HHWM Investment Insights: The Essence of Evidence-Based Investing

Welcome to the next installment in our series of Hiley Hunt Wealth Management’s Evidence-Based Investment Insights: The Essence of Evidence-Based Investing.

In our last piece, “What Drives Market Returns?” we explored how markets deliver wealth to those who invest their financial capital in human enterprise. But, as with any risky venture, there are no guarantees that you’ll earn the returns you’re aiming for, or even recover your stake. This leads us to why we so strongly favor evidence-based investing. Grounding your strategy in rational methodology helps you best determine and stay on a course toward the financial goals you have in mind, especially when your emotional reactions threaten to take over the wheel.

So what does evidence-based investing entail?

Market Return Factors: The Essence of Evidence-Based Investing

Since at least the 1950s, a “Who’s Who” body of scholars has been studying financial markets to answer key questions such as:

What drives returns? Which return-yielding factors appear to be persistent over time, around the world and across a range of market conditions?
How does it work? Once identified, can we explain why particular return-yielding factors exist, or at least narrow it down to the most likely causes?

Financial Scholar vs. Financial Professional

Building on this level of academic inquiry, fund companies and other financial professionals are tasked with an equally important charge: Even if a relatively reliable return premium exists in theory, can we capture it in the real world – after the implementation and trading costs involved?

As in any discipline from finance to medicine to quantum physics, it’s academia’s interest to discover the possibilities; it’s our interest to figure out what to do with the understanding. This is in part why it’s important to maintain the bifurcated roles of financial scholar and financial professional, to ensure each of us are doing what we can do best in our field.

The Rigors of Academic Inquiry

In academia, rigorous research calls for considerably more than an arbitrary sampling or a few in-house spreadsheets. It typically demands:

A Disinterested Outlook – Rather than beginning with a point to prove and then figuring out how to prove it, ideal academic inquiry is conducted with no agenda other than to explore intriguing phenomena and report the results of the exploration.

Robust Data Analysis – The analysis should be free from weaknesses such as:

Suspect data that is too short-term, too small of a sampling to be significant, or otherwise tainted
“Survivorship bias,” in which the returns from funds that were closed during the study (usually because of poor performance) are omitted from the results
Comparing apples to oranges, such as using the wrong benchmark against which to assess a fund’s or strategy’s “success” or “failure”
Insufficient use of advanced mathematics like multi-factor regression, which helps pinpoint the critical factors from among an otherwise confusing, noisy mix of possibilities

Repeatability and Reproducibility – Academic research requires results to be repeatable and reproducible by the author and others, across multiple, comparable environments. This strengthens the reliability of the results and helps ensure they weren’t just random luck.

Peer Review – Last but hardly least, scholars must publish their detailed results and methodology, typically within an appropriate academic journal, so similarly credentialed peers can review their work and agree that the results are sound or rebut them with counterpoints.

Your Take-Home

As is the case in any healthy scholarly environment, those contributing to the lively inquiry about what drives market returns are rarely of one mind. Still, when backed by solid methodology and credible consensus, an evidence-based approach to investing offers the best opportunity to advance and apply well-supported findings; eliminate weaker proposals; and, most of all, strengthen your ability to build and/or preserve long-term personal wealth according to your unique goals.

Next up, we’ll continue to piece together our exploration of market factors and expected returns.

We would love to invite you to learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE –Financial Planning and Investment Management.

HHWM Investment Insights: What Drives Market Returns?

Welcome to the next installment in our series of Hiley Hunt Wealth Management’s Evidence-Based Investment Insights: What Drives Market Returns?

In our last piece, “Get Along, Little Market,” we wrapped up a discussion about the benefits of diversifying your investments to minimize avoidable risks, manage the unavoidable ones that are expected to generate market returns, and better tolerate market volatility along the way. The next step is to understand how to build your diversified portfolio for effectively capturing those expected returns. This in turn calls for understanding where those returns actually come from.

