In this short video, Nobel laureate Eugene Fama discusses how financial markets work, what fuels innovation, and the upside and downside of risk.
For 20 years, we have utilized Dimensional Fund Advisors to facilitate intelligent product selection, and our philosophy parallels their approach of information based, efficient investing.
The Financial Times recently sat down with Dimensional Co-CEO and Chief Investment Officer Gerard O’Reilly. The interview covers O’Reilly’s path to Dimensional, his leadership alongside Co-CEO Dave Butler, and the firm’s research-based culture and approach to investing.
An interesting piece about one of DFA’s own, and his path to Dimensional. Read below or click HERE to go directly to Dimensional’s Web site.
The US stock market has delivered an average annual return of around 10% since 1926. But short-term results may vary, and in any given period stock returns can be positive, negative, or flat. When setting expectations, it’s helpful to see the range of outcomes experienced by investors historically. For example, how often have the stock market’s annual returns actually aligned with its long-term average?
Exhibit 1 shows calendar year returns for the S&P 500 Index since 1926. The shaded band marks the historical average of 10%, plus or minus 2 percentage points. The S&P 500 Index had a return within this range in only six of the past 93 calendar years. In most years, the index’s return was outside of the range—often above or below by a wide margin—with no obvious pattern. For investors, the data highlight the importance of looking beyond average returns and being aware of the range of potential outcomes.
Exhibit 1: S&P 500 Index Annual Returns
In US dollars. S&P data © S&P Dow Jones Indices LLC, a division of S&P Global. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Past performance is no guarantee of future results. Actual returns may be lower.
TUNING IN TO DIFFERENT FREQUENCIES
Despite the year-to-year volatility, investors can potentially increase their chances of having a positive outcome by maintaining a long-term focus. Exhibit 2 documents the historical frequency of positive returns over rolling periods of one, five, and 10 years in the US market. The data show that, while positive performance is never assured, investors’ odds improve over longer time horizons.
Exhibit 2: Frequency of Positive Returns in the S&P 500 Index
Overlapping Periods: 1926–2018
In US dollars. From January 1926–December 2018, there are 997 overlapping 10-year periods, 1,057 overlapping 5-year periods, and 1,105 overlapping 1-year periods. The first period starts in January 1926, the second period starts in February 1926, the third in March 1926, and so on. S&P data © S&P Dow Jones Indices LLC, a division of S&P Global. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Past performance is no guarantee of future results. Actual returns may be lower.
While some investors might find it easy to stay the course in years with above average returns, periods of disappointing results may test an investor’s faith in equity markets. Being aware of the range of potential outcomes can help investors remain disciplined, which in the long term can increase the odds of a successful investment experience. What can help investors endure the ups and downs? While there is no silver bullet, understanding how markets work and trusting market prices are good starting points. An asset allocation that aligns with personal risk tolerances and investment goals is also valuable. By thoughtfully considering these and other issues, investors may be better prepared to stay focused on their long-term goals during different market environments.
Click on the link below for a detailed analysis of quarterly performance of the global equity and fixed income markets.
A quick online search for “Dow rallies 500 points” yields a cascade of news stories with similar titles, as does a similar search for “Dow drops 500 points.”
These types of headlines may make little sense to some investors, given that a “point” for the Dow and what it means to an individual’s portfolio may be unclear. The potential for misunderstanding also exists among even experienced market participants, given that index levels have risen over time and potential emotional anchors, such as a 500-point move, do not have the same impact on performance as they used to. With this in mind, we examine what a point move in the Dow means and the impact it may have on an investment portfolio.
Impact of index construction
The Dow Jones Industrial Average was first calculated in 1896 and currently consists of 30 large cap US stocks. The Dow is a price-weighted index, which is different than more common market capitalization-weighted indices.
An example may help put this difference in weighting methodology in perspective. Consider two companies that have a total market capitalization of $1,000. Company A has 1,000 shares outstanding that trade at $1 each, and Company B has 100 shares outstanding that trade at $10 each. In a market capitalization-weighted index, both companies would have the same weight since their total market caps are the same. However, in a price-weighted index, Company B would have a larger weight due to its higher stock price. This means that changes in Company B’s stock would be more impactful to a price-weighted index than they would be to a market cap-weighted index.
The relative advantages and disadvantages of these methodologies are interesting topics themselves, but the main purpose of discussing the differences in this context is to point out that design choices can have an impact on index performance. Investors should be aware of this impact when comparing their own portfolios’ performance to that of an index.
Headlines vs. reality
Movements in the Dow are often communicated in units known as points, which signify the change in the index level. Investors should be cautious when interpreting headlines that reference point movements, as a move of, say, 500 points in either direction is less meaningful now than in the past largely because the overall index level is higher today than it was many years ago.
