Category Archives: S&P 500

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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Baby Boomers are Getting Richer

According to Bloomberg writer Ben Steverman, Baby Boomers – “part of the wealthiest generation in U.S. history” – just keep getting richer.   The Boomers started turning 65 in 2011 and since then the S&P 500 Index is up 91 percent.

That’s fortunate because the worst thing that can happen to a retiree is for his retirement investment portfolio to decline just as he retires and begins dipping into his savings.  If  the market declines as he retires, with no income to replenish his losses, the retiree find himself in a financial hole he may not be able to climb out of.

Older boomers have experienced what is arguably the best-case scenario: The S&P 500 has returned 269 percent since its March 2009 low. As a recent study in the Journal of Financial Planning shows, wealthy retirees can be very cautious about spending down their savings. This instinct, along with the stock market’s new record, suggests that many boomers are likely to end up with far more money than they know what to do with.

Researchers followed the spending and investing behavior of 65- to 70-year-olds from 2000 to 2008. The poorest 40 percent of the survey respondents generally spent more than they earned, according to the study, which was funded by Texas Tech University. Those in the middle were able to keep their spending at about 8 percent below what they could have safely spent from pensions, investments, and Social Security.

The wealthiest fifth, meanwhile, had a gap of as much as 53 percent between their spending and what they could have spent.

For individuals, broad statistical averages like these are not very useful.  As retirement looms, everyone should have a plan that will help them determine what happens if they get lucky and the market goes up, and what they can safely plan to spend if the market goes down.

Contact us for more information.

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Stocks, Bonds, Currencies and Commodities at the End of the First Quarter

Markets at a Glance

Major Stock Indexes

9:22 AM EDT 4/1/2016

Last Change % CHG
DJIA 17685.09 -31.57 -0.18%
Nasdaq 4869.85 0.55 0.01%
S&P 500 2059.74 -4.21 -0.20%
Russell 2000 1114.03 3.59 0.32%
Global Dow 2285.09 -29.76 -1.29%
Japan: Nikkei 225 16164.16 -594.51 -3.55%
Stoxx Europe 600 329.64 -7.90 -2.34%
UK: FTSE 100 6086.65 -88.25 -1.43%

Currencies

9:22 AM EDT 4/1/2016

last(mid) change
Euro (EUR/USD) 1.1379 -0.0002
Yen (USD/JPY) 112.04 -0.54
Pound (GBP/USD) 1.4210 -0.0150
Australia $ (AUD/USD) 0.7621 -0.0036
Swiss Franc (USD/CHF) 0.9607 -0.0010
WSJ Dollar Index 86.79 0.21

Futures

9:12 AM EDT 4/1/2016

last change % chg
Crude Oil 36.99 -1.35 -3.52%
Brent Crude 38.81 -1.52 -3.77%
Gold 1219.9 -15.7 -1.27%
Silver 14.980 -0.484 -3.13%
E-mini DJIA 17486 -109 -0.62%
E-mini S&P 500 2038.25 -13.25 -0.65%
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Global Stocks Lower After Brussels Explosions

Major Stock Indexes

4:09 PM EDT 3/22/2016

Last Change % CHG
DJIA 17582.57 -41.30 -0.23%
Nasdaq 4821.66 12.79 0.27%
S&P 500 2049.80 -1.80 -0.09%
Russell 2000 1096.95 -1.63 -0.15%
Global Dow 2315.94 -7.42 -0.32%
Japan: Nikkei 225 17048.55 323.74 1.94%
Stoxx Europe 600 340.30 -0.52 -0.15%
UK: FTSE 100 6192.74 8.16 0.13%

 

Currencies

4:09 PM EDT 3/22/2016

last(mid) change
Euro (EUR/USD) 1.1224 -0.0018
Yen (USD/JPY) 112.28 0.33
Pound (GBP/USD) 1.4214 -0.0154
Australia $ (AUD/USD) 0.7623 0.0045
Swiss Franc (USD/CHF) 0.9724 0.0025
WSJ Dollar Index 87.26 0.10

Futures

3:59 PM EDT 3/22/2016

last change % chg
Crude Oil 41.48 -0.04 -0.10%
Brent Crude 42.54 0.31 0.73%
Gold 1248.5 4.3 0.35%
Silver 15.895 0.048 0.30%
E-mini DJIA 17497 -31 -0.18%
E-mini S&P 500 2041.75 -1.00 -0.05%

Government Bonds

4:08 PM EDT 3/22/2016

price chg yield
U.S. 10 Year -6/32 1.939
German 10 Year 7/32 0.215
Japan 10 Year 3/32 -0.101
 
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At the close 3/3/2016

Major Stock Indexes

4:13 PM EST 3/3/2016

Last Change % CHG
DJIA 16943.90 44.58 0.26%
Nasdaq 4707.42 4.00 0.09%
S&P 500 1993.40 6.95 0.35%
Russell 2000 1075.96 10.28 0.96%
Global Dow 2241.14 22.44 1.01%
Japan: Nikkei 225 16960.16 213.61 1.28%
Stoxx Europe 600 339.42 -1.55 -0.45%
UK: FTSE 100 6130.46 -16.60 -0.27%
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Before the Bell: 2/26/2016 (Thursday’s Close)

