Category Archives: risk

Once you sell out, when do you get back in?

I recently heard about a 62-year-old who was scared out of the market following the dot.com crash in 2000.  For the last 17 years his money has been in cash and CDs, earning a fraction of one percent.  Now, with the market reaching record highs, he wants to know if this is the right time to get back in.  Should he invest now or is it too late?

Here is what one advisor told him:

My first piece of advice to you is to fundamentally think about investing differently. Right now, it appears to me that you think of investing in terms of what you experience over a short period of time, say a few years. But investing is not about what returns we can generate in one, three, or even 10 years. It’s about what results we generate over 20+ years. What happens to your money within that 20-year period is sometimes exalting and sometimes downright scary. But frankly, that’s what investing is.

Real investing is about the long term, anything else is speculating.   If we constantly try to buy when the market is going up and going to cash when it goes down we playing a loser’s game.  It’s the classic mistake that people make.  It’s the reason that the average investor in a mutual fund does not get the same return as the fund does.   It leads to buying high and selling low.  No one can time the market consistently.  The only way to win is to stay the course.

But staying the course is psychologically difficult.  Emotions take over when we see our investments decline in value.  To avoid having our emotions control our actions we need a well-thought-out plan.   Knowing from the start that we can’t predict the short-term future, we need to know how much risk we are willing to take and stick to it.  Amateur investors generally lack the tools to do this properly.  This is where the real value is in working with a professional investment manager.

The most successful investors, in my view, are the ones who determine to establish a long-term plan and stick to it, through good times and bad. That means enduring down cycles like the dot com bust and the 2008 financial crisis, where you can sometimes see your portfolio decline.  But, it also means being invested during the recoveries, which have occurred in every instance! It means participating in the over 250%+ gains the S&P 500 has experience since the end of the financial crisis in March 2009.  

The answer to the question raised by the person who has been in cash since 2000 is to meet with a Registered Investment Advisor (RIA).  This is a fiduciary who is obligated to will evaluate his situation, his needs, his goals and his risk tolerance.  And RIA is someone who can prepare a financial plan that the client can agree to; one that he can follow into retirement and beyond.  By taking this step the investor will remove his emotions, fears and gut instincts from interfering with his financial future.

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Are you taking more risk than you should?

 

We often take risks without knowing it.  There are some risks that are well known; things like texting while driving or not fastening your seat belt.  But there are other risks that are less well publicized and that can hurt you.

As financial professionals we often meet people who are not aware of the financial risks they are taking.  While there are countless books written about investing, most people don’t bother studying the subject.  As a result, they get their information from articles in the press, advertising, or chatting with their friends.

Many people have told us they are “conservative” investors and then show us investments that have sky-high risks.  This is because investment risks are either hiding in the fine print or not provided at all.  No one tells you how much risk you are taking when you buy a stock, even of a major company like General Electric.  GE is a huge, diversified global company, yet lost 90% of its value between 2000 and 2009.  Norfolk Southern is another popular stock in this area.  Do you know its “risk number?”   You may be surprised.

We have analytical tools that can accurately quantify your risk tolerance and give you your personal “Risk Number.”  We can then measure the risk you are taking with your investments.  They should be similar.  If not, you may find yourself unpleasantly surprised if the investment you thought was “safe” loses its value because you took too much risk.

We have no objection to daredevils who know the risk they are taking by jumping over the Grand Canyon on a motorcycle.  But we would caution the weekend cyclist not to try the same thing.  Contact us to find your personal “Risk Number” and then determine how much risk there is in your portfolio.

 

 

 

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The Biggest Myth About Index Investing

Reader Mailbag: Dividend Investing vs Index Investing

John Bogle has done a great job of “selling” index investing.  He started the Vanguard group with the promise that you could invest in the stock market “on the cheap.”  It’s the thing that made the Vanguard group the second biggest fund family in the country.

Selling things based on price is always popular with the public.  It’s the key to the success of Wal Mart,  Amazon, and a lot of “Big Box” stores.

But Bogle based his sales pitch not just on price, but also the promise that if you bought his funds you would do better than if you bought his competition.  He cites statistics to show that the average mutual fund has under-performed the index, so why not buy the index?