The Business of Investing

With all the excitement over stocks and bonds and their ups and downs in headline news, there is a key concept often overlooked. Market returns are compensation for providing the financial capital that feeds the human enterprise going on all around us, all the time.

When you buy a stock or a bond, your capital is ultimately put to hard work by businesses or agencies who expect to succeed at whatever it is they are doing, whether it’s growing oranges, running a hospital or selling virtual cloud storage. You, in turn, are not giving your money away. You mean to receive your capital back, and then some.

Investor Returns vs. Company Profits

A company hopes to generate profits. A government agency hopes to complete its work with budget to spare. Investors hope to earn generous returns. You would think that, when a company or agency succeeds, its investors would too. But actually, a company’s or agency’s success is only one factor, at best, among many others that influence its investors’ expected returns.

At first, this seems counterintuitive. It means, for example, that even if business is booming, you cannot necessarily expect to reap the rewards simply by buying stock in that same, booming company. (As we’ve covered before, by the time good or bad news is apparent, it’s already reflected in higher-priced share prices, with less room for future growth.)

The Fascinating Facts About Market Returns

So what does drive expected returns? There are a number of factors involved, but among the most powerful ones spring from those unavoidable market risks we introduced earlier. As an investor, you can expect to be rewarded for accepting the market risks that remain after you have diversified away the avoidable, concentrated ones.

Consider two of the broadest market factors: stocks (equities) and bonds (fixed income). Most investors start by deciding what percentage of their portfolio to allocate to each. Regardless of the split, you are still expecting to be compensated for all of the capital you have put to work in the market. So why does the allocation matter?

When you buy a bond …

You are lending money to a business or government agency, with no ownership stake.
Your returns come from interest paid on your loan.
If a business or agency defaults on its bond, you are closer to the front of the line of creditors to be repaid with any remaining capital.

When you buy a stock …

You become a co-owner in the business, with voting rights at shareholder meetings.
Your returns come from increased share prices and/or dividends.
If a company goes bankrupt, you are closer to the end of the line of creditors to be repaid.

In short, stock owners face higher odds that they may not receive an expected return, or may even lose their investment. There are exceptions. A junk bond in a dicey venture may well be riskier than a blue-chip stock in a stable company. But this is why stocks are generally considered riskier than bonds and have generally delivered higher returns than bonds over time.

This outperformance of stocks is called the equity premium. The precise amount of the premium and how long it takes to be realized is far from a sure bet. That’s where the risk comes in. But viewing stock-versus-bond performance in a line chart over time, it’s easy to see that stock returns have handily pulled ahead of bonds over the long-run … but also have exhibited a bumpier ride along the way. Higher risks AND higher returns show up in the results.

Your Take-Home

Exposure to market risk has long been among the most important factors contributing to premium returns. At the same time, ongoing academic inquiry indicates that there are additional factors contributing to premium returns, some of which may be driven by behaviors other than risk tolerance. Next up, we’ll continue to explore market factors and expected returns, and why our evidence-based approach is so critical to that exploration.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE –Financial Planning and Investment Management

HHWM Investment Insights: Get Along, Little Market

Welcome to the next installment in our series of Hiley Hunt Wealth Management’s Investment Insights: Get Along, Little Market

In our last piece, “Managing the Market’s Risky Business,” we described how diversification plays a key role in minimizing unnecessary risks and helping you better manage those that remain. Today, we’ll cover an additional benefit to be gained from a well-diversified stable of investments: creating a smoother ride toward your goals.

Diversifying for a Smoother Ride

Like a bucking bronco, near-term market returns are characterized more by periods of wild volatility than by a steady-as-she-goes trot. Diversification helps you tame the beast, because, as any rider knows, it doesn’t matter how high you can jump. If you fall out of the saddle, you’re going to get left in the dust.

When you crunch the numbers, diversification is shown to help minimize the leaps and dives you must endure along the way to your expected returns. Imagine several rough-and-tumble, upwardly mobile lines that represent several kinds of holdings. Individually, each represents a bumpy ride. Bundled together, the upward mobility by and large remains, but the jaggedness along the way can be dampened (albeit never completely eliminated).

