I came across an article in the Wall Street Journal earlier in the week detailing the performance of some key hedge funds as they deal with the bumpy ride the stock market has offered up lately. Amidst all of the volatility, some funds have scored impressive gains by having investments in traditional safe havens like gold and Treasuries.
Meanwhile, John Paulson's firm, Paulson & Co. has dealt with the opposite - severe underperformance to the tune of -31% at his Advantage Plus fund and -21.5% at his Advantage Fund. This serves to demonstrate how difficult it is to beat the markets, even for the experts. After all, Paulson was the fund manager who racked up very impressive gains during the mortgage market meltdown that lead to a person windfall upwards of $5 billion + dollars.
Thus, this news should give individual investors some comfort because many successful professionals who manage money for a living are having a very difficult time outperforming in such a weak environment. If the experts can't consistently outperform, why should you try to and even more importantly, why even try to pick managers who try to beat the market? Sometimes it takes a volatile market and large gyrations in stock prices to help reinforce key investing principles.
Saturday, August 13, 2011
Sunday, August 7, 2011
Change is Constant
If one thing is certain about the financial markets, it's that change is constant. We are likely to see many changes and new developments over the next few weeks, especially in light of S&P's downgrade of the United States' credit rating from AAA, the safest possible rating, to AA+, one notch below.
While we can't know of any of the changes that are likely to take place, it helps to have some perspective and take solace in the fact that in 2008, when things were much worse, we were able to recover from many major firms failing, or coming dangerously close to it including: Bear Stearns, Lehman Brothers, AIG, Washington Mutual, Wachovia, Merrill Lynch, Fannie Mae & Freddie Mac and many more. While much of the current crisis is centered on the shortcomings of policymakers in Washington, much of the blame can also be passed along to the Eurozone, whose financially secure members are forced to bear the burden - including potential bailouts - of those nations facing insolvency.
Going forward, it helps to look back on the 2008 financial crisis and realize that things are much better today than they were then. Ultimately, the United States rebounded strongly and was able to prosper in the wake of such difficulties; hopefully we are able to do much the same now.
While we can't know of any of the changes that are likely to take place, it helps to have some perspective and take solace in the fact that in 2008, when things were much worse, we were able to recover from many major firms failing, or coming dangerously close to it including: Bear Stearns, Lehman Brothers, AIG, Washington Mutual, Wachovia, Merrill Lynch, Fannie Mae & Freddie Mac and many more. While much of the current crisis is centered on the shortcomings of policymakers in Washington, much of the blame can also be passed along to the Eurozone, whose financially secure members are forced to bear the burden - including potential bailouts - of those nations facing insolvency.
Going forward, it helps to look back on the 2008 financial crisis and realize that things are much better today than they were then. Ultimately, the United States rebounded strongly and was able to prosper in the wake of such difficulties; hopefully we are able to do much the same now.
Saturday, July 30, 2011
You and the Debt Crisis
By and large, I have told readers that it's important to avoid paying too much attention to the headlines and instead employ a long-term approach when looking at investments and the financial markets. Our collective will in executing that has been shaken lately by dire news reports ticking down the hours and minutes to when the United States may potentially miss its first debt payment and in effect, will be considered in default on its financial obligations to its creditors.
While this news is indeed scary, it's not something that should shake your confidence too much for two reasons. First, if the market was taking such a prospect as seriously as the media makes it out to be, then the major market indices would have shed much more of their value in the weeks leading up to the August 2nd deadline. I look at it this way: based on the efficient market theory, everything that can be known about an investment or the market in general is already priced into it because of the speed and efficiency of information flow. Even the bond market, while under plenty of pressure given the uncertainty, has not seen the types of wholesale declines that would indicate a default was imminent.
Secondly, we must not kid ourselves. Lawmakers in Washington know how much is on the line and how disastrous a default would be, and while there has been much political grandstanding and theatre throughout the process, at the end of the day, a deal will be cut, especially if it means preserving re-election chances for many of the incumbents. Unfortunately, this is how Washington works and the media likes to capitalize on the uncertainty. Don't fall victim to the circumstances which don't seem that dire after all.
