Category Archives: market timing

The most common investment mistake made by financial advisors

Bill Miller beat the S&P 500 index 15 years in a row as portfolio manager of Legg Mason Capital Management Value Trust (1991-2005), a record for diversified mutual fund managers.  He was interviewed by WealthManagement.com about active vs. passive management.

We have written a number of articles about the mistakes individual investors make.  But what about mistakes that financial advisors make?  We are, after all, fallible and make errors of judgment.  And like all mortals we cannot predict the future.

Here’s Bill Miller’s assessment about traps that financial advisors fall into:

One problem is how they deal with risk. There is a lot more action on perceived risks, exposing clients to risks they aren’t aware of. For example, since the financial crisis people have overweighted bonds and underweighted stocks. People react to market prices rather than understanding that’s a bad thing to do.

Most importantly, most advisors are too short-term oriented, because their clients are too short-term oriented. There’s a focus on market timing, and all of that is mostly useless. The equity market is all about time, not timing. It’s about staying at the table.

Think of the equity market like a casino, except you own it: You’re the house. You get an 8-9 percent annual return. Casinos operate on a lower margin than that and make money. Bad periods are to be expected. If anything, that’s when you want more tables.

We agree.  That’s one of the reasons we are choosy about the clients we accept. One of the foremost regrets we have is taking on clients who hired us for the wrong reasons.  One substantial client came to us as the tech market was heating up in the late 1990s.  He asked us to create a portfolio of tech stocks so that he could participate in the growth of that sector.  We accepted that challenge, but it was a mistake.  When the tech bubble burst and his portfolio went down and we lost a client.  But it taught us a valuable lesson: say no to clients who focus strictly on short-term portfolio performance.  Our role is to invest our clients’ serious money for long term goals.

Like Bill Miller, we want to have the odds on our side.  We want to be the “house,” not the gambler.  The first rule of making money is not to lose it.  The second rule is to always observe the first rule.

To determine client and portfolio risk we use sophisticated analytical programs for insight into prospective clients actual risk tolerance.  That allows us to match our portfolios to a client’s individual risk tolerance.  In times of market exuberance we remind our clients that trees don’t grow to the sky.  And in times of market declines we encourage our clients to stay the course, knowing that time in the market is more important than timing the market.

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What’s Your Risk Number?

risk

Defining how much risk someone is willing to take can be difficult.  But in the investment world it’s critical.

Fear of risk keeps a lot of people away from investing their money, leaving them at the mercy of the banks and the people at the Federal Reserve.  The Fed has kept interest rates near zero for years, hoping that low rates will cause a rebound in the economy.  The downside of this policy is that traditional savings methods (saving accounts, CDs, buy & hold Treasuries) yield almost no growth.

Investors who are unsure of their risk tolerance and those who completely misjudge it are never quite sure if they are properly invested.  Fearing losses, they may put too much of their funds into “safe” investments, passing up chances to grow their money at more reasonable rates.  Then, fearing that they’ll miss all the upside potential, they get back into more “risky” investments and wind up investing too aggressively.  Then when the markets pull back, they end up pulling the plug, selling at market bottoms, locking in horrible losses, and sitting out the next market recovery until the market “feels safe” again to reinvest near the top and repeating the cycle.

There is a new tool available that help people define their personal “risk number.”

What is your risk number?

Your risk number defines how much risk you are prepared to take by walking you through several market scenarios, asking you to select which scenarios you are more comfortable with.     Let’s say that you have a $100,000 portfolio and in one scenario it could decline to $80,000 in a Bear Market or grow to $130,000 in a Bull Market, in another scenario it could decline to $70,000 or grow to $140,000, and in the third scenario it could decline to $90,000 or grow to $110,000.  Based on your responses, to the various scenarios, the system will generate your risk number.

How can you use that information?

If you are already an investor, you can determine whether you are taking an appropriate level of risk in your portfolio.  If the risk in your portfolio is much greater than your risk number, you can adjust your portfolio to become more conservative.  On the other hand, if you are more risk tolerant and you find that your portfolio is invested too conservatively, you can make adjustments to become less conservative.

Finding your risk number allows you to align your portfolio with your risk tolerance and achieve your personal financial goals.

To find out what your risk number is, click here .

 

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When is the Next Recession?

One of our favorite market analysts, Brian Wesbury – who coined the term “Plow horse Economy” to describe the current economic situation – has been accused of being a “perma-bull” because he had discounted all the predictions of recession over the last 7 1/2 years.  We can understand why people are concerned about recessions because 2008 is still fresh in our minds.  The recovery that began in 2009 has been anemic.  Millions of people have not seen their financial situation improve.