If you’d like to see a data-driven illustration of how this works, check out this post by CBS MoneyWatch columnist Larry Swedroe, “How to diversify your investments.”

Covering the Market

A key reason diversification works is related to how different market components respond to price-changing events. When one type of investment may zig due to particular news, another may zag. Instead of trying to move in and out of favored components, the goal is to remain diversified across a wide variety of them. This increases the odds that, when some of your holdings are underperforming, others will outperform or at least hold their own.

The results of diversification aren’t perfectly predictable. But positioning yourself with a blanket of coverage for capturing market returns where and when they occur goes a long way toward replacing guesswork with a coherent, cost-effective strategy for managing desired outcomes.

The Callan Periodic Table is a classic illustration of this concept. After viewing a color-coded layout of which market factors have been the winners and losers in past years, it’s clear that the only discernible pattern is that there is none. If you can predict how each column of best and worst performers will stack up in years to come, your psychic powers are greater than ours.

Your Take-Home

Diversification offers you wide, more manageable exposure to the market’s long-term expected returns as well as a smoother expected ride along the way. Perhaps most important, it eliminates the need to try to forecast future market movements, which helps to reduce those nagging self-doubts that throw so many investors off-course.

So far in our series of Evidence-Based Investment Insights, we’ve introduced some of the challenges investors face in efficient markets and how to overcome many of them with a structured, well-diversified portfolio. Next up, we’ll pop open the hood and begin to take a closer look at some of the mechanics of solid portfolio construction.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE –Financial Planning and Investment Management

HHWM Investment Insights: Managing the Market’s Risky Business

Welcome to the next installment in our series of Hiley Hunt Wealth Management’s Investment Insights: Managing the Market’s Risky Business

In our last piece, “The Full-Meal Deal of Diversification,” we described how effective diversification means more than just holding a large number of accounts or securities. It also calls for efficient, low-cost exposure to a variety of capital markets from around the globe. Today, we’ll expand on the benefits of diversification, beginning with its ability to help you better manage investment risks.

There’s Risk, and Then There’s Risk

Before we even have words to describe it, most of us learn about life’s general risks when we tumble into the coffee table or reach for that pretty cat’s tail. Investment risks aren’t as straightforward. Here, it’s important to know that there are two, broadly different kinds of risks: avoidable, concentrated risks and unavoidable market risks.

Avoidable Concentrated Risks

Concentrated risks are the ones that wreak targeted havoc on particular stocks, bonds or sectors. Even in a bull market, one company can experience an industrial accident, causing its stock to plummet. A municipality can default on a bond even when the wider economy is thriving. A natural disaster can strike an industry or region while the rest of the world thrives.

In the science of investing, concentrated risks are considered avoidable. Bad luck still happens, but you can dramatically minimize its impact on your investments by diversifying your holdings widely and globally, as we described in our last post. When you are well diversified, if some of your holdings are affected by a concentrated risk, you are much better positioned to offset the damage done with plenty of other, unaffected holdings.

Unavoidable Market Risks

If concentrated risks are like bolts of lightning, market risks are encompassing downpours in which everyone gets wet. They are the persistent risks that apply to large swaths of the market. At their highest level, market risks are those you face by investing in capital markets in any way, shape or form. If you stuff your cash in a safety deposit box, it will still be there the next time you visit it. (It may be worth less due to inflation, but that’s a different risk, for discussion on a different day.) Invest in the market and, presto, you’re exposed to market risk.

Risks and Expected Rewards

Hearkening back to our past conversations on group intelligence, the market as a whole knows the differences between avoidable and unavoidable investment risks. Heeding this wisdom guides us in how to manage our own investing with a sensible, evidence-based approach.

Managing concentrated risks – If you try to beat the market by chasing particular stocks or sectors, you are exposing yourself to higher concentrated risks that could have been avoided with diversification. As such, you cannot expect to be consistently rewarded with premium returns for taking on concentrated risks.

