we know them would cease to exist. But does that put passive investing on level with Marxism, or worse?

Is passive investing “unfair” or bad for the economy?

In “Indexing Is Capitalism at Its Best,” AQR Capital Management’s Cliff Asness counteracts the presumption that passive investing is an enemy to free market economies: “[T]he use of price signals by those who played no role in setting them may be capitalism’s most important feature. … That most of us and most of our dollars don’t have to pick stocks, or to price air conditioners, is a great benefit and taking advantage of it makes us honest smart capitalists, not commissars.”

In other words, we arrive at relatively efficient “supply and demand” pricing in our capital markets the same way we do in any other market around the world. Whether it’s for stocks or socks, donuts or dollars, all it should take is a handful of active, engaged players to create relatively fair pricing that interested buyers and sellers can agree to.

It’s also interesting to note that the players who object the most to allegedly free-loading passive investors are usually the same ones whose profits are being squeezed down by the market forces at work when passive investors avoid hyperactive trading costs.

In his review of the note, Morningstar’s John Rekenthaler observed: “Whenever active investment managers write about indexing, the suspicion arises that they arrived at the conclusion first, then searched for their reasons later. This AllianceBernstein paper does nothing to change that view.”

How many active investors does it take to keep the markets chugging along?

Bottom line, there is no definitive answer on how many active investors are required to set reasonable trading prices. In his ETF.com column, financial author Larry Swedroe explains that passive investors “receive all the benefits from the role that active managers play in making the financial markets efficient without having to pay their costs. In other words, while the prudent strategy is to be a passive investor, you don’t want everyone to draw that conclusion.”

Swedroe suggests that “at least 90% of the active management industry could disappear and the markets would remain highly efficient.” Vanguard founder John Bogle (who launched the world’s first public index fund) also has estimated that a 90% passive market should be sustainable. Burton Malkiel, author of the classic, “A Random Walk Down Wall Street,” has set the number even higher. “[W]hen indexing is 95 percent of the total, I might start to worry about that,” he says in this podcast interview (at around 1:03:30). “But I think with indexing [at] 30 to 35 percent of the total, there is [sic] still plenty of active managers out there to make sure that information gets reflected quickly. And in fact I think it’ll always be the case.”

How plausible is it that we’ll reach a breaking point, with too many passive investors?

Malkiel’s comments bring up another good point. Let’s say we’re wrong. What if, to remain relatively efficient, the markets need a lot more active players than we’re suggesting?

We’re still not worried about it.

Echoing Malkiel’s estimates, Swedroe observes of the U.S. markets: “Despite their growing share of the market (passive funds now control perhaps one-third of all assets under management), they still account for only a small percentage of trading activity. According to a Vanguard spokesman, on a typical day, only 5–10% of total trading volume comes from index funds.”

In other words, there are still plenty of active trades taking place for effective pricing, and there is good reason to believe that this necessary level of price-setting will persist indefinitely.

Behavioral finance is alive and well. The study of behavioral finance informs us that investors are, after all, only human, and are often driven by chemically generated instincts and emotions that have nothing to do with solid evidence and rational decisions. We see examples of this every time investors chase the latest trend or flee real or perceived risk en masse. Behavioral traits such as herd mentality, recency and tracking-error regret take over, and are reflected in the market’s prices. This is not passive investing; it’s active. And it appears to have remained highly pervasive, among individual and institutional investors alike.

Capitalism is also alive and well. In their purest sense, “active” and “passive” investing represent opposite extremes on a vast spectrum of possibilities. A wholly passive investor would simply buy and hold the entire market and accept its returns. A fully active investor would always seek to trade profitably by forecasting future prices.

In reality, most investors are neither fully passive nor fully active. They are often more one or more the other, especially when we consider global markets. This means we should expect price-setting participants to remain a substantial force in the markets … regardless of what we call them, and which label may be more prevalent.

As Malkiel observes: “That’s the wonderful thing about capitalism. If you have free markets and somebody can jump into the markets if there is an opportunity, you can count on the fact that somebody will. … If in fact it was the case that markets were getting less and less efficient in reflecting information, believe me, there would be a profit motive for somebody to jump in.”

Evidence-Based Investing in Capital Markets

Where does that leave an evidence-based investor? To help us chart a sensible course in an environment where even our own instincts can steer us wrong, we turn to the best evidence we can find on how to effectively manage our money in markets that mostly set fair prices.

Practically speaking, that evidence informs us that generating long-term returns calls for a patient approach, focused on managing the market risks involved, minimizing unnecessary costs, and avoiding the many behavioral traps that otherwise lead investors astray.