Exhibit 1 plots what a decline of this magnitude has meant in percentage terms over time. A 500-point drop in January 1985, when the Dow was near 1,300, equated to a nearly 39% loss. A 500-point drop in December 2003, when the Dow was near 10,000, meant a much smaller 5% decline in value. And a 500-point drop in early December 2018, when the Dow hovered near 25,000, resulted in a 2% loss.
Exhibit 1. Hypothetical 500-Point Decline of the Dow Measured in Percentage Terms
How does the dow relate to your portfolio?
While the Dow and other indices are frequently interpreted as indicators of broader stock market performance, the stocks composing these indices may not be representative of an investor’s total portfolio.
For context, the MSCI All Country World Investable Market Index (MSCI ACWI IMI) covers just over 8,700 large, mid, and small cap stocks in 23 developed and 24 emerging markets countries with a combined market cap of more than $50 trillion. The S&P 500 includes 505 large cap US stocks with approximately $23.8 trillion in combined market cap. The Dow is a collection of 30 large cap US stocks with a combined market cap of approximately $6.8 trillion.
Exhibit 2. Performance of MSCI ACWI IMI, S&P 500, and Dow by Calendar Year
Dow Jones and S&P 500 data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. MSCI data © MSCI 2019, all rights reserved. MSCI ACWI IMI is the MSCI All Country World Investable Market Index (net dividends). Their performance does not reflect fees and expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.
It is also important to note that some investors may be concerned about other asset classes besides stocks. Depending on investor needs, a diversified portfolio may include a mix of global stocks, bonds, commodities, and any number of other assets not represented in a stock index. A portfolio’s performance should always be evaluated within the context of an investor’s specific goals. Understanding how a personal portfolio compares to broadly published indices like the Dow can give investors context about how headlines apply to their own situation.
News headlines are often written to grab attention. A headline publicizing a 500-point move in the Dow may trigger an emotional response and, depending on the direction, sound either exciting or ominous enough to warrant reading the article. However, after digging further, we can see that the insights such headlines offer may be limited, especially if investors hold portfolios designed and managed daily to meet their individual goals, needs, and preferences in a broadly diversified and cost-effective manner.
Focusing on INCOME when investing for retirement, and following a strategy that addresses the RISKS that can affect your future income and standard of living is extremely important! Many are saving and investing to support future spending, but most are focused on a magic number, not the income that a that number can support. Ask yourself…
How much income should I expect my retirement savings to generate once I stop working? When thinking about retirement, understanding how much income you can expect makes planning easier, and having a clear picture of where you are today can help you make informed decisions that can influence your future.
THIS CALCULATOR is designed to help give you a sense of how much income your savings may provide in retirement based on several inputs and an assumed asset allocation that shifts over time.
If you would like to see how this calculator can fit within an overall retirement plan, please feel free to reach out to our office today!!
Investment fads are nothing new. When selecting strategies for their portfolios, investors are often tempted to seek out the latest and greatest investment opportunities. Over the years, these approaches have sought to capitalize on developments such as the perceived relative strength of particular geographic regions, technological changes in the economy, or the popularity of different natural resources. But long-term investors should be aware that letting short-term trends influence their investment approach may be counterproductive.
“There’s one robust new idea in finance that has
investment implications maybe every 10 or 15 years,
but there’s a marketing idea every week.” Nobel laureate Eugene Fama
What’s Hot Becomes What’s Not
Let’s look back at some investment fads over the decades:
1950’s – the “Nifty Fifty” (50 hot companies) were all the rage.
1960s – “go-go” stocks and funds piqued investor interest.
Late 20th century – emergence of a “new economy”
1990s – attention turned to the rising “Asian Tigers” of Hong Kong, Singapore, South Korea, and Taiwan.
2000’s – “BRIC” countries of Brazil, Russia, India, and China and their new place in global markets.
In the wake of the 2008 financial crisis – “Black Swan” funds, “tail-risk-hedging” strategies, and “liquid alternatives” abounded.
Recently – peer-to-peer lending, cryptocurrencies, and even cannabis cultivation
The Fund Graveyard
Unsurprisingly, however, numerous funds across the investment landscape were launched over the years only to subsequently close and fade from investor memory. While economic, demographic, technological, and environmental trends shape the world we live in, public markets aggregate a vast amount of dispersed information and drive it into security prices. Any individual trying to outguess the market by constantly trading in and out of what’s hot is competing against the extraordinary collective wisdom of millions of buyers and sellers around the world.