Managing market risks – Every investor faces market risks that cannot be “diversified away.” Those who stay invested when market risks are on the rise can expect to eventually be compensated for their steely resolve with higher returns. But they also face higher odds that results may deviate from expectations, especially in the near-term. That’s why you want to take on as much, but no more market risk than is personally necessary. Diversification becomes a “dial” for reflecting the right volume of market-risk exposure for your individual goals.

Your Take-Home

Whether we’re talking about concentrated or market risks, diversification plays a key role. Diversification is vital for avoiding concentrated risks. In managing market risks, it helps you adjust your desired risk exposure to reflect your own purposes. It also helps minimize the total risk you must accept as you seek to maximize expected returns.

This sets us up well for our next piece, in which we address another powerful benefit of diversification: smoothing out the ride along the way.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE – Financial Planning and Investment Management

The Latest Reasons to Think, Act and Invest Like Warren Buffet

In 2012, financial author Larry Swedroe wrote a handy little pocket book entitled “Think, Act and Invest Like Warren Buffett: Playing the Winner’s Game.” In it, Swedroe shares some of Buffett’s most successful strategies and how every investor can use them to build his or her own sound investment habits. It’s a helpful little guide and recommended reading for any investor.

Of course Buffett has not been sitting idly by since Swedroe’s book was published. As Chairman and CEO of Berkshire Hathaway, he achieves each spring what nearly every other publicly traded business owner can only dream of: He publishes an annual shareholder letter that people actually read.

Once again, the 2014 annual letter did not disappoint. Jam-packed as it is with a litany of essential “Buffettisms,” the letter reminds us and inspires us yet again on why much of Buffett’s advice about investing – and life – is worthy advice indeed. There are so many good quotes in his recent letter that it’s hard to choose just a few. I encourage you to read and enjoy the annual letter in its entirety, as it deserves. But to get you started, here are a few of my favorites from “Buffett’s annual letter: What you can learn from my real estate investments.”

“When promised quick profits, respond with a quick ‘no.’”

“I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so.”

“The fact that a given asset has appreciated in the recent past is never a reason to buy it.”

“Games are won by players who focus on the playing field — not by those whose eyes are glued to the scoreboard.”

“If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.”

“Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits. … For these investors, liquidity is transformed from the unqualified benefit it should be to a curse.”

“In aggregate, American business has done wonderfully over time and will continue to do so … The goal of the nonprofessional should not be to pick winners — neither he nor his ‘helpers’ can do that — but should rather be to own a cross section of businesses that in aggregate are bound to do well.”

“The ‘know-nothing’ investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results.”

Good stuff, don’t you think? And yet, as Swedroe observes in his book: “While Buffett is widely admired, the majority of investors not only fail to consider his advice but also tend to do exactly the opposite of what he recommends.”

Please let me know if I can help you implement these wise words into actionable investment strategy of your own. Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE – Financial Planning and Investment Management

HHWM Investment Insights: You, the Market and the Prices You Pay

Welcome to the first installment in my series of Investment Insights: You, the Market and the Prices You Pay.

When it comes to investing (or anything in life worth doing well) it helps to know what you’re facing. In this case, that’s “the market.” How do you achieve every investor’s dream of buying low and selling high in a crowd of highly resourceful and competitive players? The answer is to play with rather than against the crowd, by understanding how market pricing occurs.

The Market: A Working Definition

Technically, “the market” is a plural, not a singular place. There are markets for trading stocks, bonds, sectors, commodities, real estate and more, in the U.S. and around the globe. For now, you can think of these markets as a single place, where opposing players are competing against one another to buy low and sell high.

Granted, this “single place” is huge, representing an enormous crowd of participants who are individually AND collectively helping to set fair prices every day. That’s where things get interesting.

Group Intelligence: We Know More Than You and I

Before the academic evidence showed us otherwise, it was commonly assumed that the best way to make money in what seemed like an ungoverned market was by outwitting others at forecasting future prices and trading accordingly.

