China’s economy, the stock market and politics


(worried about investing?)

So far this year, checking your investment account balances could lead to an upset stomach, or worse. You are better off watching the historically unusual 2016 presidential campaigns. That way, you have enough to distract you from making a bad investment decision … even if Donald Trump or others upset your stomach.

What would a bad decision be? Here are several worries you may have, stated as “oh no,” along with a description of the potential bad investment decision:

“Oh no, stocks are too risky, I’m moving my money over bonds instead” – a.k.a., changing your portfolio allocation

If you (and your advisors) constructed a good long-term portfolio, then stick to the allocation in your portfolio. At present, the return on most bonds is less than the rate of inflation, after income taxes. The return on money markets is even less. So, unless you have amassed huge sums, you need the stock market returns to reach your financial goals.

That means you have to stay in stocks, and ride out the current downturn.

“But does that work?”

Let’s take the last big market dive of 2008 as an example. Measuring stock performance from 2008 through 2012, “the S&P 500 generated a cumulative return of 8.6 percent.”   See Went to Cash? Here’s the next Big Mistake You’ll Make.

Have you seen any bonds paying 8.6%?

“No.”

I didn’t think so.

True, there are alternate investments, such as hedge funds, precious metals, commodities and raw materials, which could perform better than bonds. However, each has different risks and expenses, and some of these have high barriers to entry. If any of these investments do belong in your portfolio, they are there to balance your other investments, which must still include stocks.

“Oh no, investing is too risky, I’m putting my savings in cash for now” – a.k.a., attempting to time the market

Pulling out of the market when it goes down and then putting all that cash back in just before it goes back up sounds great. However, the problem with market timing is no one can do it. Looking at 2008 through 2012, “If an investor missed the 36 percent drop in the S&P 500 in 2008 — or even worse, bailed on the markets mid-carnage — they probably also missed the 26 percent gain in the S&P 500 in 2009, and the next three positive years for the index that followed. See Went to Cash? Here’s the next Big Mistake You’ll Make.

So, you are thinking that 2008 to 2012 is an aberration.

“Yes, I still want to move to cash.”

 Then consider 1970 to 2016, where, if you missed just the best 25 days out of 11,620 trading days, “your returns would have gone from 1,910% to 371%, or [from] 6.7% a year to 3.4%. To give you an idea of how lousy that is, 1-month U.S. T-bills returned 4.9% over the same period.” See How missing out on 25 days in the stock market over 45 years costs you dearly.

The challenge of timing the market is capturing the best days. However, Nobel laureate William Sharpe “found that market timers must be right an incredible 82% of the time just to match the returns realized by buy-and-hold investors.” See Why you should stay in the stock market.

Are you that lucky?

“No.”

“Oh no, China is a total mess, this time is different, I’m am getting out of stocks forever” – a.k.a., attempting predict the future

True, the slowing of the Chinese economy is causing economic problems worldwide. But, in terms of the impact on stock markets worldwide, that is not dramatically different from the 1987 crash, only then it was Japan.

“Yes, but my friends are selling stocks …”

Did you know that the individual investor is a contrary indicator for the stock market?

“What does that mean?”

Historically, when individual investors are selling, that is a market low, a good time to invest. Similarly, when individual investors are putting everything into the stock market, that is a market peak and a time to sell the over-priced stocks.

By the time you realize that you are mistaken, you will have missed much needed performance. For emphasis, consider this:

From 1990 to 2005 a $10,000 investment would have grown to $51,354 had you just sat tight from beginning to end. However, if you had missed the best 10 days in that 15-year period, your returns would have dwindled to $31,994; if you had missed the best 30 days, you’d be looking at a mere $15,730. Why you should stay in the stock market.

Oh no, investing is too risky, I put my savings in cash” a.k.a., thinking short-term, another argument for going to cash

he stock market has to be risky, otherwise there would be no reward for investing.

“But I like cash!”

