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Posts Tagged ‘Predicting the stock market

Market Guesswork Can Come Back to Haunt.

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

People have been wondering what the stock market will do since they first began trading under the buttonwood tree in lower Manhattan.

I read an article – one of a zillion such articles that always get multiple opinions from people who invariably prove they never had a clue to begin with – yesterday by Gil Weinreich, writing for AdvisorOne,  You can find a link to it on the IFG Facebook page; and this from the article caught my eye:

“The most recent Chicago Booth/Kellogg School Financial Trust Index indicates that 47% of the public expects the stock market to plunge in the next 12 weeks, according to Wharton professor Olivia Mitchell. Mitchell’s own portfolio has outperformed the stock market since 1999, when she put all her investments in Treasury inflation-protected securities. Her difficulty today, however, is figuring out what to do now that TIPS are paying negative returns.”

The professor put ALL her investments in TIPS.   Translation:  She was ‘timing the market’.  Not the stock market, but the bond market.  And, she’s got lucky.    But, there was a price.    Those who ride high on one side are often in danger of getting ‘whipsawed’ on the other.   

The market giveth and the market taketh away. 

The professor isn’t alone.  Many intelligent people – the same people who would never build a home without a blueprint, or launch a business without a well thought-out business plan – often make investment decisions and asset allocations based on an outlook, which means it’s virtually always without a long-term written investment plan.  It’s important to note there is NO professionally-written plan on earth, for a home, business, or investments, that would use only one material, or concentrate all risk into one sector.

Risk concentration isn’t a strategy.  It’s a guess.  It’s a hope.  Yet, too many Americans do it all the time.  It’s called ‘chasing returns’.

It doesn’t work.

It’s never worked.

Some point to past successes, similar to the example above; but, those always end-up being short-term.  When you calculate the returns over time – and one might argue the professor’s track record since ’99 isn’t exactly short-term – it’s also true that returns are now negative and her investment life isn’t over yet – and won’t be for many years to come.

Anyone who’s attended a large gathering of financial types knows the room is always filled with better-than-average investors; yet, few – although the number may be closer to ‘none’ – can even beat the indexes consistently.

It’s not about being brilliant; it’s about being smart.  Being smart really all about knowing what you don’t know… it’s about managing risk, not money… you just do it with money…. And market risk is only one of them.

Jim

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Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.  

The Independent Financial GroupAdditional IFG Links:

 

IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description. Opinions expressed are those of the author.  IFG does not provide legal or tax advice and nothing contained herein should be construed as  securities  or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any security or the services of any person or organization.

Six Tips for Surviving Challenging Markets

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Here are six tips to help cope with challenging market environments:

1. Stay Engaged

When you sell an investment simply because it has declined in value,  it becomes impossible to benefit when it rebounds.  The same is true of the broad market in general.  Many of these major upside moves can happen quickly, often in just a few days.  To avoid missing these key days, you may want to consider staying invested and avoid panic selling. Consider this hypothetical example furnished to us by the folks at Principal Financial Group:

An individual who was invested in the S&P 500 from January 2, 1991, until December 31, 2010 would have turned a $10,000 investment into $58,137.02 for an average annual return of 9.20%, while an investor who panicked and sold their positions during this same period and missed the 10 best trading days in this period would have seen their return fall from 9.20% to 5.47%. [Source: Ned Davis Research]

The lesson is clear: No one can predict when the market will experience its best days.

2. Keep a Long-Term Focus

Studies show that time is your ally.   Of the three types of investments studied (stock funds, bond funds, and asset allocation investment options), the average investors in asset allocation funds held their investment options the longest (an average of 4.30 years) over the five time periods studied (1-, 3-, 5-, 10-, and 20-years).  It’s little surprise that these investors successfully weathered one of the most severe market declines in history (2000-2002). [Source: Dalbar 2010 QAIB study]

3. Have a Diversification Plan

According to the Dalbar study, investors guess incorrectly about the market’s direction 50% of the time.  So, diversification helps guard against those errors; but, many people mistake duplication for diversification by buying multiple mutual funds not knowing many of the underlying holdings are identical.

Choosing different management styles and market capitalizations of equities and bonds isn’t as simple as you’re lead to believe on television.  When was the last time you heard a financial entertainer the impact of highly correlated assets?   It’s boring stuff and makes for poor television, which is why it isn’t discussed, but it’s what you need to know.  Quality diversification enhances the benefits of asset allocation so investment balances are less affected by short-term market swings than they would be if you invested in a single asset class.