Unfortunately for those who are still trying to operate by this outdated strategy, a simple jar of jelly beans illustrates why it’s an inherently flawed approach. Academia has revealed that the market is not so ungoverned after all. Yes, it’s chaotic, messy and unpredictable when viewed up close. But it’s also subject to a number of important forces over the long run.

One of these forces is group intelligence. The term refers to the notion that, at least on questions of fact, groups are better at consistently arriving at accurate answers than even the smartest individuals in that same group … with a caveat: each participant must be free to think independently, as is the case in our free markets. (Otherwise peer pressure can taint the results.)

Writing the Book on Group Intelligence

In his landmark book “The Wisdom of Crowds,” James Surowiecki presented and popularized the enormous body of academic insights on group intelligence.

Take those jelly beans, for example. In one experiment, 56 students guessed how many jelly beans were in a jar that held 850 beans. The group’s guess – i.e., the aggregated average of the students’ individual guesses – came relatively close at 871. Only one student in the class did better than that. Similarly structured experiments have been repeated under various conditions; time and again the group consensus was among the most reliable counts.

Now apply group wisdom to the market’s multitude of daily trades. Each trade may be spot on or wildly off from a “fair” price, but the aggregate average incorporates all known information contributed by the intelligent, the ignorant, the lucky and the lackluster. Thus the current prices set by the market are expected to yield the closest estimate for guiding one’s next trades. It’s not perfect mind you. But it’s assumed to represent the most reliable estimate in an imperfect world.

Your Take-Home

Understanding group intelligence and how it governs efficient market pricing is a first step in more consistently buying low and selling high in free capital markets. Instead of believing the discredited notion that you can regularly outguess the market’s collective wisdom, you are better off concluding that the market is doing a better job than you can at forecasting prices. Your job then becomes efficiently capturing the returns that are being delivered.

But that’s a subject for a future Investment Insights. Next up, we’ll explore what causes prices to change. Chances are, it’s not what you think.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE – Financial Planning and Investment Management

Ivy League Battle: Princeton vs. Yale

If there were a mood to this year’s market, it might be apprehensive. Despite modestly positive year-to-date returns across most asset classes, many in the popular press seem fond of suggesting that there is “another shoe” out there, a stock market correction, just waiting to drop.

Are stocks overpriced? It depends on who you ask. Recently, the CAPE ratio, which stands for “cyclically adjusted price-earnings”, has been frequenting the financial headlines. Co-developed by Nobel laureate, and Yale professor, Robert J. Shiller, the CAPE ratio is meant to measure how high or low current prices are compared to long-term stock prices. In an August 16New York Times column, Professor Shiller declared the CAPE ratio to be “hovering at a worrisome [high] level.”

But before we conclude that stocks are overdue for a take-down, consider another article in the August 27 Wall Street Journal by Princeton University professor of economics and author of the classic finance book, “A Random Walk Down Wall Street” Burton G. Malkiel. Professor Malkiel compares the CAPE camp’s “worrisome level” with a capital-market camp viewpoint that the higher stock prices may be warranted based on today’s low fixed income interest rates. In assessing which camp is right, Professor Malkiel proposes that “both may be.” Shiller himself notes, “The CAPE was never intended to indicate exactly when to buy and to sell. The market could remain at these valuations for years.”

So which Ivy school is correct, do we believe the professor from Yale or Princeton? With such varying opinions from our country’s finest scholars, it’s no wonder many investors are confused! I have my own proposal to make. I am glad that scholars from Sharpe to Shiller continue to study market pricing theory. Through the years, their findings have shaped the principles that guide my investment strategy to this day.

But abandoning your own, carefully constructed investment portfolio based on the clash of the academic titans as they debate real-time market pricing is like purchasing a new home and forsaking your former residence every time a new, potentially improved flooring material is released. It’s stressful, expensive and unlikely to make you any happier in the long run.