While this news is indeed scary, it's not something that should shake your confidence too much for two reasons. First, if the market was taking such a prospect as seriously as the media makes it out to be, then the major market indices would have shed much more of their value in the weeks leading up to the August 2nd deadline. I look at it this way: based on the efficient market theory, everything that can be known about an investment or the market in general is already priced into it because of the speed and efficiency of information flow. Even the bond market, while under plenty of pressure given the uncertainty, has not seen the types of wholesale declines that would indicate a default was imminent.
Secondly, we must not kid ourselves. Lawmakers in Washington know how much is on the line and how disastrous a default would be, and while there has been much political grandstanding and theatre throughout the process, at the end of the day, a deal will be cut, especially if it means preserving re-election chances for many of the incumbents. Unfortunately, this is how Washington works and the media likes to capitalize on the uncertainty. Don't fall victim to the circumstances which don't seem that dire after all.
Saturday, July 16, 2011
Weekend Reading: Gen Y's Conundrum
A July 11th blog post at the WSJ's "Real Time Economics" blog caught my eye as it noted that most of the income growth in the United States from 1975-2009 was achieved not through wage increases, but through overtime (i.e. working longer). This conclusion was reached by the Brookings Institution's Hamilton Project which noted the following:
"Although median wages for two-parent families have increased 23 percent since 1975, the evidence suggests that this is not the result of higher wages. Rather, these families are just working more. In 2009, for instance, the typical two-parent family worked 26 percent longer than the typical family in 1975."
This news is especially sobering for Generation Y for two reasons. First, since the data was taken from 1975-2009, it does not include the last year and a half of dismal unemployment data which further suggests that a recovery might take awhile to form. Since an extra year and a half of work data was not included, the results are likely even slightly worse than the 1975-2009 data indicates. Secondly, Michael Greenstone, the MIT economist who runs the Hamilton Project notes that, "The long-run decline in wage opportunities has put lots of pressure on families. People are adjusting, but they’re adjusting in ways that we might not like very much. All of that points away from a vision of the American dream where each generation is doing better than the last."
Unfortunately, that last line should serve as a wakeup call to Generation Y. While it's common to see each successive generation better off financially than the last - this new data suggests that such progress may skip our generation entirely.
As scary as that sounds, it simply means that as a generation, we need to alter our expectations, especially from an investing perspective. On this front, my number one recommendation to Gen Y investors is to use a 7% long-term average rate of a return in all investment calculations so as to avoid any type of unreasonable optimism and to build a cushion into all assumptions. The worst feeling in the world is building an investment plan that assumes a rate of return that is much higher than what actually happens. A 7% return is reasonable since the 10-11% long-term average rates of return that we used to see seem to be a thing of the past; now, more than ever, it's better to be safe than sorry!
"Although median wages for two-parent families have increased 23 percent since 1975, the evidence suggests that this is not the result of higher wages. Rather, these families are just working more. In 2009, for instance, the typical two-parent family worked 26 percent longer than the typical family in 1975."
This news is especially sobering for Generation Y for two reasons. First, since the data was taken from 1975-2009, it does not include the last year and a half of dismal unemployment data which further suggests that a recovery might take awhile to form. Since an extra year and a half of work data was not included, the results are likely even slightly worse than the 1975-2009 data indicates. Secondly, Michael Greenstone, the MIT economist who runs the Hamilton Project notes that, "The long-run decline in wage opportunities has put lots of pressure on families. People are adjusting, but they’re adjusting in ways that we might not like very much. All of that points away from a vision of the American dream where each generation is doing better than the last."
Unfortunately, that last line should serve as a wakeup call to Generation Y. While it's common to see each successive generation better off financially than the last - this new data suggests that such progress may skip our generation entirely.
As scary as that sounds, it simply means that as a generation, we need to alter our expectations, especially from an investing perspective. On this front, my number one recommendation to Gen Y investors is to use a 7% long-term average rate of a return in all investment calculations so as to avoid any type of unreasonable optimism and to build a cushion into all assumptions. The worst feeling in the world is building an investment plan that assumes a rate of return that is much higher than what actually happens. A 7% return is reasonable since the 10-11% long-term average rates of return that we used to see seem to be a thing of the past; now, more than ever, it's better to be safe than sorry!