If we can serve you by helping you invest according to these and similar principles – if we can serve your highest interests and personal financial goals – we believe you can expect that the capital markets will continue to serve you well, as well.

[1] We would love to link to the note, so you could review it for yourself. Unfortunately, it appears to have been released as a private, client-only distribution, so we must rely on second-hand commentary as our guide.

Presidents, Politics and Your Portfolio: Thinking Beyond Stage One

It’s no surprise that this year’s U.S. presidential race has become a subject of conversation around the globe. In “Why Our Social Feeds are Full of Politics,” Canadian digital marketing executive Tara Hunt observes, “American politics, it seems, makes for high-intensity emotions far and wide.” The intensity will probably only increase as the November 8 election date nears.

We are by no means endorsing that you ignore what is going on in the world around you. Politics and politicians regularly and directly affect many aspects of our lives and our pocketbooks. But as you think through this year’s raucous race, remember this:

The more heated the politics, the more important it is to establish and maintain
a well-planned, long-term approach to managing your investments.

So go ahead and talk politics all you please – and if you are an American, be sure to vote. But when it comes to your investments, it’s best to ignore any intense emotions and the dire or ebullient predictions that spring from them, as dangerous distractions to your financial resolve.

Thinking in Stages

Have you ever heard of stage-one and stage-two thinking? They’re terms popularized by economist Thomas Sowell in his book, “Applied Economics: Thinking Beyond Stage One.” Basically, before acting on an event’s initial (stage one) anticipated results, it’s best to engage in stage-two thinking, by first asking a very simple question:

“And then what will happen?”

By asking this question again and again, you can more objectively consider what Sowell refers to as the “long-run repercussions to decisions and policies.”

Investing in Stages

In investing, we see stage-one thinking in action whenever undisciplined dollars are flooding into hot holdings or fleeing immediately risky business. Stage-two thinking reminds us how often the relationship between an event and the world’s response to that event is anybody’s guess and nobody’s certain bet. A recent Investopedia article, “Does Rainfall in Ethiopia Impact the U.S. Market?” reminds us how market pricing works:

“No one knows how any of these events will impact markets. No one. That includes financial advisors who have access to complex computer models and investment strategists in the home office with cool British accents. They don’t know, but their livelihood depends upon appearing to know. Few of them are ever held accountable for the innumerable predictions they got wrong. They simply move on to the next prediction, the next tactical move.”

Investors should avoid trying to predict future market pricing based on current market news.

Reflections on Presidential Elections

Stage-two thinking is especially handy when considering the proliferation of predictions for anything from financial ruin to unprecedented prosperity, depending on who will next occupy the Oval Office.

Again, the problem with the vast majority of these predictions is that they represent stage-one thinking. As financial author Larry Swedroe describes in a US News & World Report piece, “Stage one thinking occurs when something bad happens, you catastrophize and assume things will continue to get worse. … Stage two thinking can help you move beyond catastrophizing. … [so you can] consider why everything may not be as bad as it seems. Think about previous similar circumstances to disprove your catastrophic fears.”

In the current presidential race, we’re seeing prime examples of stage-one thinking by certain pundits who are recommending that investors exit the market, and sit on huge piles of cash until the voting results are in. At least one speculator has suggested that investors should move as much as 50 percent of their portfolio to cash!

And then what will happen?

 Here are some stage-two thoughts to bear in mind:

In this or any election, stage-two thinking should help you recognize the folly of trying to tie your investment hopes, dreams, fears and trading decisions to one or another candidate. Politics matter – a lot – but not when it comes to second-guessing your well-planned portfolio.

Reflections on Real Estate Investing

Just as the natural world around us comes from the elements found in the periodic table of elements, capital markets are made up of asset classes, broadly organized into stocks, bonds, and hard assets like commodities and real estate.

As elemental as asset classes are to investing, it often makes sense to include some real estate investments in your globally diversified portfolio. That said, as with any investment, there are better and worse ways to go about implementing an otherwise sound strategy … with a lot of misleading misinformation out there to add to the confusion.

If you intend to invest in the market’s risks and potential rewards with informed discipline rather than as a speculative venture, most of the same principles apply, whether it’s for real estate or any other asset class. To help you avoid hanging out with the wrong elements (so to speak), let’s review those essential guides.