The resulting popularity of index investing has had one big, unfortunate side-effect.  It has created the myth that they are safe.

A government employee planning to retire in the near future asked this question in a forum:

“I plan to rollover my 457 deferred compensation plan into Vanguard index funds upon retirement in a few months. I currently have 50% in Vanguard Small Cap Index Funds and 50% in Vanguard Mid Cap Index Funds and think that these are somewhat aggressive, safe, and low cost.”

The problem with the Vanguard sales pitch is that it’s worked too well.   The financial press has given index investing so much good press that people believe things about them that are not true.

Small and Mid-cap stock index funds are aggressive and low cost, but they are by no means “safe.”  For some reason, there is a widespread misconception that investing in a stock index fund like the Vanguard 500 index fund or its siblings is low risk.  It’s not.

But unless you get a copy of the prospectus and read it carefully, you have to bypass the emphasis on low cost before you get to this warning:

“An investment in the Fund could lose money over short or even long periods. You should expect the Fund’s share price and total return to fluctuate within a wide range.”

The fact is that investing in the stock market is never “safe.”  Not when you buy a stock or when you buy stock via an index fund.  There is no guarantee if any specific return.  In fact, there is no guarantee that you will get your money back.  Over the long term, investors in the stock market have done well if they stayed the course.  But humans have emotions.  They make bad decisions because of misconceptions and buy and sell based on greed and fear.

My concern about the soon-to-be-retired government employee is that he is going to invest all of his retirement nest-egg in high-risk funds while believing that they are “safe.”  He may believe that the past 8 years can be projected into the future.  The stock market has done well since the recovery began in 2009.  We are eventually going to get a “Bear Market” and when that happens the unlucky retiree may find that has retirement account has declined as much as 50% (as the market did in 2008).  At some point he will bail out and not know when to get back in, all because he was unaware of the risk he was taking.

Many professional investors use index funds as part of a well-designed diversified portfolio.  But there should be no misconception that index investing is “safe.”  Don’t be fooled by this myth.

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What does “diversification” mean?

 

Diversification is key - Wealth Foundations

To many retail investors “diversification” means owning a collection of stocks, bonds, mutual funds or Exchange Traded Funds (ETFs).  But that’s really not what diversification is all about.

What’s the big deal about diversification anyhow?

Diversification means that you are spreading the risk of loss by putting your investment assets in several different categories of investments.  Examples include stocks, bonds, money market instruments, commodities, and real estate.  Within each of these categories you can slice even finer.  For example, stocks can be classified as large cap (big companies), mid cap (medium sized companies), small cap (smaller companies), domestic (U.S. companies), and foreign (non-U.S. companies).

And within each of these categories you can look for industry diversification.  Many people lost their savings in 2000 when the “Tech Bubble” burst because they owned too many technology-oriented stocks.  Others lost big when the real estate market crashed in late 2007 because they focused too much of their portfolio in bank stocks.

The idea behind owning a variety of asset classes is that different asset classes will go in different directions independent of each other.  Theoretically, if one goes down, another may go up or hold it’s value.  There is a term for this: “correlation.”  Investment assets that have a high correlation tend to move in the same direction, those with a low correlation do not.  These assumptions do not always hold true, but they are true often enough that proper diversification is a valuable tool to control risk.

Many investors believe that if they own a number of different mutual funds they are diversified.  They are, of course, more diversified than someone who owns only a single stock.  But many funds own the same stocks.  We have to look within the fund, to the things they own, and their investment styles, to find out if your funds are merely duplicates of each other or if you are properly diversified.

You need to look at a “portfolio x-ray” which will show you how much overlap there is between two or more mutual funds.

Only by looking at your portfolio with this view of diversification can you determine if you are diversified or if you have accidentally concentrated your portfolio without realizing it.

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Piracy risk

Image Credits: nautilusint.org

Most of us are aware of the risks we take every day, but we ran across an interesting article recently that involved a risk we had not considered: being captured by pirates.

Believe it or not, in certain parts of the world, it’s happening.

Impoverished areas dotting the coasts of Nigeria, Somalia, Malaysia, Indonesia and the Philippines have been virtual breeding grounds for partially-organized collections of criminals seeking to steal, hijack, kidnap and murder their way to fortune.

