Many investors have been educated on the broad investment themes to improve their investment experience and outcomes. Some of the most basic include asset allocation (this determines the vast majority of both the risk and return of your portfolio), broad asset class diversification to reduce the overall portfolio volatility, and more recently lower cost mutual funds to improve the probability of better investment results compared to higher cost funds.
One of the most common concerns that clouds an investor’s vision of a comfortable retirement with large account balances or plenty of asset class diversification with sufficient retirement income is the inevitable equity market downturn. It has been eight years since the U.S. equity markets have had a significant correction and investors should be reminded and prepared for the eventual decline that comes with equity investing. In fact, since 1929, there have been 25 bear markets (defined by a 20% loss or more). On average, that means a bear market occurs approximately once every 3.5 years. If history is any guide, most of us are going to experience several bear markets over our lifetime.
The future is uncertain and investing is often influenced by unexpected events, some good and others bad. Predicting when or how bad the next correction will be is futile but you can be prepared for it. Behavioral coaching is most effective when clients are prepared for the eventual ups and downs of the markets and prepared in advance of such unexpected events.
This is exactly when advisor behavioral coaching with clients is most important. Human emotion and fear can allow clients left to their own choices to abandon their financial plan and run for cover. Advisors use their past experiences to bring logic, patience and discipline back into focus for client conversations. Clients must realize and accept these downturns as part of the investment journey. The reward for accepting this truth is gigantic. Over the 87 years (from 1929 to 2016) that I quoted above, an investor who kept their money in the S&P 500 would have seen $1,000 grow to over $2.7 million. It is important to note, that to generate this return they would have experienced 25 bear markets, everyone different in their own right!
Saying you need to be prepared and actually experiencing the next downturn can be challenging. What can you do to prepare? Here are several ideas. First, recognize that market declines will happen. The sooner that you accept that you can’t control that piece of investing, the better you will be able to handle the short-term volatility when it occurs. Second, review your asset allocation model and be prepared to rebalance if certain asset classes are either overweight or underweight versus their target allocations. Third, think about how much money do you have saved in your “rainy day bucket”? Clients could consider these cash reserves as their “first source of funds” when markets correct so they can avoid selling assets as they are declining in value. Finally, maintain balance in your portfolios and life. Broad asset class diversification can help reduce volatility in your portfolios. As it relates to your day-to-day life, turn off the news, stop looking at the declining asset values on-line or statements and go on with your life and trust that markets will once again have better days.
On March 9, 2009 the S&P 500 hit a low of 667 (as I write this it is trading at 2365). It seems like an eternity ago, but I thought it would be fun to pull out the letter we sent to clients on February 26th of that year, just a week or so before the ultimate bottom. While reading the letter I am reminded of the carnage we felt all around us at the time. More importantly, I am proud of the way we counseled clients through the worst investment markets since the Great Depression.
Feel free to click on the link below to stroll down memory lane…
The author Malcolm Gladwell recently explored the idea of strong-link and weak-link networks in his podcast, Revisionist History. A strong-link network is when a few great people matter most to your success. A good example of this would be basketball. When you have LeBron James on your team, you don't need a whole lot of other superstars to be great. In fact, you could have a bunch of below average players on your team and still win the championship. A weak-link network is when an above-average group matters most. In keeping with the sports analogy, soccer is a great example of this. An above average team has a better chance of winning than a team with one superstar. The reason is that the entire team is essential to win the game. Lionel Messi is considered the best soccer player on the planet now, but it still may take 5 or more passes from his teammates to set him up to make a play. If you have below average teammates your success will be limited.
So what type of network is investing? Is it better to try to pick a few stocks with the hope of having one or two be huge gainers (strong-link network) or have an above-average type of portfolio with no superstars, but no disasters either (weak-link network)? We are of the belief that the weak-link network, by diversifying the portfolio using low-cost funds (not superstars but above average) is superior when it comes to investing. Here is our thinking:
- Losses are harder to recover from- if your portfolio goes down 50% then up by 50%, you are not back to even. You are down 25%. A weak-link strategy lessens the probability of major losses because of the diversification benefits.
- Loss aversion- a strong-link strategy would require major fortitude to see substantial portfolio volatility (since this strategy would be more concentrated). Loss aversion refers to an investor's tendency to prefer avoiding losses to acquiring equivalent gains. We believe most investors trying to pursue a strong-link strategy would have a higher tendency to bail out of their portfolio at the worst possible time.
- There is no evidence that strong network strategies would work- trying to pick a few great investments can work, but most evidence seems to suggest that positive results are more based on luck than skill. Luck is not an effective investment strategy.
- The odds are against you- research shows that picking individual stocks (a strong-link strategy) is a low probability approach. During their lifetime, 64% of stocks underperformed the Russell 3000. You have about a 1 in 3 chance of outperforming the overall market when you pick a stock. The weak-link strategy of owning the market gives you a higher probability of success.