Instead, whether stock prices are over-priced or fairly valued in the near term (or even if they have dropped by the time you read this post), We remain confident in the solid structure we’ve built for you in the form of your personalized, low-cost, globally diversified portfolio. If you are considering a “remodel” at any time, please let us know.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE – Financial Planning and Investment Management

HHWM Investment Insights: Ignoring the Siren Song of Daily Market Pricing

Welcome to the next installment in my series of Investment Insights: Ignoring the Siren Song of Daily Market Pricing.

In my last piece, “You, the Market and the Prices You Pay,” I explored how group intelligence governs relatively efficient markets (as well as jelly bean jars) in an imperfect world. Today, let’s look at how prices are set moving forward. This, too, helps us understand how to play with rather than against the wisdom of the market, as you seek to buy low and sell high.

News, Inglorious News

What causes market prices to change? It begins with the never-ending stream of news informing us of the good, bad and ugly events that are forever taking place. For example, when news of the first U.S. Ebola case began to spread, the stock of a maker of hazmat suits soared over 150%.

But what does this mean to you and your investment portfolio? Should you buy, sell or hold tight? Before the news tempts you to jump into or flee from breaking trends, it’s critical to be aware of the evidence that tells us the most important thing of all: You cannot expect to consistently improve your outcomes by reacting to breaking news.

Great Expectations

How the market adjusts its pricing is why there’s not much you can do in reaction to breaking news. There are two principles to bear in mind here.

First, it’s not the news itself; it’s whether we saw it coming. When a security’s price changes, it’s not whether something good or bad has happened. It’s whether the next piece of good or bad news is better or worse than expected. If it’s reported that the aforementioned Ebola virus is continuing to spread, pricing changes to the stock may be minimal; everyone was already expecting doom and gloom so it is already priced into the stock. On the other hand, if the U.S. spread of Ebola is quickly contained, prices may drop dramatically in reaction to the unexpected resolution.

Thus, it’s not just news, but unexpected news that alters future pricing. By definition, the unexpected is impossible to predict, as is how dramatically (or not) the market will respond to it. Once again, group intelligence gets in the way of those who might still believe that they can outwit others by consistently forecasting future prices.

The Barn Door Principle

The second reason to consider breaking news irrelevant to your investing is what I’ll call “The Barn Door Principle.” By the time you hear the news, the market already has incorporated it into existing prices, well ahead of your ability to do anything about it. The proverbial horses have already galloped past your open trading door.

This is especially so in today’s micro-second electronic trading world. In his article, “The impact of news events on market prices,” CBS MoneyWatch columnist Larry Swedroe explored how fast global markets respond to breaking news. Pointing to evidence from a number of studies among several developed markets, the universal response was nearly instantaneous price-setting during the first handful of post-announcement trades. In the U.S. markets, it was even faster than that.

In other words, unless you happen be among the very first to respond to breaking news (competing, mind you, against automated traders who often respond in fractions of milliseconds), you’re setting yourself up to buy higher or sell lower than those who already have set new prices based on the news – exactly the opposite of your goal.

Your Take-Home

Rather than try to play an expensive game based on ever-changing information and cut-throat competition over which you have no control, a preferred way to position your life savings is according to a number of market factors that you can better expect to manage in your favor. In future Investment Insights, I’ll introduce these factors to you.

But first, you may be wondering: Even if you aren’t personally up to the challenge of competing against the market, you may think you can select a pinch-hitting expert to compete for you. Next up, I’ll explore the strikes against that tactic as well.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE – Financial Planning and Investment Management

HHWM Investment Insights: Myth of the Financial Guru

Welcome to the next installment in my series of Investment Insights: Myth of the Financial Guru

In my last piece, “Ignoring the Siren Song of Daily Market Pricing,” I explored how price-setting occurs in capital markets, and why investors should avoid reacting to breaking news. The cost and competition hurdles are just too tall. Today, I’ll explain why you’re also ill-advised to seek a pinch-hitting expert to compete for you. As Morningstar strategist Samuel Lee has described, managers who have persistently outperformed their benchmarks are “rarer than rare.”