Cash is not volatile, but it is still “risky” – the return on cash – the interest earned – is less than the rate of inflation. Over time, investing only in cash puts you far behind, while long-term investing reduces the risks of stocks. The key is, you have to withstand the downturns to gain from the upturns:

A study by SEI Investments reviewed all the bear markets since World War II. According to the study, reported in The Wall Street Journal, stocks rose an average of 32.5% in the 12 months following the bear-market bottom. Yet, if you missed the bottom by just a week, that return fell to 24.3%. Waiting three months after the market turned cut your gain to less than 15%. Why you should stay in the stock market.

“Oh no, I need money to buy a house” – a.k.a., having the wrong investment strategy

What was your short-term investment doing in the market in the first place?

“I need my money to double so I can buy my dream house!”

Sorry, if you need that much then your dream is wrong.

For the stock market, anything less than 5 years is “short term.” If you have money set aside for a vacation, new car or other major purchase, like a house, those funds need to be invested more conservatively, taking less risk. Otherwise, while you could double your money in a couple of years, you could also end up with much less.

“Oh yes!” a.k.a., the conclusion, an important message – don’t forget it:

After watching investors for several decades, I know this to be true: you must create a good investment strategy and stick to it for it to work.

Even if do not have an optimum strategy, your investments will perform far better than someone who keeps altering their strategy.

“But the fund I have didn’t do as well as another fund last year, so I am selling ….”

Chasing after the last year’s star mutual fund usually works out poorly. You sell your current fund, paying fees and taxes, to buy the star fund, only to watch its performance return to the mean. Disappointed, you then sell the new star fund to chase another star performer, only repeat the same mistake with fees and taxes. After you repeat this a few times, you could end up with negative returns while someone who simply a bought and held a mediocre fund will have substantial gains.

If your investment strategy is better than mediocre, and it includes stocks, stick with it!

“Okay, I will.”

Good, the future you, sitting on a beach sipping drinks with paper umbrellas, will be so glad you did!

Faults of the Individual Investor to Avoid (Reasons for Impartial Advice)

Individual investors historically act as a contrary indicator. That is, looking at recent events, they assume that a market going up will continue to go up, or that a falling market will continue to fall. The individual investor fixates on the past, as if it will continue, rather than gauging the future. With this perspective, the behavior of the individual investor is to buy at the peak and sell at the trough, hence making them a contrary indicator to what will really occur. Countering this behavior takes substantial discipline, experience and information, and usually a good advisor.

A good advisor should add value through asset allocation and fund selection, but foremost by guiding you to counter bad investment behaviors. You need to stay invested when you fear a fall and sell when you are convinced of sure upswings. Advisors need to provide value-added guidance that will:
(1) avoid giving any serious weight to short-term indicators;
(2) avoid trying to pick “winners”;
(3) closely examine expenses, as high costs result in much lower net returns;
(4) investigate riskier classes as a component of a good overall asset allocation (e.g., emerging markets);
(5) look for funds that stick to their own goals, rather than trying to match any index, as such discipline pass off over time;
(6) take a contrarian view at times because too often a fund doing well at a given time will ultimately revert to the mean of all funds; and
(7) be clear with clients on the risks being taken (that is, measure the risks for say a bond differently than stocks).
All these are ways in which advisors increase the chance that you achieve good investment returns over time.

Recent history provides a good example. With the crash in 2008, we spoke to many clients and started a flow of e-mail updates and strategy suggestions. This became our newsletter on our web site. The key advice was that, if you have a good allocation, and good investments, stick to your long-term plan, do not sell. Those of our clients who followed the advice returned to their pre-crash peak values by last year, something none of us thought would be possible so soon. However, those that sold were selling as investments declined in value. Moreover, they had no clear signal in mind as to when to reinvest. That meant that most missed the rise of greater than 11% in the beginning of 2009. That upswing can never be regained. Therefore, they sold at a low point and were forced to buy back in at a higher point.

How could those that stayed invested be back to their peak when most indices have not returned to their all-time highs? A well-managed portfolio, employing good asset allocation, will not drop as much so it will have less to recover to be “whole.” Therefore, it could regain its peak value more easily, and with less risk. Again, this points to all that we have published before on the need for asset allocation analysis and diversification within each investment type as well as among investment types. It also makes clear how important not losing capital is: losing 50% requires a 100% gain to recover, while losing 25% takes only a 33% gain.