 

Major Stock Indexes

9:15 AM EST 2/26/2016

Last Change % CHG
DJIA 16697.29 212.30 1.29%
Nasdaq 4582.20 39.60 0.87%
S&P 500 1951.70 21.90 1.13%
Russell 2000 1031.58 9.50 0.93%
Global Dow 2173.29 10.51 0.49%
Japan: Nikkei 225 16188.41 48.07 0.30%
Stoxx Europe 600 332.06 5.52 1.69%
UK: FTSE 100 6092.74 79.93 1.33%

 

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Bull and Bear Markets – A History

Following the “Great Recession” of 2008 not a day goes by without a prediction of another Bear Market. It’s often useful to remind ourselves of market history. While we need to remember that past performance is no guarantee of future results, we received the this fascinating chart which shows the historical performance of the S&P 500 stock market index since 1926. It’s quite dramatic.

Bull and Bear Markets

Bull and Bear markets follow each other.

What’s a Bear Market? It’s often defined as a drop of at least 20% from the previous high.

A Bull Market is measured from the point where the market stops dropping until it reaches a new peak.

What’s obvious from the chart is that historically, Bear Markets are relatively short and Bull Markets last a much longer time. A large part of this is driven by investor psychology. When markets begin to decline, the typical investor becomes concerned. As the value of their portfolio continues to go down they reach a point where fear of further losses forces them to sell. This selling contributes to a further decline. However, at some point all the fearful investors are out of the market. The decline stops, setting the stage for the next Bull Market.

  • The average Bull Market period lasted 8.8 years with an average cumulative total return of 461%.
  • The average Bear Market period lasted 1.3 years with an average cumulative loss of -41%.

Of course retirees on a fixed income have to be cautious because a major loss of retirement assets, even if a Bear Market is relatively short, can have a major impact on their lifestyle. For this reason it’s important to create portfolios that are going to participate in Bull Markets but are also robust enough to survive Bear Markets.

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3 Mistakes to Avoid

There are several common mistakes that many investors make when they view their investments.

  1. Comparing your investment results to the S&P 500.
    • This is the biggest error people make.  The returns you should be concerned about are those that you require to meet your objective.  Most people have some objectives that involves money.  It could be a certain level of income, a certain level of wealth, a specific home or other lifestyle objective.  But none of these are tied to a stock market index.  Everyone who wants to beat the S&P 500 as it goes up 50% must realize that they may well go down over 50% if there’s a repeat of 2008.
  2. Viewing the future through a rear view mirror.
    • Too often people will buy last year’s top stock pick or “Hot” mutual fund.  There’s a reason why prospectuses always say “past performance is no guarantee of future results.”  I vividly remember as the year 2000 approached and the Dot.com bubble was peaking.  Money was pouring into internet and tech stocks and delivering spectacular results.  But then the tech bubble burst and those who invested because they believed that those returns would continue lost their savings.  Since then we have seen other bubbles – including the real estate bubble – burst.   People lost their homes and their dreams.  It’s dangerous to view the future by looking backward.
  3. There’s no such thing as a free lunch.
    • If something looks too good to be true, find out what the catch is.  Some are simply scams by crooks who want to sell you worthless securities.  But there are investment products out there that seem to be too good to be true.  But that’s because the people selling these products don’t tell you the downside or won’t explain what can go wrong.  One example were the “structured notes” that were offered with a guarantee against loss.  The problem was that the guarantee was issued by a company that went bankrupt.  Insurance products are sometimes sold without sufficient explanation.

Quite often, the best thing that you can do is to ask the advice of an RIA, an experienced financial advisor, a fiduciary, who is can provide unbiased advice and has the knowledge and experience to know what to look for and what questions to ask.

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Markets rise as year-end approaches

We are approaching the end of 2014 with the markets at/near a record high. The market’s recovery since March of 2009 has now lasted nearly 5 years with only a few pullbacks. There has been some concern about the market’s rise as headlines bring reasons for concern. The American middle class does not seem to be benefitting from the less-than-robust economic recovery. The labor force participation rate has hit a 35 year low. Add to that a record national debt now over $18 trillion, unrest both here and abroad; there are a lot of things to worry about.

That is all true, but stocks are driven by corporate profits and profits are rising.

spprofits

It’s too easy to get distracted by “noise.” While the issues that get the headlines are important, they may have little or no impact on the price of any one stock or the direction of the market. And in the investment business, that’s what counts.

There is one issue that can create a problem for many investors. It’s the issue of “indexing” and relative performance. The S&P 500 index is the primary benchmark for many investors and portfolio managers. However, it can create a self-fulfilling prophesy because it is market weighted. That means that all 500 stocks are not treated equally. The larger the company, the more impact it has on the index. Consider that the 20 largest stocks in the S&P 500 are just 4% of the stocks in the index but about 30% of the weight of the index. That means that just a few stocks have an outsized influence on the index.

That’s fine when the price of these large companies go up. But when they begin to go down, people have the impression that all stocks are going down. This is not true. But since indexing has become so popular, the passive investors in the index funds will experience a great deal of financial pain if and when these over-valued stocks come back down to earth.

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