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Six Simple Truths About Volatility

By | October 25th, 2018|Markets, volatility|

Volatility is back. Just as many people were starting to think markets only ever move in one direction, the pendulum has swung the other way. Anxiety is a completely natural response to these events. Acting on those emotions, though, can end up doing us more harm than good.

There are a number of tidy-sounding theories about why markets have become more volatile. Among the issues frequently splashed across newspaper front pages: global growth fears, rising interest rates, policy uncertainty, geopolitical risk, and trade issues.

In some ways, the increase in volatility in recent weeks could be just as much a reflection of the fact that volatility has been very low for some time.

So, the increase in market volatility is an expression of uncertainty. Markets do not move in one direction. If they did, there would be no return from investing in stocks and bonds. And if volatility remained low forever, there would probably be more reason to worry.

As to what happens next, no one knows for sure. That is the nature of risk. In the meantime, investors can help manage their risk by diversifying broadly across and within asset classes.

For those still anxious, here are six simple truths to help you live with volatility:

1. Don’t make presumptions

Remember that markets are unpredictable and do not always react the way the experts predict they will.

2. Someone is buying

Quitting the equity market when prices are falling is like running away from a sale. While prices have been discounted to reflect higher risk, that’s another way of saying expected returns are higher. And while the media headlines proclaim that “investors are dumping stocks,” remember someone is buying them. Those people are often the long-term investors.

3. Market timing is hard

Recoveries can come just as quickly and just as violently as the prior correction. For instance, in March 2009—when market sentiment was at its worst—the S&P 500 turned and put in seven consecutive months of gains totaling almost 80%. This is not to predict that a similarly vertically shaped recovery is in the cards, but it is a reminder of the dangers for long-term investors of turning paper losses into real ones and paying for the risk without waiting around for the recovery.

4. Markets and economies are different things

The world economy is forever changing, and new forces are replacing old ones. This applies both between and within economies. For instance, falling oil prices can be bad for the energy sector but good for consumers. New economic forces are emerging, as global measures of poverty, education, and health improve.

5. Nothing lasts forever

Just as smart investors temper their enthusiasm in booms, they keep a reserve of optimism during busts. And just as loading up on risk when prices are high can leave you exposed to a correction, dumping risk altogether when prices are low means you can miss the turn when it comes. As always in life, moderation is a good policy.

6. Discipline is rewarded

The market volatility is worrisome, no doubt. The feelings being generated are completely understandable and familiar to those who have seen this before. But through discipline, diversification, and understanding how markets work, the ride can be made bearable. At some point, value re-emerges, risk appetites reawaken, and for those who acknowledged their emotions without acting on them, relief replaces anxiety.

If you’d like to discuss your specific investment situation, please do not hesitate to call our office.

All expressions of opinion are subject to change without notice. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products or services. Diversification does not eliminate the risk of market loss. There is no guarantee investment strategies will be successful. The S&P 500 Index is not available for direct investment and does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results. Contributions from Dimensional Fund Advisors LP.

Park + Elm Investing Principle #8: Do Emotions Affect Investment Returns?

By | October 22nd, 2018|Markets|

PRINCIPLE #8 IS HERE!

Do Emotions affect Investment Returns!

Download the rest of our Ebook Here to get all 10 principles!!

Many people struggle to separate their emotions from investing. The chart above shows the correlation between emotional cycles and market returns. Investors typically buy at “Elation” and sell at “Fear”, inherently creating a dreaded “selling low, buying high” strategy.

A philosopher once said that nothing is as difficult for people as not deceiving themselves. But while most self-delusions are relatively costless, those relating to investment can come with a hefty price tag.

Market volatility in 2008 and 2009 took investors on a bumpy, emotional ride. Despite the market’s strong performance after March of 2009, many investors were too exhausted to endure the ongoing stress of an uncertain economy and market. By making an emotional decision to avoid the stress, there are millions of investors who never recovered their losses and sacrificed the enormous gains that would follow.