Good investing will lead you to avoid the behaviors that constitute what Carl Richards dubbed the “Behavior Gap” (April/May issue of Morningstar Advisor), meaning the gap between investment returns and investor returns. Simply opting for index funds is not a quick fix that works. Instead, individual investors require guidance. They can have the best possible investment approach “only to blow it up completely with one big behavioral mistake at the wrong time.” He goes on to write that all approaches are tested over time, so the advisor’s role is one of helping “rid the world of negative behavioral alpha, to close the Behavior Gap.”

In another article, he writes that “ … if 83% of mutual fund investors are getting advice from advisors and are doing poorly, maybe we advisors are part of the problem. (See First, Do No Harm by Carl Richards 02-10-11) To state the opposite side, “Still the trend seems clear. Investors who were inclined to invest for the long term were likely to have better returns. A look at how the markets have worked during the past 10 years illustrates why that is. We had two bear markets and two dramatic rallies. Those who sold equities in the bear market missed out on the rally and therefore nearly all would have been better off riding out the bear market.” (Inside the Vanguard Science Project Vanguard’s more-patient shareholders outperformed the rest. by Russel Kinnel 05-05-11)

Investors doing all the work with no advisors have access to good tools, such as E-Z Planner for retirement planning, but that can be dangerous. Again, the risk of bad input, generating bad outcomes, comes from the same issues of perspective and bad investment behavior. With an objective source to counter your own bias or “bad investment behavior,” this can be avoided. For example, in addition to the investment issues reviewed above, most individuals understate spending. “Oh, yes, we did buy [something] last year, but that was a one-time event.” Each year will have “one-time” events. Building a good plan takes some means by which tough questions like cash flow and investment risk are addressed. Otherwise, the best software will produce results with erroneous conclusions.

Conclusion
You need terrific discipline or good advice to resist psychology of risk aversion and the urge to use recent events as a gauge for what will occur next. Otherwise, your investor returns will fail to match investment returns over time.

Having said that, what is the Next Step:
First, review how your portfolio performed in recent times, did you react from fear and leave your strategy or hold on?
Second, review your portfolio; does it fit your risk tolerance and financial goals?
Third, take a second look at your portfolio, but from a contrary perspective; did your answer on risks match the actual investments made? (For example, someone claiming worry about the economy should not be 80% in US stocks.)
Finally, check to see if the portfolio, with any on-going savings, will be sufficient to achieve your financial goals. If you are not certain, then advice from an objective source could make a substantial, and very important, difference.

Need help? Contact us!

Year-end Tax Planning, Tax Credits, and all Continued

There are two parts to this e-mail – year-end moves for 2009 and planning for long-term capital gains rate changes over the next three years…..

First is a repetition of some year-end ideas to make sure you have addressed all that you should to save taxes, between 2009 and 2010 combined.

One idea to check out is the sales tax deduction for purchase of a large item like a new car, especially with all the sales on cars at year end. These and other ideas are reprinted from Kiplinger’s below, along with links to other articles.

Also, be careful about withholdings – some people had reductions early in 2009 and will end up owing taxes if they do not change the withholding rate now or pay an estimate

Remember to use the 2009 $13,000 gift exclusion before it expires.

Finally, you can adjust your withholdings the other way if you will have the benefit of the first-time home buyer credit or expanded tuition credit.

Second is a strategy on capital gains. As we said, this is a year for planning 2009, 2010 and 2011 taxes. The long-term capital gains rate will remain at 15% in 2010, but then the rate jumps back up to 20%. This argues for selling in 2009 or 2010 to increase the basis, buying back and then having less taxed in 2011 or later at the higher rates.

Reprinted below is a table from Wikipedia along with their description of the US Capital Gains Tax.

There are many issues raised in this Newsletter, so let me know if you have questions or comments.