We have seen news reports of pirates attacking oil tankers and holding them for ransom.  The peak of this occurred in 2011.  Since then, shippers have improved security, hired armed escorts and received military assistance.

 This modern era of the 21st century pirate is being successfully stunted, yet maritime kidnappings for ransom are on the rise. Although the number of pirate attacks is decreasing throughout the world, the number of kidnappings taking place during those attacks is increasing. Internationally, pirates kidnapped 62 persons in 2016, all of whom were or are still being held for ransom.

Pirates realized that it’s easier to capture people and spirit them away that to deal with ships that can’t be hidden.  People are smaller and pound-for-pound a great deal more valuable.  So we now have a new growth industry: Kidnap and Ransom (K&R) Insurance. If you are planning to travel to the pirate infested waters of Southeast Asia or off the coast of Africa you may want to check out the rates for K&R insurance.  For a premium you’ll get unlimited funding for a crisis response team whose sole mission is to get you safely home.

If you plan to take your yacht through the South China Sea or the Malaccan Straights this is something you may want to consider.

Meanwhile, in this part of the world, we’ll keep an eye on the risks with which we are more familiar: market fluctuations, tax changes, interest rate increases, economic trends and even those things we can’t foresee known as Black Swans.   Stay safe.

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New Years Resolutions for 2017

As another year winds to a close, we wanted to present you with some New Years resolutions designed to improve your financial health in the coming year.

  • Update your estate plan. Has there been a change in your family over the last year?  A marriage, a new baby, a death in the family?  If so, you need to update your estate plan, your insurance policies and your beneficiary designations.
  • Update your internet passwords. Are you using the internet to pay bills, shop, or access your investment accounts?  You will want to update your passwords and make them harder to guess.
  • Review your investments. Have you reviewed your portfolio recently?  Is it still aligned with your needs and goals?  If not, make some changes.
  • Get a personal “Risk Number.” Do you know how much risk you can take?  Most people don’t really know.  Resolve to get your personal “Risk Number“this year.  If you don’t know yours, click here to figure it out.
  • Get your portfolio’s “Risk Number.” Do you know how risky your investments are?  Most people don’t know how much risk they are taking.  Get your portfolio’s “Risk Number” and compare it to yours.  If it’s not the same, you need to consult your financial advisor.
  • Update your financial plan. If you don’t know where you’re going you probably won’t get there.  What’s your financial plan?  If you answered: “I don’t have one” resolve to get one this year.
  • Set your financial goals. Do you know how much you need to save to retire?  Here are some guidelines:

A 30-year-old can open a retirement account and make regular monthly contributions.  By investing properly and aiming for a modest 6% per year rate of return:

  • Saving just $200/month, by age 67 his account will have grown to nearly $350,000.
  • By saving $500 per month the account will be worth over $850,000.
  • Saving $1,000 per month will make our 30-year-old a millionaire by age 59.

 

If you have problems with any of these resolutions, you should definitely consider working with a financial advisor; someone who will be like a health coach for your personal finances.  Resolve to find one this year.

Think of the Advisor as your Sherpa, as it were, whose job it is to guide you amid the extreme altitudes and treacherous passes in investing’s hazardous terrain. That is to say, an Advisor is not someone you hire to beat the market for you, but rather someone who can help you achieve your personal financial objectives as “a facilitator, mentor, and market strategist” for those who, on their own, struggle to achieve their goals.

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A reader asks: what’s the difference between risk tolerance and risk capacity?

Korving -1016 RET web

That’s an interesting question and it depends on who you ask.  The investment industry measures risk in terms of volatility, taking the opportunity for both gains and losses into consideration.

I will answer with a focus on losses rather than gains because, for most people, risk implies the chance that they will lose money rather than make money.

 Risk tolerance is your emotional capacity to withstand losses without panicking.  For example, during the financial crisis of 2008 – 2009 people with a low or modest risk tolerance, who saw their investment portfolios decline by as much as 50% because they were heavily invested in stocks, sold out and did not recoup their losses when the stock market recovered.  Their risk tolerance was not aligned with the risk they were taking in their portfolio.  In many cases they were not aware of the risks they were taking because they had been lulled by the gains they had experienced in the prior years.