Remember fears about adjustable-rate mortgage re-sets, or the looming wave of foreclosures that would lead to a double-dip recession? Remember the threat of widespread defaults on municipal debt? Remember the hyperinflation that was supposed to come from Quantitative Easing? Or how about the Fiscal Cliff, Sequester, or the federal government shutdown? Or the recession we were supposed to get from higher oil prices…and then from lower oil prices? How about the recession from the looming breakup of the Euro or Grexit or Brexit?

None of these things has brought on the oft-predicted recession.  Wesbury says that at some point a recession will come.  We have not reached the point where fiscal or economic policy has eliminated that possibility.  He mentions several indicators, including truck sales and “core” industrial production as indicators that should be watched.

Meanwhile,

Job growth continues at a healthy clip. Initial unemployment claims have averaged 261,000 over the past four weeks and have been below 300,000 for 80 straight weeks. Consumer debt payments are an unusually low share of income and consumers’ seriously delinquent debts are still dropping.   Wages are accelerating. Home building has risen the past few years even as the homeownership rate has declined, making room for plenty of growth in the years ahead.

Meanwhile, there haven’t been any huge shifts in government policy in the past two years. Yes, policy could be much better, but the pace of bad policies hasn’t shifted into overdrive lately.

In other words, our forecast remains as it has been the past several years, for more Plow Horse economic growth.   But you should never have any doubt that we are constantly on the lookout for something that can change our minds.

While the next recession may or may not be right around the corner, serious investors should be prepared for the eventuality so that when it does arrive, they will be ready.   We invite your inquiries.

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How a stock market slump affects retirees

Because retirees are no longer earning income, they view a decline in their investments with more concern than those who are still working.

Many savers in retirement also focus on a number that represents the peak value of their portfolio and view any decline from that value with concern.

Psychologists refer to this as the “anchoring effect.”

The unfortunate result of this is that it causes them to worry, leading to bad decisions. This includes selling some – or all – of their stock portfolio and raising cash. This makes it more difficult for their portfolios to regain its previous values, especially when the return on cash-equivalents like money market funds and CDs are at historic lows.

The answer to this dilemma is to create a well-balanced investment portfolio that can take advantage of growing markets and cushions the blow of declining markets.

This is often where an experienced financial advisor (RIA) can help. One who can create diversified portfolios and who can encourage the investor to stick with the plan in both up and down markets.

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What the tortoise knows about financial security.

Remember the race between the tortoise and the hare? The tortoise won because he kept plugging along while the hare took a nap. Everyone would like to get rich quick; it’s the reason that people buy lottery tickets. But the chances of actually striking it rich are astronomical.

The way to get financially well-off is within the reach of almost anyone, even people who start out poor. What it takes is following a few simple rules.

  • Avoid destructive behavior.
  • Get an education and acquire a skill.
  • Spend less than you earn.
  • Start saving early.

The temptation to parlay a small bundle of cash into a fortune is what gets most people into trouble. Consistent saving over time is much more likely to pay off than strategies such as timing the market. Risk-the-farm investing strategies have a high probability of failure, but saving and prudent investing always wins.

Getting rich slowly is the primary way that most people achieve their financial dreams. The advantage of saving 10% or more of your income cannot be overemphasized. Do that and then let compounding go to work for you.

Compounding does a lot of the heavy lifting for investors. But it needs time to work. That means starting the process as early as possible and staying with it as long as possible. Waiting until you’re in your 40s or 50s means that you have given up twenty to thirty years of financial growth that you will never get back.

Want to have a million dollars by the time you’re 65? If you begin when you’re 25 with $25,000, save $3000 a year and invest the money to get a 7% return you’ll have $1 million when you’re 65. Of course as you get older and make more money you’ll be able to increase your savings rate, and end up with more than a million.

Finally, control your emotions or – better yet – hire an investment manager who will help control your emotions for you. Markets don’t go in one direction forever and that’s a good thing to keep in mind when the inevitable correction happens. An investment portfolio that lets you sleep well at night helps to cushion the blow of a decline and avoid the temptation to “bail out” at exactly the wrong time. In fact, investing more when the market’s “on sale” is a way to increase your wealth.

This is New Year‘s Eve; 2016 starts at midnight. It’s a great time to start if you have not done so already.

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The Folly of Trying to Time the Market (Illustrated)

The problems of market timing came vividly to our attention recently. We were shown the portfolio of someone that was actively involved with their investments and reads a lot about investing strategies. This person managed their retirement portfolio quite actively, often making substantial changes to their account. When the stock market began to drop in August, they watched the value of their account decline. (See chart below)

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This person had about 80% of their account in stock funds up until Friday, August 21st. On that day the decline got to him and he sold all the stock funds. It turns out that this person sold out of stocks within two trading days of the market bottom. By the time they came to see us, their account was mostly in bonds.