Group Intelligence Wins Again

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

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

The Proof Is in the Pudding

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

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

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

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

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

Your Take-Home

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

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE – Financial Planning and Investment Management

2014 In Review

2014 may go down in financial history as the year that a lot of things didn’t happen to investors. For example, despite numerous nervous headlines that it might be best to prepare for the worst, there was no universal stock correction. And despite Federal announcements on tapering quantitative easing in the U.S., there was no major slump in the bond markets.

Another non-event for globally diversified investors was that we were not rewarded with higher annual returns relative to a concentrated, stay-at-home position. Large U.S. companies happened to enjoy a remarkable, double-digit year, even as other markets experienced negative to ho-hum results, especially for international, emerging market and small-cap stocks.

In light of all that did not happen, there is one more thing I hope continues to not happen. I hope you do NOT react to the current market by succumbing to two common behavioral biases: Recency, or giving recent events more weight than they deserve; and Tracking-Error Regret, or abandoning your personalized diversified portfolio to chase last year’s Old Glory returns.

In his article, “There’s a Perfect Storm Brewing,” financial author Larry Swedroe describes the risks associated with chasing past performance. While the U.S. S&P 500 Index has outperformed the MSCI EAFE (international stock) Index since 2010 by an annualized return of around 9 percent, the MSCI EAFE happened to deliver about the same outperformance in reverse from 2002–2007. Clearly, the tables can turn abruptly and destructively for an undiversified investor. As Swedroe says, “Diversification is like insurance. It’s insurance against having all your eggs in the wrong basket.”

There remains decades of resounding evidence that one year or even several years does not a strategy make. That’s why, come what may, we remain as convinced as ever that individualized diversification is the right policy every year. Maintaining a globally diversified portfolio according to your personal goals and risk tolerances does not guarantee that you will outperform other lucky scores you might have made instead. But it continues to offer the most rational approach to reaching your desired destination while managing the rocky risks along the way.

As always, we welcome the opportunity to explore your particular goals and investments in light of this and any other market climate.

Learn more about HHWM and who we serve in Omaha, NE – Financial Planning and Investment Management

HHWM Investment Insights: The Full-Meal Deal of Diversification

Welcome to the next installment in our series of Hiley Hunt Wealth Management’s Investment Insights: The Full-Meal Deal of Diversification

In our last piece, “Myth of the Financial Guru,” we concluded our exploration of the formidable odds you face if you (or your hired help) try to outsmart the market’s lightning-fast price-setting efficiencies. Today, we turn our attention to the many ways you can harness these and other efficiencies to work for, rather than against you.

Among your most important financial friends is diversification. After all, what other single action can you take to simultaneously dampen your exposure to a number of investment risks while potentially improving your overall expected returns? While they may seem almost magical, the benefits of diversification have been well-documented and widely explained by some 60 years of academic inquiry. Its powers are both evidence-based and robust.

Global Diversification: Quantity AND Quality

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

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

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

Increases your vulnerability to specific, avoidable risks

Creates a bumpier, less reliable overall investment experience
Makes you more susceptible to second-guessing your investment decisions

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

A World of Opportunities

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

Your Take-Home

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

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

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

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE – Financial Planning and Investment Management

50 Years of Buffett Letters

For 50 years, Warren E. Buffett has been at the helm of Berkshire Hathaway, among the largest publicly held companies in the world. For 50 years, Buffett has been publishing annual letters to shareholders. With our evidence-based, diversified investment strategy, we don’t typically focus on particular companies’ annual announcements, nor do we typically share them as recommended reading.

Warren Buffett’s letters to Berkshire Hathaway shareholders are different.

While his letters lead with the usual corporate analytics, they’re also generously seasoned with Buffett’s legendary combination of wisdom and practicality on business, finance, family wealth, philanthropy, life lessons and “just for fun” jabs. Investment advice aside, they’re simply fascinating reads from a thoughtful man who is leading a life well-lived.