People who bought homes in the run-up to the real estate crash of 2008 were unaware of the risk they were taking because they believed that home prices would always go up.  When prices plunged they were left with properties that were worth less than the mortgage they owed.

This exposed them to the issue of risk capacity.

Risk capacity is your ability to absorb losses without affecting your lifestyle.  The wealthy have the capacity to lose thousands, millions, or even billions of dollars.  Jeff Bezos, founder of Amazon, recently lost $6 billion dollars in a few hours when his company’s stock dropped dramatically.  Despite this loss,  he was still worth over $56 billion.    His risk capacity is orders of magnitude greater than most people’s net worth.

The unlucky home buyer who bought a house at an inflated price using creative financing found out that the losses they faced exceeded their net worth.  As a result many people lost their homes and many declared bankruptcy.

There are some new tools available to measure your risk tolerance and determine how well your portfolio is aligned with your risk number.  Click HERE to get your risk number.

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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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Avoiding Tax Scams

Financial Advisor magazine ran an excellent article about a scam that is being run by people pretending to be IRS agents. One of these scams defrauded more than 5,000 people out of more than $25 million.  Here’s how one scam works:

Victims are told they owe money to the IRS and it must be paid promptly through a pre-loaded debit card or wire transfer. If the victim refuses to cooperate, they are then threatened with arrest, deportation or suspension of a business or driver’s license. In many cases, the caller becomes hostile and insulting.

Here’s what you must know: the IRS never solicits payments by phone or e-mail.  If they need information they will always write a letter first.  Do not respond to e-mails that appear to be from the IRS or an organization closely linked to the IRS, such as the Electronic Federal Tax Payment System.

There are a number of other frauds that involve taxes.  A thief may steal your identity and fraudulently file a tax return and claim a refund.  There are several ways to avoid this happening to you.  First, protect your identity by shredding all documents that contain personal information.  Second file early and electronically; electronic filing eliminates paper documents with sensitive information will not get stolen in the mail.

Beware of tax preparer fraud.  It is important to choose carefully when hiring an individual or firm to prepare your return. This year, the IRS wants to remind all taxpayers that they should use only preparers who sign the returns they prepare and enter their IRS Preparer Tax Identification Numbers (PTINs).

Beware of “Free Money” from the IRS or scams involving social security.

Flyers and advertisements for free money from the IRS, suggesting that the taxpayer can file a tax return with little or no documentation, have been appearing in community churches around the country. These schemes promise refunds to people who have little or no income and normally don’t have a tax filing requirement – and are also often spread by word of mouth as unsuspecting and well-intentioned people tell their friends and relatives.

 

We protect your identity and work hard to safeguard sensitive financial information.  It’s why we provide you with a password protected Lock Box when we send information such as performance reports to you electronically.

For more information, please contact us.

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A Reflection on Risk

The beginning of 2016 was, we are told, the worst first week of the year in the history of the stock market. How bad was it? The DJIA was down -6.13%. While there’s no denying that it was an incredibly unpleasant start to the year, in a broader sense the magnitude of the decline is not unprecedented when you consider that since 1997 we have had 6 single-day drops that have been larger than that. In fact, during our own investment career we’ve experienced much worse. Some of you will remember October 19th, 1987, the day that the market dropped 22.6%. In one day. Within 14 months of that day, the market had recouped all of its losses, and then went on to far greater heights (remember the bull markets of the 1990s?).

However, extreme market volatility usually causes people – especially those who have been complacent, or who have not paid attention to the amount of risk they are taking – to let emotion take over and cloud their thinking. The price of oil has plummeted in the last year, and while that has been great news at the pump, it has caused the majority of oil-related stocks to decline. Railroad stocks have come under pressure as coal shipments have declined. Technology stocks have been affected by a cutback in production of Apple phones.

We are not in the business of predicting the future. However, we will say that we have faith in the strength of free enterprise to overcome economic obstacles. We are in the business of creating diversified portfolios designed to reduce risk so that whatever market conditions we may face, we will be able to take advantage of market advances and cushion market declines.

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