If you are an investor who is nearing retirement, consider consulting your advisor about this issue.  Remember, asset allocation/diversification does not guarantee a profit or protect against a loss, but it will likely make your journey much smoother.

4. Utilize an Auto-Rebalance Strategy

Historically, business cycle contractions last about one-sixth as long as expansions.  Now may be a good time to re-evaluate your risk tolerance. If you want a professionally managed investment option to handle this complicated task, you might want to consider a unified managed account (UMA).  It’s an option that simplifies your paperwork, virtually automates the rebalancing process, gives you consolidated reporting while providing the diversification of management, styles, and investments needed to do the job right.  UMAs can hold mutual funds, index funds, ETFs, institutional separately managed accounts, and more.  A UMA is not an investment; it’s a type of account you use to execute your investment plan.  Ask your advisor or – shameless plug – feel free to contact me for information about UMAs. 

There are also target-date and target-risk asset allocation funds available on the market; but, tread carefully.  Different funds with the same target date or target risk can still have very, very different holdings, styles, and risk profiles.  Not everyone retiring in the same year has the same financial picture or ideas about how they want to make the financial journey.  As you can tell, I’m not a big fan of ‘cookie-cutter’ solutions.

5. Keep Your Focus

Discipline is something everyone has until panic sets-in.  Quite often, that’s when an advisor can show the most value.   Successful investing is a marathon, not a sprint.  The tortoise did win the race, you know.

6. Get Regular Checkups

Too many individual investors are still stuck in the old paradigm under which their advisor, actually a broker, would call them with investment ideas or changes they should make.  Today, with the emergence of the fee-only – that’s different from fee-based – business model utilized by ‘pure’ Registered Investment Advisors (not dually registered to sell securities, too), the new paradigm operates more like other professional practices in law, medicine, or accounting.  In short, you need to make an appointment for your checkup, at least annually.   And, today, with online meeting technology, you can even do it without getting in your car… so there’s no excuse.   Get your checkup!  If you don’t, your financial health will likely suffer.

If you like information UMAs, you can request it here:

 
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The Independent Financial GroupSubscribe to IFG Insights letters for individual investors. 

Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors, and retirement and wealth management services for individual investors. IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG also does not provide tax or legal advice.  The reader should seek competent counsel to address those issues.  Content contained herein represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a written plan.  The Independent Financial You can reach Jim at 805.265.5416 or through the IFG website, www.indfin.com, Keep up to date with IFG on Twitter: @JimLorenzen

How To Hedge Your Portfolio

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Here’s a short little tip you might find helpful.

The other day I was talking with someone when the conversation finally turned to the familiar, ‘what do I do now’ question.

I told him what he intuitively already knew:  No one can predict the future and no one really knows.  Asset management isn’t about prognostication, contrary to what you see on the business talk shows; it’s about managing risk.  In fact, it’s about managing a list of risks which include market risk, inflation risk, legislative risk (taxes), interest rate risk, currency risk, etc.  It’s quite a list.

So, we don’t manage money, we manage risks – We just do it with money.

Today, we have uncertainty in the stock market – That’s a constant.  Markets have always been uncertain and they always will be.  No sense spending time gnashing our teeth over that one.   There’s also a lot of concern about inflation, interest rates, as well as the price of energy due to mid-east uncertainties that seem to have no end.

Let’s move on to how all that uncertainty can be managed.

One way is hedge your portfolio.   But how do you do it?  It isn’t as difficult as you might think.  Recognize that, in the investment world, there are only two things you can do with money:  You can use it to own or you can use it to loan.   Ownership happens on the equity (stock) side of your portfolio.  When you loan your money out, you’re in bonds.   You can hedge your bond allocation against inflation risk by using Treasury Inflation Protected Securities (TIPS).  You can hedge your equity (stock) allocation against a variety of risks by using real estate and commodities, which include food, energy, and hard assets like precious and strategic metals, etc.  All of these hedges can be purchased individually or through a variety of mutual funds, including index funds, and exchange-traded funds (ETFs).

How do you do it?

Take a simple hypothetical allocation of 40% stocks and 60% bonds.  If you wanted your portfolio to be 10% hedged, then you would use equity hedges for 4% of your stock allocation and you’d use TIPS for 6% of your bond allocation. 

A 20% hedge would look like this:  The 40% equity allocation would end-up as 8% in equity hedges and 32% stocks.  The 60% bond allocation would end-up as 12% in TIPS and 48% in bonds.