With the benefit of hindsight, it is easy to point out the fortune one could have amassed by making the right call on a specific industry, region, or individual security over a specific period. While these anecdotes can be entertaining, there is a wealth of compelling evidence that highlights the futility of attempting to identify mispricing in advance and profit from it.
It is important to remember that many investing fads, and indeed, most mutual funds, do not stand the test of time. A large proportion of funds fail to survive over the longer term. Of the 1,622 fixed income mutual funds in existence at the beginning of 2004, only 55% still existed at the end of 2018. Similarly, among equity mutual funds, only 51% of the 2,786 funds available to US-based investors at the beginning of 2004 endured.
What Am I Really Getting?
When confronted with choices about whether to add additional types of assets or strategies to a portfolio, it may be helpful to ask the following questions:
1. What is this strategy claiming to provide that is not already in my portfolio?
2. If it is not in my portfolio, can I reasonably expect that including it or focusing on it will increase expected returns, reduce expected volatility, or help me achieve my investment goal?
3. Am I comfortable with the range of potential outcomes?
If investors are left with doubts after asking any of these questions, it may be wise to use caution before proceeding. In addition, there is no shortage of things investors can do to help contribute to a better investment experience. Working closely with a financial advisor can help individual investors create a plan that fits their needs and risk tolerance. Pursuing a globally diversified approach; managing expenses, turnover, and taxes; and staying disciplined through market volatility can help improve investors’ chances of achieving their long-term financial goals.
Fashionable investment approaches will come and go, but investors should remember that a long-term, disciplined investment approach based on robust research and implementation may be the most reliable path to success in the global capital markets.
PRINCIPLE #9 IS HERE!
Look Beyond the Headlines!!
Download the rest of our Ebook Here to get all 10 principles!!
Daily market news and commentary can challenge your investment discipline. Some messages stir anxiety about the future while others tempt you to chase the latest investment fad. When tested, consider the source and maintain a long-term perspective.
Why doesn’t the media run more good news? Because bad news sells! It sells because fear is a more powerful emotion than greed. If people preferred good news, the media would supply it. Newspaper editors know it, which is why the front pages are often so depressing.
When the readers are investors, the danger can come when the emotions generated by bad news prompt them to make changes to their portfolios, unaware that the news is likely already built into market prices. For the individual investor seeking to make portfolio decisions based on news, this presents a real challenge. First, to profit from news you need to be ahead of the market. Second, you have to anticipate how the market will react. This does not sound like a particularly reliable investment strategy. Take, for instance, these headlines from the last presidential election:
Trump’s win turns stock market into shock market, CBS News
A Trump win means recession, stock market crash , CNBC
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 continued the rally for 2 years. From Trump’s election to Mid-term elections, the S&P 500 gained nearly 25%.
Take also the summer of 2015, when Greece was on a fast track to bankruptcy. Media around the world described the financial crisis to come in Greece, yet the following year, Greece was the #1 performing stock market in the world.
Conversely, what about those EXTREME jackpot prediction headlines:
Six Stocks to Kick Start Your Portfolio
Make Money in Any Market
12-Month Get Rich Plan
In early 2013, the Daily Mail in the UK carried the headline, “Gold Set to Shine Even More Brightly in 2013.” The rationale was that with investors scouring the world for “safe havens,” gold could reach as high as $2,500 an ounce by year end. As it turned out, gold suffered its biggest annual loss in three decades that year, with its spot price falling 28% in US dollar terms. From an all-time high of $1,920 in September 2011, gold fell to just over $1,200 by the end of 2013.
The notion that the path to long-term wealth lies in locating secret and previously undiscovered treasures in the global marketplace of securities is one regularly featured in media and market commentary. It’s a haphazard approach, reliant on chance and requiring a lot of work that is unlikely to be rewarded. Worse, it means taking unnecessary risks by tying one’s fortunes to a handful of securities or to one or two sectors.
A BETTER APPROACH
Luckily, there is better approach to investing. It involves working with the market and accepting that news is quickly built into prices. Those prices, which are forever changing, reflect the collective views of all market participants and reveal information about expected returns. So instead of trying to second-guess the market by predicting news, investors can use the information already reflected in prices to build diverse portfolios based on the dimensions that drive higher expected returns.
WHAT SHOULD YOU DO?
Sound investment boils down to a handful of principles – accepting that markets work, understanding that risk and return are related, diversifying, keeping costs low and maintaining a long-term perspective. You should turn off MSNBC and Mad Money and work with an Adviser to develop an investment strategy that fits YOUR financial goals for your family and retirement.
Click on the link below for a detailed analysis of quarterly performance of the global equity and fixed income 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.
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.
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.