Referring again to the chart, notice that as of October 28th the market actually had a positive return year to date. By trying to time the market, this investor locked in a loss and was wondering what to do now.

This investor made two mistakes. First, they thought they could time that market and get out when things were bad and buy back in when things were better. Timing the market is a term that is used when people buy or sell based on market gyrations, often trying to get in when they think it’s at a low point and get out when they think it’s at a high point. Some people get lucky and may do it once or twice but it’s simply not possible to do this consistently. The second mistake was that they had created portfolios that were out of line with their personal risk tolerance – they started out much too heavily in stocks and then swung too far in a conservative direction when the stock market went down and is now too heavily invested in bonds.

Most people will look at the value of their investments only occasionally. Some will do it daily; it is like a game to them. It’s also counter-productive. The secret to long-term investing success is to create a portfolio that is properly aligned with your personal risk tolerance and financial goals, so that you don’t have to get concerned with every market move. .

Not every stock market recovery is as V-shaped as the one illustrated in this chart. However, it’s a great illustration of the opportunities that are missed by trying to guess short term market moves. We believe in prudent investing for the long term and design portfolios that reflect the risk tolerance of our clients. If you are interested in a free consultation of your portfolio, contact us.

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Avoid Self-Destructive Investor Behavior

Charles Munger is Vice Chairman of Berkshire Hathaway.  Munger and Warren Buffett are viewed by many as the best investment team in the country.  He provided some excellent investment insight:

“A lot of people with high IQs are terrible investors because they’ve got terrible temperaments.  You need to keep raw emotions under control.”

Dalbar, Inc. has studied the returns of the average stock fund investor and compared it to the average stock fund.  Over the last 20 years investors sacrificed nearly half of their potential returns by making elementary mistakes such as:

  • Trying to time the market – thinking you can get out before a market decline and get back in when the market is down.  It never seems to work.
  • Chasing hot investments – from chasing internet stocks in the 1990s to real estate ten years later often leads to financial disaster.
  • Abandoning investment plans – if you have a strategy, and it’s sound, stick with it for the long term.
  • Avoiding out-of-favor areas – for some reason, people want bargains in the store but avoid them in the market.  Don’t be part of the herd.

Few amateur investors have the training or discipline that allows them to avoid these costly mistakes.  One of the most important services that a trusted investment manager can provide is to remain disciplined, stick with the plan, remember the goal and focus on the long term.

For more information about professional investment management visit Korving & Co.

Korving & Co. is a fee-only Registered Investment Advisor (RIA) offering unbiased investment advice.

Arie and Stephen Korving are CERTIFIED FINANCIAL PLANNER™ professionals.

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4 Reasons Why You Need a Good Financial Advisor Now

A good financial advisor has a number of roles: planner, investment manager, educator who is willing to teach you about investing, and sounding board with whom you can share your fears and aspirations.

Why is a Registered Investment Advisor (RIA), a fiduciary who puts your interests ahead of his own, so important now? People often get over-confident during a Bull Market. It’s when the market gets scary that financial professionals really prove their worth.

We have all heard the old sayings about being diversified, buy low and sell high, and stay the course. That’s often harder to do than it looks, especially in trying times such as these, when investor psychology overtakes reason. A financial advisor’s job sometimes involves protecting investors from themselves. And to protect them from all the bad advice that’s out there and from the bad actors in the industry.

  1. The first thing that a fiduciary does is tell their clients that despite what you hear, no one can time the market. There may be some people who are exceptionally good at stock picking, but those rare individuals are not giving away their advice to you on TV, in Money Magazine, or in newsletters; I don’t care what they claim. If they exist at all, they are managing their own portfolios on an island in the Caribbean.
  2. The retail financial services industry has an incentive to sell you expensive products as often as possible. And they are very good at it. Don’t get caught in the frequent trading trap; it’s not to your benefit. A fee-only RIA does not have an incentive to sell you investments to earn a commission.
  3. Investors typically allow their portfolios to get too risky during the good times. When the stock market is going up, it’s too easy to get caught up in the excitement and ignore asset allocation guidelines. A good investment manager will rebalance your portfolio regularly to keep you from running into a Bear Market with a portfolio overloaded with risky stocks.
  4. A fee-only RIA works for you. Stockbrokers, insurance agents, even mutual fund managers, work for the companies that pay them. They are legally required to work in the best interest of their employers, not their clients. Some of them do try to work in their clients’ best interests, but there can be large financial incentives to do otherwise. A fee-only RIA works only for you. We act in your best interest and use our expertise to allow you to take advantage of opportunities in good markets and weather the bad ones.

During volatile markets, we focus on the important things that really matter, not the daily chatter. We keep open lines of communication with our clients, helping them make sense of what’s going on, providing perspective, and helping them distinguish between what’s just noise and what’s a genuine trend. We work hard to control risk and manage portfolios to help our clients maintain confidence in their financial future.