The real question:  What size hedge should you have?  Ah, that depends on your age, income, outlook, goals, risk assessment, etc.  Various hedging ratios will undoubtedly have an impact on portfolio volatility and performance.   In order to know IF you should be in a hedged portfolio – and the degree of hedging that would be prudent, you should meet with your advisor – many like myself often conduct online meetings with clients – review your plan, and have your advisor review your portfolio by conducting a portfolio stress-test and compare it to a hedged portfolio.  At that point you should be able to make a determination.

Jim

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Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Beware of Easy Answers

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

There I was with my feet up on a Sunday afternoon watching football when a commercial break came.  As I started for the refrigerator, a friendly voice asked the question many people ask:  “How much can you withdraw from your nest-egg without worrying about running out of money?”   

Since this is an issue I’ve been dealing with for more than twenty years, I was interested in their answer.  So, I postponed my trip to the refrigerator; but, then the voice then said, “The answer in a moment…” and went on with the commercial.  That was my cue; but, I returned in time to hear their answer.  It was their belief that investors should be able to draw between 4-5% annually.  I won’t tell you which company aired the commercial – okay, it was Fidelity.

4-5%?  Really?  Well, maybe. 

Morningstar published a hypothetical 50% stock/50% bond portfolio and the effect various inflation-adjusted withdrawal rates had on the end value of the portfolio over a long payout period.  Each hypothetical portfolio has an initial starting value of $500,000 and assumed that a person retired at age 65 and withdraws an inflation-adjusted percentage of the initial portfolio wealth ($500,000) each year beginning at age 66.  Morningstar concluded that someone withdrawing 4% annually would have a 95% chance of achieving his/her goals.  At a 5% withdrawal rate, the investor would still be somewhere around an 87% confidence level.

Here’s a point worth noting:  Annual investment expenses were assumed to be 0.83% for stock mutual funds and 0.64% for bond mutual funds.   Interesting, since most stock mutual funds have much larger expenses.  It’s also worth noting, they were using historical data covering for the 1926-2010 in a Monte Carlo simulation.  Monte Carlo does test all possible outcomes, but often it assigns the same weighting to events that happen often as it does to those that may have happened only once in all of human history.  Sophisticated planning platforms not only weight outcomes, they also allow you to perform ‘stress-tests’ by performing some `worst-case’ scenarios on timing.

The commercial, however, reminded me of when I opened my first office in Winter Park, Florida in the early ‘90s.  In those days, the stock market was doing extremely well and there was a local independent broker who used to buy a lot of radio ads promoting his retirement seminars – Florida has a lot of retirees.  His commercials used to promote attendance by saying something like, “You can withdraw 8% a year with possible growth of principal!”  He packed them in.   

Commercials seem to do well when they tell people what they want to hear.  The problems came, of course, for those who clung to that belief when markets weren’t so friendly.  While I think most advisors would feel comfortable with the 4% figure, few are likely to be comfortable with the 5% figure, at least for a 65-year-old in good health; and, the wealthier you are, the less likely you’ll have significant stock exposure, which would likely result in a withdrawal rate closer to 3%, or maybe less.

As usual, it depends.

Jim

Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Contributing To A 401(k)? Count Your Blessings!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Particpants in company 401(k) plans may be in the best market they could hope for! 

Yes, you read that right.  It was just about one year ago when I showed the math on why investors who don’t quit can win, even if the market goes down and only gets back to even!  You can read that post here.

Unfortunately, they don’t teach investment literacy in school; so, most plan participants know only what they see on the financial entertainment shows or in one of the consumer publications.   But, make no mistake about it, this is the time participants shouldn’t quit, especially if your employer is contributing for you with some kind of match!

Tune out the noise!  Just keep on contributing!  And, don’t try to pick winning stocks.   A good mix of low-cost indexes will likely do just fine.  Remember, studies show most investors can’t even tie an index, much less beat it – and that includes the so-called professionals!

Questions?  Talk to your plan advisor or to your personal advisor.  Of course, if all else fails, you know where to find me.

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NOTE:  Jim Lorenzen was interviewed by The Wall Street Journal’s Glenn Ruffenach for an article appearing in SmartMoney magazine.  You’ll find it on page 46 in the September 2011 issue now on newstands.

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and an Accredited Investment Fiduciary®  in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Scared of Stocks? Take a Lesson from Warren!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

If you have to ask, “Warren Who?”, you probably should just pass on this posting altogether.