Friday, July 8, 2011
Building Wealth Can Be a Slow Process
One of the toughest things for many Gen Y investors to accept is that building wealth is exactly what its name implies: a process, sometimes slow, that starts with something small and ultimately grows to something much bigger. Much of the time, we're put out of a touch with reality when we hear stories of instant wealth being "made" either by investors, company founders or the like.
This all highlights an important principle: it's easier to make money when you already have it. However, do not fret! Just because you're not starting off with a billion dollars does not mean that it's impossible to become wealth; just the opposite, in fact. Just because building wealth can be a slow process does not mean it's the wrong process. Being cautious but at the same time well-calculated, meaning you have an asset allocation that fits your tolerance for risk but also allows you enough flexibility to enjoy the here and now, will ultimately make you a better person and investor.
Many readers know that I like to use examples to illustrate why even though building wealth may seem "slow" it ultimately pays off. Consider an investor who begins with $5,000 at at age 22 and is able to earn a 7% return without adding any additional capital. Of course, 99.9% of investors reading this blog will actively add to their nest egg over time, but this example proves that even if our investor doesn't, the magic of compounding still works. After 40 years, our investor would have $74,872. Now, some people might ask what the point of investing and saving is if we can't enjoy today. My response is simple: give yourself enough flexibility to enjoy today - set aside a comfortable amount of discretionary income per month so you can go away on a trip, buy a new TV or do whatever else you'd like to do - and by investing the rest today, you'll ultimately ensure a much earlier retirement than age 62.
This all highlights an important principle: it's easier to make money when you already have it. However, do not fret! Just because you're not starting off with a billion dollars does not mean that it's impossible to become wealth; just the opposite, in fact. Just because building wealth can be a slow process does not mean it's the wrong process. Being cautious but at the same time well-calculated, meaning you have an asset allocation that fits your tolerance for risk but also allows you enough flexibility to enjoy the here and now, will ultimately make you a better person and investor.
Many readers know that I like to use examples to illustrate why even though building wealth may seem "slow" it ultimately pays off. Consider an investor who begins with $5,000 at at age 22 and is able to earn a 7% return without adding any additional capital. Of course, 99.9% of investors reading this blog will actively add to their nest egg over time, but this example proves that even if our investor doesn't, the magic of compounding still works. After 40 years, our investor would have $74,872. Now, some people might ask what the point of investing and saving is if we can't enjoy today. My response is simple: give yourself enough flexibility to enjoy today - set aside a comfortable amount of discretionary income per month so you can go away on a trip, buy a new TV or do whatever else you'd like to do - and by investing the rest today, you'll ultimately ensure a much earlier retirement than age 62.
Thursday, June 30, 2011
The "Best of Both Worlds"? - There's No Such Thing!
Every once in awhile I come across a personal finance article that offers up shockingly bad advice which, if followed, would do much greater harm to an investor’s situation than it would to help them. A recent Forbes article does just that in claiming that there is a way to have “the best of both worlds” between actively and passively managed investment strategies.
As a passionate indexing advocate, my interest was piqued. The strategy is presented as follows: rather than invest in international stock funds, simply buy 10-30 foreign stocks according to the weightings of your favorite international mutual fund. The writer sums up the strategy’s “benefits” - “by avoiding the high fees of an actively managed fund, investors who buy a diversified portfolio of individual stocks are getting much of the same low cost advantage as index fund investors.” In reading that, I was speechless. Why recommend a much more difficult and costly strategy when it’s already been stated that your goal is to replicate the low-cost strategy of the index fund? Why not just buy an index fund?
Not only is this bad advice for obvious reasons – assets are being spread too thin and high transaction costs eat away at returns (the strategy is by no means low cost), it goes completely against the tenet that investors should keep investing simple. How is this strategy “the best of both worlds” when it so obviously involves actively managing your portfolio? After all, the investor is picking both the fund to replicate and the stocks to own when managing their money.