Thanks,

Steven

Review Your Year-End Tax Plans

Making the right moves now can save you plenty.
By Mary Beth Franklin, Senior Editor, Kiplinger’s Personal Finance
November 17, 2009

The end of the year is fast approaching, but you can still take steps to lower your 2009 tax bill. Don’t focus just on this year, though. Look ahead to next year as well. That may help you decide whether you should take advantage of certain tax breaks due to expire at the end of this year, such as a sales-tax deduction when you buy a new car, or delay action so you can reap a tax break still available in 2010, such as claiming a tax credit of up to $1,500 for installing energy-efficient home improvements.

In general, it makes sense to accelerate as many deductible expenses into this year as possible to reduce the income that’s taxed on your 2009 return. But that’s not always the case. If you expect to be in a higher tax bracket next year, for example, you may be better off postponing some deductible expenses until 2010, when they will be worth more.

Those who itemize have plenty of leeway when it comes to shifting deductions. Start with state and local income taxes. Mail your January estimated payment in December and you can claim a deduction for the payment this year, not in 2010. (Warning: this doesn’t work if you’re subject to the alternative minimum tax. State taxes aren’t deducted under the AMT, so there’s no benefit in accelerating the payment.) Or, make your January 2010 home-mortgage payment before the end of this year and you can deduct the interest portion in 2009.

Accelerating charitable contributions planned for next year into this year will boost your itemized deductions. Just make sure your mail the check or charge the donation to your credit card by December 31 so the gift counts for 2009. And if you’re close to exceeding the threshold of 7.5% of adjusted gross income for medical expenses, consider getting and paying for elective procedures in 2009.

Sometimes you have to spend money to cash in on certain tax breaks, such as buying a first home or purchasing a new car. But pay close attention to income eligibility limits to make sure you’re able to capture these and other tax breaks. Some incentives, such as the home-energy tax credit, are not tied to your income.

In the coming weeks, we’ll be rolling out a new tax tip every weekday. You can sign up for outo have the best and latest tax information delivered right to your in-box.

Let us know if you have questions or comments. Thanks,

Steven

Lessons on portfolio construction and investment planning

The Morningstar article on mutual fund selection suggests that fund selection is not nearly as important as knowing your goals, picking your allocation appropriately and being aware of the lessons of history

You can expand this approach to selection of managers or narrow it to selection of specific stocks. Either way, the goal should drive the investment selection and you should have a strategy that fits.

If you want to discuss this more, let me know.

Thanks,

Steven

Two Things to Consider Before Picking Funds

by John Coumarianos | 01-05-10

Is a Morningstar mutual fund analyst really telling you that other issues are more important to consider than deciding which mutual fund to own? Yes.

Many investors spend too much time thinking about individual mutual funds and too little time thinking about more important investment questions such as their goals and overall asset allocation. Two such issues should take precedence over the consideration of specific funds. Only after you’ve addressed them should you begin thinking about which funds are appropriate.

Know Your Goal

Before coming to Morningstar I worked as a financial advisor, and I was amazed by how many clients just “wanted to make money” but couldn’t articulate a specific goal for the money they were investing.

My clients weren’t completely off base. Having and making more money is clearly better than having and making less, or losing money. But people have specific financial goals to meet. Some of the most common are paying for their kids’ college educations, owning a home, and providing for retirement. A simple desire to have and make more money without thinking about its specific purpose can get you into a heap of trouble.

A big challenge is that different goals require different time horizons. An area offering the potential for high gains can be the right choice in some cases but not others. In retrospect, a high-yield bond or emerging-markets fund clearly would have been great to own in 2009, as the Merrill Lynch High Yield Master II Index and the MSCI Emerging Markets Index have gained 57% and 77%, respectively, for the year to date through Dec. 28. But they wouldn’t have been appropriate places for money that an investor planned to use to buy a home in the middle of 2010 or for the entire allocation of Junior’s college fund, out of which the first tuition payment is due next September. Big near-term losses are just too common in these asset classes. For example, if one had to meet those goals in 2008 or early 2009, the results could have been catastrophic; those same indexes plummeted 26% and 53%, respectively, in 2008. And there was no guarantee that those asset classes would bounce back so well in 2009.