On the contrary – prior to the tech bubble of the early 2000’s, investors were pumping money into the dot coms because they saw their neighbor or co-worker getting rich. Driven by media and emotional investing, American’s poured their savings into tech stocks, only to endure the bubble bursting in 2000.

Some media outlets claim a similar bubble for tech stocks in ‘15 and ‘16. A Bing search on this claim literally pulled up the following article titles, one after another on page 1:

“Why this Tech Bubble is Worse than the Tech Bubble of 2000”

“Why this Tech Bubble is Less Scary than the Tech Bubble of 2000”

Magazines sell by appealing to the emotions of a reader. When it comes to investments, reacting to what you read or see on TV can be detrimental to your long-term retirement plan. Keep these tips in mind before making an emotional investment decision:

  1. Market timing is hard.
  2. Never forget the power of diversification.
  3. Markets and economies are different things.
  4. Discipline is rewarded.

Overcoming self-deception is not impossible. It just starts with recognizing that, as humans, we are not wired for disciplined investing. We will always find one way or another of rationalizing an emotional reaction to market events. But that’s why even experienced investors engage advisors who know them, and who understand their circumstances, risk appetites, and long-term goals. The role of your advisor is to listen to and acknowledge your very human fears, while keeping us in the plans we committed to at our most lucid and logical moments. Can you say with confidence that your investment decisions are based on a long-term strategy, or are your current emotions playing a role?

Quarterly Market Review: Q3-2018

By | October 8th, 2018|DFA, Dimensional Fund Advisors, Markets, Quarterly Market Review|

Click on the link below for a detailed analysis of quarterly performance of the global equity and fixed income markets.

CLICK HERE TO READ THE 3RD QUARTER 2018- QUARTERLY MARKET REVIEW

Total Cost of Ownership

By | October 3rd, 2018|Dimensional Fund Advisors, Markets|

Costs matter. Whether you’re buying a car or selecting an investment strategy, the costs you expect to pay are likely to be an important factor in making any major financial decision.

People rely on a lot of different information about costs to help inform these decisions. When you buy a car, for example, the sticker price indicates approximately how much you can expect to pay for the car itself. But the costs of car ownership do not end there. Taxes, insurance, fuel, routine maintenance, and unexpected repairs are also important considerations in the overall cost of a car. Some of these costs are easily observed, while others are more difficult to assess. Similarly, when investing in mutual funds, different variables need to be considered to evaluate how cost‑effective a strategy may be for a particular investor.

Expense ratios

Mutual funds have many costs, all of which affect the net return to investors. One easily observable cost is the expense ratio. Like the sticker price of a car, the expense ratio tells you a lot about what you can expect to pay for an investment strategy. Expense ratios strongly influence fund selection for many investors, and it’s easy to see why.

Exhibit 1 illustrates the outperformance rate, or the percentage of funds that beat their category index, for active equity mutual funds over the 15-year period ending December 31, 2017. To see the link between expense ratio and performance, outperformance rates are shown for quartiles of funds sorted by their expense ratio. As the chart shows, while active funds have mostly lagged indices across the board, the outperformance rate has been inversely related to expense ratio. Just 6% of funds in the highest expense ratio quartile beat their index, compared to 25% for the lowest expense ratio group.

This data indicates that a high expense ratio presents a challenging hurdle for funds to overcome, especially over longer time horizons. From the investor’s point of view, an expense ratio of 0.25% vs. 1.25% means savings of $10,000 per year on every $1 million invested. As Exhibit 2 helps to illustrate, those dollars can really add up over time.

Exhibit 1.       High Costs Can Reduce Performance, Equity Fund Winners and Losers Based on Expense Ratios (%)


Exhibit 2.      
Hypothetical Growth of $1 Million at 6%, Less Expenses

For illustrative purposes only and not representative of an actual investment. This hypothetical illustration is intended to show the potential impact of higher expense ratios and does not represent any investor’s actual experience. Assumes a starting account balance of $1 million and a 6% compound annual growth rate less expense ratios of 0.25%, 0.75%, and 1.25% applied over a 15-year time horizon. Performance of a hypothetical investment does not reflect transaction costs, taxes, other potential costs, or returns that any investor would have actually attained and may not reflect the true costs, including management fees of an actual portfolio. Actual results may vary significantly. Changing the assumptions would result in different outcomes. For example, the savings and difference between the ending account balances would be lower if the starting investment amount were lower.