If you do know who Warren is, read on – you may enjoy this.  I’ll let him talk to you in his own words, taken from The Essays of Warren Buffett, which is really a collection of his reports to Berkshire Hathaway investors.  This from Essay II, Section A, entitled, Mr. market:

“Whenever Charlie and I buy common stocks for Berkshire’s insurance companies (leaving aside arbitrage purchases, discussed in the next essay) we approach the transaction as if we were buying into a private business.  We look at the economic prospects of the business, the people in charge of running it, and the price we must pay.  We do not have in mind any time or price for sale.  Indeed, we are willing to hold a stock indefinitely so long as we expect the business to increase in intrinsic value at a satisfactory rate.  When investing, we view ourselves as business analysts – not as market analysts, not as macroeconomic analysts, and not even as security analysts.”

The rest of the essay goes on to point out that market movements in the pricing of the company’s stock are immaterial and largely go unnoticed.  Again, it’s the intrinsic value of the company that’s important.  Mr. Buffett says that each day, “Mr. Market” offers him a price for his share of the company; but, if the company is still meeting his business performance expectations (not price performance), he simply ignores the offer.  He says that even though the business may be stable, Mr. Market’s price quotations virtually never are.

It’s an interesting read.   For those of you who want to know how one of the best investors who ever lived does it, I recommend the essays, which I’m sure you can find through one of the online stores.

Jim

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NOTE:  Jim Lorenzen was interviewed by The Wall Street Journal’s Glenn Ruffenach for an article appearing in SmartMoney magazine.  You’ll find it on page 46 in the September 2011 issue now on newstands.

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and an Accredited Investment Fiduciary®  in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

How To Handle Uncertainty

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

Markets hate uncertainty.

You’ve heard that a thousand times.  We all have.  And, it doesn’t matter which decade you’re in.  The 1970s, 80s, 90s, and the last ten years have all been periods of uncertainty.   Whether the questions were about inflation, interest rates, tax laws, or increased market volatility, there’s been one constant:

Markets never have been, and never will be, certain of anything.   I remember people back in 1991 wanting to wait until they would `know what the market was going to do’.  They’re still waiting, I think.

Name a time you’ve ever heard anyone say, “Well, at last we have certainty in the markets!”  I’ve never seen it; and I don’t know anyone who has, either.

Warren Buffett, someone everyone loves to quote, is famous for saying he never met anyone who could predict the stock market.  He knows more people than I do.  All I know is when I begin getting market advice from my dry cleaner, it does send me a message; but I digress.

Right now, everyone’s worried about congress and whether they’ll raise the debt ceiling[1].  The Democrats are doing their best to scare everyone regarding the consequences of failure, claiming the U.S. will default.  The Republicans are claiming our biggest problem is the spending and borrowing more won’t help – I guess we all remember our younger days using our first credit card, so we can relate to that.

History has been filled with uncertainty and unpredictability:

  • Pearl Harbor
  • The Korean War
  • The Cuban Missile Crisis
  • The Vietnam War
  • The rise of the Japanese manufacturing
  • Mid-East Oil Crisis
  • Skyrocketing inflation and interest rates
  • Plunging interest rates
  • The Iranian Hostage Crisis
  • President Reagan walking out of the peace talks with Soviet Premier Gorbachev
  • The fall of the Soviet Union

That’s enough; I’m sure you can add many more to the list, including the first Iraq war, etc. 

Uncertainty is not new.  It’s normal.

Predicting the future worse than futile – it borders on the idiotic

And so, it should go without saying that reacting to events is not smart.  It’s counter-productive.

Don’t fall for the line, “This time it’s different.”  It isnt’.

The answer isn’t simplistic; but, it is simple:   Those who succeed are generally those with a plan. 

Your plan is like a lighthouse in a storm:  No one pays much attention during fair weather; but, when the skies turn dark and storms are raging and your boat is being tossed around – when it’s hard to see through the dense fog – the lighthouse shows you the way. 

It’s the one thing that isn’t moving.  It’s what you depend on to get you through the uncertainty.  It’s tangible.

Your plan should be tangible, too.  If your financial plan is `in your head’, face it:  You don’t have one.  It must be tangible.  It must be something you and your spouse can both see, touch, feel, and refer to when the uncertainty is all around you.

And, it always is.

Jim

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Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any secrity or the services of any person or organization


[1] Just for the record, most are confusing two issues.  There is a difference between meeting debt obligations – bond payments to Treasury investors – and funding spending programs.  Failing to raise the debt ceiling will not result in debt default simply because Treasury revenue from current taxes is sufficient to meet those current obligations.  The real issue is not credit default, but the funding of the spending programs.  Without increase ability to borrow more, the government will be forced to prioritize their spending, which means cutting back on some programs which help get some politicians re-elected.  Naturally, if forced to prioritize, especially during an election season, many politicians will love to see programs cut for the largest voting constituency first – pain generates letters to representatives to change their vote.