The appropriate place for money that you’ll spend within two years is in cash–a money-market fund or a certificate of deposit. For a time horizon of two to three years, you can consider a conservative short-term bond fund or an ultrashort bond fund. Anything else is too risky. Then you must be prepared to see the return on that investment lag many other choices. In fact, it’s virtually guaranteed that some asset class or sector funds will dramatically outperform that money-market account safeguarding next year’s tuition payment or down payment for a house. Learn to live with the fact that returns on short-term money may look weak next to alternatives.

In short, getting the best possible returns on that money isn’t the point; protecting it from loss is more important. Certainty comes at a price.

Understand Market History

Over the long haul, stocks have been better performers than money markets and short-term bond funds, but they’re no panacea. Knowing market history can help you build a successful long-term portfolio that neither overdoses on stocks nor avoids them altogether.

Stocks have returned about 10% annually for nearly a century, but they can go through extended periods of very poor performance. For example, the S&P 500 Index has posted a cumulative loss of 8% for this decade through Dec. 28, 2009, while the BarCap US Aggregate Bond Index has posted a more pleasing 85% return over that time. Additionally, stocks produced virtually no return from the period beginning in the mid-1960s through the early 1980s. Use this grim knowledge to set and temper your expectations.

The immediate future is unclear. It’s encouraging that stocks are not as expensive now as they were at the start of this decade, when many top companies were trading at P/E ratios of 30 or more. Still, it’s difficult to know whether the market’s current valuation is artificially inflated or depressed because it’s not clear if underlying corporate earnings are representative of future levels.

Because uncertainties like this almost always exist, Benjamin Graham thought a 50/50 stock/bond portfolio was a reasonable choice for most people’s long-term money. Vanguard founder Jack Bogle, by contrast, prefers the formula indicating that your stock exposure should be 100 minus your age. Others ratchet Bogle’s formula up to 110 minus your age for stock exposure. It doesn’t matter too much which of these you use but that you pick one and stay with it, rebalancing diligently as the markets take your prearranged allocation out of whack.

Knowing what stocks have returned over the longer haul, and knowing that they can disappoint over multidecade periods, can also help you keep saving appropriately. Don’t count on a roaring stock market to bail you out of not having saved enough for retirement or another major financial goal. Then, if the next decade for stocks turns out to be a great one, that will be icing on the cake.

John Coumarianos is a mutual fund analyst with Morningstar.

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Let us know if you have questions or comments. Thanks,

Steven

Investment questions as financial planning questions in disguise

Our goal is to help people make good decisions about their personal finances. And, as I say when I first meet a potential client, our best clients call saying “I am thinking of ….” while our toughest clients call saying “Guess what I just did…”

The article below from Morningstar emphases the need to do the analysis of your goals in order to make good financial decisions – in other words, getting advice and creating a financial plan that you implement over time, including answering investment decisions, especially in these tough times.

Contact us if we can help you with this

Steven

Planning Questions in Disguise

I spent last week answering questions for investors on the new Bucks Blog at The New York Times. It was an interesting reminder of the vital role of a real financial planner and the ongoing process of planning.

Almost every question I answered should have been answered by saying: “Find a real financial planner, tell them everything, and do what they say.” Of course, you can’t do that over and over because no one will listen to you, but boy, it was tempting.

This experience got me thinking about a couple of questions:

1. How can you make reasonable investment decisions without an overall plan?
2. How do you decide when or what to invest in without any context?

Can you imagine visiting the doctor and getting a prescription before a diagnosis (and feeling good about it)? Why do we expect anything different when it comes to investing?

I guess it is because people are confused about the goal. Finding the best investment is not the goal. Having the money to send your kids to college or retire on your own terms is a goal. If finding the best investment is the goal, you may not need a plan. Then, you are left with some really hard questions about market-timing and stock-picking. Good luck.

But if the goal is to reach your financial goals given a certain set of resources, then the questions of what investment or when, can only be made within the context of those goals. All this got me thinking about how many investing questions are really planning questions in disguise, and how many of these questions go away with a real planner involved.

Let us know if you have questions or comments. Thanks,

Steven