Going beyond The expense ratio

The poor track record of mutual funds with high expense ratios has led many investors to select mutual funds based on expense ratio alone. However, as with a car’s sticker price, an expense ratio is not an all-encompassing measure of the cost of ownership. Take, for example, index funds, which often rank near the bottom of their peers on expense ratio.

Index funds are designed to track or match the components of an index formed by an index provider, such as Russell or MSCI. Important decisions in the investment process, such as which securities to include in the index, are outsourced to an index provider and are not within the fund manager’s discretion. For example, the prescribed reconstitution schedule for an index, which is the process of deleting or adding certain stocks to the index, may cause index funds to buy stocks when buy demand is high and sell stocks when buy demand is low. This price-insensitive buying and selling may be required so that the index fund can stay true to its investment mandate of tracking an underlying index. This can result in sub-optimal transaction prices for the index fund and diminished overall returns. In other words, for a given amount of trading (or turnover), the cost per unit of trading may be higher for such a strictly regimented approach to investing. Moreover, this cost will not appear explicitly to investors assessing such a fund on expense ratio alone. Further, because indices are reconstituted infrequently (typically once per year), funds seeking to track them may also be forced to buy and sell holdings based on stale eligibility criteria. For example, the characteristics of a stock considered value as of the last reconstitution date may change over time, but between reconstitution dates, those changes would not affect that stock’s inclusion or weighting in a value index. That means incoming cash flows to a value index fund could actually be used to purchase stocks that currently look more like growth stocks, and vice versa. Metaphorically, these managers’ attention may be more focused on the rear-view mirror than on the road ahead for investors.

For active approaches like stock picking, both the total amount of trading and the cost per trade may be high. If a manager trades excessively or inefficiently, costs like commissions and price impact from trading can eat away at returns. Viewed through the lens of our car analogy, this impact is like the toll on your vehicle from incessantly jamming the brakes or accelerating quickly. Subjecting the car to such treatment may result in added wear and tear and greater fuel consumption, increasing your total cost of ownership. Similarly, excessive trading can lead to negative tax consequences for a fund, which can increase the cost of ownership for investors holding funds in taxable accounts. Such trading costs can be reduced by avoiding unnecessary turnover and seeking to minimize the cost per trade.

In contrast to both highly regimented indexing and high-turnover active strategies, employing a flexible investment approach that reduces the need for immediacy, and thus enables opportunistic execution, is one way to potentially reduce implicit costs. Keeping turnover low, remaining flexible, and transacting only when the potential benefits of a trade outweigh the costs can help keep overall trading costs down and help reduce the total cost of ownership.

conclusion

The total cost of ownership of a mutual fund can be difficult to assess and requires a thorough understanding of costs beyond what an expense ratio can tell investors on its own. We believe investors should look beyond any one cost metric and instead evaluate the total cost of ownership of an investment solution.

Park + Elm Investing Principle #7: Avoid Market Timing

By | September 24th, 2018|Markets|

PRINCIPLE #7 IS HERE!

AVOID MARKET TIMING!

Download the rest of our Ebook Here to get all 10 principles!!

You never know which market segments will outperform from year to year. By holding a globally diversified portfolio, investors are well positioned to seek returns wherever they occur. Trying to correctly time your entry point to the market is difficult, and unfortunately humans have an instinctive desire to take control and make a change when things aren’t moving in the direction we want.

The problem is that what appears to be an intelligent alternative may actually be a distraction. Remember, hindsight is twenty-twenty. There are always short-term investments that do better than a balanced portfolio, but chasing returns is dangerous. What works is having a successful investment strategy and the discipline to stick with it.