Instead of trying to pick the next Apple, focus on a weak link-strategy. Make sure every part of your portfolio is above average. Maybe not the best, but above average. The way to ensure you have above average investments is to focus on low-cost, passive vehicles. Research tells us these investments won't be number one in their asset class, but they will be in the top third. This is a textbook weak-link strategy.
I literally cringed when I read this article on Bloomberg. I am not sure why our DNA hasn't adapted to fight against the greed that seems to totally blind us to the fact that when something is too good to be true, it is. The article tells the story of a hedge fund in Atlanta that has generated returns of 13, 24 and 91% since 2013. That's not all, as you read further you find this:
Meyer is so confident in his approach that he offers an extraordinary guarantee: With Arjun, you will never lose money. His price of admission is steep, however. Investors must hand over their cash for a decade. If they exit early, Meyer keeps half the principal.
If that isn't enough to make investors run, here are some more pieces of data:
- He has no employees
- A computer comes us with the trades, since he can't "manually do something like that"
- He's been through 3 auditing firms
- There are irregularities surrounding how much money they manage (anywhere from $39 million to $338 million)
- No one seems to be able to explain how he earns these returns
- He doesn't send audited financial statements to his investors
- He invests in treasury bonds, which are yielding almost nothing today
- Oh, last one…he's under investigation
But still, you have some of his investors making comments like this:
David Recknagel, a sales executive in Detroit, met Meyer when the money manager was doing consulting work. Recknagel says he invested in Arjun after losing confidence in big banks and money-management companies. He concedes he’s not sure how Meyer does what he does. “I understand it in general, but I probably don’t understand it completely,” Recknagel says.
One more quote from another investor:
Jeff Roberts, who runs a real-estate appraisal company in Asheville, North Carolina, says he met Meyer in 1989, while the two were at First Union. They became friends after Meyer, wearing jeans and a T-shirt, turned up one day in a Ford pickup to give Roberts a lift. A 12-pack of Budweiser rested on the front seat. Roberts says he’s invested several hundred thousand dollars and Meyer has been great.
“How many hedge-fund managers can you get to call you back? The guy that’s actually the investment officer or, you know, chairing the fund? It just doesn’t happen," Roberts says.
Roberts and Recknagel say they’ve also enjoyed a Statim perk: Meyer extends inexpensive short-term loans against their investments. Recknagel says he’s used the money to invest even more with Meyer. He says he also has a Statim corporate American Express card.
I truly hope that my instincts aren't validated, but I would venture to guess that this article could be the beginning of the end for this hedge fund. While it seems like common sense, here are some tips to make sure your investment advisor isn't running a scam:
- Make sure you fully understand the investment strategy your advisor is using with your money
- Check out your advisor on the SEC and FINRA websites- you can check to see if they have any disciplinary history
- If it sounds to good to be true, it is. There is no free lunch when it comes to investing.
- Make sure a third party custodian holds your money if you are working with an independent advisor. Using a Fidelity, Schwab or TD Ameritrade can prevent the outright fraud that can happen when an advisor commingles his client's assets
If it walks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck. For the investors in this hedge fund, I think they are going to find out the hard way.
The Presidential race is heating up and both sides are preparing for battle. Republicans and Democrats alike will tell you that if they don't win, the country will be in for a horrific four year stretch. The county's populace seems to be just as divided with politics as polarizing as ever. While conventions, stump speeches, and political scandals may be great for the news media, a recent study has come out confirming our long-held view: politics have no place in portfolios. Researchers studied the returns of hedge fund managers that supported Republican candidates after Obama was elected. The results weren't pretty:
Upon closer inspection using monthly regressions, we find that the Democratic managers outperformed the Republican managers from December 2008 to September 2009 by approximately 7 percentage points annualized return, which conversely is a high price paid by Republican managers and their clients to maintain a consistency of beliefs.
You may think if a certain candidate gets elected this country is going down the tubes. Hopefully, you continue reading this article, step back from the brink, and don't make any changes to your portfolio. None of this is meant to say that Republicans or Democrats are better for the economy (or as managers). What we are saying is that who is in office has very little impact on stock market returns. Studies have found this to be case, but investors still seem to entangle their political beliefs with their portfolio. One of the reasons given in the paper for the underperformance of the Republican hedge fund managers was the idea of cognitive dissonance. The Cognitive Dissonance Theory states that individuals tend to seek consistency among their beliefs and opinions (ask yourself what type of news you watch or articles your read). When inconsistencies between facts and attitudes don't match, our unconscious works to either change our beliefs or silence the facts.
When it comes to investing, it is best to ignore politics. In almost all cases, they have very little impact on financial markets.
Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.