Not only is this bad advice for obvious reasons – assets are being spread too thin and high transaction costs eat away at returns (the strategy is by no means low cost), it goes completely against the tenet that investors should keep investing simple. How is this strategy “the best of both worlds” when it so obviously involves actively managing your portfolio? After all, the investor is picking both the fund to replicate and the stocks to own when managing their money.
The writer even notes “owners of individual stocks also get the added advantage of being able to reduce their taxes by controlling when and how they sell individual shares. They can sell shares that have dropped in value, buy them back after 30 days, and then use the losses to offset other taxes.” Most of the individual investors I know have neither the time nor the patience to pull off such a bad strategy. Besides, indexing is inherently tax efficient which would negate any positive effect the above tax loss selling strategy would have over the low costs of indexing. Here’s a better idea then the one offered up in the article: buy an index fund and forget about everything else!
Ultimately, the article offers up no rational argument against indexing – the simplest and most efficient way to long-term wealth. Indeed, the article opens up explaining how indexers think:
Since you have no way of knowing which lucky manager will outperform, you're better off just buying the whole market and minimizing your fees with passive index funds. The evidence seems to largely bear this out as studies show that up to 80% of actively managed mutual funds underperform the market and that those that did outperform didn't tend to continue doing so over subsequent periods of time.
The facts are all laid out for the reader. I’m at a loss for why people still try to justify owning actively managed funds – or an investor’s replication of an actively managed fund - provided there’s a passively managed fund that is considered an equal or greater representation of a specific area of the market as compared to the actively managed fund.
Ultimately, the article offers up no rational argument against indexing – the simplest and most efficient way to long-term wealth. Indeed, the article opens up explaining how indexers think:
Since you have no way of knowing which lucky manager will outperform, you're better off just buying the whole market and minimizing your fees with passive index funds. The evidence seems to largely bear this out as studies show that up to 80% of actively managed mutual funds underperform the market and that those that did outperform didn't tend to continue doing so over subsequent periods of time.
The facts are all laid out for the reader. I’m at a loss for why people still try to justify owning actively managed funds – or an investor’s replication of an actively managed fund - provided there’s a passively managed fund that is considered an equal or greater representation of a specific area of the market as compared to the actively managed fund.
Thursday, June 16, 2011
A World Without Soothsayers
Dictionary.com defines a soothsayer as "a person who professes to foretell events." Another name for this type of person is a prognosticator or clairvoyant, and I can't help but think that Wall Street is becoming populated more and more with these types of people and less and less with people who actually know something. In short, Wall Street is trying to sell you something that they shouldn't: their predictive power.
The problem with Wall Street analysts and strategists making predictions and claims is that they're never held accountable. They are free to predict Dow 36,000, economic malaise, food lines and the like without any system of checks and balances. After all, why should they have one? The people making these predictions get paid to make them and for the most part, get to keep their jobs even if they're wrong. Just like your local weatherman may think but never openly admit, "we have met the enemy and he is us".
All of this leads me to the question - what would a world without market soothsayers be like? If Wall Street's hype and prediction machine collectively ceased to exist, would things run more efficiently? For one, dissemination of facts and true information could be acted upon without the potential for personal judgment to be clouded by the opinions of others. It may sound like a perfect world, one in which Wall Street and the media have no ability to impact your investments. Indeed, it is a perfect world for all investors - it is the world in which we simply ignore what Wall Street's prognosticators are saying and enjoy our lives.
The problem with Wall Street analysts and strategists making predictions and claims is that they're never held accountable. They are free to predict Dow 36,000, economic malaise, food lines and the like without any system of checks and balances. After all, why should they have one? The people making these predictions get paid to make them and for the most part, get to keep their jobs even if they're wrong. Just like your local weatherman may think but never openly admit, "we have met the enemy and he is us".
All of this leads me to the question - what would a world without market soothsayers be like? If Wall Street's hype and prediction machine collectively ceased to exist, would things run more efficiently? For one, dissemination of facts and true information could be acted upon without the potential for personal judgment to be clouded by the opinions of others. It may sound like a perfect world, one in which Wall Street and the media have no ability to impact your investments. Indeed, it is a perfect world for all investors - it is the world in which we simply ignore what Wall Street's prognosticators are saying and enjoy our lives.
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