Market timing is a seductive strategy. If we could sell stocks prior to a substantial decline and hold cash instead, our long-run returns could be exponentially higher. But successful market timing is a two-step process: determining when to sell stocks and when to buy them back. I can think of a couple of examples where getting these two key things correct would have been extremely difficult and maybe even impossible.

First, leading up to the presidential election in 2016, everyone predicted that a victory for Donald Trump would send the stock market into a tailspin. Nearly every media outlet predicted a market crash if Trump won, and many investors took the advice and withdrew. Yet after some brief jitters following Trump’s win, the stock market kept marching skyward. By the time Trump clinched the presidency, the market rallied and closed the trading day 256 points higher.

And let’s not forget the Brexit news of a couple of summers ago. Wasn’t Britain’s exit from the European Union finally the trigger of the next Stock Market crash? If you read the headlines and listened to the noise, you may have sold your stocks that June when the DJIA was just over 18,000. Four days after Brexit, the market stabilized and began its steady incline.

So how do we get our egos and emotions out of the investment process? One answer is to distance ourselves from the daily noise by appointing a financial advisor to help stop us from doing things against our own long-term interests. Investment advice is not about making predictions about the market. It’s about education and diversification and designing strategies that meet the specific needs of each individual. Ultimately it’s about saving investors from their own, very human, mistakes. What often stops investors from getting returns that are there for the taking are their very own actions—lack of diversification, compulsive trading, buying high, selling low, going by hunches and responding to media and market noise.

An advisor begins with the understanding that there are things we can’t control (like the ups and downs in the markets), and things we can (like proper diversification, rebalancing, minimizing fees, and being mindful of tax consequences). Most of all, an advisor helps us all by encouraging the exercise of discipline—the secret weapon in building long-term wealth.

Working with markets, understanding risk and return, diversifying and portfolio structure—we’ve heard the lessons of sound investing over and over. But so often the most important factor between success and failure is ourselves. Do you have a plan for navigating the “media noise”, and avoiding the temptation to time the market?

Today’s Video: Do Mutual Funds Outperform Benchmarks?

By | September 17th, 2018|DFA, Dimensional Fund Advisors|

Our partner, Dimensional Fund Advisors’ analysis of US-based mutual funds shows that only a small percentage of funds have outperformed industry benchmarks after costs—and among top-ranked funds based on past results, only a small percentage have repeated their success. Check out the short video!

The ABCs of Education Investing

By | September 6th, 2018|College Planning, DFA|

educ]With school back in session in most of the country, many parents are likely thinking about how best to prepare for their children’s future college expenses. NOW is a good time to sharpen one’s pencil for a few important lessons before heading back into the investing classroom to tackle the issue.

THE CALCULUS OF PLANNING FOR FUTURE COLLEGE EXPENSES

According to recent data published by the College Board, the annual cost of attending college in the US in 2017–2018 averaged $20,770 at public schools, plus an additional $15,650 if one is attending from out of state. At private schools, tuition and fees averaged $46,950.

It is important to note that these figures are averages, meaning actual costs will be higher at certain schools and lower at others. Additionally, these figures do not include the separate cost of books and supplies or the potential benefit of scholarships and other types of financial aid. As a result, actual education costs can vary considerably from family to family.

Exhibit 1. Average Published Cost of Attending College in the US

ABCtable
Source: The College Board, “Trends in College Pricing 2017.”

To complicate matters further, the amount of goods and services $1 can purchase tends to decline over time. This is called inflation. One measure of inflation looks at changes in the price level of a basket of goods and services purchased by households, known as the Consumer Price Index (CPI). Tuition, fees, books, food, and rent are among the goods and services included in the CPI basket. In the US over the past 50 years, inflation measured by this index has averaged around 4% per year. With 4% inflation over 18 years, the purchasing power of $1 would decline by about 50%. If inflation were lower, say 3%, the purchasing power of $1 would decline by about 40%. If it were higher, say 5%, it would decline by around 60%.