Here is what Microsoft founder Bill Gates had to say about this year’s letter:

Warren Buffett’s new annual letter to Berkshire Hathaway’s shareholders hasn’t received nearly as much attention as it deserves. I wonder if that’s because financial journalists feel like they just can’t write another story about how wise Warren is. Fortunately, I don’t have any such limitation. I have read all 50 of Warren’s letters and feel this is the most important one he has ever written.

We urge you to take the time to read this year’s golden anniversary letter for yourself. You may agree or disagree with Buffett’s ideas, but you can expect to take something worthwhile from the experience. To get you started, here are a few of our favorite nuggets from this year’s letter.

On American Enterprise …

“Though we will always invest abroad as well, the mother lode of opportunities runs through America. The treasures that have been uncovered up to now are dwarfed by those still untapped.”

“Charlie and I have always considered a ‘bet’ on ever-rising U.S. prosperity to be very close to a sure thing. Indeed, who has ever benefited during the past 238 years by betting againstAmerica?”

“Though the preachers of pessimism prattle endlessly about America’s problems, I’ve never seen one who wishes to emigrate (though I can think of a few for whom I would happily buy a one-way ticket).”

On Business Management …

“The [2014 Berkshire employee] increase, I am proud to say, included no gain at headquarters (where 25 people work). No sense going crazy.”

“It’s better to have a partial interest in the Hope Diamond than to own all of a rhinestone.”

“We don’t have a legal office nor departments that other companies take for granted: human relations, public relations, investor relations, strategy, acquisitions, you name it. We do, of course, have an active audit function; no sense being a damned fool.”

On Wealth and Investing …

“Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do.”

“A sound investment can morph into a rash speculation if it is bought at an elevated price.”

“You can’t get rich trading a hundred-dollar bill for eight tens.”

On Capital Markets …

“One of the heralded virtues of capitalism is that it efficiently allocates funds. The argument is that markets will direct investment to promising businesses and deny it to those destined to wither. That is true: With all its excesses, market-driven allocation of capital is usually far superior to any alternative.”

“Periodically, financial markets will become divorced from reality – you can count on that.”

“No advisor, economist, or TV commentator – and definitely not Charlie [Munger] nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.”

On Risk Management …

“We will always be prepared for the thousand-year flood; in fact, if it occurs we will be selling life jackets to the unprepared.”

“When bills come due, only cash is legal tender. Don’t leave home without it.”

“In our view, it is madness to risk losing what you need in pursuing what you simply desire.”

On Ethics and Conflicts of Interest …

“If horses had controlled investment decisions, there would have been no auto industry.”

“Money flows from the gullible to the fraudster. And with stocks, unlike chain letters, the sums hijacked can be staggering.”

“A lot of mouths with expensive tastes then clamor to be fed – among them investment bankers, accountants, consultants, lawyers and such capital-reallocators as leveraged buyout operators. Money-shufflers don’t come cheap.”

On Human Nature …

“Charlie told me long ago to never underestimate the man who overestimates himself.”

“If you’ve attended our annual meetings, you know Charlie [Munger] has a wide-ranging brilliance, a prodigious memory, and some firm opinions. I’m not exactly wishy-washy myself, and we sometimes don’t agree. In 56 years, however, we’ve never had an argument. When we differ, Charlie usually ends the conversation by saying: ‘Warren, think it over and you’ll agree with me because you’re smart and I’m right.’”

“To have our fellow owners – large and small [shareholders] – be so in sync with our managerial philosophy is both remarkable and rewarding. I am a lucky fellow to have you as partners.”

If you enjoyed these samples, there are plenty more where they came from, plus an equally interesting, first-ever addendum written by Berkshire Hathaway’s Vice-Chairman Charles “Charlie” T. Munger. We hope you’ll take the time to read Buffett’s and Munger’s thoughts in their original context in Berkshire Hathaway’s 2014 annual shareholder letter. We also encourage you to be in touch with us if we can answer any questions about how to apply these insights into your own business and personal wealth management.

Learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE – Financial Planning and Investment Management