If you want to receive our weekly commentary, view our latest guides, or get a free download of the first three chapters of our book “Before I Go”, or just find out about us, visit us at http://www.korvingco.com.

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On Recent Market Volatility. An Open Letter to Our Clients.

And you thought we saw volatility last Thursday and Friday?…

It is normal to for you to wonder how all of this volatility affects your wealth.  As we are hearing it, China seems to be the straw that broke the camel’s market’s back.  Other forces added to the weight, including uncertainty over the timing of the Fed raising interest rates and the Greek debacle.  However, we do not think that any of these things are cause for long-term concern regarding your portfolios.  If you are feeling some stress because of the recent market volatility, remember:

Stock markets are supposed to go up and down

There have been over a dozen market pullbacks of at least 5% since March 2009, so this isn’t unprecedented.  We all realize that stocks are inherently volatile investments, and we must accept the fact in order to earn the expected higher long-term returns.  You have all undoubtedly heard us preach asset allocation and the importance of having a long-term, strategic view.  Your portfolio is invested in a model based on your unique financial and personal circumstances.  It is important to take the long view and realize that it is typical for bull markets to have corrections of 5% – 10%.

Market timing is a sucker’s game

None of us has a crystal ball.  Not even the traders and speculators on TV that want you to think that they do.  Luckily, you do not need a crystal ball to be a successful investor.  In times like these, it is best to keep your cool and stay invested.  Studies consistently show that missing just a few days of strong returns can affect your performance dramatically.  It is important to stay disciplined and not make short-term trading decisions based on fear and emotion.

Your portfolios are properly diversified

This is our most important point.  As we mentioned, we have invested your money in an appropriate allocation for you, so those investments that have not done as well as the stock indices the past couple of years (looking at you, bonds) should help cushion the blow from this market correction.  That is exactly why they are in there.  Having a mix of different types of investments is like having shocks and struts on your car – these things provide a smoother and more stable ride for your portfolio.  When the stock markets are going great, these other investments do cause drag, but we do not invest to beat an arbitrary benchmark, rather we invest to help you achieve your financial goals with the least amount of risk possible.

The things that are causing this correction are just noise

China is slowing.  So what?  To say that their growth rate is slowing is admitting that they are still growing, just at a slower pace.  Did anyone really expect them to grow at 20% per year forever?  Moreover, if you look at it from a numbers perspective, exports to China only account for 0.7% of U.S. GDP.

The Yuan is falling.  Just a few months ago weren’t the talking heads lamenting the thought of the Chinese yuan as the world’s new reserve currency?  Now that talking heads who brought you that idea are being proven wrong, they want you to believe that this is supposed to be bad, too?  Which is it that we are supposed to fear again?  We wrote a blog piece about this last week, so we won’t go into great detail rehashing it here, but our general reaction is, again: So what?

The Fed is going to raise interest rates. (Eventually.)  It was not that long ago that tapering was supposed to bring financial ruin to us all…  Look, we all know that the Fed is eventually going to raise rates.  We can argue about the timing, but whenever it finally happens and the federal funds rate increases by 0.25%, does anyone really think that will keep Apple from introducing the latest re-iteration of their products?  Or keep anyone from buying them?

We realize that we have been having some fun with things that may cause some of you serious concern.  What we do not take lightly as your advisors and financial fiduciaries is the amount of concern and care we place on your financial well-being.  In times like these, it is important to stay calm and avoid making hasty decisions that could harm you financially.  We will continue to monitor your portfolios with vigilance, and as always, please do not hesitate to contact us if you have any questions or concerns.

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Successful and investing and emotional control

One of the big benefits of professional money management is “emotional control.”

Emotional control is the ability to control one’s emotions in times of stress. Napoleon once said that “The greatest general is he who makes the fewest mistakes.” There is a similarity between war and successful investing. Both require the ability to keep a cool head at times of high stress.

There is another old saying in the investment world: “Don’t confuse brains with a Bull Market.” When the market is going up, it’s easy to assume that you are making smart investment decisions. But your decisions may have nothing to do with your success; you may simply by riding the crest of a wave.

That’s when people become overconfident.

When the market stops going up, or the next Bear Market begins, the amateur investor allows fear to dominate his thinking. The typical investor tend to sell as the stock market reached its bottom. In fact, following the market bottom in early 2009, even as the stock market began to recover, investors continued to sell stock funds.  Since then the market has doubled.

Professional investors are not immune to emotion, but the good ones have developed investment models that allow them to ride through Bear Markets with moderate losses and ride the rebound up as the market recovers. It is that discipline that allows them to make fewer mistakes and, like Napoleon’s general, come out ahead.

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