While we do not know what inflation will be in the future, we should expect that the amount of goods and services $1 can purchase will decline over time. Going forward, we also do not know what the cost of attending college will be. But again, we should expect that education costs will likely be higher in the future than they are today. So, what can parents do to prepare for the costs of a college education? How can they plan for and make progress toward affording those costs?

DOING YOUR HOMEWORK ON INVESTING

To help reduce the expected costs of funding future college expenses, parents can invest in assets that are expected to grow their savings at a rate of return that outpaces inflation. By doing this, college expenses may ultimately be funded with fewer dollars saved. Because these higher rates of return come with the risk of capital loss, this approach should make use of a robust risk management framework. Additionally, by using a tax-deferred savings vehicle, such as a 529 plan, parents may not pay taxes on the growth of their savings, which can help lower the cost of funding future college expenses.

While inflation has averaged about 4% annually over the past 50 years, stocks (as measured by the S&P 500 Index) have returned around 10% annually during the same period. Therefore, the “real” (inflation-adjusted) growth rate for stocks has been around 6% per annum. Looked at another way, $10,000 of purchasing power invested at this rate over the course of 18 years would result in over $28,000 of purchasing power later on. We can expect the real rate of return on stocks to grow the purchasing power of an investor’s savings over time. We can also expect that the longer the horizon, the greater the expected growth. By investing in stocks, and by starting to save many years before children are college age, parents can expect to afford more college expenses with fewer savings.

It is important to recognize, however, that investing in stocks also comes with investment risks. Like teenage students, investing can be volatile, full of surprises, and, if one is not careful, expensive. While sometimes easy to forget during periods of increased uncertainty in capital markets, volatility is a normal part of investing. Tuning out short-term noise is often difficult to do, but historically, investors who have maintained a disciplined approach over time have been rewarded for doing so.

RISK MANAGEMENT AND DIVERSIFICATION: THE FRIENDS YOU SHOULD ALWAYS SIT WITH AT LUNCH

Working with a trusted advisor who has a transparent approach based on sound investment principles, consistency, and trust can help investors identify an appropriate risk management strategy. Such an approach can limit unpleasant (and often costly) surprises and ultimately may contribute to better investment outcomes.

A key part of maintaining this discipline throughout the investing process is starting with a well-defined investment goal. This allows for investment instruments to be selected that can reduce uncertainty with respect to that goal. When saving for college, risk management assets (e.g., bonds) can help reduce the uncertainty of the level of college expenses a portfolio can support by enrollment time. These types of investments can help one tune out short‑term noise and bring more clarity to the overall investment process. As kids get closer to college age, the right balance of assets is likely to shift from high expected return growth assets to risk management assets.

Diversification is also a key part of an overall risk management strategy for education planning. Nobel laureate Merton Miller used to say, “Diversification is your buddy.” Combined with a long-term approach, broad diversification is essential for risk management. By diversifying an investment portfolio, investors can help reduce the impact of any one company or market segment negatively impacting their wealth. Additionally, diversification helps take the guesswork out of investing. Trying to pick the best performing investment every year is a guessing game. We believe that by holding a broadly diversified portfolio, investors are better positioned to capture returns wherever those returns occur.

CONCLUSION

Higher education may come with a high and increasing price tag, so it makes sense to plan well in advance. There are many unknowns involved in education planning, and no “one-size-fits-all” approach can solve the problem. By having a disciplined approach toward saving and investing, however, parents can remove some of the uncertainty from the process. A trusted advisor can help parents craft a plan to address their family’s higher education goals.

Park + Elm Investing Principle #6: Practice Smart Diversification

By | August 28th, 2018|Markets|

PRINCIPLE #6 IS HERE!

PRACTICE SMART DIVERSIFICATION!

Download the rest of our Ebook Here to get all 10 principles!!

It’s not enough to diversify by security. Deeper diversification involves geographic and asset class diversity. Holding a global portfolio helps to lower concentration in individual securities and increase diversification.