Seek Global Diversification

As with stocks, it’s wise to spread your real estate risks around by diversifying the number and types of holdings you own. By diversifying your holdings across a number of investments and a mixture of property types, you are best positioned to earn the returns that the asset class is expected to deliver, without being blindsided by holding-specific risks such as property damage, deadbeat tenants or unscrupulous property managers.

One way to achieve diversification is through a well-managed, low-cost Real Estate Investment Trust (REIT) fund, or a “fund of funds” combination of multiple REIT funds. As one REIT fund prospectus describes, this enables you to own hundreds of properties across a diversified range of domestic and global companies “whose principal activities include ownership, management, development, construction, or sale of residential, commercial or industrial real estate.”

Understand the Risks and Expected Rewards

Why bother with real estate? The magic word is “correlation.” As Forbes contributor Frank Armstrong III wrote in 2013, “It’s really nice in times of volatile markets like now to have an asset class that may zig when traditional stocks and bonds zag. An asset with low correlation to others in your holdings can both reduce risk at the portfolio level and increase returns.”

In his July 2016 column, “The best performing asset class no one talks about,” Reformed Broker Josh Brown observes that, “Going back to the year 2000, REITs are the best performing asset class in the market, according to JP Morgan, up 12% on an average annual basis. … [I]t’s weird that people generally don’t focus on them.”

So, real estate can serve as a stabilizing force and a source of returns in your portfolio. But, like any investment, potential rewards are accompanied by notable risks.

Investors discovered these risks in 2007–2009 when a U.S. and U.K. housing market collapse generated a global credit crisis. Investors had been treating any and all real estate prices as sure bets, despite the underlying risks involved. As reported in “On Shaky Foundations,” we’re seeing these risks play out again in the U.K., “in the shape of a concentrated sell-off of Open Ended Property funds.” Investors in these funds are discovering that the return “smoothing” they thought they were enjoying may have been built on a house of cards. The columnist observed: “Just because risk is not immediately visible, does not mean it isn’t there.”

Select an Appropriate Allocation – for You

In light of its potential returns and known risks, evidence-based investment strategy suggests that stocks and bonds are typically the staples in most investors’ portfolios, with real estate acting more as a flavor-enhancing ingredient.

Beyond this general rule of thumb, your personal circumstances also may influence the allocation that makes sense for you. For example, if you are a real estate broker, or you own a rental property or two as a side business, you may want to hold less real estate in your investment portfolio, to offset the real estate risks that you’re already exposed to elsewhere.

Incidentally, we suggest you avoid treating your home as a real estate investment. If it happens to appreciate over the years, that’s great. But don’t forget that its highest purpose is to provide you and your family with a dependable roof over your heads. This is one of several reasons your home is best thought of as a consumable expense rather than a reliable source of investment returns. For a heart-wrenching tale of what can happen otherwise, consider this powerful piece by Behavior Gap’s Carl Richards, “How a Financial Pro Lost His House.”

Manage the Costs

As always, the less you spend on your investments, the more returns you get to keep. Given that there are well-managed REIT funds that offer relatively cost-effective and efficient exposure to the asset class being targeted … why would you choose a more complicated alternative where the costs may be both insidious and excessive?

Adopt a Long-Term Perspective

While, it can often make sense to include real estate in your globally diversified portfolio, the advantages are accompanied by portfolio performance that may often deviate from “the norm.” That’s by design, to help you achieve your own financial goals, not some arbitrary norm. Given these practical realities, it’s essential to embrace a patient, long-term approach to participating in real estate’s risks and expected returns. If your time horizon or risk tolerance isn’t in line with such an approach, you may be better off without the allocation to begin with.

Use Investment Vehicles That Best Complement All of the Above

If an allocation to real estate makes sense for you and your financial goals, the final ingredient to successful application is to select a fund manager whose strategies align with yours. Look for a fund that clearly discloses the investments held, the approach taken, the risks realized, and the costs incurred. Consider a provider who scores well on all of these counts; offers diversified exposure to domestic and global markets; and appeals to disciplined investors like yourself, who are less likely to panic and force unnecessary trading during times of stress.

Also, note that you may already be invested in real estate without knowing it. It’s not uncommon for a stock or hybrid fund to include a shifting allocation to real estate. Unless you read the fine print in the prospectus, it’s hard to know just what you hold, in what amounts.

Ask for Help

Is real estate investing right for you? If it is, how much should you invest in, which holdings make sense for you, which account(s) should hold which assets, and how can you maintain control over your target allocations? These are the kinds of questions we cover when helping investors with their real estate investments, embracing each family’s highest interests as our personalized guide. Please be in touch if we can help you with the same.