Over long periods of time, investors can benefit from consistent exposure in their portfolios to both US and non-US equities. While both asset classes offer the potential to earn positive expected returns in the long term, they may perform quite differently over shorter cycles. The performance of different countries and asset classes will vary over time, and there is no reliable evidence that performance can be predicted in advance. An approach to equity investing that uses the global opportunity set available to investors can provide both diversification benefits as well as potentially higher expected returns.

The global equity market is large and represents a world of investment opportunities. Nearly half of the investment opportunities in global equity markets lie outside the United States. Non US stocks including developed and emerging markets, account for 47% of world market cap and represent more than 10,000 companies in over 40 countries. A portfolio investing solely within the US would not be exposed to the performance of those markets.

However, when Americans talk about the stock market, they’re generally referring to the Standard & Poor’s 500 index or the Dow Jones industrial average. But these indices represent only one part of the available investing universe. The total U.S. stock market makes up only about 53% of global market capitalization. Yet, on average, U.S. mutual fund investors possess a home bias, with a disproportionate amount of their portfolio invested in the United States. If their portfolios were balanced according to world market capitalization, about half of their assets would reside in non-U.S. stocks. This “home bias” leads to less diversification, and as a result, greater volatility with lower returns.

It’s well know that concentrating in one stock exposes you to unnecessary risks, and diversifying can reduce the impact of any one company’s performance on your wealth. From year to year, you never know which markets will outperform, and attempting to identify future winners is a guessing game. Diversification improves the odds of holding the best performers, and by holding a globally diversified portfolio, investors are positioned to capture returns wherever they occur.

Put very simply, DIVERSIFICATION:

· Helps you capture what global markets offer

· Reduces risks that have no expected return

· May prevent you from missing opportunity

· Smooths out some of the bumps

· Helps take the guesswork out of investing

There is no single perfect portfolio. There are an infinite number of possibilities for allocation based on the needs and risk profile of each individual. The most important question investors should ask… “IS MY PORTFOLIO GLOBALLY DIVERSIFIED?”

Today’s Video: How Much Should You Save For Retirement?

By | August 17th, 2018|Markets|

So many investors search for the answer to this question! This video discusses important factors that can help you meet your goals – like determining your savings rate, monitoring your progress, and making adjustments over time.

CHECK IT OUT!!

Park + Elm Investing Principle #5: Consider the Drivers of Returns

By | August 8th, 2018|Markets|

dimensions

Principle #5 is HERE!

Consider the Drivers of Returns!

Download the rest of our Ebook Here to get all 10 principles!!

Throughout history, many of the greatest advancements in finance have come from Academia. Our investment philosophy has been shaped by decades of research by leading academics. We structure portfolios on the principles that markets are efficient; that returns are determined by asset allocation decisions, and that portfolios can be structured around dimensions of expected returns identified through academic research. It is through our strategic partnership with Dimensional Fund Advisors, a leading global investment firm that has been translating academic research into practical investment solutions since 1981, that we can pursue dimensions of higher expected returns through advanced portfolio design, management, and trading.
Much of what we have learned about expected returns in the equity and fixed income markets can be summarized in these dimensions.

  • Stocks have higher expected returns than bonds – it has been well documented over time that stocks outperform bonds, and that risk = reward
  • Among stocks, expected return differences are largely driven by company size – small companies have higher expected returns than large companies.

 

chart1

  • Relative price – low relative price “value” companies have higher expected returns than high relative price “growth companies.

chart2

  • Profitability – companies with high profitability have higher expected returns than companies with low profitability.

chart3

Since 1981, Dimensional has incorporated rigorous academic research on the capital markets into the design, management, and trading of clients’ portfolios. Some of the major milestones in academic research shown in the chart below have had a profound effect on our investment philosophy.

picture7

 

Our enduring philosophy and deep working relationships with Dimensional and the academic community underpin our approach to investing. Over a long period of time, Academics have been able to identify dimensions of higher expected returns, and with Dimensional, we can structure portfolios around these dimensions in a very cost-effective manner.

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